PCCW: 2000 Deal of the Year...lemon of the decade

PCCW took out a $12 billion syndicated loan to pay for the acquisition of Hong Kong Telecom. The loan was a success, but the acquisition was named one of the biggest disasters since the end of the Asian financial crisis.

In 2000, we gave our Deal of the Year award to a $12 billion syndicated loan that was issued to then small start-up tech company Pacific Century Cyberworks (PCCW). The company is now the largest integrated communications company in Hong Kong, but at the time of the deal, PCCW had only been running for 10 months.

PCCW was always destined to grow. Run by Richard Li, second son to property tycoon Li Ka-shing, it had the financial and operational backing locked in from the outset.

At the time, the $12 billion loan was a record transaction in the Asia syndicated loan markets -- more than double the size of the previous record holder in fact -- and in our awards write-up we said it "opened the door for leveraged financing across the broader spectrum of the region's capital markets".

The leads decided to structure a deal as a leveraged financing secured against the assets of the target company and a non-recourse structure through a special purpose vehicle owning the HKT shares was used. The debt-to-Ebitda ratio was nine times, versus typically no more than 5.5 times for European deals at the time.

Aside from kick-starting the loan market into booking bigger and better deals, the loan also paid almost $90 million in fees, which got divvied up between the four lead arrangers (Bank of China, Barclays, BNP and HSBC). The deal was not so profitable for the second tier of 18 banks that were left with an average return of about $2.5 million each because of over-subscription. In absolute terms this was still a fairly sound pay-out, but considering initial indications of returns of up to $10 million each, some of the banks may have come off feeling slightly short-changed for their participation.

And as soon as the mechanics of the loan were done and dusted, everything began to go a bit sour for PCCW.

The proceeds of the loan were used to fund the acquisition of Hong Kong Telecom from its UK parent Cable & Wireless, which did not roll out smoothly. In fact, in 2002, FinanceAsia rated the HKT acquisition as one of the worst deals to come out of Asia since the end of the Asian financial crisis. At that time, the deal had generated a 52.2% negative return for investors. But while it may have been viewed as a lemon for shareholders, it was still a good deal for PCCW chairman Richard Li.

Over the past decade, the share price performance has progressively weakened. After adjusting for subsequent splits, in 2000 PCCW reached a share price high of $131.75 and a total market value of $41 billion. Since the acquisition of HKT, the company has lost more than 90% of its value. Yesterday it closed at HK$2.11, resulting in a market capitalisation of $1.8 billion. Shareholders have understandably lost a lot of faith in the way the finances have been managed and some are not willing to let go until the value of their dwindling shares are somewhat recouped.

Since 2006, Li has attempted four times to and buy out shareholders and turn PCCW into a private enterprise. However, shareholders have resisted. The most recent attempt in April 2009 also ran into issues with the Hong Kong regulators and Li was, once again, forced to give up his plans.

From a fixed-income perspective, the liquidity in PCCW's three outstanding US dollar bonds -- a $1 billion issue due November 2011 and two $500 million 10-year securities due in May 2013 and May 2015 -- has thinned out completely since the moves to privatise the company began. A successful buy-out would effectively be viewed as a change of control, which would trigger a redemption clause on the bonds.

Therefore, a lot of uncertainty over transparency and overall management decisions has driven the performance of the bonds. Investors are said to have no insight into where the company is heading or what would happen to the bonds if Li was eventually to succeed in his attempts to take the telecom giant private.

Realistically, in an environment such as this, where shareholders are hostile to the management, further attempts to privatise are likely to be met with the same fate. 

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