Deutsche Bank Research Report 1/10/2001: Pacific Century CyberWorks (0008) - UNDERPERFORM
Source from Deutsche Bank
Summary
PCCW confirmed on Friday that interest rates on its new US$4.7bn re-financing package (to re-finance the short-term facility used to acquire HongKong Telecom (HKT) will be increased. In aggregate, the effective cost of borrowing will rise from LIBOR + 63bp to LIBOR + 111bps, implying an additional US$22m of annual interest payments.
The reason for this increase is to make the facility more attractive for syndication - the process by which the lead arrangers (Barclays Capital, BOCI, Chase Manhattan, Fuji, HSBC) pass on large portions of underwriting commitment to other banks. This is unsurprising when one considers that similar bond issues from British Telecom and Deutsche Telekom were sold at spreads of 200bp + i.e. PCCW's revised cost of financing is still relatively cheap.
The stock at fell almost 3% on Friday, closing at HK$5 against an index that was up around 1.5% so clearly there was a marginal sell-off this news. However, we would remind investors that when on e factors I the drop in interest-rate expectations over the past week (100-125bp down) against the increase in borrowing costs announced today (53bp up ), then PCCW is still a net beneficiary.
Table 1
Year end Dec
99
2000E
2001E
2002E
Net profit (HK$m)
8029
3824
16616
3279
EPS (HK$)
0.33
0.19
0.67
0.13
EPS change (%)
-32
-41
252
-81
DPS (HK$)
N.A
N.A
N.A
N.A
Yield (%)
N.A
N.A
N.A
N.A
PE (X)
15
26
7
38
Suggested price: HK$5.00 (04/01/2001)
Highlights
How does this change our view on PCCW? The bottom line is that it won't change a great deal. Although PCCW is spiritually an Internet Company. It is in actual fact neither more an Internet company than France Telecom, Deutsche Telekom, Korea Telecom, nor any other telecom operator globally. Therefore its base of relatively stable free cash flows make its DCF valuation less sensitive to movements in Internet rates than hi-tech/Internet companies with higher-growth business models
Our valuation of around HK$4/share already incorporate generous valuation multiples for the majority of the telecom assets, including US$9.1bn (4.5x revenues v global average of 3x) for the IPBC venture with Telstra; US$6.1bn for the core HKT business (US$1750 per line v global average of US$1000/line); and US$2.2bn for the Netvigator ISP (US$3000/sub v global average of <US$2000/sub). If we value these businesses in-line with the global average for the telecom sector, our NAV for PCCW drops to around HK$2.5/share.
Therefore, even at HK$5/share, we continue to believe that PCCW is too expansive, a viewpoint that is generally accepted in the market. this makes its share price extremely susceptible to news flow and sentiment, explaining the decline of the share price on Friday. So how does the news flow look over the next six months? Negative,
We expect Cable & Wireless to dispose of its 15% stake when the lock-ups expire between February 2001 and August 2001.It is difficult to believe that the C&W will hold PCCW any longer than absolutely necessary.
We expect the final results ot contain a large number of charges that should wipe out net income. PCCW would need to account for goodwill amortization on the acquisition of HKT. This will depend on a number of factors, including the final valuation of HKT's net assets and the period of amortization (probably between 20-40 years).
PCCW management has staked a lot of credibility capital on IPO's for its IPBC business, mobile venture and data centre operations. Unless markets rebound significantly in 2001, there is a significant risk that these businesses will be released into illiquid markets, which could result in disappointing IPO prices and subsequent performances.
The bottom line is that we anticipate a broadly negative stream of news flow over the next six months, which could weight-down the share price further. Therefore, despite PCCW under-performing the benchmark Hang Seng Index by 14% since we launched coverage, we recommend that investors maintain an underweight position to levels approaching HK$4/share.
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