Pre-marketing begins today (September 6) for the dual Hong Kong and New York Stock Exchange listing of a selection of Hutchison Whampoa's telecommunication assets.
The syndicate has assigned an average fair value of $5 billion to the listing vehicle, which contains the Hong Kong conglomerate's 2G and 3G assets in Hong Kong, India, Thailand, Israel, Sri Lanka, Paraguay, Ghana and Macau. This figure is nearly 20% lower than the $6 billion initially targeted by Hutch, but is, nevertheless, still considered punchy by a number of outside observers.
Lead manager Goldman Sachs is keeping the exact percentage of issued share capital as flexible as possible given that market conditions remain unsettled. However, Hutch has previously indicated that it intends to float up to 30% of old shares, indicating an IPO size of roughly $1.2 billion to $1.5 billion. The low end of this range assumes an IPO discount of 20%, while the top end prices the deal flat to fair value.
After two-weeks of pre-marketing and two weeks of roadshows, the deal is scheduled to price during the first week of October. The Hong Kong IPO will have the standard 10% base allocation for retail investors and there is also a POWL (Public Offer Without Listing) in Japan led by Daiwa SMBC.
Alongside Goldman, joint-lead is ABN AMRO, with Citigroup, HSBC, JPMorgan and Merrill Lynch as co-leads, plus Kotak Mahindra and Morgan Stanley as co-managers.
Specialists say the valuation also remains fairly fluid given that the list co has an eclectic array of assets all subject to different growth profiles. As such, investors will need to do a sum of the parts valuation. However, fund managers suggest the starting point is an EV/EBITDA multiple of to 12 times forward earnings, which is again considered ambitious.
Obvious comparables are Sing Tel and Bharti Televentures.
The former has a similar profile to Hutch because it owns or holds stakes in a variety of cellular and fixed line operators in Asia. However, analysts say Sing Tel derives a much higher proportion of its revenue from developed markets (Singapore and Australia) and does not have majority ownership of its cellular assets in markets such as Indonesia, the Philippines and Thailand. Singapore also tends to trade a slight valuation discount to Hong Kong.
At Friday's close, Sing Tel was trading at S$2.35, representing a forward EV/EBITDA multiple of about 11 times and a forward P/E multiple of about 15.5 times. Unlike Hutch, Sing Tel pays a dividend and as of Friday, the stock was yielding 2.8%.
Bharti Televentures is also cited as a key comparable since the Indian assets are considered the crown jewel of Hutchison Telecommunications International (HTI). As of June, the Indian assets accounted for 32.2% of total assets and 46.5% of first half turnover.
As of Friday, Bharti was trading at Rs134.5, representing a forward EV/EBITDA multiple of about 11.5 to 12 times and a forward P/E mulitple of 21 times. The stock does not pay a dividend.
Bharti has come down from its early May high of Rs189 because of perceived tariff pressures in the intensely competitive domestic market. Analysts say the stock has historically traded at a high EV/EBITDA multiple relative to both the Indian and reginal telco average. Partly this is because the stock has a scarcity premium and partly because it has a huge market cap and low earnings base. It only became profitable towards the end of 2003.
The group's scarcity premium seems likely to fade if HTI goes ahead with plans to list its Indian assets within the next year. Under the terms of its waiver from the Hong Kong Stock Exchange, HTI must list the Indian assets by next June.
In its F1 filing, which became public on Friday, the group said it had agreed with its Indian partners to effect a listing by the end of this year. However, specialists believe this is unlikely and say a mid 2005 IPO is far more realistic, if for no other reason than India's application process is highly bureaucratic.
Indian regulations state that HTI must have a freefloat of at least 10%. Specialists say it is unlikely to list very much more than this, which means the dilutive effect on the hold co will be lessened. If it lists just 10%, HTI's "economic" ownership of its India assets will be reduced from 56% to 50%. Under current regulations, foreign operators are not allowed to own more than 49% of a domestic telco.
Specialists say management are likely to highlight their long-standing expertise in the telecoms sector and the synergies they will be able to extract across the different operating companies. "I'm not sure the market really understands this company right now," says one observer. "During roadshows it will become clear how all the different parts move in tandem with each other."
Specifically the more mature parts of the business (Hong Kong) will be able to provide cash flow and expertise to the more immature. Because HTI has majority ownership of all of its vehicles, except Partner in Israel, it is also likely to argue that it can drive its businesses in a more effective manner than SingTel, which it will argue is more of an "investor" in some of its companies..
