PCCW-HKT: back around the block

Telco raises $404 million from top up placement.

PCCW-HKT returned to the international capital markets for the second time in a week yesterday (Wednesday) with a 715 million share block trade. The offering was led by Citigroup, which also handled the disposal of a 14% stake by Cable & Wireless just over a month ago.

The placement was priced at HK$4.40 representing a 9.27% discount to the stock's HK$4.85 close. This was towards the bottom end of a HK$4.37 to HK$4.56 indicative range and reflected a book, which closed with a fair degree of price sensitivity. At the placement price, it was 1.3 times covered, with participation from 85 accounts.

Because the deal is a top-up placement, Pacific Century Regional Development (PCRD) will subscribe to an equal number of new shares, in the process marginally reducing its stake from roughly 32% to 29%. This is the entity through which Richard Li holds his stake.

The deal represents 13.4% of the enlarged share capital and 19.7% of the freefloat, which in turn stood at 63% pre-transaction, backed by a market capitalization of $2.89 billion.

Yet, where one week ago a $500 million bond deal was hailed as credit positive for the group, the equity transaction has received a more mixed response. Those investors which purchased the 651.9 million share divestment by C&W are not likely to be happy about the dilution, nor the 8% discount at which the new deal has come relative to the old. The earlier deal was sold with a similar 9% discount at HK$4.78 per share.

However, PCCW-HKT can hardly be blamed for ramming the market with paper, since it was not responsible for the first trade and as a result of the new deal, equity investors may benefit from an accelerated resumption of dividend payments. Proceeds from the deal are being used to pay down debt and a couple of days ago, the group announced its intention to re-pay the remaining $533 million portion of a Hong Kong dollar loan due 2008.

Re-payment of this loan together with the re-payment of the final tranche of the group's $4.7 billion syndicated loan, should mean that debt to EBITDA will fall to 2.6 times. This is almost the 2.5 times threshold at which there ceases to be a cap on PCCW-HKT's ability to upstream dividends to its parent. According to UBS research, debt should fall to $2.831 billion on re-payment of the loan, a far cry from the $12 billion taken on board to buy Hongkong Telecom in the first place.

But given that analysts also estimate PCCW group companies to hold upwards of $1 billion in cash on the balance sheet, a number have queried why it was necessary to raise new equity. There appears to be two main reasons.

Firstly, officials have re-iterated their intention to continue de-leveraging the company. If they are able to do this and retain a strong liquidity cushion, the rating agencies might be persuaded to upgrade the company sooner rather than later.

Secondly, once debt has been paid down to a comfortable level, the stage is set for a resumption of dividends to equity investors. Earlier this year the company said that it would be unable to start paying a dividend in 2004 as it had previously hoped.

However, there is still the matter of how PCCW accounts for Reach. In February, the company decided to write down to zero only 50% the $1.06 billion book value, whereas Telstra wrote down 100%.

But if PCCW-HKT can start to pay dividends, it may encourage long-term equity players back into a stock, which has long been one of hedge funds' favourite shorts. Currently, PCCW-HKT is trading on a P/E ratio of just over seven times forecast 2004 earnings, a discount to the regional average around the 10 times level.

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