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October 17, 2001 


AES Hits Brick Wall in Venezuelan Acquisition 



By Will McNamara
Director, Electric Industry Analysis 


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[News item from Reuters] Venezuelan telecommunications firm CANTV, or Compania Anomima Nacional Telefonos, facing a $1.37-billion hostile takeover bid by AES Corp. (NYSE: AES) has forced a showdown with the U.S.-based global power company by announcing a share repurchase program. The Board of Directors of CANTV, Venezuela's biggest telecommunications company, recommended that shareholders approve a proposed share buyback program of up to 15 percent of CANTV's shares at a price of $30 per American Depositary Share (ADS), or approximately $4.29 per share. Analysts said the CANTV Board's proposals, which would be submitted to shareholders at an extraordinary meeting set for Oct. 24, clearly flung down the gauntlet to AES. 

Analysis: AES' expansion in Latin America's telecommunications market was always seen as a risky move, and now that risk seems to be resulting in a big bite out of the company's strategy. CANTV, which was an appealing takeover target for AES due to its long-standing monopoly over the telecom market in Venezuela, has a strong ally in the form of Verizon Communications (NYSE: VZ), which holds a 28.5-percent stake in the company. Verizon came out in support of the 15-percent repurchase program being launched by CANTV, which clearly is a form of aggressive resistance against AES' efforts to gain control over the company. The repurchase could be seen as a power play, with Verizon also seeking to increase its share in CANTV, which many analysts might see as a more appropriate synergy. However, this story also highlights the difficulty that AES has had with its expansion efforts in Latin America, especially since CANTV's resistance comes on the heels of AES' pulling out of another acquisition project in Ecuador. 

For background, it is important to note that AES already owns 6.9 percent of CANTV through its majority ownership of Electricidad de Caracas, Venezuela's largest private electricity company. Thus, the takeover effort is an attempt to gain majority ownership of the company and take control away from Verizon. CANTV, which was privatized a decade ago, is a full-service telecommunications provider offering switched and local, domestic and international long-distance service throughout Venezuela Company. CANTV also offers mobile cellular services, wireless services, Internet access and other value-added services, and owns all of the Venezuelan public exchanges and national network of public telephone lines. CANTV became privatized about 10 years ago and until last year reportedly had a monopoly on the fixed-line telephone service in Venezuela. The company has a market capitalization of $2.6 billion. 

AES had bid $24 in cash for each of the 28.57-million U.S.-listed shares in CANTV and $3.43 in cash for each of the 200 million shares of CANTV traded in Venezuela. AES' offer for CANTV's American shares represents a 9.2-percent premium over CANTV's closing price of $21.98 on Aug. 29, the time at which the takeover effort was launched. From the start of the offer, some critics charged that this bid was too low, but AES has maintained that the offer is fair. AES reportedly plans to sell off CANTV's mobile services, which account for about a quarter of the company's revenues, and distribute the proceeds to shareholders. 

CANTV was never very receptive to AES' bid, and did consider it to be a hostile takeover. In fact, workers' representatives at CANTV circulated a statement strongly objecting to the bid from AES, stating that the deal would severely damage Venezuela and CANTV workers. CANTV employees hold a 10.9-percent interest in the company. Now we see that CANTV is upping that resistance a notch by attempting a repurchase of its own stock. Note that CANTV will most likely issue the buyback program at $30, compared to the $24 that AES had offered. Thus, the challenge for AES, if it still wants to gain control over CANTV, will be to increase its already 9.2-percent premium offer. The word circulating in the industry is that AES still intends to proceed with its takeover attempt, and the CANTV strategy will not derail these attempts. 

AES' rationale for increasing its holdings in the company is most likely twofold in nature. First, AES obviously finds great appeal in the Latin American market as the company already owns electricity assets in Brazil, Chile and other countries. Just this week, AES announced its penetration of the Argentina market by inking a $376-million deal to purchase distribution and generation assets in that country from New Jersey-based Public Service Enterprise Group (PSEG). In another recent announcement, AES launched a cash tender offer to acquire all of the outstanding loan participation certificates of Empresa Electrica del Norte Grande in northern Chile, a company that consists of 716 MW of generation and 1,056 kilometers of transmission. In fact, AES reportedly rivals Spain's Endesa as the region's most dominant power company and by all appearances now derives a large part of its business throughout Latin America. Whereas AES was clearly diversified across the United States, Asia, Europe, and Latin America, many investors now perceive the company as moving into a heavier focus on Latin America, which constitutes a risky proposition in and of itself due to unique politics in the various Latin American countries. 

