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TEO: a great growth play in Argentina

TEO 5 year price chart (click to enlarge)

Today, independent consulting group IES Consultora* reported on the growth in the Argentine cellular phone sector during 2007. They noted a 36.4% growth in handsets and 40.4 million phone lines in service, a growth of 28.2%.

Impressive stuff. However the consultants also noted a YoY slowdown in growth, something that happens when a cellular market nears maturity and saturation. It was estimated last week by Argentine cellular player CTI Movil (now re-naming itself Claro to get in line with the other Carlos Slim companies in South America) that the Argentine market is at 90% saturation. This compares to 110% penetration in developed world markets, which may sound illogical at first until you think of your Uncle Fred with his cellphone for business and the other for personal calls, or Auntie Eva with her new phone and the old pre-pay phone she has collecting dust in the kitchen.

This slowdown in growth is natural and comes as no surprise to anyone, but it isn't all bad for the investor. When a cellular market saturates, it means the competing companies don't have to fight tooth and nail to hold on to (or even grow) their market share, with the result that the top line earnings start flowing to bottom line net profits. Put another way, top line growth may slow somewhat, but bottom line growth takes off. This is a pattern seen in more mature markets of Europe, US etc, and I think we're about to see pay-off time in Argentina too, as it's arguably the most mature South American telco market.

The way to play it? Well I like Telecom Argentina (TEO in New York, in Buenos Aires), a stock I briefly mentioned the other day when doing the overview of the Argentina stock market. TEO has roughly 1/3 of total market share in Argentina with the other 2/3rds roughly split between CTI Movil/Claro and Telefonica de Argentina. Reasons to like TEO? Well this is a big subject, I'm only going to be able to broadstroke outline the company in a post like this and you have to do your own DD on this as well**, but let's start by having a look at this chart:

This shows TEO sales for the previous quarters to 4q07, and you can clearly see how the cellphone sector has fuelled growth. All very up-and-up, for sure.

Now have a look at this chart, which maps out the earnings in U$ for each ADR and also my projected earnings for 2008 (it says the source is SEC filings...that only counts til 4q07, obviously)
For a long time, that top line growth wasn't reaching the bottom line. For example, in 1q06 TEO had revenues of around U$520m (1.61 billion Argentina pesos, to be exact), but only earned a penny per share. But if we fast-forward to the last quarter TEO had revenues of around U$810m (exactly ArgP$2.259Bn) and earned 44c per ADR. For 2008, my estimates put TEO making U$2.23/ADR, which means with today's ADR at U$20.29 the forward PE is 9X. That's really cheap when you look around and see peers like America Movil (AMX) and Telefonica (TEF) at much higher ratios.

When it comes to TEO, there are kickers, too. Here are four of them:

1) TEO is market leader in Argentine broadband internet, a sector that has a lot of growth left in it. Current internet domestic penetration stands at around 20%, whereas in mature markets like the USA between 45% and 50% of homes have internet. TEO has done the major capex investment in broadband, and more future topline revenue can now be moved to the bottom line.

2) TEO has a large stake in the still maturing Paraguay telecoms sector. Although that market is obviously smaller in absolute size than Argentina, I estimate it will bring its own bottom line reward at an 18 month to two year lag to the Argentina market.

3) Argentines are spending more on phonecalls, and the SMS (texting) business has really begun to take off in the last 12 months. In 4q07, monthly spend per client was up 5% YoY. This means that not only are there more clients, but those clients are spending more on average.

4) It's an obvious buyout play. The company is majority owned by Telecom de Italia, with the local Werthein family also owning a large share. I can imagine two scenarios that will benefit the minority shareholder: Firstly, an aggressive bid for the company, or secondly Telecom de Italia wanting to take all the shares and buying out minorities like the Wertheins (or you).

Bottom line: Even though growth is beginning to flatten out in the Argentine market, there's plenty of reason to like the results that TEO will post in the quarters to come. Bottom line growth will push the share price up from here, and I'm looking for U$32 as a 12 month target. That kind of valuation this time next year indicates a 15X trailing PE according to my EPS estimates (in the chart above), which would put it right in line with its peers. Disclosure: I recommend TEO to clients.

* It's a client-only website, but i thought I'd link it anyway
**ALWAYS do your own DD before investing in anything. Remember you got to read this note for free. Think about that