Deals

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

How did Li Ka-shing manage to sell his fixed-line phone business at a higher price than the parent company's entire market cap?

Hutchison Global Communications Ltd. said in an exchange statement Sunday that it would offload the unit to New York-based infrastructure investor I Squared Capital for HK$14.5 billion ($1.9 billion).

That's more than Hutchison Telecommunications Hong Kong Holdings Ltd.'s market value on Friday of HK$13.5 billion, even allowing for a 22.7 percent increase in the shares since the transaction was first reported in mid-May. (HGC is owned by Hutchison Telecom, a listed arm of Li's CK Hutchison Holdings Ltd. conglomerate.) The fixed-line business contributes about half of Hutchison Telecom's total profit, while the mobile business makes up the rest.

At first glance, it looks like Li is getting a great deal.

The sale has been done at 11.6 times Hutchison Global's trailing 12-month Ebitda of HK$1.25 billion, on par with the 11.5 times EV/Ebitda that private-equity firms MBK Partners and TPG Capital forked out in October 2016 for Wharf T&T Ltd. It's also 16 percent more than the 10 times level that Hong Kong Broadband Network Ltd. paid for the telecommunications and online marketing units of New World Development Co., according to Morgan Stanley.

Unleashing Value
Hutchison Telecom's fixed-line business was sold at higher price than the parent company's entire market value
Source: Morgan Stanley
Note: Morgan Stanley assumes Hutchison's mobile business is worth 8.5 times EV/Ebitda.. It estimates the mobile business can generate HK$1.3 billion in Ebitda this year.

But Li is likely getting a fair price considering profit margins at the fixed-line business probably aren't that robust. Hutchison Telecom's mobile unit uses a lot of the fiber-network resources owned by the fixed-line arm. Since Hutchison Telecom owns both, the mobile business only pays the fixed-line business at cost, plus some inter-company transaction expenses.

It's difficult for outsiders to quantify what Hutchison's fixed-line profit margin would be if the mobile unit paid market price. According to company filings, "international and local carrier" constituted 51 percent of fixed-line revenue in the first half. In other words, Hutchison's land-line unit should be more profitable than its reported 31 percent profit margin.

After the sale, Hutchison Telecom could be worth as much as HK$4 a share. Its Hong Kong-traded stock rose as much as 14.6 percent on Monday to HK$3.22.

While sell-side analysts will probably worry how Hutchison Telecom will operate -- its fixed-line business was the steady cash cow while its mobile division faces intense competition -- shareholders could hardly care less. The lure of buying into telecommunications companies in mature markets these days is mostly about dividends. Among its peers, Hutchison Telecom leaves a lot to be desired.

Baby of the Bunch
Hutchison Telecom has one of the lowest dividend yields among its Hong Kong peers
Source: Bloomberg

For its part, I Squared Capital doesn't lose out. It gets to own a business with reliable cash flows, as befitting one whose clients include nine of the top 10 global investment banks, most Hong Kong government departments, hospitals and the city's stock exchange. Corporations and businesses contributed 32 percent of fixed-line revenue in the first half. Furthermore, not having to support the mobile unit means Hutchison Global can now charge its former parent market prices.

I Squared will probably be able to wring more profit from Hutchison Global's assets, shareholders should receive a nice windfall, and stock in Li's telecom unit is up 22 percent this year.

This is one call set to make everyone happy.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Shuli Ren in Hong Kong at sren38@bloomberg.net
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net