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Web-only Exclusives
November 30, 2000

From Our Correspondent: Hirohito and the War
A conversation with biographer Herbert Bix

From Our Correspondent: A Rough Road Ahead
Bad news for the Philippines - and some others

From Our Correspondent: Making Enemies
Indonesia needs friends. So why is it picking fights?

Asiaweek Time Asia Now Asiaweek story

The Ultimate Red Chip

But don't expect rapid price rises this time

By Jonathan Sprague / Hong Kong


WHAT WOULD YOU PAY for a stake in a company that dominates a growing telecommunications market in vast China, and one that can buy assets at bargain prices from its mainland parent, which happens to be the industry regulator? Quite a lot, apparently. Thousands of Hong Kong investors lined up at dawn last week to pick up application forms for the initial public offering of China Telecom (Hong Kong). With a potential value of more than $4 billion, the IPO is the biggest-ever red chip offering to hit the market.

Yet the stock prices of other Hong Kong-based companies backed by mainland parents are deflating. Leading counters are down 50% from peak levels, along with the sector index. So why apply to pay between HK$9.39 to HK$12.48 a share -- the final price will be set after the offer period ends Oct. 16 -- for China Telecom, at a very pricey 22 to 28 times prospective 1997 earnings? "People want to own the company," says Howard Gorges, vice chairman of South China Brokerage. "It's a stock they have to have in their portfolios."

Reasons are not hard to assign. China Telecom runs mobile telephone services in the booming Chinese provinces of Guangdong and Zhejiang. It has 2.64 million subscribers in the two regions, which have a combined population of 115 million people. Still, that's a mighty 98.4% market share. And the customer base grew 64% last year. Earnings in 1996 topped $544 million, down from 1995's $564.2 million because of rising costs tied to its growth and reorganization. But the profit margin remained impressive at 43.5% (from more than 60% in 1994 and 1995). The company says margins averaged 39.8% in the first five months of this year.

The key attraction is the expectation that ultimate parent Ministry of Posts and Telecommunications (MPT) will sell, at rock-bottom prices, its other cellular operations to China Telecom. At the moment, the soon-to-list company is the only vehicle for non-mainland Chinese investors to gain exposure to China's domestic telecom industry. (Trading on the New York Stock Exchange in China Telecom's American Depository Receipts starts Oct. 22; the company's stocks list in Hong Kong the next day.) If these asset injections happen, says Gary Greenberg of Peregrine Asset

Source: Datastream

Management, the high IPO price would be justified.

But that is not a sure thing. "It's really a question of the authorities keeping their promises," says Greenberg. "Given the recent worries about [leading red chip] Beijing Enterprises, it is probably incumbent on the authorities to make sure that the market is comfortable." Beijing's stock price was recently pummeled by talk that its parent, the Beijing municipal government, may float another company in Hong Kong. The worry is that the new firm will compete with Beijing Enterprises for asset injections. Company officials denied the rumors.

Not that Beijing Enterprises has been the recipient of new assets to add to its portfolio of toll roads, beer, fast-food, tourism and property since it listed in May. While the company is generally seen as having good quality holdings (including the McDonald's franchise in Beijing), the prospect of injections was the main reason why its IPO was 1,276 times oversubscribed. The price was HK$12.48 per share. The stock peaked at HK$65, more than 70 times projected 1997 earnings, but was trading last week at HK$31.60.

China Telecom comes to market at a time of diminished expectations. While many miss the excitement, longer-term investors say the slowdown is just as well. "I think people are coming to grips with the reality that red chips are not that exceptional," says one fund manager. The froth around China Telecom has also been evaporating somewhat. Offers for shares in the gray market have dropped from around HK$25 to as low as HK$14. Still, the issue is expected to be oversubscribed.

The company has been dampening too high hopes. It warns that the Hong Kong stock exchange may not approve any application to buy assets from the MPT for six months following the listing. But it also insists that the ministry will not be listing any other cellular unit in Hong Kong or abroad.

Gorges says China Telecom's listing may mark the birth of a more mature red chip market. Its huge size will make it harder for speculators to toy with. The red-chip slump has also sobered up many a punter drunk on asset-injection hopes. "Previously there was a lot of pie-in-the-sky for some of them, and certainly quite high expectations for most," he says. "Now the expectations are pretty well dashed. But there will be injections. I think we can get the market responding to these in due course."

The bottom line? Buy China Telecom if you can, but don't expect stratospheric returns. At least not in the first few weeks. The rewards may come the longer you hold on.


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