What Price Mobile?

We examine the price on the mobile phones in the Telstra-PCCW deal, and find a huge premium to listed competitors Smartone and Sunday. We also look at how the HK Government's pending decision on 3G will affect all players. Finally Webb-site.com walks the Telstra board through some of the many alternatives to an over-priced deal with PCCW.

What Price Mobile?
2nd October 2000

With both sides in the Telstra-PCCW deal now admitting that the terms of their deal are back on the negotiating table, it is time to take a look at the mobile side of the deal, and on the other two listed "pure" players, Smartone Telecommunications Holdings Ltd and Sunday Communications Ltd.

When the original Memorandum of Understanding between Telstra and PCCW was announced on 12-Apr-00 it was proposed that Tesltra would pay US$1.5bn for 40% of a "Regional Mobile Company", subject to due diligence and valuation. Skip forward to 24-Aug-00, and a further announcement of an "agreement in principle" was made, containing further details.

By now, the pretence that this was a pooling of regional mobile interests had been abandoned, as Telstra's sole regional mobile venture, Mobitel in Sri Lanka was left out, as was HKT's 14.7% interest in Mobile One of Singapore. So the deal boiled down to Telstra buying 40% of Cable & Wireless HKT CSL Ltd for US$1.5bn.

On 28-Sep-00 PCCW announced its interim results for the six months ended 30th June 2000. At the time of writing, their web site still doesn't contain the announcement - and the Stock Exchange site, which should be the fount of all knowledge, contains only a brief summary, as it does with all main-board companies. In the world of web-based disclosure, both the SEHK and PCCW still have a long way to go. This is why at Webb-site.com we still have to maintain a library full of announcements published in newspapers.

Although PCCW acquired HKT on 17-Aug-00, after the 30-Jun-00 period end, the newspaper announcement did include some figures on HKT's business.

On the mobile side, HKT's Average Revenue per User (ARPU) increased just 4% to HK$456 per month compared with the first half of 1999. HKT's ARPU is higher than its competitors, but this is for one simple reason - as one of the first two providers in Hong Kong, and a former monopoly utility, it traditionally had a larger share of the corporate market in Hong Kong. Corporate customers are slower than individuals to react to competition in the market, so HKT's ARPU has benefited from this. HKT even introduced a new One2Free brand in 1998 in an effort to compete at the retail level without reducing margins on the corporate 1010 product, which works on the same network. However, over time, even corporates make purchasing choices and will either demand lower charges or take their high-volume business to other networks.

The last published total figure for HKT subscribers was 958,000 at 31-Mar-00, up 33,000 on the 925,000 as at 30-Sep-99, which was down 23,000 from 31-Mar-99.

No figure for mobile subscribers was given in the published results to Jun-00, but a bar chart circulated at a press conference indicated a net fall in numbers, while accompanying slides mentioned a 1% increase in GSM subscribers, so this was presumably offset by a greater fall in the company's D-AMPS network, some of whom defected to other networks.

We'll assume it is now down to about 930,000. At US$1.5bn for just 40% of the business, this implies that the original Telstra-PCCW deal values the business at US$4,032 per subscriber.

Pacific Link

The American D-AMPS standard is not popular in HK and the only such network was acquired when HKT bought Pacific Link from First Pacific in 1998, rebranding the service "1+1". Pacific Link also brought with it a PCS (GSM-1800) license. At the time of purchase in Jan-98, Pacific Link has 268,000 subscribers. HKT paid HK$4,835m (US$624m) for the business, or around US$2,330 per subscriber. In 1997, Pacific Link recorded ARPU of HK$500 per month, down from HK$590 in the previous year.

No sane person buys a D-AMPS phone for use in HK today, and when customers upgrade their handsets they are much more likely to change their choice of service package or operator than at any other time. This was made easier with the introduction of number portability on 1-Mar-99, meaning that a customer no longer has to change numbers when changing operators.

Smartone

Smartone has a latest published figure of 930,000 subscribers at 15-Sep-00, up from 867,000 at 30-Jun-00 and 725,000 at 31-Dec-99. ARPU figures were not published but we estimate they are about HK$300 per month. The company is 20% owned by British Telecommunications plc, which subscribed for the shares at HK$25 each in Apr-99. The largest shareholder is Sun Hung Kai Properties Ltd with 26.4%.

Now, at HK$12.25 per share, Smartone is valued at HK$7.38bn (US$946m). The last published balance sheet, at 30-Jun-99, shows net cash of about HK$3.9bn but we'll assume (probably on the excess side) that they got through about HK$0.7bn of that in the last year, leaving them with net cash of about $3.2bn (US$410m). That means that the un-geared valuation of the business is about US$536m, or just US$576 per subscriber. For that you also get one of the new wireless local-loop broadband licenses.

Sunday

Sunday is Hong Kong's smallest but arguably most dynamic listed mobile provider. It is run by much of the same management team that created Hutchison Telecom, now HK's largest mobile provider. It is 46.2% owned by unlisted Distacom International Ltd, 11.5% by HK-listed USI Holdings, and 11.5% by the financially-challenged Lai Sun Group. Of this, 9.87% is held by eSun Holdings Ltd (formerly known as Lai Sun Hotels), and 1.67% is held by Lai Sun Development Co Ltd. That leaves the public holding 30.8%. Distacom shareholders are believed to include investment house Lazard and the Singapore Government, as well as the management team.

