China reshapes telecom mandates

Merrill Lynch, Morgan Stanley and CICC retain the mandate for China Telecom South as investment banks position themselves to win the northern mandate.

China Telecom South is likely to be the first of four major international capital fundraisings from the Mainland's telecom sector next year, with the leads said to be targeting listing on the Hong Kong and New York stock exchanges by the end of the second quarter. Bankers comment that the pecking order and exact structure of the four deals from - China Telecom South, China Mobile, China Unicom and China Netcom (CT North) - will be critical if China is to successfully push out well over $10 billion of paper in a market where telecom valuations remain low. 

As the head of Asian telecoms at one US investment bank puts it, "Emerging market fixed line telephone companies are completely out of vogue and valuations are exceptionally low. Each company needs to carefully consider its fund raising mix for international versus domestic and debt versus equity markets."

The Chinese government announced last week that incumbent fixed line operator China Telecom is being divided into southern and northern companies in a split that falls almost exactly along the Yangtze River. The northern company will contain 10 provinces and about a quarter of existing fixed line customers, while the southern will contain 21 provinces and three quarters of existing customers.

Prior to the split, advisors Merrill Lynch, Morgan Stanley and CICC had audited four provinces in the south and two in the north. One key question will be whether China Telecom South now decides it needs to inject more provinces into the listed vehicle, or to retain them at the parent level and wait for global valuations to improve. Currently, the leads are said to be targeting an IPO of about $5 billion.

Morgan Stanley and CICC also hold the mandate for a roughly $2 billion follow-on offering for China Unicom, which forms part of a $10 billion asset injection from the parent to the listed vehicle. Telecom experts say that this stands either second or third in the pecking order with China Mobile, leaving China Netcom to bring up the rear.

The battle to win China Netcom is already shaping up to be one of the most keenly fought mandates of 2002, with Goldman Sachs a clear front runner because of its close relationship with the old China Netcom management and particularly its entrepreneurial and politically well-connected head Edward Tien. The 38-year old, who has built China Netcom into an efficient company of less than 5,000 employees since inception in 1999, is also tipped to become the new CEO of the northern company, which will retain the China Netcom name.

Goldman, along with News Corp, Bank of China and China Construction Bank purchased a combined 12% stake in China Netcom for $325 million earlier this year, although their shareholdings are likely to be heavily diluted in the new entity.

Because of its shareholding, BOCI Capital is also likely to be frontrunner for domestic advisor. Other international banks with strong credentials will include UBS Warburg, which has been working with both Goldman and BOCI Capital on the Bank of China IPO and is keen to further its Chinese privatization credentials.

So too, Salomon Smith Barney now has the services of Margaret Ren, one of the most well connected bankers in the Mainland telecoms sector and a well-respected pan Asian telecoms team behind her. Following its recent hiring of CICC head Carl Walters, JPMorgan will also be hoping to leverage his advisory experience with the old China Telecom.

In some respects, telecom experts believe that China Netcom has a number of advantages over China Telecom South. Although it is a much smaller proposition, the inclusion of the old China Netcom gives the company a valuable national fibre optic network, which can be teamed up with the underutilized packet switching capabilities of China Telecom's Data Bureau.

"Jitong Communications has also been thrown into the northern half," a banker explains, "although this has probably been designed to put it out of its misery since its fibre optic network has not been a success.

"But," he adds, "Netcom has a modern IP backbone and with the northern part of China Telecom, it gains scale and access. Future competition is not going to be adding new fixed line services, but in the high margin, low capex, data services business. Because it has a national network, Netcom has, at the very least, a heads up in this respect."

A second key consideration will be the government's attitude to awarding new mobile licenses. Uncertainty over this issue and billing methods has placed a heavy drag on the share prices of China Mobile and China Unicom all year. Although both companies have now rebounded from their 52 week lows, they have still vastly underperformed every single China index.

China Mobile closed Friday at HK$27.65, down 35.09% on the year and China Unicom at HK$8.90, down 25.52% on the year.

To the end of October, the Chinese government said that there were 136 million cellular users on the Mainland, up from 131 million in September and 175 million fixed line users, up from 171 million the previous month.