PCCW stock becomes a value number

PUBLISHED : Monday, 08 October, 2012, 12:00am
UPDATED : Monday, 08 October, 2012, 12:24am

Some investors would shudder or roll their eyes at the thought of investing in PCCW. The firm's chairman, Richard Li Tzar-kai, remains an entrenched symbol of 2000-era dotcom excesses. Hong Kong shareholders were briefly gripped by PCCW mania. This allowed the firm to take over Hongkong Telecom with little more than the Li name, vague plans of global internet broadcasting and a lot of debt.

PCCW's share price has dropped over 90 per cent since this audacious takeover (in 2000), and investors have not forgiven the firm.

However, there is a price for everything. Believe it or not, PCCW could represent good value at its current share price.

PCCW last November spun off its telecom assets as a separate listed firm called HKT Trust.

This was to show investors the value of the HKT assets, with its strong recurring income. These accounted for about 80 per cent of PCCW's revenue in 2011.

Meanwhile, because PCCW still owns about two thirds of HKT, it is entitled to its share of the trust's profits. PCCW's share price should fully reflect the value of the trust.

PCCW's stake in HKT is worth about HK$28 billion. This number alone exceeds PCCW's capitalisation of around HK$23 billion, and this gap has widened since the beginning of the year.

This means that an investor in PCCW effectively gets for free its other assets, such as its 94 per cent interest in Pacific Century Premium Development (PCPD), NOW TV, its technology solutions business, and cash reserves.

Let's do an exercise to see how much PCCW is undervalued.

PCPD is listed with a market capitalisation of about HK$670 million, so PCCW's 94 per cent share should be worth HK$625 million.

NOW TV and the technology solutions business are not listed but one can estimate their value by looking at their disclosed earnings.

NOW TV generated operating income of about HK$631 million in 2011. Using the same earnings multiple investors pay for i-cable (although NOW TV should have a higher multiple given its stronger performance), a listed local rival, NOW TV should have an implied market value near HK$1.8 billion.

Its technology business is probably worth HK$1 billion.

PCCW is sitting on net cash of over HK$2 billion, excluding the cash that belongs to HKT and PCPD.

So it should be worth about HK$34 billion, a sum that implies PCCW's shares trade at a discount of more than 30 per cent. (See table.)

PCCW ought to suffer from some holding company discount since HKT, which comprises more than 80 per cent of its valuation (based on the above computations) is listed separately. As such, investors who want exposure to the telecoms sector would rather invest in HKT directly than through PCCW.

Investors might also be applying a Richard-Li discount as they have not had the best experience with Li-led firms. That said, Li is head of both PCCW and HKT, so the discount should apply equally.

There could also be concerns over the costs of PCCW's imminent foray into the free-to-air television business (its licence application is pending) in which it will compete against strong incumbents. Li has said the company will not engage in cut-throat competition or embark on a hiring spree, like City Telecom.

NOW TV, which broke even in 2009 after years of losses, saw its operating profit drop in 2012 - despite an increase in revenue - due to start-up costs relating to the launch of its free-to-air TV business.

Despite that, PCCW's HK$10 billion undervaluation seems excessive. Investors who want exposure to dividend-paying telecom assets might consider PCCW as a cheap way into HKT.

PCCW also pays a generous dividend yield of over 5 per cent, which appears to be sustainable given the stable cash flows generated by HKT.

Investors discount PCCW largely because they are concerned that the firm will follow old patterns and bleed value. To buy the stock, people only have to believe the firm will not actively destroy shareholder capital.