RIO DE JANEIRO, Brazil – When Brazil privatized its dilapidated telecom system in July 1998, industry watchers hailed it as the country’s most significant privatization in three decades.
The Brazilian government had declared growth of the telecom sector integral to the development of its economy, the tenth largest in the world. And as the sixth most populous nation – with 155 million people – the country has had much to gain from its underdeveloped wireline infrastructure. So much so that investment in telecom in Brazil is projected to exceed $200 million by 2003, according to a study from the research firm Frost & Sullivan.
The telecom industry – telephony and convergence, wireless, cable, satellite and the Internet – has reached different stages of development from Mexico to Brazil and elsewhere in Latin America. But overall, telecom privatization across Latin America has been enormous, and private equity firms have been moving in to take advantage.
BancAmerica Equity Partners is in the process of setting up local offices in So Paulo and Buenos Aires to expand the firm’s existing investment base, a move that follows last year’s merger between Bank of America and Nationsbank. The firm’s portfolio companies include Mexico-based MaxCom, formerly known as Amaritel, which began operations earlier this year to compete with the country’s sole telephone provider, TelMex, S.A.
BancAmerica is MaxCom’s largest shareholder, investing $20 million in the company, said Jacques Gliksberg, managing director of BancAmerica’s Latin American group.
Cesar Baez, a partner with Dallas-based Hicks, Muse, Tate & Furst, said his firm also would focus on the Latin American telecom sector over the next 12 to 18 months as a follow-up to its $250 million investment in RCN, a United States-based fiber-optic cable company, that has successfully converged the Internet and cable television. The firm sees the region’s demand for telephone services growing faster than the telephone companies’ ability to supply them, Baez said.
Hicks Muse has a $1 billion Latin America buyout fund, some of which is allocated for media investments with Cisneros Group, Caracas. Both firms have substantial investments in Latin American wireless cable and satellite TV companies, most recently expanding to broadcast and radio.
Meanwhile, BellSouth Corp. already has announced plans to invest $200 million in preparation for competing local and long distance service in Argentina, where the state-run company EnTel ran the country’s telecom services until 1990. At the time of deregulation, the government sold 60% of the company to two international corporations, including Spain’s Telefonica and Telecom, a joint venture between two French companies. The government also plans to open this duopoly to competition at the end of the year.
Argentina, Venezuela, Peru and Brazil all are opening up to wider competition this year, said investors, who ultimately hope to capture the existing demand for telecom services more efficiently.
“A lot of people were going to public phones in the past and spending a fortune,” said Rahul Desai, director of the Latin American Group for Emerging Markets Partnership (EMP). More than one-third of EMP’s $1 billion AIG-GE Capital Latin American Infrastructure Fund is invested in telecom.
“Hungary has twice as many fixed lines as Mexico with the same level of development,” he added. “This is what makes telecom throughout Latin America so compelling.”
Supply and Demand
And privatization in some cases has cut costs to more than half of what they were before. In Brazil, for example, a cellular phone line costs about $300, a dramatic drop from its previous $700 price tag.
Moreover, an analyst who follows the country’s developing telecom sector predicts 71% growth in cellular phone usage in 1999, with compounded growth of 35% over the next three years. Fixed telephone lines are expected to grow by 24% this year and have 17% compounded growth over the next three years.
EMP developed its first telecom project two years ago in Mexico with Axtel (formerly Telenor) and the company is set to provide fixed wireless local service in Mexico to compete with Telmex.
“The initial demand in Monterey [Mexico] has been much higher than we expected,” Desai said. “Before starting service in Mexico City and Guadalajara by the end of the year, we’re redesigning the networks for higher capacity.” EMP also invested in Pegaso in Mexico, a PCS mobile wireless provider, and in cable television in Brazil.
Desai said the latter was a new company that participated in auctions for cable TV licenses at the end of 1998.
“Cable is a very underdeveloped industry in Brazil,” Desai said. “It’s the last country with major cities without cable service. We’re in the process of designing the initial networks.” There also are plans in October to expand to Niteroi, across the bay in Rio, and eventually to Salvador and Recife, Brazil’s fourth largest city.
A Growing Sector
Meanwhile, “There are a number of technologies, such as fixed wireless, DSL, and the increase in bandwidth to the customer that are causing the industry to evolve in ways it has never experienced before,” said Andrew Sheiner, a partner at Onex, Canada’s largest private equity firm with $4 billion under capital, which recently held a $400 million close on Gramercy Capital Partners, one of the biggest private equity funds dedicated to telecom. The vehicle has a target of at least $1 billion and is a partnership between Onex, Telefonica and a management team led by Larry Grafstein, who until recently headed the global mergers and acquisitions practice for First Boston, Sheiner explained. “We wanted to establish a dedicated fund of capital managed by a communications-experienced management team,” he said.
Significantly, although the fund’s focus is North America, Sheiner said it will take advantage of deals throughout Latin America through Telefonica, Spain’s largest telephone company and a major player in Latin American telecom. Officials at Telefonica could not be reached for comment.
“The opportunities for investment are with the improving demographics of the entire region,” said Grafstein, managing director of Gramercy Capital, adding that demand is driven by the advent of the Internet and deregulation. “Latin America is a beneficiary of both trends.”
For example, according to a report from the Santiago Chamber of Commerce, telecom has been the most dynamic sector of the Chilean economy. Its average annual growth rate of 14% since its privatization in 1989 has also made it one of the fastest growing sectors.
Likewise in Venezuela, where the market for telecom services is the fastest growing sector of that country’s economy. In 1997, telecom represented 3.5% of the country’s GDP, a number that is expected to double by next year.
The situation in Latin America resembles the crumbling of the U.S. telephone monopoly in the early 1980s, when the government dissolved AT&T’s grip on the telephone market by opening it to competition. As a result, a one-minute call from New York to Miami now costs nine cents a minute rather than 59 cents. (AT&T’s major competitor, MCI, purchased the Brazilian long-distance carrier, Embratel, at an auction last year.)
“We believe what’s happened in the States’ telecom activities will be reflected in Latin America over time,” said Everett Santos, CEO of Latin American Group, EMP.
Telecom growth across the region is taking place “much faster than the general economies,” Desai said. For example, “Venezuela was in a recession last year, but the cellular market grew at huge rates, because [Latin America] is so behind in terms of penetration.”
BancAmerica’s Gliksberg agrees that despite the sector’s huge growth over the last few years, the level of pent up demand remains high. Pre-paid cellular and PCS sytems are driving growth in Latin American telecom because the region has suffered from a generational skip in technology. With underdeveloped copper telephone line systems, particularly throughout the interior of Central and South America, some companies have jumped directly to satellite and other wireless technologies.
Despite telecom’s potential, however, regulations are complicated. Unlike the United States, which has the Federal Communications Commission (FCC) already in place, regulatory mechanisms are only beginning to emerge in Latin America. Demands on such things as interconnection fees “can make or break a project,” Desai said. “So sometimes even with good intentions [governments] don’t do the right thing on time.”
Add to this the overall difficult atmosphere for fund raising in Latin America and “activity has slowed down dramatically,” Gliksberg said. In addition, most private equity investors agree the importance of developing strong local partners is more crucial than ever.
However, in a region notorious for next to impossible exits, telecom companies have two advantages: the ease of holding an initial public offering in a receptive global market and, alternatively, the appetite of several global corporations willing to acquire them.
“From an exit standpoint, telecom is one of the most attractive industries in the world,” Desai said.