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Investing in Brazil: TIM Participações

Naeem Iqbal

Nato Jangirashvili

Aaron Lichtschein

Fayaz Meher

Faiz Sabbiruzzaman

_____________________

International Financial Markets

Professor Kishore Tandon

Spring Semester 2016

May 23rd, 2016

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EXECUTIVE SUMMARY   3  

COUNTRY OVERVIEW: INVESTING IN BRAZIL   4  

Social Aspects   4  

Political Aspects   5  

Macroeconomic Perspective   7  

Microeconomic Perspective   11  

Financial Changes In Brazil Within The Last 5-7 Years   13  

Industrial Changes Within The Last 5-7 Years Of Economic Growth   15  

COUNTRY OVERVIEW: TIM PARTICIPAÇÕES   17  

Brazil Telecom Industry Overview   17  

TIM Participações Company Overview   18  

Investment Rationale   19  

Financial Valuation   22  

Risks/Mitigants   23  

Conclusion   25  

WORKS CITED   26  

 

 

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Executive Summary Investing in emerging markets is always a daunting task. However, Brazil is a country

with promise and potential. It is a country with a huge, young population. Though still amid

heavy political and social reform (after being ruled as a military dictatorship for many years), the

Brazilian private sector is strong and growing. Consistent economic growth and great potential

for future thriving given its young population render Brazil a strong investment opportunity. This

is particularly true for the Brazilian telecommunication company,  TIM Participações. As nearly

100% of the Brazilians use mobile phones and invest heavily in the data-plans they have, the

telecommunications sector is an alluring one to invest in. TIM Participações is well positioned

within this prospering industry and is primed to continue thriving within it. Crucially, our

financial metrics directly illustrate that the company is implicitly undervalued. Ultimately, as

will be expounded upon in this report, it is the belief of this investment team that Brazil is a

smart country to invest in at this juncture of time and TIM Participações is a promising Brazilian

company to investment in.

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Country Overview: Investing in Brazil

Social Aspects Brazil is the largest country in Latin America both geographically speaking, as well as in

population size. As of 2014, the population of the country was 206.1 million (the fifth largest

population size in the world) and of this, almost 90% were Christians ("Brazil - Pew-Templeton

Global Religious Futures Project”). In spite of this almost exclusive presence of Christians,

according to a Pew study, Brazil has the highest level of religious freedom among the 26 most

populous countries, including the USA ("WorldWide Religious News"). The majority of

Brazilians (30%) are in the 15-29-age range and generally embrace the religious-culture of their

forebearers (Ibid). In terms of geographic breakdown, Brazil has extreme regional differences in

its rich South and Southeast and its fledgling North and Northeast regarding nutrition, health,

infant mortality, in addition to overall wealth. Ultimately, the country is rife with a young,

vibrant population that spans the country’s vast territory.

A social analysis of Brazil would be misleading and ill-informed if it did not start off by

mentioning the country’s severe inequality in terms of wealth and overall quality of life. The

disparity in income in the country is the second highest in Latin America and nefariously affects

the lives of the downtrodden class. The country had a Gini Index (an internationally recognized

index of income distribution) measurement of 52.7 as of 2012 (as recent as the data gets) and this

is startlingly high (Dalberis). In the same vein, Brazil also falls prey to corruption of business

leaders and politicians. In fact, Brazilians took to the streets in late 2014 to protest such

corruption that manifested itself in the large paydays the construction companies building the

infrastructure for the 2014 World Cup received, while such money was not being directed to the

masses suffering from the large income disparity. Civilians also took to the streets in 2015 to

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protest a kickback scandal that involved Petrobras (the large state-run Brazilian oil company)

and President Dilma Rousseff. Brazil is also racked with a large crime problem and drug trade.

In fact, the country is currently the world’s second largest market for cocaine and its derivatives,

trailing behind the United States (Ibid). These issues persist and are perhaps either a byproduct or

a cause of the large wealth gap and lack of upward mobility apparent in the society.

It is important to note that Brazil has not sat idly by and let these issues metastasize.

Rather, it has asserted itself as an innovator in terms of combating such problems through the

social initiatives it has undertaken. Perhaps most notably, Brazil is home to the innovative social

program, Bolsa Familia, a social welfare program which provides minimum income individuals

with financial aid, free education and more (Matijascic, Kay). In the same vein, Brazil provides

free AIDS medicine to those inflicted with the disease and is adamant on the need to provide aid

and quality healthcare to those of its population that live in more far-flung, isolated regions

(Ibid). Additionally, as indicated in International Social Security Review’s 2014 assessment of

Brazil, the country is unwavering on the right of all people to have education, pension coverage

and healthcare. In fact, these three are “Universal rights and state obligations” according to the

Brazilian Constitution and are touchstone factors for the Brazilian people.

