July 12, 2006
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Hong Kong is a city where the average punter is at best ignored when it comes to politics or money. For example: say you owned a telephone company. You bought into it when there was much hype over the future of the telecommunications and then proceeded to watch the guy running it destroy massive amounts of value thanks to a takeover of an old world telecom utility by a new-fangled internet/property venture (and no, I'm not talking about AOL/Time Warner). After watching the share price sink, finally there's a glimmer of hope when a couple of private equity types say they're prepared to pay a hefty amount for the company's assets. But these private equity types may pose a threat to national security by running the phone company, so Beijing makes its displeasure known. This is despite the share price sinking because the market (and world) has decided that old world telecom companies are being rapidly superceded by broadband internet, mobile phones etc.
Thankfully a local financier is ready to come to the rescue of the major shareholder in the company, buying him out and effectively gaining control of the company without having to launch a full takeover bid. The major shareholder, despite being the son of the richest man in the land, is so grateful to be out of the mess and feels so guilty he is even prepared to pay a special dividend to the minority shareholders who are again going to be stuck.
Here's the maths of the PCCW deal. Richard Li is going to pay a special dividend of around 35 cents a share to the minorities. The share price was about $4.80 before all of this fuss. Francis Leung is paying $6 for Richard Li's shares. The other bids were around the $5.60 mark. But $4.80 plus 35c gives you $5.15. The minority shareholders are at least 45c a share worse off under this deal. Francis Leung, on the other hand, gets control of PCCW without having to pay a takeover premium, without having to make an offer to all shareholders and knowing that at least two other parties value to the firm at $60 billion, as opposed to the $40 billion or so his purchase implies.
Somewhat unbelievably, Richard Li has effectively gifted about $20 billion to Francis Leung. And there's this mea culpa:
Li, PCCW's chairman since 2000, said he will step down from the post after Leung finishes paying his initial 30 percent, or HK$2.748 billion. "I think [Leung] will make a much better new chairman of PCCW because of his experience in finance," Li told reporters. "I don't think I have been doing a particularly good job."PCCW shares went as high as $140 in the internet share bubble, and were $80 6 years ago, $15 5 years ago. No, Li hasn't done a very good job at all...except for getting himself out of his self-created mess. How frustrating to know someone is prepared to pay 50% more for your shares but are blocked because of false protectionist reasons - Li must be truly desperate to cash out of PCCW. It's not exactly a vote of confidence in the company's future from its current chairman and erstwhile major shareholder. And for all those who jumped up and down when CNOOC was blocked from buying an American oil company, welcome to the same thing in reverse.
What a fine day to be Francis Leung and a terrible day for PCCW minority shareholders. I wonder if David Webb will weigh in?
Update July 12th
Today's SCMP reports that somewhat bizarrely, the source of financing for Leung's purchase of Richard Li's shares is....Richard Li. The bankers are apparently not interested in financing the purchase, and given how high profile this deal is you can bet the banks would have all cast a close eye over the deal. But Francis Leung is not a silly man and obviously has an ace or two up his sleeve.posted by Simon on 07.12.06 at 11:26 AM in the Hong Kong category.
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When I read something so well written and well reasoned as this, I find myself thinking there would be some way to get this in front of more people. The only idea that comes to mind is a letter to the editor of the humorously inadequate SCMP. Maybe translated and sent to Apple Daily instead?
I never bought PCCW stock because I always knew that Richard Li was a fraud propped up by his loathsome father but a lot of other people seem to worship the ground that Li Ka-Shing shits on and have allowed themselves to be bilked once again.posted by: Spike on 07.11.06 at 02:55 PM [permalink]
Beijing/China Netcom (virtually the same entity for the purposes of this deal) are just buying time so they can get their heads around the private equity proposals, while Richard Li is busting to get out. Beijing and CN would probably prefer Li out so they can deal with Leung's cooler head.
I suspect this is why the payment to Li is staggered over 18 months - that provides enough time for PCCW to select one of the private equity deals to proceed with, then returning the proceeds to its shareholders (including Leung's syndicate) so that Leung can pay out Li in full and walk away with upside.
Only risk is that the private equity offers get withdrawn, which leaves Leung stuck with a stake in PCCW that he probably didn't want to hold long term. He may be happy with this, but I suspect that he was prompted by Beijing to step into this role in the first place and that a long-term holding is not his intention.posted by: Tiu Fu Fong on 07.11.06 at 03:12 PM [permalink]
Spike - appreciate the sentiment but I ain't sending it to the papers. No point giving them good material for free.
TFF: I suspect you are right, and indeed that Leung has been given a hint that his downside is limited (not to mention his financing is likely to be at least partially sourced from the mainland). But he'd much rather be buying the stock here and now than 5 years ago at three times the price. There's plenty of potential upside in PCCW, which is why both Macquarie and Newbridge are bidding for its phone assets - they clearly see more upside from $60bn, and Leung is getting in for the equivalent of $40bn. In terms of value investing, paying 50% less for something is a great buffer.
The one thorny problem is the political one...but who would be surprised when Netcom turns around and bids for the whole thing down the track?posted by: Simon on 07.11.06 at 06:08 PM [permalink]
I am not a finance person myself but...
Why didn't China Netcom simply increased its shares by buying out Li, why does it have to through a merry-go-around?
Is it for regulatory, financial, or political reasons?posted by: bx on 07.11.06 at 09:15 PM [permalink]
If Beijing/Netcom can influence PCCW via its proxies (there is no shortage of patriotic businessmen in Hong Kong), why bother?posted by: LfC on 07.11.06 at 09:42 PM [permalink]
I suspect China Netcom would not do a buy out as it lacks the expertise to run PCCW properly and doesn\'t want to have the responsibility of a 100% holder of PCCW.
On the other hand, the foreign options would look very attractive to China Netcom, I think. Assuming China Netcom retains a strategic stake in the purchasing syndicate (whether it\'s Macquarie or Newbridge) - and this will be pretty much a prerequisite for Beijing to allow either of them to get their hands on these assets - this also presents an opportunity for China Netcom to get a look into how assets can be run efficiently. Call it one more chapter in the great intellectual property and know how transfer from the West to China.posted by: Tiu Fu Fong on 07.12.06 at 09:46 AM [permalink]
BX - if China Netcom acquired Li\'s shares, it\'s total holding in PCCW would exceed the HK takeover offer limit and it would be forced to make a 100% takeover offer for PCCW.posted by: Tiu Fu Fong on 07.12.06 at 09:49 AM [permalink]
Li's personal one page announcement in SCMP refers correctly once only to PCRD as the PCCW shareholder and for the rest of the time as "my stake", which it is not. PCRD has minority shareholders. The only way Li can personally pay out PCCW minority shareholders is if PCRD pays a dividend to Li himself and other PCRD shareholders. Singapore law criminalises abuse of minorities.
There is no withholding tax on dividends in Singapore. Singapore adopts an imputation system for tax purposes. That is, to the extent a dividend is paid from profits previously taxed at the corporate level, no further tax liability will arise. In this regard, every Singapore resident company is required to maintain a "Section 44 account" which is credited with the taxes paid by the company at the prevailing corporate tax rate. This Section 44 account balance is reduced whenever non-tax exempt dividends are paid. However, if a dividend in excess of the amount "supported" by the balance on this Section 44 account is paid, then a tax charge at the prevailing corporate tax rate will become payable on the re-grossed amount of the dividend. This charge will be treated as a prepayment of corporate income tax and can be used to offset any future income tax liability. Non-resident companies are not required to maintain any Section 44 account.