Few businesses make the eyes of investors glaze over like a power utility. However, as in many industries, the Internet is working its magic on these traditionally dull assets, and some utilities are actually beginning to look exciting, and even glamorous.
“All of a sudden [utility] companies are becoming sexy,” says Mark Hoff, director of CG/LA Infrastructure’s power sector. “This new line of business adds some cachet that these companies did not have before.”
As investors in the US and in western Europe have already discovered, companies such as power transmission companies, railroad or highway operators own the potentially lucrative right to lay high-density data transmission cables between cities, the hardware that provides the backbone for Internet communications.
The Internet’s explosive growth has created strong demand for data transmission in Latin America as it has in the US. Luiz Carvalho, Latin America telecom analyst at Morgan Stanley Dean Witter, believes data transmission in the region is likely to grow at an average rate in excess of 30% over the next five years. A handful of utility companies in Latin America see this demand-and are preparing to capitalize on it.
Electricity distribution companies, in particular, are well positioned to provide data transmission venues: they own the valuable rights-of-way linking cities, as well as the so-called “last mile” into every household and office. Growth in the data transmission market could help boost recent lackluster performance of power companies.
While some electric companies like Brazil’s Companhia Paranaense de Energia (Copel) are already selling their data transmission services to third parties by using their fiber optic networks built for internal communication, other companies are investing heavily to expand their current networks. Once in place, the companies can either lease the lines or rights-of-way to third parties-exchange carriers, Internet Service Providers, cable or long-distance companies-to become a “carrier’s carrier,” or use the network to provide high-value services such as data storage or specialty software to clients.
As Mario Epelbaum of Morgan Stanley Dean Witter points out, it would be faster and cheaper for a telecom company entering a new region to lease physical space from a electricity company and lay fiber optic cables along the poles and towers that the electric company already has in place.
Electric utilities like Copel, which covers the southern Brazilian state of Parana, and Eletropaulo Metropolitana, which serves Sao Paulo, are taking advantage of their local loop and long-haul connections linking major Brazilian cities-an important advantage in this highly competitive and space-constrained environment. Both companies have telecom subsidiaries to oversee their data interests.Copel already has a 2,200 kilometer network in place, and has space-leasing contracts with about 40 third parties, including clients such as Embratel, Impsat and Global Telecom, through Copel Telecom, a wholly-owned subsidiary of Copel. Its revenues from these clients is approximately $7.5 million a year, a figure the company says it can quadruple by 2002. Copel was the first Brazilian utility to be granted permission by regulatory agency Anatel to sell data transmission services to third parties in 1995.
While Metropolitana’s network is not as developed as Copel’s, it has enormous potential, particularly because it controls the rights-of-way in Sao Paulo, say industry analysts. By the end of next year, Metropolitana is aiming to more than triple the current 600 kilometers of fiber it has in place. “That’s a very powerful piece of real estate in terms of having a presence in Brazil,” says MSDW’s Epelbaum.
Through its telecom subsidiary Metropolitana Telecom, the company has already started leasing lines to Vesper, a new company set up to provide wireless local loop telephone services. It also has a contract with Megatel, the competitor of Telefonica, and is bidding for new contracts with companies like Nextel and Inelig.
Epelbaum says Metropolitana Telecom represents a “significant hidden value” for shareholders. While analysts estimate that utilities data transmission business could add as much as 15% to the market capitalization of several Brazilian utilities, Epelbaum says this number could be higher for Metropolitana. “[Data transmission business] is the cream on the crop,” he says. “It makes [the stock] look more interesting, people are more attracted to the story.”
Data transmission indeed could provide a potential upside for utilities in Latin America, like it has for companies in the US and Europe. Spanish utility Endesa is a case in point. In the week following the company’s announcement of its joint venture with US electronic commerce company Commerce One Inc. and accounting firm PricewaterhouseCoopers in February, Endesa’s shares jumped more than 10%. The recent successful tests by European and Asian firms of data transmission through power lines could one day transform utilities into Internet providers, also helped boost Endesa’s stock price.
Endesa has publicly stated its interest in expanding into the telecom sector. Last year, Endesa paid $170 million for an additional 7% in Retevision, Spain’s second largest phone operator, raising its stake to 28.7%. Endesa plans to float the company’s Internet unit in June. Spanish utility Union Fenosa and Telecom Italia also hold stakes in Retevision. Analysts speculate that Endesa may bid for telecom licenses in Latin America.
Meanwhile, David Hurd of Deutsche Bank points to Chilean electricity company Chilectra, which earns income by renting its electricity poles for fiber optic installation. “That’s not its operating line, but if you strip it out, it represents about 10% of their bottom line. That’s basically what I’m eyeing: the possible 10% contribution [of data transmission] to the bottom line of these companies over the coming three years.”
Shawn Cumberland, managing director of Enron Caribbean, says the market has already rewarded Enron in its stock price for “jumping into the intellectual capital business” in US. Duff&Phelps Credit Rating Co. in January raised Enron’s rating from stable to positive outlook because of the company’s upside in broadband as well as its strong performance in the retail energy services and its reduced debt. While Enron has not yet delved into the data transmission business in Latin America, it is studying the possibilities to do so soon, says Cumberland.
A Cautionary View
But not all investors and analysts are applauding utilities’ jump into telecommunication ventures. Graham Makohoniuk, director of research at Globalvest Management Company, says investors should be careful to not repeat what is happening with Internet companies, which are exceedingly overvalued.”When and if these utility companies become ISP or telecom players, you really have to question the focus of the management and what they are doing,” he says. “Is this the best use of shareholder capital, or are they trying to capitalize on a sexy trend? I think it’s better if they stick to investing capital in reducing losses.”