Political Aspects

For decades, Brazil functioned as a military dictatorship. The country had its first

democratic political election in 1989, causing a number of political parties to spring up, many of

which still exist to this day. The main parties include the Brazilian Democratic Movement Party

(PMDB), the Liberal Front Party (PLF) and the Brazilian Social Democracy Party (PSBD).

Three branches of government run Brazil: the legislative branch, judicial branch, and executive

branch. The legislative power flows through the two-chambered National Congress made up of

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the Chamber of Deputies (made up of 513 members) and the National Congress (made up of 81

members). The judicial power flows through the Supreme Federal Tribunal, which features

lifetime judges. The executive power flows through the president, who is elected every four

years by direct ballot. The government has a very hands-on role in the Brazilian economy,

controlling crucial sectors such as oil and natural gases, telecommunications and more ("Brazil -

Politics, Government, and Taxation").

In the present moment, Brazil is experiencing absolute disarray and upheaval in their

political system. President Dilma Rousseff is facing impeachment charges and the very real

possibility that she may soon be without a job. The impeachment charges stem from two alleged

major corruptions on the part of Rousseff and her government. Firstly, there is the allegation that

Rousseff was not forthright about the true nature of Brazil’s deficit problem during her run for

reelection in 2014 and covered up the problems by using funds from state banks to cover up the

budget gaps, a practice viewed by Brazil Congressional leaders as not only “Improper,

but...[also] illegal” (Romero,"Dilma Rousseff”). As explained further by New York Times, this

illicit move has lasting negative ramifications on the country as, “The moved [may have] eroded

confidence in the government’s accounting practices and made it more expensive for the state to

borrow money” (Ibid). This scandal would be a large stain on any government and yet it is the

least of the Brazilian Leader’s problems.

President Rousseff has additionally drawn enormous criticism for her alleged presiding

over the huge corruption scandal of Petrobras, the national oil company. The corruption scheme

took place between 2010 and 2014 and was of mammoth proportions, comprised of over $5

billion changing hands illicitly. The corruption was that construction executives came together to

coordinate bids on Petrobras contracts, in order to charge the company more than was

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appropriate. This excess money charged was in turn paid back to the executives, as well as to

Brazil’s major political players and higher-ups at Petrobras (Romero, "Insider’s Account”).

To date, over 40 business-moguls, politicians and executives have been arrested for the

scandal and many more arrests are expected to still come. Although Rousseff herself has not

been implicated for any wrongdoing pertaining to the matter, she resided on the Petrobras board

as a chairwoman from 2010 to 2013, a period in which the corruption was at its peak. Thus, the

fact that this occurred with Rousseff at the helm, calls into question her integrity, competence

and legitimacy to serve as the nation’s president (Beauchamp). The further intricacies of the

scandal are boundless and can be written about endlessly. At the current moment however, the

legal actions are ongoing and has rendered Brazil’s political realm a true mess. Rousseff has

been impeached by the Chamber of Deputies and suspended by the Brazilian Senate. Nearly 68%

of Brazilians are in favor of impeaching and replacing Rousseff as President, according to

Datafolha (Ibid). Rousseff’s impeachment trial may take as long as six months and is set to begin

in early June. She will be replacement by Vice President Michel Temer, who is also facing

scrutiny for potentially violating Brazilian campaign finance limits. All things considered, the

current political disarray in Brazil is immense and only time will tell how it all is addressed and

sorted out.

Macroeconomic Perspective

From a macroeconomic perspective, the economy of Brazil has undergone significant

change during the past decade. Before the mid-2000s, there was little growth in per capita GDP

for nearly 25 years. However, GDP per person (modified for inflation) went up at a rate of 2.5%

annually from 2003-2014 compared to 0.8% annually from 1995-2002 (Johnston). Furthermore,

from 1960-2014, the average GDP in Brazil was worth 586.15 billion U.S dollars (Economics).

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This increase in growth is notable as it occurred in spite of the 2008 financial crisis. The crisis

did indeed force Brazil into a recession of sorts in 2009 that set back the country’s growth.

Nonetheless, Brazil is showing strength these past few years despite the slowdown due to the

positive changes the country has made with a GDP that was worth 2346 billion U.S dollars in

2014 (Ibid).

