The company held beauty parades earlier this week to appoint ratings advisors and lead managers for what is said to a $300 million to $500 million financing. About a dozen international and local banks had previously been sent an RFP (Request for Proposals) to suggest possible structures and maturities for a dollar bond, which may also yet be complemented by a small domestic issue as well.
Clear favourite to win the mandate has to be Salomon Smith Barney, which has long been regarded as the company's house bank and is its advisor on the resolution all five KSO disputes with foreign partners. Indeed, it is the recent resolution of two of these disputes and ongoing negotiations with the remaining three, which has prompted the need for a bond issue in the first place.
The other houses with recent experience of the Indonesian credit markets are HSBC and CSFB. The former led a $100 million FRN for Bank Mandiri back in December and is becoming more active in the domestic bond market, while the latter is currently roadshowing a $150 million issue for PT Medco Energi, although its position as house bank to rival PT Indosat may preclude it from the final selection.
Other bidders include; ABN AMRO, Deutsche Bank, Goldman Sachs, JPMorgan, Merrill Lynch and UBS Warburg, which also holds a key advantage because of its close relationship with the management of Telkom's cellular subsidiary Telkomsel.
Should a deal transpire, it will almost certainly prove to be one of the most interesting and challenging bond issues from Asia in some years. Not since the financial crisis has a company with no US dollar earnings attempted to raise funding in the international bond markets, let alone in such size. And even before 1997, although the Asian FRN market was full of borrowers gaily engaging in currency mismatches, international high yield investors generally demanded a huge number of safeguards to ensure re-payment from issuers with limited dollar revenues such as the Chinese toll road companies.
Consequently, high yield experts argue that any prospective deal may have to incorporate a sinking fund (containing either one or two coupon payments), covenants restricting increases in gearing beyond pre-set levels and possibly warrants as an additional sweetener. And above all else, investors are likely to demand that covenants are stressed tested to a high degree against sharp falls in the rupiah against the dollar.
On the positive side, a benchmark deal could be well received in a low interest rate environment where investors are prepared to move down the credit curve to pick up yield. With the demise of Asia Pulp & Paper, what remained of the Asian high yield market has all but disappeared and it is only now that a couple of Indonesian companies appear willing to try to stir investors' interest once more.
And although PT Telkom is unlikely to obtain a government guarantee, its 54% state ownership is likely to be regarded as an implicit guarantee by many investors. So too, PT Telkom is a strong cash flow generator, with increasing net profit levels underpinned by the high growth of its cellular subsidiary.
From Telkom's perspective, an international bond issue makes sense for a number of reasons, not least of which is that it has little other option. With three-year Treasury bills yielding 17.7%, the domestic bond market would not only be prohibitively expensive, but also unable to absorb either the size or maturity being contemplated by the company. So too, Telkom would have great difficulty returning to the equity markets after the government's recent divestment in December and $300 million would be hugely dilutive.
Given that the company intends to resolve all five KSO disputes, it makes sense to lock in long-term funding while interest rates remain low. Subject to its rating appraisal, outstanding benchmarks suggest that it might be able to achieve an all-in cost below the 11% mark.
The most relevant is PT Medco, which has B+ rating four notches above the sovereign and is looking to price a $150 million five year fixed rate bond around the 10.5% mark on Monday.
In the secondary market, illiquidity has generated artificially tight prices that provide a less reliable guide. However, PT Sampoerna, with a B3 rating two notches above the sovereign, has a $65 million 2006 issue trading on a yield of 9.67%. Indosat's unrated cellular subsidiary Satelindo - considered a much weaker credit - also has a $72 million FRN due 2006 outstanding. This deal currently yields 9.4%.
In the domestic bond market, Telkom is the only local company with a AAA rating from Pefindo. This, however, expired in January and officials say that it is currently under review.
For international investors, the big issue is the lack of a dollar revenue base. Local analysts calculate that PT Telkom should have a net debt position of about Rp7 trillion ($703 million) by the company's fiscal year-end in June. Of this amount, about 45% is said to be foreign currency denominated and much of it vendor financing.
More importantly, analysts say that only 10% has been hedged. As BNP Paribas Peregrine analyst Manog Nanwani explains, "The bottom line may be very sensitive to currency movements, but it is very expensive to set up a hedging policy."
During 2001, Telkom saw gearing expand from 22% to 155% according to UBS Warburg calculations. Most of this derived from the unwinding of cross shareholdings with Indosat which created two separate integrated operators and led Telkom to gain majority control of Telkomsel. The entire goodwill associated with the transaction was immediately written off against equity.
As part of this transaction, Telkom signed a sale and purchase agreement for the sale of KSO IV, which was dependent on a number of conditionalities being met by January 2002. As these did not happen, Telkom now has a net outstanding liability to Indosat of $198 million, which it is currently proposing to re-pay in monthly installments over a two-year period.
The KSO arrangements, which form the core of Telkom's financing dilemma, were first established in 1995. Five consortia, all with foreign operators, agreed to fund fixed line growth in five separate regions in return for the right to manage the businesses until 2010. Disputes quickly erupted, however, after the KSOs missed their installation targets, the rupiah went into freefall and management fell out with Telkom over revenue sharing agreements.
These intensified further in 1999 when the Indonesian government legislated to open up the domestic market to competition and the KSOs saw their exclusivity rights threatened. How the KSOs would be unwound and compensated has been hanging over Telkom's balance sheet and share price ever since.
In April 2001, it announced that it had resolved KSO VI, Dayamitra, whose foreign partner was Cable & Wireless. Under the terms of the agreement, Telkom absorbed $88.5 million of the company's debt and agreed to pay $121.93 million to Dayamitra shareholders. Some $18.29 million was paid up-front and the remainder is being re-paid in equal quarterly installments over a two-year period.
A similar arrangement was also recently forged with KSO 1, Pramindo, in which France Telecom is a shareholder. Under this agreement, Telkom will absorb $85 million in debt and make an up-front payment of $54 million, followed by 10 equal quarterly installments at an 11% interest rate.
Based on the figures above, Telkom will need just over $300 million during to buy out the KSOs, although part of the funds will be generated from the EBITDA earnings of the KSOs themselves. Telkom was already receiving some EBITDA through its previous revenue sharing agreements with the KSO and with each new payment, will receive a proportional share of the full cash flows.
Local analysts also estimate that Telkom will require about $170 million in dividend payments and $200 million to fund capital expenditure during 2002. According to UBS Warburg, the company is likely to report free cash flow of about $330 million at the 2001 Year-end, leaving a roughly $400 million shortfall.
Nevertheless, many remain impressed that, so far and with the notable exception of AriaWest (KSO III), Telkom has been able to unwind the KSOs without overloading its balance sheet. As Nanwani concludes, "It has been able to keep gearing at reasonable levels because it isn't paying in full upfront for any of these KSOs. What it has been able to achieve over the past year is quite remarkable."