However, AES recently pulled out of its attempt to launch a $128-million takeover bid for Chilean generator Edelnor. Currently, Edelnor, which is one of the largest electrical generators in Chile, is controlled by Mirant Corp., one of AES' direct competitors in the independent power producing market. Perhaps also reacting to the volatility in the region, Mirant has announced that it will not sink any additional capital into the Edelnor unit unless it can be assured of repayment. AES did not give a reason for its decision to terminate the Edelnor takeover, but one can surmise that investor reactor to its ongoing efforts in Venezuela may have been a significant factor. Further, on Sept. 25, AES cut its earnings estimate for 2001 to a range of $1.25 to $1.45 per share from a previous range of $1.75 to $1.90. AES blamed poor currency exchange rates between the Brazilian real and U.S. dollar, lower U.K. power prices, and the company's inability to replace earnings anticipated from the planned acquisition of the Mohave power plant. The drop in AES' earnings estimate may have lowered available capital that the company needed to purchase Edelnor. 

AES shares were priced at $24.25 prior to the earnings revision. After the announcement, at least as of early morning trading on Sept. 27, AES shares were priced at $12.25, significantly down from the 52-week high of $73, which is what the stock was priced at a year ago. As of early morning trading on Oct. 17, AES shares were priced at $14.81. 

Moreover, investors did not react positively to AES' plan to increase its stake in CANTV. In fact, after word of the deal began to circulate on Aug. 29 (a day on which many stocks fell) AES' stock closed down $2.94, or 8.3 percent, to a 20-month low of $32.65 on the New York Stock Exchange. AES CEO Dennis Bakke immediately attempted to reassure investors that the purchase did not represent a change of strategy for AES, which he says will remain focused on power. In addition, Bakke noted that the purchase does not represent a new venture for AES as the company already holds telecom assets in Brazil and Bolivia. Further, Bakke clearly stated that AES is "not going to announce a bunch of telecom acquisitions around the world." Nevertheless, some investors believe that AES is imprudently expanding into the telecom sector, which is already significantly troubled, and becoming too heavily entrenched in Latin America, a market that is prone to political volatility. One investment analyst perhaps spoke for many when he commented that AES has little experience in the telecom sector and its limited experience to date has not been terribly successful. This, coupled with the general market downturn for most companies with telecom exposure, does not make for a good recipe from an investor's perspective, at least as of today. 

In fairness to AES, penetrating the Venezuelan market could represent a very strategic move from a long-term perspective. With a population of 23.5 million, Venezuela represents a large potential market for energy and other related services. In addition, Venezuela is an asset-rich country, particularly with regard to oil resources. According to the Department of Energy, Venezuela is important to world energy markets because it holds proven oil reserves of 77 billion barrels, plus billions of barrels of extra-heavy oil and bitumen. Venezuela consistently ranks as one the top suppliers of U.S. oil imports and is among the top 10 crude oil producers in the world. In addition, as noted AES' investments in Latin America are not exclusively focused on Venezuela, as the company also is present in Argentina, Brazil, Chile, etc. 

Concerns about telecom arguably overshadow concerns about expansion in Latin America and play a larger role in the drop in AES' stock, especially when we consider that AES has been present in Latin America for some time. Only little more than a year ago, the telecom sector was at its peak, with billions of capital investment flooding into the sector as wildly optimistic expectations for demand seemingly exaggerated the scale of the market. However, a massive downturn has ensued, impacting not only companies operating in the telecom space but the nation's entire economy as well. The bottom of the telecom sector has fallen out, due in large part to the fact that the increase in bandwidth capacity has outpaced the growth in market demand. 

As I've said before when analyzing this company, the further that AES departs from its core strategy, the more likely it is that we will continue to see volatility in the company's stock. Up until these recent announcements, AES maintained that it was engaged in three lines of businesses, which were all equally important to its strategy: power generation, network delivery services and retail energy marketing. Generation always appeared to be the main core of the company's business model, as AES controls some 125 facilities totaling over 44 gigawatts of capacity worldwide. This business model worked well for AES and was well received by investors. Any perceived deviation from this successful strategy-especially if it includes expansion into the dangerous territory of telecom-could mark a new and risky era for AES. 

Nevertheless, one could also surmise that AES has found a market opportunity that is worth exploring. Latin America has low electrification and Internet usage statistics. Some analysts project high growth in the next 5 to 10 years in Latin America in both electrification and Internet use, which in turn involves telecommunications. The telecom industry is struggling at the moment. Thus, if one believes that telecom will make a comeback, then buying now may make a wise strategy for those involved. 


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