President Luiz Inácio Lula da Silva helped usher in major change after taking office in

2003. Under his tenure in the past decade, Brazilians experienced increases in both income and

employment levels (Loman). These two factors along with the expansion of social programs

(namely, the aforementioned Bolsa Familia) aided the reduction of poverty and inequality

(Johnston). Under Lula, a strong growth in the minimum wage occurred, which further helped

the quality of life for many poor workers. Lula also affected change into how gains from

economic growth were spread out within the different social strata of Brazilian society. For

instance, the top earners got more than half of all income gains from 1993-2002 (Ibid). However,

under Lula’s regime, the biggest recipients of income gains were the middle class citizens who

experienced double digit growth in their share of income gains, going from 11.3% to 21.1%

(Ibid). Thanks to Lula’s leadership, millions of Brazilians avoided being entrenched in poverty.

Under Lula’s administration, Brazil’s macroeconomic policy consisted of a number of

main principles. The first principle was the inflation targets that the Central Bank of Brazil had

to meet. To make its inflation target consistently, Brazil allowed the exchange rate to rise as

needed (Ibid). This effectively lowers import prices and export prices. This concept is reflective

of the “very dirty” floating exchange rate regime, which was the second principle Brazil

followed (Ibid). In 1999, Brazil made a decision to float the Real, which pushed the country to

focus on inflation targeting rather than exchange rate targeting (Loman).

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The Central Bank’s utilization of policy interest rates does not control inflation in the

usual fashion like in other countries because “Brazil’s inflation is not demand-driven”

(Johnston). For instance, though the Federal Reserve in the United States raises interest rates in

order to ward off inflation, this actually tends to effectively lower demand for industries that tend

to leverage a lot of debt. As a result, the U.S economy slows down and unemployment starts to

rise. These two factors allow a downward pressure to exist on wages and prices.

Brazil acts in a different manner because when interest rates increase, inflation lowers

and net capital inflows are increasing (Ibid). This in turn causes the Real to increase in value,

thereby lowering import prices and export prices. Therefore, in order to reach a desired inflation

target, Brazil must increase short-term interest rates, thus raising capital inflows. By allowing the

Real to appreciate, inflation decreases as a result of the price of imports being lowered. However,

cheaper imports harm Brazilian producers of tradable goods (Ibid). This is also applicable for

goods that by nature are not standardized as well as for Brazilian exporters. With a higher Real,

Brazilian goods are less competitive in the global market. An example of this is evident from

how an appreciating Real hurt Brazil’s manufacturing industry in the past (Ibid).

As stated previously, Lula helped usher in favorable economic conditions in Brazil after

2004. Such favorable conditions directly impacted fiscal officials’ decision-making processes.

For example, in 2005, the government reduced a large portion of “Short-term foreign debt

relative to foreign exchange reserves” (Ibid). Furthermore, the Central Bank met its target

inflation rate with lower domestic interest rates in part due to the low international interest rates

at that time. The difference between international and domestic rates affects capital inflows and

outflows, and this has directly enabled Brazil to become an emerging market (Loman).

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Another principle of Brazil’s macroeconomic policy set by Lula was setting a target for a

budget surplus. The idea of this target was comprised of the idea that it is not the size of

surpluses that were of note but rather, whether the surpluses were increasing or decreasing

annually. Such a decrease in the surplus for instance, represents a bigger fiscal policy meaning a

positive fiscal impulse (Johnston). Ideally, high growth periods should see a negative fiscal

impulse and low growth periods should see a positive fiscal impulse from the country (Ibid).

When Dilma Rousseff took office in 2011, she made a point in emphasizing the need to acquire a

budget surplus and as a result, she continued most of Lula’s macroeconomic policies especially

in the aftermath of the global financial crisis of 2008.

The effects of the financial crisis of 2008 have had a long, lingering impact on all

countries in the world, particularly on those containing emerging markets. The world GDP

growth fell as well as the growth of world trade continued to fall sharply as far as in 2010-2011

(Ibid). These elements had a negative effect on the real value of Brazil’s exports as they

progressively dropped precipitously from 11.5% in 2010 to 4.5% in 2011 and finally to 0.5% in

2012 (Ibid). Accordingly, Brazil’s economy slowed down immensely during this period of time.

Given this, the fiscal impulse was positive, thereby indicating that fiscal policy was far-reaching

during this period. There were interest rate hikes starting in 2010 as a result and continued under

Rousseff's presidency when the government created a fiscal stimulus package that included

subsidies and tax cuts. For instance, the interest rate in March 2010 was 8.75% and it jumped to

12.50% in July 2011 (Ibid).

