Investors in large Latin American mobile phone service provider America Movil (NYSE:AMX) have gotten a respite lately from the worries about serious changes to the regulatory environment in Mexico. A decent earnings report showed that there's still some room for performance, while a transaction in Europe highlighted the potential value of at least one of its strategic investments. All told, though, this is a company still facing some serious challenges in its business, and one where investors still aren't completely confident in management's long-term ambitions.
A Good Second Quarter … Sort Of
Late last week, America Movil announced a set of results for the second quarter that, while better than expected, weren't exactly what investors were hoping to see.
Revenue rose 2% as reported (up 1% sequentially), with currency-neutral revenue growth of about 8%. That revenue figure was about 2% better than analysts expected, with revenue in key markets Mexico and Brazil up 5% and 8%, respectively. The “but” here is that service revenue was actually down 1%, with the beat coming from higher-than-expected equipment sales.
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Profitability was also higher than expected, but not exactly strong. EBTIDA was about 4% higher than expected, but still down 2% from the year-ago period. Profits were helped in part by more restrained marketing spending. It's worth noting, though, that while consolidated EBTIDA declined, profits were higher in both Mexico and Brazil (2% and 3%, respectively) and rebounded nicely in Colombia (up 11%).
Still Growing The Business, But At A Slower Pace
Even with fierce competition from the likes of Telefonica (NYSE: TEF) and Millicom, America Movil continues to grow the business, but not in wireless. America Movil saw a net loss of nearly 900,000 wireless customers this quarter, though the wireless subscriber count is still above 262 million. Importantly, America Movil continues to add subs in key markets like Mexico, Brazil, and Colombia, and has been supplementing its wireless business by getting more customers to sign up for additional offerings like pay TV, leading to 9% growth in “revenue generating” units.
The Company's European Strategy Gets Even Murkier
One of the issues for this company has been its uncertain deployment of capital – uncertain as in whether or not management is maximizing shareholder value by investing large sums of capital into struggling European service providers like KPN (Nasdaq: KKPNY) and Telekom Austria. While a recent development at KPN has highlighted some of the underlying value, America Movil's response likewise highlights the uncertainty around management's intentions.
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A unit of Telefonica surprised the market with a cash and equity bid for E-Plus, KPN's German mobile unit, that could be worth close to 8 billion euros (with 5 billion of that in cash). While that bid was quite a bit more than where the market was valuing the unit, KPN's financial results, with revenue down 7% in the Dutch telco business, are a reminder that this business is still seriously challenged.
What makes this all curious is that America Movil has now indicated that it intends to end the agreement that capped its ownership of 30% at KPN. The acquisition of the E-Plus unit allows AMX to do this legally, and speculation is now building that America Movil not only feels that the Telefonica bid for E-Plus is too low (and that's not a done deal), but wants to acquire a majority stake in this company. With Western Europe's telecom markets thoroughly penetrated and growing slowly, this would be a controversial move, particularly as America Movil has never shown any particular expertise in turning around businesses or generating impressive margins in highly competitive markets (like Brazil).
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The Bottom Line
I continue to believe that the changes in the Mexican regulatory environment will be less damaging to the company than many fear. Likewise, I believe the long-term margin/profit potential in Brazil is better than it looks today, as America Movil's rivals cannot generate the returns on capital they need to remain competitive long-term.
Even so, the shares are not remarkably cheap today. Low-to mid single-digit revenue growth should translate into better long-term free cash flow growth as the company leverages past investment, and that suggests the shares are about 10% undervalued. Given the risks with capital allocation and regulatory changes, readers will need to decide for themselves whether 10% reward is sufficient for those risks.
Disclosure – At the time of writing, the author owned shares of America Movil.