At 5-Sep-00, Sunday claimed 330,000 subscribers, up from 297,000 at 30-Jun-00 and 287,000 at Dec-99. ARPU in the six months to Jun-00 was HK$282 per month.

Sunday's customers are on average "newer" than those of Smartone or HKT, because Sunday didn't launch its PCS service until 1997. That probably means the users have more modern handsets and are less likely to upgrade (and change networks) than say a D-AMPS customer at HKT.

The company went public in Mar-00 and was fortunate to catch the top of the tech valuations, raising net proceeds of HK2.35bn. Nasdaq peaked at 5,049 the day after the offer closed. The retail portion of the offer was 35x subscribed and the offer priced at HK$3.78 per share.

What a difference six months makes. The shares are now trading at just HK$0.80, down 79% from the IPO price. This values the company at HK$2.39bn (US$307m). At 30-Jun-00 the company had net cash of about US$8m, so the business is valued at US$299m or US$906 per subscriber.

For that, you also get the possibility (but no guarantee) of future acquisitions from Distacom, Sunday's largest shareholder, which has interests in Indian mobile networks, which could Spice up the business in the future.

So what is HKT's mobile business worth?

Something is clearly wrong here. For a minority interest in HKT's mobile business (PCCW has a casting vote), Telstra is being asked for about US$4,000 per subscriber. But the market prices a minority interest in Smartone at under US$600 per subscriber, and Sunday at about US$900 per subscriber. Even when revenues per subscriber were higher in early 1998, HKT was only willing to buy Pacific Link at US$2,330 per subscriber.

Now admittedly, HKT currently has average revenue per user some 50% greater than the market average, but that lead will decline as corporate customers gradually seek better deals either with HKT or by defecting. HKT's falling subscriber numbers speak for themselves.

Telstra may be desparate to do an international deal, but their public investors should applaud if they walk away from these terms. Even paying half the price would look generous.

Telstra's Plan B

Over the last weekend a lot of classic "spin" has appeared in newspaper articles. The SCMP on Saturday 30-Sep-00, quoting "sources familiar with the situation" wrote that "Cyberworks is in talks with one of the five biggest telecoms companies in the US - believed to be AT&T." PCCW's spokesperson has been telling more than one media publication that "we always have a Plan B". Other publications cited NTT DoCoMo (which is already a partner of Hutchison) as a possible investor. And there is always Hutchison itself (we'll call that Plan Z - asking Dad for a bail-out).

A dangerous game of bluff is going on. PCCW may indeed be approaching other telecoms operators, but would any of them pay as much as Telstra for a minority stake in the mobile business? Would any of them also want to put up US$1.5bn of funding for PCCW's subordinated convertible debt? Does Telstra really believe that PCCW represents the last chance to do a deal in Asia? Surely not.

Telstra executives should read this "Plan-B" noise as a sign of their own strength and PCCW's weakness - with US$9bn of debt which comes due on 28-Feb-00, PCCW is more than keen to secure funds to pay some of it back.

Rather than tolerate this kind of brinkmanship, Telstra would do well to look at its own Plan B and open discussions with Smartone or Sunday if they really want to enter the mobile market here. In Smartone, they would find themselves in partnership with one of HK's leading conglomerates (SHKP) and a global operator (BT). In Sunday, they would find themselves in partnership with a group (Distacom) that has experience of Asian mobile ventures and some high-growth assets in India.

In either case, the deal could be done at significantly lower cost - and with no need to invest another US$1.5bn in convertible loan notes as was proposed with PCCW. The reduction in financial commitment would leave Telstra with a potentially better credit rating and more funds to spend on building its broadband network at home.

Another HK mobile provider, New World Mobility (owned by HK-listed New World Development) had 620,000 subscribers in Jun-00 and is looking for a strategic partner or possibly an outright sale. Singapore Telecom is known to be interested in bidding for a third generation license in HK, and is believed to have been in talks with New World about investing in New World Mobility, as has venture capital firm Chase Capital Partners.

Telstra could do worse than pay a visit to SingTel - which, like Telstra, has a majority government shareholder, an extensive international IP network, and ambitions to expand into HK and the rest of Asia. The corporate cultures may fit surprisingly well.

The Government of Hong Kong is still pondering its next move on third generation (3G) mobile licenses. While we believe license auctions are a better route than beauty parades (as explained in our recent article) the Government has never been prone to logical argument and we believe they are more likely to fudge the issue with what they will call a "reverse auction" or basically a beauty parade with parameters, such as pledges on pricing, capital expenditure and network coverage. This would help PCCW by relieving them of the need to find the money for a 3G license - and we are talking about the same government that awarded Pacific Century Group the Cyberport project without tender.

Unless and until we run out of spectrum, 3G service pricing will be based on what the market will bear rather than the up-front cost of licenses, so the lack of a license fee would represent an immediate financial benefit to the operators.

If the Government goes with the beauty parade, you can expect an immediate boost to both Sunday and Smartone as they will be in line to win licenses. In the beauty parade scenario, we would also expect the government to go with the maximum number of licenses (six) so that they can give one to Hutchison and one to PCCW without being accused of perpetuating the Li family's dominance of the sector. That leaves Smartone and Sunday pitching for 2 of the remaining 4 licenses.

If we are wrong, and the Government goes with a license auction, then expect rapid consolidation in the sector. Sunday would have to find a lot of capital fast or it would end up as an also-ran. So in that scenario, it becomes a prime target for takeover by a new entrant looking for an existing user base.

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