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Brazilian telecom carrier Telefonica Brasil SA (VIV - Analyst Report) reported second quarter 2012 net income of R$1,085.5 million ($554.7 million), down 5.6% year over year. Earnings per ADS came in at 49 cents, considerably lagging the Zacks Consensus Estimate of 56 cents.

Revenue dipped 0.2% year over year to R$8.24 billion ($4.2 billion), and also missed the Zacks Consensus Estimate of $4.37 billion, mainly due to the slowdown in fixed-line customer base.

Consolidated EBITDA inched up 1% year over year to R$3.1 billion ($1.6 billion) with EBITDA margin increasing 40 basis points (bps) to 37.5%. Operating expenses dropped 0.9% year over year to R$5.15 billion ($2.63 billion).

Revenue Segments

Mobile revenue climbed 8.4% year over year to R$5.12 billion ($2.62 billion), driven primarily by data and VAS, and access and usage revenues. Telefonica Brasil added 0.93 million customers in the quarter, thus taking its total subscriber base to 75.72 million (up 18.2% year over year). Post-paid and prepaid subscribers grew 20.6% and 17.5% year over year to 17.17 million and 58.54 million, respectively.

Average revenue per user (ARPU) fell 7% to R$21.9 ($11.2) as lower voice ARPU fully mitigated the growth in data ARPU. As a result of higher termination of 1.6 million inactive prepaid subscribers, customer churn upped 1% year over year to 3.8%.

Fixed revenue fell 11.7% year over year to R$3.11 billion ($1.6 billion). Pay TV performed the worst with revenue decline of 20.2% followed by declines of 17%, 13.5% and 3.2% in fixed voice and access, other services and interconnection revenues, respectively. However, data transmission revenue increased 2.2%.

Total fixed access lines reached 15.13 million at the end of the reported quarter, reflecting a 0.9% year-over-year decrease. Telefonica Brasil added 32,000 fixed broadband service customers, bringing the total subscriber base to roughly 3.72 million (up 7.1% year over year) during the quarter. The Pay TV subscriber base dropped 4.6% year over year to 650,000 customers. Fixed voice lost 113,000 customers and the subscriber base stood at 10.77 million at the end of the second quarter.

Liquidity

Telefonica Brasil, a subsidiary of Telefonica SA (TEF - Analyst Report), exited the second quarter with cash and cash equivalents of R$2.11 billion compared with R$2.67 billion in the year-ago quarter. Net debt decreased to R$3.17 billion from R$3.21 billion in the year-ago quarter. Net debt-to-EBITDA ratio improved to 0.26 times from 0.27 times in the year-ago quarter.

Capital expenditure decreased 38.2% year over year to R$1.14 billion ($0.58 billion) in the reported quarter.

Our Take

Despite the expansion of video, broadband Internet and Pay TV services, we remain skeptical about the company’s ability to regain lost profitability in the fixed-line segment. Tariff cuts, intense inflationary pressure, stiff competition from rivals like America Movil S.A.B. de C.V. (AMX - Analyst Report) and Telecom Italia S.P.A. (TI - Snapshot Report), and excessive government intervention would put added pressure. All these factors might restrict potential synergies derived from the mobile business and restrain top and bottom-line growth.

We are currently maintaining our long-term Underperform recommendation on the stock. For the short term (1-3 months), Telefonica Brasil holds a Zacks # 5 (Strong Sell) Rank.

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