Temasek enters Telekom Malaysia

Singapore government finally gains a foothold in Malaysia through the country''s largest ever secondary offering.

Malaysian government-owned Khazanah Nasional Berhad raised M$2.91 billion ($769 million) from the sale of 300 million shares in Telekom Malaysia yesterday (Monday). Singapore government-owned Temasek Holdings took up half of the deal, which was priced at M$9.70 per share.

The transaction represents the largest ever secondary offering from Malaysia, but its true significance lies in the policy shift it signals from the Badawi government. The new prime minister has said he would like to develop closer links with Singapore, boost liquidity on the Kuala Lumpur Stock Exchange and improve the productivity and accountability of major government-linked companies such as Tenaga and Telekom.

The Telekom Malaysia divestment embraces all three and marks the first direct investment Temasek has ever made in Malaysia. During the Mahathir regime, Singapore Inc's attempts to gain an economic foothold led to some very public failures. Most notably these were through Singapore Telecommunications, which made unsuccessful bids for Binariang, Celcom and Timedotcom.

But Temasek has long been keen to diversify into Malaysia as it seeks to broaden its investment portfolio away from Singapore and capture the higher GDP rates of its ASEAN neighbours. The group has already made a number of investments in the region's banking sector and management have also said they would like to invest in the telecom, healthcare and education sectors, since they believe these represent the best proxies for the region's emergent middle class.

As a result of yesterday's sale, which represented 9.17% of the company's issued share capital, Temasek will gain a stake of just under 5% in Telekom. Khazanah will see its shareholding drop from 41.9% to 32.8%, while the freefloat will increase from 28.1% to 37.27%, taking the stock into the next MSCI weighting.

The group's remaining shareholders are all government-owned institutions led by the Employees Provident Fund, with a 13.8% stake, Bank Negara 7.7%, Permodalan Nasional 5.1% and the Ministry of Finance 3.4%.

In late December, the Ministry of Finance quietly embarked on a divestment programme of stakes it has built up since the financial crisis. A 300 million share stake in Telekom, for example, was sold to Khazanah, with the intention that its investment arm would on-sell the shares in the public market. Khazanah still has an option to purchase a further 194 million shares from the MOF and is not subject to a lock-up under the terms of the current sale.

With an approximately $8.8 billion market capitalization, Telekom currently ranks as the country's second largest listed company behind Maybank. Nevertheless, while placement was not large by the standards of North Asian stock markets, it was very large for Malaysia, highlighting the challenges the government faces as it attempts to broaden the market's scope. The transaction represented 68 days trading in Telekom shares on a one-month basis, or a far more weighty 123.6 days trading on a six-month basis.

The deal was priced at a 1.5% discount to Monday's close of M$9.85, or a 4% discount to Friday's close of M$10.10. Unusually, the stock remained open to trade throughout the accelerated bookbuild, which was launched at Monday's open.

As news of the deal began to circulate on Friday, however, the stock fell heavily closing 5% down on the day. But it has outperformed the Malaysian market so far this year, rising 17.26% to Monday's close, compared with a 12% gain for the overall index. Since the beginning of the fourth quarter it has run up 33%.

The stock first began to climb after Credit Suisse First Boston re-rated it in mid-October - jumping from M$8.05 to M$9.20 in the space of two weeks. At the time, and still to a certain extent today, the investment bank has taken a contrarian view to the rest of the market.

Observers believe this gave the bank a headstart in winning the deal, which was formally mandated to CIMB just over two weeks ago. The domestic investment bank took the role of global co-ordinator and bought in three other bookrunners - AmMerchant Bank, CSFB and ECM Libra Partners.

Together the four build a book that closed just over two times oversubscribed. Taking away Temasek, the deal had a split, which saw about 40% placed onshore and 60% offshore, of which 60% went to the rest of Asia and 40% to Europe. The international book encompassed just under 80 accounts.

Most research houses do not believe the stock has much upside from current levels and have assigned target prices around the M$9 to M$10 level. Prior to the placement, CSFB had a target price of M$12 per share.

The stock currently trades on a P/E ratio of about 17 times 2004 earnings, above an Asia (ex-Japan) average of roughly 13.5 times for fixed line companies and on an EV/EBITDA ratio of 5.5 times, slightly below a 6.2 times average.

In a research report published in January this year CSFB said, "Telekom Malaysia has an enviable position in both cellular and fixed line. In our view, all the company has to do is manage those positions even reasonably well and earnings should surprise on the upside."

The company's 2003 earnings went on to do just that, with full year revenue rising 20%, driven largely by cellular operator Celcom, which became a formal subsidiary in April. Celcom saw its EBITDA margin expand from 41% to 46% during the fourth quarter and accounted for 20% of total net profits for the full financial year.

The company's supporters argue that with only two telecom players, Malaysia's benign operating and regulatory environment should support strong growth. Greater operational efficiencies, for example, may allow Telekom to inch further towards Maxis Communications EBITDA margin of 53.5%.

On the cellular side, penetration rates are still just below the Asian average of 50%. And on the fixed line side, Telekom has a monopoly share of 95%. During the fourth quarter, the company's overall EBITDA margin fell from 49% to 44%, but some analysts believe it may be able to offset declining fixed line revenues from increasing broadband penetration, which stood at just 2% at the end of 2003.

However, there are a number of uncertainties surrounding the company, which may unsettle its share price in the coming months. Firstly, management have been saying they intend to spin-off Celcom at some point this year. Secondly, Telekom may divest one non-core asset Telekom South Africa, only to purchase another - Indonesia's Excelcomindo.

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