Hutchison Whampoa: Exceptional Exceptionals

Apr 3, 2001

To 3G or not to 3G is the question facing many global telecos amid a slump in sentiment and valuation. But such concerns discount Hutchison WhampoaÆs massive war chest and chairman Li Ka-shingÆs record as a master asset trader.

Headline numbers fail to tell the full story of Hong Kong's largest conglomerate Hutchison Whampoa [13]. Despite a steep 70.9% drop year-on-year (yoy) in financial year 2000 net profit, StockHouse Logo the company is sitting on a pile of liquid assets worth more than HK$200 billion ($25.65 billion), leaving it well positioned to face a challenging year in the global economy and as a forerunner in the third generation (3G) telecoms market.

For the year to 31 December 2000, Hutchison Whampoa reported net profit of HK$34.1 billion, 70.9% lower than its record net profit of HK$117.4 billion in FY1999. The earnings shortfall was largely the result of substantially lower exceptional gains (HK$25.7 billion in FY2000 versus HK$109.5 billion in FY1999). On an ex-exceptional basis, the company reported earnings growth of 7% yoy to HK$8.38 billion.

Hutchison Whampoa FY2000 Exceptional Items

	($m)
Disposal of 50% interest in HK fixed-lines to Global Crossing	1,720
Disposal of 19% stake in HK Mobile to NTT DoCoMo	2,200
Exchange of Husky shares after merger with Renaissance Energy	4,222
Exchange of Mannesmann shares for Vodafone shares	50,000
Sale of 1.5% stake in Vodafone	1,600
Provision for investment in Vodafone	-34,000
Total	25,742

Source: Hutchison Whampoa Annual Report

The presence of exceptional items makes the job of putting a fair value on the stock particularly difficult. Ex-exceptionals, Hutchison Whampoa looks expensive on a PER basis. However, investors should bear in mind that an investment in Hutchison Whampoa is a vote of confidence in billionaire Chairman Li Ka-shing's ability to buy and sell assets, in which he has a proven record as a master trader. Looking ahead to the current fiscal year, exceptional gains will continue to account for a significant portion of the company's earnings.

The most significant exceptional gain for FY2001 is expected to come from the merger of VoiceStream Wireless [VSTR] and Deutsche Telekom [DT] in the second quarter of this year. Salomon Smith Barney estimates the sale of Hutchison Whampoa's 18.4% stake in VoiceStream will bring in an exceptional gain of HK$30 billion.

Ex-exceptionals, Hutchison Whampoa looks expensive on a PER basis. However, investors should bear in mind that an investment in Hutchison Whampoa is a vote of confidence in billionaire Chairman Li Ka-shing's ability to buy and sell assets, in which he has a proven record as a master trader.

However, Hutchison Whampoa's share price has taken a battering over the past few months. It lost 16% during the first quarter of the year amid negative news flow, a slew of earnings, NAV and target price downgrades, and bearish sentiment in the global telecoms sector.

"Hutchison's stakes in Vodafone [L.VOD] and Deutsche Telekom represent approximately 25% of its market cap. Therefore, its share price will continue to be affected by the performance of overseas telecoms shares, especially European telecoms counters," says Arthur Law, conglomerates analyst at Core Pacific-Yamaichi.

JPMorgan provides a clearer picture of the magnitude Hutchison Whampoa's share price malaise. It estimates that, "the current price (HK$80.25) has effectively factored in 30% write-downs for Vodafone and Deutsche Telecom, respectively. This effectively means Vodafone's share price would have to fall to ú1.00 ($1.42) and Deutsche Telekom's to Eu12.50 ($11)."

Vodafone closed last Friday at ú1.935, while Deutsche Telekom finished trading at Eu23.19.

In addition, the market has taken an extremely dim view of Hutchison Whampoa's European 3G investments. The company has acquired operating licenses in the UK, Italy, Austria and Sweden. Despite the high cost of entry and long payback periods, the company is upbeat about the prospect of 3G mobile services.

"We have full confidence in the future of 3G," Li said during the results announcement. "This will be an excellent business for Hutchison."

Hutchinson Li has indicated that Hutchison will seek one more European 3G, though he did not specify in which country. In addition, the company will be bidding for 3G licences in Asia, including at the upcoming Hong Kong auction-cum-beauty pageant.

Hutchison Whampoa will enjoy first mover advantage in the European market. While most of its competitors are facing financing concerns, the company is charging ahead and building its networks. It was announced on Monday that its UK 3G unit had secured a ú3.6 billion financing package. Hutchison Whampoa is expected to roll out its 3G services in the four European countries by next year.

Amid the continued bearish global sentiment towards telecoms shares, the share price of Hutchison Whampoa is likely to remain under pressure over the short term. However, on a longer-term horizon, further acquisitions and spin-offs could become share price catalysts. In a report following a meeting with group managing director Canning Fok, Merrill Lynch analyst Christine Leung said Hutchison would improve its ROE by means of acquisitions and spin-offs. Possible divestment targets include certain telecoms and port operations.

Hutchison Whampoa closed Monday trading at HK$82.50, down 35.7% from its 52-week high of HK$128.25 recorded on 3 April 2000. Although most analysts see little in the way of near-term share price catalysts, the current weakness provides an attractive buying opportunity for investors who believe in the old adage 'In Li we trust' .