HKBN tests IPO market with dividend play

CVC could almost double the return on investment in the Hong Kong broadband operator with the flotation, which will test investor appetite for yield plays.

HKBN launches roadshows for Hong Kong's first big initial public offering of the year on Tuesday, hoping to capitalise on clear equity markets and dovish comments by the US Federal Reserve, which suggest yield plays still have room to run.  

Led by CVC Capital, the private equity owners of Hong Kong's second-largest broadband operator also look set to almost double the return on their 2012 investment as they reduce their combined interest in the group from 90.1% to 26% pre greenshoe. 

The base deal comprises 645 million shares priced at between HK$8 and HK$9 per share. Pre greenshoe this will net the group proceeds of HK$5.16 billion to HK$5.8 billion ($670 million to $750 million). 

In May 2012, CVC Capital paid HK$4.87 billion for a 90.1% holding in what was then called City Telecom, before selling an 11.3% stake to GIC and 8.1% to AlpInvest (Carlyle Group) a few months later. At the top end of the IPO price range, its remaining 70.7% holding is now worth $831 million compared with $495 million three years ago. 

HKBN has delivered its owners considerable upside thanks to an aggressive strategy of grabbing market share in residential broadband services, mainly at the expense of smaller operators HutchTel and i-Cable. It now hopes to replicate the same success in Hong Kong's corporate broadband sector at the expense of incumbent HKT Trust.

As such, company officials are likely to argue the IPO offers investors both a growth and a dividend story. They are also likely to flag its rarity value in a market dominated by Chinese listings.

HKBN is not only a pure Hong Kong company but an independently owned one in an economy dominated by a small group of families.

Its tagline is "Making Hong Kong a better place to live."

The company says this motto extends to its own employees, which it calls the "Talent" through a co-ownership structure. Pre-IPO, 79 top managers gave up about two years' worth of salary to own shares and this will now be extended to about 400 who are being offered 1% of the IPO.

Roadshows launch after a few weeks of pre-marketing.

Tight premium?

In terms of valuation, HKBN is being pitched on a 2015 EV/Ebitda multiple of 10.5 to 11.4 times and a dividend yield of 4.8% to 5.4%.

The group's nearest comparable HKT Trust is currently trading on a forward dividend yield of 5.7%, while HutchTel is trading at 4.63%. This means HKBN is offering a premium of 5.8% to 15.8% over HKT's dividend yeild

The difference is very tight at the top end of the range given HKT's larger scale and the need for an IPO discount. However, it leaves the syndicate some room for manoeuvre should HKT continue to trade up before HKBN prices on March 5.

Shares in HKT have performed extremely well in the last 12 months, rising 26.4%, but have been broadly flat year-to-date and closed Monday at HK$10.02, up 0.2% on the day. 

So far one cornerstone investor, Canada Pension Plan Investment, has come in for $200 million at any price within the given range and the lead managers are believed to have anchor demand from a further 40 investors keen on the yield pick-up.

US interest rates

One of the main considerations for investors mulling the HKBN IPO is the likely direction of US Treasury yields, always a pressing concern in Hong Kong in view of the Hong Kong dollar's US dollar peg.

Based on current trading levels of 1.657%, HKBN is offering a pickup of about 314 basis points to 374 bps over Hong Kong government bond yields.

US Treasury yields have climbed nearly 50bp from their 1.64% lows in mid-January when investors began to weigh the possibility that the Fed would begin raising US interest rates this summer. The central bank's most recent minutes released last week suggest this view might be premature after the Fed cautioned its committee members were "inclined toward keeping the fed funds rate at its effective lower bound for a longer period of time."

So far 10-year US Treasury yields have failed to respond and are trading at around the 2.13% level. But investors who believe the Fed will continue to feel nervous about tightening monetary policy (no matter how good the underlying numbers) are likely to remain keen on income stocks. 

Moreover, despite the recent spike US Treasury yields are still 60bp below where they were a year ago, when investors thought the Fed was set to start raising rates later that year. 

New tariff war?

Another likely consideration for investors is how competition between HKT and HKBN will play out in the coming years. HKBN wants to improve its Average Revenue Per User, or ARPU, by grabbing some of HKT's higher paying corporate clients, while HKT is preparing to roll out its own high speed network, which may win back some of HKBN's residential clients if it also decides to cut tariffs in order to match HKBN's lower-priced offering.

In its recent earnings results, HKT said 36% of its subscriber base is already on its new fibre network and that 80.8% of its network is fibre-ready. During the second quarter it also plans to begin trialling its 10 gigabyte per second offering, with a commercial rollout scheduled for the third quarter. 

But the company's management also said they are more focused on profitability than expanding market share and believe earnings growth will come from rising ARPU as existing customers re-contract on higher monthly fees.

Hong Kong's extremely high broadband penetration rates and the recent lack of any price war means churn rates are very low (about 0.8%). So any revenue growth has come from increasing ARPU.

That stands in contrast to 2007 when HKBN began to scale up by offering cut-throat packages, particularly to price-sensitive customers on Hong Kong's public housing estates.

As a result, it was able to build its overall market share from 13% in 2007 to 24.4% by 2014. Over the same period, HutchTel lost about 8% and i-Cable about 3%, while HKT stayed fairly flat around the 57% to 59% mark. 

HKBN's success has been down to residential where it has a 34.2% market share and, especially, residential fibre broadband where it had a 53.7% market share as of August 2014 and ARPU of HK$175.

On the corporate side, its share is much lower at 12% but its ARPU much higher at HK$1,026. 

HKBN now hopes to boost earnings by targeting the high-end residential and corporate sectors, especially small- and medium-sized businesses and hotels. In July 2014, it took a big step in this direction by forging a partnership with SmarTone, which became a re-seller of HKBN's broadband network under its own brand name. 

In a recent research report, Credit Suisse said it believes this will help HKBN to make inroads among high end residential and corporate clients. It forecasts that HKBN will achieve a 5.2% compound annual growth rate in revenues between 2014 and 2017 compared with 2.8% for HKT, 0% for HutchTel and -2.7% for i-Cable. 

Joint global co-ordinators for the IPO are Goldman Sachs, JP Morgan and UBS, with CLSA and HSBC as joint bookrunners and Rothschild as financial advisor to the company. 

Listing is scheduled for March 12. Pre-IPO shareholders will be subject to a six-month lock-up, with the CEO William Yeung and CFO Ni Quiaque Lai subject to a 12-month lock-up for 50% of their stake and 24 months for the remaining 50%. 

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