Description

Summary: I recommend taking a long position in UOLL4 due its attractive valuation, growth prospects (internet ads) and pristine balance sheet. The company is trading at EV/EBITDA of 5,3x  (2008), well below other alternatives in the sector.  Almost two years ago (January 31, 2006), I had recommended to short this stock, because we were skeptical that the company could face the competition from other global companies (Google, Yahoo, Terra/Telefonica etc.) and the powerful local media companies (Globo, Abril). Despite these threats, UOLL4 thrives by growing ads revenues, launching new products and maintaining its position as the leading portal in the Brazilian market and is the largest globally in Portuguese language. We made money in the short, and now is time to go long.

 

Background

 

The Company’s flagship portal in Brazil is organized into 42 thematic stations with more than 1,000 channels of news, information, entertainment, and services, representing a total of more than seven million pages. UOL’s extensive interactive platform offers communications products, VoIP, Internet communities, security and search engine, among others.

 

It is a leading web Portal aimed to Brazilian market and Portuguese speaking people around the world. Besides that it has an ISP business with 1.7 million subscribers, the largest on-line subscriber base. UOL provides local Internet access in more than 3,000 cities throughout Brazil and 14,000 cities abroad. For each 10 people that access Internet from home, around 6 to 7 visit regularly UOL sites, base on data collected by market research outfit IBOPE NetRatings (Oct/ 2007). Besides that, the average time spent on UOL’s sites by the users is 1:11 hours, which is a slight increase on September/2007 figures.

 

According to IBOPE//NetRatings, UOL lead alone the news category on the Internet in Brazil, with information updated 24 hours a day, 365 days a year. The Company has its own teams of reporters in addition to reliable sources of information in Brazil and abroad, including Folha Online, Reuters, France Presse, and BBC.

 

The company belongs to a leading newspaper group in Brazil – Folha de São Paulo, that provides a good chunk of its content, and the other big shareholder is Portugal Telecom.

 

UOL derives more than 75% of its revenues from subscription revenues related to Internet Access services, and the remaining is from online ads ( +/- 25%) and other services (VoIP). The company does not disclose its ads revenue in P&L line alone, and barter transactions. According to company, they have around 25%-30% market share of internet advertising in Brazil. The number of paying broadband subscribers reached 972,000 in Sept/2007, an increase of 29% over September/2006, and the number of dial-up subscribers is decreasing from 783K (3Q06) to 756K (3Q07), which means -3,5%.

 

The company was voted as the preferred portal by InfoExame’s readers, a leading PC magazine in Brazil, with 44% of the votes. Terra (Telefonica) got 38% and IG (owned by Brasil Telecom) 18%.

 

UOL has established a commercial partnership with Google, sharing revenues from traffic to Google’s search engine through UOL’s portal. It has also launched new products to attract more viewers/traffic, such as:

 

a) Shopping UOL: Online price comparison tool, which competes with BuscaPé.

 

b) Pagseguro: Online payment website, which is similar to PayPal and competes with MercadoPago offered by Mercado Libre (Ticker: MELI), and this has synergies with the auction site TodaOferta.

 

c) UOL Megastore: Online music store

 

d) TodaOferta: Auction site, which competes com Mercado Livre, a subsidiary of Mercado Libre (ticker: MELI).

 

The IPO’s price was R$ 18.00 per share valuing the company at approximately R$

2.1 billion or the equivalent to US$ 950 million on December 16th, 2005.

 

AUDIENCE

 

UOL  maintained leadership in page views and time spent online among content portals in Brazil with 1,608 million page views and an average time spent online of 1h:05min:22sec in September 2007, according to IBOPE//NetRatings.

 

In the same month, also according to IBOPE//NetRatings, we recorded a 46% increase in unique visitors over September 2006, in line with market growth.

 

UOL Busca (UOL Search) ended September 2007 with more than 4.9 million unique domestic search visitors, putting us in second place in the IBOPE//NetRatings search rankings.

