Initiating Coverage Attractive Story, but Speculative Premium Makes It Expensive

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1 Latin American Equity Research Mexico City, September 29, 2010 Initiation of Coverage Mexico Telecom & Media MEGACABLE UNDERPERFORM Initiating Coverage Attractive Story, but Speculative Premium Makes It Expensive Gregorio Tomassi*, CFA Valder Nogueira* Diana Leyva* Mexico: Banco Santander S.A. Brazil: Banco Santander S.A. Mexico: Banco Santander S.A (9/27/10) CURRENT PRICE: M$30.97/US$2.47 TARGET PRICE: M$34.00/US$2.58 Initiation of Coverage Rating: Initiating with an Underperform Price Target (US$): YE2011: 2.58 EBITDA Estimates 2010E: 251 (US$ Mn) 2011E: E: 306 Company Statistics Bloomberg MEGACPO 52-Week Range (M$) E P/E Rel to the Mexican IPC (x) E P/E Rel to LatAm Telco & Media (x) 1.07 Mexbol IPC (US$) 2,646 3-Yr EBITDA CAGR in US$ (09-12E) 12.4% Market Capitalization (US$ Mn) 2,129 Float (%) 24 3-Month Avg. Daily Vol. (US$Mn) 1.7 Shares Outst. Mn 860 Net Debt/Equity (x) 0.05 Book Value per Share 0.97 Estimates and Valuation Ratios 2009A 2010E 2011E 2012E Net Earn. (M$ Mn) 1,987 1,907 2,141 2,383 Current EPS Net Earn. (US$ Mn) Current EPS (US$) P/E (x) P/Sales (x) P/CE (x) FV/EBITDA (x) FV/Sales (x) FCF Yield (%) Div. per Share (US$) Div. Yield (%) Sources: Bloomberg, company reports, and Santander estimates. Investment Thesis: We are initiating coverage on Megacable with an Underperform rating and a YE2011 target price of M$34.00/share (US$2.58). Megacable is the largest cable-tv operator in Mexico, with a 31% share of the country s subscribers as of the end of Our estimated upside of 4.1% in US$ terms to YE2011 falls below our 9.8% threshold for a Hold recommendation; thus, our Underperform rating. We believe that the potential upside in Megacable s stock is being eroded by a valuation premium based on expectations of M&A activity involving the company. Valuation premium. Relative to the Mexbol IPC s P/E multiple on 2011 estimates, Megacable s stock is trading at an abnormally high ratio: 0.99x vs. a 0.87 long-term average, reflecting a 14% premium. Relative to the average of its regional peers (Latin American telecom & media sector) Megacable s 12.9x P/E is 5% higher. Paying the premium is too risky in our view, as M&A expectations are reasonable, but likely overblown. In an industry poised for further consolidation, we believe that expectations of M&A activity with Megacable at the center of it are reasonably founded. However, we see little near-term likelihood of a materially favorable transaction for the company: acquisition opportunities for Megacable are fewer and smaller, and conversely, Megacable s current market valuations, a 30% control premium required by its by-laws, and existing restrictions on foreign control do not yet position it as a likely takeover target, in our view. Accordingly, with our YE2011 target price we estimate the stock s 12-month-forward P/E multiple will decline 11% to 12.3x from the current 13.9x. Catalysts for a drop in its valuation multiple could result from competitive pressures, while the company is still developing its ongoing major projects (e.g., service digitalization and fiber-optic deployment), and any news that might represent a reduction in likelihood or a delay of any of the different M&A scenarios. Valuation and Risks: Our YE2011 target price of M$34.00 (US$2.58) is based on a DCF model applied to a 10-year cash-flow forecast, assuming a WACC of 9.5% and 2.5% perpetuity growth rate, both in U.S. dollar terms. Risks include competition, macroeconomic conditions, reduced float, and high management turnover. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

2 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive TABLE OF CONTENTS Megacable...1 Summary of Positives and Negatives...3 Valuation Premium...3 An Industry Poised for Further Consolidation...5 Likely Lead Actors: Megacable and Televisa...6 M&A Scenarios: Theoretically Five...7 Acquisition Space for Megacable: Fewer and Smaller...8 Earnings Outlook...10 Subscribers and ARPU Outlook...11 MVNO with Telefonica...13 The Fiber-optics Consortium...14 The Digitalization Project...15 ROE, Balance Sheet and Cash Flows...16 Free Cash Flow to Rise to M$1.62 per Share on Average in 2011 and Capex Estimated at Around US$125 Million Per Year...17 Working Capital a Source of Cash from 2011 On...18 From a Net Debt to Net Cash Balance; No US$ Exposure...19 No Cash to Shareholders Yet...19 Macroeconomic Outlook...19 Valuation...20 Company Description...21 Geographic Footprint...21 Portfolio of Services and Segments Served...22 Ownership And Float...25 Restrictions on Foreign Ownership and Control...25 Change of Control: At Least a 30% Control Premium...25 Corporate Governance...25 Industry Sizes, Service Penetration and Players...26 Comparison of Cable TV Operators...28 Risks U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

3 Megacable is the largest cable-tv company in Mexico, with TV subscribers representing 20% of the country s pay-tv subscribers (including non-cable) as of the end of Headquartered in Guadalajara, Megacable s cable-tv footprint reaches urban areas in 25 of the 32 states in the country (main cities excluded are Mexico City and Monterrey). The company also offers broadband access and fixed telephony, with which it served 32% and 25% of its customers, respectively, by the end of In 2009, Megacable posted consolidated revenue of US$510 million, EBITDA of US$216 million (margin of 42.2%), and net profits of US$147 million. SUMMARY OF POSITIVES AND NEGATIVES Our underperform rating on Megacable s stock is primarily based on valuation. We believe the company offers a generally attractive story, with proven management. However, we see limited upside in its current stock price, as current expectations about corporate actions in the cable-tv industry may be overblown. Below we highlight positives and negatives considered in our investment thesis, as detailed in the report. Positives Healthy earnings growth outlook: estimated at yearly averages of 11%, 12%, and 6% in revenue, EBITDA and net income, respectively, in local currency from 2009 to Ongoing actions and projects aimed to strengthen the company s competitive stance: customer service enhancement and piracy reduction through the digitalization program, securing additional data transport capacity at better costs through the participation in the fiber-optic consortium, and the MVNO agreement with Telefonica to add mobile services to its offer. A more conservative approach to profitability: compared to performance of other cable-tv operators in Mexico. Industry consolidation opportunities, relative to which Megacable is well positioned to participate favorably. However, the available opportunities are fewer and smaller, reducing the likelihood of a value leap that could result from them. Concerns and Risks Expensive valuation: driven, in our view, by expectations about the role that Megacable could play within an industry that is prone to further consolidation. Competition currently from Telmex in telecommunication services, and mainly from satellite TV offers (Sky and Dish) which might create downward pressures on prices and margins in Megacable s key service segments. Inclination to retain excess cash: industry conditions and management s belief in the necessity to be ready to act may drive the company to maintain a suboptimal level of leverage. Reduced float of 24% that provides little room for the current average daily trading volume of US$1.5 mn to improve. Recent management turnover in key posts: particularly in the CFO post and more recently, the Director of Network Operations. Cuts both Ways Change of control rules: the company s by-laws impose a minimum 30% control premium, which can, in weak equity markets, be a good protection for minority shareholders, but in more favorable market conditions, could be an obstacle to a transaction that could be attractive for shareholders even at a lower premium. VALUATION PREMIUM We see a valuation premium slightly over 10% in P/E multiple. We are assuming that the current valuation premium will not be sustainable to the end of Our YE2011 target price estimates the stock s 12-month-forward P/E multiple to decline 11% to 12.3x from the current 13.9x. Two factors support our view. Relative to the Mexbol IPC s 2011E P/E multiple, Megacable is trading at an abnormally high level. Relative to regional peers (Latin American telecom & media sector) Megacable s 2011 E12.9x P/E is 5% higher. At our target price, the estimated P/E multiple would be closer to the 12.3x current P/E average of our 2011 estimates for the Latin American telecom & media sector we cover. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

4 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive We believe Megacable s stock looks expensive compared with the Mexican stock market: Trading at an average of 0.99x (the ratio of Megacable s P/E multiple on 2011 estimates to the Mexbol s) since mid-may 2010, compared to the 0.87x average posted during the period between September of last year and mid-may 2010 (see Figure 1). What may have caused the increase in relative expectations? The two events that occurred chronologically around mid-may this year which, in our view, could be related to the change in relative valuation were Megacable s withdrawal from the spectrum auction (announced on April 23), and the acquisition of Omnicable (announced on June 15). We believe that the acquisition of Omnicable (detailed below) had a larger impact on market expectations, as it may have reinforced Megacable s stance as a potential market consolidator. Figure 1. Ratio of P/E Multiple of Megacable over Mexbol IPC s, LTM as of September S-09 O-09 N-09 D-09 J-10 F-10 M-10 A-10 M-10 J-10 J-10 A-10 A-10 S-10 P/E: MEGA / MEXBOL Index Period average Avg +/- 1 STD P/E multiples for each date are based on next year consensus earnings estimates as compiled by Bloomberg under the BEST_EST_PE_NXT_YR and GEN_EST_PE_NEXT_YR_AGGTE functions for the company s stock and the IPC, respectively. Sources: Bloomberg and Santander estimates. Megacable also looks expensive compared to the listed Latin American telecom & media companies. Megacable s 12.9x and 7.6x P/E and FV/EBITDA on our 2011 estimates compare unfavorably to the Latin American averages of 12.3x and 5.4x, respectively, given that the company s earnings growth outlook is similar to the estimated average for the sector in the region. Evidence of overpricing of Megacable s stock is not as strong when compared to a reduced sample of two Latin American media companies and three U.S. cable-tv companies (see Figure 2). However, we have a Hold recommendation on the two Latin American stocks of the sample, Televisa (TV/TLEVICPO, current price US$18.48/M$46.57) and Net Serviços (NETC/NETC4, current price US$12.52/R$21.70), reflecting our consideration that neither stock is currently undervalued. Figure 2. Comparative Valuation of a Global Sample of Comparable Companies Prices as of September 27, 2010 Stock Price Market Cap. Valuation Multiples a 2-Year CAGR to 2012E Company Name Ticker (US$) (Mn of US$) P/E11E FV/EBITDA10E Earnings EBITDA Televisa TLEVICPO Equity , % 7% Net Servicos NETC4 Equity , % 13% Time Warner Cable TWC US Equity , % 0% Cablevision US CVC US Equity , % 4% Comcast CMCSA US Equity , % 6% Sample Average b % 5% Megacable MEGACPO Equity , % 12% a Estimates and multiples for companies are based on consensus ( Bloomberg), estimated in local currency for each company. Sample companies are not all covered by Santander. b Sample averages are market-capitalization-weighted.. Sources: Santander estimates and Bloomberg.The Acquisition Game in Cable-TV in Mexico 4 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

