With 1996 barely under way Merrill Lynch and JP Morgan struck an early blow in the battle for dominance in the Latin American underwriting league tables: they won the mandate to lead the upcoming international equity offering for Telefónica del Perú.
The announcement from the Peruvian government, which is disposing of its remaining 29% stake in the privatized telecoms utility, came on January 30 following several weeks of delay and growing suspense among the mostly US investment banks which were invited to pitch for the deal.
Morgan and Merrill won out with a 2.42% fee after presentations were made in Lima by five investment banks or groups. Their four rivals were CS First Boston, Goldman Sachs, Salomon Brothers together with SBC Warburg, and Morgan Stanley together with ING. The winners will need all their global distribution power and experience in leading underwriting syndicates in order to successfully place the issue, which could top $1 billion, making it one of the largest equity offerings ever to come out of the region. The Telefónica board has already agreed that following the international offering, which it is hoped will come to market some time during the first half of the year, the shares will be listed in New York, London, Madrid and Tokyo.
The Peruvian government has had plans to dispose of its 29% stake in Telefónica ever since the sale two years ago of a controlling interest in the telecoms monopoly. At that time, the sector was structured as two companies, the Lima operator Compañia Peruana de Teléfonos (CPT) and long-distance carrier Entel Perú, both held 70% by the state with a free float of 30%. In February 1994 Telefónica Internacional (Tisa) of Spain, the holding company for Telefónica de España’s South American operations, won the bidding and bought a 31.5% stake, with Peruvian partners the Wiese and Grana & Montero groups each coming in for a further 1.75%. Telefónica employees were allocated 6% of the company.
The new management merged the two companies later in 1994, renaming the new unit Telefónica del Peru. The total price paid for the 35% was $2.002 billion, but as part of the sale agreement, the government returned $611 million to Telefónica in order to support its ambitious capital expenditure requirements. Thus the amount received by the Peruvian state for its 35% stake totalled $1.39 billion.
The current market capitalization of Telefónica on the Lima Stock Exchange is $5.3 billion and the latest share sale could bring in around $1.5 billion, giving a valuable boost to Peru’s overstretched public finances. The underwriters will be helped by the fact that Telefónica is seen as the bellwether for the Peruvian market and that many institutions wishing to increase their exposure to Peru will want the stock.
Not all the shares will be sold internationally. The privatization agency Comisión de Promoción de la Inversión is committed to promoting widespread share ownership, and there will be a domestic offering as part of its citizens’ participation programme. The domestic offering will be led by Banco de Credito, Peru’s largest bank, for a 3% fee. In the coming weeks Banco de Crédito will meet with Merrill and Morgan to decide upon the exact allocation of shares domestically and internationally.
The award of the mandate was originally expected in mid-January, but was delayed in part because of the winter storms which disrupted Wall Steet. That prevented several of the investment banks from being in Lima on the appointed day to make their presentations. Having agreed to reschedule, the Peruvian authorities then decided to take some extra time to weigh up the various presentations.
Investors are likely to be attracted by the strong GDP growth in Peru and by the tremendous growth potential for Telefónica del Perú. Peru has the lowest level of line penetration in Latin America, with a recent report from ING Barings estimating that lines per 100 inhabitants stand at only 4.6, compared with 17 in Argentina. Peru has a population of 24 million.
Merrill Lynch initiated coverage of the stock in January with a buy recommendation and noted that Telefónica del Perú is the fastest-growing publicly traded telephone company in the world, with the highest projected five-year growth rates for earnings before interest, taxes, depreciation and amortization, and earnings per share of the 43 companies covered by the Merrill global telecoms research team. “This superior growth likely will be driven by rapid network expansion, substantial productivity improvements, a favourable regulatory environment and an experienced management team that knows how to exploit the opportunity that it faces,” the report said.
Since Tisa took over at the phone company, the service has improved following years of state-run neglect. Expansion has been rapid. This year $600 million in new investment is expected, with an additional 400,000 lines installed. The company has a five-year monopoly, until May 1999, on both local and long-distance wire telecommunications, and it is also pursuing opportunities in cellular phones and cable television. The market will be opened up to full competition in May 1999, at which point Telefónica is certain to be aggressively challenged by another public-listed telecoms company, Tele 2000, which is already a competitor in the cellular and cable TV sectors.
By that time Telefónica should also be benefiting from regional growth, since from 1998 there will be a fibre-optic network in place linking it with Argentina and Chile, where Tisa also has controlling interests in Compañia de Telecommunicaciones de Chile and Telefónica de Argentina. Tisa also holds a minority stake in Venezuela’s telecoms company Compañia Anonima Nacional de Teléfonos de Venezuela (CANTV).
