Sunday, July 18, 2004

Dueling Analysts on PLTL: Bullish Mr. BearBull, Bearish Random Walker

Here are two articles by high profile analysts engaging in a Piltel 'Bull-Bear' debate...
 
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A stock with certain growth potential
Posted: 0:43 AM 
Jul. 13, 2004
Ron Nathan
Inquirer News Service

NOTHING of importance has happened in the stock market this week, here or abroad, so I will write about a company instead.
 
My last recommendation was Petron Corp. at P1.80 and allowing for the 20-centavo dividend, anyone who bought it almost doubled his money.
 
Before that was Philippine Long Distance Telephone Co. (PLDT), which has risen to more than 5.5 times my original price of P226.
 
The first was on the basis of a guaranteed 11-percent return; the second, purely on the chart.
 
There were no fundamentals, but the technical indicators suggested minimal downside risk and large potential recovery.
 
Now I have a similar pattern, connected to the last stock, only this time with compelling fundamentals as well.
 
The stock is PLDT affiliate Pilipino Telephone Co. (Piltel), which was issued originally at P20 and went subsequently to a high of P44 before biting the dust.
 
After rising from a low of 28 centavos very rapidly, the shares have moved within a narrow range of P1.60 to P1.88 for the past four months.
 
Suddenly, just over a week ago, the price surged to P2 on unusually high volume of 43 million shares.
 
This constitutes a breakout and bearing in mind the length and narrow width of the base, a short-term target price of P2.55 looks likely. There should be good support at P1.88 so the current buying price of P1.94 has little downside risk.
 
In March, the PLDT group set in motion a series of events that will eventually make Piltel a very profitable and valuable company.
 
At the end of the day, PLDT's wholly owned Smart Communications will be both the majority owner (with a 92-percent stake) and biggest creditor (69 percent of debts).

Smart decided to acquire its equity and debt holdings in Piltel (stock symbol: PLTL) in order to access the latter's huge base of deferred tax assets, thereby reducing its own tax burden.
 
Management said that the only way to accomplish this is by revising the revenue-sharing agreement between Smart and PLTL.
 
The new split has not yet been disclosed, but from the current 50:50, I believe that it will be changed to 85:15 in favor of PLTL.
 
By shifting more revenue into PLTL, Smart will substantially reduce the tax it has to pay for its own account. At the same time, the profits of PLTL will surge.
 
For example, if we assume P15 billion in net cellular revenues for next year, the 35 percent difference between the old and new sharing schemes will result in P5.25 billion worth of additional revenue for PLTL. Because it has huge deferred tax assets, nearly all of the P5.25 billion will flow into the company's bottom line.
 
Thus, even with an expanded capital base of 11.77 billion shares, the 2005 earnings per share should be at least 50 centavos. Minority shareholders should therefore take the impending dilution in its stride because the company's recovery will accelerate rapidly in the coming months and the stock should follow suit.
 
Meanwhile, how high PLTL can go is anybody's guess. Assuming, an undemanding price-earnings multiple of 6, the shares should be worth at least P3.
 
Given its negative equity of over P22 billion, the company is unlikely to declare cash dividends before 2011.
 
On the other hand, the negative equity can easily be wiped out in four or five years, by which time, earnings per share should comfortably exceed P1.
 
Management has admitted that a 50:50 sharing is not fair to PLTL because it does not affect the true profitability of the company.
 
On the other hand, an 85:15 split would be unfair to Smart in the long run because it is the one that is making all the investments for the cellular infrastructure upon which PLTL is dependent.
 
After the deferred tax assets are eventually depleted, I expect that the revenue sharing will be shifted again and that a compromise would be reached at around 60:40.
 
This will allow substantial profits to remain with PLTL and at the same time allow Smart to earn a good return on its investments.
 
Smart will always have the best interests of PLTL in mind. As mobile penetration reaches the lower income groups, Piltel's Talk 'N Text will be the brand of choice.
 
Already, Piltel's subscriber base is foreseeable future, and so the firm will remain profitable in the long term.
 
PLTL, therefore, represents a near-term recovery story as well as a play on the industry's substantial future growth.
 
It was noticeable that this week most of the advertising was on Talk 'N Text instead of Smart.
 
