Tricom's Day of Reckoning

The day of reckoning approaches for Tricom, shortly to be renamed Pacific Century CyberWorks. Yesterday Pacific Century announced an injection of its Intel joint venture into Tricom, on terms we examine in this article. In a previous article we called the stock over-valued at $1.83. It closed yesterday at $1.00, on the eve of a 5 to 1 consolidation. We review the share transactions since the deal was announced, and give you our take on what happens next.

Tricom's Day of Reckoning
3rd August 1999

Three months after the announcement, Pacific Century Regional Developments (PCRD) is today due to complete the injection of its Hong Kong and PRC property interests into Tricom, having received the necessary approvals on 29-Jul-99.

Three days later, on Friday 6-Aug-99, the lucky recipients of the placing shares will take delivery of their stock. The shares today begin trading in consolidated form, with every 5 old shares being combined into 1 new share. That should take last night's closing price to $5 from $1. In terms of new shares, the placees (through HSBC Investment Bank Asia and BNP Prime Peregrine) purchased about 1,151m new shares at $0.31 per share. So they are sitting on a paper profit of $4.69 per share, or 1,513%.

Don't expect them to just sit there - the gains represent a staggering HK$5,398m. If we had participated in this placing we would be sitting on the beach right now shouting sell orders into our satellite phone.

In our piece Pacific Century Cyberwok (5-May-99) we said the shares were over-valued at $1.83 per old share ($9.15 per new share). They've fallen 45% since then. The adjusted net asset value, according to the Tricom circular dated 7-Jul-99, is $2,238m, or $0.347 per new share. Since the convertible bonds issued to PCRD and its parent convert at only $0.31 per new share, way below the current price, it is a near-certainty that they will eventually convert. That means we should be looking at the fully diluted adjusted net asset value of around $0.335 per new share, before adding on the value of the Cyber-port.

The Cyber-Port

When the Tricom circular was dispatched (and as far as we know nothing has changed), negotiations between the Government and Pacific Century Group on a definitive agreement for the Cyber-Port property development were still at a "preliminary stage" and they had not signed anything except a non-binding letter of intent. In particular, the circular stated:

Interestingly, the letter from Anglo Chinese Corporate Finance (the independent adviser to Tricom) revealed that they had been denied access to the letter of intent which forms the basis of all the hype around Tricom. They wrote:

However, we'll assume that the Government has too much face attached to the project to do the decent thing and put it out to tender. Therefore we add our estimate of the net present value of the project ($9,000m) to Tricom in reaching a fair value.

That leaves net assets of Tricom (assuming conversion of the bonds) at about $1.28 per new share, as shown below:

We therefore see about 74% downside from the current price of $5, which values the diluted Tricom at almost $48bn compared with our estimate of $12.2bn. With the new shares due to be issued on 6-Aug, expect the selling to start from 4-Aug onwards (allowing for T+2 settlement).

Pacific Convergence Corp

Yesterday Pacific Century Diversified (another wholly-owned vehicle of Mr. Richard Li Tzar Kai) announced a deal to transfer its interest in a joint venture with Intel into Tricom. The deal will be classified as a "Very Substantial Acquisition" for Tricom but the announcement was very short on details.

The joint venture, Pacific Century Convergence Corporation (PCC), was established in Feb-98 and is 60% owned by PCD and 40% owned by Intel Pacific, Inc. (which we presume is wholly-owned by Intel Corp.). A one-paragraph description says that PCC "intends to provide high speed Internet services" and that its initial target is in the Asia-Pacific region. There is no information on how much the two partners have invested in the project, nor what its turnover (if any) and net assets might be. The Stock Exchange will doubtless require this information to be disclosed when the circular goes out.

In the absence of any financial data it is impossible at this stage to say what the deal is really worth to Tricom. However, one interesting aspect is the consideration.

PCC is being transferred first into a Cayman islands holding company, of which Tricom will hold 60% and Intel will hold 100,307 shares equal to 40%. Hence we can calculate that Tricom will have about 150,460.5 shares in the Cayman company.

PCD will receive 752,302,268 new shares in Tricom in exchange for its 60% stake in the Cayman company, or 5,000 new shares per Cayman share, while Intel will retain its 40% stake in PCC but have an option to sell it over 10 years in return for 1,003,070,000 new shares in Tricom, or 10,000 new shares per Cayman share.

What this suggests is that Intel thinks the Tricom shares are worth 50% of what PCG thinks. Either that, or the terms of the purchase are not equal. Note that at the end of the 10 year period, Tricom can require that Intel exercises the option, forcing it to sell its 40% of PCC for the new Tricom shares. If Tricom pays any dividends in the mean time, then Intel will be compensated with more shares by lowering the conversion price.

In practice, the option arrangement is probably just a way to keep the public float in Tricom at a level which the Stock Exchange will tolerate, since it will already be reduced to 22.16% by this deal.

At the current inflated price level, the deal values PCC at an amazing $8,777m. Perhaps most curious is the news that Intel will invest a token US$50m in new shares of Tricom at $5 per share. At that level, it only gets 0.75% of Tricom on a fully-diluted basis. The deal also requires Tricom to invest at least the US$50m in the business of PCC to enable PCC to buy equipment from Intel for its projects. The announcement says:

For some unknown reason, this seems to ignore the fact that Intel will be a 40% shareholder of a subsidiary of Tricom (PCC) and therefore it will be a connected party of Tricom.

