Indosat completes first secondary offering

The government scales back its ambitions to achieve desired pricing while the company considers a high yield bond to buy out Deutsche Telekom.

A reduced 83.5 million share deal was priced late Friday New York time by lead managers Danareksa and Credit Suisse First Boston, raising $110 million for the cash strapped Indonesian government. As a result of the offering, the government has sold 8.1% of the integrated telco, cutting its stake from 65% to 56.9%. This marks the first increase to the company's free float since its flotation in 1994, but the government now hopes to replenish public coffers by ceding majority ownership and plans to sell a 36.9% strategic stake later in the year.

At Rp12,000 per share, pricing came at a 4.8% discount to a closing price of Rp12,800. Originally the government had hoped to divest up to 117.175 million shares (an 11.32% stake), but decided to cut the amount back in order to avoid pricing at a much wider discount. As a result of its decision, allocations became more heavily skewed towards international investors with a final split of roughly 80%/20% compared to 60%/40% where demand was concerned.

Three accounts placed 10% orders, but there was no retail tranche and no SEC registration, so accounts will not be able to convert shares into ADRs for 12 months. The local structure of the offering also meant there was no pricing reference to the ADR, which typically trades at a 1% to 2% discount to the underlying. Representing 31 days trading, the placement further subjects the government to a three-month lock-up from selling more shares.

Pricing at a 4.8% discount is likely to viewed as something of an achievement given the level the government managed to clear when it sold a $300 million block of PT Telkom at a 3.7% discount to close in December. Back then, the Indonesian telecommunications sector was trading on an EV/EBITDA multiple of three times 2002 earnings and investors were tempted back to a stock, which was felt to have been overlooked and consequently undervalued.

Since then, both Telkom and Indosat have performed extremely well and many investors believe they are almost fully valued at current levels. Indosat, for example, is up 53% on the year and is presently trading on an EV/EBITDA multiple of 5.7 times 2002 earnings against Telkom's 4.1 level. On a per subscriber basis, it trades at roughly $800 per share.

In helping to secure the success of the placement, the government and company haven taken two key steps since the beginning of the year. The first was the decision to cancel the IPO for Indosat's cellular subsidiary Satelindo. As rumours that this might transpire began to circulate in early April, the company saw its stock price shoot up from Rp10,000 to a high of Rp14,050 in the space of two weeks.

In cancelling the IPO for the subsidiary, there was no danger of compromising the valuation of the parent. Since Indosat has a negative valuation on a stand-alone basis (based on declining IDD revenue growth) and derives 80% of its NAV from its cellular operations, investors were likely to have demanded a substantial discount.

The second decision was to spend $320 million allowing Deutsche Telekom to exit from a strategic stake in Satelindo, which it had purchased in 1995 for $586 million. Clearly there was no way the German company would have given its permission for the Indonesian government to sell a strategic stake in Indosat when this would have compromised its own ability to sell out of Satelindo.

In the end, the government appears to have taken the sensible decision to buy out Deutsche Telekom's 25% stake itself, even if it meant overpaying slightly. Whereas Singapore Telecommunications recently paid 6.9 times 2002 EV/EBITDA to increase its stake in Telkomsel, Indosat has paid 7.4 times 2002 levels to get rid of DT. Analysts calculate that regional acquisitions average a 6.7 times multiple.

As a result of the acquisition, Indosat has said it will inject $75 million in cash to its subsidiary, in turn lifting debt covenants that have prevented the latter from spending more than $50 million on capex. The company spent 2001 pushing hard for market share, but the resulting increase in subscribers (68% year-on-year) has put pressure on its existing network.

Observers consequently note that while the increase in capex will depress EPS, investors now accord Indosat a higher valuation than Telkom because it should generate higher returns. Following SingTel's increase of its stake in Telkomsel to 35%, Telkom will generate about a third of its EV from its subsidiary's high growth cellular operations, while Indosat will generate 80% of its EV from Satelindo's.

But the big question overhanging Indosat's stock price is whether the Indonesian government will be able to find a strategic partner for its second telecommunications operator and if not, whether it will sell down further shares through the public markets. Some argue that while the Indonesian story is extremely attractive and easy to read - high growth and low penetration equals high returns - there are not that many global operators with either the free cash or willingness to purchase the stake.

In the meantime, Indosat is likely to fund the purchase of DT's stake through a combination of cash - it will receive $198 million in installments from Telkom as compensation for the collapse of KSO IV - and a high yield dollar bond. The company's house bank CSFB is believed to hold the mandate.

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