Telecom Argentina: Buying The Dividend - Part II

In part one of this article, I highlighted a potential trade on Telecom Argentina SA (TEO) around its ex-dividend date. From the response in the comments section and upon further research, I decided a second article that delved deeper in this South American stock was warranted.

The big name authors on Seeking Alpha - the ones that pump out an amazing amount of quality analysis - continue to extol the high virtues of this website: namely that through the course of discussion, we can all learn more. In that spirit, I've accepted the challenge presented by those who commented on my last article. Here is a more thoughtful, scenario-encompassing approach to trading TEO with its ex-dividend date on the horizon.

When $2.21/share is up for grabs, I want to find a way to get that dividend. The key statistics on Yahoo! Finance tell us that's nearly double last year's yearly $1.15/share dividend. However, "news" floating around has called the legitimacy of TEO paying its dividend this year into question.

First, last Friday, a local Argentine financial newspaper, Pagina 12, purported that TEO would not pay the dividend due to government pressure to keep capital in the country. Both Reuters and Bloomberg reported the claim, however, the paper did not provide any sources and they could not be reached for comment. Maybe it is difficult to reach a financial newspaper in a foreign country after they flat out state that one of the most substantial yearly dividends won't be paid - it's just a little fishy.

Furthermore, Morgan Stanley downgraded TEO from Buy to Hold (Over-Weight to Equal-Weight) on Friday as well, and the stock fell over 6%. MS thinks there is limited upside for the stock until the "outlook for the dividend improves."

Then Bloomberg provided a reminder, gleaned from the minutes of the last board meeting, that shareholders would vote on whether to reinvest or pay dividends from its 2011 profits. Nothing unusual there, except that Telecom Italia owns the controlling share - and I bet they want that dividend, especially in light of TEO's strong earnings this year.

In my mind, the Argentina government is the only potential blockade. In theory, it could implement some sort of regulation that only allows the dividend to be distributed to shareholders within Argentina. This pressure has been apparent since November 2011, when the government imposed currency restrictions that prevent sovereign companies from buying U.S. dollars without permission - something that would be necessary for TEO to do in order to pay its dividend to U.S. shareholders, or any foreign shareholders for that matter. After this change, TEO called a press conference where CEO Franco Bertone said, "We don't have problems making dividend payments. I don't expect restrictions in this sense."

These restrictions have already taken their toll on Argentina's Banco Macro (BMA), which in February, announced it may be unable to pay its yearly dividend because of new capital requirements dictated by the central bank, despite increasing 4Q 2011 net income by 26%. Previously, having 30% excess capital was enough to pay dividends; now it's 75%.

Argentina has struggled with economic volatility in the past, and worries of significant currency devaluation weighs heavily on them. The government's attempt to reduce the volatility and stabilize the currency has cast doubt on the reality of payments from Argentina's dividend behemoths. In addition to BMA, the dividends of YPF S.A. (YPF), the main oil and natural gas explorer in Argentina, and TEO, the second largest phone company in Argentina, could be in jeopardy.

While I do believe there is risk investing in TEO at this point, I think the benefits are worth the risk at this point. Here's why:

• TEO is very cheap right now trading at 5 times forward earnings.
• Its 2011 net income increased 33% from 2010 and its 4Q net profits were up 18%. Net revenues for FY2011 were up 26%. In other words, it's an undervalued money-making machine and will have no problem paying its forward dividend of $2.21/share.
• It has substantial technical support $17.
• There is no legitimate source affirming the cancellation of TEO's dividend. Just swirling news.
• Telecom Italia (TIT) owns the controlling stake in Telecom Argentina, meaning its vote will determine whether a dividend will be paid (excluding further action from Argentina's government). Interestingly, TIT reduced its 2011 dividend payout to focus on cutting its debt to maintain its credit rating. However, its full-year profit, before restructuring its debt, was up 7.3%, helped by South American countries like TEO.

Scenarios

Here are some basic outcomes I see (which can be elaborated on):

Buy TEO before ex-dividend; collect an easy 12% profit from very solid cash cow. If the stock doesn't move up, so what? Selling covered calls on your position is just like getting another dividend payment.

Buy TEO before ex-dividend, but dividend is reduced by shareholders. So what? The company is so cheap right now and at a solid price, especially after falling 6% and retesting its support around $17 this week. Sell covered calls to boost profits in the face of potential headwinds from the Argentina government.

Buy TEO before ex-dividend, but the Argentina government is able to prevent the dividend from leaving the country. Stock price will probably fall a little, but how much really? I think there is strong enough support to weather whatever Argentina drums up. Selling covered calls will bring in returns to compensate. But based on the evidence, I see this as a very unlikely scenario.

Even with the expected price fluctuations around ex-dividend dates, I cannot see how, if you go long TEO at its current price you will be in bad shape in the future. I see its stock price continuing to rise until we get another announcement either for or against the dividend, after which it will continue to rise or fall back to its support at $17. At the very least, you will be long a profitable stock for a great price. I hope this article will help investors to continue their own due diligence.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TEO over the next 72 hours.