5 Expectations about Megacable s potential role in what could be further consolidation of the Mexican cable-tv industry are, in our view, driving the current valuation premium at which Megacable trades compared to the Mexbol IPC s and to Latin American telecom & media peers, that reduces the estimated upside on the stock price. While the opportunity exists for Megacable, we believe it has contracted over time, as the remaining potential targets with significant scale are fewer. AN INDUSTRY POISED FOR FURTHER CONSOLIDATION The still highly fragmented character of cable-tv licenses in Mexico, and the investment amounts that are required to keep up with growing service expectations and competitive pressures, create conditions for further consolidation of the industry and an increased likelihood of M&A activity in which Megacable may be involved. A large portion of the Mexican space of cable-tv operators is controlled by four independent groups. These four groups accounted for 86% of the country s cable-tv subscribers by the end of The remaining 14% share of the cable-tv market is highly fragmented (see Figure 3 for details). Figure 3. Mexico Breakdown of Cable-TV Subscribers by Operator, as of December 2009 Notes Other, 14% Grupo Hevi, 7% Cablecom, 13% TVI, 5% Cablevisión, Cablevisión, 12% 12 % Cablemas, 18% Megacable, 31% Cablemas, Cablevision, and TVI are each majority owned by Televisa, and combined, they represented a 35% share of the country s cable- TV subscribers. Cablecom is a privately held company controlled by the Tinajero family. Grupo Hevi is a privately held company controlled by the Vielma family. Other is the combination of over 220 licenses, of which we estimate that the largest one has licenses over an area of no more than 7.5% of the population of Megacable s licensed area Source: Cofetel, Company data and Santander estimates. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

6 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive LIKELY LEAD ACTORS: MEGACABLE AND TELEVISA Megacable and Televisa, the two players that moved clearly ahead in the first wave of consolidation in recent years, now stand both as likely lead actors in most of the future M&A in the Mexican cable-tv industry. We do not have enough information on Cablecom and Grupo Hevi to assess their financial conditions and performance. However, we believe that Megacable and Televisa currently possess a combination of characteristic that would be difficult to match by any other cable-tv operator in Mexico aspiring to play a consolidator role: Scale of business. As the largest cable-tv operators in Mexico, already leading in terms of network and transport capacity (including their joint plans with the CFE s fiber-optic network), these two companies have an advantage relative to the other players in the industry in terms of absorbing further operations. Balance sheet strength. Both groups have been consistently focused on reducing leverage levels and maintaining high cash balances in anticipation of further acquisition opportunities, while at the same time being able to keep up with the investments required by the business. Access to capital. Both groups are the only ones in the Mexican cable-tv industry with stocks listed in the equity markets. In our view, no other cable-tv group in Mexico has the scale to successfully tap the equity capital markets. Regulatory support for further acquisitions. Although we believe Megacable is better positioned than Televisa in the eyes of the antitrust regulator considering further acquisitions, Televisa has successfully tested the regulator s stance in the recent past when it assumed control of Cablemas and TVI in 2008 and Controlling shareholders groups with apparently little motivation to sell. In our opinion, we deem it unlikely that in the near term the controlling shareholders of Megacable and Televisa would be willing to divest their investments in cable TV. For Televisa, the cable-tv business is at the center of its strategy in the telecommunications business. 6 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

7 M&A SCENARIOS: THEORETICALLY FIVE There are several potential M&A scenarios involving Megacable and Televisa, not necessarily mutually exclusive: Figure 4. Potential M&A Scenarios Involving Megacable Different consolidation scenarios include Megacable and Televisa as acquirers but also Megacable as potential acquisition target. We deem: (i) unlikely a sale of control in Megacable in the near term; but (ii) likely, Megacable continuing as acquirer. Scenario Megacable acquires other cable-tv operators Televisa acquires other cable-tv operators Televisa acquires Megacable A foreign operator acquires Megacable Source: Santander estimates. Comments from the Perspective of Megacable Likely in our view. This is in line with Megacable s recent track record and with management s declared intentions. May boost growth estimates as our model considers only organic growth. However, size of potential targets is limited, and few larger targets may be of interest also for Televisa. Likely in our view. May represent competition for Megacable in acquisitions in Mexico, probably reducing the potential discounts that Megacable might otherwise reach in negotiating purchase prices of operators that are of interest also to Televisa. Unlikely in the foreseeable future, as Megacable s stock valuation, and our belief that Megacable s controlling shareholders have little motivation to sell, could make it expensive for Televisa to consider acquiring control in Megacable. Regulatory approval could be a challenge to overcome. Although we believe that further acquisitions of cable-tv companies by Televisa are no different than the acquisitions already approved for Cablemás and TVI in recent years. Unlikely in the near term. Depends on a change in law that would allow foreign control. Although we believe this change in law will be eventually passed, timing is still uncertain and may still take years. Needs a buyer willing to pay a control premium over Megacable s stock valuation (see section Change of Control: At Least 30% Control Premium below). This could be better justified for foreign operators already present in Mexico who can extract value from potential synergies. In our summary, of all scenarios mentioned in Figure 4, we believe it is likely that Megacable will continue acquiring smaller operations that may provide a slight boost to the growth estimates considered in our current model, but we see less likely a near-term sale of Megacable s controlling stake. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

8 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive ACQUISITION SPACE FOR MEGACABLE: FEWER AND SMALLER Two still large potential acquisition targets, and the rest is fragmented into rather small opportunities. The opportunity space exists but has contracted over time, as remaining potential targets with relevant scale are fewer. There are two categories of acquisition opportunities for Megacable: (i) the other two independent large groups, Cablecom or Grupo Hevi; and (ii) the smaller operators. THE OTHER TWO LARGE OPERATORS Megacable s management has expressed interest in acquiring Cablecom and Grupo Hevi, and any of these acquisitions would be material. We understand Cablecom and Grupo Hevi would represent an increase of 41% and 21%, respectively, over current Megacable s TV subscribers. These two companies could be worth around M$5.9 billion and M$3.1 billion, respectively, in terms of enterprise value, when applying a simple valuation multiple per subscriber recognized by Megacable in its most recent acquisition. For Grupo Omnicable, bought in 2Q10, Megacable paid a total of M$550 million, for a company that posted approximately M$87 million in EBITDA, and had 61,000 and 3,000 TV and broadband subscribers, respectively. The value paid was equivalent to M$9,000 per TV subscriber, and 6.3x trailing EV/EBITDA. We believe Megacable, is better positioned than Televisa to acquire Cablecom and/or Grupo Hevi, assuming the controlling shareholders of these two companies are willing to consider a sale of control. We estimate synergy value from the integration of Cablecom or Grupo Hevi would be larger if acquired by Megacable than if acquired by Televisa as: The value in the integration of two cable operations increases with the degree of complementarities and adjacency of their networks footprints. The degree of complementarity between any two operators in Mexico is normally high, as the overlaps between networks of any two cable-tv operators are negligible. Therefore, as long as minimum network quality standards are met, network adjacency is the fundamental driver of potential network and commercial synergies between two cable-tv operators. In the case of Cablecom and Grupo Hevi, and based on a rough profiling of geographic presence of each of the largest cable-tv operators in Mexico (see Figure 5), proximity looks higher for Megacable and Televisa s Cablemas. Therefore, we believe that Televisa s interest would be driven more by integration opportunities with Cablemas. Capturing potential synergies from an acquisition of Cablecom and/or Grupo Hevi, would be faster and easier, in our view, for Megacable than for Cablemas. In order to capture full synergies, Televisa would probably have to make the acquisition through Cablemas. However, the amounts potentially required for the acquisition, paired with the regular investment needs that Cablemas has (US$115 million estimated for 2010), could make the acquisition difficult to approve by Cablemas s shareholders. Although Televisa owns over 58% of Cablemas s equity, it only owns 49% of its voting stock, making it unlikely in our view, that Televisa could, in its sole discretion, force agreement on an acquisition. Televisa could also directly purchase another cable operator. However, we believe that without an actual integration with the operations of Cablemas, Televisa will not be able to exploit the full potential of the integration. The controlling shareholders of Cablecom and Grupo Hevi have not stated that they would be willing to sell. We have had no access to financial data or knowledge of the current business conditions of these companies to try to gauge their intentions. Specific conditions could increase the possibility that either of these two companies would consider a change in control: (i) the recent increase in competition from DTH operators Sky and Dish, with service offerings at prices 8 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

9 significantly lower than what was the case in earlier years; and (ii) the demand for transport capacity to support higher broadband speeds. It could take time for these conditions to materialize to a sufficient degree to create the necessary pressures on Cablecom and Grupo Hevi s controlling shareholders to increase their willingness to sell. Figure 5. The Four Largest Cable-TV Operators in Mexico: Size and Geographic Distribution by States (subscriber and population figures in millions) Televisa Megacable Total Cablemas Cablevision TVI Cablecom TV Subscribers As % of Pops (a) 6% 5% 7% 3% 13% 5% 4% Licensed Pops (a) México Distrito Federal Jalisco Guanajuato Tamaulipas Veracruz Chihuahua Baja California Michoacán Nuevo León Puebla Coahuila San Luis Potosí Sonora Querétaro Sinaloa Chiapas Guerrero Zacatecas Durango Tabasco Morelos Hidalgo Oaxaca Yucatán Aguascalientes Quintana Roo Nayarit Campeche Colima Tlaxcala Baja California Sur (a) Refers to an estimate of the population of licensed areas for each player, total and broken down by states. Source: Company data, Cofetel and Santander estimates. THE SMALLER OPERATORS Grupo Hevi Acquisition opportunities for cable-tv operators in Mexico, beyond Cablecom and Grupo Hevi, are all significantly smaller. In Figure 6, we show our estimate of the dispersion of cable- TV licenses, in terms of their size relative to Megacable. Approximately 90% of the cable-tv licensees have concessions in areas with less than 1% of the population that Megacable has under coverage. Probably service penetration in areas covered by the majority of these licensees is comparatively low, so TV subscribers compared to Megacable s are likely lower. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