The financial crisis aftermath continued to resonate in 2013 when the Central Bank raised

interest rates again. This cycle of raising interest rates lasted for one year. The rates were raised

in order to tamper down inflation. By doing this, Brazil ceded short term economic growth

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experienced negative growth in the third quarter of 2013, which pushed the country into a slight

recession during the first half of 2014 (Ibid).

Ultimately, Brazil’s macroeconomic policies have faced tough challenges these past few

years and will continue to do so in the coming future. Although Brazil is an emerging market, it

is still a developing country. A comparison of the country’s trajectory can be drawn from that of

South Korea. From 1960-1980, the growth rate of Brazil was very similar to that of South Korea

but Brazil had a much higher income per capita. However, after 1980, South Korea was on a

fast-growth rate policy, which led the country to first-world level living standards.

Simultaneously, Brazil stagnated and turned towards “neo-liberalism policies” after 1990.

Compared side by side today, Brazil has about one-third of the per capita income of South Korea

(Weisbrot). Under Lula’s presidency, Brazil has taken important steps in breaking long-term

policy failures with neo-liberalism, but there is still a long road ahead in terms of

macroeconomics for Brazil to reach its potential.

Microeconomic Perspective

Brazil is considered one of the four main emerging markets in the world, along with

Russia, India and China, given its rapid growth and developing economy. Since 2003 Brazil has

experienced a rise in the demand for its commodities, which has increased the country's total

exports, thereby leading to overall economic growth. With only 6.9 % of arable land, Brazil is

one of the world’s largest producers of agricultural products such as sugarcane, coffee, tropical

fruits and frozen concentrated orange juice (FCOJ). Brazil is also a country rich in natural

resources, including bauxite, gold, iron ore, manganese, nickel, phosphates, platinum, tin,

uranium, petroleum, hydropower and timber. Agriculture contributes to 6.1% of the country's

total GDP and employs 20 % of its total labor force (“Brazil Economic Structure”).

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Brazil is also one of the world's leading producers of hydroelectric power, which accounts

for 69% of the country's total electricity generation. Furthermore, nuclear energy contributes to

4% of Brazil's electricity. Great progress has also been achieved in reducing deforestation in the

rainforest and other sensitive biomes. However, the country still faces major development

challenges, especially in finding ways to combine the benefits of agricultural growth,

environmental protection and sustainable development. In 2015 Brazil has achieved its

leadership role in international negotiations on climate change, demonstrated by significant

contributions to climate change mitigation within its borders. Brazil has voluntarily committed to

reducing its greenhouse gas emissions between 36.1% and 38.9% by 2020 (“Brazil Economic

Structure”).

Brazil has undergone a structural transformation in past few years. Initially Brazil was

economy run by agricultural, then developed into one driven by manufacturing, and now,

services (Cardenas). Brazil has an expanding services industry, which employs about 66% of the

total labor force. It has a well-developed services sector, with major industries including

telecommunications, banking, energy, commerce and computing sectors (“Brazil Economic

Structure”). The issue is that productivity in the services industry is very low, this added to the

fact that Brazil is facing competitiveness challenges because of the rigid local content

requirements, investments in service industry have declined significantly (Cardenas).

Decreased competitiveness is further affected by Brazilian government’s involvement in

many sectors of the country’s economy, effectively hindering potential development within the

private sector. Most importantly, the corruption within Brazil continues to exist, private property

rights are insecure, and the judicial system remains vulnerable to political influence ((Roberts,

Schreiber, Scissors). These elements serve as barriers to enter the private sector in the country,

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forcing investors out of these sectors. Worryingly, it takes 13 procedures, 119 days, and roughly

the cost of 5.4 % of income per capita to start a business in Brazil (Roberts, Schreiber, Scissors).

Financial Changes In Brazil Within The Last 5-7 Years

Although ostensibly, Brazil is a country rife with social and political unrest, the country’s

financial system has gone through a lot of changes over the course of last decade and is

decisively strong. We chose to invest in Brazil for number of reasons. According to Santander

Trade portal, the country has removed many of the barriers, which previously prevented the

foreign direct investment in Brazil ("Brazil: Foreign Investment"). Despite the sizable disparity

in the real inflation rates in Brazilian currency over the last five years, the country has not lost its

attraction to foreign investors due to its investment policies, assurance to protect investors needs,

and substantial development in capital market.

It is widely known that the Brazilian economy has contracted slightly since 2011.

However, as it is also described in macroeconomic section that the foreign investment reached to

65 billion U.S.D during the years of 2011 and 2012, which makes Brazil the fifth largest FDI

recipient in the world. Brazil is open to the FDI except in some economic sectors or having fully

right of ownership of coastal land (“U.S Department of State”). As mentioned, the growth rate

experienced by Brazil from 1999 up until the global recession of 2008 was a consistent 3.4%

annually. This growth is likely to continue as commodities are gaining more stability and the

global markets are strengthening.

