Telemig Celular SA (TMB)

Telemig Celular Participa es S.A. (TMB) is the leading provider of cellular telecommunications services in the state of Minas Gerais in southeastern Brazil. The Brasilia-based company was formed in May 1998 as a result of the breakup of Telecomunica es Brasileiras S.A. (Telebras), which was part of the Brazilian privatization program. The company is well managed and has a dominant position in the state of Minas Gerais, southeast of Brazil, which has a population of nearly 18 million and is the country's third wealthiest state. Minas Gerais is an area full of potential growth opportunities. As of September 2008, the company reached 4.52 million subscribers, representing an estimated market share of 28.9% in its region. Telemig has been investing in the modernization of its network by implementing a modern Global System for Mobile Communications (GSM) technology. Telemig was recently acquired by Vivo (VIV) the market leader in the Brazilian wireless industry.

The Brazilian wireless business continues to grow rapidly. According to ANATEL, at the end of 2006 wireless subscribers were over 99 million, up 15.9% from December 2005 and at the end of 2007, total subscribers reached 121 million. The growth continued in 2008, reaching 140.79 million at the end of third quarter 2008. Considering those numbers it is quite clear that the wireless business in Brazil will remain heated. Currently, the penetration ratio in Brazil is now over 71.0% and has been growing sequentially, but it still remains below international levels. Given strong subscriber growth figures and higher overall growth levels in the Brazilian economy, we are now forecasting the wireless penetration level in Brazil to reach around 93% and total subscribers representing something close to 184 million by 2010. The current economic crisis will certainly affect Brazil and its wireless market. However, we believe the growth will continue at a slower pace. Below, we can see the growth of the Brazilian wireless subscriber base during December 2005 until September 2008:

The continued expansion in the Brazilian wireless market has been fueled by the positive environment for the Brazilian economy. The economic outlook for Brazil for the medium-term remains promising and continuous improvement in the Brazilian economic environment made Brazil reach investment grade just some months ago when the rating agency Standard & Poor's and Fitch upgraded Brazil to investment grade. However, Brazilian Central Bank decided to raise basic interest rates in the very short-term. After the August 2007 Bank meeting, an official report was released with strong comments on domestic inflation pressures. In October 2007, it was decided to leave rates unchanged for the first time in two years. In December 2007 and January 2008, rates were left unchanged. In March and May 2008, the Brazilian Central Bank decided to raise rates by 50 basis points consecutively for each month to 12.25 % per year. In July and September 2008, the BCB consecutively hiked rates by another 75 basis points to 13.75%, where it currently stands after no hike in the October 2008 meeting. The international crisis reaches Brazil in a more positive economic situation. The country has huge international reserves (above US$200 billion), a positive trade balance, slightly negative current account balance, reasonably solid fiscal situation and very high interest rates that could be reduced over the following quarters in order to keep the economy growing. Even though Brazil will be affected by this crisis, we do not expect a recession or anything alike, GDP growth for 2008 will be over 5% and expected Brazilian GDP growth for 2009 remains around 3.5%.

The fiercely competitive environment and the recent global financial crisis is a problem for the wireless industry in Brazil. Nevertheless, Telemig has been posting good results much better than most of the Brazilian wireless operators. Telemig has one of the strongest balance sheets in the Brazilian wireless industry. This strategy has been very important for TMB in order to take advantage of the still high interest rates in Brazil, avoiding the risky strategy that other companies followed to finance growth using a large amount of debt. The strong cash position coupled with the huge cash-flow generation and low exposure to the international cycle will help TMB in the following quarters.

On August 3, 2007, Mr. Roberto Lima, the Chairman of Vivo (VIV), announced the acquisition of Telemig and Amazonia Celular by the amount of R$1.2 billion (US$619 million). In fact, this acquisition was very important for Vivo, since it needs to expand its national coverage to remain a market leader. Telemig is an important player in the State of Minas Gerais, which is a very important region. We always thought that the acquisition of Telemig was just a matter of time, since it was a small independent company within a very competitive market dominated by few big players. The acquisition of TMB was the beginning of the consolidation process of the Brazilian wireless industry, a development that will help to reduce competition and increase margins in the medium-term. Nevertheless, just some months ago it was announced the merger of Telemar (TNE) and Brazil Telecom (BRP). Both companies have a strong presence in the wireless market and the new company will certainly be a major force in the market. Even though this is not positive news, we does not change our positive view on Telemig, mainly now that TMB belongs to Vivo group with a huge national presence and capacity to fight for market share against other national players.

The company always had a more rational attitude towards sales promotions, maintaining its strategy focused on high-value client acquisition and retention, and keeping handset prices above market's average. However, after the acquisition by Vivo the company became more aggressive in terms of client retention and handsets subsidies. The company implemented an aggressive growth strategy for the Christmas period and achieved a huge growth in its client base during the first quarter of 2008 however this achievement came with a price and we found first quarter ARPU somewhat disappointing. Due to a more aggressive marketing strategy, the company posted higher equipments and marketing costs, but lower EBITDA margin, and net income. At the end of second quarter of 2008, Telemig Celular's client base totaled 4.26 million users, and thus, regained its market leadership in the state of Minas Gerais. Such improved performance in the quarter was based on the launch of the Vivo brand, the Company's coverage expansion throughout the country, the wider offer of plans and handsets, and, also, the Mother s Day and Valentine's Day campaigns in the second quarter. During the third quarter of 2008, the company maintained its market share of 28.9% but total client base reached to 4.52 million. The company has been showing the efficiency of its operations and the commitment to upholding the quality of its services and enhancing its coverage. During the quarter revenue increased 25.0% year over year but EBITDA remained flat on a yearly basis. Net income decreased 11.0% year over year but increased 233.3% from the previous quarter on the basis of an increase in EBITDA during the quarter compared to the previous quarter, thanks to strict cost discipline. In addition, Telemig still has the most solid balance sheet in the Brazilian wireless industry, with a net cash position of R$692.3 million (US$364.4 million) at the end of the third quarter 2008. In fact just the cash position represents US$20.25 per share. The current price seems absurd, mainly considering the high and stable cash position coupled with the fact that the company is profitable and efficient.

The company's very low valuation compared to the other Brazilian wireless operators is also remarkable. We believe that in the short-to-medium-term the valuation of Telemig will converge to that of Vivo. Additionally, in the medium-term, we expect Telemig to be incorporated into Vivo, with considerable synergy gains. In this sense we were pleased by the on April 3 2008 Vivo met all the conditions and formalities needed for the acquisition of Telemig, the amount of R$1.23 billion (US$707 million) was paid for the control of the company. Even better was that on April 8 2008 Vivo made a tender offer for the acquisition of 1/3 of the preferred stocks of Telemig Celular and Telemig Celular Participa es (TMB) with a premium of 25% over the average market in the 30 days before August 1, 2007, around US$76.00 per ADR. On August 15, 2008, TCO-IP, subsidiary of VIV, acquired Telemig Celular Participa es and Telemig Celular. Additionally, the company generates a lot of cash and is less exposed to the international economic cycle, a fact that would attractive risk-averse value seeking investors. Thus, we are keeping our Buy recommendation on Telemig, even though the less favorable international economic environment.

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