Dealings in PCRD

Recent transactions in PCRD, Tricom's new parent, give us insight into the directors' views.

Andrew Yang Fan Shing, Chief Executive of Pacific Century Insurance, set the ball rolling by selling his entire holding of 100,000 shares in PRC on 4-May-99 (the first dealing day after the Tricom deal) for S$5.2925 per share, or about HK$2.44m

Mr. Francis Yuen Tin Fan, Deputy Chairman of PCRD, is beneficiary of a discretionary trust which sold 1,764,000 shares at S$7.35 per share on 10-Jun-99 and another 2,029,000 shares at S$7.36 the next day, for a total gross proceeds of S$27.9m, or about HK$129m. We can't blame him for cashing in when the shares were up 387% from just S$1.51 prior to the announcement of the Tricom deal. The sales cut his holdings by 62% to 2.355m shares.

PCRD also took advantage of its inflated price by placing 27m new shares at S$4.95 per share on 24-May-99, to raise net proceeds of S$130.6m (HK$602m). This boosted PCRD's net asset value from about S$1.32 to S$1.64 per share. The placing was the maximum allowed under Singapore listing rules (10% of the enlarged company per annum).

3 days later, on 27-May-99, a mysterious company called Pacific Light International sold 9,563,832 shares out of 14,563,832 shares held by it, also at S$4.95 per share. The whole block had been pledged to Pacific Century Finance (BVI), in which Richard Li has a controlling interest, pursuant to a loan agreement between it and Xie International Holdings. We know nothing else about Xie or Pacific Light. The sale, which raised about S$47.3m (HK$218m), resulted in the discharge of the loan and the remaining 5,000,000 shares were released from the pledge.

The shares sold by Pacific Light do not appear to have crossed the Singapore exchange, as only 1,800,000 traded that day. Perhaps they went to satisfy excess demand from the placing 3 days earlier.

In fairness, we should also point out that Richard Li bought 2,000,000 shares in PCRD at S$4.50 per share on 23-Jul-99. Exchange volume that day was only 877,000 shares, and the lowest price was S$4.92 with a close at S$5.00, so the deal appears to be off-exchange. That was pretty good timing as the stock rose to S$6.15 before it was suspended on 30-Jul-99 for the announcement of the Intel deal.

Dealings in Tricom

There were a couple of big winners here. Most obviously, Star Telecom (a listed subsidiary of China Strategic Holdings) found itself rich beyond its wildest dreams when the Tricom shares went into orbit. So it sold 400m old shares on 19-May-99 through BNP Prime Peregrine, Lehman Brothers and Kingsway SW Securities at HK$1.23 per old share ($6.15 per new share), raising HK$479m net. This cut their holding from 74.8% to 57.5% before the deal with PCRD was completed.

Star celebrated with a $0.20 special dividend to shareholders, absorbing about $182m. It then split its stock 10 for 1, which takes it back down into penny-share territory, and is renaming itself "China Online (Bermuda) Limited". This is the same company which sold its internet service provider, Star Internet, to Cable & Wireless HKT last year. How fashions have changed!

The remaining 266m shares Star holds in Tricom are worth about $1,329m at current prices. Split-adjusted, Star Telecom's price has risen from $0.018 on 31-Mar-99 to $0.153 on 2-Aug-99, an increase of 750%, valuing Star at about $1.39bn. The company is now in talks to buy a Chinese internet content provider, helping it live up to its new name.

Star Links with PCRD

Meanwhile, on 29-Jul-99 China Strategic agreed to sell 135m old shares of Star Telecom (or 1,350m after the split) to PCRD in exchange for 6,548,360 new shares in PCRD. This gives Star an inconsequential holding of only 2.15% in PCRD, while PCRD will hold 14.82% of Star Telecom, described as a passive investment; PCRD will not seek a board seat.

In the announcement, there was a notable lack of reasons for Star to be holding such a small percentage of PCRD shares and no commitment to hold them for any period of time. Expect them to sell.

The transaction was a share swap in which CSH was able to value the Star shares at HK$1.50 each (a premium of 14.5% to the last traded price) while PCRD was able to value its shares at S$6.65 (a premium of 8.13% to the last traded price). This is all a little hypothetical since in a share swap you can raise or lower these prices by the same percentage and still make the sums add up. We prefer to look at it as PCRD shares at market price of S$6.15 and Star Telecom shares at $1.39. It's amazing what you can do with a calculator.

Presumably the main goal is that PCRD's involvement in Star should help to achieve a strong share price for Star (sorry, China Online Bermuda) ahead of its expected internet deal. The stock was up 17% yesterday at $0.153 (ex-split).

A surprise winner

In an amusing side-show, a listed company called Companion Building Materials (Holdings) hit the jackpot when it sold 68.7m Tricom shares, or about 3% of the company, on 4-May-99 (the first day after the announcement) at an average of $1.76 per old share ($8.80 per new share) raising HK$121m. The shares had been acquired in March-98 as a short-term investment.

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