Watsons float little reason for Hutch investors to celebrate

Proceeds from a possible AS Watson listing would be more likely to end up in Europe than in Hutchison Whampoa shareholders' hands

PUBLISHED : Friday, 04 October, 2013, 12:00am
UPDATED : Friday, 04 October, 2013, 3:04am

Shares in ports-to-telecommunications conglomerate Hutchison Whampoa have jumped 4.25 per cent in the last two days on the rumour that controlling shareholder Li Ka-shing is planning to float the company's retail business.

The positive reaction is no surprise. Like Asia's other family-run conglomerates, Hutch as a whole has long traded at a deep discount to the value of the sum of its parts.

Even after the upward pop of the last couple of days, the company's shares are still trading at a discount to their net asset value of some 30 per cent.

Now, with the prospect of an initial public offering for Hutch's retail subsidiary AS Watson, investors hope they might realise their long-cherished wish that a series of spin-offs will finally allow them to realise the full value of their shareholdings.

They are likely to be disappointed. Whether floating Watson could help Hutch to narrow its discount to net asset value would depend on what Li and his lieutenants decide to do with the proceeds.

Handing the money back to investors through a share buy-back programme would achieve the effect shareholders desire.

That's not Li's style. Reports suggest he is more interested in raising cash to fund acquisitions in Europe's telecommunications and infrastructure sectors.

But whether selling Watsons to buy such assets will make an attractive proposition for investors is doubtful.

Events in Britain show how vulnerable utilities are to political grandstanding

It is true that after years of bleeding money Hutch's third-generation phone businesses are now finally generating cash, even after accounting for their capital expenditure. In a business in which scale is vital, any consolidation powered by the acquisition of weaker players will further boost cash flows.

Even so, the sector's future capital expenditure needs are daunting, and operating margins will remain tight.

Compared to margins of 6 per cent last year at Hutch's 3G businesses, according to JP Morgan the company's infrastructure investments earned a far more attractive operating margin of 44 per cent.

Yet it would be a mistake to assume Hutch will be able to make such fat margins on European infrastructure assets in the future. The announcement last week by Britain's Labour Party that it will freeze energy prices should it win the country's 2015 election illustrates how vulnerable utilities are to political grandstanding.

That makes it unclear whether any new acquisitions will promise significantly fatter margins than Hutch can make from Watsons.

Admittedly, at 6 per cent last year the retail arm's operating margin doesn't look especially impressive. But that number was dragged down by ParknShop, the Hong Kong supermarket chain which Watsons has been looking to sell.

In contrast, the company's mainland health and beauty shops enjoy a generous 18 per cent margin, and handsome growth prospects in a rapidly expanding market.

As a result it is doubtful whether spinning off the retail business will help either to narrow Hutch's conglomerate discount or to generate better returns for shareholders.

Rather than bidding up Hutch at the prospect, investors might just be better off cashing out and buying into a Watsons offering instead.

Asobering view on Hong Kong property prices from Credit Suisse managing director Dong Tao, who argues that with transaction volumes and values down by half over the last 12 months, the housing market is in the first phase of a correction.

The second phase will come when the US raises interest rates, with Tao calculating a 1 percentage point rise would add HK$1,368 a month to the cost of a typical mortgage.

That would push bills up from 50.3 per cent of household income to 56.3 per cent.

"That's big enough to drop a rock on the Hong Kong property market," Tao warns.