Don't Pity Richard Li - Buy His Stock
By David H. Smith
Columnist
04/12/2001 11:07 AM
Hong Kong is a little place. When times are good and one of the business elite is solidly on the
make, there is no better place to flaunt the success. But the opposite is true too: when things go
bad, there is no hiding from the heat of harsh criticism, in two languages no less, from five million
fellow villagers.
Lately the heat is on Richard Li and his battered flagship, Pacific Century CyberWorks (PCW).
You remember Richard Li. He took an unlikely collection of Internet assets, gained a
stock-market listing for them through a reverse takeover, gave them a whiz-bang cyber-name,
and then got Cable & Wireless (CWP) to take the shares in exchange for their holding in Hong
Kong Telecom (HKT), the territory's old former monopoly telecom. So far, so brilliant.
Sadly the Richard Li story, like so many other brilliant stories, were revealed to have a dark side
in our 2000-2001 bear market. The Internet assets, if that is not a contradiction in terms, are
basically worthless in today's rigorous valuation environment. If you needed a constant reminder
of that sad fact, the "cyber" prefix, which seemed so clever and up-to-date in 1998, is there to
provide one.
Eager to Say Goodbye
The telecom assets were bought at a price that seems too high in retrospect, and the earnings
yield from them has dropped as competition intensifies in glutted markets for telecommunications
services. Cable & Wireless is plainly desperate to dump the giant Pacific Century holding it
acquired for Hong Kong Telecom, which gives the market a formidable overhang.
The negative case against Pacific Century is put in fastidious detail by analyst Richard Ferguson
at Nomura Securities in Hong Kong, the most capable analyst working in the sector. If you can
access his report using Multex, by all means do so. Otherwise beg, borrow, or steal a copy. This
is the kind of work a smart analyst can do if he actually analyzes, rather than sucking up
guidance at managements' knees while hoping to score corporate finance deals.
In the popular press, on the Web, and whenever investors get together to grieve for their lost
cyber-wealth, the analysis is less fastidious and detailed, more in the nature of ad hominem
attack. Those who call him Sonny, Junior, Young Master Li or plain Richard mock his relative
youth and inexperience and suggest that what success he had came to him through his famous
father, Li Ka-Shing, the Superman of Asian business.
Knocking the fallen Web heroes is good sport. When the stock of a public company falls 90% to
95% with no obvious fraud, we in the stockholding public feel free to question the intelligence of
the captains of industry who preside over such a collapse. We do the same with Tim Koogle and
Jeff Bezos. And the fans give Chuck Knoblauch a hard time when he fumbles the ball, without
thinking how they would perform on the grass of Yankee Stadium.
Not the Villains
I actually like Chuck Knoblauch. And I like Richard Li, and what's more, I just bought his stock.
Here is why.
When the history of the late Internet mania is written, the Li's and Koogles and Bezos's are not
going to be the villains who lost the widows their pensions. It was the widows' own greed, which
gets them every time there is one of these market frenzies that end badly. Besides blaming
themselves, they can blame Wall Street -- that is always safe, and this time the old stock
factories of lower Manhattan really outdid themselves in their efforts to produce truly shoddy
goods.
No, I believe the Web tycoons themselves were only a little less clueless than the rest of us, but
they did have the wit to get out in front and capitalize to the fullest extent while the game was on.
(OK, I will allow that some of them were even more clueless than the rest of us.)
But who comes out of the bust looking better, Tim Koogle of Yahoo! (YHOO) or Steve Case of
AOL-Time Warner (AOL)? It is Case, by miles. Case made AOL real and pulled off the deal of
the millennium, by persuading Time's shareholders that it would be better to have half of his
company with $8 billion of cash flows than all of their company with $7 billion. Koogle could have
done the same, but he was too pure to see that he could tender his cyber-shares for real-world
assets. Case's company shed 50% of its market value -- a bad outing no doubt, though nothing
like the 90%-plus gassing Yahoo! and the other Internet stocks took.
But wait a minute -- Richard Li pulled off the same trick, didn't he? He got the venerable Cable &
Wireless to take Cyberworks paper and in return he got Hong Kong's dominant telephone
company. What a trade, Richard! And yet Pacific Century is one of the sad stocks that have lost
more like 90% than 50%.
Two Questions
There are two questions I care about as an investor in Pacific Century. First, is there going to be
any happy news in the real world of running telephone companies with Internet appendages?
And second, is there any technical factor that makes this stock a worthwhile bet?
Yes, and yes.
First, the phone business is going to get better. We are at the point in the global telecoms bust
where weak players start to run out of money and disappear, taking their ruinous price-cutting
with them. Pricing is not going to be the killer it has been. An influential report from CS First
Boston this week has ignited the European telecom sector with its suggestion that expansion
and market share will take a back seat to improvement in asset yields.
It will happen in Hong Kong as in Europe. It will happen everywhere else as well. In the Internet
business, the same kind of business pressures demand the same kind of decisions. Proprietors
of Web properties such as Pacific Century are taking a hard look at cutting their costs, raising
their revenues, making them viable or pulling the plug if that is not possible. The advantage is
that with the early Internet gold rush period having passed, proprietors can take advantage of
cheaper and more available equipment, hosting, talent, software, you name it -- and they can
take their time.
Second, as my business partner travels in Asia meeting analysts and investors, it strikes him as
funny that no one owns Pacific Century, and the more aggressive ones are still short the stock.
Pacific Century is a stock that is in all the indexes, and every fund manager has outperformed
the index by being short or out. But when an index stock has suffered such a relative loss of
weighting compared with rivals such as China Mobile (CHL), the negative bet has far less to
recommend it. This lemon has already been squeezed dry. It is clearly not going to blow away.
And it seems unlikely that the index-keepers will replace it in the indexes.
What to Look For
On the other hand, it would not take much to ignite an explosive round of short covering and new
investment in the stock. Here are some of the things I am looking for:
1. Upgrades by key analysts (we already have that, thanks to CLSA, a major force in Asian
investment).
2. An asset re-allocation from China Unicom (CHU) and China Telecom to Pacific Century by
telecom funds.
3. A more general move to a less-aggressively underweight posture by other investment funds.
4. Management of the C&W overhang (we already have that as the holding has been
restructured into a bond).
5. A bankruptcy or corporate failure among one of the minor telecom-service providers.
6. An attenuation of competitive pressures among surviving Hong Kong telecoms.
7. A reorganization of telecom assets within the Li family empire.
8. An investment in Pacific Century by the elder Mr. Li.
David H. Smith is managing director of Grayling Management. Grayling manages hedge funds
and private accounts, and performs customized research for institutional clients. Smith
specializes in Asian and emerging market equities. His column analyzes global economic and
corporate events that happened overnight, and tells investors how those events affect their
portfolios. He has clients with long positions in PCW. Positions can change at any time.
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