China Telecom IPO: Right idea, wrong time

November 10th 2002 (FriedlNet.com) - Global herding behavior in the strudel of the Telecoms markets downward spin has hobbled China’s transformation of SOEs into privately-funded enterprises, with the multibillion China Telecom IPO having been postponed and cut in half after the initial offering failed to enthuse large institutional investors last week.

The initial IPO of state-owned China Telecom , which was aimed at raising between $3.19 and $3.68 billion by a sale of 16.8 billion shares on the New York and Hong Kong stock exchanges, was slashed by more than half after the institutional order book only filled to 75% by the time the offering closed last week. Roughly half of the initial demand came from lower quality retail orders, the larger institutions conspicuously absent from investing in the future of the oriental Telecoms giant. Had it gone through, the initial offering would have been the world’s 3rd largest this year and China’s largest overseas asset sale since 2000. Closest to home, the Hong Kong tranche was only marginally oversubscribed.

In a last-ditch effort to raise some capital, the IPO was restructured to raise in between $1.43 and $1.66 billion, composed of 7.556 billion shares in the price range of HK$1.48 to HK$1.71 (including 1% brokerage fee). The offering was open to institutional investors until Wednesday, raising $1.43 billion, and will be offered to Hong Kong retail investors from Wednesday until next Monday; trading is due to begin in New York on November 14th and in Hong Kong the following day. Despite the unattractive market environment and weak demand, China Telecom was unable to go down with the price, as Beijing’s Chinese Securities Regulatory Commission (CSRC) doesn’t allow the sale of state assets below book value - in this case HK$1.47 per share. The drastic measure to save face was only made possible by a share reduction, but it is very likely that the delay has had adverse effects on investor sentiments - investor nerves do not like to be tampered with. The $1.2 billion of retail demand that swelled up the first time around is not likely to be as strong for the delayed IPO once word of mouth passes the news that institutional investors did not support the initial deal. “The sentiment towards this offer is very bad after the delay and people probably won’t commit big orders,” said Kenneth Kwan of the Bank of Communications, according to Bloomberg. Observers expecting China Telecom to raise the dividend pay-out ratio were also disappointed to learn that the second time around there will be no sugar on top.

The cut deals a blunt blow to the Chinese phone company, which was planning to use as much as half of the new capital from the initial deal to invest in its country-spanning fixed-line infrastructure, lay the groundwork for future growth, and gain a competitive edge to be able to elbow its domestic rivals China Mobile and China Unicom . Despite the gloomy forecast of many analysts, the company is actually doing quite well, defying the general global downturn. Although spending on equipment in China has dropped 28% to under $9 billion so far in 2002, operations have been expanding. Revenues almost reached 97 billion yuan ($11.7 billion) in the first 3 quarters of this year, and 128 million fixed-line subscribers have been registered by September of this year, up 15% from last year’s figures. The number of dial-up Internet users has increased to almost 26 million, up 16%, and the number of broadband users has reached nearly 1.85 million, up more than 160% from last year. China Telecom operates the nation’s largest fiber-optic network, having expanded capacity by more than 30,000 kilometers of cable by this September, year-on-year, now boasting almost 900,000 kilometers of cable.

Despite this, though, the company will have difficulty taming the market in its favor. After the IPO volume slash, the Ministry of Information Industry (MII) initiated a very questionable trick to lure in investors, raising costs of international directs calls to China (including calls from Hong Kong) to 17 cents a minute in an attempt to make China Telecom’s shares seem more attractive. After waves of enraged feedback from Hong Kong operators, many of whom experienced a sharp drop in calls placed after the rate hike, the government Tuesday backed down on the charges by agreeing to reimburse the extra costs incurred by Hong Kong operators, according to the South China Morning Post. Hitting a similar note, up-front connection fees for new customers - hitherto classified as non-recurrent revenue - are now being amortized over a 10-year period as of July, an accounting trick making the price-earnings-ratio appear lower and shares more attractive than they actually are. Such arbitrary and sporadic regulatory roadblocks, together with accounting practices in the name of window-dressing, are likely to further eat away at investor complacency. But even with this in mind, China Telecom would have an adjusted price-earnings at around 11 times earnings, thus being offered at a discount to China Mobile, which sports a level of around 13 times earnings. It must be said, however, that the two companies are not directly comparable, with China Telecom mainly focused on a costly fixed line network, resulting in a rate of return lower than that of the trendy wireless providers. When global market sentiments turn around in the years to come, prospects will be rosier, but for the time being China will have a hard time tickling a few bucks out of financial markets.

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