China Telecom rolls on with IPO

The fixed line operator is preparing to submit its F1 filing to the US SEC within the next two days as it embarks on its long-awaited IPO.

China's dominant fixed line player is being primed to list on the Hong Kong and New York stock exchanges during the final week of October under a provisional timetable, which will see the analysts meeting convened in late August and pre-marketing begin towards the end of September. The first step in this process will take place before the end of the week when the company submits its initial filing for an NYSE listing with the SEC.

However, as a result of declining telecom valuations and the current state of global equity markets, the company is now said to be targeting IPO proceeds of $3 billion to $3.5 billion through a sale of 25% of its equity via joint global co-ordinators, CICC, Merrill Lynch and Morgan Stanley. This represents a far cry from the $10 billion many originally believed it might raise, or even the $5 billion envisaged ahead of the company's latest restructuring in May.

The restructuring, which was prompted by a desire to create greater competition within the Chinese telecommunications industry, saw China Telecom split into southern and northern companies. The China Telecom name was retained in the south, while China Netcom and Jitong were folded into the northern company to become China Netcom.

Proceeds from China Telecom's IPO will also be significantly less than both its domestic competitors were able to secure at the time of their listing. In 1997, for example, China Mobile raised $4.2 billion from its IPO, while China Unicom still holds the record for Asia ex-Japan's largest flotation, with a $5.65 billion deal in the summer of 2000.

Yet few industry players are playing down the significance of the deal, which will rank as one of only a very small handful of sizeable global offerings attempted since 3G burst the sector's bubble a couple of years ago. Many market participants are already starting to make comparisons with South Korea's fixed line incumbent Korea Telecom, which successfully raised $2.24 billion in June 2001.

On completion, China Telecom should have a market capitalization around the $12 billion mark, placing it seventh in the Hang Seng Index, behind Sun Hung Kai Properties and displacing Bank of China, which completed its IPO last weekend.

According to industry experts, China Telecom is planning to include three provinces and one municipality in the IPO vehicle - Jiangsu, Zhejiang, Guangdong and Shanghai. Currently, the four are estimated to have about 52 fixed line subscribers between them, representing 44% of China Telecom's roughly 117 million subscriber base. Putting the number in a wider perspective, this means the four will have just over twice the number of fixed line subscribers that Korea Telecom has, presently Asia ex-Japan's largest fixed line telecom operator.

The four also contribute well over 50% of overall revenues generated by China Telecom's 21 provinces. Prior to its restructuring, China Telecom posted revenues of $21.8 billion for 2001 and analysts say there was a 60:40 split between the southern and northern companies. This means the 21 provinces in the south made about $13 billion, while the 10 in the north made about $8.8 billion. On a revenue per line basis, analysts say the southern company averaged about $11 per month during 2001.

The figure is dragged down by the fact that up to a dozen of China Telecom's provinces are said to be unprofitable, particularly in the centre and west. Overall, the company also has a lower GDP per capita in its service areas than the north and lower fixed line penetration - 13% in the middle of last year versus 14.8% for the north. In its favour, however, are a lack of the integration and complicated shareholder issues, which surround China Netcom.

As of end March, China had 350 million telephone users, making it the world's largest telecoms market. A total of 188.65 million users were fixed line and 161.5 million were mobile, representing respective increases of 9.61 million and 16.88 million over the previous quarter.

In terms of overall market share, the new southern company now ranks second to China Mobile. At the of the first quarter, China Mobile had a market share of 36.7%, with China Telecom on 32.6%, China Netcom 18.5%, and China Unicom 11.3%. Less than 1% came from the remaining operators China Railcom and China Satellite Communications, which are both trying to develop fixed line businesses.

Telecom experts say that the lead managers will market China Telecom as more of a defensive play rather than a growth stock. Initial valuations suggest that it will be pitched midway between Mobile and Unicom, both of which have badly underperformed the market for the last year-and-a-half.

China Mobile closed Wednesday at HK$20.90, down 23.86% year-to-date, while Unicom closed at HK$5.45, down 36.63%. Having once traded at hugely inflated multiples to regional comparables, both companies now straddle the sector average. Where regional cellular companies currently trade at an average of 6.2 times 2002 operating cash flow, Mobile stands at a 6.4 times level, while Unicom is languishing at 4.4 times.

By contrast fixed line operators average about five times operating cash flow and telecom bankers say that China Telecom may well be able to pierce the average, with six times viewed as the upper limit of its ambitions subject to an improvement in sentiment.

As one industry expert explains, "In the current environment, being the incumbent operator is all that counts and China Telecom is nothing if not a dominant monopoly. Investors don't really want to hear about growth, it's just the icing on the cake. What they want is stability."

Indeed, China Telecom has emerged from every one of the country's industry restructurings as the dominant player and the decision to divide the country along geographical lines has in effect created two regional monopolies in place of one national monopoly. Future growth will come from the fixed, cellular and data markets as the company pushes to become a truly integrated player.

Industry experts say the prospectus will emphasise the company's ambitions to gain a cellular license, although one is unlikely to be forthcoming until early next year. Under MII targets (Ministry of Information Industry), China hopes to increase penetration from 15% to 40% by 2005, with over half a billion phone users, of whom 250 million will be fixed line subscribers.

It also hopes to have 200 million internet users. As of June, China had 45.8 million users, making it the world's third largest user after the US and Japan.

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