With such growth prospects Telefónica del Perú should be a big hit with buyers of Latin American equities, and by the end of 1996 their depositary receipts are likely to be a core holding in the portfolios of most large institutional investors interested in the region.
Michael Marray
POLAND
The battle for Polish copper
The flotation of KGHM Polska Miedz in the third quarter of this year will be Poland’s largest privatization and one of the most significant in eastern Europe since 1990. It’s no wonder that such a prestigious mandate has drawn most of the major investment banks into a bidding war that promises to be tough.
The path for the eventual victor is likely to be equally so, marked by political interference, competing demands from management and unions, and controversial legislation that reflects Poland’s still unresolved ownership laws.
Favourite for the mandate was SBC Warburg which has teamed up with Bank Handlowy, Poland’s most internationally experienced bank. (SG Warburg had been appointed adviser for the country’s suspended mass-privatization programme back in 1991, but has not been paid – so perhaps its compensation will come now.) But a more likely winner is the JP Morgan, Goldman Sachs, HSBC and local bank Pekao consortium.
Morgan’s successful Poland Eurobond issue last year and the surprising award of the Gdanski Bank mandate to HSBC (with Daiwa), despite Schroders’ extensive (although unsolicited) work, gives them an edge over rivals – even CS First Boston which has been busy in Poland since 1990 and has joined forces with Salomon. Other challengers are Flemings and BRE, Morgan Stanley and Dresdner, and a powerful consortium of BZW, UBS and the Polish WBK bank.
The most curious duo is Société Générale and the highly respected BIG bank, the only organically independent bank to form since 1989 and a haven for ex-communist apparatchiks. SocGen has little experience with east European privatizations, but France has been a prominent financier and adviser to Poland’s structural reforms – creating the Warsaw Stock Exchange, for example – and must be keen for some monetary reward. Conspiracy theorists suggest that French representatives have been fiercely lobbying the new communist government and that the BIG alliance with SocGen is evidence of their success.
The bidding process occurs in two stages. A technical proposal giving details of the deal’s management and underwriting structure, a timetable and distribution forecasts, is sealed in an envelope and submitted for assessment by a privatization ministry committee. Those who pass must then offer a financial proposal, providing a breakdown of fees.
The technical proposals were to be submitted on January 23, but were deferred to January 30 and then again to February 2. Banks blame “bureaucratic delays”, but Poland is more sensitive than other central Europeans in ensuring its assets are not hijacked by western bankers. Intensive searches are conducted on consortia personnel to weed out any directors with criminal records and to check on the past behaviour of consortia firms – including lawyers and accountants – in Poland.
Unofficial estimates value the copper-mining company, the world’s fifth-largest producer, at between $2 billion and $3 billion. Banks have been privately advised that their proposals should assume that the state will retain a controlling stake in the company. KGHM is Poland’s biggest export earner and, with profits last year of over $200 million from sales worth $1 billion, it is the country’s most profitable company and the third most profitable company in the Central European Free Trade Area.
According to CRU International, a London-based copper research unit, KGHM mines contain 1.25 million tonnes of copper ore – enough to sustain production for 45 years. The company has benefited from government spending on research and development, with the result that its extracting and processing operations are efficient and comparable to western competitors. It has also enjoyed high copper prices during the last two years, so its gamble not to hedge has paid off – at least for the time being. But if copper prices fall to below $1,500 per tonne, KGHM will operate at a loss.
Other worries for investors are a history of political interference, escalating fixed costs and a need for rationalizing support companies. Labour union politicians forced the sacking of KGHM’s president, Krzysztof Sedzikowski, last May after his cost-cutting measures reduced the workforce and his disposal of non-core businesses caused further redundancies. Record profits in 1994 prompted labour unrest last summer: instead of workers being rewarded with one-off bonuses, long-term fixed costs were increased by wage rises. KGHM Metale, a 90%-owned subsidiary, has started a programme of vertical integration by purchasing copper component and manufacturing companies, but a major concern is the pending rationalization of ancillary welfare businesses: job losses and social infrastructure cuts might save money but are unlikely to be popular or accepted by the unions.
The biggest problem is the ownership of KGHM – or any Polish company for that matter. A 1990 law stipulates that employees must be allocated 20% of the shares of a privatized company at half the offer price, as long as the value of each individual’s portion does not exceed the average annual Polish wage. On that basis, KGHM’s 30,000 workforce would take up considerably less than 20%.
