AES Hits Brick Wall in Venezuelan Acquisition

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October 17, 2001=20

AES Hits Brick Wall in Venezuelan Acquisition=20

By Will McNamara
Director, Electric Industry Analysis=20

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[News item from Reuters] Venezuelan telecommunications firm CANTV, or Compa=
nia Anomima Nacional Telefonos, facing a $1.37-billion hostile takeover bid=
by AES Corp. (NYSE: AES) has forced a showdown with the U.S.-based global =
power company by announcing a share repurchase program. The Board of Direct=
ors of CANTV, Venezuela's biggest telecommunications company, recommended t=
hat shareholders approve a proposed share buyback program of up to 15 perce=
nt of CANTV's shares at a price of $30 per American Depositary Share (ADS),=
or approximately $4.29 per share. Analysts said the CANTV Board's proposal=
s, which would be submitted to shareholders at an extraordinary meeting set=
for Oct. 24, clearly flung down the gauntlet to AES.=20

Analysis: AES' expansion in Latin America's telecommunications market was a=
lways seen as a risky move, and now that risk seems to be resulting in a bi=
g bite out of the company's strategy. CANTV, which was an appealing takeove=
r target for AES due to its long-standing monopoly over the telecom market =
in Venezuela, has a strong ally in the form of Verizon Communications (NYSE=
: VZ), which holds a 28.5-percent stake in the company. Verizon came out in=
support of the 15-percent repurchase program being launched by CANTV, whic=
h clearly is a form of aggressive resistance against AES' efforts to gain c=
ontrol over the company. The repurchase could be seen as a power play, with=
Verizon also seeking to increase its share in CANTV, which many analysts m=
ight see as a more appropriate synergy. However, this story also highlights=
the difficulty that AES has had with its expansion efforts in Latin Americ=
a, especially since CANTV's resistance comes on the heels of AES' pulling o=
ut of another acquisition project in Ecuador.=20

For background, it is important to note that AES already owns 6.9 percent o=
f CANTV through its majority ownership of Electricidad de Caracas, Venezuel=
a's largest private electricity company. Thus, the takeover effort is an at=
tempt to gain majority ownership of the company and take control away from =
Verizon. CANTV, which was privatized a decade ago, is a full-service teleco=
mmunications provider offering switched and local, domestic and internation=
al long-distance service throughout Venezuela Company. CANTV also offers mo=
bile cellular services, wireless services, Internet access and other value-=
added services, and owns all of the Venezuelan public exchanges and nationa=
l network of public telephone lines. CANTV became privatized about 10 years=
ago and until last year reportedly had a monopoly on the fixed-line teleph=
one service in Venezuela. The company has a market capitalization of $2.6 b=
illion.=20

AES had bid $24 in cash for each of the 28.57-million U.S.-listed shares in=
CANTV and $3.43 in cash for each of the 200 million shares of CANTV traded=
in Venezuela. AES' offer for CANTV's American shares represents a 9.2-perc=
ent premium over CANTV's closing price of $21.98 on Aug. 29, the time at wh=
ich the takeover effort was launched. From the start of the offer, some cri=
tics charged that this bid was too low, but AES has maintained that the off=
er is fair. AES reportedly plans to sell off CANTV's mobile services, which=
account for about a quarter of the company's revenues, and distribute the =
proceeds to shareholders.=20

CANTV was never very receptive to AES' bid, and did consider it to be a hos=
tile takeover. In fact, workers' representatives at CANTV circulated a stat=
ement strongly objecting to the bid from AES, stating that the deal would s=
everely damage Venezuela and CANTV workers. CANTV employees hold a 10.9-per=
cent interest in the company. Now we see that CANTV is upping that resistan=
ce a notch by attempting a repurchase of its own stock. Note that CANTV wil=
l most likely issue the buyback program at $30, compared to the $24 that AE=
S had offered. Thus, the challenge for AES, if it still wants to gain contr=
ol over CANTV, will be to increase its already 9.2-percent premium offer. T=
he word circulating in the industry is that AES still intends to proceed wi=
th its takeover attempt, and the CANTV strategy will not derail these attem=
pts.=20

AES' rationale for increasing its holdings in the company is most likely tw=
ofold in nature. First, AES obviously finds great appeal in the Latin Ameri=
can market as the company already owns electricity assets in Brazil, Chile =
and other countries. Just this week, AES announced its penetration of the A=
rgentina market by inking a $376-million deal to purchase distribution and =
generation assets in that country from New Jersey-based Public Service Ente=
rprise Group (PSEG). In another recent announcement, AES launched a cash te=
nder offer to acquire all of the outstanding loan participation certificate=
s of Empresa Electrica del Norte Grande in northern Chile, a company that c=
onsists of 716 MW of generation and 1,056 kilometers of transmission. In fa=
ct, AES reportedly rivals Spain's Endesa as the region's most dominant powe=
r company and by all appearances now derives a large part of its business t=
hroughout Latin America. Whereas AES was clearly diversified across the Uni=
ted States, Asia, Europe, and Latin America, many investors now perceive th=
e company as moving into a heavier focus on Latin America, which constitute=
s a risky proposition in and of itself due to unique politics in the variou=
s Latin American countries.=20

