SK Corp divested a 6.47% stake in SK Telecom yesterday (August 3) raising $1.025 billion to fund the redemption of a $1.25 billion exchangeable bond. The success of the new deal marks a far cry from SK Corp's initial attempt to sell the SKT stake via the exchangeable back in July 2002.
At that point, the company had to deal with extremely choppy equity markets and increasingly negative commentary from analysts, including the imposition of a sell recommendation by one of its lead managers mid way through roadshows. However, it turned out to be a perceptive call on the part of Goldman Sachs since the exchangeable never hit its conversion price of $25.50 and 98% of the bonds were put back to the company on August 1.
This time round, the deal has been an unequivocal success. Similar to a $2.185 billion deal for LG Philips LCD in late July, it was able to generate strong momentum and specialists report a book where there was no price sensitivity for 95% of orders placed.
Under the lead of ABN AMRO Rothschild and Merrill Lynch, SK Corp sold 47.9 million ADRs at $21.40 each. There is a ratio of nine ADRs to one share.
At this price, the deal was priced flat to the ADR's spot close in New York at the end of Wednesday's trading and at a 3.4% premium to the common share price in Korea. Typically, the ADR has been averaging a 3% to 4% premium to the local share price, although it was trading up as high as 15% to 20% at the beginning of the year.
In the immediate run up to the deal, both the local shares and ADRs came under the usual short-term selling pressure. Having hit a year-to-date high of Won196,000 on July 29, for example, the local share price has come down steadily since then, hitting Won191,000 at the end of Wednesday's trading in Seoul.
However, specialists believe the removal of the overhang and expansion of the ADR float should lead to strong follow-through buying. This is because SKT has a foreign ownership limit of 49% and has been trading very close to its ceiling for a long time.
But the new deal will not affect the ceiling since the shares have been counted as part of the limit since they were first issued via the exchangeable in 2002. What should happen is that the ADR pool will become more liquid. Pre-deal, the ADR was trading about $14 million to $15 million a day, which means the new offering represents a fairly hefty 73 days trading volume.
Follow-through buying may also be fuelled by a very tight allocation policy, which favoured a core group of long-term holders at the expense of wide distribution. The order book is said to have closed about five times covered with participation by 150 accounts.
About 17 accounts placed orders for more than 10% of the deal and one account for upwards of $300 million. About 65% of the book constituted long-only money and the remaining 35% hedge fund demand.
About 43% was placed into Asia, 32% into the US and 25% into Europe.
As one observer comments, "At the beginning of roadshows hedge fund interest was very strong, but there were price limits in the book. When the long only accounts started coming in, they did so with big orders and no price sensitivity at all. This prompted all the hedge funds to remove their limits too."
There were a number of drivers fuelling this demand. Firstly, the Asian equity markets and Korea in particular are currently being propelled by very strong momentum. The Kosdaq and Kospi are the region's two top performing indices so far this year - up respectively about 45% and 25%.
SK Telecom, on the other hand, has under-performed. Year-to-date it is down 3.82%, although a number of analysts believe it may now be at a turning point.
This renewed optimism has followed the release of second quarter results, which revealed profit growth for the first time in four quarters. Quarter-on-quarter, net profit was up 27% to Won467 billion. Year-on-year, it was up an even more impressive 56.4%.
Analysts believe this shows that the negative impact of mobile number portability (MNP) is diminishing. In January 2004, the Korean regulator imposed MNP in a move that only benefited SKT's two main rivals KT Freetel and LG Telecom.
Subscribers that moved from SKT to either of the other two operators would be able to keep their original phone numbers, but the reverse would be true the other way round. The regulator hoped to create a move even playing field and reduce SKT's dominant market share.
During 2004, a total of 2.8 million subscribers opted for MNP, of which two million were existing SKT subscribers. SKT now has about 19 million customers, giving it a 51.2% market share.
But once its market share appeared to start stabilising, the company felt able to reduce its marketing budget and analysts say this cost benefit was one of the chief reasons behind the Q205 profit growth.
The second demand driver is likely to have been SKT's valuation. At roughly 9.3 times 2005 earnings, SKT is the lowest rated mobile operator in Asia. Both KTF and LGT trade above 10 times, while the regional average is about 12.8 times.
Specialists believe SKT may now benefit from signs that the global telecom sector is being re-weighted. What remains unclear is whether Korea's mature market status means its stocks will increasingly resemble dividend plays like their counterparts in Singapore and Taiwan, or whether the country's cutting edge R&D and associated capex needs will propel them down a different path.
SKT currently maintains a pay-out ratio of 35% below KTF's 50% ratio and analysts hope management will increase it. The company already yields about 0.1% to 0.2% above KTF and should it increase the ratio up to 50% the differential may widen to more like 1% to 1.5%. Analysts say the company is currently yielding roughly 4% on a 2005 basis.
Korea has one of the most developed telecom markets in the world. Mobile penetration stands at 75% and broadband penetration at 77%. Key for all three operators has been how to expand domestic revenues in the face of a saturated market.
Over the past few years, SKT has been able to do so thanks to a strong uptick in mobile data usage. At the beginning of 2002, the ratio stood at 7.5% of total ARPU. It is now roughly 18%, second only to Japan's DoCoMo, with the UK's Vodafone in third.
Most of this increase has come from new services rather than text messaging. Second quarter figures show that only 28.5% of SKT's total data revenues were generated by SMS and most of the remaining 71.5% by NATE, the company's data platform. Of this latter figure, about 12% was generated by games, 8% by porn and 46% by music through the company's digital music service Melon.
In the first nine months since its launch, Melon has attracted 2.5 million registered users. Korea, it would seem, is bypassing the iPod phenomenon and moving straight to music-enabled handsets. Industry figures estimate that about 80% of Korean mobile phones have built in music players.
The Korean government has always made sure its telecom operators are at the forefront of the digital revolution and the global convergence trend between mobile phones and computers. Three new technologies are poised to move the industry one stage further.
In May, for example, SKT gained a first mover advantage by becoming the first Korean operator to launch DMB (Digital Media Broadcasting). This is a satellite-enabled service that allows unlimited broadcasting of eight video channels and 25 audio channels onto mobile phones.
In the middle of 2006, SKT is also preparing to roll out WiBro, Korea's version of WiMax. This will give users of laptops, PDA's and mobile phones roaming internet access as long as they are travelling at speeds of under 60km per hour.
The third new technology is HSDPA, a high speed version of WCDMA.
Korea's use of CDMA technology has historically been one of the country's main constraints when it has come to M&A. Given that most of Asia uses GSM it has been difficult for Korean companies to break-out of their national straightjacket and find growth opportunities elsewhere in the region.
But this also may now be changing. In January SKT entered into a $440 million joint-venture with Earthlink, the fourth largest US internet provider. Together, the two hope to offer mobile services to US customers and have targeted a market share of 2% by 2009.
It has also been rumoured that SKT is considering a $600 million investment in India's Tata Teleservices.