An alternative proposal was that 15% of privatized companies should be distributed free to employees, but the draft legislation was thrown out by the constitutional court last year. However, one source at the privatization ministry hints that, because of union pressure, the aborted law might be enacted for KGHM only. In central Europe, bankers will have to learn to live with what Stephen Fries, economist at the EBRD, calls the “social dimension”.
“KGHM is a very large and successful company and a major export earner,” says David Clark, director of corporate finance at BZW. “Its flotation will be a very important development for the Warsaw Stock Exchange and will lead to a significant increase in interest for Polish equities by international investors.”
Australia’s Western Mining and the US’s Asarco both tried to make strategic investments in KGHM in 1992 and were forced to back off after popular demonstrations demanded “hands off Polish copper”. Privatization in Poland will continue to be a sensitive topic, challenging the easy assumptions and sanguine faith of EBRD model-makers and investment bankers pursuing the latest IPO mandate.
Rupert Gordon-Walker
RUSSIA
Stet stand-off
It should have been the Russian Privatization Centre’s (RPC) finest hour: an above-board $1.4 billion deal with a well-known international company completed in time to fulfil the state’s 1995 budget target for privatization receipts.
After a year in which Russian privatizations had become synonymous with sleaze, the sale of a 25% stake in telephone operator Svyazinvest to state-controlled Italian telecoms group Stet was intended to breathe new life into the country’s struggling disposal programme.
Unfortunately, it didn’t work out that way. And ever since Maxim Boycko, head of the centre, cancelled the deal at the end of December, people have been asking why. Was the cancellation, as president Boris Yeltsin’s economic adviser Alexander Livshitz suggested, triggered by the strong showing of the Communists in December’s parliamentary elections? Livshitz implied that Stet had effectively withdrawn, frightened by Communist pledges to revoke “unfair” privatizations. Other observers said that it was the Russian government itself that had lost its nerve, cowed by Communist and nationalist taunts about selling off the family silver to foreigners.
The sale of Svyazinvest probably broke down for more prosaic reasons. The RPC had been pressing for a more “professional” approach to privatizations and Svyazinvest was its chance to prove that open auctions of large assets could work. But clearly this required the deal to be closed on time and at the $1.4 billion headline price. Unfortunately, the Russians’ determination to achieve this caused the breach with Stet. For, although the Italian company wanted to do the deal, it couldn’t meet the Russians’ timetable because of fears that a botched acquisition would sour its own $7 billion privatization later this year.
Svyazinvest, established in 1994, the second telecoms utility after Rostelekom, is little more than a shell owning 51% stakes in 85 regional telephone companies and a recently granted licence to develop an as yet unbuilt long-distance and international telephone network. A Moscow-based investment banker calls it “a derivative: an instrument holding a basket of shares in companies which have assets but need to be restructured”.
As a result, when the auction was held last November, only two bidders emerged: Stet and a consortium consisting of US West, France Télécom and Deutsche Telekom. Stet was widely seen as the most logical partner. The company has an ambitious international strategy involving expansion in eastern Europe but had been outbid in two previous auctions in the region – the 1993 sale of the Hungarian telephone utility Matav and last year’s Czech offering. Therefore, few were surprised when it emerged as the winner, having outbid the rival consortium by some $200 million.
At this point the RPC’s hopes for a clean deal seemed likely to be realized. Stet had offered a good price and seemed keen to complete the deal quickly. Stet’s Moscow representative, Carlo del Bo, talked confidently of how the stake in Svyazinvest would lead to a series of projects to develop Russia’s telecommunications.
But then the Italians woke up to the complexity of the deal. Most other potential bidders had been put off by the uncertainties surrounding Svyazinvest. How much influence, for instance, would it have over the 85 local operators it “controlled”? And what regulations would oblige Rostelekom to make its long-distance network accessible to Svyazinvest until it could create its own fibre-optic and satellite links to join up the pieces in its telecoms jigsaw? Encouraged by the fact that theirs was now the only show in town, Stet’s executives settled down for some hard-nosed negotiation.
This was not on the Russian agenda at all. Already alarmed by Stet’s increasing unwillingness to meet their December 22 deadline for completion, the Russians found the Italians getting tough on the price. One investment banker who advised the government says angrily that, having bid high in the auction, Stet was trying quite openly to chip away at the price in the belief that the Russians were committed to a sale.
If that’s what they thought, their strategy didn’t work. Pressed by the Russians to close the deal, Stet listed its concerns – including tariffs and the access it would get to the Rostelekom network. Stet said that, until these were satisfied, it would pay money for Svyazinvest shares only into an escrow account. This was a deal-breaker. The Russians felt they had been ambushed. According to Elena Shalneva, a spokeswoman for the RPC, although Stet had listed similar concerns before, these had always been presented “in a very much more minor way”.
