All Wired Up, But Nowhere to Go
Pacific Century CyberWorks has disappointed investors hoping to cash in on Richard Li's vision of an Asia-wide broadband network. What they have got is a telecoms company with Internet ambitions
By Bruce Gilley/HONG KONG
Issue cover-dated September 28, 2000
SOMETIMES IT TAKES one kid to tell when another kid may be bluffing. On September 8, Asia's aspiring Internet king, Hong Kong's Richard Li, 33, had his bluff called by a fellow 30-something Net-head, Jeffrey Koo Jr., the scion of Taiwan's powerful Koo family.
GigaMedia, a Koo-controlled supplier of broadband services, backed out of a planned $100 million venture to produce Chinese-language content in Taiwan with Li's Internet and telecoms group, Pacific Century CyberWorks. GigaMedia pulled the plug because of differences over valuations and the partners' respective stakes. In effect, Jeffrey, who oversees his family's Internet expansion, was declaring that Li's value as a partner wasn't as great as it had seemed in May, when the plan was first mooted.
The impact of this snub turned out to be huge. After a year-long rise to prominence, Li's claim that PCCW is "Asia's preferred Internet partner" had been unceremoniously rejected in public for the first time. Coming on the same day as another setback--U.S. Internet incubator CMGI pulled out of a $1.5 billion investment fund planned with PCCW--the rebuff sent stock investors stampeding for the exits. By September 18, PCCW shares had fallen more than 35% to HK$10.50 ($1.35), little more than a third of their February high.
"There's a lot of success that's been built into the PCCW valuation, and these are the first deals to unravel," says Greg Feldberg of Indosuez W.I. Carr Securities, who responded to the failures by slicing a 20% "positive surprises" premium off his HK$15 fair-price valuation of PCCW.
With Li's reputation for invincibility dented, PCCW now confronts a future without the "positive surprise" premiums on which its rapid rise has depended.
Analysts say the failed deals may portend more difficulties as PCCW seeks to expand beyond its strong home base in Hong Kong. Potential partners in key markets like Japan, India, China, Taiwan and Australia may demand a bigger say in ventures or a higher price for their participation. "This is all about whether PCCW can land in other countries and what it means if it cannot," says Shea Kai-ming of Tai Fook Securities in Hong Kong.
At the same time, GigaMedia's withdrawal has highlighted the uncertainty surrounding PCCW's hyped-up broadband content service, Network of the World. For several months, PCCW has been promoting NOW as a category-killing service that will power the company's future. Li even effused in August that NOW's success would enable him to double the company's market capitalization--implying, at the time, a target value of $94 billion.
But it's clear that NOW remains a distant money-spinner at best, due to the difficulties of tying up key markets like Taiwan. Analysts say that with its market capitalization now below $30 billion, PCCW needs to put renewed emphasis on the growth potential of the less glamorous business of Hongkong Telecom, recently acquired from Britain's Cable & Wireless. "They'll have to make all their businesses work if they want to reach their goal," says Feldberg.
Alex Arena, PCCW's deputy chairman, downplays the $94 billion target, calling it "a comment by Richard to give management a challenging task." But, he says, the company's new executive committee "is applying itself to every corner of the business" in equal measure.
PCCW's broadband strategy is to get a regional stranglehold so that NOW becomes the favoured, or even exclusive, network. But that goal is proving elusive in key markets. The content venture with GigaMedia was supposed to result in NOW becoming the preferred supplier to GigaMedia's 4-million-customer network in Taiwan--a network that represents a sixth of the potential customers PCCW says it has lined up for NOW. But in early September, GigaMedia, led by Jeffrey Koo Jr. and his uncle Chester Koo, chose instead to sign a deal to develop broadband content with U.S. portal Yahoo!. As a result, both NOW and Yahoo! content will be piped through the network.
A RETHINK IN JAPAN
This wasn't the first setback for NOW's expansion into the region. In Japan, arguably the mother-lode of Asian broadband, PCCW has been unable to lure Internet giant Softbank into a deal to distribute NOW locally and provide Japanese-language content. As a result, PCCW is investing $60 million in its own production facility in Japan and has turned to a little-known cable-TV network, Tomen Mediacom, to distribute its service.
Analysts have estimated that PCCW could corral between 8 million and 12 million broadband subscribers by 2004. Depending on how big the market is by then, this could account for anywhere between 5% and 25% of the region's subscribers. But Deputy Chairman Arena says PCCW's broadband growth model doesn't depend on controlling the infrastructure to sell the content. "The viability of NOW is based on the content," he says.