 

AUDIENCE
Metrics	Sept2006	Sept2007	Change %
Page views (million)	1,293	1,608	24%
Unique visitors (000)	8,898	13,019	46%
Unique visitors - search (000)	3,451	4,936	43%
Reach (% of Brazilian Internet users)	65%	65%	n.a.
Time spent online (hours:min:sec)	1:14:56	1:05:22	-13%
Source: Ibope//NetRatings (portal audience, home panel, brand, excluding Internet applications).

 

 

WHAT HAS CHANGED

 

- UOL continues to maintain its leadership in audience amongst Brazilian portals (Globo, iG, Terra (Telefonica), YahooBrasil). We thought that its market position would be eroded. This leadership is the foundation for advertising of mark/banners and its advertising revenues are having a healthy growth.

 

Monthly reach (%) entire Latin America – All Sites

                                                  Total unique                              Total pages

        visitors (000s)    Reach (%)      viewed (mm)

 

Total Internet audience                       51,809             100.0               126,713

1 Microsoft sites                                  45,968               88.7                 13,282

2 Google sites                                     44,966               86.8                 35,533

3 Yahoo sites                                      35,219               68.0                   4,264

4 Terra Networks (Telefônica)             27,512               53.1                   3,060

5 MercadoLibre                                   24,601               47.5                   1,352

6 Wikipedia                                         21,051               40.6                      320

7 France Telecom sites                       16,624               32.1                      387

8 UOL sites (Brazil)                           14,013               27.0                   3,022

9 Time Warner Network                      13,459               26.0                      239

10 IG sites (Brazil)                              10,976               21.2                   1,197

 

Source: MediaMetrics March 2007

 

- ISP business segment despite doomness of the sell side analysts is more resilient than we expected. It is a commodity business, but due law protection, it will stay more than expected and it’s a cash cow. Brazilian telecom regulations requires that every subscriber has to have an ISP account; however NET (ticker: NETC4), the largest cable modem operator in Brazil, is giving an ISP account for free. Last quarter Subscription revenues reached R$133.8 million in the 3Q07 and R$392.2 million in the 9M07, representing an increase of 10% and 9% respectively, over the same period in 2006. This growth was primarily related to the increase in the subscriber base, which reached 1.73 million in September 2007, 13% higher than in September 2006. Of this total, 972,000 were broadband subscribers, up by 29% in the same period; and the remaining is dial-up.

 

- The company’s management is careful on asset allocation; despite its huge cash pile is not doing any silly acquisition. They choose to develop inside company the new products instead of buying existing competitors, because the acquisition premiums are still very high.

Growth of Internet Users. According to a report by GNETT/IBOPE, the number of Internet users in Brazil reached 37 million in 2Q/2007 (approximately 20% of the total population). This includes people that uses internet from all access places (home, work, schools, cyber cafes etc.).  Having grown at a compound annual rate of 15 % since 2002, and is expected to reach 55 million by 2010.

The Internet penetration (= Internet Users by total population) in Brazil is 17%, slight below Latin America average of 18%, however Brazil is the largest market in Latam. (Source: Internetworldstats.com – June 10, 2007)

Looking at the internet market in Brazil, with more than 37 million users, and all these users with a 21-hour usage per month, we believe that these two factors, size of the market and number of users and the time they are spending on the web represent a high growth potential for portals with good content, therefore high traffic and brand recognition by advertisers, as UOL, going forward.

 

PNAD Data on Households
Item		2005	2006	Change
Refrigerator		88,0%	89,2%	1,4%
Telephone		71,6%	74,5%	4,1%
TV set		91,4%	93,0%	1,8%
Computer		18,6%	22,1%	18,8%
Source: IBGE - PNAD 2006

 

The table above shows that computers penetration is behind other appliances/equipments/services existing at Brazilian homes; and among other categories surveyed by IBGE it has have the fastest growth.