10 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive Looking forward, we deem it as unlikely that Megacable could grow 5% or more in subscribers in a single year just from acquisitions (considering the remaining pool of opportunities besides Cablecom and Grupo Hevi). The acquisitions by Megacable have been dropping in size, probably reflecting the increasing dispersion of cable-tv operators. Since 2007, the number of TV-subscribers that Megacable added per year from acquisitions has dropped: nearly 420,000 in 2007, 59,000 in 2008, and 61,000 so far in Figure 6. Dispersion of Cable-TV Licenses in Mexico, Excluding the Four Largest Cable-TV Groups 8% 7% 6% 5% 4% 3% 2% 1% 0% Legend: The vertical axis represents the size of each licensee, expressed in terms of the estimated population under licensed area as percentage of Megacable s estimated 25.3 million pops. The horizontal axis represents the rank of each licensee in terms of the estimated population under licensed area. The chart excludes the four largest cable-tv groups: Megacable, the Televisa group, Cablecom and Grupo Hevi Source: Cofetel. EARNINGS OUTLOOK We estimate EBITDA three-year US$ growth at 12%, with margins between 42%- 43%. Net profits to grow 6%. We believe that from 2009 to 2012, Megacable will grow at yearly averages of 11%, 12% and 6% in revenue, EBITDA and net income, respectively. Our lower forecast for growth rates in net profits is driven by two factors: (i) the unfavorable basis that 2009 earnings represent due to a foreign exchange gain of M$137 million posted that year, which we do not expect to recur, and (ii) our assumption that Megacable s effective tax rate will increase from 2009 s 15% to 28% by Our US$ growth estimates do not differ much from our estimates in local currency. Our foreign exchange forecasts assume a rather stable local currency. We estimate the EBITDA margin will remain within the 42%-43% range, as downward pressures on average revenue per RGU (revenue generating unit, referring to each individual service that customers may be subscribed to) is expected to be offset by a gradual reduction in the average cost per RGU. The average revenue per RGU should continue to drop, in our view, as Megacable continues to penetrate household segments with lower purchasing power, and as lower value bundles gain relative weight within Megacable s subscriber base. However, we also believe that Megacable s goal to increase service penetration per unique subscriber (all active customers regardless of the number of services each customer has), combined with the effects of the ongoing digitalization program (explained below), should be successful in reducing the average cost per service provided (average cost per RGU). Considering only cable TV operations, Megacable s EBITDA is forecast to grow 12% annually, on average, to 2012, with a margin in the 44%-45% range. Megacable s consolidated EBITDA includes approximately 2% that comes from non-tv cable operations, carried on by Megacable s 10 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

11 100%-owned subsidiary, MCM Holding. MCM Holding, which provides communication services to medium and large-sized companies in Mexico City, Monterrey and Guadalajara, posted a 9.2% EBITDA margin in 2009, and is expected to post an average of 11.6% EBITDA margin in the three years to Figure 7. Earnings Outlook, 2009A 2012E YoY Growth Rates 2009A 2010E 2011E 2012E H10A 2010E 2011E 2012E In Million of M$ CAGR Revenue 6,895 7,549 8,510 9,516 18% 8% 9% 13% 12% 11% RGUs (000) 2,524 2,938 3,299 3,644 15% 18% 16% 12% 10% 13% Avg. rev./rgu (M$/month) % -8% -6% -2% 0% -3% Costs & Exp. (excl. D&A) (3,983) (4,335) (4,940) (5,471) 32% 12% 9% 14% 11% 11% Per RGU (M$/month) % -5% -6% -1% -1% -3% EBITDA 2,912 3,214 3,570 4,045 3% 3% 10% 11% 13% 12% EBITDA Margin 42.2% 42.6% 42.0% 42.5% Operating income 2,206 2,482 2,813 3,262-1% 1% 13% 13% 16% 14% Net income 1,987 1,907 2,141 2,383 14% 1% -4% 12% 11% 6% In Million of US$ Revenue % 16% 16% 11% 10% 12% Costs & Exp. (excl. D&A) (295) (339) (379) (414) 9% 20% 15% 12% 9% 12% EBITDA % 10% 17% 9% 12% 12% EBITDA Margin 42.2% 42.6% 42.0% 42.5% Operating income % 9% 19% 11% 14% 15% Net income % 9% 1% 10% 10% 7% Foreign exchange (M$/US$) End of period % -2% -2% 3% 0% 0% Average % -7% -5% 2% 2% -1% Sources: Company reports and Santander estimates. Our 2010 revenue and EBITDA estimates are slightly below guidance. Compared to management s guidance for 2010, our estimates fall slightly short. For the current year, the company is targeting 11% growth in both revenue and EBITDA, higher than our 9% and 10% growth estimates. Our earnings and cash flow forecast take into consideration estimates on number of subscribers and ARPUs, as well as three key projects that the company is currently undertaking: MVNO with Telefonica: mobile services to be launched before the end of 2010, following a recent agreement to use network capacity from Telefonica. The fiber-optics consortium: Megacable s equal participation in a consortium with Telefonica and Televisa that was recently awarded a license to use fiber-optics capacity from the national state-owned, electricity company CFE. The digitalization project: Megacable s effort, launched in June 2010, to switch from an analogue to digital signal for the majority of the areas served, in order to reduce piracy, disconnection/reconnection costs, and to enhance service possibilities. Unique subscribers to grow 10% and RGUs per subscriber to reach 1.7x. SUBSCRIBERS AND ARPU OUTLOOK We believe that in the three years from 2009, Megacable will combine nearly 10% growth, on average, in unique subscribers, with a favorable penetration of additional services that would allow RGUs to reach 1.73x the number of subscribers by the end of 2012, from 1.54x posted by the end of June In our model, we have considered the upcoming launch of mobile services that Megacable has already announced (see details in section MVNO with Telefonica ). U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

12 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive Service penetration should boost growth in ARPU per unique subscriber. 12 In terms of ARPUs per service, we believe that 2010 will be the year of the largest YoY drop, driven by two causes: (i) the effect of the increased importance of the sale of services targeting lower-value segments; and (ii) the potentially favorable impact on ARPUs of the increase in overall transport capacity that could be expected by the end of 2011 from the beginning of operations of the fiber-optics network, in which Megacable participates together with Telefonica and Televisa. ARPU per unique subscriber is expected to rise 2%, on average, from 2009 to 2012, as the estimated increase in service penetration is expected to more than offset the drop in the ARPUs of individual services. Figure 8. Subscriber and ARPU Estimates, 2009A 2012E YoY Growth Rates 2009A 2010E 2011E 2012E H10A 2010E 2011E 2012E CAGR Subscribers and RGUs (000) Unique subs. 1,635 1,855 1,971 2,104 7% 14% 13% 6% 7% 9% RGUs 2,524 2,938 3,299 3,644 15% 18% 16% 12% 10% 13% RGU/Un.-Subs TV 1,593 1,810 1,926 2,059 7% 15% 14% 6% 7% 9% % of Un. Subs. 97% 98% 98% 98% Fixed internet % 19% 16% 13% 12% 14% % of Un. Subs. 32% 32% 34% 36% Fixed telephony % 31% 25% 19% 15% 20% % of Un. Subs. 25% 28% 31% 34% Mobile telecom % 47% - % of Un. Subs. 0% 1% 4% 6% Net additions, excluding acquisition of Omnicable a (000) Unique subs % 440% 59% -27% 15% 10% RGUs % 13% 4% 3% -5% 1% RGU/Un. Subs TV % 222% 42% -26% 15% 6% Fixed internet % -13% -9% -5% 5% (3%) Fixed telephony % -44% -25% -5% -5% (12%) Mobile telecom % -47% - ARPU (M$/month) Unique subs % -3% -2% 3% 5% 2% RGU % -8% -6% -2% 0% (3%) TV % -7% -5% -2% 0% (2%) Fixed internet % -8% -6% -3% 0% (3%) Fixed telephony % -9% -8% -3% 0% (4%) Mobile telecom % 1% - a The acquisition of Omnicable executed in 2Q10 represented net additions of 61,000 and 3,000 TV and Internet subscribers, respectively, that have been excluded from net addition figures in this table, seeking to render a more comparable view on historical and estimated organic trends. Sources: Company reports and Santander estimates. Some considerations underlying our subscriber growth estimates shown in Figure 8 follow: Generally, we are expecting a recovery in net additions in 2012, mostly related to TV services and fixed internet access, along with the improvement in macroeconomic conditions; We are estimating TV net additions to drop 26% YoY in 2011 (after excluding the 61,000 TV subscribers added in 2010 from the acquisition of Omnicable), as we expect Megacable to experience an increase in churn from TV subscribers that were added in the months prior to the FIFA World Cup Relative to 2010 guidance provided by the company, our TV and fixed telephony subscriber estimates are slightly lower, and our internet subscriber estimates are in line. Our estimates of 1,810,000 TV subscribers and 519,000 telephony subscribers for year-end 2010 are 1.2% and 3.9% below the company s target of 1,831,000 and 540,000 subscribers, respectively, disclosed in July U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