"This is not a holding company per se," the specialist adds, "but an operating company across different markets. It can, for example, secure significant savings from its procurement costs.
"The parent will rely on dividend income from the operating companies, but it has also provided a decent amount of loans to the operating companies," he continues. "When these get re-paid, they will generate additional cash flow for the parent."
In essence, the lead and the company are likely to argue that HTI represents a unique opportunity to gain exposure to high growth and high quality telcoms assets. The Indian assets will be the main driver, but the domestic IPO is likely to be small and, therefore, relatively illiquid. A number of fund managers are also likely to prefer trading the stock on the larger and more easily accessible stock exchanges of Hong Kong and New York.
The growth profile of the Indian cellular market is undoubtedly strong. The mobile penetration rate is only 2.67%, covering a total of 28.2 million subscribers as of December last year. A year previously, the figures had been respectively 1.01% and 10.48 million.
HTI is in the process of consolidating its six domestic cellular operators into one company. As of June, the six were operating in 13 of India's 23 service areas.
Reliance Infocomm is currently the largest national CDMA operator in India, while Bharti is the largest GSM operator. However, Hutch has very strong market shares in the service areas it covers and particularly the country's two key cities.
In Mumbai, Hutch ranks above Bharti with a 32% market share versus the latter's 15%. In Delhi, it is second to Bharti with a 28% market share versus 36%.
Operating profit at the Indian operations rose from $28 million in 1H03 to $54.5 million in 1H04. Likewise, operating margins expanded from 11.3% to 13.3% over the same time period.
Critics acknowledge that India is registering strong growth, but the highlight tariff pressures that have made the market one of the most competitive worldwide. Despite receiving their first licenses almost a decade ago, most operators have only just started to record profits.
ARPU (Average Revenue Per User) is consequently dropping sharply and operators need to keep new subscriber momentum high in order to maintain profitability. Bharti, for example, saw ARPU fall 18% during the last quarter.
But critics main problem with HTI is what a number have termed, "the rag bag nature" of the assets in the list co. Many fail to see what the Hong Kong and Indian operations have in common and believe the former may take the shine off the latter's lustre.
Hutchison has said it decided not to inject its European and Australian operations into HTI because they are mature markets with a heavy 3G component. At first glance, Hong Kong would seem to fit this profile too and some have argued that the Hong Kong assets were only included because the list co had to have something other than India in it to justify two fund raising exercises.
But specialists say the Hong Kong operations are very different to their counterparts in Europe and Australia. "These markets are mature, but Hutch's businesses in them are immature," comments one specialist. "In Europe, Hutch is building businesses from scratch and since they are still at the roll-out stage, they are cash flow negative. In Hong Kong, the 3G model is different because the company already has a 2G platform, which it is using to migrate clients to 3G. It's more of an evolution where the two platforms feed off each other. This company is the leader in the 3G space."
Hong Kong currently has a penetration rate of 105% and Hutch is the leading cellular operator with a 25% market share as of December 2003. Like India, competition between the six local operators is intense.
Operating profit during 1H04 was negative $5 million compared to $35.4 million for the same period the previous year. This has been attributed to the operating expenses associated with the roll-out of its 3G operations. Hong Kong cellular accounted for 25% of HTI's revenue during 1H04.
Its fixed lines services in Hong Kong have fared slightly better, with operating profit rising from $11 million in 1H03 to $14 million in 1H04. Its operating margin, on the other hand, fell from 11.2% to 8.9% over the same period. The fixed line assets contributed 17.8% of turnover in 1H04.
For HTI as a whole, operating profit rose to $217 million during 1H04 compared to $64 million for the same period last year. However, the increase is massaged by a one-off gain generating $166 million following the disposal of shares in its fixed line operations (Vanda) earlier this year.
Without it, operating profit would have dropped sharply to just $4.7 million thanks to the 3G costs, which affected its Hong Kong mobile operations and the start-up costs of its Thai operations. The latter registered a loss of $52 million.
Key to the IPO's success will be how investors evaluate these disparate business profiles and how confidently they can see past the start-up losses to the long-term growth potential. If HTI cannot convince investors it has a defined growth profile and market conditions deteriorate, it many not be so readily embraced.
Non-syndicate bankers also believe that Hong Kong retail will play an extremely important role. Hutchison's handling of Vanda's listing attracted considerable criticism and many wonder whether this will have finally tarnished the group's legendary reputation with retail investors.
Others believe that confidence is returning to the local market following the recent release of strong GDP numbers. "Risk appetite is increasing," says one banker. "We seeing investors looking to put money back to work during the last quarter of the year."