The market capitalization of listed domestic companies has been decreasing since 2011,

largely a result of the country’s volatile inflation rate. Directly, according to a World Bank

report, the market cap in Brazil was 47% to the GDP in 2011, whereas it is 34.9% to GDP in

2014 (“The World Bank”). This illustrated decrease in Market Cap is pretty intuitive. For

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example, one would be wary of making an investment in a given country, if the return on such an

investment does not outpace the inflation of the county. For this uncertainty in the inflation rate,

only short-term investment return has been relatively consistent. However, since the average

inflation is currently 3.4% (i.e. it is slowing down), investors may soon begin to invest on a long-

term basis in greater numbers.

On a similar note, Brazil’s credit market on an aggregate scale has not performed very

well enough within the last five years. According to the FX Market report, the credit market

declined around 4% (“The Forex Market”). However, many believe that as investors begin to

invest more with the long-term in mind, the credit market will rebound and start performing in a

stronger manner. Such anticipated improvement in performance of the bond market is

correspondingly critical to the growth in Brazil’s Market Cap and also to attract further Foreign

Direct Investment (FDI). Joonkyn Park, a PhD student at Wisconsin University compares the

Brazilian stock market capitalization with other emerging markets and he asserts in his PhD

paper that despite high inflation rate and other impediments, Brazil is still a strong option for

foreign investors given its many opportunities for growth and development in myriad sectors

(“IMF Working Paper”).

It is important to note that Brazil’s bond market is susceptible and responsive to relevant

inflation rates and foreign exchange rates. Due to economic uncertainty, short-term bonds are

doing a lot better than the long-term bonds, in both the government and private sectors. Notably

in Brazil, there has been a big decline in bonds based on inflation rate and fixed rate, whereas

exchange rate based bonds performed well even during the more turbulent times the country has

experienced of late (Ibid).

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Industrial Changes Within The Last 5-7 Years Of Economic Growth

Brazil’s economy is not highly diversified. Its economy relies heavily on agriculture and

commodity based industries, which provides a strong base of production and employment for

Brazilian workers. Brazil is also the largest supplier of coffee in the world and one of the largest

suppliers of rice. Heavy manufacturing of civilian and military aircraft and aircraft parts also

takes place in Brazil and the country is additionally a large manufacturer of packaging materials,

which represents 1.5% of GDP.

GDP growth in Brazil has been present for the last few years but has been rocky of late.

Such rockiness is in part a result of the country’s recent political instability, which translates to

economic instability. Equally problematic is the wealth gap between Brazil’s rich and poor. The

lower class’ anger manifested itself in the numerous protests that erupted across the South

American state in the summer of 2013. For days, hundreds of thousands of Brazilians took to the

streets to protest the increase public transport fares, but the demonstrations evolved into a more

general protest against increasing social inequalities among the Brazilian population, despite

increased prosperity.

As of today, Brazil’s economy is challenged by the stagnation of commodity prices. It

has greatly affected foreign exchange reserves; foreign currency inflows are major elements for

the country’s credit rating. The reduction of foreign currency casts a dark shadow on the

country’s ability to repay its debts in the future, and on top of the production slowdown due to

raw materials slump, many people have become jobless in Brazil. Following the impeachment of

President Dilma Rousseff just two weeks ago and allegations of her replacement as a former US

informant, the future of Brazil as a country with an identity and independent economic future of

its own is now being debated.

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Country Overview: TIM Participações

Brazil Telecom Industry Overview

The telecommunications industry in Brazil is a rapidly growing. Brazil, a country of

200.43 million people according to CIA World Factbook, has an online population of 78 million

people. Brazil’s telecommunication industry includes landline and mobile phone service, internet

service, and cable television. According to Marcelo Sampaio of Federal University of Campina

Grande, “Regarding the population access to telecommunication services, 39,121 localities are

served by the fixed telephone system, and 17,059 have individual access, and increase from the

number of 38,452 localities in 2011” (Alencar). Brazil has enabled access to any one form of

telecommunication to 100% of its citizens, mostly through cellular means. For instance, the

country had just four mobile phones for every 100 people in 1998 (Paulo). In complete contrast,

according to Brazil’s Telecommunication National Agency (Anatel), there are now roughly 116

cell phones to every 100 person in Brazil, which translated to 280 million mobile devices for a

population of 200 million (Jelmayer, Lewis).

The case could very well be made that Brazil has the largest telecom market in the world.

