Tackling Telekom Malaysia

Malaysia’s corporate makeover

Surachet aims high with Aseambankers

UEM provides reform blueprint

THE TELL-TALE sign is in the price. When Khazanah, the Malaysian state’s investment arm, became the first borrower to issue an Islamic exchangeable bond in late September it chose Telekom Malaysia as the counterpart into whose shares the bonds can be exchanged.

TM is the biggest firm in Khazanah’s portfolio, and, as such, is most closely associated with the mainly historically pedestrian performance of Khazanah’s various holdings. In the past year, however, as part of Khazanah’s drive to overhaul the companies in which it owns stakes, the telecoms operator has started to clean up its act and make headway in its restructuring. Revenues are up, costs are down and the company’s total outstanding debt is less than 33% of its assets, fulfilling one of the criteria for Shariah compliance.

The success or failure of the exchangeable, for which UBS, HSBC Amanah and CIMB Islamic acted as lead arrangers, would be a good guide as to whether investors believe in the reform story and the price would be the most telling sign of all.

Luckily for Khazanah and TM the deal proved a big hit. The final issue size of US$750 million was a 50% increase on the original amount offered. Moreover, it was priced in the middle of the marketed range of between 32.5 basis points below five-year swaps and 32.5bp over. The conversion premium was set at 19%, having been offered at between 17% and 20%.

A broad spectrum of investors bought the bonds, with about one-third going to hedge funds, just under a quarter to outright convertible bonds and equities funds, 15% each to conventional Middle East buyers and Islamic investors and the rest to proprietary trading desks.

The deal is being heralded as an important step in the reform process of the GLCs. If the bonds convert, Khazanah’s stake in TM will fall to 32.7% from 40%. Although Khazanah would remain as the company’s biggest shareholder, the move to attract more international investors indicates the government’s willingness to accept a more transparent investment policy, say market observers. Only time will tell if that analysis proves correct.

For its part TM, which has a dominant market share in fixed-line services and is the country’s second-biggest cellular services provider, is beginning to turn its fortunes around, albeit gradually. The company has restructured, cutting the number of divisional managers reporting to Dato Abdul Wahid Omar, group chief executive, to four. Certainly, since Abdul Wahid’s appointment in July 2004 – he was formerly head of fellow government-linked company the UEM Group – Telekom Malaysia has undertaken changes for the better and this is reflected in some of its financial statements. The company’s ebitda for the first half of the year improved 18% year on year to M$3.5 billion (US$951.6 million), for example. Profits before tax (excluding the impact of foreign exchange) jumped 28% over the same period.

Regional expansion

“The improvement in operating revenue was largely due to the growth in cellular and internet multimedia services as well as increasing contributions from our international operations,” says Bazlan Osman, group chief financial officer.

Like many Malaysian companies, the telecom operator is expanding its services regionally. TM is active in nine countries. In March, the company bought a 49% stake in India’s Spice Communications for just under $180 million. Spice is a privately held company providing mobile services in the states of Punjab and Karnataka. “India is the missing piece in our regional footprint,” said Tan Sri Mohd Radzi Mansor, chairman of TM, at the time. The acquisition, he adds, “strengthens our regional presence and complements our existing presence in Sri Lanka where we are number one and Bangladesh where we are the number two mobile operator”.

The Spice transaction followed moves in February to acquire Thailand’s Samart Corp’s 49% stake in Cambodia’s Casacom and a 24.4% stake in Samart subsidiary Samart-I-Mobile.

TM’s portfolio of regional investments, which accounted for 24.5% of consolidated revenue in the first half of the year, up from 10.2% previously, is expected to drive its earnings growth in the long term, according to Fitch Ratings.

Still, these improvements cannot hide the fact that the company is falling short of some of its key performance indicators. “The 2006 KPIs, which were announced in the first quarter are stretched and taking into account the declining contribution from the group’s fixed-line business and competitive pressure in the domestic mobile market, achieving them would prove a challenge,” says Osman. “Nevertheless, the group is focused on improving the profitability of its core businesses while building on its execution capacity and has taken the first step with the launch of a performance improvement programme.”

The KPI targets for this year include revenues of M$17 billion and an ebitda margin of 45.9%. However, according to its first-half results, TM’s revenues reached only M$7.8 billion, while the company’s ebitda margin was 44.5%. Its net debt to equity ratio rose to 0.4 from 0.27, although Osman says that was largely due to a reduction in cash balance from international acquisitions, a one-off payment following an arbitration case and increased debt from the consolidation of XL, its Indonesian subsidiary .

Price competition hits home

Pushing these indicators up will not be easy. Fitch warns that TM faces considerable hurdles, not least a decline in its domestic fixed-line business because of increasing competition from internet and mobile providers. The company’s fixed-line business contributes about a half of its overall revenues but it has not shown growth for two years. For that reason, TM is keen to push its broadband service aggressively. The company is also in discussions with the authorities to deregulate fixed-line telephony rates to allow it more flexibility in pricing its offerings.

Another potential hazard in the domestic market is intense price competition in the cellular sector, pushing down average revenue per user. “We are strong in terms of customer numbers but our priority is gaining a bigger market share in terms of revenue,” admits Osman.

TM, moreover, faces several challenges on the cost side of the balance sheet. “Cost management throughout the group will indeed be a main priority to improve margins moving forward,” said Abdul Wahid earlier this year. But costs as a percentage of revenue for the first half of 2006 stood at 81.2%, virtually the same as the corresponding period in 2005.

Cost cutting

One of TM’s problems is that the company is bloated, and big layoffs in Malaysia are still a taboo. Last year, it had to implement a voluntary redundancy scheme to shed 10% of its staff. Further reductions will be needed if it is to realize its full potential. Trade unions in Malaysia, however, remain a powerful force and dismissing staff is not easy.

Other areas that company management is looking at more closely include contracts and maintenance. In April, the company set up a new division, which oversees procurement policy.

At least, also in compliance with Khazanah guidelines, the company is trying to instil greater discipline. All senior management personnel are on fixed three-year contracts, whose renewal is dependent on performance. In addition, almost all employees are given incentives through share options based on performance and loyalty. But as one banker in Kuala Lumpur says, with reference to all of Malaysia’s government-linked companies, the issue is not one of whether these companies are reforming – they are. It’s whether they are reforming quickly and aggressively enough. The same is true of TM as of all the others. Osman admits that it’s not a lack of plans but rather to improve TM’s execution capacity that is key to its future success.