Telkomsel proves the exception to the rule

Pricing of a debut dollar bond comes tighter than expected as the Indonesian cellular operator bids to oust Globe Telecom as Asia''s sexiest high yield name.

An increased $150 million five non-call three offering was priced yesterday (Tuesday) by lead manager UBS Warburg after books closed three-and-a-half times oversubscribed. Launched on an issue price of 99.75% to yield 9.825% or 474bp over Libor (532.5bp over five-year Treasuries), the deal surprised a number of observers who believed that 10% would be a psychologically hard hurdle to cross.

The transaction broke the mould of recent Indonesian offerings from PT Medco and Bank Mandiri both of which required extensive credit work and in Medco case's extremely tight covenants. However, rather than consider Telkomsel's transaction the next logical marker in the re-opening of the international markets for Indonesian credits, investors appear to have viewed it as a leveraged play on the credit of AA-/A1 rated Singapore Telecommunications, which now has a 35% stake in the company. Majority government-owned PT Telkom owns the remainder.

Under the terms of Telkomsel's shareholders agreement, SingTel can veto virtually any material change in the company's business including borrowings exceeding a debt to equity ratio of 40:60 and payment of dividends in excess of 30% of profits. Lead bankers consequently argue that the financial discipline imposed by the agreement makes covenants somewhat superfluous and the transaction as a whole a completely unique proposition that no other Indonesian borrower will be able to match.

"The shareholders agreement is even more restrictive than the kind of covenants typically attached to bank loans," one banker comments. "It would have been pointless and impossible to mirror this level of protection in a bond offering, so it made more sense to leave covenants out and just use standard negative pledge and event of default clauses."

However, the lack of covenants did make the issue unattractive to traditional US high yield funds and the order book was said to have been dominated by cross-over accounts. The placement pattern also differed markedly to both Mandiri and Medco, whose respective issues of $125 million and $100 million attracted just over 20 investors each and had a much higher degree of placement in Indonesia - 60% for Mandiri and 40% for Medco. Similar to Medco, Telkomsel's deal was 100% risk weighted for domestic accounts.

Bankers report a 60 strong order book for the Reg S offering, with a geographical split which saw 41% of paper placed in Singapore, 27% in Europe, 25% in Indonesia and 7% in Hong Kong. About 30% of the accounts were first time investors to Indonesia and of the 70% that had previously invested, 55% had not invested since the Asian financial crisis.

By account type, demand was split 42% asset managers, 20% private banking, 20% insurance companies, 16% banks and 2% corporates. In terms of allocation, however, the banking component was increased to 30% at the company's request to satisfy its domestic banking relationships. As a result, final placement saw 18% go to asset managers, 22% to insurance funds, 28% to private banks and 2% to corporates.

In benchmarking pricing, some fixed income analysts have compared Telkomsel with PLDT and concluded that the latter offers better value because it has a higher rating and the prospect of greater yield. The Philippines telco is due to launch a split five and 10 year transaction next Monday, with investors shown indicative pricing of 10.75% and 11.5%.

On a like-for-like basis, B+/B3 rated Telkomsel has, therefore, come 92.5bp through the indicative level of BB-/Ba3 rated PLDT. As HSBC analyst Imogine Baker states, "Overall, for a higher yield and better rated credit, we prefer the new PLDT over Telkomsel. Higher liquidity, higher US dollar-denominated revenues and less perceived threat from riots/uprisings also help support our view."

Others, however, argue that Globe makes a better comparable. In this respect, the Philippines telco has the advantage of higher dollar-linked revenues, a more stable domestic currency and trusted track record with investors. Rated two notches higher than Telkomsel by Standard & Poor's, Globe is trading 175bp tighter based on its interpolated curve.

The issue of Telkomsel's almost exclusively rupiah currency base and its apparent lack of any kind of hedging policy has worried a number of high yield specialists. But in a recent research report, UBS Warburg pointed out that even if the currency completely disintegrates and falls from its present Rp9,600 level to close to Rp20,000 to the dollar, Telkomsel will still be able to service its debt payments as long as it cuts its $1.5 billion capital expenditure in half. During the Asian financial crisis, the lowest point reached by the currency came in late 1998 at Rp14,900 against a Rp2,450 level pre-crisis.

Bankers also add that dollar funding makes much more sense than the domestic market. A break even analysis reveals that the rupiah would need to plummet to around Rp16,500 to Rp17,000 before current domestic yields of 18% to 19% render the domestic market more cost effective.

Where Telkomsel stands apart from Globe is the sheer upward trajectory of its growth levels, making it one of the few truly dynamic and exciting propositions from the Republic.

The figures speak for themselves.

Revenue has grown by a CAGR (compound annual growth rate) of 77.9% since 1997, subscribers numbers have grown at a CAGR of 86%, growth has been funded through internally generated cash rather than debt and at the end of December 2001, the company reported an EBITDA margin of 71.1% based on EBITDA of $336 million.

But with a subscriber base of 3.25 million and 50% market share, Telkomsel has only just begun to make inroads into a sprawling archipelago housing a population of 210 million and penetration rate of 3%. Through a three-year $1.5 billion capex plan, the company hopes to treble network capacity.

Prior to the bond offering, the company had only $48 million in debt and ran a debt to EBITDA ratio of 0.1 times against a 4.5 median for its rating category. Post bond offering, the figure moves up to 0.58 times, or a gross debt to equity ratio of 36%.

Having almost satisfied a $200 million funding requirement for 2002, attention will now turn to JPMorgan's $150 million five-year issue for PT Telkom and in particular what premium the parent will need to pay over its pubescent offspring.