As Hong Kong Telecom Turns[Fool on the Hill] April 28, 2000

An Investment Opinion

As Hong Kong Telecom Turns

By Bill Mann (TMF Otter)
April 28, 2000

In case you haven't been scouring the international news wires, there's a battle a-brewing over C&W Hong Kong Telecom (NYSE: HKT), the dominant local and long distance carrier in the Chinese Special Administration Region of Hong Kong. It's got all the components of a great soap opera -- money, power, influence, jealousy, and political intrigue.

Hong Kong Tel is majority-owned by Cable & Wireless (NYSE: CWP), a NOW 50 component. The government of China also holds a large stake in Hong Kong Tel through its state-owned telecommunications company, China Telecom (NYSE: CHL). Hong Kong Tel has faced increased competition in all of its main lines of business, and has been criticized for not responding effectively to the technological and usage requirements of its customers. Until 1998 Hong Kong Tel's biggest drawing card had been its perceived position as holding the keys to the Chinese international telecommunications market. However, this perception imploded when China Telecom listed its shares in Hong Kong and in New York, making it clear that it was going to try to fund its expansion through internal means.

At the end of last year and the beginning of this year, Hong Kong Tel came in play as a potential takeover candidate when Singapore Telecom, the monopoly and majority-government-owned carrier of Singapore (don't you love how nice and clear these names are?) made a bid to buy a controlling stake in Hong Kong Tel. This bid was soon countered by Pacific Century Cyberworks (OTC: PCCLF), an upstart that has gone from nonexistent a year ago to being one of the largest companies in Hong Kong in terms of capitalization. Pacific Century Cyberworks' founder is Richard Li, the 33-year-old wunderkind son of one of the wealthiest and most powerful men in Hong Kong, Li Ka-shing, a man who has long held very close ties with the Chinese government in Beijing and is believed to have been instrumental in the selection of the current leader of Hong Kong.

China is important in this issue, just as China is important for everything having to do with Hong Kong. In this case, Beijing was noticeably less than enthusiastic about another Chinese-dominated, capitalist government having latent control over Hong Kong's largest telecommunications company. Enter Richard Li and Pacific Century. The company has little in the way of assets, a grand plan to offer Internet satellite throughout Asia, a buoyant stock, the backing of the Li family, and the tacit support of China. So Li scrambled to come up with the cash for the deal, trumping the Singapore Telecom offer with a cash and stock mixture valued at $38.1 billion.

However, Pacific Century's shares have fallen sharply since then, and now their deal is worth only $25 billion, which is an 8% discount to the current market price of Hong Kong Tel stock. So Singapore Telecom is coming back to the table, and they've got a big force in Asia riding with them -- Rupert Murdoch's News Corp. (NYSE: NWS). According to The Wall Street Journal, the two companies are preparing a joint offer for Hong Kong Tel that will exceed $30 billion. And unlike the Pacific Century deal, it is primarily cash-based. News Corp.'s subsidiary Star TV -- a pan-Asian satellite network -- has a large joint Internet and pay TV project with Hong Kong Tel that Murdoch would like to protect.

Murdoch and Richard Li have already had large business dealings in the past. Seven years ago Li sold StarTV to Murdoch for $850 million. Murdoch believed that StarTV would give him access to the potentially massive Chinese media market. But many people familiar with the Li family and their connections with China were skeptical, saying that if the family was selling StarTV, that buying it for the sake of access to China would be a bad idea. These wags thus far have turned out to be correct, as News Corp. has been stymied at every turn, and StarTV has bled money. Now that Li has stepped in and gotten Hong Kong Tel, it may have been too much for Murdoch to bear.

The drop in stock price at Pacific Century has caused all sorts of problems with the bid, starting with the simple fact that the offer is now below the market price for the company. This is a scenario that Cable & Wireless would dearly like to avoid, and the specter of it having to bite hard and swallow such a depressed deal has conspired to knock down its share price. Cable & Wireless, in trying to avoid being so beholden to the share price of Pacific Century, announced soon after the merger agreement that it would be swapping a large portion of the stock with CMGI (Nasdaq: CMGI) for stock in CMGI, which it perceived to be more stable. Well, CMGI has dropped even harder than Pacific Century, though its deep roster of operating companies and projects suggests that it is far less risky.

Pacific Century, on the other hand, has suffered a triple whammy. Certain people were skeptical from the outset about its high-tech plans being weighed down by a relatively dowdy Hong Kong Tel. Others began to sell in order to buy Hong Kong Tel once Pacific Century shares dropped below the open market value of Hong Kong Tel in an attempt to arbitrage the deal. Still others have sold because they fear that the SingTel/Murdoch bid will force Pacific Century to up the ante, most likely with cash.

And the wild card in this is still China. The perception that Beijing has meddled at all in ensuring that Pacific Century beat out SingTel has sent a cautionary shiver down the spines of those hoping that Hong Kong's business activities will truly remain free from Chinese government intervention. The fact remains that neither SingTel nor Rupert Murdoch are as palatable to China as owners (and partners) in Hong Kong Tel as would be Richard Li. Certainly the combined Pacific Century and Hong Kong Tel would have a much more open door in China for development. But perhaps Cable & Wireless sees something in Pacific Century stock that they could not have in cash -- the chance to grow along with Richard Li, someone who by most reckoning is believed to have the vision, contacts, and resources available to provide sensational return on their investment.

One thing's for sure: This has all the makings for a dynamite finish.

Fiat Fool!

Bill Mann, TMFOtter on the Fool discussion boards