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May 17, 2007 9:19 pm

Telefónica joins battle for Brazil bonanza

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When Telefónica of Spain paid €2.3bn ($3.1bn) to join a consortium taking control of Telecom Italia last month, there was little doubt in the industry that the focus of its attentions was not the companies’ home markets in Europe but a battle being played out on the other side of the Atlantic in Latin America.

“What Telefónica paid for was a clause in the contract that prevents Telecom Italia from selling its assets to a competitor,” says Samuel Possebon of Teletime, a Brazilian telecommunications industry website and magazine.

That competitor is Carlos Slim, the Mexican billionaire who controls América Móvil and Telmex, mobile and fixed telephone operators that for several years have been vying with Telefónica for dominance in the region.

Fixed telephony has reached maturity and growth in mobile markets in the developed world is slowing. But mobile growth in emerging markets is still strong, and Brazil is no exception.

Units wholly or partly controlled by Telefónica (Vivo), América Móvil (Claro) and Telecom Italia (TIM) share three quarters of what is already the world’s fifth largest mobile market.

Telefónica says it wants to reach an operating agreement with Telecom Italia. If successful, it would surge ahead in Brazil, gaining enough additional scale, synergies and purchasing power to claim a decisive victory over Mr Slim.

Yet to do so it would have to overcome seemingly insurmountable obstacles. Brazil’s regulators have rejected smaller deals in the past. When Telecom Italia, during a byzantine dispute with co-investors, found itself controlling more companies than regulations allowed, it was forced to put its share of control of Brasil Telecom, a big fixed and mobile operator, into an escrow account and withdraw from management. A combined Vivo and TIM would dominate the market to a far greater extent.

Telefónica must also resolve questions over Vivo, of which it shares control with Portugal Telecom. Earlier this week it reiterated its determination to take full control. But Vivo is Portugal Telecom’s main source of income growth and the Portuguese have shown no sign of budging. Telefónica could sell its share, but to whom?

“Who would want to buy half an operator where they have to share control with stubborn partners who have no desire to play nice?” asks Thomas Abreu of Pyramid Research, a Boston-based telecommunications consultant.

However the situation eventually plays out, Telefónica has taken a stand. “The main benefit [of the deal] was to stick their fingers in the eyes of América Móvil and Telmex,” says Mr Abreu. “Latin America is a major portion of Telefónica’s revenues, and this is where they draw the line.”

If the battle is complex, so is the battleground. At privatisation in 1998, Brazil’s mobile market was divided into ten regions, each with four separate licences. The market has since consolidated, but that has still left between three and six operators competing in each region. Vivo, Claro and TIM dominate, but two locally-owned operators – Oi, controlled by fixed operator Telemar, and Brasil Telecom’s BrT Celular – are gaining ground.

Pre-paid subscribers make up 80 per cent of the total because wealth is concentrated in such a small percentage of the population. Indeed, many mobile users never make a call and only use the handsets to receive calls.

Price wars have also taken their toll in the scramble for market share. Mobile phone numbers are not portable between networks yet. Nevertheless, the rate of poaching between operators is high.

Since last year, operators have declared a truce and their focus has switched to higher margin services – basically post-paid subscribers targeted with loyalty programmes, but also text messaging and other services.

Many have stopped supplying handsets to pre-paid customers, instead selling SIM cards only. Pyramid Research says 50 per cent of handset sales are now through supermarkets and other retailers; 30 per cent through dealers and just 20 per cent through operators themselves.

Margins are tight and many operators have yet to make a return on investment. But most are now profitable and the prospects for growth – especially if Brazil succeeds in lifting economic growth above the recent average of just 3 per cent a year – are among the most attractive in the world. The Spaniards and Mexicans have everything to fight for.

Additional reporting by Mark Mulligan in Madrid

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