Richard Li

Big questions over PCCW's business trust spin-off plan

PUBLISHED : Wednesday, 08 June, 2011, 12:00am
UPDATED : Wednesday, 08 June, 2011, 12:00am

There are plenty of questions about PCCW's plan to float its telecoms arm as a business trust, but so far precious few answers.

The big question is not why PCCW boss Richard Li Tzar-kai wants to spin off the company's unexciting telecoms interests - he's been trying to do that for years - but why he has decided to spin it off in the shape of a business trust, a structure which until now has not been allowed to list in Hong Kong.

What advantage, potential investors will ask, does a business trust offer us over a conventional spin-off?

A business trust is a curious creature, neither fish nor fowl. It is not a company in its own right, but rather a vehicle managed by a trustee. It doesn't have shareholders like an ordinary company, but unit holders, to whom it pays an annual dividend.

PCCW claims that listing its telecoms arm as a business trust will 'align its mature and stable cashflow-generating characteristic with the appropriate investor base that favours highly stable yields and pure-plays'. As a result, PCCW reckons it can get a higher valuation.

But this explanation doesn't stand up. If the unit were floated as a conventional company it would offer the same pure telecoms play, with the same ability to generate cashflow and the same stable yield.

In other jurisdictions business trusts offer investors tax advantages over normal companies, but that won't be the case in Hong Kong.

As a result, structuring the spin-off as a business trust adds no obvious value to investors. In that case, you have to conclude that the advantage accrues instead to Richard Li and PCCW.

A comparison with real estate investment trusts, or reits, suggests this conclusion is correct.

Traditionally reits have offered real estate companies a neat way to cash out of mature property assets, while retaining full control over them and earning a fat fee for their management into the bargain.

That's pretty much what Li is intending to do here. He's failed before to spin off the telecoms business outright after the plan was shot down by PCCW's Beijing-backed shareholders, who feared that communications assets they consider strategically sensitive might pass into foreign control.

But by spinning off the unit into a business trust, PCCW, as trustee and manager, will retain control over the business and its operations. And it will earn a handsome management fee to boot.

What's more, the trust structure means it will be almost impossible for dissatisfied unit-holders to dislodge PCCW as the business manager. As trustee, PCCW will get to appoint the trust's independent directors. And with a 55 per cent stake in the trust, PCCW will face little chance of dissident unit holders mustering enough support to oust it in a vote.

In short, the business trust mechanism allows Li to monetise a portion of his stake in PCCW's telecoms arm without surrendering any influence over the business to outside investors, who will be very much second-class citizens.

This, however, begs the question why Hong Kong's regulators seem so ready to approve the business trust model when it involves clear weaknesses of governance compared with the existing company structure.

The answer appears to be political pressure. Officials were thrown into an unseemly flap earlier this year when Li's tycoon father Li Ka-shing spun off the port interests of conglomerate Hutchison Whampoa as a business trust listed in Singapore.

Without provisions allowing similar vehicles to be listed here, officials were told, Hong Kong would miss out. In their panic lest Hong Kong lose another listing, they appear to have bounced the regulators into approving business trusts, despite their shortcomings.

Investors are unlikely to be so easily gulled. Far from commanding a higher valuation as PCCW hopes, the spun-off unit is likely to trade in the market significantly below its net asset value, as investors demand a hefty discount to reflect the governance weaknesses of the business trust structure.

Areader writes in questioning whether the 30 per cent fall in shares of Chaoda Modern Agriculture is justified following media reports that the company exaggerated its holdings of agricultural land on the mainland.

'It would be tough to fake being one of the biggest agricultural companies in China,' he comments.

Actually, no.

I don't know about Chaoda, but there is plenty of evidence of fraud and fakery among other similar 'big boss' agricultural companies on the mainland.

Typically these companies lease their land from the peasants that hold the farming rights.

Or that's what they claim. But stories abound of big agricultural companies conspiring with local officials illegally to force farmers off choice land.

According to a survey conducted earlier this year by the Beijing office of rural development institute Landesa, as many as 45 per cent of these corporate leasing agreements with small farmers were only struck following coercion by local officials.

So no, although I can't comment about Chaoda, apparently it isn't very hard at all to fake your land holdings in China.