More than a decade after PCCW bought Cable & Wireless’s Hong Kong telecoms business in a high-profile and highly leveraged transaction, it is getting ready to spin off the asset in the form of a dividend-paying trust that could raise as much as $2 billion.
In June it announced that Hong Kong Exchanges & Clearing (HKEx) had approved the proposed spin-off of its telecoms business by way of a listing of a business trust and on Thursday last week it confirmed that its application for a listing had been reviewed by HKEx’s listing committee, suggesting it is on the final leg of the preparations for an IPO.
It didn’t say that the application had been approved, although sources said it was approved in principal. They added that the regulations will be in place for PCCW to proceed with the listing according to its planned timetable, which includes an extraordinary general meeting to approve the spin-off and is working towards a trading debut in the second half of October. A circular with more details is expected to be published towards the end of this week.
PCCW’s controlling shareholder Richard Li, the youngest son of Hong Kong tycoon Li Ka-shing, has made several attempts to take the company private in recent years, but has run into resistance both by minority shareholders and by the Hong Kong regulators. It now seems he has found a solution that will allow PCCW to raise cash for debt repayments and at the same time distribute a bigger portion of the earnings from the telecoms business to shareholders.
The telecoms business is the cash-cow of the PCCW group and in the first six months of this year accounted for 78% of total consolidated revenues and 96% of Ebitda, but because of the company’s extensive debts and the fact that a lot of this cash is being reinvested into other areas, such as its cable TV business, information technology and property, shareholders have not been able to reap the full benefit. Rather, the share price has continuously lagged the broader market since the buyout in 2000. However, it has outperformed the Hang Seng Index so far this year with a 1.7% gain and on Friday closed at HK$3.50.
The initial plan, announced in March, was to spin off the telecoms operations and list them as a business trust, which can pay 100% of the operating cash flow, essentially the Ebitda, as dividends. This is different to a traditional company, which is only able to pay dividends from its net profits, in other words after accounting for interest payments, tax and non-cash items such as depreciations and amortisations.
This should encounter less resistance from existing shareholders than a privatisation as it will allow them to continue to benefit from the steady cash flow of the telecoms business. The fact that the dividend payments may also be greater than they have been for the group as a whole should also help. To further apiece its existing shareholder base, PCCW has earlier said that it intends to allocate about 5% to 10% of the IPO to its existing shareholders in the form of a bonus issue and to set aside a further 30% for a preferential offering.
It remains to be seen, however, whether existing shareholders are interested in paying for the same assets that they have already bought once.
Another key issue when PCCW first announced its spin-off plan was that Hong Kong didn’t have a regulatory framework that allowed for the listing of business trusts — although it does allow real estate investment trusts (Reits). However, after Li Ka-shing opted to list part of Hutchison Whampoa’s ports assets in Singapore because he wanted to use the business trust structure, HKEx and the local securities regulator got to work on adding the necessary regulations so that Hong Kong would be able to compete with its arch rival for similar listings in the future. The Hutchison Port Holdings Trust IPO raised $5.45 billion and ranks as the largest listing in Asia so far this year, excluding Glencore’s $10 billion dual-listing in London and Hong Kong.
However, in an announcement issued last Thursday, PCCW said it has been working closely with the regulators and the exchange during the past three months to finalise an acceptable listing structure that would operate within Hong Kong’s existing regulatory framework.
This suggests that the listing vehicle might not actually be called a business trust, although sources say it will definitely be in the trust format. Indeed, the Thursday announcement no longer made references to a business trust — which the announcement in June did. It is unclear what this might mean in terms of the overall structure and whether it suggests that Hong Kong will in fact not introduce a legislative framework that will allow business trusts. If that is the case, it could mean that future trusts listed in Hong Kong will differ from the business trusts that are listed elsewhere.
One thing is clear: the holding structure will be complicated. According to last week’s announcement, PCCW will own at least 55% of the listing vehicle, which will be named HKT Trust and which in turn will own 100% of HKT Limited. HKT Limited will also be listed and will be the holding company of the telecoms business and its operating subsidiaries. The telecoms assets will be managed by a trustee-manager that will be 100% owned by PCCW.
The business will be listed in the form of share stapled units, which will have three components: a unit in HKT Trust; a beneficial interest in one ordinary share of HKT Limited that is linked to the unit; and a preference share in HKT Limited that is stapled to the unit.
The three components will be traded together as one entity and the ordinary shares and the preference shares in HKT Limited will each entitle the holder to one vote. The ordinary shares, which will be held by the trustee-manager, will entitle the holders to dividends from the telecoms assets that will be passed on to the owners of the share stapled units. The preference shares will not carry the right to dividends.
PCCW said that the listing structure is “expected to align its mature and stable cash flow-generating characteristic with the appropriate investor base that favours high stable distributions and pure-play investments.” It added that it also believes the separate listing of the telecoms business will facilitate the HKT Trust to distribute dividends that will be “substantially higher than the accounting profits of the telecommunications group”.
The telecoms business will pay 100% of its annual adjusted funds flow, after potential debt repayments, in the form of dividends to HKT Trust every year. And HKT will pass on 100% of these dividends to the holders of its share stapled units, after deducting taxes and other expenses. The adjusted funds flow will be equal to the Ebitda of the telecoms business, minus capital expenditures, customer acquisition costs, licence fees, taxes, finance costs and interest expenses, and adjusted for interest income received and changes in working capital.
This should make the listing an interesting alternative in light of the current volatility in global equity markets where many investors are turning to relatively “safer” investments that pay stable dividends. As always, though, the final response will depend on the valuation.
The IPO will be led by CICC, Deutsche Bank and Goldman Sachs, with DBS, HSBC, J.P. Morgan and Standard Chartered also expected to have a role.
