HKT Completion

The PCCW takeover of HKT became effective today. The resultant shareholdings add up to one giant overhang. We also look at how many people failed to elect for the more valuable of the two offers, the shrinking investment portfolio, and the silence surrounding key deals by PCCW needed to refinance its debt as it transits from concept stock to telecom utility.

HKT Completion
17th August 2000

Pacific Century Cyberworks Ltd (PCCW) today announced (Word format) the completion of its takeover of Cable & Wireless HKT Ltd (HKT).

PCCW said that HKT shareholders who chose the Increased Cash Election (ICE) can expect an additional HK$18.62 per PCCW share in respect of approximately 3.2% of the PCCW shares otherwise receivable pursuant to the Combination Alternative.

The additional cash is available because some shareholders did not make the rational election for the Combination Alternative (0.7116 PCCW shares and $7.23 in cash), worth $18.19 at the election deadline. As we warned back in June, those who did nothing would get the Share Alternative by default, and would lose out. At the election deadline, this was worth only $16.94 per HKT share.

Those shareholders who made the ICE (including Cable & Wireless plc, C&W) will get, for every HKT share, about 0.689 PCCW shares and HK$7.65 in cash. That's $0.45 more in cash than the standard Combination Alternative. Based on the closing price on the election deadline (15-Aug-00) of $15.40, they get a total value of $18.26 per HKT share.

Asleep at the wheel

We don't know how many of those who elected for the Combination Alternative also chose the ICE (as they logically should). But even if they all chose the ICE, the implication is that not more than 5.5% of HKT shares received the Share Alternative. If not all electing shareholders made the ICE, then the figure would be less than 5.5%.

Prior to the merger (and allowing for the exercise of all share options) HKT was owned 54.1% by C&W, 10.8% by China Mobile (Hong Kong) Group Ltd (CMHKG, parent of HK-listed China Mobile (Hong Kong) Ltd) and we estimate that 7% was still owned by the Hong Kong Government, making a total of 71.9%. It is safe to assume that none of the top 3 shareholders failed to elect for the more valuable Combination Alternative.

That means that, of the 28.1% of HKT in public hands, up to one fifth failed to make the election. There will be more than a few investors choking on their breakfast this morning. If you are a trustee of a fund, ask your investment manager whether they made the election.

C&W's resulting stake

We scratched our head when we read this. The numbers didn't quite add up. Now we know why. In fact, C&W has come out with 21.5% of PCCW, or 20.2% assuming conversion of outstanding PCCW options. Of those options, at 22-May-00 there were 336.4m executive share options, and 1,003m shares under option to Intel, which can exchange its 40% stake in Pacific Century Convergence for shares in PCCW at any time in the next 9 years.

C&W plans to sell 4.9% by way of a placing, as soon as possible. On 29-Feb-00 they also announced a share swap with CMGI Inc (a US-based internet company) in which they would swap US$500m of PCCW shares for the same value in CMGI shares. At current prices, that would be about 253m PCCW shares, or about 1.2% of PCCW.

Since the announcement, CMGI has slumped 71% from US$129.56 to US$$37.44. So US$500m now buys about 4.5% of CMGI, not 1.3% as was the case when the swap was announced. No word on whether that deal is still on and whether C&W would sell the resulting CMGI shares, putting further pressure on the US stock.

If the CMGI swap and the placing are completed, then that leaves C&W with 15.4% of PCCW, and they have undertaken to hold this for 6 months, after which they can sell half, or 7.7%. After 17-Aug-01, they are free to do what they like.

Meanwhile unlisted CMHKG, assuming it elected for the ICE, will receive about 904m shares or 4.3% of PCCW. The letter from independent adviser ING Barings in the Scheme document wrote:

The HK Government, which we estimate still held about 7% of HKT (down from 8.9% after the stock market intervention due to sales of the Tracker Fund), would receive about 586m shares, or 2.8% of PCCW. It is the Government's stated intention to dispose of the bulk of its equity portfolio over the long term.

The top 3 shareholders of HKT add up to one giant overhang of stock totalling 6.03bn shares or 28.6% of PCCW, worth US$11.9bn at current prices.