 

Increased adoption of e-commerce among Internet users. We believe that the relatively high penetration of online banking and the large number of income tax returns filed online, as well as the popularity of online communities (e.g. Orkut) illustrate the willingness of Brazilians to adopt new technologies. E-commerce in Brazil is growing from its current low penetration of approximately 20% of Internet users, compared to 85 % of internet users in the United States. We believe that e-commerce penetration in Brazil will likely increase as more people have positive experiences buying online.

 

In September/2007, the comparison shopping segment has the following ranking in Brazil based on unique visitors (000):

 

Buscapé                       2,514

UOL                               1,961

Bondfaro              835

Terra (Buscapé)               728

 

Source: Ibope/NetRatings – Sept 2007.

Note: This table is not comparable to the one below, because they are estimated by different companies and periods.

 

Brazil–– Retail Sites

Total unique

visitors (000s)  Reach (%)

Total Internet audience                       15,307             100%

1 Mercado Libre (1)                               7,440                48.6

2 Submarino (2)                                    3,775                24.5

3 Buscapé (3)                                        3,539                23.1

4 Americanas  (2)                                  2,883                18.8

5 Claro (4)                                             1,985                13.0

6 Bondfaro (3)                                       1,228                  8.0

7 UOL Shopping                                   1,205                  7.9

8 eBay                                                  1,165                 7.6

9 Shoptime (2)                                      1.077                 7.0

10 Livrarias Saraiva (5)                            975                  6.4

 

Notes:  (1) Mercado Libre is the equivalent to Ebay and operates in Latam (ticker: MELI).

(2) All belong to B2W (Bovespa ticker: BTOW3).

            (3) Buscapé owns Bondfaro, and they are comparison shopping engines.

            (4) Belongs to American Movil’s Brazilian operation.

            (5) Publishing, bookstore and online store operating in Brazil (Bovespa ticker: SLED4).

 

Source: Comscore Media Metrix; March 2007

 

According to Forrester Research, online sales of general merchandise reached R$2.8 billion in 2005 and are expected to grow to R$12.8 billion by 2010 representing a compound annual growth rate of approximately 38%.

 

Rising broadband penetration. According to a report by www.teleco.com.br , Brazil had almost 7 million (3Q07) broadband subscribers (approximately 3.7% of the Brazilian population or equivalent to 16.7% of the households). The growth Y-O-Y is 34.7%, based on data of Set/2006.  It is expected to reach 10 million broadband subscribers by 2010. Broadband penetration will increase as the cost of service is reduced and greater awareness of the benefits of broadband develops; this increase in broadband penetration is expected to yield higher average expenditures per online shopper. Around 86% of the broadband connections are from homes. For comparison purpose, Argentina has 2.8 millions of broadband subscribers, for a population of 38 million.

 

Low Internet Advertising Expenditures. According the newsletter “Meio & Mensagem”, who tracks the advertising expenditures by media in Brazil with the help of PriceWaterhouse Coopers, advertising aimed to Internet is having a huge growth, as can be seen in the table below.  

 

ADVERTISING SPENDING by MEDIA (BRL million)
Brazil	Acum.	Acum.
MEDIA	Set/06	Set/07	Change %	Share %
TV	7.482	7.855	5,0%	59,3%
Newspaper	1.988	2.191	10,1%	16,5%
Magazines	1.018	1.057	3,8%	8,0%
Radio	530	528	-0,4%	4,0%
Pay-Tv	368	427	16,1%	3,2%
Billboard etc.	467	391	-16,2%	3,0%
Guides/Phone Lists	443	383	-13,6%	2,9%
INTERNET	253	353	39,7%	2,7%
Movie Theaters	40	49	24,3%	0,4%
Total	12.589	13.234	5,1%	100,0%
Source: Inter-Meios - Nov 26, 2007.

