The combination of two challenger telecoms providers means for the first time in Hong Kong businesses have a credible alternative to the overweening incumbent, Hong Kong Telecommunications (HKT).
Hong Kong-based residential carrier HKBN is buying the territory's second-largest fixed-line telecoms operator for businesses WTT, formerly known as Wharf T&T, in an all-stock deal that enlarges HKBN's share base by 47%.
Buyout firms MBK Partners and TPG are essentially swapping their recently acquired control of WTT for a 32% stake in a larger, more efficient business, according to a Hong Kong stock exchange filing on August 7.
The transaction pegs WTT at an enterprise value of HK$10.5 billion ($1.34 billion), marginally above the HK$9.5 billion the funds bought it for in late 2016.
“It’s a beautiful match,” HKBN's chief operating officer and co-owner NiQ Lai told FinanceAsia. “We are up for the challenge of taking on HKT, it’s in our DNA."
Hong Kong’s business data, voice, broadband and IT services market is dominated by HKT, part of the PCCW group, which has around a 60% market share. WTT’s share is a distant second at 16% as of 2016, while HKBN's offering to enterprise clients is ranked fourth.
“The bottom line is businesses will get far better services and lower prices over time as we play out the efficiencies of scale that come from this combination,” said HKBN's Lai.
Investors should watch out for any impact on margins as HKT braces for a more fearsome competitor.
HKBN has long sought to acquire WTT to combine with its own burgeoning offering to business clients. It fought TPG and MBK for the company back in 2016.
HKBN’s Lai said it’s a good job they lost in a way as now is the best opportunity so far.
“The opportunity cost is a 32% dilution whereas our last attempt would have cost us closer to 40%,” Lai said.
HKBN is using its buoyant stock price, which hit a record high on July 23 at HK$12.90, to finance the acquisition.
HKBN plans to issue shares at HK$11.6 to MBK and TPG, as a result its stock dipped by 0.8% on Wednesday to HK$12.16 in trading on the Hong Kong stock exchange.
Lai’s message to shareholders annoyed by the dilution was that he and the chief executive, William Yeung, have sunk more than 80% of their personal wealth in HKBN stock and they’re recommending the deal because they believe it will be accretive.
Lai put his own money in 2012 into a management buyout that involved a HK$2.54 billion investment from CVC Capital Partners and a $2.5 billion syndicated loan. He now owns about 3.3% of HKBN.
“Stick with it – we have far more money exposed than you do proportionately as a shareholder,” Lai said.
SYNERGIES
Investors will clearly be scrutinising the potential synergies from combining the two businesses and judging management’s ability to execute their integration.
HKBN said the post-acquisition synergy should be about 7% to 10% of the combined business’ cash operating expenses on an annualised basis, according to its filing to the Hong Kong stock exchange.
It also sees cross-selling opportunities and capital expenditure savings of HK$60 million a year, which could be fully realised in the third year post the merger. Headcount cuts are likely, acccording to a person familiar with the deal.
HKBN is buying WTT at a multiple of about 12.9 times the last twelve month's Ebitda. When HKBN factors in its expected synergies, that acquisition multiple drops to around nine times.
For a young company, HKBN already has a relatively strong track record of absorbing businesses. It acquired Y5Zone – the kernel of its current enterprise segment – in 2013, New World Telecom in 2016 and I Consulting Group in 2018.
To be sure, they are all much smaller than WTT.
“It’s nice to have had a warm up – we’ve learnt some lessons along the way,” said HKBN’s Lai.
Founded in 1995, WTT focuses on larger corporate clients while HKBN focuses on small and medium-sized enterprise clients.
HKBN’s energetic corporate culture could well energise WTT which has been a sleepy subsidiary of Wharf for years.
HKBN’s Lai said the key to integration is giving new employees “skin in the game”. He said HKBN pays more than its competitors and offers better benefits such as a half day on Friday every month, free broadband connections and more holidays. In return staff contribute far more to the company than they did at their previous employers.
PRIVATE EQUITY
TPG Capital and MBK Partners jointly acquired all of Wharf T&T in late 2016 from real estate conglomerate The Wharf Holdings. The funds paid about 11.5 times earnings before interest, taxes, depreciation and amortisation and layered on an aggressive leverage multiple of around seven times.
The sale to HKBN gives them a stake in a potentially more efficient player. In crowded Hong Kong, HKBN and WTT often end up digging up the street and laying cables alongside each other.
MBK and TPG will each own a 11.66% stake in HKBN. MBK Partners and TPG shall each nominate a director for appointment HKBN’s board at closing.
In addition, MBK Partners and TPG will each hold a vendor loan note valued at HK$970.5 million.
HKBN did not want to trigger a general mandatory offer which would make the offer unconditional.
Under rule 26 of Hong Kong stock exchange, because TPG and MBK own HKBN jointly, meaning they are deemed to be acting in concert, their sale would normally mean a general offer.
So HKBN is offering them effectively equity without voting rights. The vendor loan note is a non-voting, perpetual, no coupon instrument convertible into HKBN shares at $11.6 a share under certain conditions.
So some time after closing, the sponsors will look to persuade the regulators they are not acting in concert, convert the vendor loan note into straight equity and can then have the freedom of acting independently.
TPG and MBK have agreed to a lock up of their shareholding for 18 months.
DEBT
As part of the transaction, HKBN will assume the existing debt and cash of WTT, which is loss-making due to its high credit costs.
HKBN decided the simplest thing to do would be to rollover WTT’s debt into its own structure and continue to service an outstanding high-yield bond.
WTT’s $670 million 5.5% yielding bond was issued to take out an 11% coupon attached to a HK$814 million ($104.26 million) mezzanine loan and to repay a HK$4.2 billion senior term loan.
The high yield bond maturing in 2022 jumped above par Wednesday in early trading, as the combination with HKBN is credit enhancing.
Ratings agency Moody's said on Thursday it had placed WTT on review for upgrade.
"The rating action reflects our expectation that the proposed merger, if completed successfully, will lead to a significant improvement in WTT's credit profile," said Gloria Tsuen, a Moody's senior
analyst.
HKBN may seek to refinance the bond at a later date, according to a person familiar with the deal.
HURDLES
The transaction remains subject to the approval of HKBN shareholders and regulatory approval, and is expected to close in the first quarter of next year.
Current shareholders’ ownership will be diluted to 77% post new share issuance and 68% post the loan notes' conversation.
HKBN's two largest shareholders, Canada Pension Plan Investment Board and GIC, have undertaken to vote in favour of the shareholder resolution to approve the transaction, which means they are over half way to getting to the 50% threshold for approval.
CPPIB owns 18.1% of HKBN, which could be diluted down to about 12.3% after conversion of both stock and loan notes.
Shareholders had voted down in the past HKBN’s request to issue new shares on one occasion; but when HKBN acquired the telecom business of New World Development, the most comparable transaction, it was approved by an overwhelming majority.
The deal includes a HK$350 million break fee payable to WTT's owners if HKBN's shareholders
reject the transaction.
HKBN worked with JP Morgan as financial advisor and Latham & Watkins as legal counsel on the transaction. JP Morgan also worked on HKBN’s IPO in 2015 and the acquisition of New World Telecom.
Goldman Sachs is acting as the financial advisor and Clifford Chance is acting as legal advisor to MBK Partners and TPG for the transaction.
This story has been updated to include Moody's view of the transaction