We can expect retail selling by smaller shareholders to begin on Monday 21-Aug-00, the day on which PCCW share certificates will be dispatched to HKT shareholders, for settlement on Wednesday. Those who sell early risk defaulting on their sale and being nabbed for short selling if the stock does not arrive on time.

Optional profits

Rumours in today's press that PCCW executives are about to cash in on their options are also likely to depress the price, since the options were good for the next 9 years. If they felt the stock had any upside, they should hang on.

By coincidence, a slew of options became exercisable today at HK$2.356 per share, of which PCCW directors hold 111.916m options worth HK$1.46bn (US$187m) in profits at current prices. They also hold options exercisable from 25-Oct-00 worth another US$52m in profits.

The Telstra Deal

We await news on whether the proposed deal with Telstra will go ahead. There has been no news since the Memorandum of Understanding was announced 4 months ago on 12-Apr-00. In that announcement, they wrote:

In other words, that "shared vision" was due by 12-Jun-00, over 2 months ago. Is no news good news?

The deal is particularly important to PCCW because it would bring in US$1.5bn from the sale of 40% of HKT's mobile business, plus US$1.5bn in the form of a subordinated convertible loan note which is convertible at the improbable price of $23.69 per PCCW share. The total of US$3bn is needed to help pay back the debt taken out to acquire HKT.

The HMTF deal

On 29-Feb-00, with the offer for HKT, PCCW also announced a proposal to raise US$500m by issuing convertible preference shares to HMTF PCCW Investors, LLC, an affiliate fund of Texan investor Hicks, Muse Tate and Furst Inc. The deal was "subject to finalisation of appropriate legal documentation". In an announcement 3 months later on 26-May-00, PCCW said "the definitive agreements are currently being negotiated". Normally, documentation of this nature takes only days to settle. We wonder what the hold-up is.

If the deal proceeds, PCCW will need to call a meeting to amend its Articles to allow for the issue of the new class of shares. If it doesn't proceed, PCCW will have to find the US$500m somewhere else.

The incredible shrinking portfolio

PCCW has 8.12m shares in CMGI, or a 2.75% stake, which is now only worth about US$304m, down over US$1bn from its high. They got the shares in a swap agreed in Sep-99 in which CMGI received 448.3m shares in PCCW, now a 2.1% stake and worth US$885m.

In Oct-99 PCCW agreed to pay US$128.8m in cash at US$25.75 per share for a stake in Softnet Systems Inc. The shares have since fallen 78% to US$5.56 and the stake is worth only US$27.8m.

PCCW's internet portfolio is now miniscule relative to its investment in HKT. For example, the CMGI stake is only worth about HK$0.11 per PCCW share. Even the Cyberport (we estimate it will bring in US$1.2bn in present dollars) is only HK$0.44 per share.

Lifting the Veil

Analysts will gradually recognise that what they are now looking at is a highly-geared telecom utility company struggling to maintain its operating profits in a deregulated market, while at the same time adapting to the internet age and the prospect of heavy capital investment to secure participation in the next round of technology.

All the hype and hope in "Network of the World" doesn't disguise the fact that it will cost good money to build the physical network, for which one can expect utility rates of return (we are only talking about moving bits of data from A to B here). Meanwhile on the content side, PCCW will be competing with far more experienced content providers both globally (AOL-Time Warner, News Corp, Sony, Viacom etc) and specialists in each Asian country.

Pacific Century Matrix, the private arm of the group which is 70% owned by Richard Li and 30% by DaimlerChrysler Aerospace, is expected to spend US$1.5bn on its own satellites, and at some point we can expect that to be injected into PCCW when it can afford the funding.

The HK Government is still considering whether to auction licenses for 3rd Generation (3G) mobile, but the recent European precedents all point in this direction rather than a beauty parade. That could cost another US$1.5bn.

Valuation

We make no change to our post-merger valuation of HK$6 per PCCW share. See a previous article for how we arrived at that.

Stop Press: Name that site

PCCW has just purchased the domains cyberworks.com and cyberworks.net from Nasdaq-listed internet incubator Venture Catalyst Inc. for a combined US$1m. Venture Catalyst president Sanjay Sabnani explained to Webb-site.com that the company acquired Cyberworks Inc in Nov-98 and the latter was established as early as 1996. And you thought the name was original!

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HKT Completion 17th August 2000