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 Business News | July 2005 
Telmex 2nd-Quarter Net Probably Rose 50% on Brazil Cost Cutting
 Bloomberg
Telefonos de Mexico SA, Latin America's largest fixed-line telephone company, probably increased second-quarter profit by 50 percent after cutting costs at its Brazilian unit.
Mexico City-based Telmex, controlled by billionaire Carlos Slim, will report net income of 6.87 billion pesos ($645 million), compared with 4.59 billion pesos a year earlier, according to the median estimate of six analysts surveyed by Bloomberg. Sales probably rose 24 percent to 38.8 billion pesos. Telmex is scheduled to release earnings today after 4 p.m. New York time.
Chief Executive Jaime Chico Pardo, facing tougher regulations and little growth at home, is seeking to boost profit by expanding in South America. The strategy may fail to offset a decline in Mexican sales, its biggest source of profit, as Telmex cuts rates to head off competition from resellers and internet-calling companies, said analysts such as Morgan Stanley's Mario Epelbaum.
"The investment in Brazil is still small to improve results in a meaningful fashion," said Gilberto Nagai, who manages about $650 million of Latin American equities at ABN Amro NV in Sao Paulo, including Telmex shares. "They want to expand and add cable in Brazil, but in the short term I don't see a trigger for the stock," he said in a telephone interview last week.
Shares of Telmex have underperformed Mexico's benchmark stock index this year. Telmex fell 2.2 percent through July 25 as the Bolsa index gained 9.3 percent. Slim has been buying Telmex shares on the market in the past year. He increased his stake in Telmex to 41 percent, according to Securities & Exchange Commission filings on July 7, from 37 percent in September 2004.
Brazil
Telmex injected 1.6 billion reais ($645 million) in Brazilian unit Embratel Participacoes SA in April to finance investment and cut debt. Rio de Janeiro-based Embratel, Brazil's largest long- distance carrier, yesterday said it had second-quarter net income of 93.6 million reais, the second straight quarterly profit since Telmex took control of the company in August 2004.
Chico Pardo, 55, expects to further cut costs at Embratel by using the cable network of Net Servicos e Comunicacao SA, a Brazilian company in which Telmex purchased a 54 percent stake in March for 535 million reais. Net can give Embratel direct access to 6.7 million Brazilian homes, bypassing interconnection charges the company now pays.
"A deal with Net will bring interesting new perspectives for Embratel," said Eduardo Roche, a telecommunications analyst with AgoraSenior Corretora, Brazil's biggest stock brokerage. "The problem is when this deal will come about," he said in a telephone interview from Rio de Janeiro.
Telmex's earnings also got a boost from the peso's 3.9 percent gain against the dollar in the quarter, which reduced its dollar debt. The company probably had a currency gain of 233 million pesos, compared with a loss of 991 million pesos a year ago, wrote Citigroup Inc.'s telecommunications analyst Patrick Grenham in a July 13 report.
Competition
Telmex had the equivalent of $8.07 billion in debt as of March 31, of which 34 percent was in foreign currency.
By investing in Brazil, South America's largest economy, and in other countries in the region, Telmex is seeking to offset stagnant sales in Mexico. Mexican revenue, which accounts for more than three-quarters of total sales, has grown less than inflation for more than three years because of rising competition. In the first quarter, Mexican sales fell 1.3 percent to 30 billion pesos.
Telmex competes against mobile telephones on local calls and against Internet calling companies on international calls. Soon it will face new rivals as Mexican regulators prepare to allow companies to lease lines from its phone carriers to provide long- distance calls as resellers, said Clara Luz Alvarez, a director of Mexico's telecommunications agency, in an interview on July 5.
Less Cash
Telmex may earn 10 percent less per minute on domestic long- distance calls this year and 8 percent less on international calls because of resellers and increasing use internet calling, Bear Stearns & Co. telecommunications analyst Rizwan Ali wrote in a July 12 report. The decline could as big as 15 percent in 2006, Ali said.
Telmex, a former state monopoly that a group led by Slim purchased in 1990, handles about 80 percent of Mexico's domestic long-distance calls, and 60 percent of international calls, according to Morgan Stanley estimates. Long-distance calls accounted for 22 percent of Telmex's 13.5 billion pesos first- quarter revenue in Mexico. The company had 17.5 million lines in service as of March 31.
Chico Pardo's expansion into South America, which includes purchases in Argentina, Chile, Peru and Colombia, reduced cash available to buy back stock and pay dividends. Telmex slowed stock buybacks to 158.73 million shares in the first quarter from an average 177.3 million shares per quarter in 2004, as it took on debt to invest in Brazil. Telmex's debt rose 16 percent to $8.07 billion in the first quarter.
Less Profitable
The expansion also reduced Telmex's profitability. The company probably earned 46 pesos for every 100 pesos in sales in the second quarter before interest, taxes, amortization and appreciation, according to the Bloomberg survey. Telmex earned 49 pesos for every 100 pesos in sales a year earlier.
Six of nine analysts that cover Telmex, Mexico's second- biggest company by market capitalization, have a "hold" recommendation on the stock, according to Bloomberg data. Two have a "buy" recommendation and one has a "sell".
Standard & Poor's rates Telmex's long-term foreign-currency debt BBB, the second-lowest investment grade rating and the same as Mexico's sovereign rating. Moody's assigns Telmex an A3, the fourth-lowest investment grade rating and one level above the Mexican government. Both companies have a stable outlook on Telmex's credit rating.
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