13 MVNO WITH TELEFONICA Megacable will start offering mobile services, following a capexlight model supported by a capacity agreement with Telefonica. We believe the mobile service launch is a convenient initiative. However, the measurable contribution to value is limited. Megacable announced on August 25, that it reached an agreement with Telefonica Mexico that will allow Megacable to offer mobile telecommunications services within the markets that Megacable serves. Megacable plans to launch the offering by the end of We believe that following this agreement, Megacable will act as an MVNO (mobile virtual network operator): based on cellular network capacity purchased in bulk from Telefonica, Megacable will sell mobile telecommunications services under a proprietary brand, and will be responsible for pricing the offer, and serving and billing its mobile subscribers. The service will be offered within Megacable s areas of coverage, which currently accounts for 5 million homes passed, of which over 1.7 million homes are already subscribed to at least one of Megacable s current services (TV, Internet or fixed telephony). Megacable has yet to define the range of the offer in terms of voice and data mix. We see the upcoming launch of mobile services by Megacable, supported by Telefonica s network, as a convenient addition to its service portfolio, but one that would make a limited contribution to the company s EBITDA. Considering gains in scale that may occur in time, the added mobile service should help increase customer retention, and also increase revenue per unique subscriber at an appropriate cost. However, assuming reduced margins for Megacable likely under the MVNO model, we believe that the measurable contribution to value is limited: based on our estimates, the MVNO s contribution to Megacable s revenue and EBITDA in 2012 would be 3.3% and 0.4%, respectively. In our model, we have made a first attempt to include revenue and EBITDA estimates related to this upcoming service launch. We understand that Megacable s management plans to disclose further details in their conference call to be held in October to discuss 3Q earnings results. Our key modeling assumptions, most of them shown in Figure 9, are: Potential for mobile subscribers: to reach approximately one-fifth of Megacable s fixed telephony subscribers, and 6% of Telefonica s postpaid subscribers, by the end of 2014, four years after launch. We believe that the traction for gaining mobile subscribers under an MVNO model and considering Megacable s bundling ability could be lower than the one Megacable has already enjoyed with fixed telephony services, as competition is harder, and the on-net/off-net pricing differential could still represent a competitive barrier for smaller providers. According to our estimates, the 116,000 mobile subscribers estimated for Megacable by the end of 2012 would represent 5% of Telefonica s postpaid subscribers. We have assumed that Telefonica s postpaid subscriber base would grow 32%, on average, in the next three years (from 48% YoY growth posted in 1H10). Another model reference we have used is Maxcom s experience as the only other MVNO in Mexico. As shown in Figure 3, within their residential subscriber base, their mobile subscribers have represented in the last three years from 16% to 25% of their fixed line subscribers. Our comparable 22% penetration estimate in year 2014 for Megacable assumes a similar experience to Maxcom s, despite possible differences there may be in the commercial strategy that Megacable would follow with this service compared to Maxcom s. ARPUs for mobile service are estimated to be slightly above M$260 per month during the next two years. Our ARPU estimate is higher than the M$120 blended ARPU posted by Telefonica in Mexico in 1H10, as we believe Megacable would target subscribers of a higher value segment than Telefonica s current average. EBITDA margin from the mobile service offer is estimated to be initially negative and then to increase to the equivalent of around 12% in year Although we still have questions about Megacable s commercial approach in terms of target segments and U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

14 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive 14 handset subsidies, the MVNO model under which Megacable will offer this service would not provide EBITDA margins over 15%, in our view. We also believe that margins will be affected initially by the costs associated with the launching and promotion of this new service. Figure 9. Megacable s MVNO Business Estimates Three-Year Estimates 2010E 2011E 2012E Five-Year Estimates Mobile Telecom Subscribers Telefonica Postpaid Subs. 1,529 2,024 2,473 YoY Growth 43% 32% 22% Mobile Subs. as % of Telephony Subs. Megacable's MVNO Subs % 19% % of Unique subs. 1% 4% 6% 16% 13% % of Fixed Telephony 2% 13% 16% 2% % of Telefonica's Postpaid 1% 4% 5% Financials from MVNO (Mn of M$) 2010E 2011E 2012E 2013E 2014E Revenue Mobile Subs. as % of TEF s Postpaid Subs. Costs % exp. (excl. D&A) (4) (127) (268) EBITDA EBITDA Margin (%) (10.0%) 6.2% 12.0% 6% Maxcom s MVNO Subs a 6% 5% 4% Last three years Jun-08 Jun-09 Jun-10 1% % of Unique subs. 17% 26% 19% % of Fixed Telephony Subs. 16% 25% 19% 2010E 2011E 2012E 2013E 2014E a Maxcom (ticker: MAXCOMPCPO, not covered) is the only other Mexican operator with experience as an MVNO, and also leases network from Telefonica. Numbers here refer only to Maxcom s residential customer base. Sources: Santander estimates. The MVNO agreement with Telefonica is an optimum choice, in our view. An investment of M$728 million in a fiber-optics network, shared with Telefonica and Televisa. We believe that the business model that Megacable chose to add mobile telecommunication to its portfolio of services is a convenient one. Megacable had the option to participate in the spectrum auction recently held in Mexico. On April 23, Megacable announced in a press release that it decided to withdraw from the spectrum auction of blocks in the 1.7/2.1 GHz band in which they had previously registered. In the same announcement, Megacable also reiterated that they would have continued to explore the MVNO model ( mobile virtual network operator ) as a means to add mobile telephony to its array of services in the short term. Four months later, they announced the agreement with Telefonica. In our view, they resisted the lure of the spectrum auction and probably also resisted from joining in in a more complex model led by Televisa in their partnership with Nextel Mexico. We believe they understood that they had little chance of creating competitive advantages in the operation of a cellular network in Mexico, and they took the risk of continuing to negotiate the MVNO model with an experienced operator that we believe was able to provide a combination of faster time-to-market and better terms. THE FIBER-OPTICS CONSORTIUM On July 2, 2010, Cofetel published its favorable opinion on granting a 20-year concession title to Grupo de Telecomunicaciones de Alta Capacidad (GTAC) to operate a pair of fiber-optic wires in three different routes of the network of Comisión Federal de Electricidad (CFE), the state-owned electricity company with nationwide coverage. GTAC is a consortium formed by Megacable, Telefonica Mexico and Televisa, through which they each participate on equal terms, one third each. This consortium was the only participant in the auction organized by the State, and was granted the concession at a price equal to the minimum starting bid. The concession grants the use over a total of 19,469 km of a pair of dark fibers plus the possibility to extend it for an additional length of 1,739 km over the CFE network. This network represents U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

15 Payback from the fiber-optics investment is implicitly reflected in the trends we have assumed in ARPUs and cost per RGU. A US$40 million investment in 2010 to fight piracy, to reduce service costs, and to allow for premium TV offers. The goal of 1 million digital boxes installed before year-end looks challenging. nearly 10% of the country s total fiber-optic network. The network licensed is divided into three routes: (1) Pacific, 8,120 km running along the western coast of Mexico; (2) Center, 5,789 km going from the north to the south through the center of the country; and (3) Gulf, 5,560 km running along the Gulf coastline. The consortium paid M$883.8 million for the license and plans to make an additional investment of M$1.3 billion to start offering services in the fiber-optics network in 2H10. According to Megacable s management, the M$1.3 billion investment should suffice for the following five years of operations. Total investment commitment in GTAC for Megacable is therefore M$728 million, M$295 million to pay for the concession plus M$433 million of capex. Most of this investment, M$660 is expected to be disbursed before year-end. As of June 2010, the company had made M$350 million as an investment related to GTAC. Management expects this investment in fiber-optics to protect, or even increase ARPUs, rather than being a measure for cost reduction. In our model, the contribution of this investment in fiberoptics is reflected in our assumption of a lower decline in ARPUs in 2011 and flat nominal ARPUs in We also believe that the estimated reduction in the average cost per RGU partially reflects the favorable impact of lower transport costs. Management has mentioned, for example, that the higher transport capacity should allow the introduction of video-on-demand services in specific areas without incurring in investments in hardware and software that would otherwise be required. THE DIGITALIZATION PROJECT In June 2010, Megacable launched a network revamp program to migrate its subscribers to digital transmission in 16 cities, representing 80% of its current subscribers. Migrating to digital transmission would it allow to: Reduce piracy of the TV signal, as viewing the signal would require a decoder at the viewer s premises to be provided by the company. Currently, in areas with no digital signal, selling telephony and internet services opens the window for theft of the TV signal. Increase operating efficiencies, as several tasks (e.g., disconnections and reconnections) that currently require a visit from Megacable s technicians to the customers premises, will be performed remotely. Improve the introduction of premium offers, as digital transmission would allow for higher compression of the signal, and therefore the ability to actively add additional channels. The key metric under which progress of this program is measured is the number of digital set-top boxes installed. The company needs to persuade customers to exchange their current set-top boxes for digital ones. The target is to reach 1 million digital boxes installed by the end of 2010, from 290,000 digital subscribers the company already had at the launch of the program in June. By the end of August, the company already had 400,000 digital boxes installed in 6 cities, which represents an average of less than 50,000 boxes added per month. The required average of 150,000 digital boxes installed per month for the last four months of year 2010 to reach the 1 million target appears to be challenging. In terms of capex, the digitalization program in 2010 would amount to nearly US$40 million, of the US$120 million estimated in total capex for the year. The digital boxes remain as company property, and their installation is accounted for as capex. The unit cost of the digital set-top box ranges from US$30-$40. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

16 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive ROE, BALANCE SHEET AND CASH FLOWS After a major corporate leap in 2007, Megacable has shown a conservative and strategically focused cash flow management. Of the last three full calendar years, 2007 marked a leap in Megacable s corporate stance. In that year the company raised over US$200 million in an IPO and made acquisitions for over US$500 million. In the two and a half years since then, to June, 2010, Megacable has been able to generate a yearly average of M$500 million in free cash flow to equity holders, while: (i) reducing the leverage ratio net debt/ebitda from 0.9x to 0.2x; (ii) increasing its capex levels to a yearly average of US$100 million (from previous US$52 million three-year annual average); and (iii) making additional acquisitions and investments (including first disbursement in GTAC made in June this year) for a total amount equivalent to US$108 million. Since 2007, Megacable s ROE dropped to levels closer to 20% (9% in the first six months of 2010), as a result in our view of the increased investment, combined with lower leverage levels, downward pressure on operating margins, and increasing effective tax rates. Figure 10. Megacable ROE, 2007A 2012E 37.8% 25.7% 23.0% 17.9% 16.9% 16.0% Actual Forecast Source: Company data and Santander estimates. Management s preference to retain cash in anticipation of possible acquisition opportunities is reflected in our estimate of declining ROE. Looking forward, our estimates indicate a further decline in ROE to 16% in In our view, the expected decline in ROE reflects the costs related to management s decision to further strengthen Megacable s cash position. With our model assumptions that consider only organic growth in Megacable s outlook, the company s net debt is expected to decline further while free cash flow to equity would rise. We understand that management is not considering any cash distribution to shareholders within the next three years and that they will continue to favor the build-up of a strong cash balance to be able to act swiftly on any acquisition opportunity that they believe may appear. The rising cash balance and low leverage ratios assumed for the next years, would have an unfavorable impact on the company s ROE. For a discussion on our views about Megacable s acquisition opportunities see below section titled The Acquisition Game. Following we discuss our cash flow estimates. 16 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

