Pre-marketing wraps up for China Resources Peoples Telephone

No frills cellular operator hopes to entice investors with high dividend yield.

Lead manager UBS is preparing to launch formal roadshows on Monday for an IPO of up to $200 million in Hong Kong cellular operator, China Resources Peoples Telephone. With ABN AMRO Rothschild and CLSA as co-leads, the company will sell 30% of its enlarged share capital (including the greenshoe) through an offering that comprises an equal mix of old and new shares.

The selling shareholders are Holland's Royal KPN and Sweden's TeliaSonera AB, which both own 8% of the company and will completely divest their stakes. The two have been involved with Peoples Telephone since it won a cellular license in 1996, initially providing technical assistance and latterly as pure financial investors.

The majority shareholder is China Resources, which owns 60%, with managing director Michael Leung owning a further 20% and South Africa's Celtel the remaining 4%.

The Hong Kong retail offer will run from March 22 to 25, with pricing and allocations scheduled for Friday March 26.

The deal is being marketed on a 2004 P/E range of about 10 to 12 times earnings. This represents a 5% to 20% discount to the group's nearest comparable SmarTone, which is currently trading on a market average P/E of 12.6 times 2004 earnings.

Taking into account the standard IPO discount of about 10%, the valuation seems fairly reasonable given that Peoples and SmarTone share very similar profiles. Both have subscriber bases of just over one million, both intend to pay out about two thirds of net income as dividends, both will have similar market capitalizations and both operate in the highly competitive and saturated Hong Kong telecom sector.

The main difference between the two is that SmarTone has a 3G license and Peoples does not - opting instead to add EDGE technology to its existing 2G network. SmarTone is also slightly more profitable.

For the first half of its Financial Year ended December 31, SmarTone reported net income of HK$235 million ($30 million), while Peoples reported third quarter net income of HK$84 million ($10.7 million) in its most recently released results from July to September 2003.

However, specialists say investors' main focus is the divided yield. SmarTone is currently yielding about 5.73% and Peoples is being pitched between 5% and 6%. The average for the small to mid-cap sector in Hong Kong is about 3.5%.

In this respect, Peoples may have timed its IPO perfectly. At the beginning of the year investors were still chasing growth stocks and market momentum. However, the Hong Kong/China market is currently experiencing a period of consolidation, with the Hang Seng Index down from a year-to-date high of 14,058 to close yesterday at 13,214.

As such investors have started to become more wary and a number are once again keeping an eye out for interesting defensive stocks to re-balance their portfolios.

Peoples is likely to offer little in terms of subscriber growth given that Hong Kong now has an official penetration rate of more than 100% (6.8 million population versus 6.9 million mobile subscribers in October). Analysts have often wondered how six operators have been able to survive in such as a small and highly competitive environment.

Pressure to consolidate should have been strong, but the background of most of the operators means that personalities have often got in the way. Many of the operators are the offspring of Hong Kong conglomerates, which decided to plough their excess profits from the property market into the telecoms sector at the height of the latter's pre-3G boom period in the mid 1990's. SmarTone, for example, is majority-owned by Sun Hung Kai.

In this environment, operators have chosen to differentiate themselves by targetting different audiences and latterly by capturing roaming revenues from Mainland tourists. Peoples styles itself as the Ryanair of the cellular industry and has always gone for the mass market. It built its network cheaper than anyone else, it maintains stringent cost controls and pledges to match any other operator's lowest cost offer as long as it is not loss making.

On this basis, it says it is less sensitive to price wars, since customers attracted to low cost offers tend to compensate by spending more time on the phone. During 2003, when Hong Kong experienced its most intense tariff war to date, Peoples saw MOU expand 16.5%.

The company currently has a 14.6% market share.