 

Internet share in Brazilian’s advertising pie is well below world averages, 2.7% against 7.4% in 2007, so there is a huge growth ahead. Besides that, Brazil spends comparatively a good chunk of its GDP in advertising as can be seen below.

 

 

Advertising Spending as % GDP - 2006 (selected Countries)
USA		1,32%
UK		0,94%
Argentina		0,74%
Brazil		0,69%
India		0,51%
Mexico		0,50%
China		0,47%
Source: ZenithOptimidia

 

 

For comparison purpose the total advertising market in Argentina is about ArP$ 5 billion (equivalent to BRL$ 2.9 billion) which is equal to about 0.7% of GDP. The Ad market in Brazil is six times bigger than Argentina.

 

Global advertising expenditure by Media (US$ million)

	2005	2006	2007e	2008e	2009e
Newspapers	120,367	125,043	127,916	131,369	135,011
Magazines	52,722	54,616	56,397	58,618	61,152
Television	151,191	161,389	168,988	180,318	188,759
Radio	34,225	35,225	36,283	37,461	39,064
Cinema	1,717	1,794	1,908	2,096	2,320
Outdoor	21,944	23,948	25,685	27,615	29,718
Internet	19,419	26,031	33,465	41,197	47,436
Total *	401,585	428,047	450,642	478,673	503,460

Source: ZenithOptimedia

·        *The totals here are lower than the overall totals, because few countries are not included above because spend is not itemized by medium.

·        Notes:  In US$ million at current prices and currency conversion at 2006 average rates.

 

	2005	2006	2007e	2008e	2009e
Newspapers	30.0	29.2	28.4	27.4	26.8
Magazines	13.1	12.8	12.5	12.2	12.1
Television	37.6	37.7	37.5	37.7	37.5
Radio	8.5	8.2	8.1	7.8	7.8
Cinema	0.4	0.4	0.4	0.4	0.5
Outdoor	5.5	5.6	5.7	5.8	5.9
Internet	4.8	6.1	7.4	8.6	9.4

Source: ZenithOptimedia

 

 

RELATED COMPANIES FUELED by INTERNET GROWTH

 

We are mentioning this in order to double check what is going on the overall internet business in Brazil, so the reader can figure out that the growth drivers have a solid foundation.

 

Positivo Informática, the largest PC manufacturer in Brazil (listed at São Paulo Stock Exchange – ticker: POSI3) is growing fast its computer sales. For the 9 months of 2007, its units sales increased from 533K PCs to 941K y-o-y, this mean an increase of 77%. According to IDC data from 9/2007, Positivo is the leading computer manufacturer with a market share of almost 15%. Total sales of PCs in Brazil in the last 12 months were 8.5 million units. Household PC penetration in Brazil is 19.6%, and in Mexico is 20.5%, but in absolute terms Brazil is the largest market in LATAM.

 

Net Serviços de Comunicações S.A. (it has an ADRs and is also listed at Sao Paulo Stock Exchange – ticker: NETC4) is also growing fast its broadband business based on cable modem. Broadband subscribers reached 1.3 million (3Q07), which means 71% up year-over-year. The net additions have a CAGR of 85.2% from 3Q05 to 3Q07. Broadband subscribers in the 3Q05 were 302 thousand.

 

GVT (holding) S.A. (Bovespa ticker: GVTT3) is a telephone company that competes in the same region of Brasil Telecom (ADR ticker: BTM). GVT is also having an enormous growth in its ADSL broadband business, from 117K (3Q06) to 213K (3Q07), which means a growth of 82%. The company has 1.17 million lines in service (LIS) at end of 3Q07, after a growth of 29.7% over 3Q06.

 

B2W – Cia. Global de Varejo (Bovespa ticker: BTOW3) is the largest online retailer in Latin America. They sell from dishwashers to vacation packages, including computers, books etc. Their sales increased 45% Y-O-Y, from R$ 1.6 billion to R$ 2.3 billion at end of 3Q07. Gross profit in the first nine months of 2007 totaled R$ 487 million, generating gross margin of 30.2% of net revenue compared to gross profit of R$ 335 million and gross margin of 29.7% in the first nine months of 2006. EBITDA reached R$ 220 million in the first nine months of 2007 up 63% in relation to the same period of 2006.