17 FREE CASH FLOW TO RISE TO M$1.62 PER SHARE ON AVERAGE IN 2011 AND 2012 We are forecasting free cash flow generation to rise to around M$1.4 billion per year in years 2011 and 2012, from the M$500 million yearly average posted so far since the end of Free cash flow in 2010 is expected to be slightly negative as a result of the M$1.2 billion total investment being disbursed for the acquisition of Omnicable (M$550 million), and for Megacable s participation in GTAC (M$660 million in 2010). Figure 11. Megacable Free Cash Flow to Equity, 2007A 2012E Historical Forecast 2007A 2008E 2009E 1H10E 2010E 2011E 2012E EBIT 1,558 2,237 2,206 1,176 2,482 2,813 3,262 Effective tax rate 41% 6% 15% 22% 22% 24% 28% NOPLAT 919 2,102 1, ,947 2,138 2,335 Depreciation & Amort EBITDA, net of adj. Taxes 1,336 2,700 2,581 1,278 2,679 2,895 3,117 Dec./(Inc.) in working capital (122) 497 (325) (417) (121) Net cash flow from operations 1,215 3,197 2, ,558 2,953 3,159 Capex (581) (1,117) (1,372) (635) (1,535) (1,628) (1,665) Net cash flow after capex 634 2, ,024 1,325 1,494 Net financial inc./(exp.), net of taxes 0 (339) 98 5 (31) (36) (28) Other (4,084) (1,123) (220) (362) (1,061) (3) 35 Free Cash Flow to Equity (3,450) (131) (68) 1,286 1,501 FCF per Share (M$) NM (0.15) (0.08) Source: Company data and Santander estimates. CAPEX ESTIMATED AT AROUND US$125 MILLION PER YEAR We are expecting capex to be around US$125 million per year, dropping to 17.5% of sales in 2012 from 19.9% posted in As percentage of sales, capex in 2010 and 2011 is reflecting the increased investment related to the digitalization program, that should be mostly absent in Figure 12. Megacable s Capex, 2007A 2012E % % 19.9% 20.3% 19.1% 17.5% 20.0% % % 10.0% 5.0% A 2008A 2009A 2010E 2011E 2012E 0.0% Capex (US$) % of Sales Source: Company data and Santander estimates. Capex for the digitalization program accounts for 33% of the total capex estimate for 2010 (see Figure 11), and would continue to be an important part in U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

18 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive Figure 13. Capex Breakdown, 2009A and 2010E 25% 20% Other Digitalization Netw ork Upgrade Internet & Teleph. Netw ork Build-up 13% 10% 20% 33% 5% 20% 32% 22% E Source: Company data and Santander estimates. WORKING CAPITAL A SOURCE OF CASH FROM 2011 ON While in 2010, Megacable is expected to experience a M$121 million increase in working capital, we are assuming that from 2011 on, regular terms with suppliers would allow working capital to be a net source of cash. The significant variations in working capital accounts experienced in the first half of 2010 are related to specific non-recurrent causes. Approximately M$298 million of accounts receivable in June were related to the investment in GTAC and is to be capitalized as equity. The increase in inventory and accounts payable in the first half of 2010 is related to the purchase of set-top boxes planned for the digitalization program. Figure 14. Megacable Working Capital, 2007A 2012E Historic Forecast 2007A 2008E 2009E 1H10E 2010E 2011E 2012E Working Capital (Mn of M$) Accounts receivable Days of LTM sales Inventory Days of LTM sales Accounts payable ,054 Days of LTM costs & expenses Working capital 34 (464) (139) 278 (18) (76) (118) Dec./(Inc.) in Working Capital (122) 497 (325) (417) (121) Source: Company data and Santander estimates. 18 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

19 FROM A NET DEBT TO NET CASH BALANCE; NO US$ EXPOSURE With the debt restructuring in August, 2010, Megacable remained with no US$-denominated debt and reduced the total debt amount to M$2.1 billion. Our estimate of M$2.1 billion debt by the end of 2010, M$900 million lower than the balance posted at the end of June 2010, reflects the threeyear loan at TIIE + 90bps, contracted in August to partially fund the M$3.0 billion balance in debt maturing in August. Under our assumptions of organic growth, we see no need for additional financing for Megacable. Given the estimated cash flow generation, Megacable is expected to shift to a net cash position of M$2.2 billion by the end of 2012, from the M$580 million net debt balance posted in June, Figure 15. Megacable Net Debt, 2007A 2012E Historical Forecast 2007A 2008E 2009E 1H10E 2010E 2011E 2012E Net Debt (Mn of M$) Debt 2,912 3,170 3,028 3,003 2,100 2,100 2,100 Curr. portion and short term ,028 3, ,100 Long term 2,853 3, ,100 2,100 0 % in local currency 50% 52% 52% 52% 0% 0% 0% Cash 981 1,857 2,576 2,423 1,583 2,869 4,370 Net debt 1,932 1, (769) (2,270) Net debt / EBITDA (0.22) (0.56) Source: Company data and Santander estimates. NO CASH TO SHAREHOLDERS YET Management does not plan to propose dividends any time soon. We understand this stance is aligned with the interests of the controlling shareholder. For the foreseeable future, they plan to continue retaining cash in Megacable s balance sheet to act in case further acquisitions or investment opportunities arise. The share buyback fund was created in April, 2008 and is limited to M$209 million. It was created more as a mechanism to provide liquidity to the stock than to reduce the capital of the company and distribute cash to shareholders. In 2008, the company was a net buyer of 5.0 million of its own shares, and in 2009, the company was a net seller of 4.8 million shares. Megacable does not plan to cancel the shares that it buys. MACROECONOMIC OUTLOOK Figure 16. Mexico Select Economic Projections, 2009A 2012E 2009A 2010E 2011E 2012E Real GDP (%) -6.5% 4.7% 3.5% 3.2% CPI Inflation (%) 3.6% 4.7% 3.9% 3.8% US$ Exchange Rate (Year-End) US$ Exchange Rate (Average) Interest Rate (Year-End) 4.5% 4.50% 5.00% 7.00% Interest Rate (Average) 5.4% 4.51% 4.60% 6.44% Fiscal Balance (% of GDP) 0.0% 2.8% 2.8% 0.0% Current Account Balance (% of GDP) -0.6% -1.1% -1.2% nd International Reserves (US$ Bn) nd Total External Debt (% of GDP) 18.6% 16.9% 16.2% nd Source: Santander historicals and forecasts. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

20 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive VALUATION We are introducing our YE2011 target price of M$34.00 per share (US$2.58 per share), based on a DCF model (see details in Figure 17), assuming a cost of equity of 10.5%, equivalent to the sum of the Mexican risk-free rate of 4.4%, an equity risk premium of 5.5%, and a beta of 1.09 versus the Mexbol IPC index. We also assumed a cost of debt of 6.1% in US$, and a 15.0% debt-to-totalcapitalization ratio. Given these assumptions, we arrived at a WACC of 9.5% in nominal U.S. dollar terms. Our terminal value is based on a nominal annual growth rate in U.S. dollar terms of 2.5%. Figure 17. Megacable Free Cash Flow, 2012E 2021E 12E 13E 14E 15E 16E 17E 18E 19E 20E 21E Term. EBIT (M$ Mn) 3,262 3,590 3,828 4,036 4,216 4,362 4,471 4,535 4,548 4,741 EBIT (1-Tax) (M$ Mn) 2,284 2,549 2,756 2,906 3,036 3,141 3,219 3,265 3,275 3,413 (+) Depr./Amort. (M$ Mn) ,064 1,229 1,423 1,650 1,914 2,214 2,317 (-) Capex (M$ Mn) (1,665) (1,775) (1,856) (1,932) (2,003) (2,072) (2,143) (2,218) (2,296) (2,403) (+) Chg in Wk Cap (M$ Mn) FCF to Firm (M$ Mn) 1,443 1,646 1,850 2,064 2,286 2,515 2,750 2,985 3,218 3,354 FX rate FCF to Firm (US$ Mn) ,200 PV FCF (US$ Mn) ,175 NPV of FCF (US$ Mn) 2,176 (-) Net Debt (US$ Mn) 58 (-) Minorities' Stake (US$ Mn) 18 Equity Value (US$ Mn) 2,216 Shares Outstanding (Mn) Target Price (US$) 2.58 FX Rate as of Dec 31, Target Price (M$) Source: Santander estimates. Our estimated upside in the stock price of 4.1% in U.S. dollar terms to YE2011 falls below our 9.8% threshold for a Hold recommendation, thus our Underperform rating. Figure 18 shows a sensitivity analysis to different assumptions of perpetuity growth and cost and discount rates. Figure 18. Megacable Sensitivity of Target Price (in M$) to Discount and Terminal Growth Rates Growth in Perpetuity 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 8.0% % % WACC 9.5% Source: Santander estimates. 10.0% % % U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

21 COMPANY DESCRIPTION Megacable, which originated as two cable-tv companies founded in 1979 in the states of Sonora and Sinaloa, is the largest cable-tv company in Mexico with TV subscribers representing 20% of the country s pay-tv subscribers (including non-cable), as of the end of Headquartered in Guadalajara, Megacable s cable-tv footprint reaches urban areas in 25 of the 32 states of the country (main cities excluded are Mexico City and Monterrey). The company also offers broadband access and fixed telephony, with which it served 32% and 25% of its unique subscribers, respectively by the end of Megacable started offering telephony services in 2006, initially supported by an agreement with Bestphone (which today is a subsidiary of Televisa s Cablevision). By mid-2007, Megacable obtained a concession to offer directly telephony services from the Secretary of Communications and Transport (SCT), and started to negotiate an interconnection agreement with Telmex, which was finalized in December, GEOGRAPHIC FOOTPRINT Megacable is the cable-tv operator with the largest geographic footprint in Mexico, served with 21,800 km of network. Although Megacable is established in key cities and regions in Mexico, the company does not provide yet cable-tv services in Mexico City and Monterrey. The company s offer in Mexico City and Monterrey is only related to corporate telecommunication services offered through its subsidiary MCM Holdings, which in 2009 represented 5% of Mecables total revenues. Figure 19. Megacable s Footprint and Geographic Distribution of Revenues States of Mexico % of Revenue (1) (2009) Pops. (2) (Mn) GDP per Capita (3) (US$) Map of Mexico 1. Jalisco 19% 4.0 7, Sinaloa 12% 2.2 6, Puebla 10% 2.2 5, Sonora 9% 1.9 8, Veracruz 9% 1.8 5, Durango & Coahuila 7% 2.3 8, Michoacan 7% 1.3 5, Edo. de Mexico 6% 2.8 5, Guanajuato 4% 1.4 6, Nayarit 3% 0.4 5,043 Others 16% 5.1 9,842 Total 100% , Country s total ,998 % of country s total 24% 21% Source: Company data, Cofetel and Santander estimates (1) Based on 2009 revenue (2) Population of areas under license (3) Estimated for 2009 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

