Brasil Telecom Still Attractive

We are keeping our current Buy recommendation on Brasil Telecom (BRP). The company posted better-than-expected results in the second quarter of 2008, and the short-term outlook remains positive. The company also has solid cash flow, decent operating margins in the wireline business, and an attractive valuation.

Additionally, the growth in the wireless and the broadband segments are encouraging and should continue in future quarters. Moreover, the merger with Telemar and the voluntary public tender offer creates a positive environment for the stock in the very short term. Finally with the creation of a subsidiary in Colombia recently, the merged company is planning for international expansion as well.

BRP is trading at 7.8x our 2008 EPS estimate, a huge discount to the industry mean and median, and an enterprise value to EBITDA (a more common valuation metric for the telecom industry) of just 2.6x our 2008 estimate. The EV/2008 EBITDA valuation remains well below the industry mean, and is lower than the historical range of 3.0x to 6.0x for most of the wireline Latin American telecom operators.

Additionally, BRP is trading at just 0.7x its price/sales ratio, well below the industry median and also below other Latin American telecom operators. We think the stock is trading at a highly attractive valuation. Our target price is US$84.50, which is based on an EV/2008 estimated EBITDA of 3.5x, close to the industry mean.

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