 

OTHER RELEVANT DATA

 

Company’s management /controlling shareholder is not promotional about the business and they are not disclosing cash ads due competitive reasons. Besides that, there is no disclosure separately about the results of two main business segments, which difficult outside analysts to ascertain the true company valuation/potential. We don’t believe that there is any problem with UOL’s accounting, because the main shareholder (Frias family) owns the Folha de São Paulo, a newspaper with a prestige similar to the Washington Post in the Brazilian market, besides that they own 50% of Valor Economico, the main a business newspaper in Brazil.  Maybe they are not so interested in promoting the stock, because they are planning to buyout Portugal Telecom stake, which could be another use for the excess cash or buyout the market, and turn the company private again.

 

The explosive computer sales growth is being driven by three factors:

 

1)     government reduced some taxes on the low end computers, so they become affordable to low income people;

 

2)     the Brazilian central bank is reducing the basic interest rate (Selic rate); and the private banks increased maturity for consumer credit and created other credit products (consignee credit) that allowed the lower income people to afford a basic computer which in most of the cases come with a Linux operating system; and increased the overall retail sales of other products as well;

 

3)     the Real appreciated enormously against the Dollar in the last five year, from US$ 1.00 = R$ 3.6 to US$ 1.0 = R$ 1.80; and this provoked a huge reduction on computer prices/costs, besides the continued decrease in Dollars of the computer hardware’s price.

 

Therefore, any change on the three variables aforementioned (taxes, credit conditions / costs and exchange rate) will slow down computer sales and will affect the expected growth of internet users and all that depends on it.

 

On the other hand, the Brazilian government is trying to implement measures that will allow internet access by all citizens. One of the initiatives is to build a public broadband network which will link schools, universities, government services, public cyber stations etc, but private broadband suppliers are against that.

 

The cheapest broadband connection in Sao Paulo state (37% of Brazilian GDP) with all costs included (service, cable modem and ISP account) is R$ 65.00 (around US$ 36.00) for 200MBps, which is offered by Net (ticker:NETC4). Embratel, a company owned by Telmex (ticker: TMX), offers a free-dial up connection to internet, as also IG and YahooBrasil.

 

A basic branded computer such as a Compaq (HP) Model 3110br which comes with a Celeron CPU, 80 GB HD and a Linux operating system costs R$ 800,00 ( around US$ 440.00), and this could be paid in 12 installments without additional charges at www.americanas.com.br (one of the online shops owned by BTOW3). A very basic and  the cheapest computer that we found is an Amazon PC (a local brand) which comes with a VIA CPU – 1Ghz, 80GB HD and Linux operating system that costs R$ 449,00 (around US$ 250.00) and it could be paid up to 12 installments without additional charges at www.saraiva.com.br (which is owned by SLED4). The minimum wage in Brazil since May/2007 is R$ 380.00 (around US$ 211.00). Therefore, this low price for PCs and credit facilities allows internet penetration to increase at low income classes (C & D).

 

For comparison purpose, a basic TV set with 21” (CRT flat panel) made by Philips or LG could be purchased for R$ 429,00 (US$ 238.00) at www.submarino.com.br (another online shop owned by BTOW3), and it can be paid in 12 installments without additional charges.

 

FINANCIALS /  VALUATION

 

UOLL4 – EV/Ebitda Calc	BRL Million
Number of Shares (million)	120,1
Price	12,7
Mkt Cap	1.525,7
(-) Excess Cash	(451,4)
(-) Tax Credit	(124,6)
(+)Debt (Leasing contracts)	8,0
(+)Tax Debts Renegotiated	20,8
Enterprise Value	978,5
Ebitda 2008	183,0
EV/Ebitda Multiple	5,3

 

 

UOLL4 is cheap because it is trading at same level as other similar companies in other countries, which don’t have the same brand recognition and growth prospects as UOL.