The Brazilian telecommunications services market reached a US$80 billion valuation in 2015

and by 2017 is forecasted to reach US$100 billion ("Telecommunications"). There are currently

four major players in the telecom industry, Oi SA, Telefonica SA, TIM Participações SA, and

America Movil SAB. The four companies provide both telecom service as well as mobile lines in

Brazil. The industry has experienced a rapid surge in development since Brazil hosted the 2014

World Cup and in the wake of the 2016 Olympics. Major infrastructural planning and

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development had to be done in order to accommodate the immense increase in tourist traffic

("Global Wireless Telecommunications Carriers”).

It is crucial to note that the industry is facing various challenges due to a slowdown in the

economy and also high taxes that impede its growth. Nonetheless, the reported investment in the

telecommunication sector, until January, 2013, was R$273,8 billion since privatization, including

the price paid for all the licenses, valued at R$35,8 billion (Alencar). Additionally, in 2012,

Anatel predicted that the industry projects a R$240 billion growth within 10 years, equivalent to

$67.9 billion, and the industry seems to be still headed in such a positive direction (Paulo). Most

of the investment into Brazil’s telecommunication industry is obtained through government

support, and this has amounted to hundreds of billions in the past decade (Ibid). A crunch in

government-linked investments resulted in the apagão, literally “big blackout” post-2001, which

propelled President Dilma Rousseff to rise in power. Just two weeks ago, she has been

impeached amid Brazil’s turbulent political reshuffling, possibly erasing a clear path forward for

all industries in Brazil, including telecommunications.

TIM Participações Company Overview

TIM Participações is one of the largest telecommunications companies not only in Brazil

but in the rest of Latin Americas. The company was established in 1998 as a TIM Italy

subsidiary and since then it has become the first mobile phone company present in all Brazilian

States and has more than 70.9 million customers throughout the country. TIM Participações is a

mobile only operator headquartered in Rio de Janeiro (“Telecom Italia says TIM Participações

not for sale”). TIM is a public-held company, managed by a Board of Directors and a Statutory

Board of Officers and supervised by a Fiscal Council. The Board of Directors also has the

support of three committees: Statutory Audit Committee; Compensation Board and; Control and

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Risk Board. Its shares are listed on São Paulo’s BM&FBOVESPA under the ticker symbol

TIMP3, and ADRs listed on the NYSE under the ticker symbol TSU. TIM is also the only

company in the telecommunications industry listed on BM&FBOVESPA's "New Market,"

recognized for requiring the maximum level of corporate governance, and is also part of the

Corporate Sustainability Index (ISE), and the Carbon Efficient Index (ICO2). (TIM website).

TIM Participações is considered as a solid growth stock with current price yields of 2.5%.

Company is growing and expanding tremendously with 218 funds holding 20 million shares

(Gold).

Investment Rationale

The rationale for investing in TIM Participações (TIM) is comprised of a number of

factors. Firstly, we believe that the company is significantly well positioned within the Brazilian

mobile cellular market. In fact, TIM is the sole company in Brazil that offers complete coverage

within all of Brazilian territory, achieving this via its subsidiaries, TIM Celular S.A. and TIM

Nordeste S.A. ("TSU Company Summary"). TIM management further highlighted its unique

position within the market during its November 2015 meeting with investors in asserting that the

firm currently has 74.6 million customers which is good for 26% market share. Such customers

can purchase products and renew mobile contracts at the 455,000 points of sales availed to the

firm in Brazil, 179 of which are TIM’s own, personal stores. Additionally, there are also 15 TIM

Customer Care Centers in the country that are akin to Apple Stores in the troubleshooting and

product fixing that they provide on a daily basis (Ibid).

Despite this prominent market position, TIM has not rested on its laurels and instead in

2015 rolled out a new portfolio of offerings featuring different levels of service, with the hopes

of targeting the various segments of the market. This new portfolio was comprised of three

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levels, a new Prepaid Plan (R$7.00 for seven days), a new Control Plan (R$50.00 for a month)

and a new Postpaid Plan (R$99.00 for a month). The three plans price point reflect the number of

minutes, data capacity, SMS messages allotted, the way in which roaming charges are applied

and more, given each specific plan. The new Prepaid Plan and Control Plan are significant in the

way that they provide a “SIM card consolidation” that uses off-net offerings (meaning routing

calls through a network the user is not technically subscribed to) in order to expand areas with

service for its users (“TIM Participações”). The plans are also crucially more in line with

potential customers spending capacity. The Postpaid Plan features an even bigger umbrella of

on-net and off-net calls as well as an outsized data figure (2GB) that duly justifies its premium

price. Thus, the new offerings offer varying packages for the different economic groups within

Brazil.

