Korea Telecom gears up ADR

Pre-marketing begins on Monday for a roughly $2.5 billion government sell-down in the integrated telecoms provider.
Formal presentations for the Morgan Stanley and UBS Warburg-led deal are scheduled to begin on Monday, June 11, meaning that Korea Telecom (KT) will embark on international roadshows as Hynix Semiconductor, its immediate predecessor, closes. Pricing will then take place the week beginning June 25.

In a bid to stop the inevitable short selling pressure that will reduce the stock's ADR premium in the run-up to pricing, the government has come up with an unusual measure. In a letter sent to the deal's 14 syndicate banks on Monday, it has requested that each sign a declaration committing themselves to not short sell on their own account around the time of the offering.

Aside from the two bookrunners, the 14 include Daewoo Securities, Goldman Sachs, Good Morning Securities, Lehman Brothers and Salomon Smith Barney in the US tranche and ABN AMRO, Deutsche Bank, DkW, Hyundai Securities, ING Barings, Nomura and Samsung Securities in the international tranche.  

For the last year, KT has averaged a 9% ADR premium to underlying, climbing to a high of 30% in January this year. As of Monday's New York close, the ADR stood at $26.48, an 11.5% premium to Tuesday's underlying close of W60,400 ($46.64). One unit equals half a common share.

Despite the government's attempts to avert selling pressure, most market participants doubt whether there will be much of a premium left when the deal closes. But what may be avoided is a repeat of last September's sell down of a 6.84% stake in Pohang Iron & Steel (Posco) held by the Korea Development Bank. At what marked the government's third attempt to sell the stake, it finally admitted defeat and allowed foreign investors to buy Posco at a small discount to the local trading price.

Where KT is concerned, there is a widespread belief that the company's share price has been depressed by the overhang of the government's privatization program and constrained by the size of its ADR float. Some 11.7% of the company is currently in ADR format, with foreigners holding a further 5% through the local market. Despite the government's recent move to introduce two-way convertibility between the local and international markets, these local shares cannot be exchanged for ADRs.

The forthcoming ADR offering is likely to comprise a further 17.8% stake, although this will be diluted down to 16% once the government completes the sale of a strategic stake. A foreign partner will be sold 15% through a roughly 10% primary share deal and 5% secondary share deal that will increase the company's outstanding common shares from 312 million to 347 million. Government ownership currently stands at 59% and foreign investors are now allowed to hold up to 49%.

KT was first sold in the international markets in May 1999 at $27.56 per unit, representing a 20.3% premium to a spot price of W54,500. Since then, its domestic shares have peaked at W199,000 in December that year, then declined to a low of W52,000 in April this year, before recovering slightly to current levels around the W60,000 mark.  

At this level, the stock is said to be trading on a 2001 EV/EBITDA multiple of 4.9 times. Although a Korean discount has to be applied, analysts say that this still represents a sizeable discount to regional comparables trading on an 8.4 multiple (mature operators) and 5.4 times (developing operators). For example, Singapore Telecommunications, the favoured bidder for the strategic stake, is currently trading on a multiple of 7.4 times 2001 earnings.

Analysts almost universally have a buy recommendation on the stock and believe that the potential success of an ADR for KT may mark the first signs of a de-coupling of strong Asian telecoms plays from their debt-burdened European brethren.

“It’s quite strange that this hasn’t yet happened already,” says one banker. “But we remain confident that it will.”

Having agreed to pay W1 trillion ($768 million) for one of two key WCDMA 3G licenses last December, KT is far from overleveraged, and as part of a consortium bid, only has to pay half the amount. For FY00, for example, KT had W5.265 trillion in debt against shareholders' equity of W14.265 trillion.

In marketing the deal, the leads are likely to emphasize that it is both a value and growth stock. Most of this growth is coming from the country's phenomenal internet growth rates, although recent tariff re-balancing is likely to provide a more consistent revenue stream for fixed line operations in the face of declining overall usage.

In April, the government allowed the company to increase local tariffs for what is said to be the first time since 1982. The net result was that local customers' flat monthly charge of free air time was increased by 40% (W1000 to W1200), while the cost of any additional three minute slots above and beyond this amount was reduced by 13%. Since most customers do not use up free air time, analysts calculate that this will have a very beneficial impact on the company's bottom line and finally turn its return on investment per local line from negative to positive.

So too, where internet usage is concerned, there were a total of five million broadband subscribers in Korea as of end March, an 11% penetration - the world's highest. KT's market share came to roughly 44%. Analysts also estimate that the figure is set to continue growing strongly to upwards of eight million users by the end of 2001 and 10 million the following year.

KT provides broadband through asynchronous digital subscriber line (ADSL) and analysts believe that the company will be able to expand through leveraging its existing infrastructure rather than incur additional operating costs. Breakeven per subscriber is estimated to be 15 months, half the time of competitor firms.
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