Imagine a Latin American investment conference in Miami in mid-1996 where a senior Brazilian official rises and outlines what then must have seemed like an ambitious vision for the state-owned telecommunications company, Telebras-one of the region’s largest and most liquid stocks.
In only two years, says the official, the nationwide Telebras group of 28 integrated telecommunications companies will spin off its cellular operations to create 54 new operating companies. These assets will then be restructured into 12 regional companies, separating their local, long-distance, and cellular networks and businesses. Not only will competition be introduced in every service category by 1999, but a new independent authority and a comprehensive regulatory framework will be established.
Moreover, a simultaneous sale to strategic investors of all the new companies will occur in just one day, with the restructuring and privatization conforming to rigorous SEC disclosure standards. Finally, the 12 new companies will be listed and traded on the New York Stock Exchange. And from all of this, the government will raise almost $20 billion.
In all likelihood, the audience would have laughed at such a privatization plan. Yet, by the end of 1998, thanks to the government’s management of the process, this seemingly improbable series of events was accomplished.
The ministry of communications faced the challenge of repackaging the Telebras system into attractive assets that would generate significant proceeds, but it also desired to elevate the Brazilian telecommunications network into the 21st century.
Three milestone policy choices created the framework for success: (a) the regulatory structure; (b) the break-up of Telebras; and (c) the simultaneous strategic sale auction.
The ministry’s direction of the sale-through its late Minister of Communications Sergio Motta-made the timing possible; he ran the two-year process like a forceful CEO rather than a cautious bureaucrat.
The transformation of the sector started with the creation of a unique regulatory approach.
Beginning in 1996, at weekly meetings in the ministry, the government’s principal financial advisers, Lehman Brothers and Dresdner Kleinwort Benson (which led a consortium of advisers between July 1996 and March 1998), assessed different regulatory models and canvassed potential investors for their views.
Consensus was reached on the need for an independent regulator and the desire for transparent regulatory procedures.
Opinions differed, however, over the timing of full competition and the level of mandated investments; full competition and heavy investment burdens could reduce investor demand, lower potential valuation, and create incentives for non-constructive competition.
To safeguard the sale process and maximize valuation, the ministry initially adopted graduated liberalization with differentiated protection periods and modest build-out targets.
During ratification of the General Telecommunications Law in early 1997, however, the phrase “immediate competition” had replaced gradual competition and a policy of substantial build-out targets became favored.
Since the legislative process developed a different framework, the ministry and the advisers developed a compromised approach: duopoly in all services would bring immediate competition, but full liberalization would not occur until three years later.
Through flexibility in the law, the ministry and the new regulatory agency, ANATEL, determined that investment burdens would be borne by both incumbents and new entrants, albeit to differing extents. While bringing neither the potential societal benefits nor the potential sale disadvantages of full competition, this compromise resolved political objectives and provided comfort to investors.
Generating significant sale proceeds and creating a competitive telecommunications industry were the central objectives that led to the massive restructuring of Telebras.
Initially, the simplest strategy appeared to be the “pulverization” of Latin America’s largest, publicly traded telephone company-a global equity offering similar to the Deutsche Telekom, France Telecom, or CANTV transactions.
Under this model, however, control premium prices would not be captured and international management expertise would not be lured.
Moreover, serious doubts were raised by the advisers about the feasibility of a strategic buyer purchasing control of a single company serving a population of over 160 million people.
The ministry then mandated the advisers in mid-1997 to explore all possible restructuring and sale alternatives, taking into account network reconfiguration, legal implications, company reorganization, employee redistribution, service territory combinations, valuation levels, and political sensitivity regarding regional integration.
This analysis indicated that: (a) strategic sales achieved more of the government’s objectives than public offerings; (b) cellular and fixed telephony businesses should be separated; and (c) 10 to 15 regional companies should create service territories of sufficient size to be not only attractive but also manageable enough to be “digestable” by potential buyers.
At a climactic meeting in early November 1997, the minister of communications summoned Lehman Brothers, Dresdner Kleinwort and the rest of his advisers and held a dramatic “roll call” meeting to render his decision: Telebras would cease to exist as a single company and would be sold as 12 regional holding companies-eight cellular entities, three local service companies, and one long-distance operator.
Telebras would become the “Ma Bell” of Latin America, without de jure monopoly power.
A Change in Strategy
As global market conditions began to worsen in 1997, a new imperative began to enter the policy dialogue in the form of the 1998 presidential electoral campaigns. With the strategic sale strategy and the restructuring model in place, the timing and the completion of the sales became the focal points of the ministry’s deliberations.
The measure of political success was the sale of all 12 companies at premium prices by August 1998. According to conventional wisdom, the sales were expected to be sequenced over two years, with the conclusion in late 1999.
However, since market and political risks were growing daily, advisers outlined a more radical approach which would maximize value and conclude the sales by mid-year 1998-the simultaneous strategic sales of all 12 companies on a single day. This had never been done before on such a massive scale; the closest models were the AT&T spin-offs and the United Kingdom’s regional electricity company public offerings.
The advisers developed and oversaw a timetable that attempted to resolve issues regarding the separation and reorganization of the companies, regulatory requirements of both the SEC and its counterpart in Brazil (the CVM) and the preparation for the auction process to be led by Brazil’s national development bank, BNDES.
Assembling hundreds of personnel from the ministry of communications, ANATEL and Telebras, plus an army of lawyers and consultants, the government began implementing the timetable, targeting July as the sale month. In spite of significant challenges, the sale model and the timetable was maintained, even as the oversight of the privatization process was transferred from the ministry of communications to the BNDES. By the time of the auction on July 29, 1998, the bulk of the tasks had been completed, which resulted in all 12 companies being sold at a premium to the established minimum prices, generating proceeds of almost $20 billion.
After two years, the unthinkable had been achieved. Along the way, numerous obstacles emerged that could have derailed the privatization-deadlines were tight, legal complications abounded, and various interests were opposed to the process. The government overcame these impediments in various ways on various fronts, but the chief internal driver was the late minister Sergio Motta.
As time ran short on the implementation of the restructuring and sale model, Motta and his associates streamlined bureaucratic procedures, reorganized the Telebras companies internally, and helped ensure that the Brazilian legal appeal mechanisms would not delay the privatization. He was also one of the chief public spokesmen for the marketing of Telebras to the Brazilian public and the global investor community. His approach was rather non-traditional for a privatization manager; he designed a comprehensive methodology, became personally involved in all the details of implementation, directed the ministry and the Telebras system as the controlling shareholder, and sold the story.
The Telebras model challenges governments around the world to be bolder in planning future privatizations and dares them to think the unthinkable. The lessons here are numerous, but a fundamental message is that privatizations should not be treated as simple sales; they are tools for the transformation of industries, and indeed, societies. In a world of privatizations where the choice can be to do them rapidly or to do them properly, the scope of the Telebras privatization demonstrates that they can be done both rapidly and properly.
Three Lehman Brothers bankers contributed to this article: Vinode Ramgopal, head of global privatization; A. Roger Marinzoli, vice president in the global privatization and telecommunications group; and Ian Andrade, an analyst in the Latin American M&A group.