PLAYING FOR KEEPS
In presenting this year's Performance 100 rankings, CFO Asia gives a snapshot of how much wealth Asia's 100 biggest companies are generating. Justin Wood takes a look at the best and worst performers.
By Justin Wood

It would be enough to make most managers despair. Back in February 2000, the share price of PCCW hit a high of HK$28 (US$3.6). Fast forward to October this year, however, and the price had tumbled almost 97 percent to reach a low of just HK$0.88 cents.

"There's no denying that our shares have performed poorly," sighs Alex Arena, CFO of the US$2.8 billion-a-year Hong Kong telecoms firm.

As he sees it, much of the decline in PCCW's share price has been beyond his control. "The global economic downturn, coupled with negative sentiment towards the telco sector, has conspired against us," he notes. What's more, he adds, the changing character of his company hasn't helped. Set up in Hong Kong in mid-1999 to invest in telecoms, media and technology, PCCW became the epitome of Asian Internet hysteria. Investors hoping to cash in on the "new economy" shovelled billions of dollars into the unproven company and sent its share price soaring. So much so, in fact, that in August 2000 PCCW was able to pull off the US$28 billion acquisition of Cable & Wireless HKT, Hong Kong's chief telecom operator. Overnight, PCCW transformed itself from a high-profile growth stock with little in the way of revenues into a stodgy, but cash-generative, utility. That change, maintains Arena, "caused a lot of churn in the share register which inevitably led to a falling share price".

Analysts, however, see other factors at play. Doe Tien Xuan, head of investment research at Morley Fund Managers in Singapore, points to a surfeit of debt and a deficit of cash. For a start, when it bought HKT, PCCW had to borrow US$12 billion. To make matters worse, at the time the firm also owned a plethora of loss-making Internet start-ups. And then there was CyberPort, Hong Kong's new IT business park. Started in early 2000 and due for completion next year, PCCW will have sunk a total of US$700m into the project.

"While HKT had lots of free cash flow, it didn't have enough to support the debt, the losses and the investment taking place in the rest of the business," says Doe.

Add it all up, and PCCW's recent performance earns it the ignominy of finishing 99th in CFO Asia's Performance 100 this year. (See tables below in pdf format) The list, compiled annually, looks at the 100 biggest companies across Asia and measures how much wealth they have created - or destroyed - for their shareholders.

A Capital Idea

In producing the list, CFO Asia teams up with the Singapore office of consultancy Stern Stewart, and uses a metric known as market value added, or MVA. Put simply, MVA is the difference between the market value of a company - counting both debt and equity - and the capital that lenders and shareholders have entrusted to it over the years in the form of loans, retained earnings and paid-in capital. In other words, MVA is a measure of the difference between the cash which investors have put into a company and the cash they could take out if they sold it at today's prices. If MVA is positive, it means the company has increased the value of the capital entrusted to it, and so created shareholder wealth. If MVA is negative, the company has destroyed wealth.

In PCCW's case, investors have given the company more than US$26 billion during its short, three-year lifetime. However, the current market value of the company's debt and equity amounts to just under US$10 billion, giving an MVA score of minus US$16.26 billion. Wealth has been destroyed on an epic scale.

At the other end of the list, and topping this year's P100, is Korea's Samsung Electronics with an MVA score of US$23.1 billion, followed by Taiwan Semiconductor Manufacturing Company with an MVA score of US$15.2 billion. Both firms have more than doubled the money put into them.
Alongside these two leaders, another 63 companies in the P100 have also managed to create wealth during their lifetimes. Amazingly, though, 35 of Asia's 100 biggest companies have never created any wealth for their shareholders since being set up. PCCW is merely the second-worst offender (after South Korea's Kepco) in a rogue's gallery of value-destroyers.

And even for those companies which have managed to create wealth over the longer term, in the past year most of them destroyed it. (See the column in the P100 tables which shows "one-year change in MVA".) Indeed, of all the companies in the P100, 69 percent saw their MVA figures decline over the past 12 months. Only 31 percent created new wealth for their owners. The biggest faller of them all was China Mobile. In a single year, the Hong Kong-based wireless phone company, which operates in China, lost a staggering US$60 billion of MVA, falling from pole position in last year's table of wealth-creators to 98th place in this year's P100. Real estate companies have fared almost as badly, with seven out of the nine property players in the list recording a negative MVA.

Turnaround Time

Of course, the rankings are really only a snapshot of wealth creation at one point in time - in this case September 24, 2002. As time moves on, and managers implement new strategies, it's possible for today's value destroyers to become tomorrow's star performers.