22 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive Areas licensed to Megacable for cable-tv services represent approximately 24% of the country s population, according to our estimates. In Figure 19, we rank the ten states in Mexico that represent most for Megacacable in terms of revenue, which combined represent 84% of Megacable s revenues. Jalisco (capital city Guadalajara) provides 19% of Megacable s revenues being the largest contributor; followed by Sinaloa and Puebla with 12% and 10%, respectively. Economic wealth in areas covered by Megacable is probably lower than the country s average, thus providing some structural limits to the company s revenue potential compared to operators located in wealthier areas (e.g. Mexico City and Monterrey), where Megacable does not have a presence. As shown in Figure 19, the average GDP per capita in states where Megacable is present was 9.5% lower than the national average. PORTFOLIO OF SERVICES AND SEGMENTS SERVED Megacable derives the bulk of its revenues through the provision of three main services: cable TV, fixed internet access and fixed telephony. Also, through its subsidiary MCM Holdings (MCM), Megacable provides telecommunication services to medium-sized and large companies in Guadalajara, Mexico and Monterrey. Finally, among other services, Megacable provides virtual private network and other network services to business customers under the Metrocarrier brand, and produces content related to news, culture and music, among others, for its own channels Video Rola and Megacanal. The residential segment represents the largest source of Megacable s revenues, although revenues from the non-residential segment grew faster since 2006 (see Figure 20). Revenues from residential customers represented 89% of total revenues in Most of it corresponds to TV services. Figure 20. Megacable Residential and Non-Residential Revenues FY2009 % of Total Revenues 3-Year CAGR ('06-'09) Residential 6,120 89% 27% TV 4,270 62% 25% Internet % 11% Telephony % 215% Advertising 85 1% 6% Non-Residential 585 8% 48% TV 43 1% 25% Internet 149 2% -1% Telephony 56 1% 185% MCM 336 5% NA Other 191 3% -8% Total 6, % 27% Source: Company data and Santander estimates. TV SERVICES The company deploys its pay TV services in four different offers: basic, minibasic, lifeline, and premium, seeking to reach customer segments with different income levels. The three most important ones are: Basic video is the company s top-selling package, accounting for 55% of the company s total revenue. This service provides approximately an access to 69 channels. Lifeline video is the second most important package in this segment, in terms of revenues. Lifeline is an entry-level package and was introduced as a package to retain subscribers. Lifeline offers access to approximately 30 channels. 22 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

23 Premium video is a package with additional channels above basic digital video service.the digital basic package offers 165 channels, thus premium packages have the option to add different channels that the subscriber chooses (HBO/Max Digital, Movie City, Playboy Tv, PPV Adults and PPC Peliculas). Revenue from advertisers, representing 1% of the company s total revenue in 2009, is one additional revenue stream associated with the TV service. Figure 21. Megacable TV Services (Mn of M$) 2009 % of Total Revenues 3-Yrs CAGR ('06-'09) Basic Video 3,728 55% 29% Premium Video 217 3% -7% Lifeline Video 285 4% 96% Mini-basic Video 82 1% -14% Advertising 85 1% 6% Total 4,398 64% 25% Source: Company data and Santander estimates. TRIPLE PLAY BUNDLES As is the current practice by the largest operators in the cable-tv industry in Mexico, Megacable seeks to maximize the value of its relationship with the households it serves by bundling telephony and internet access with its TV services. Regulations have evolved to foster this: (i) cable-tv companies in Mexico are allowed to offer telecommunication services; (ii) in July 2008, number portability became mandatory for fixed voice line subscribers who decide to switch from one service provider to another; and (iii) interconnection conditions with other telecom operators have improved and the regulator is pushing forward actions to improve them even further. Service bundling with pay-tv has been the main route for Megacable to introduce internet and voice services into the residential segment. Internet and fixed telephony services are offered separately and in different packages combining either two or the three of them. However, close to 100% of Megacable s internet and telephony residential subscribers are TV subscribers. Megacable s triple-play subscribers already represent approximately 20% of unique subscribers. This means that the approximately 350,000 triple-play bundles active as of June 2010, represent 65% and 78% of Megacable s internet and telephony subscriptions. Figure 22, summarizes a comparison of triple-play packages offered by different cable TV operators, plus the ones that effectively can be assembled by combining Telmex s double-play with the satellite TV service provided by Dish (which has a commercial alliance with Telmex that includes billing and sales). We show bundles separated into three main segments determined by the total monthly price of the package. Effectively, direct competition with the triple-play offers occur mainly between the cable companies and the Telmex/Dish alliance. Bundles provided by the other cable-tv companies do not compete directly with Megacable s, as their footprint do not overlap, but are included to show what these other cable TV operators offer under competitive conditions that are similar than the ones Megacable faces. Bundles under the YOO brand are also included. The YOO brand was launched in May 2009 jointly by Televisa s cable companies and Megacable, as a marketing umbrella with nationwide reach to promote a lowerpriced triple-play bundle. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

24 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive Figure 22. Megacable Triple-Play Pricing, 2010 Price Premium Rent Over Norm. (1) Lowest in for DLD Segment min (M$) Segment 1: Less than M$600 a month, compromising channel numbers Calls / Minutes Included Monthly Rent (M$) Local calls DLD calls DLI calls Broadband (Mbps) Yoo Cablemas 4% Unlimited Yoo Cablevisión 11% Unlimited Yoo Megacable 22% Unlimited TMX 1 + Dish calls 100 min Telecable 1 4% calls Telecable 2 10% calls 100 min Megacable 3% calls Megacable 13% Unlimited Megacable 22% calls Segment 2: Between M$600 and M$800 a month, having access to increased channel grid Megacable 20% Unlimited Number of TV Channels Megacable 20% calls Megacable 29% Unlimited Cablecom 35% Unlimited Cablecom 44% Unlimited Cablemas 23% Unlimited Cablevision 36% Unlimited TMX 1 + Dish calls 100 min TMX 2 + Dish 1 27% calls Unlimited 100 min TMX 2 + Dish 2 36% calls Unlimited Telecable 15% calls 100 min Telecable 30% calls 200 min Segment 3: Over M$800/month Cablevision Monterrey 2 19% Unlimited Megacable 3 25% Unlimited Unlimited TMX 3 + Dish 1 44% Unlimited Unlimited * 100 min TMX 3 + Dish 2 50% Unlimited Unlimited * Unlimited * Telecable calls 200 min Source: Company websites, and Santander estimates a Where necessary, an additional amount was added to monthly rent so as to include 100 minutes of calls to long distance calls, to increase the comparability of offers presented. Megacable offers bundles in each of the three segments, as Telmex effectively does when its alliance with Dish is considered. In Figure 22, we highlight: Megacable s products in segment 1 are not the cheapest, but reflect higher value in terms of broadband speed and number of channels provided. In segment 2, Megacable has more competitive offers in terms of price. In Segment 3, Megacable package is competitively priced against TMX 3 + Dish 1 package, offering a clear advantage in terms of number of channels, which the Telmex/Dish offer does not reach. 24 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

25 OWNERSHIP AND FLOAT Megacable is controlled by the Bours and Mazon families. Through a control trust with HSBC Mexico, S.A. the Bours family and Mazon hold around 42% and 11% of the outstanding shares, respectively. Other non-family-related shareholders, also included in the Control Trust, hold 13% of the company. Independent shareholders hold 10% while the remaining 24% is free float. Figure 23. Megacable - Shareholders Shareholders Shares % of Shares Control Trust Bours y Mazón Families Enrique Yamuni 1,130 66% Manuel Urquijo Float % Independent Shareholders Ernesto F. Echavarría S % Treasury Shares 0 0% Others (a) 6 0% Total 1, % Source: Company data and Santander estimates (1) Group of seven other individual investors, of which the largest individual equity stake represents 0.1% of the company s equity. Equity shares of the company are traded in the Mexican stock exchange in the form of CPOs (Certificados de Participación Ordinaria), equivalent to two series-a shares each. The 24% float of the company is represented by million CPOs. RESTRICTIONS ON FOREIGN OWNERSHIP AND CONTROL The Foreign Investment Law and the Telecommunications Law limit foreign ownership and vote capacity in fixed line operators up to 49%. The law allows foreign investors to hold shares indirectly through neutral shares or CPOs. We understand there is a project led by a committee in the lower house of Congress, aiming to reduce the restrictions on foreign control in fixed line telecommunication assets. However, the timing and reach of an eventual approval, if any, of this proposed change in law is still uncertain. CHANGE OF CONTROL: AT LEAST A 30% CONTROL PREMIUM In case of a proposed change of control or the acquisition of 20% or more of the voting shares of Megacable, the buyer must make a public tender offer for 100% of the shares. The price of the tender offer should be no less than 1.3x the highest of three specific reference values: (i) book value per share; (ii) the last-12-month share price peak; and (iii) the highest price per share ever paid by the buyer seeking control. Any transaction involving 7.5% or more of the total shares of the company (2% or more in case of sale to a competitor), or a change in control, requires approval from Megacable s Board of Directors. CORPORATE GOVERNANCE CONTROL TRUST Megacable has 1,129 million ordinary shares, which represent around 65.6% of the company s capital, managed through a Control Trust. The Control Trust requires holders of contributed shares to cast a single block vote in all matters related to Megacable. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

