A towering offer

It is the stock market flotation which, to some, seems to come from another era. For if the 2000s were punctuated by the listing of one after another major state-owned enterprises from China, then the 2010s have been all about the private sector, particularly China’s dynamic tech companies.

And yet here comes China Tower Corp (CTC) – which is one of the country’s largest state-owned enterprises by asset size and could go public on the Hong Kong Stock Exchange at the end of this month.

China’s three major telecom carriers accessed the public equity markets almost two decades ago, but the infrastructure arm they cofounded is a much newer creation. It was set up only three years ago after the government forced the trio to hive off their infrastructure assets – mainly base stations – into a new vehicle.

CTC’s initial public offering is all the more symbolic given it is following hard on the heels of Xiaomi, one of the most hotly anticipated new economy listings in years. However, volatile market conditions have hampered the smartphone maker’s trading debut.

Xiaomi managed to scrape home with a valuation that was only half of what its management had been hoping for after raising HK$37 billion ($4.7 billion) at the end of last month. Can CTC beat that? Will it be a case of the “revenge of the old economy,” as the South China Morning Post puts it?

Local newspapers have been bandying around a $10 billion IPO size for CTC. That would make it the territory’s fifth largest flotation after Bank of China.

However, this number is based on earlier estimates and far more benign market conditions – i.e. before an all-out trade war between China and the US pushed every single one of Asia’s benchmark country stock market indices into negative territory for the year.

One of its key shareholders, China Mobile, might have a lesson to share on how to brave a tough market. During the day the carrier started trading in Hong Kong (then as China Telecom) in October 1997, the key Hang Seng Index plunged more than 1,000 points as the Asian financial crisis began to unfold.

No wonder CTC’s bankers are taking a wait and see approach before deciding whether to hit the launch button.

If the deal progresses beyond pre-marketing, which began on Monday, it will almost certainly end up being far smaller than $10 billion, particularly as CTC has applied for a regulatory exemption to sell less than 25% of its equity.

Based on a 15% freefloat and a 10% IPO discount, the deal’s two sponsors have assigned a fair valuation that respectively spans $32.8 billion to $42 billion and $40.5 billion to $51.1 billion. At the mid-point of both ranges this suggests an offering of around $5.6 billion to $6.9 billion.

Financial analysts have been fairly positive about CTC given its monopoly position and its highly visible cashflows, which may play well at a time when investors are looking for defensive assets to hide in. And there is no doubt that the company is a towering presence within its own sector.

At the end of 2017, it had 1.87 million towers: more than all the world’s listed tower companies combined. By comparison, American Tower Company (ATC) had 150,000 towers, while India’s Bharti Infratel had 162,000.

(Even China’s second largest player, Guodong Tower, is bigger than most other Asian comparables. The private sector firm has a miniscule 0.77% market share, yet its 17,260 towers beat Indonesia’s Protelindo’s 15,167, for example.)

The more bearish financial analysts point out that despite CTC’s sheer size it is not so good at extracting cash from them. Smartkarma analyst, Chris Hoare, argues that lease rates are very low and it seems like a classic case of an owner-dominated tower company where the aim is to reduce costs for the operators not boost profits for the tower company.

CTC’s three main shareholders – China Mobile (38%), China Unicom (28.1%) and China Telecom (27.1%) – have done a good job extracting discounts every time their contracts come up for renewal, which is far more often than other global tower companies. In July 2016, they managed to achieve a 7% to 10% discount and in February 2018, a 4% to 9% discount.

At the end of the last round of negotiations, the discount for two operators co-sharing one tower rose from 20% to 30% and from 30% to 40% for three operators. The contract is up for renewal again in 2022.

How well the IPO is received may pivot around 5G: how much investors think it will cost China and how those costs are likely to be split between the telecom operators and CTC. In CTC’s preliminary prospectus, Frost & Sullivan estimates 5G investment will amount to Rmb1.2 trillion ($181 billion), roughly similar to 4G.

Analysts believe CTC will end up accounting for about 25% of the total. However, there may be hidden costs if the three telcos decide to defray some of their own 5G expenses by pushing CTC to offer them bigger discounts.

China’s 5G capex also means that CTC is unlikely to pay much of a dividend for the first couple of years, nor generate any free cashflow. But its IPO is likely to help the company to reconfigure its balance sheet and improve its efficiency ratios.

At the end of 2017, CTC had net debt of Rmb148 billion, with Rmb95 billion of this short-term, which pushes up its financing costs.

As a result, CTC’s net margins are very low by industry standards – 2.8% at the end of 2017 compared to 18.6% at ATC and 37.7% at Bharti Infratel. Consequently, analysts expect CTC to use IPO proceeds to partially repay short-term debt and finance 5G capex using longer-term debt.

Investors’ other main consideration is CTC’s growth prospects. The company has a much lower tower-sharing ratio than its peers: 1.43 at the end of 2017 compared to 1.9 at ATC and 2.35 at Bharti Airtel.

This either shows it is not operating very efficiently or has plenty of upside. Management argue the latter and also point out how the ratio has improved from 1.28 at the end of 2015 when CTC was first formed. So too, the sharing ratio on newly leased towers stood at 72% in September 2017 compared to 14.3% before CTC was established.

The Chinese government has clearly achieved its aim of bringing down the industry’s overall capex costs by encouraging domestic players to share infrastructure. The number of towers should also grow strongly thanks to 5G, with analysts predicting 2.4 million towers by 2022.

Then there is still a 4G legacy rollout since China still only has 71% 4G national coverage compared to 97% in the US. Frost & Sullivan estimates this factor alone will prompt a 6.7% annual growth in 4G base stations through to 2022.

And CTC may well be able to cut costs further by extending its ‘sharing model’ with other towering state behemoths, including the State Grid and Southern Power Grid. In April, it signed a cooperation agreement to use the former’s 2.91 million pylons and the latter’s 5,300 electricity transmission towers for telecom base stations.

Over the longer term, CTC also has ambitions to transmit far more than just data. As we first reported in WiC372, CTC would like to use its infrastructure expertise to build a national network of electric car charging stations.

So far this has yet to materialise and it is an upside option, which analysts have not baked into their growth forecasts. At the end of 2017, non-telecom revenues amounted to just 0.2% of sales. If the IPO does well, it may even boost its three telco owners. Their valuations have languished behind their regional peers for some years because of concerns about the extent to which government interference means they are not run for the benefit of minority shareholders.

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