Hong Kong’s Ailing Telecom Company Comes Up for Air

After eight solid years of near-disaster, Hong Kong’s leading telecommunications company is starting to come alive again. With a renaissance built on an increasing number of services, particularly broadband and mobile, PCCW may be turning a corner that once looked to be nearly impossible. But it has been a long and harrowing ride for investors.

The group’s prospects appear to have begun to look up, with stockbrokers finally starting to take an interest again. Encouraging FY 2007 results, reported in March, have partly been built on PCCW’s continuing concentration on mobile telephony and IPTV, which delivers television content over the internet instead of via traditional broadcast and cable formats. PCCW’s format was called “arguably the world’s most successful IPTV operation to date” by Telecommunications Online Magazine in December.

Nonetheless, it will be a long time before any shareholders who have been around from the start -- if there are any -- get their money back. When Richard Li, the scion of tycoon Li Ka-shing, took over Hong Kong Telecom in 2000 from the colonial owner Cable & Wireless, local investors reacted in the face of common logic the way they have traditionally when any member of the Li family makes a major market move. The takeover and subsequent decision to take PCCW public was hailed as a goldmine for investors -- briefly.

But, having lost its monopoly on telephony, the ensuing years saw PCCW shed 97 percent of its market capitalization, falling from a high of HK$28 – after a five-for-one consolidation -- all the way to a low of just HK$0.88 cents as the world came to recognize that fixed-line telecommunications was a dying industry. The shares have since recovered to trade at about HK$5.

pccw-graph2

The Hang Seng Outruns PCCW…

The sale of Hong Kong Telecom to Richard Li was largely looked upon as the Li family doing its national duty. The leading offer, and one that almost won the 75-year-old telecom utility, was from Singapore Telecommunications. But that raised concerns in China that a Singaporean concern was going to end up owning one of the sinews of Hong Kong’s telecommunications industry. PCCW at the time was no more than a dotcom startup that managed to swing US$11 billion in bank loans on the strength of the Li name and government connections, and put that together with a PCCW stock offer to Cable & Wireless.

It was a deal that was enthusiastically endorsed by all of the bulge-bracket investment banks in the city except for what was then Dresdner Kleinwort Wasserstein, which put a sell on the shares – although cynics said that was only because the London-based investment bank didn’t get to participate in the flotation. They turned out to be dramatically right.

The government connections helped out in the form of one of the territory’s most notorious land deals, property handed to Richard Li to develop a HK$15.6 billion commercial, retail and residential project at the extreme west end of Hong Kong, in Pok Fu Lam. Cyberport, as it was called, was designed to compete with such grandiose projects as former Malaysia Prime Minister Mahathir Mohammad's Multimedia Super Corridor, a 750 sq. km-zone south of Kuala Lumpur to which he hoped to lure the world's major information technology companies. Alas, the cyber portion of the port has never developed beyond a few IT companies that moved from elsewhere in the territory where they were already set up.

It also didn’t help the share price. Eventually PCCW plummeted to its 2002 low, driven down by the company’s overwhelming debt and a disastrous international undersea cable venture with Telstra, the Australian telecoms company. Li would give up his position as PCCW’s CEO in 2003, to be replaced by Jack So, the former chairman of MTR although Li remains the company’s major shareholder.

Ultimately, by the time Cable & Wireless got finished cashing in its US$5 billion in shares from PCCW, they were worth only US$1.9 billion. And by and large the market has never forgiven Li himself for a 2006 episode in which he sought to shed his 23 percent majority shareholding through a Singapore-based holding company to Texas Pacific Group. Australia’s Macquarie Bank countered with an offer to buy most of PCCW’s assets.

The Chinese state-owned telecom company, China Netcom, however, which owns 20 percent of the stock, refused to give approval because of Beijing’s antipathy towards allowing the territory’s main telecoms company to be sold to foreigners. After considerably more back and forth, during which it emerged that Li Ka-shing himself was financing part of a deal to sell the shares at less than their highest value to a family retainer, the minority shareholders rebelled. The Stock Exchange of Singapore refused to allow Richard Li to sell his shares. Richard remains stuck with the shareholding, saying he is devoted to development of the company, however.

In the ensuing years, PCCW has diversified energetically and is now involved in a panoply of services and telecommunications activities. In a turnaround, its fixed-line service, which provides more than 70 percent of group revenue, reported 8 percent revenue growth. In particular, as Hong Kong has continued to grow as an international business center, PCCW’s international lease circuits, broadband and equipment sales have soared up with it. Revenue from international business operations was up by 15 percent and growth in retail telephony has largely kept pace with the growth of the economy, with international direct dialing volume growing annually by 10 percent to 1.9 billion minutes.

pccw-chart1

But PCCW starts to recover

Broadband subscribers in particular, despite intense competition in what amounts to a mature market, have nonetheless increased by 11 percent in the last year as PCCW has managed to hold off competition. Its fibre network now covers two thirds of Hong Kong’s densely-packed residential households.

One of the beneficiaries to Richard Li himself is Pacific Century Premium Developments, which Li spun out in 2004 as a property company through a backdoor listing via what previously had been Dong Fang Gas Co. Ltd. Li is listed as chairman and executive director. PCPD receives the revenues from the Cyberport's residential housing sales and also retained right of first refusal to redevelop PCCW's 60 existing telephone exchange sites, which long ago were granted by private treaty to Hong Kong Telecom.

PCPD had a relatively strong year, selling more than 700 units of its Bel-Air flats, boosting PCCW’s consolidated earnings by HK$800 million. PCCW is now seeking to privatize PCPD. The analysts are upgrading their earnings forecasts and their recommendations. Life is finally getting better for Mr Li and perhaps even his battered minority shareholders.