Merrill's HOLDR upgrade from July 29th...
Thanks Mike!
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July 29, 1998
TELEBRAS HOLDRs
A great way to Play the Privatization
Reason for report: Initial Opinion
BUY Long Term BUY
Investment Highlights:
- We are initiating coverage of Telebras HOLDRs (TBH) with a Buy rating.
- The depository recepits opened for trading yesterday and closed at $113 1/4 per DR, which is 36% below our $154 price objective.
- On a daily basis, TBH should trade close to the price of Telebras ADSs (TBR) or the sum of its parts after the spin-off occurs. Any significant price discrepancies would result in short-term arbitrage profits.
Fundamental Highlights:
- Telebras has been reorganized into 12 holding companies that will be spun-off to shareholders over the next few weeks. Telebras HOLDing Company Depositary Receipts (HOLDRs) are simply ADRs that currently represent TBR and will ultimately represent the twelve underlying companies.
- We recommend that most individual investors who currently own Telebras, sell their Telebras shares and buy Telebras HOLDRs.
- Institutional investors who plan to only own two or three of the larger spin-off companies can improve their liquidity, buy some decision making time and lower their transaction costs by swapping to TBH.
- Investors with long-term options contracts on Telebras should find TBH to be an economical vehicle for covering their margin positions.
What are Telebras HOLDRs?
Telebras has been reorganized into 12 holding companies that will be spun-off to shareholders. The first spin-offs should take place later this week and the last could occur as late as mid-September. Telebras HOLding Company Depositary Receipts (HOLDRs) are ADRs that currently represent Telebras ADS (TBR). As Telebras is spun-off, TBH will provide a single NYSE traded instrument representing an investment in all of the spun-off companies.
We recommend TBH for those investors who prefer to own one security that represents a diversified and relatively liquid position in the Brazilian telecommunications industry.
A Transitional Investment
We view TBH as an investment vehicle that will help both individual and institutional investors make the transition from one Telebras to 12 holding companies. It is designed to help three groups of Telebras investors - individuals, certain institutions and those who hold options contracts on Telebras.
We do not view TBH as a security that investors should hold for several years. From a practical standpoint we only expect it to be actively traded for the next 18 to 24 months. After this point, we expect that most investors will have either realized their gains and/or decided to focus their investments on a few of the underlying stocks.
We expect TBH to trade very closely to the sum of its individual parts. If it trades at a discount or a premium we expect the arbitrage community ti bring the price of TBH back into line with its underlying components in short order.
Individual Investors - A Question of Suitability
To date, we believe that Telebras ADRs have been an appropriate way for many individual investors to play the privitization of Brazil's telecom industry. While Telebras is a high-risk (D-rated) investment, it is reasonably liquid and provides investors with an opportunity to diversify their portfolios. After the spin-off companies begin to trade separately, investors should find that many of the new entities are much less liquid and much more volatile than their original Telebras investment. In particular, we believe that the four smallest companies, which provide cellular service in remote parts of Brazil, will be so small and illiquid that they will not be suitable investments for most individual investors.
We believe that such investors would be better served to sell their Telebras ADRs and buy Telebras HOLDRs. This will place one as close to ones original risk position in Telebras as is possible under the circumstances.
Institutional Investors - Liquidity and Lower Transaction Costs
We expect very few institutional investors to hold all twelve stocks after the spin-off. Most portfolio managers are likely to select two or three stocks from among the six largest companies. The smallest companies will represent tiny positions in most portfolios and we expect strong initial selling pressure on these names.
Investors who only plan to hold a few names should be able to lower their transaction costs and increase their liquidity by owning TBH rather than TBR. Let's say that you want to keep three of the underlying stocks. It would probably be cheaper to buy those shares and sell TBH (a total of four transactions) thatn to receive delivery of all twelve shares and sell nine of them.
Expected Performance of TBH
We expect the market to be confused regarding valuation when the spin-offs occur. Investors with a clear sense of the underlying value of these securities can reap substantial gains by exploting the initial mis-pricing of these securities. Indeed, an investor who picks the right stocks has an opportunity to substantially outperform those investors who hold all 12 securities.
By definition, TBH's appreciation potential should closely approximate the weighted average for the 12 underlying companies. Some of the companies will outperform TBH and some will under-perform it. At this stage it is not possible to recommend which names will outperform because they do not yet trade individually. However, we can and do recommend purchase of TBH because our price objective for the basket of securities is $154, which is 30% higher than the current price. The table on page one provides our price objectives for the underlying securities which total to our $154 price objective for TBH.
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