THE DEBT MONSTER
PCCW has been associated with just about every financial instrument known. But what is the cost of its deal-spinning?
By Jasper Moiseiwitsch

In March 2000, Softbank vice-president Yoshitaka Kitao dismissed Richard Li's Pacific Century CyberWorks (PCCW) as a mere product of "financial technology". Sniffed Kitao: "I can't see how he's changing the companies in which he has invested."

Truly, the firm's brief history has been defined by a blitz of financing, refinancing and related deal-making. Company-watchers are more likely to comment on its latest transaction than its latest Now netcast, more likely to marvel at its skills with convertibles than convergence. But where the transactionally bionic PCCW has raised billions from the capital markets it has also piled up financing costs (HK$1.8 billion for the six months ended June 30, 2001 alone). And, in the midst of cost cutting - which included 846 layoffs in 2001 - and a 20 percent tariff rise it foisted on a recession-weary Hong Kong public early in 2001, its cost of capital has become a less-than-academic matter.

A recent transaction is instructive. PCCW's wholly owned Hongkong Telecom (PCCW-HKT) sold a pair of global bond offerings in November 2001, coming in at a combined US$1 billion. The deal was a success, markets-wise, so much so that other banks reportedly sounded investors out about the possibility of a quick-to-follow euro-denominated issue. If overweening bankers were getting ahead of themselves here, their enthusiasm spoke to the success of PCCW-HKT's twin November offerings (the two-times oversubscribed issues performed solidly in the after-market).

Too Cheap?

When you consider that PCCW-HKT had just pulled a bond offering in July following tepid investor interest, and that its November deal carried a lower coupon (7.75 percent versus July's proposed 8.5 percent), it seems as though PCCW-HKT plucked an unlikely victory. The truth is that its November issues were priced at a generous spread over ten-year Treasuries of 360 basis points (for the US$750 million tranche) and 315 basis points (for the US$250 million tranche) - compared to a proposed 325 basis points spread in the summer. In November, the company had the wind of falling interest rates at its back. JPMorgan says PCCW-HKT used the bond proceeds to retire about US$1.8 billion of the US$4.7 billion syndicated loan the company drew down in February 2001 as part of its efforts to refinance the US$12 billion bridge loan it arranged to buy Hongkong Telecom.

Chris Nicholas, managing director of Asia credit markets for JPMorgan, which acted as sole lead, was centrally involved in the November global bond offerings. He denies the bonds were underpriced. "My reaction to [the question] 'Was it too cheap?' is that the company listened to investor feedback and they priced the transaction based on that feedback," says Nicholas. At press time PCCW had not returned our calls.

Every deal write-up obsesses over pricing, with players from both sides wonkishly dissecting a transaction's inner workings. But given that PCCW-HKT announced layoffs of 506 immediately following the closure of the November issues, for an estimated annual savings of about HK$190 million, the spread to Treasuries suddenly takes a real-world significance.

So the question keeps coming back: Did PCCW-HKT under-price? Its Singapore counterpart SingTel launched a bigger but otherwise identical issue on November 15 - and the US dollar tranche of SingTel's US$2.3 billion global bond offering was priced at 185 basis points over Treasuries. If PCCW-HKT had managed a similar spread, it would have saved HK$127.4 million a year over the ten-year life of the two global tranches, or enough to preserve 339 jobs of the 506 that were axed.

Apples and oranges say bankers. For starters, SingTel's double-A minus credit rating beats PCCW-HKT's triple-B. Further, SingTel is 67.5 percent government-owned, a fact that brings enormous comfort to investors. While Jason Carley, Merrill Lynch's head of Asia Pacific fixed income research, agrees that a comparison to SingTel is unfair, he still asserts that PCCW-HKT under-priced its issue. He says: "We told investors we saw fair value on that bond as the low 300s, 300 to 320 area. And to be honest that's proven to be the case. That's where the bond traded to in about a week."

Rival banks invariably question their competitors' pricing on major deals, but even JPMorgan agrees that PCCW-HKT's November bonds came at a mark-down. The company, say many, had to recover credibility following its fizzled summer deal. "You could argue that there was some level of discount in [the November bonds] for the fact that they couldn't afford the risk of a failed transaction," says Nicholas in reference to the aborted July issue.

Looking back, PCCW-HKT hoped to crack the dollar market last summer in a very major way. Its proposed deal size wafted between US$2.5 billion and US$3.8 billion - extraordinary numbers and an extraordinary range, which unnerved investors. "Having a US$1.3 billion difference between the high and the low end is pretty big. Particularly since Hutchison Whampoa was at the time the largest-ever corporate bond deal in Asia at US$1.5 billion," notes Carley.

The mooted July deal would have enabled PCCW-HKT to refinance almost all of its US$4.7 billion syndicated loan debt, thus bypassing the covenants attached to that debt. Specifically, the covenants restrict the percentage of net profit PCCW-HKT can upstream to its parent, PCCW. If total debt to Ebitda falls below 3.5 times, PCCW-HKT would be free to feed as much as 75 percent of its net profit to PCCW, according to these terms. PCCW wants the money. Merrill Lynch telecoms analyst Agnes Ho estimates it needs HK$800 million in 2002 for its Cyber Port development project.

The covenant issue goes a long way in explaining why PCCW-HKT was so ambitious in July, why that deal failed, and why, in November, it priced so aggressively (Carley adds that these bonds carry covenants similar to the syndicated loan).

Irked Investors

Equally ambitious were media reports that investors were solicited for yet another euro-denominated bond issue about a week after the November deal closed. Few in the market are able or willing to confirm the truth of these reports, but insiders say banks may have independently acted to prepare a deal for PCCW. Affirms Nicholas: "My sense is that the company is inundated with investment banks pitching them. It would not be unreasonable to assume that, as a result of the success of the SingTel deal, that either Goldman or Salomon would have been around there trying to persuade them to do a euro deal."

Investors were upset - there was a tacit understanding that PCCW-HKT would wait before issuing again. "Francis Yuen (PCCW deputy chairman) was quoted as saying that the unwritten rule is that, after you've done a deal, you're not supposed to come back to the market within three months," says Merrill Lynch's Ho. Such quick-to-follow issuance threatened to swamp the market, sapping price tension out of existing PCCW-HKT bonds.

The company quickly denied that it was involved in another issue, but the damage was done. The Asian Wall Street Journal published a lengthy, front-page feature on the matter entitled, "How PCCW's Strategy Irked Bond Investors". Spreads on PCCW-HKT bonds widened.

Where this leaves PCCW and its great, rolling tour of global capital markets is unclear. Parent company PCRD issued a US$100 million exchangeable in mid-January. In one sense, this is all prudent and sound corporate finance. Every large blue-chip has an abiding interest in capital markets and, by issuing now, the company would be locking in long-term debt at very favorable interest rates.

The question becomes, how much is too much? With every markets approach, and with each investor-relations wobble, PCCW's capital charges rise. If it continued its January to July 2001 pace, PCCW's net financing costs for all of 2001 would have been about HK$3.5 billion. Meanwhile, one analyst estimate puts its staff expenditure for 2001 at HK$4.5 billion - they are almost paying their bankers and investors as much as their employees. The year 2002 will show whether they will make that ratio even.

Jasper Moiseiwitsch is a contributing editor at CFO Asia based in Hong Kong