Hong Kong Telecoms Sector - A Lackluster Market Punctuated by Events

PCCW and Smartone both Holds. PCCW: $4.50/shr privatization offer at a 17% premium to our $3.85 fair value, but deal rejection could see stock revert to $3.15 levels (on peer average 5.2x EV/EBITDA) or lower, at least 15% lower than now. Weaker business outlook, persistent minority concerns, and underperformer in bull markets = take offer in our view. Smartone: Trading close to fair value following run-up. $2.99/share in cash, ongoing share buybacks and recent SHK stake increase keep us a Hold.

Sellers of HTIL – Why own a stub? 1) Payment of $7/share at one go takes out further capital management angle. HTIL indicates further dividends as unlikely for the next two years; 2) Start-up losses at Indonesia and Vietnam (nationwide GSM early '09 onwards) leave uninspiring earnings profile with nil yield support; and 3) Partner separately listed, offering cleaner exposure to those interested in exposure to Israeli wireless.

Proposed PCCW deal – HK$4.50/share in cash to public shareholders (holding 52.28%) – works out to total cash consideration of HK$15.934bn-HK$16.555bn, of which Richard Li (through Starvest, PCRD) and Netcom BVI will pay 74.27% and 25.73% respectively. A successful deal would see Richard Li's & Netcom's respective stakes increase from 27.74% to 66.67% and 19.84% to 33.33%.

HTIL - Is there a Part 2? Why is HWL (60% stake, we think driving bumper payout) doing this? HTIL rules out privatization as an option. Could there be further asset sales to upstream more cash (Partner, Indonesian business)? Possible, though we do note current markets are unlikely to drive valuation premia of any significance.

Watch Points: (1) PCCW: Voting results on privatization proposal on 4 Feb, 09. (2) FMNP: Still under review by OFTA. (3) FMIC withdrawal: Talks ongoing, though resolution unlikely before 2-year deadline.

HTIL: $7/share special dividend announced in Nov-08 means further dividends as very unlikely for the next two years - we forecast no '09 dividends.

PCCW: '09 dividends depend on outcome of proposed privatization. We see $0.20/share in '08 dividends maintained deal or not, supported by strong FCF profile – a 5.4% yield at current levels.

Smartone: 5.2% FY09 forecasted dividend yield could see downside risk off a 100% payout policy on weaker than expected FY09 earnings. However, $2.9/share in net cash means special dividends always a possibility given strong track record of returning cash to shareholders ($3.5/shr in '03 and $0.85/shr in '07)

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