That's not reassuring for anyone who has seen NOW's initial English-language offerings on cable television in Hong Kong. The service so far consists of a mish-mash of games and videos presided over by impudent teenagers, as well as hipper-than-thou articles about pop music and sports. (The service has yet to launch in other languages.)
With so many competing channels coming on-stream, advertisers and consumers are understandably wary of locking themselves into NOW. Advertising and on-line-sales revenues for NOW will remain negligible this year and next, according to UBS Warburg. It expects NOW to lose $1.6 billion in the four years to the end of 2003, a significant drag on the company's bottom line (see chart). "Investors want to see some tangible progress, like a big advertising client. But this is not happening right now," says Ronald Chan of Dresdner Kleinwort Benson in Hong Kong.
The doubts about NOW mean PCCW needs to spread its risks by focusing on other businesses with assured profits. The dull fixed-line telecoms network in Hong Kong will remain the group's biggest contributor for several years, and Arena, a former Hong Kong telecoms regulator, calls it "a growth business." Profits will also be fed--it is hoped--by two ventures with Australia's Telstra: one supplying cross-border telecoms infrastructure around Asia, the other a regional mobile-telecoms outfit. UBS Warburg estimates PCCW will earn around $6.5 billion from these three businesses over the four years ending in 2003.
The irony of PCCW's rediscovery of telecoms is that for the foreseeable future the company is going to be exactly the sort of "telecoms plus" concern that HKT was trying to turn itself into when Li swooped on the company just a few months ago and declared its business model hopelessly out of date. If NOW fails, those telecoms businesses may even save PCCW.
Arena says the idea is to make each of PCCW's business units "more transparent over time," and even sell shares in a few, such as the regional infrastructure and mobile-telecoms companies. "This will give the market a way of valuing the separate companies and benchmarking their performance against the rest of the industry," he says.
Unlocking the value of those telecoms assets will be crucial if PCCW is to win back worried investors. Since the collapse of the GigaMedia and CMGI deals, analysts have back-pedalled on their forecasts for PCCW's share price.
Bethany Chan, Internet analyst in Hong Kong with UBS Warburg, an underwriter of PCCW shares, says her HK$24 target price, issued on August 29, "assumes that Internet sentiment revives;" that, she admits, doesn't seem likely soon. Rival investment bank Dresdner Kleinwort Benson says the stock's fair-market value is HK$10, while Credit Lyonnais pegs it at HK$11.50. Independent stock analyst David Webb, an arch-pessimist on PCCW, in March suggested a $6.40 target for the shares.
Analysts say further bad news may be in the pipeline from some of PCCW's other partnerships. Telstra, for example, is now paying a hefty premium on the value per subscriber of its 40% stake in the regional mobile-telecoms venture, although it denies it is seeking to renegotiate the $1.5 billion price tag. Meanwhile, analysts say that Chinese computer maker Legend Holdings, which has signed up PCCW as its sole partner for developing broadband in China, may want to widen its options.
And although CMGI has not said it will pull out of a planned Internet business-development venture with PCCW--a deal aimed at helping some of CMGI's companies expand in Asia--the arrangement may now die by neglect. Engage Technologies, a CMGI company that was supposed to be among the first brought to Asia through the venture, has recently embarked on its Asia expansion on its own, in Japan.
"If suspicions appear about some of these deals then there will be a lot of downward pressure on the share price," says Shea of Tai Fook.
SHARE SALES LOOM
But there will be downward pressure even without failed deals. Cable & Wireless holds 19% of PCCW and has set out a timetable to dispose of its stake by the end of next year. Selling by other major shareholders--in particular CMGI, which holds 3.4%--could also keep the price depressed. "Right now, the stock overhang weighs more heavily than the no-go deals," says Chan of UBS Warburg.
Deputy Chairman Arena blames PCCW's weak share price on risk-averse investors in the former blue-chip HKT who received PCCW shares in the takeover and sold on the first bad news. But he admits that PCCW also has a problem in explaining its business model, which has been relayed to a confused public in press releases buzzing with phrases such as "connectivity" and "delivery platforms." Says Arena: "There is a lag in the markets before they understand what we are doing."
The company hopes that a global image-building campaign, due to be launched before year-end, will put a coherent spin on its future. But with $6.7 billion of debt and doubts about the viability of its core broadband business, it may have to deploy more than spin to keep investors interested.
"At the end of the day," says Feldberg, the Indosuez analyst, PCCW is "just another risky Internet business.”
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