Win win in Jakarta

PT Telkom and IndosatÆs recent M&A activities have left international observers very excited.

If IndosatÆs and PT TelkomÆs recent moves are anything to go by, investors may soon recover their enthusiasm for Indonesia. In what is being described as a win-win situation, PT Telkom and Indosat have bucked the negative news from the political scene and unwound their cross-shareholdings.

In the process Indosat has gained control of number two cellular company Satelindo, while Telkom has gained control of number one cellular company Telkomsel. This will allow both companies to be re-rated by analysts, and unlock value in the cellular phone area that was previously hidden by their cross-shareholding structure. It will also create two dominant competitors in the Indonesian telecoms sector, improve IndosatÆs debt position, and see it take control of former Bambang Suharto company Bimagraha. So whatÆs the deal?

On Thursday, the two companies announced that Telkom would buy IndosatÆs 35% stake in Telkomsel for $945 million, taking it up to 78% and gaining control. Meanwhile, Telkom sold Indosat a 22.5% stake in Satelindo for $186 million, and fixed line phone assets in Central Java for $375 million. It also allowed Indosat to take its stake in Lintasarta, a leading player in the data communications market, up to 70%. In total, Indosat emerged from this unwinding exercise with $346 million of cash.

On Friday it emerged just how this cash would be used. Indosat announced it would buy 70% of Bimagraha for $260 million and thus gain an effective 31.5% stake in Satelindo. Together with the stake bought from Telkom that takes IndosatÆs control of Satelindo above 50%.

The deal has thus created two consolidated telecoms companies each owning a rapidly growing mobile phone business. For Indosat this will help offset falling margins in its dominant IDD business, and with the acquisition in Central Java, allow it to target new customers.

For Telkom, it has allowed it to gain full control of Indonesia top mobile phone company, and this is certain to see a re-rating of its stock. Amazingly, it is one of the cheapest companies in the world, trading at 4.5 times 2001 cashflow. The Telkomsel acquisition looks certain to see its stock price move closer to international comparables.

IndonesiaÆs mobile phone market is an exceptional cash-cow û which is very unlike the situation elsewhere in the world. 3G costs are not being incurred as the market is still at a basic level. But demand for such basic services has been growing fast. Telkomsel took on 80,000 new subscribers per month in the last quarter of 2000. It ended the year with 1.7 million users, and if these rates continue it could have 2.7 million by year end. This growth was achieved without any downward pressure on average revenue per user û which again, makes Indonesia highly unusual.

Salomon Smith Barney research forecasts there will be 16 million users (out of a population of 207 million) by 2005. So there is a lot of potential for both Telkomsel and Satelindo to grow.

Telkomsel has very good cashflow and is the number one player in Indonesia. SatelindoÆs growth has been restrained only by its limited ability to commit capital expenditure thanks to agreements made in its debt restructuring. It has a net debt position of $450 million, and some of the cash thrown off by this deal could be used to pay down some of the debt and thus improve the debtÆs market price.

Telkom was advised by Salomon Smith Barney, and Indosat was advised by Danareksa and Credit Suisse First Boston (which also advised Satelindo on its debt restructuring).

Telkom went into the deal with by far the stronger balance sheet, sitting on a net cash position of $800 million. The price it paid for Telkomsel equated to $1500 per year-end 2000 subscribers. Comparable Asian companies trade at $1400 per year-end 2000 subscribers.

But, says Greg Mazur, co-head of Asia Telecom at Salomon Smith Barney: "A slight premium was paid for a controlling stake. It also has to be remembered that Telkomsel is the market leader in Indonesia and has one of the highest operating cash flow margins of any mobile company in Asia."

In the case of Satelindo û when the debt is taken into account û a price of $1160 per subscriber was paid. However, in SatelindoÆs case there are issues that arise from the debt restructuring and the covenants it is working under.

TelkomselÆs higher valuation reflects its relative freedom from such covenants, and its greater ability to commit capex. Telkomsel also has higher average revenues per subscriber and better cash flow.

Where CSFB and Danareksa have clearly done a good job is in making certain their client, Indosat, paid exactly the same valuation to Bimagraha as it did to Telkom û valuing the company at $825 million (excluding debt).

Why? Well, in the case of Telkom it was only buying 22% and not gaining control. The Bimagraha stake, on the other hand, included all sorts of covenants that gave it effective management control. The fact that a higher price was not paid for this stake û previously controlled by Bambang Suharto û is a sign that the advisers struck a very good deal indeed.

Indosat will emerge from the deal with around $200 million of cash, while Telkom will still have more than $400 million. Indosat will also become an integrated telephone company with land lines, cellular, international (IDD) and a satellite business. That will allow it to compete head on with Telkom, which currently dominates land lines and is the leader in cellular.

Foreigners are now able to buy 49% of either company, and the potential for foreign investment is in both companiesÆ minds. Both Deutsche Telekom and KPN of Holland currently have minority stakes in the cellular businesses.

For Eric Varvel, CSFB managing director and Indonesian expert, says this is a very positive deal: ôForeign investors will say that this time Indonesia got it right. TheyÆll say finally theyÆre getting it together.ö

The government currently holds 65% in Indosat and 66% in Telkom. Thus, says CSFBÆs Edwin Low, a director in Investment Banking who ran this deal: "These transactions removed the shareholding uncertainty in Telkomsel and Satelindo. And that increases the value of the governmentÆs stake in Indosat and Telkom. Both these companies are a big percentage of the Indonesian stock exchange, so this is likely to help lift the index."

Both CSFB and Salomon have been working on the deal for six months. The dealÆs total value û from a league table perspective û is $1.5 billion, although CSFB will get $260 million of extra credit for the Bimagraha transaction.