Increasing Regulatory Burdens Depressing America Movil's Growth

By Stephen D. Simpson, CFA | June 10, 2013 AAA

America Movil (NYSE:AMX) has historically been a pretty popular one-stop-shop pick for investors looking for broad exposure to Latin American consumer demand. While the markets have long since evolved beyond a point where investors had few emerging market choices beyond banks, telecom providers, and utilities America Movil still serves a growing region with an increasing focus on high-value bundled services. Worries about regulatory burdens have pushed these shares into value territory, but investors need to appreciate that the company is past the point where underlying market growth can patch over any and all problems.

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Mexico Turning The Screws On The Dominant Player
Whether or not America Movil has earned its dominant (roughly 67% market share) position in Mexico through better service and execution really doesn't matter anymore. What does matter is that the Mexican government has decided that it is in the best interests of the public to make it easier for rivals to compete with the company.

To that end, a host of new potential changes to the market have been proposed and could take effect later this year. America Movil could be required to share its network and infrastructure at regulated prices (typically the incremental cost), sell capacity at wholesale prices, receive asymmetric termination rates (paying out more than it receives), and may be placed under price controls and spectrum caps.

A few of these measures have been implemented in other markets America Movil services (including Chile and Colombia), and the results have been as you might expect โ€“ lower growth and lower margins.

Can Brazil Make It Better?
It is pretty clear that Mexican authorities want Telefonica (NYSE:TEF), NII Holdings (Nasdaq:NIHD), and Iusacell (not to mention newcomers to the market) to have a bigger share of the Mexican phone market. That should be bad for margins at America Movil, but improvements in Brazil could theoretically offset some of this pressure.

While Brazil represents almost as many subscribers to America Movil as Mexico, the profit contribution is much, much smaller as carriers have been competing fiercely for subs and market share. This can only go on so long, though, and providers are finding that the weak margins are starting to create some concern about future cash flows. If NII Holdings, Vivo Participacoes (NYSE:VIV), and Oi (Nasdaq:OIBR) decide to be more rational, the margin improvement potential could be significant.

But America Movil isn't waiting around for that. The company is moving to better integrate its cell services in Brazil with its pay TV business (where it has more than 50% share), with an eye towards generating more operating synergies and bundled subscribers.

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Survive Versus Thrive
America Movil has some built-in advantages that shouldn't be underestimated โ€“ including big advantages in network quality in many of its key markets. While limitations on participating in new auctions and forced sharing could erode this advantage in time, the company also has access to capital that many of its rivals do not and the company is nearing a point where big investments in 4G LTE infrastructure should start helping (instead of hurting) margins. Likewise, the company should become more of a player in pay TV throughout key Latin American markets (including Mexico), while also reaping the benefits of more higher-margin data traffic.

What this all means to me is that America Movil is not going to go away, but it will likely be much harder for the company to post the sort of growth that makes investors stand up and take notice. Unfortunately, it's not clear whether management will adapt to this new reality and offer a better dividend to ease the blow of lower growth โ€“ the company has been spending money building stakes in slow-growth European telcos and further value-destroying moves are likely to get a very negative reaction in the future.

The Bottom Line
I've held America Movil shares for some time now, and I'm still willing to wait and see if the company can start delivering some better margin leverage from Brazil and the network upgrades. That said, this stock now fits a different slot in my portfolio, one more skewed to value and potential income generation.

SEE: 5 Must-Have Metrics For Value Investors

If America Movil can generate mid-single digit free cash flow growth, these shares are at least 10% too cheap today. That sort of upside may not be enough for investors who fear the risks (currency, politics, economic volatility, etc.) that go with the stock, but investors looking for an under-appreciated Latin American services giant may want to still consider these shares now that it seems so much of the regulatory bad news has already come.

At the time of writing, Stephen D. Simpson owned shares of America Movil.

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