Hutchison bites the bullet

The cash offer of HK$4.23b (US$545m) by Hutchison Whampoa Ltd (HWL) to take its subsidiary, Hutchison Telecommunications Ltd (HTL), private should come as no surprise and was long overdue. The main reason underlying this move is probably HTL’s inability to generate sufficient cash from operations to pay dividends to shareholders.

The value of HTL’s portfolio of mobile assets took a big hit when it sold off its large and profitable mobile property in India (Hutchison Essar) and then did the same in Israel. With the subsequent spinoff of its Hong Kong and Macau subsidiaries, HTL was left with an extremely disappointing and sluggish portfolio of mobile assets in Indonesia, Thailand, Vietnam and Sri Lanka. None of these operations has really taken off and all are struggling to attain profitability and generate free cash flow.

One cannot help but wonder at what lay behind Hutch’s strategy that resulted in the acquisition of this dreadful portfolio of mobile operations. Hutch normally buys assets like these with a view towards selling them off in a few years at a much higher price. It worked for them in the UK, in Europe and in India. But surely it must have been apparent to the parent as well as the subsidiary that these particular assets were not going to follow that pattern.

Hutch made its entry into Thailand in a JV arrangement with CAT (Communications Authority of Thailand) , the state-owned international operator, who along with TOT (Telephone Organisation of Thailand) were the two state entities who granted ‘concessions’ to private players to operate wireless services in that country. It was probably the only way into a market that was all but sewn up by GSM operators, AIS and TAC (now DTAC). Hutch’s CDMA operation was doomed to failure from the start. By its own admission, HTL found it difficult to procure competitively priced CDMA handsets. Network coverage was spotty and subscribers did not take its offering seriously. Working with a bureaucracy like CAT was difficult. Handset subsidies caused a massive drain on cash flow. Today, Hutch’s Thailand wireless operation does not even register in terms of national market share.

In Vietnam, Hutch followed a similar path. It obtained a CDMA licence in a business cooperation agreement with state-owned Hanoi Telecom. After failing to get off the mark with this CDMA operation for all the same reasons as in Thailand, the licence was changed to a GSM one. Today, the operations are an also ran in a fast growing market.

The most surprising action of all was Hutch’s entry into Indonesia. It had long coveted entry into this large and fast growing market. An earlier bid in Indonesia’s first and only competitive 3G/2G licence tender in 2003 had failed. Hutch entered the market by acquiring 60% of the licence that was won in that competitive tender process by Charoen Pokhpand Indonesia (CPI). CPI was looking for much more for a share of its licence. However, it was pre-empted by Maxis (of Malaysia) making an offer of US$100m for 50% of a licence owned by the Lippo Group, thus establishing the value of a new licence in Indonesia at $200m. A few days later, Hutch’s haggling with CPI ended when its offer of $120m for 60% of the licence had to be accepted by a disappointed CPI. It was certainly a good price to pay for market entry into Indonesia – however, to build value quickly and then exit at a future date was quite another question.

It entered a market where three operators controlled over 85% of the market. A new operator entering a market with established and well-entrenched players can only hope to match them with massive investments in network coverage, marketing and customer acquisition subsidies. Hutch basically focused on the last of these three points and now claims to have 7 million subscribers in a market of about 140 million subscribers. The subscribers it has are almost all of the pre-paid variety, with no loyalties whatsoever and with very low minutes of usage and ARPU. It has been difficult to generate positive cash flow in this situation. Finding a buyer who will pay a premium to take Hutch’s stake in this operation will be difficult.

In summary then, HWL’s offer to take HTL private makes sense.  Capital expenditures and dividends cannot continue to be paid out of operations. The question remains as to how a private HTL will work towards turning round these failing operations. And why such shrewd investors as Hutchison got into these operations in the first place.