MTR Corp takes to the tracks

The analysts meeting for the high profile privatisation of Hong Kong''s urban rail network takes place today (Friday) ahead of its flotation next month.

Launch of what is projected to be a HK$20 billion ($2.58 billion) deal is scheduled to take place in mid-September for listing on the Hong Kong Stock Exchange by the end of the month. Backed by lead managers Goldman Sachs, HSBC and UBS Warburg, the government is hoping to sell a 25% stake in the rail operator, ahead of a second 25% stake next year.

The offering is also expected to be very much a domestic affair with a very strong retail element. Where, for example, most Hong Kong retail offerings are initially capped at 10%, subject to clawbacks in the event of certain levels of oversubscription, this deal is said likely to start off with a 25% target range.

Marketing of the deal and the incentives it will incorporate are expected to closely mirror the partial sale of the government's massive share portfolio last November through its tracker fund (TraHK), whose units track the Hang Seng Index. Of the HK$33.3 billion that was raised, HK$23 billion was allocated to retail investors who appeared to love the product because it provided a straightforward and easily comprehensible way of buying the entire index.

As well as getting the units priced at a discount, investors were offered two sets of loyalty bonuses in the form of further units if they held onto scrip for up to two years. Where MTR Corp is concerned, regular passengers are also expected to be given additional price incentives.

"These kind of products appeal to investors who want to buy and hold a safe instrument," says one banker. "The most notable thing about the distribution pattern of TraHK, for instance, was the fact that the average investor put in for HK$80,000. These were investors that normally place their savings in bank deposits, not the stock market."

Because of the high retail element to its deal, MTR officials are also planning to outline the company's future dividend policy ahead of listing. And most analysts warn that dividend payments are likely to be sparse until 2003 at the very earliest. "MTR Corp's high capex means that interest coverage ratios will be cut to shreds if it starts paying out dividends, particularly in 2002 when expenditure hits its peak," says one.

"It seems much more likely that the company will price its shares at slightly more of discount to allow for greater capital appreciation as compensation," he adds.

Unlike Singapore's MRT, which listed last month, Hong Kong's MTR is a strange hybrid of property company and railway operator. Therefore, where SMRT is viewed as a solid utility with steady earnings and little upside, MTR Corp will be seen as a much more volatile proposition, despite the fact that it runs one of the most profitable railway companies in the world.

In the 1999 Financial Year, for example, the company reported HK$2.38 billion in net profits, of which gains on property development accounted for HK$2.03 billion of the total. Property is an essential part of the company's earnings mix, because the government grants land rights to develop real estate at stations along every new track built.

However, instead of assuming the development risks of these projects itself, the company invites property companies to develop individual projects and then takes a fixed percentage of any future profits. The company also benefits from a hidden subsidy in terms of the land premium it pays to the government for every new plot purchased.

"On the surface the company pays the market average and that seems fair," says one analyst. " But the reality is that these properties are located at prime sites - ie stations - and it should pay a premium."

MTR Corp also differs significantly from SMRT because its raises all its own financing from the capital markets, rather than relying on equity injections from the government. As result, the company will have a significant debt burden going forwards to meet the requirements of its Tseung Kwan O Extension project.

Analysts predict that capex will peak in 2002 at HK$9.2 billion, resulting in a debt to EBITDA ratio of 8 times in 2001 and an interest coverage ratio of 1.7 times, down from 2 times in 1999.

Sector specialists also say, however, that MTR's diversified earnings mix reflects a broader local trend away from focused property companies. "There are no pure property stocks here anymore," says one. "It's very hard to make broad comparisons across the sector, because every company has to be analysed on its own merits."    

"Sun Hung Kai and Henderson are typically used as benchmarks and both are trading close to NAV (Net Asset Value) and at price/earnings ratios of about 15 times 2001 earnings," the analyst adds. "But even Sun Hung Kai now has SUNeVision, although admittedly it doesn't yet account for very much."

Analysts tend to agree that MTR is Hong Kong Inc and investors are likely to lap it up as such. "You will be buying the government and getting a yield kicker to boot," one concludes.

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