At PCCW, CFO Arena is certainly working towards that end. For the past two years he has been spearheading a series of reforms designed to turn the company around and "establish a solid platform for future growth".

His number one priority has been to restructure the firm's balance sheet and reduce its debt burden. And observers say he's been highly successful. Since buying HKT, PCCW has lowered its borrowings from US$12 billion down to US$4.1 billion. It's done so in a number of ways, from suspending its dividend - which the firm says will be re-introduced towards the end of 2004 - to selling off many of its assets, such as mobile phone arm CSL.

Interestingly, Arena says that even without the need to reduce debt, PCCW would still have hived off its mobile assets. "The future of 3G technology isn't clear, so we'd rather wait on the sidelines and see what develops," he explains. Given that Hong Kong tycoon Richard Li is the chairman and biggest shareholder in PCCW, the company's strategy flies in the face of recent actions by Li's father, Li Ka-Shing, whose firm Hutchison Whampoa has just bet billions of dollars on the future of 3G.

As for the rest of PCCW's outstanding debt, Arena has tried to change its profile. For one, he has extended the maturity of the company's borrowings, from a little over 18 months to an average of 7.1 years, and brought down the weighted average cost of his debt to 4 percent. He's also tried to diversify his funding sources as much as possible to avoid over-reliance on one type of financing and to enable easier repayment. A good example came in October last year when PCCW issued JPY30 billion (US$250m) of bonds due in 2031 and with a coupon of 3.65 percent.

As things stand, PCCW carries a BBB credit rating from Standard & Poors and a Baa1 rating from Moody's. Within two years, however, Arena wants to improve that to a single-A rating. An analyst says that Arena has a shot at achieving this, but that he will have to shed another US$1 billion in debt before any upgrade.

A second focus has been on cutting costs, boosting efficiencies and completing the integration between PCCW and HKT. To that end, many of PCCW's original technology investments have been closed down, sold or merged and several rounds of redundancies have taken place. During 2001, for example, PCCW cut its operating costs by 9 percent.

At Morley Fund Managers, Doe applauds the company's efforts, though he cautions that they still have some way to go. "From being a sexy growth story, PCCW now needs to focus on the boring things and grind out good operating results quarter after quarter," he says.

Not that growth and new deals aren't on the cards too. Retrenchment may be the name of the game today, but PCCW is laying the groundwork for expansion when the time is right. It is banking on growth in its Business eSolutions division, which helps companies set up and integrate their IT and communications needs. Analysts, while noting the potential in the area, cite big risks. Companies like Datacraft Asia have been burned doing similar things in China. Plus, the current economic climate isn't exactly conducive to heavy IT spending. Broadband and increased business in China represent other potential areas
of growth.

Not Just Hot Air

Not surprisingly, a move into China lies at the heart of many of the companies in this year's P100. None more so than Hong Kong & China Gas (HK&CG), which places an impressive fifth in the list with an MVA tally of US$6.3 billion. In fact, utilities have done well this year - of the 15 included in the P100, half appear in the top quartile of Asia's wealth-creators.

For Indy Sarker, head of utilities research at Deutsche Bank in Hong Kong, it comes as no surprise that HK&CG has scored highly. Having been the premier gas supplier in Hong Kong for 140 years, the company "is massively cash-generative and has a very strong balance sheet". It has also grown at an impressive rate in its domestic market - over the past nine years, turnover has expanded at a compound annual growth rate of 9.8 percent to reach HK$6.9 billion in 2001.

The real issue for HK&CG now, says Sarker, is where future growth will come from, and the answer lies firmly in the mainland. To that end, the company has gradually been investing in more and more gas supply projects since it made its first foray into China in 1994.As Ronald Chan, CFO of HK&CG, notes, "Only 3 percent of China's energy needs come from natural gas so there is huge scope for growth."

The markets agree and have sent the company's share price climbing steadily, from HK$7.50 two years ago to HK$9 a year ago to HK$10 in October 2002. It's little wonder, then, that HK&CG's MVA has risen by US$616m over the past 12 months.

That said, opinion is divided over the value of the company's China ventures. "The big debate raging in the market is, 'How much should you pay for China?' It's far from clear," observes Deutsche Bank's Sarker. Given that the utility-like cash flows of the group's Hong Kong business are "very easy to value", determining the right price for the firm's shares all hinges on the potential value of HK&CG's business north of the border.

