The International Investor: PCCW falls to earth
April 3
Remember Icarus, from Greek mythology? His father, the master architect and sculptor Daedalus, fashioned wings of wax and feathers for himself and his beloved son. But in his eagerness to soar as high as the gods, Icarus flew too close to the sun and scorched his wings. They melted, and Icarus fell into the sea and drowned.
Remember Richard Li, of Pacific Century CyberWorks (NYSE: PCW)? His father, the powerful Hong Kong tycoon Li Ka-shing, supported his son's ambitious plans, and in 1999 the younger Mr. Li founded PCCW, which was to be a pan-Asian Internet content, broadband, and telecommunications group. But it seems that Mr. Li also flew a bit too high -- in his case, to the peak of the Internet bubble -- and PCCW's stock has come crashing back to earth.
Last week, the company announced an $886 million loss for 2000. Some $259 million of that can be attributed to its faltering plan to use income from fixed-line services to pay for high-risk Internet expansion. The real whopper, though, was the $627 million from net unrealized losses on Internet investments that PCCW doesn't expect to recoup. (The company stated in its annual report that much of its investment losses were "other than temporary.")
Adding insult to injury was this bizarre little twist: Richard Li admitted publicly that it was a "mistake" to allow his company to say that he had graduated from Stanford University with a degree in computer engineering, when in fact he left school in his third year to join a Canadian bank. The ignominy extended to jeering messages displayed on a giant video screen during Hong Kong's annual international rugby tournament this past weekend. "Dr. Richard Li," the message read, according to Bloomberg News, "we want our money back."
That message was obviously from a consumer, because investors seem to have already taken their money back. PCCW's American depositary receipts (ADRs) closed on Monday at a price of $3.40, 80 percent below their 52-week high. And investor enthusiasm for PCCW's services isn't expected to pick up anytime soon.
REVENUE BY ANY OTHER NAME
Last August, the company merged with Cable & Wireless HKT, making it Asia's second-largest Internet concern. Then the company was restructured into four operating sectors: telecommunications services, global communications services, Net enterprises, and infrastructure services. This restructuring made the company's year-end results difficult to compare with other years. Indeed, some 10 to 15 percent of PCCW's $2.65 billion in 2000 revenue appears to be a result of inter-company transactions, according to Jahanzeb Naseer, an ABN AMRO analyst in Hong Kong.
The company is also saddled with huge amounts of debt, nearly $5 billion. And that debt, coupled with an estimated $800 million of 2001 earnings before interest, taxes, depreciation, and amortization (EBITDA), will prevent shareholders from seeing much upside in the next year, Mr. Naseer says.
If you look hard enough, though, there are a few optimists following this company. PCCW's plummeting share price was no more than an unwarranted knee-jerk reaction by skittish investors, according to Jonathan Iu, an analyst at SG Securities in Hong Kong. "Heavy provisioning on the losses of its investment, as a result of the dot-com crash, and one-off fees relating to the HKT acquisition have driven PCCW into the red," he rails in a recent report. "Moreover, these actual results do not present an accurate picture of the company, as it only included four and a half months of contribution from HKT." Mr. Iu shrugs off the debt load, saying that EBITDA would have to fall by 60 percent before PCCW's ability to pay interest would be impaired, and its cash flow going forward should be more than sufficient to finance its interest expenses and fund expansion plans.
Analysts and portfolio managers alike agree that the company needs to undergo some further restructuring before things turn around, though. PCCW is shifting from the voice business into the higher growth and more lucrative Internet and data services market. The company has also outlined a cost-cutting program, projected to save $101.3 million next year.
A CROWDED ISLAND
The outlook for Hong Kong telecommunications companies in general, however, doesn't look bright. Because of Hong Kong's strategic value inherent in its proximity to China, telecom carriers will always be willing to lose money there, so they can say to shareholders that they have a credible China strategy, according to Mr. Naseer. The problem, though, is obvious: China is in no rush to open up, prompting an overly competitive Hong Kong market that local economics simply cannot support. In addition to PCCW, companies like City Telecom (Nasdaq: CTEL), New T&T (a part of Hong Kong's powerful Wharf Holdings conglomerate), Sunday Communications (Nasdaq: SDAY), and France Telecom's (NYSE: FTE) Orange unit all have a presence in the city.
Hong Kong's regulatory policy encourages this competition, and even if consolidation occurs, there will be little to keep cutthroat competition from emerging once again, Mr. Naseer says. This won't hurt larger companies that can afford a longer-term outlook and can put up with some insignificant losses in Hong Kong in the short term. But the hyper-competitiveness creates negative value for Hong Kong-specific investors like PCCW, which derives almost all of its revenue from the city. Of all the operators in Hong Kong, none has higher exposure to the market's weak fundamentals than PCCW.
And PCCW's sweeping approach to the Internet won't likely save it. "I've always thought of PCCW as a CMGI (Nasdaq: CMGI) type of play," says William Valentine, a portfolio manager with Valentine Ventures. "The consolidation of Internet assets seemed like a great idea, but now it's hard enough to run any one of those businesses as a stand-alone and make money." And it's not getting any easier.
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