It remains to be seen whether the stand-off has wider political consequences. But for now, everyone has egg on his face. The RPC has failed to launch its showcase deal, strengthening the hand of those who argue that privatizations should be cosy domestic affairs, with the country’s banking cartel lending the government money in return for shares in state corporations. Stet has been told that whatever happens to Svyazinvest in future, it won’t be involved – although the Russians may be softening. “We don’t exclude entirely the possibility that Stet will be involved in a second auction, although it remains unlikely that they will be allowed to participate,” says Shalneva of the RPC.
And what of the international investment banks which handled the sale – the first that Russia has hired to conduct an auction. NM Rothschild, Barings and MC Securities are silent about the deal, but one banker says that they are “pretty cut up”, largely because their fees were “highly success-oriented”. There’s no guarantee they’ll get a second chance. When asked if the same team would be appointed for the next auction, a Russian official says tersely: “No comment.”
Jonathan Ford
THAILAND
Telecoms double act
Thailand’s privatization programme is moving about as fast as the capital’s infamous traffic jams. But the end of the road is in sight for the sell-off of two state-owned telephone companies, the Telephone Organization of Thailand (TOT) and Communications Authority of Thailand (CAT), with the government setting a five-year deadline and advisers being shortlisted for asset valuations.
The question now is whether Thailand’s mobile-phone-wielding investors will stump up enough cash to absorb the share issues being talked about.
A year ago the stock market looked invincible, but an election last July and fears about inflation put the Stock Exchange of Thailand (SET) Index into a spin for much of 1995, resulting in a drop of 5.4% over the year.
Salomon Brothers’ telecoms analyst in Bangkok, David Riedel, says a “back of the envelope” calculation values TOT at around $4 billion. Meanwhile, any privatization of CAT is hampered by the loss-making, overstaffed postal services attached to it.
The key lies in the structure of the privatizations and a controlled overall strategy. A Coopers & Lybrand-led consortium recommended in late 1994 that 49% of TOT should be retained by the government, 5% issued to staff, 25% sold to a strategic partner and the remaining 21% floated by the end of 1996. Realistically, TOT is likely to be floated by 1997 at the earliest and CAT by 1998, say analysts.
The government’s telecom master plan, recently approved by the cabinet, requires both TOT, which covers domestic calls, directories and public telephones, and CAT, which handles the postal service, international telephone calls, data services, and domestic mobile and paging services, to be privatized within five years. They must also be split, with the network remaining in government hands and only the service elements of the companies being sold off.
TOT has shortlisted around 20 foreign and local investment banks to carry out an asset valuation, which will be separate from any contract for commercial valuation. Hot contenders for the asset valuation are Merrill Lynch, JP Morgan and local finance and securities companies.
Once the valuations are complete, a strategic partner will be brought in, taking a 20% to 25% stake in TOT and working with the organization to restructure the business. British Telecom, Deutsche Telecom, Nynex, AT&T, Cable & Wireless, and Motorola are being touted as obvious candidates for a stake.
“The drift is that TOT is not going to survive in the long term unless it has a foreign strategic partner,” says Paul Ngo, an analyst at Barings in Bangkok.
Riedel’s valuation would mean around $1 billion of shares being offered to the public. He is confident the market can stand it, given that almost inevitably there would be an international tranche. “It’s not going to swamp the market like an Indonesian Telkom or Singtel [Singapore Telecom],” he says.
The amount is only one sixth of the market capitalization of Telecom Asia, Thailand’s second-largest listed company by market capitalization at Bt177 billion ($7 billion), he points out. Telecom Asia’s IPO in 1993 was the largest single offering to date and raised Bt12.265 billion ($500 million) through the sale of 10% of the company. The Thai stock market’s total capitalization is currently around Bt3,840 billion ($154 billion).
Despite a loss of confidence small investors haven’t forgotten the privatization bonanza a year ago when Thai punters trebled their money on the debut of the newly privatized Electricity Generating Company (Egcomp).
Egcomp’s 51% issue raised Bt4.5 billion ($180 million), with about 28% sold internationally. The shares almost trebled in value on their first day of trading, rising from Bt22 to Bt60. A year on, they are trading at around Bt86.
Many government sell-offs are born out of a pressing need to raise cash. With an eighth consecutive year of budget surplus and a growing economy, the Thai government has been in no hurry to offload its state enterprises. “There’s no rationale for rushing into a fire sale,” said a 1994 World Bank report.
Gill Baker