However, AES recently pulled out of its attempt to launch a $128-million ta=
keover bid for Chilean generator Edelnor. Currently, Edelnor, which is one =
of the largest electrical generators in Chile, is controlled by Mirant Corp=
., one of AES' direct competitors in the independent power producing market=
. Perhaps also reacting to the volatility in the region, Mirant has announc=
ed that it will not sink any additional capital into the Edelnor unit unles=
s it can be assured of repayment. AES did not give a reason for its decisio=
n to terminate the Edelnor takeover, but one can surmise that investor reac=
tor to its ongoing efforts in Venezuela may have been a significant factor.=
Further, on Sept. 25, AES cut its earnings estimate for 2001 to a range of=
$1.25 to $1.45 per share from a previous range of $1.75 to $1.90. AES blam=
ed poor currency exchange rates between the Brazilian real and U.S. dollar,=
lower U.K. power prices, and the company's inability to replace earnings a=
nticipated from the planned acquisition of the Mohave power plant. The drop=
in AES' earnings estimate may have lowered available capital that the comp=
any needed to purchase Edelnor.=20

AES shares were priced at $24.25 prior to the earnings revision. After the =
announcement, at least as of early morning trading on Sept. 27, AES shares =
were priced at $12.25, significantly down from the 52-week high of $73, whi=
ch is what the stock was priced at a year ago. As of early morning trading =
on Oct. 17, AES shares were priced at $14.81.=20

Moreover, investors did not react positively to AES' plan to increase its s=
take in CANTV. In fact, after word of the deal began to circulate on Aug. 2=
9 (a day on which many stocks fell) AES' stock closed down $2.94, or 8.3 pe=
rcent, to a 20-month low of $32.65 on the New York Stock Exchange. AES CEO =
Dennis Bakke immediately attempted to reassure investors that the purchase =
did not represent a change of strategy for AES, which he says will remain f=
ocused on power. In addition, Bakke noted that the purchase does not repres=
ent a new venture for AES as the company already holds telecom assets in Br=
azil and Bolivia. Further, Bakke clearly stated that AES is "not going to a=
nnounce a bunch of telecom acquisitions around the world." Nevertheless, so=
me investors believe that AES is imprudently expanding into the telecom sec=
tor, which is already significantly troubled, and becoming too heavily entr=
enched in Latin America, a market that is prone to political volatility. On=
e investment analyst perhaps spoke for many when he commented that AES has =
little experience in the telecom sector and its limited experience to date =
has not been terribly successful. This, coupled with the general market dow=
nturn for most companies with telecom exposure, does not make for a good re=
cipe from an investor's perspective, at least as of today.=20

In fairness to AES, penetrating the Venezuelan market could represent a ver=
y strategic move from a long-term perspective. With a population of 23.5 mi=
llion, Venezuela represents a large potential market for energy and other r=
elated services. In addition, Venezuela is an asset-rich country, particula=
rly with regard to oil resources. According to the Department of Energy, Ve=
nezuela is important to world energy markets because it holds proven oil re=
serves of 77 billion barrels, plus billions of barrels of extra-heavy oil a=
nd bitumen. Venezuela consistently ranks as one the top suppliers of U.S. o=
il imports and is among the top 10 crude oil producers in the world. In add=
ition, as noted AES' investments in Latin America are not exclusively focus=
ed on Venezuela, as the company also is present in Argentina, Brazil, Chile=
, etc.=20

Concerns about telecom arguably overshadow concerns about expansion in Lati=
n America and play a larger role in the drop in AES' stock, especially when=
we consider that AES has been present in Latin America for some time. Only=
little more than a year ago, the telecom sector was at its peak, with bill=
ions of capital investment flooding into the sector as wildly optimistic ex=
pectations for demand seemingly exaggerated the scale of the market. Howeve=
r, a massive downturn has ensued, impacting not only companies operating in=
the telecom space but the nation's entire economy as well. The bottom of t=
he telecom sector has fallen out, due in large part to the fact that the in=
crease in bandwidth capacity has outpaced the growth in market demand.=20

As I've said before when analyzing this company, the further that AES depar=
ts from its core strategy, the more likely it is that we will continue to s=
ee volatility in the company's stock. Up until these recent announcements, =
AES maintained that it was engaged in three lines of businesses, which were=
all equally important to its strategy: power generation, network delivery =
services and retail energy marketing. Generation always appeared to be the =
main core of the company's business model, as AES controls some 125 facilit=
ies totaling over 44 gigawatts of capacity worldwide. This business model w=
orked well for AES and was well received by investors. Any perceived deviat=
ion from this successful strategy-especially if it includes expansion into =
the dangerous territory of telecom-could mark a new and risky era for AES.=
=20

Nevertheless, one could also surmise that AES has found a market opportunit=
y that is worth exploring. Latin America has low electrification and Intern=
et usage statistics. Some analysts project high growth in the next 5 to 10 =
years in Latin America in both electrification and Internet use, which in t=
urn involves telecommunications. The telecom industry is struggling at the =
moment. Thus, if one believes that telecom will make a comeback, then buyin=
g now may make a wise strategy for those involved.=20

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