LatAm TMT - Inflation: Tech better positioned in an inflationary environment

With macro factors becoming frequent in TMT discussions, we are launching a series of reports investigating the fundamental impacts on the sector. Our conclusions: 1) Tech margins are the most affected by inflation swings, with ~85% of sector Opex impacted by inflation (vs. low-to-high 60's of Telco's). However, their contracts with clients are mostly adjusted by inflation, which makes the sector broadly protected against increases; 2) Another key theme on Tech is the difference between the main inflation indexes in Brazil: IPCA/IGPM (affecting revenue growth) and INPC (influencing personnel cost). Index mismatches might cause additional margin volatility on the companies; 3) ISPs are more exposed to inflation swings compared to Big Telcos, due to (a) more expenses indexed to inflation and (b) higher capex/ sales ratio; both taking higher tolls on FCF; 4) Valuation multiples (EV/EBITDA) may cause an artificial distortion when looking at large telcos.

We believe that ISPs have the highest challenge on an inflationary scenario. The sector's average impact in FCF yield is -250bps with a 2p.p.'s increase in inflation. We believe that companies should not have an easy pass-through dynamic, considering segment competitive landscape with thousands of players.

Our studies suggest that Large Telcos are the least impacted by inflation swings, (FCF yield impacts of -65bps w/ a 2p.p.'s inflation increase). However, the companies have often struggled to pass-through inflation in Brazil, due to the competitive landscape (although we're seeing an improvement in 2023 due to the mobile consolidation).

We see the Tech segment as the best positioned in a higher inflation scenario. Even though a material chunk of companies' opex is indexed by inflation, the overall impacts in FCF yield are the most limited in TMT (-50bps average impact in FCF and -8% earnings impact with a 2p.p.'s increase in inflation). The outperformance is partially explained by their high bargaining power, coming from the essentiality of their products and high switching costs.