26 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive BOARD OF DIRECTORS AND KEY MANAGEMENT Megacable s Board of Directors may have up to 12 principal members, designated by renewable terms of one-year. Following the Mexican law, the board needs to be integrated by at least 25% of independent counselors. Megacable s Board of Directors is comprised of 11 members, of which, three are independent directors, and eight are related to shares contributed to the Control Trust: five members of the Bours family, one member of the Mazón family, Manuel Urquijo, and Enrique Yamuni. Mr. Francisco Javier R. Bours Castelo is the Chairman of the Board. Enrique Yamuni, a founding member of the company, member of the Board of Directors, and owner of A shares, acts as Chief Executive Officer. Other key management posts are held by Raymundo Fernández, Deputy Chief Executive Officer, and Luis Zetter as Chief Financial Officer. Since 2009, there have been a number of changes in key management posts, suggesting potential instability: Luis Zetter was appointed CFO in May 2010, to replace Luis Andrade who held the CFO post for less than a year. Also recently in the beginning of September, Megacable announced that their Director of Engineering and Network Operations resigned after having spent 10 years with Megacable. His responsibilities have been taken over by Enrique Yamuni temporarily. INDUSTRY SIZES, SERVICE PENETRATION AND PLAYERS Service convergence rules promoted by the state and agreed to by the players in 2006, allowed players such as Megacable to offer three service segments: pay-tv services, fixed telephony and broadband access. Shortly, Megacable will also offer mobile telecommunication services. By the end of 2009, penetration of pay-tv, broadband and fixed telephony were 29% (per households), 9% (per pops), and 18% (per pops), respectively. Relative to other Latin American countries, Mexico s pay-tv penetration is between Brazil s 13% and Argentina 65%; Broadband penetration lies within a narrower range between Brazil s 6% and Argentina s 9%. Figure 24. Mexico - Population and Subscribers, in thousands Population and Subscribers, figures in thousands June 10 CAGR ('06-'09) Population 106, , , ,396 1% 2% Households 26,611 27,213 27,815 28,116 2% 2% YoY 1H10 Pay TV Service Subscribers 6,515 7,038 7,990 9,174 10% 25% Penetration (% of households) 24% 26% 29% 33% By Technology Cable TV 4,338 4,823 5,085 5,274 9% 7% DTH 1,449 1,524 2,440 3,518 22% 98% MMDS % -38% Fixed Lines Lines in Service 19,998 20,491 19,425 19,473-1% -5% Penetration (% of Population) 19% 19% 18% 18% Broadband Subscribers 4,386 7,379 9,484 NA 48% NM Penetration % of Population 4% 7% 9% NA % of Population of Households 16% 27% 34% NA Source: CONAPO, INEGI, company data and Santander estimates 26 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

27 Figure 24 shows historical figures for penetration and growth for the three service segments considered. The Mexican pay-tv services had a CAGR of 10% from 2006 to 2009 and a YoY growth of 25% in June 2010, which reflects an acceleration of growth probably due to promotions related to the FIFA 2010 World Cup event but also to the introduction by the end of 2009 of lower-value bundles mostly on satellite-tv services (DTH) aimed at broader segments of the population. Broadband access was the fastest growing service segment in the past three years, reaching a still low 9% penetration, while fixed telephony penetration has remained nearly stable in the same period. PLAYERS In terms of subscribers, Megacable is the second largest pay-tv operator (first in cable- TV), behind Sky, Televisa s satellite-tv (DTH) service provider (see Figure 25 for details). In 2009, the company had 1,593 subscribers in pay-tv, representing around 20% of Mexico s total pay-tv subscribers, and posted a CAGR of 32% from 2006 to 2009 which is the highest growth in the segment. However, we highlight the acceleration in subscriber growth reached by DTH providers (Sky and a majority of others) during 1H10. We believe this acceleration was driven by the lower-priced promotions paired with an easier installation process. Looking ahead, we believe that the strongest competition for Megacable s pay-tv service will come from DTH providers. Figure 25. Subscriber Share and Growth by Service Provider in Mexico June 10 CAGR ('06-'09) YoY 1H10 Pay TV Service Megacable 20% 21% 20% 19% 32% 15% Televisa - Sky (DTH) 24% 23% 23% 25% 8% 38% Televisa - Cablemas (Cable) 12% 12% 11% 10% 9% 8% Televisa - Cablevision 8% 8% 8% 7% 9% 8% TVI - Televisa 0% 3% 3% 3% NM 29% Other 36% 32% 35% 35% NM 32% Fixed Line Megacable 1% 1% 2% 2% NM 31% Telmex 89% 86% 82% 80% -5% -10% Axtel 5% 5% 5% 5% 7% 10% Telefonica 0% 1% 2% 2% 451% 112% Televisa - Cablemas (Cable) 0% 0% 1% 1% 80% 89% Televisa - Cablevision 0% 0% 1% 1% NM 84% TVI - Televisa NM NM NM NM NM 82% Other 6% 7% 8% 8% 23% 10% Broadband Megacable 9% 6% 5% NM 23% 19% Telmex 67% 68% 69% NM 53% 12% Axtel 2% 1% 2% NM 40% 81% Televisa - Cablemas (Cable) 5% 3% 3% NM 18% 30% Televisa - Cablevision 3% 3% 3% NM 38% 26% TVI - Televisa 2% 1% 1% NM NM NA Other 13% 18% 17% NM 46% NA Source: Company data and Santander estimates In fixed line and broadband services Megacable s growth appears to be lagging other cable- TV operators. We believe the gap in terms of growth is the result of a combination of two drivers: (i) Megacable may have room to improve its commercial approach to resume growth levels in broadband and fixed line services closer to the ones that are being posted by Televisa s cable-tv operators; but also (ii) Megacable s reduced growth may be the result of a more conservative approach in terms of profitability as we highlight in the following section, Comparison of Cable-TV Operators. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

28 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive COMPARISON OF CABLE TV OPERATORS Megacable has the highest EBITDA margin compared to other Mexican cable-tv operators, and also compared with Net Servicos from Brazil. This profitability advantage appears to be driven by costs rather than from revenues: Megacable s average revenue per RGU is the smallest in Mexico, and its average revenue per unique subscriber is higher only than Cablemas s. In Figure 26, we show the key cable-tv operators in Mexico and Brazilian Net Servicos compared. Figure 26. Cable TV Operators Compared Megacable Cablevisión Cablemás TVI Net Serviços Households Under License (000) 25,344 17,263 13,807 1,818 NA Homes Passed (000) 4,599 1,877 2,738 1,000 10,777 % of Household Under License 18% 11% 20% 55% NA Unique subscribers (000) 1, ,727 Subscribers to Homes Passed 36% 34% 35% 25% 43.9% RGU to Unique subscribers RGUs (000) 2,524 1,016 1, ,118 % of Homes Passed 55% 54% 49% 42% 94% TV 1, ,690 Internet ,882 % of TV 32% 40% 32% 47% 78% Telephony ,557 % of TV 26% 21% 16% 32% 69% ARPU (Local currency/month) ARPU per RGU ARPU per Unique subscribers TV NA Internet NA Telephony NA Advertising N.A NA Revenue (Mn of Local Crncy.) 6,895 3,379 3,653 1,241 4,613 EBITDA (Mn of Local Crncy.) 2,912 1,263 1, ,241 EBITDA Margin 42% 37% 36% 32% 27% 1H10 YoY Growth Rates in Local Currency RGUs TV 15% 8% 8% 29% 12% Internet 19% 26% 30% 44% 19% Telephony 31% 84% 89% 82% 21% ARPU TV -7% -2% -8% -5% NA Internet -8% -3% -8% -8% NA Telephony -9% -14% -12% -19% NA Advertising NA NA NA NA NA Revenue 8% 15% 10% 33% 18% EBITDA 3% 11% 22% 37% 25% Source: Company data and Santander estimates 28 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

29 RISKS Competition: from Telmex currently on telecommunication services, and mainly from satellite TV offers (Sky and Dish), may reduce prices and margins in Megacable s key service segments. Macroeconomic conditions: further penetration of services and retention of current subscribers depend on the population s purchasing power, and this may lead the company to a lower-than-expected growth in RGUs or downward pressure on ARPUs. Also, a depreciation of the local currency vis a vis the U.S. dollar may have an adverse impact on profitability, as a significant portion of operating costs (around 40%) is linked to U.S. dollars, while service prices are set in local currency. Reduced float: of 24% that provides little room for the current average daily trading volume of US$1.5 million to improve. High management turnover: in key posts: particularly, the CFO post and more recently, the Director of Network Operations. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

30 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive FINANCIAL STATEMENTS 30 Figure 27. Megacable Income Statement, Balance Sheet, and Cash Flow Statement, E (U.S. Dollars in Millions) Income Statement 2009A 2010E 2011E 2012E % Sales % % % % Cost of Sales (171) (33%) (195) (33%) (215) (33%) (232) (32%) Gross Profit % % % % Oper. and Adm. Expenses (176) (35%) (201) (34%) (223) (34%) (241) (33%) Operating Profit % % % % Depreciation (52) (10%) (57) (10%) (58) (9%) (59) (8%) EBITDA % % % % Financing Costs 7 1% (5) (1%) (6) (1%) (5) (1%) Interest Paid (12) (2%) (12) (2%) (9) (1%) (12) (2%) Interest Earned 10 2% 7 1% 3 0% 7 1% Monetary Gain/Loss FX Gain/Loss 10 2% (1) (0%) 1 0% 0 0% Other Financial Operations 1 0% 2 0% 2 0% 2 0% Profit before Taxes % % % % Tax Provision (26) (5%) (41) (7%) (51) (8%) (69) (10%) Profit after Taxes % % % % Subsidiaries 3 1% 1 0% 5 1% 8 1% Extraordinary Items Minority Interest (1) (0%) (2) (0%) (2) (0%) (2) (0%) Net Profit % % % % Balance Sheet 2009A 2010E 2011E 2012E % Assets 1, % 1, % 1, % 1, % Short-Term Assets % % % % Cash and Equivalents % % % % Accounts Receivable 22 2% 33 3% 35 3% 38 2% Inventories 11 1% 32 3% 32 2% 33 2% Other Short-Term Assets 35 3% 24 2% 24 2% 27 2% Long-Term Assets 5 0% 57 5% 64 5% 70 4% Fixed Assets % % % % Deferred Assets % % % % Other Assets 30 3% 51 4% 50 4% 51 3% Liabilities % % % % Short-Term Liabilities % 73 6% 80 6% % Suppliers 43 4% 67 5% 73 5% 80 5% Short-Term Loans % % Other Short-Term Liabilities 4 0% 6 1% 7 0% 7 0% Long-Term Loans % % - - Deferred Liabilities Other Liabilities 60 5% 63 5% 69 5% 77 5% Majority Net Worth % % 1,040 77% 1,218 79% Net Worth % % 1,048 77% 1,224 79% Minority Interest 10 1% 11 1% 8 1% 6 0% Cash Flow 2009A 2010E 2011E 2012E % Net Majority Earnings % % % % Non-Cash Items 30 6% (26) (4%) 55 8% 56 8% Changes in Working Capital (23) (4%) (9) (2%) 4 1% 3 0% Changes in Debt 3 1% (68) (11%) (5) (1%) (0) (0%) Capital Increases/Dividends 7 1% 0 0% Capital Expenditures (102) (20%) (120) (20%) (125) (19%) (126) (18%) Net Cash Flow 63 12% (74) (12%) 94 14% % Beginning Treasury Ending Treasury Sources: Company reports and Santander estimates. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