 

We think that brand recognition as UOL enjoys (mainly for companies running sites or a community of sites) is an essential intangible asset and that today it is difficult to build this up from scratch. Brand (and image) takes on a strategic dimension since it provides audience figures or “natural traffic” that can be used by advertisers.

 

Multiples for internet companies that can take advantage of web advertising are trading at very high multiples (Google, Yahoo etc.).  However, I am not saying that UOL deserves the same multiple, but also doesn’t deserve a multiple similar to United Online (ticker: UNTD) of EV/Ebitda 5,7x (2008) which has a poor business model or like Earthlink (ticker: ELNK) with a multiple EV/EBITDA of 5.2x (2008). Besides that, newspapers are trading at EV/Ebitda 8.1x (2008) according Lehman Brothers.

 

Internet companies domiciled in Asia are trading at EV/Ebitda 17.1x (2008), and with the exclusion of Baidu (ticker: BIDU), that has a multiple of 60x EV/Ebitda (2008), according to Credit Suisse.

 

There were some acquisitions by media companies of content sites, such as:

 

1)     www.newsweb.fr which was purchased by Largardere Group, a French media conglomerate, which paid an EV/Sales of 6.8x or an EV/Ebit of 19.2x .

2)     www.aufeminin.com , that was acquired by the German media group, Axel Springer, and the multiples paid were EV/Sales 11.7x or an EV/Ebit  of 21.2x.

 

Both websites are pure content outfits, however based on recurring EBIT and a multiple of 15x, because UOL is not a pure content company, it could imply a share price of around R$ 21.00 ( Operations Value = Ebit R$ 128,2 MM x 15 + Net Cash of R$ 547 MM). Therefore UOLL4 has an upside of 65%.

 

We think that UOLL4 deserves a multiple 50% higher than the present multiple which means a price around R$ 17.00 or an upside of 34%.

 

UOL P & L (BRL Million)	2004	2005	2006	2007e	2008e
Gross Revenues	479,2	563,8	634,3	720,2	816,3
Subscription	393,1	456,9	484,6	527,5	569,7
Advertising+Other	86,1	106,9	149,7	192,7	246,6
(-) Deductions	(71,1)	(119,7)	(153,6)	(200,5)	(227,3)
Net Revenues	408,1	444,1	480,7	519,7	589,1
Net Revenues Growth	n.a.	8,8%	8,2%	8,1%	13,4%
COServicesSold	(193,3)	(214,7)	(215,4)	(207,9)	(241,5)
Gross Profit	214,8	229,4	265,3	311,8	347,6
Gross Margin	52,6%	51,7%	55,2%	60,0%	59,0%
S, G &A	(159,6)	(154,1)	(150,3)	(156,7)	(164,5)
Other Oper (Exp.) Reven.	(4,3)	24,1	19,8	17,0	0
Depreciation & Amortiz.	(24,7)	(21,5)	(32,7)	(43,9)	(54,9)
EBIT before Non-Recur.	26,2	77,9	102,1	128,2	128,2
(-) Non Recurring	4,3	(24,1)	(19,8)	(17,0)	0
EBIT Recurring	30,5	53,8	82,3	111,2	128,2
(+) Depreciation & Amort.	24,7	21,5	32,7	43,9	54,9
EBITDA	55,2	75,3	115,0	155,1	183,0
Ebitda Growth	n.a.	36%	53%	34,9%	18%
Ebitda Margin	14%	17%	24%	30%	31%

Catalyst

1)Shares buyback next year and they have excess cash for that, so it will not impair the business.
2)Advertising revenues continue to growth despite the competition due its portal content, popularity among internet users and brand recognition by advertisers.
3)The company could be acquired by another media company due its preeminence among the Brazilian portals.