The three new mobile plans have been received well by consumers since its rollout in

2015. For instance the Prepaid Plan has had a 2% increase in users but most notably, saw more

customers reducing their usage of the plan and moving to the Control Plan, in hopes of better

efficiency and an overall better deal. This is a very positive thing for TIM of course, as it locks in

users for longer contracts and paying a larger price-point. Despite this only slight growth in

Prepaid, TIM retains the role as the leading Prepaid service provider in Brazil. In terms of the

Control Plan, TIM experienced 43% gross additions in users and in terms of the Postpaid Plan,

TIM experienced 46% gross additions in users (Johnson). Thus, consumers have quite clearly

responded to the 3-tiered plans positively and further growth within them is very likely. Perhaps

most importantly, TIM’s initiating its new portfolio of offerings exemplifies the adroit manner in

which the company analyzes and targets its diverse customer base. We believe that such an

approach to its consumer base and possible further bundled packaged and emphasis on recurring

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payments instead of the classic pay as you go approach are indeed in store for the firm and will

continue to attract new users and bolster those already using TIM.

Another positive factor TIM possesses is its place as the leader in the Brazilian 4G

market both in population served as well as in the number of cities it covers. The company has

over 7 million 4G users and has coverage in over 411 cities. This position largely stems from the

large investments the firm has made in 4G infrastructure (adding nearly 387 cities with coverage

since 2013) and use of the refarming of the 1.8 gigahertz frequency that is a unique method, not

employed by TIM’s competitors (“Bloomberg Transcript”). Such infrastructure growth and

capital investment has enabled TIM’s “Innovative revenues” as management calls them

(revenues which excludes SMS revenues and instead weights those stemming from data usage

more heavily) to grow almost 40% year-over-year, between 2014 and 2015. The “Innovative

revenues” have experienced such growth in large part due to the vast 4G usage by TIM

consumers, seeking to use data in the more seamless, readily available manner provided by the

service (“Bloomberg Transcript”). Given TIM’s leading position in the 4G market as well as the

upward trajectory that the 4G market seems to be poised for, TIM is well-positioned and well-

equipped to continue to reap the benefits moving forward.

Ultimately, TIM represents an investment opportunity given the company’s strong

fundamentals, sizeable market share, forward-looking business approach and wide-ranging

consumer base. Additionally, the company has promising financials and seeks to distribute “The

minimal level of dividends to the next shareholders' assembly at 25% of the adjusted net profit”

(“Bloomberg Transcript”). TIM also achieved its highest ever EBITDA margin in 2015 of 31%

(up from 28% in 2014) and is set to continue building upon this notable figure (“TIM

22    

Participações”). For this reason as well as our financial valuation in the next section, we are

bullish on TIM stock.

Financial Valuation

We employed the comparable companies method in order to determine the financial metrics of

TIM Participações (TSU) vis-à-vis that of its competitors. The firms below are comprised of five

from South America, one from Japanese and one from China.

Company Name EV/Sales EV/EBITDA EV/EBIT P/E Gross Margin %

EBITDA Margin %

EBIT Margin %

NII Holding Inc 0.6x -1.5x -2.0x 238.1x 47.5% (17.9%) (2.2%) Telecom Argentine 1.2x 4.3x 7.3x 13.1x 88.8% 26.8% 15.9% TIM (TSU) 1.0x 2.7x 5.5x 8.0x 51.5% 38.6% 18.9% Telefonica (TEF) 1.6x 5.4x 12.4x 15.6x 49.5% 29.9% 13.0% NTT Docomo Inc. 1.9x 6.4x 12.9x 20.5x 54.1% 29.6% 14.5% KDDI Corp. 1.7x 6.1x 10.5x 15.9x 5.5% 27.6% 16.2% China Mobil 1.6x 4.4x 9.8x 13.8x 4.2% 37.1% 16.5% High 1.9x 6.4x 12.4x 238.1x 88.8% 38.6% 18.9% Mean 1.4x 4.0x 8.1x 46.4x 0.4x 0.2x 0.1x Low 0.6x -1.5x -2.0x 8.0x 4.2% (17.9%) (2.2%)

As evident from this model, TSU’s EV/Sales is about 50% beneath the mean EV/Sales.

Similarly, TSU’s EV/EBITDA is also significantly lower than the mean of its peer companies.

