Portugal Telecom Signs New MOU with Oi over Impending Merger

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The long awaited cross-country merger between Portugal Telecom SGPS S.A. (PT) and a leading Brazilian telecom operator Oi S.A. (OIBR) is nearing completion. On Oct 2, 2013, the two companies had reached an agreement to merge in order to strengthen Oi’s operations in Brazil and will also give Portugal telecom a strong foothold in the largest emerging market of Latin America. The joint venture will be known as “CorpCo.”

However, trouble broke out earlier this month. The issue was Portugal Telecom’s purchase of €897 million (approximately $1.22 billion) in debt (commercial papers) of Luxembourg banking giant Espirito Santo Financial Group’s RioForte Holding Company.

In the meantime, Espirito Santo declared serious financial problems cropping from its dubious investments in several businesses. Notably, Espirito Santo holds a 10% stake in Portugal Telecom.

Meanwhile, RioForte failed to repay its first portion of debt amounting €847 million (around $1.15 billion) to Portugal Telecom within the stipulated time. Accordingly, RioForte can be held a defaulter unless it restructures the whole debt within the next 7 days. The remaining €50 million of debt repayment is due today.

The impending merger deal of Portugal Telecom and Oi got disrupted once it was clear that Portugal Telecom had kept Oi in the dark regarding its disputed investments in RioForte. Oi has also raised serious concerns over Portugal Telecom’s corporate governance.

In such an unfavorable scenario, Portugal Telecom was compelled to sign new Memorandum of Understanding (:MOU) with Oi for the proposed merger. Per the new MOU, Portugal Telecom will hold just 25.6% stake of CorpCo instead of the previously agreed 39.6%.

In addition, the Portuguese telecom giant will also take back bad Espirito Santo debt earlier transferred to Oi and its affiliates. Further, Portugal Telecom in association with Oi will pursue legal proceedings against RioForte.

Brazil is the most lucrative emerging market in Latin America. At present, the country has around 2.2 million 4G LTE subscribers and its mobile broadband penetration rate is just about 42%, indicating vast opportunities for telecom operators.

We believe the combined Portugal Telecom-Oi entity will have the much needed scale and technical skill to compete with America Movil S.A.B. de CV (AMX) and Telefonica S.A. (TEF). Currently, Portugal Telecom carries a Zacks Rank #3 (Hold) whereas Oi has a Zacks Rank #4 (Sell).

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