Telecoms

Mixed messages

China Unicom announces big restructuring as new investors pay up

China-Unicom-w

Smart phone deal? Unicom gets a host of new investors, notably Tencent

Investing in telecoms carriers can be uninspiring but these utility firms typically offer stable cashflows and healthy dividend payouts.

Perhaps that explains their occasional attraction for some of the world’s internet bosses, who tend to head much riskier propositions.

Take Hong Kong’s Richard Li. His Pacific Century CyberWorks (PCCW) was the most sought-after internet stock in Asia in 2000 but he opted to merge his highflying firm with Hongkong Telecom, just when its monopoly in the former British colony was about to end.

Li later decided to sell a 20% stake in a certain start-up called Tencent for $20 million as part of a move to reduce debt levels after the leveraged buyout. That stake would be worth around $80 billion today. His Hong Kong Telecom investment has proved safe, but a lot less spectacular.

This kind of precedent didn’t stop Softbank’s Masayoshi Son from sinking $22 billion into Sprint, a struggling American telecoms firm, four years ago. The talk on Wall Street is that the Japanese internet mogul is trying to broker another mega merger between Sprint and other ailing American carriers including T-Mobile.

In China, the country’s tech tycoons have had their eye on the same kind of company, after agreeing to invest in China Unicom, the second biggest of the country’s big three state-owned carriers.

The proposed investment has taken a while to broker. A trio of internet firms first indicated in 2014 they would answer the State Council’s call for private sector capital and managerial experience at some of the country’s largest state-owned enterprises (see WiC236). Since then the so-called “the mixed ownership reform” process has been slow-going but there was a breakthrough last week as Unicom finally unveiled its restructuring proposals.

The reorganisation is rather complicated thanks to Unicom’s unwieldy shareholding structure. Firstly, Unicom’s parent firm has said it will raise about Rmb78 billion ($11.7 billion) by selling a 35% stake (involving both new and existing shares) in the company’s Shanghai-listed arm to 14 strategic investors including Baidu, Alibaba and Tencent (aka the BAT internet trio).

Then the parent firm will inject roughly the same amount of money into Unicom’s Hong Kong-listed unit.

Other private sector firms that have agreed to invest in Unicom include Alibaba’s e-commerce rival JD.com, retailer Suning, car-hailing firm Didi Chuxing and a company representing the interests of Unicom’s staff (which will have access to 2.7% of the share pool as part of an incentive programme).

The transaction will cut the state-owned parent’s holding in the telco giant to 36.7% from 63.7%. Private sector firms will get a combined 19% of Unicom’s Shanghai unit, with Tencent getting a 5% stake for Rmb11 billion.

Nonetheless, it’s newcomers from the state sector that will end up having the biggest slice of reconstituted Unicom, with China Life Insurance taking a 10.2% stake.

The China Structural Reform Fund, a Rmb350 billion private equity firm backed by the central government with a goal to finance restructuring of the SOEs, will purchase a 6.1% stake too.

The changes have stoked plenty of questions. To begin with, why don’t the newcomers just invest directly in Unicom’s Hong Kong-listed shares?

The explanation brings us back to 2002, when the China Securities Regulatory Commission allowed Unicom, which was already listed in Hong Kong, to go public in Shanghai as well. An exemption was needed because Unicom’s Hong Kong-listed unit is categorised as a “red chip”, which means it is incorporated offshore and thus not supposed to be eligible for an A-share listing. (H-shares, which are incorporated in mainland China and subject to CSRC rules, are also listed in Hong Kong. SOEs going public in Hong Kong in the 1990s normally took the form of red chips, such as China Mobile and CNOOC. But more recently the CSRC has insisted that state firms that IPO in Hong Kong do so as H-shares.)

To make the Shanghai listing possible, Unicom created a mainland incorporated vehicle which has no business except an indirect holding (via another unit incorporated offshore) in Unicom’s Hong Kong business. This controls most of the group’s Rmb600 billion of assets.

Unicom’s reform plan has effectively required its new shareholders to buy into this pricier layer of the company. According to Huxiu.com, Unicom’s Shanghai-listed shares were trading at a whopping 90% premium over their Hong Kong-listed siblings before the deal was announced. “Why are the likes of BAT willing to take part in Unicom’s reform with such steep premiums?” the tech-focused portal asked. “They would definitely be better off investing directly in Unicom’s Hong Kong unit.”

Chinese regulators seemed to have concerns over Unicom’s restructuring plan as well. It was first announced on August 16 via a stock exchange filing in Shanghai. In a matter of hours the circular was taken down. According to Caixin Weekly that was because the Rmb78 billion fundraising violated new rules issued by the CSRC in February that tightened the size and pricing of placements by A-share firms.

Unicom’s placement plan was republished last week after receiving “special approval from the State Council under mediation of different departments” including the CSRC, the magazine said.

The regulatory exemption, state media outlets explained, has been allowed because the changes at Unicom are seen as being of exceptional significance to the future of China’s bloated state sector.

Since the State Council kicked off the mixed ownership campaign in 2013, a number of state giants have undertaken restructuring but limited most of the action to their non-core subsidiaries. (For example, Sinopec has introduced private sector investors to its distribution business, while China Eastern Airlines restricted outside capital to its logistic division.) Hence the claim that something more groundbreaking is happening at Unicom. “To reform a SOE as a whole is revolutionary,” ThePaper.cn suggests. “Cutting the state ownership in a major SOE to less than 40%? No one would be brave enough to do this in the past.”

Unicom has reserved four seats of its 15-member board for private investors (and five seats for independent directors), with hopes that the changes might spark a new chemistry between the telecoms carrier and some of China’s most influential internet firms.

“With new investors on board, Unicom will likely revamp its business model to become a more open tech platform, adding competitive pressure to China Mobile,” a telecoms executive told Caixin Weekly.

How the mix of new shareholders (some of whom are deadly rivals) are going to contribute to Unicom’s future will become clearer with time. But more cynical voices point to the premium they have paid to invest in the Shanghai vehicle and portray the situation as an example of private sector giants like Tencent being made to do ‘national service’ by the govenment. And as for their own shareholders, in the best case scenario these minority stakes could lead to the safe but unspectacular returns referenced earlier in this article.

Elsewhere, the Party’s invisible hand is still working overtime to merge more of the major SOEs into more formidable national champions. The real estate conglomerate China Poly Group said last month it is planning to combine with Sinolight Corp, a provider of light industry materials, and China National Arts and Crafts Group. This week, the top coalminer Shenhua said it will join up with electricity provider China Guodian. The merged entity will have assets worth Rmb1.8 trillion, making it the world’s biggest power company.

These mega deals help to meet goals to reduce the number of centrally-controlled SOEs. But they hardly wave the flag for mixed ownership and a more market-oriented approach. That said, another upshot of the Unicom deal is that it puts to rest the speculation that it would merge with state rival China Telecom as a means to counterbalance the clout of the far larger China Mobile.


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