PCCW stock declines on Leung deal

Richard Li exits and Leung acquires asset on which he has to book loss on day one.
Late on Monday, July 10 at a press conference Richard Li announced he had sold his 22.66% stake in PCCW to Francis Leung, ending weeks of speculation about what he intended to do with the company. Leung will acquire the stake in PCCW held by Singapore-listed Pacific Century Regional Developments (PCRD) at HK$6 ($0.77) per share for a total consideration of about. HK$9.2 billion ($1.2 billion). The price represented an 8% premium to PCCWÆs closing price of HK$5.55 on Friday. PCRD is 75% owned by Pacific Century Group Holdings, which is entirely owned by Richard Li. Li also owns a 3% stake directly in PCCW which he will retain.

Leung - who is believed to be leading a consortium of undisclosed parties - will now own the single largest block of shares in PCCW, followed by China Netcom which bought a 20% stake in the company in January, 2005 at a price of HK$5.90 per share. The transaction - in some senses - marks a full circle for Leung. He is widely credited with helping Richard Li, in 1999, acquire the company which would ultimately become PCCW.

Bankers were not necessarily enthusiastic about the deal - since it promises less financing fees than the alternatives proposed by Macquarie and Newbridge. Nor seemingly were investors, with the stock ending yesterday at HK$5.10, a HK$0.45 decline.

Among the many things under the spotlight yesterday was the Hong Kong takeover code. The code regulates the acquisition of shares in a company in which there is a change in control. Control is defined simply as 30% or more of the voting rights of a company irrespective of whether holdings at a lower level give de facto control. The 30% trigger was introduced in 2001 to replace an earlier 35% trigger. Control is by its very nature an ambiguous concept as it can be exercised through composition of the board, management structure, etc. Indeed, instances abound in emerging markets where families which ôcontrolö companies own far less then 30% of the shares and thus can effectively precipitate a change in control at far lower shareholding levels.

China Netcom was also aware of the consequences of the code. Had it bought LiÆs stake it would have triggered a general offer to all shareholders. China Netcom might have been reluctant to tie up so much capital in PCCW.

The latest deal did not trigger the takeover code, but Richard Li announced that he would make a special payout to minority shareholders. This payment represents the difference between the price of HK$6 per share at which the transaction was consummated and the HK$4.80 share price on June 16, before an announcement was made regarding the first expression of interest. Li said ôI expect my payment totalling about HK$1.38 billion to equal between 33 and 38 cents per applicable PCCW share.ö China Netcom has agreed to waive its share of the payout. This is being widely perceived as a magnanimous gesture by both the tycoon and its partner, China Netcom.

However, minority shareholders - which hold 54% of PCCW - could disagree. The fact that TPG-Newbridge and Macquarie had submitted expressions of interest (EOI) was made public by PCCW itself in press releases on June 19 and 21. The numbers in the news are that Macquarie had bid $7.3 billion and TPG-Newbridge $7.55 billion including debt for the telecommunications and media assets of PCCW. The price at which the transaction has been consummated suggests a firm value of around $5.3 billion.

The questions which lingers is if minority shareholders had been consulted which buyer and structure would they have preferred? The share price tanked in trading on Tuesday losing almost 10% in initial trades going as low as $5 though it recovered slightly in later trading to close at HK$5.10. This suggests shareholders may not be as enthusiastic about the sale of LiÆs stake to Leung as they were with the asset sale. The reason could be that shareholders were looking forward to a hefty payout from the proceeds of the asset sale. The reaction of the stock suggests the market thinks that would have been larger than the special payout Li has seen fit to share.

China syndrome
What complicates the entire picture is the attitude of Netcom and China. It is clear that both were taken by surprise by Li's discussions to sell PCCW's assets to either Newbridge or Macquarie. China Netcom made its disapproval of an asset sale blatantly clear in its statements in June after the news of the Macquarie and TPG Newbridge bids was made public saying ôwe do not want to see any changes in assets in PCCW which is owned and managed by Hong Kong peopleö. In a statement issued after the transaction was announced China Netcom welcomed the sale to Francis Leung.

Li himself commented on Monday: "Circumstances dictate that we can't have an asset sale."

Another unanswered question relates to LeungÆs game plan with respect to the investment. It seems unlikely that a savvy deal maker like Leung will indefinitely tie up his capital in a transaction which on a mark-to-market basis saw an erosion of value of more than 15% in one day. At the low the share touched of $5 on Tueday, the value of LeungÆs investment in PCCW was down from the HK$9.2 billion he agreed to pay on Monday to around HK$7.7 billion. That kind of capital erosion is unlikely to be small change even for Leung. (Albeit it is just a paper loss at present - since he isn't scheduled to make his first payment to Richard Li until December.)

All things considered it seems unlikely that Leung's entry may only signify an end to the first act of the latest PCCW drama. Some kind of transaction for control of PCCW is probably still lurking around the corner. Indeed, amid all the rumours that were circulating yesterday, one interesting one was that Macquarie has definitely not lost interest in acquiring this asset and is in continuing talks with all parties.

All in all, the deal represents a fitting epilogue to the dotcom boom that originally saw Richard Li buy Hongkong Telecom from Cable & Wireless. That deal was made possible by a bubble that had inflated his stock, and ironically enough, by the nod from China, which had opposed an alternative bid and viewed Li as its preferred bidder. The financial community was also enthusiastic, since the leveraged financing used to acquire HKT paid fees in excess of $120 million.

In the end Li has displayed that he carries asset trading genes. The old PCCW - with whose stock he acquired HKT - had a satellite-internet business and a TV channel, neither of which are core to the current business (although the brand name NOW is still used). He traded these assets - which would be worth little today - and six years later is exiting with around $1 billion.

It will be interesting to see what he does with the money. Given his penchant for riding the latest wave, no one should be surprised if he uses the cash to set up either a hedge fund or a private equity firm.

¬ Haymarket Media Limited. All rights reserved.
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