While Hoff says fiber optic network expansion is “perfectly logical and necessary,” he says there are still doubts surrounding companies that have not yet disclosed the direction and use of these systems. “Will they be able to offer a coherent set of value added services?”
But expertise and savvy management are necessary for utilities to become data movers.
Sandra Boente of Salomon Smith Barney says most utilities lack both the know-how and the resources to compete successfully with the traditional telecom operators in the data transmission business.
“[Utilities] might feel they are well positioned to capture that value, but that doesn’t mean they are well positioned to mange the business,” says John O’Connor, vice president in the global power group at Duff&Phelps. “One thing is to manage a business in a regulated environment, another is to compete in a deregulated, hotly contested market. You better have a darn good business plan.”
In a number of Latin American countries, the government regulates power companies while there is no oversight in the telecommunications industry.
While industry analysts say the jury it still out on which utilities will successfully diversify into data, a number of companies hope to prevail by expanding their networks and forming partnerships with telecom-related companies as a way of gaining the necessary expertise.
Most of the action is in Brazil, which is no surprise given that more than half all Internet connections in Latin America are there. The simultaneous telecommunications and utility privatizations in Brazil-which opened the market to outside competitors-also make it a preferable market. Copel, for example, has a 45% ownership in Sercomtel, a telecom provider in Parana.
Several US-based utilities, like Enron, are looking to capitalize on Brazil’s potential market. Enron’s Cumberland says Enron Broadband Services (EBS)-formerly Enron Communications -is interested in getting involved in the data transmission business in Latin America, either through its gas pipelines or power line assets in countries where Enron already has a presence. Enron has operations in Argentina, Brazil, Bolivia, Colombia, Venezuela, Central America and the Caribbean.
“Enron is good at leveraging their physical network, their network of human capital and knowledge of countries,” says Cumberland. “There is a big push to explore ways to use this expertise to build up this new business [in Latin America].”
O’Connor, of Duff&Phelps, says that in the next couple years Enron’s ventures in Latin America may contribute significantly to the company’s overall earnings and cash flow. “Enron is flexible enough to adapt a business model where others can’t. Enron is a market maker, it plays a significant role in the deregulated market. They did it in natural gas.”
Meanwhile, Sempra recently created Sempra Communications to oversee the company’s telecom ventures, says Michael Allman, president of Sempra Communications. The company, he says, wants to capitalize on its assets in Latin America, especially in Chile, Peru and Argentina, where it has utility operations. “But this is all still in development stage,” he says.
AES, meanwhile, has already embarked on an ambitious $500 million project that includes construction of a fiber optic network comprised of 12 network connections called rings throughout Brazil. Electronet, a long-haul fiber optic company that uses Electrobras’ transmission grid controlled by AES, will integrate its partners’ existing electric distribution and transmission systems. Partners include Infovias (Minas Gerais), Electropaulo Telecom (Sao Paulo), Light Telecom (Rio) and AES SUL Telecom. This project is AES’s first telecom venture ever.
Last year, AES paid $170 million for 51% of Eletronet through Lightpar, a subsidiary of Eletrobras. Electrobras own the remaining 49% of Electronet. Construction of the network, which will include 22,000 kilometers of long-distance and 8,000 kilometers of local network, began in March and is expected to done by the end of next year, says Elson Lopes, president and CEO of Eletronet. The first and most important ring, which connects the major cities in Brazil, from Rio de Janeiro, Sao Paulo, Minas Gerais and Brasilia, should be completed by the end of this year.
AES and its partners are financing the project with $170 million in equity, as well as new cash generated from the second year of operation of the network, and debt.
Lopes says it is possible that Eletronet may become a complete Internet access provider, and not just a carrier’s carrier after the Brazilian telecommunications market opens up in 2002. “Everybody has this in mind,” says Lopes, who coordinates the telecom efforts of AES in Brazil. “We still haven’t defined how and when to tackle the assets we have.”
AES may even consider spinning off Eletronet as a separate company to oversee its data business. “Right now AES is gaining muscle in the telecom business in Latin America,” says Lopes. This means quickly building its ambitious fiber optic network. “We need to implement [the network] in a short time window because if we don’t provide a solution to our [telecommunication] customers, they will build [the networks] themselves. We want to discourage them to do that.”
Sticking to Their Knitting
Rather than exploring new ventures, some analysts and investors says utilities should focus on expanding and even improving their core business in Latin America-especially in Brazil, where the electricity supply is not meeting the demand.
“Companies should focus on creating additional capacity to meet that demand, especially with natural gas from Bolivia,” says Globalvest’s Makohoniuk. “Government and regulators in Brazil have a tariff structure to encourage capacity construction, and that’s where capital would be going in a logical and rational world.”
Some say that utilities venture into the telecom business is just a gimmick to draw attention to utilities. “Anything that smells or rubs up against the Internet, or has the letter “I” attached to it, is rewarded by the market,” Makohaunic says.
At the same time, some analysts say that with continued investment in network expansions and management and the right regulatory structure, data transmission could turn into a lucrative business for utilities. But it will some time before these benefits materialize.
“There is still uncertainty in some markets in Latin America, even on the distribution side, such as price resets, foreign exchange risk, political changes,” says O’Connor. “So as an asset manager in a Latin American country, you could have your hands full just with looking at regulated assets.”