Korea Telecom moves forward with ADR

The Korean government has issued the RFP (Request For Proposals) in the next round of the privatization of Korea Telecom.

The RFP to lead a roughly $2.3 billion ADR has been sent to 16 banks, with submissions due next Friday. The only notable omissions are JPMorgan and Merrill Lynch, both of which have been conflicted because of the ongoing sale of a strategic stake in the telecoms company.

Merrill's would have been automatically unable to participate because it is acting as the sell side advisor. However, the exclusion of JPMorgan is more controversial, since the bank is only acting as a buy side advisor for Singapore Telecommunications in a continuation of the latter's aggressive acquisition trail across Australasia.

Representing a 16% stake, the prospective ADR marks the company's second foray into the international equity markets following the launch of a $2.49 billion privatization offering via Morgan Stanley Dean Witter in May 1999. This was priced at $27.56 per unit, equating to a 20.3% premium to a then spot price of Won54,500. One unit equals half an ordinary share. The government currently holds 59% overall.

Were a new issue to be launched today flat to the company's existing ADR price, Korea Telecom (KT) would raise about $2.3 billion based on Friday's trading price of $23.30. In turn, this represents a roughly 10% premium to an underlying price of Won56,100.

The Korean government is hoping to complete the deal by the end of June, having failed to secure domestic participation for the divestment of a 14.7% stake to local institutions and corporates in February. Regulations forbidding any one group to bid for more than 5% of the stock, resulted in a dismal participation rate of only 1.1%, with local investors bidding for only 3.3 million shares at an average price of Won66,967, a 4.5% discount to spot.

The decision to press ahead with an international sale in the wake of a failed domestic offering would appear to mirror the recent and unsuccessful efforts of the Taiwanese government to divest itself of Chunghwa Telecom. At a time of extreme uncertainty in the straight equity markets and particularly for telecom-related stocks, some bankers would argue that the Korean government's strategy is equally misguided.

However, local bankers argue that the two comparables differ in one key respect. Where the Taiwanese government was unwilling to price an ADR at a discount to underlying, they believe that the Korean government may be prepared to break its own long history of failing to budge on the same issue.

As the Seoul-based head of one investment bank puts it, "The government is under the gun right now because it has an election looming. Korea Telecom is the most lucrative asset it has to sell and it’s prepared to do so at cheap levels, because it needs to prove that it's capable of selling something.

"The government has poured money into the banking system, but failed to privatize a single bank," the banker notes. "Likewise, government money has flowed into the insurance sector, but not one single institution has been privatized. Even if investors short the hell out of the ADR and the government is faced with pricing at a discount, I think they'll still do the deal because they know they have to keep the privatization programme moving. There's too much pressure this time."

Domestically, the stock has badly underperformed the market since the failed domestic offering, falling 16.27% year-to-date, versus a 3.686% gain in the Kospi. Part of its recent problems, stem from the stock overhang, which the completion of an ADR should remove.

Global markets aside, the company's supporters argue that KT stands to be well received because it is trading at cheap levels and does not have the 3G related debt problems of the world's wireless companies. In a research report last year, Standard & Poor's reported a debt to capitalization ratio of 21.3%, an interest coverage ratio of 8.6 times and total debt of $3.4 billion.

 "Korea Telecom is the dominant player in Korea and it spans fixed line, wireless and data," one banker comments. "Weakness in any one sector is offset by strength in another."

And the figures remain impressive. While competition has been gradually increasing, the company has managed to maintain a dominant position, with an 82% share of the fixed line market, 29% share of the wireless market and 44% share of the ASDL market (asymmetric digital subscriber line). It is also one of only two groups to be awarded a key WCDMA 3G license.

Analysts highlight that the ASDL figure is particularly important, since revenue from data services and the internet has been able to balance declining revenue from the fixed line business. With an ASDL penetration rate of 29%, Korea has the world's highest user rate for high-speed internet access.

The company's background may have been one as a state-owned monolith, but this has not stopped it from driving the kinds of technological development that have kept Korea at the forefront of the telecommunications sector. The country was, for example, the first in Asia to make the crossover to more wireless than fixed line subscribers. During 2000, KT also saw ADSL subscriber numbers rise above the two million mark for the first time, a 56% increase over 1999.

And the growth is set to continue. As Deutsche Bank concludes in a recent research report, "The field seems to be shifting decisively in favour of KT, Hanaro and Thrunet. We estimate broadband subscribers to reach 3.5 million by the end of the year, with KT capturing 48% of the market. In the longer-term, as the broadband market continues to expand albeit with rising competition, we believe KT is in a strong position to become a dominant provider in view of its extensive infrastructure network in the country."

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