The Price to Earnings ratio of TSU is the lowest in the model and according to this measure, the

firm’s prospective earnings is 12.5%. These three metrics indicate that our firm is likely

undervalued. In terms of Gross Margin %, the proportion of each dollar of revenue that TSU

retains, is $0.515, which is quite noteworthy. Furthermore, TSU’s EBITDA margin, the firm’s

operating profitability, is 38.6%, which is highest from all its peer companies or to its

competitors. Ultimately, the above valuation illustrates how TSU’s stock is undervalued and has

much promise for growth in the near term.

23    

Risks/Mitigants

There are certain risks involved in investing in TIM Participações (TIM). For instance, a

risk the company currently faces is not being able to successfully execute its business strategy.

TIM’S business strategy is focused on enhancing revenues while ensuring that debt does not soar

to exceedingly high levels. In order to reach this goal, the company has to build up its market

position by “Leveraging mobile telephony to increase broadband usage” (“TIM Participações 10-

K 2015”). In addition, TIM has to make full use of opportunities coming from fixed-to-mobile

transactions (Ibid). However, there are factors that are outside of the company’s control that can

affect the outcome of the business strategy.

The most obvious factor for any company is an increase in the number of competitors in

the industry that could have an impact on TIM’s market share. Another factor is related to how

capable the company is to operate efficiently and how it is able to refinance its debt with the

current economic conditions in Brazil. And finally, there is the production of key suppliers on

whom the company depends on that can affect the end result of the business strategy (Ibid).

Another risk involving TIM is trouble answering to new telecommunications

technologies. Brazil’s market is undergoing significant changes. For example, there are “Shorter

time periods between the introduction of new telecommunication technologies and subsequent

upgrades or replacements” (Ibid). This concept is related to the advancement of LTE and 4G

technologies as well as the introduction of the 4.5G network layer to customers (Ibid). As a

result, the company may be unable to keep pace with these technological changes.

The company also has a risk in facing a potential decline in customer growth as well as

having a high rate of customer turnover. These factors could expand operational costs and reduce

revenue. Furthermore, the company has a subscription base system and its procurement rate can

24    

be harshly affected by market penetration and how quickly products become stagnant due to

slow growth (Ibid). All these conditions are related to TIM’s churn-rates.

Churn means the number of customers who close their contracts or have their contracts

discontinued during a period, “Expressed as a percentage of the simple average of customers at

the beginning and end of the period” (Ibid). The company’s churn-rates are influenced by prices

settled by other companies. These rates are also impacted by macroeconomic conditions in

Brazil. These conditions are the reason why the company has a harsh policy of getting rid of

consumers who do not carry on the services or who do not pay their bills on time.

The company indicates that it would encounter a high rate of customer turnover based on

historical churn rates. As a result, revenue would decrease and operational costs might increase

as mentioned before. The subscriber acquisition rate is influenced by many different factors. As

stated before, increased competition has a direct influence on the rate. Another factor is limited

network coverage, which can turn off some customers. And finally, there is a lack of reliable

service as well as the economic conditions in Brazil that could have an impact on the acquisition

rate.

TIM is also affected by market risk from changes in both foreign currency and interest

rates. The firm is influenced by foreign exchange risk mainly because certain costs are

designated in currencies like the U.S dollar while revenues are earned primarily in the Brazilian

Real (Ibid). For example, the company gets its equipment from global suppliers, which the prices

are mainly set in U.S dollars. As a result, there is foreign exchange risk coming from the need to

make “Dollar-denominated expenditures especially for imported goods that have limited capacity

to hedge” (Ibid). The company has decided to put R$599 million in a U.S dollar-designated hard

currency fund in order to move exchange rate risk connected to capital expenditures and

25    

operating expenses (Ibid). In addition, there is additional risk involved if the Real devalues

against the dollar because it might force Brazil to increase the price of imported goods.

As mentioned before, the company can experience interest rate risk, which may impact

the cost of financing assets. Before 1999, TIM did not utilize derivative tools, such as forward

contracts and foreign currency options to manage market risk. However, after 1999, the company

decided to shift market risk coming from changes in interest rates for some debt commitments

(Ibid). According to the company’s annual report of 2015, outstanding debt total R$6,372

million. In addition, the company has cash and cash equivalents of about R$6,700 million

accumulating interest at the CDI rate according to the report.

Conclusion

After carefully studying and evaluating both Brazil and TIM Participações we believe

that the country and the company represent attractive foreign investment opportunities. Although

Brazil is facing some political, social and economic problems, the telecommunication industry

that we focused on and are bullish on demonstrates great growth potential. Furthermore, our

financial evaluation of TIM Participações confirms that the company is undervalued and is

primed to experience an uptick in its stock price. All things consider we are confident that this is

a strong investment opportunity bolstered by strong rationale and financials.

26    

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