Everyone agrees that China will be less profitable than Hong Kong - Sarker reckons domestic investments earn a return on equity of around 30 percent compared to just 15 percent in China. But finding a consensus on just how much less is tough. At a price of HK$10, Sarker says the market is valuing the company's future China business at HK$1.15 a share. He thinks it should be closer to HK$0.65.

The Naked Truth

Still, what nobody disputes is that HK&CG is highly profitable. And not just in terms of accounting profits, but also true economic profits whereby companies earn a return that is greater than their cost of capital. In the P100 rankings there is a measure to show this, called Economic Value Added, or EVA. It's simply a matter of taking a firm's net operating profit after tax and deducting from that a charge for the capital it uses.

At HK&CG, EVA for the year 2001 stood at a healthy US$202m. It was one of the few companies in the list to post a positive score. Not that a negative score is necessarily bad. Companies which invest heavily today - so recording low returns, or even losses - in the expectation of big future profits, may show poor EVA results and yet have a healthy MVA as the market factors in future earnings. Consistently negative EVA, however, is a sign of a company in trouble.

Needless to say, companies trying to boost both EVA and MVA can do so not only by improving their profit margins - as PCCW is doing through its cost-cutting initiatives - but also by reducing the capital tied up in their business. That's certainly been the case at HK&CG. During 2001, the company embarked on a massive share buyback program, snapping up 7.9 percent of its issued share capital and returning HK$4.4 billion to shareholders in the process.

According to CFO Chan, HK&CG had been conserving cash to fund its drive into China. As things turned out, however, the expansion progressed more slowly than anticipated. What's more, thanks to local banking reform, it has become much easier to raise renminbi financing for projects. So, rather than let the cash sit around, acting as a drag on the company's returns, Chan decided to give it to his shareholders.

As Chan explains, "The buyback not only gave us a more efficient capital structure, but boosted our return on capital employed and enhanced earnings per share." So, while the profit attributable to shareholders only increased by 2 percent in 2001 over the previous year, earnings per share grew by 5 percent.

Quanta's cash quantum

That sort of approach to efficient capital management is something that many other companies in the P100 would do well to emulate. Take Taiwan's Quanta Computer, the US$3.4 billion-a-year contract manufacturer of laptop computers.

With NT$22 billion (US$631m) of cash on its balance sheet, equity of NT$42 billion and debt of just NT$6.6 billion, Quanta has "a very high net cash position," observes Ross Teverson, a fund manager at Standard Life Investments in Hong Kong. "If they returned some of their cash to shareholders, perhaps via a share buyback, they could generate a much higher return on equity," he says. Naturally, the firm's MVA and EVA would also improve.

Nonetheless, Quanta hasn't done badly - far from it. Since it was set up in 1988, the company has generated US$3.8 billion of shareholder wealth and it comes 16th in this year's P100. It's done so by acting as both the design and manufacturing arm of US computer giants like Dell and Apple, building and dispatching laptop computers direct to consumers around the world on a just-in-time basis.

As its MVA figure shows, Quanta has performed well up until now. Whether it continues to do so is an open question, for Quanta's position as the world's biggest maker of laptops is under attack.
"Quanta is in a transition period, so everything depends on how well it handles that transition," comments Eve Jung, an analyst at ABN Amro Securities in Taipei.

Fierce competition from Taiwanese rivals such as Compal Electronics and Arima, and price pressure following the consolidation of customers such as Hewlett Packard and Compaq, mean that profit margins have slumped from the mid-teens to around 8 percent.

For Quanta's CFO, Tim Li, boosting the company's returns by handing back his cash pile to investors isn't an option. He'd rather keep the money at the ready in order to fund new investments. Instead, Quanta is focusing on reducing its reliance on making laptops and is moving into new, higher-margin areas such as servers and handheld devices like personal digital assistants.
"The pressure in the market on margins is constant so we need to reinvent ourselves," says Li. "Laptops are becoming a mature product. It's inevitable that margins will drop to below 5 percent where they are for desktop computers."

That said, Quanta isn't giving up on its core business without a fight. Last year it shifted a big chunk of its production from Taiwan to a huge factory just outside Shanghai where labour costs are significantly cheaper. And while engineers in Taiwan will continue to focus on designing the next generation of products, staff in China will concentrate on coming up with innovations in cost-cutting and extending the lifecycle of existing products.

Whether or not Quanta succeeds, only time - and next year's P100 rankings - will tell.

View PDF of the P100 list

Justin Wood is executive editor, Southeast Asia, for CFO Asia, based in Singapore.