31 Figure 28. Megacable Income Statement, Balance Sheet, and CF Statement, E (Millions of M$) Income Statement 2009A 2010E 2011E 2012E % Sales 6, % 7, % 8, % 9, % Cost of Sales (2,309) (33%) (2,491) (33%) (2,796) (33%) (3,068) (32%) Gross Profit 4,586 67% 5,058 67% 5,714 67% 6,448 68% Oper. and Adm. Expenses (2,380) (35%) (2,576) (34%) (2,901) (34%) (3,186) (33%) Operating Profit 2,206 32% 2,482 33% 2,813 33% 3,262 34% Depreciation (707) (10%) (732) (10%) (757) (9%) (782) (8%) EBITDA 2,912 42% 3,214 43% 3,570 42% 4,045 43% Financing Costs 101 1% (65) (1%) (73) (1%) (67) (1%) Interest Paid (169) (2%) (151) (2%) (123) (1%) (161) (2%) Interest Earned 133 2% 92 1% 40 0% 93 1% Monetary Gain/Loss FX Gain/Loss 137 2% (7) (0%) 10 0% 1 0% Other Financial Operations 14 0% 25 0% 25 0% 28 0% Profit before Taxes 2,321 34% 2,442 32% 2,765 32% 3,223 34% Tax Provision (349) (5%) (526) (7%) (664) (8%) (916) (10%) Profit after Taxes 1,972 29% 1,916 25% 2,102 25% 2,307 24% Subsidiaries 34 1% 19 0% 65 1% 103 1% Extraordinary Items Minority Interest (20) (0%) (27) (0%) (25) (0%) (27) (0%) Net Profit 1,987 29% 1,907 25% 2,141 25% 2,383 25% Balance Sheet 2009A 2010E 2011E 2012E % Assets 14, % 15, % 17, % 20, % Short-Term Assets 3,466 24% 2,724 18% 4,079 23% 5,660 28% Cash and Equivalents 2,576 18% 1,583 10% 2,869 16% 4,370 21% Accounts Receivable 283 2% 418 3% 461 3% 504 2% Inventories 144 1% 415 3% 427 2% 431 2% Other Short-Term Assets 463 3% 307 2% 322 2% 355 2% Long-Term Assets 59 0% 735 5% 848 5% 920 4% Fixed Assets 6,008 42% 7,140 46% 8,011 45% 8,894 43% Deferred Assets 4,303 30% 4,303 28% 4,303 24% 4,303 21% Other Assets 395 3% 650 4% 665 4% 680 3% Liabilities 4,426 31% 3,832 25% 4,070 23% 4,266 21% Short-Term Liabilities 3,645 26% 930 6% 1,053 6% 3,252 16% Suppliers 566 4% 852 5% 964 5% 1,054 5% Short-Term Loans 3,028 21% ,100 10% Other Short-Term Liabilities 52 0% 78 1% 89 0% 98 0% Long-Term Loans - - 2,100 14% 2,100 12% - - Deferred Liabilities Other Liabilities 781 5% 802 5% 917 5% 1,013 5% Majority Net Worth 9,675 68% 11,585 74% 13,726 77% 16,109 79% Net Worth 9,804 69% 11,720 75% 13,836 77% 16,192 79% Minority Interest 129 1% 135 1% 109 1% 83 0% Cash Flow 2009A 2010E 2011E 2012E % Net Majority Earnings 1,987 29% 1,907 25% 2,141 25% 2,383 25% Non-Cash Items 472 7% (320) (4%) 715 8% 741 8% Changes in Working Capital (325) (5%) (121) (2%) 58 1% 42 0% Changes in Debt (142) (2%) (928) (12%) Capital Increases/Dividends 99 1% 3 0% Capital Expenditures (1,372) (20%) (1,535) (20%) (1,628) (19%) (1,665) (18%) Net Cash Flow % (993) (13%) 1,286 15% 1,501 16% Beginning Treasury 1,857 2,576 1,583 2,869 Ending Treasury 2,576 1,583 2,869 4,370 Sources: Company reports and Santander estimates. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

32 Megacable: Initiating Coverage Attractive Story, but Speculative Premium Makes it Expensive IMPORTANT DISCLOSURES Megacable 12-Month Relative Performance (U.S. Dollars) MEGACABLE IPC 80 S-09 O-09 D-09 J-10 F-10 M-10 A-10 M-10 J-10 A-10 S-10 Sources: Bloomberg and Santander. Televisa 12-Month Relative Performance (U.S. Dollars) IPC Televisa S-09 N-09 J-10 M-10 M-10 J-10 S-10 Sources: Bloomberg and Santander. Televisa Three-Year Stock Performance (U.S. Dollars) B $ /3/08 B $ /9/08 B $ /1/08 B $ /3/09 UP $ /20/09 UP $ /8/09 H $ /21/10 H $ /15/10 3,500 3,000 2,500 2,000 1,500 1, Analyst Recommendations and Price Objectives B: Buy H: Hold UP: Underperform UR: Under Review 0 J-07 S-07 D-07 M-08 J-08 S-08 D-08 M-09 J-09 S-09 D-09 M-10 J-10 0 Source: Santander. Televisa (L Axis) IPC (R Axis) 32 U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) / (212)

33 NET 12-Month Relative Performance (U.S. Dollars) NET Serviços Ibovespa 80 S-09 N-09 J-10 M-10 M-10 J-10 S-10 Sources: Bloomberg and Santander. NET Three-Year Stock Performance (U.S. Dollars) *Assuming Coverage 50,050 45,050 40,050 35,050 30,050 25,050 Analyst Recommendations and Price Objectives B: Buy H: Hold UP: Underperform UR: Under Review 8 6 B $ /29/07 H $ /8/09 20,050 15,050 4 B $9.10 B $14.40 H $ ,050 B $ /1/08 8/31/09 6/17/10* 8/17/07 5, J-07 O-07 M-08 J-08 D-08 A-09 S-09 J-10 J-10 Source: Santander. NET (L Axis) Bovespa (R Axis) U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

34 Key to Investment Codes IMPORTANT DISCLOSURES Rating Definition % of Companies Covered with This Rating % of Companies Provided Investment Banking Services in the Past 12 Months Buy Expected to outperform the local market benchmark by more than 10% % 59.09% Hold Expected to perform within a range of 0% to 10% above the local market benchmark % 40.91% Underperform/Sell Expected to underperform the local market benchmark. 6.22% -- Under review The numbers above reflect our Latin American universe as of Thursday, September 16, For a discussion, if applicable, of the valuation methods used to determine the price targets included in this report and the risks to achieving these targets, please refer to the latest published research on these stocks. Research is available through your sales representative and other electronic systems. Target prices are 2010 year-end unless otherwise specified. Recommendations are based on a total return basis (expected share price appreciation + prospective dividend yield) unless otherwise specified. Stock price charts and rating histories for companies discussed in this report are also available by written request to Santander Investment Securities Inc., 45 East 53 rd Street, 17 th Floor (Attn: Research Disclosures), New York, NY USA. Ratings are established when the firm sets a target price and/or when maintaining or reiterating the rating. Ratings may not coincide with the above methodology due to price volatility. Management reserves the right to maintain or to modify ratings on any specific stock and will disclose this in the report when it occurs. Valuation methodologies vary from stock to stock, analyst to analyst, and country to country. Any investment in Latin American equities is, by its nature, risky. A full discussion of valuation methodology and risks related to achieving the target price of the subject security is included in the body of this report. The benchmark used for local market performance is the country risk of each country plus the 1-year U.S. Treasury yield plus 5.5% of equity risk premium, unless otherwise specified. The benchmark plus the 10.0% differential used to determine the rating is time adjusted to make it comparable with the total return of the stock over the same period. For additional information about our rating methodology, please call (212) This research report ( report ) has been prepared by Santander Investment Securities Inc. ("SIS"; SIS is a subsidiary of Santander Investment I, S.A. which is wholly owned by Banco Santander, S.A. ["Santander"]) on behalf of itself and its affiliates (collectively, Grupo Santander) and is provided for information purposes only. This report must not be considered as an offer to sell or a solicitation of an offer to buy any relevant securities (i.e., securities mentioned herein or of the same issuer and/or options, warrants, or rights with respect to or interests in any such securities). Any decision by the recipient to buy or to sell should be based on publicly available information on the related security and, where appropriate, should take into account the content of the related prospectus filed with and available from the entity governing the related market and the company issuing the security. This report is issued in Spain by Santander Investment Bolsa, Sociedad de Valores, S.A. ( Santander Investment Bolsa ) and in the United Kingdom by Banco Santander, S.A., London Branch. Santander London is authorized by the Bank of Spain. This report is not being issued to private customers. SIS, Santander London and Santander Investment Bolsa are members of Grupo Santander. The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed, that their recommendations reflect solely and exclusively their personal opinions, and that such opinions were prepared in an independent and autonomous manner, including as regards the institution to which they are linked, and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report, since their compensation and the compensation system applying to Grupo Santander and any of its affiliates is not pegged to the pricing of any of the securities issued by the companies evaluated in the report, or to the income arising from the businesses and financial transactions carried out by Grupo Santander and any of its affiliates: Gregorio Tomassi*, Valder Nogueira*, Diana Leyva*. *Employed by a non-us affiliate of Santander Investment Securities Inc. and not registered/qualified as a research analyst under FINRA rules, and is not an associated person of the member firm, and, therefore, may not be subject to the FINRA Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances, and trading securities held by a research analyst account. 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