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Saturday 21 December 2013

HKT's acquisition of CSL is a vote of confidence in Hong Kong's telecoms industry

On Friday (20 Dec, 2013), HKT (6823) a subsidiary of PCCW (8) ultimately owned by the Li family announced the acquisition of CSL New World for US$2.425bn (HK$18.9bn), a unit of Telstra.  This follows hot on the heals from Vodafone's summer sale of Verizon Wireless its US wireless joint venture wireless business to its joint venture partner, Verizon Communications Inc.  

This being one of HK's largest M&A deals in awhile have brought some relief into the beleaguered Hong Kong telecommunications industry that have otherwise suffered significant share price falls.  It was all doom and gloom, particularly in the past three months when the Hong Kong government decided to re-auction a portion of the 3G spectrum in 2016.

Even after Friday's bounce of 19% for Smartone (315) and 11% for Hutchison Telecommunications (215) the two companies' share price remain firmly in bear market territory. Smartone (ST), the perceived weaker of the four major players share price remains down 35% and HT is down 20%.  Incumbent in the Hong Kong market China Mobile (941) also went up.

Hong Kong has one of the most competitive telecom market in the world.  Saturation, slowing data growth, large capex needs and expensive spectrum tax have scared away a lot of investors lately.  But it really is not all a disparaging picture.  HK Telcos have valuable assets.  Competition ensures that it has one of the world's most advanced infrastructure, well maintained and assiduously updated.  While data usage have put huge stress on the infrastructure in the past few years, investments in 4G have largely been made and with its roll out internet connections will be fast enough to cope with the increasingly voracious data consumption.

More importantly, ST and HT remains cheap in comparison with major Asian telcos on several metrics.  But comparable analysis does not in itself confirms value.  Free cash flows and dividends are more important metrics in assessing an opportunity.  

Deal analysis

So what is the deal dynamics?  Has HKT overpaid for CSL?  The acquisition price implies a P/Book multiple of 3x and P/EBITDA multiple of 9.2x and PE of 18.5.  From those multiples and comparing it to Asian players, it does not look like HKT have overpaid.

If you can get comfortable with the multiples HKT have paid, then even with Friday's spike, ST and HT remain relatively undervalued.  Particularly HT where it is less exposed to the highly competitive mobile business as it also has a fixed line business stretching across the globe.


One can be cynical that Telstra is selling out at the top and HKT did not get a bargain. But this is superficial thinking.  Accepted the Li family's empire is said to be managed independently by father and son(s), but one interesting point that can be gleaned is the fact that while the elder Li have been busy selling assets in Asia and deploying capital in Europe, the younger Li (Richard) have continued to show faith in the local market.  I think the Li family have proven themselves to be superb capital allocators by taking advantage of depressed values to buy good quality assets.

HT is owned by the elder Li through Hutchison Whampoa (13) and removing a competitor is helpful to both father and son.  Strategically, HKT acquires valuable wireless business which will provide it with a more balanced portfolio (mobile revenues are currently only 12%) and it will help protect margins at HT as well.

Telstra, I suspect needs the money to focus on its home market Australia where the NBN infrastructure roll out is sucking a lot of capital and the increasing competitive climate from upstarts such as TPG and DoDo is likely to affect margins going forwards.

Many investors are short term and prefer to leap from one hot stock to another.  But it would be wise to stick with Hong Kong's richest family as they rearrange the deck chairs in the telecoms market and patient investors will be well rewarded in the longer term.

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