Telesp Upgraded to Neutral

Net income in the second quarter rose 10.3% year over year. Growth in Interconnection, data transmission and Pay TV business led to the company’s profitability. However, net operating revenue fell 1.6% year over year, due to the erosion in legacy telephony business despite higher access lines.

Telesp, the Brazilian subsidiary of Spanish telecom giant Telefonica (TEF - Analyst Report), provides local voice, intra/inter-regional and international long-distance services and custom data transmission services. The company also offers broadband Internet (under the “Speedy” and “Ajato” brands) and Pay-TV services.

The company is diversifying its business to offset the decline in its traditional wireline telephony operation. Investments in new businesses can be attributed to the limited opportunity in Telesp’s highly matured local and long-distance phone operations. Growth in the company’s relatively new broadband Internet and Pay-TV businesses has been encouraging so far.

Operating metrics for broadband and Pay-TV businesses are high (boosted by bundled services) and continue to offset declines in voice access. Telesp’s broadband business is expected to deliver respectable growth going forward with its “Speedy” broadband service (offering top speeds of 30 Mbps) dominating the domestic market.

Though the company’s new business opportunities are paying off, we believe Telesp remains significantly challenged by the falling subscriber base of its legacy voice telephony operation. Telesp is exposed to competition from alternative services including wireless telephony, VoIP (Internet phone) and cable services (voice, video and broadband). Telesp operates in a highly matured local and long-distance phone market and is exposed to a stringent regulatory environment (including tariff revisions).