What will happen to the eight percent still in the hands of the public? It is quite possible that Smart will let it be, although it slightly reduces the maximum advantage it can get from Piltel's tax losses of P50 billion.
 
It might decide to bid when PLTL has paid off all its debt to Smart and redeemed its outstanding preferred shares.
 
The only problem is that by then the shares will be worth much more, and eventually large dividends could be paid out.
 
This is an ideal stock for pension funds, insurance companies, bank trustee departments and anyone who does not need income but would rather hold a stock whose inherent value is steadily accumulating.
 
I do not expect the original buyers to see their money back (anyway they probably committed suicide years ago,) but I can envisage a price of P6, five years from now.
 
My 85:15 split is admittedly a guess, but Smart will announce the actual figure within the next month. If I am anywhere close, analysts will be doing their calculation and extrapolations, and foreign brokers might then get interested as the telecom sector is their favorite.

If this should happen, my short-term target could be comfortably exceeded.

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A Smart exit strategy from Piltel
Noel G. Reyes
Random Walker
Businessworld, July 14, 2004
 
An astute reader made some keen observations about last week's column, "Why Smart and Piltel cannot wed," and I must admit, he pointed out a number of flaws in the 1,000-word column that I had to rush off in less an hour last week.
 
At any rate, the reader (name withheld on request) added in his e-mail: "I hope I've made sense. Obviously, I'm bullish on the stock [of Piltel]. And I have to admit that I do own a small number of Piltel shares. But I believe my objectivity is intact and that my optimism is well-placed. Of course, I may be wrong so please comment on any error made."
 
So now I am taking him up on that last request for a comment on his comments.
 
He makes three major points:
 
first, on the planned change in revenue sharing between Smart Communications, Inc. and Pilipino Telephone Co. (Piltel);
 
second, on any potential leakage of these revenues to the minority shareholders of Piltel; and
 
third, on whether or not Piltel can be a viable stand-alone business even after its tax assets will have been depleted in two years.
 
On the first point, he wrote:
 
"As you mentioned, the revenue-sharing agreement between Smart and Piltel will need to be revised in order to take advantage of the latter's deferred tax assets. Assuming PhP17 billion in cellular revenues for 2005 and a shift in the revenue split from 50:50 to 80:20, Piltel stands to earn PhP5.1 billion more next year under the new sharing scheme as compared to the old one. Practically all of this will flow into the company's bottom line and is equivalent to 43 centavos per share based on the enlarged number of shares outstanding (PhP5.1 billion/11.77 billion shares). Thus, even with the huge dilution minority shareholders will experience, they will still come out far ahead vis-a-vis their position if the debt swap/Smart buy-in had not occurred."
 
A possible weakness in his reasoning here is that the assumed PhP17 billion in revenues for 2005 takes for granted that Piltel's revenues would continue to grow at a 30% to 35% clip this year and next year, the same as the past two year's average growth. On the other hand, a mere 30% growth in revenues this year would not be enough for Piltel to take advantage of the PhP10.2 billion in deferred tax assets, otherwise known as net operating loss carryover (NOLCO), that would be expiring this year. Another PhP3.3 billion worth of NOLCO would be expiring next year.
 
The tax benefits of both, at the statutory 32% corporate tax rate, are equivalent to PhP4.32 billion -- this represents the amount of tax savings available to Piltel if it had enough taxable income to cover it.
 
In other words, if Piltel and Smart were to rely solely on the existing Facilities Service Agreement signed in April 2000 (amended in December 2003), then part of the rationale for Smart's purchase of a major portion of Piltel's debt and 85% of its equity would collapse like a house of cards.
 
The agreement covers Piltel's use of Smart's GSM service network and facilities, which service it markets under the Talk 'N Text brand. For such usage, Piltel pays Smart a combination of fixed and variable fees. These fees last year amounted to PhP1.4 billion for interconnection and PhP4.25 billion as Smart's direct share in Piltel's GSM revenues; altogether, both fees came to almost 55% of Piltel's subscriber revenues of PhP9.77 billion.
 
Even if the terms of these fees were dropped to zero percent, meaning all PhP5.3 billion of last year's fees would immediately drop to Piltel's bottom line, this won't be enough to take advantage of this year's expiring NOLCO of PhP10.2 billion.
 
Since it would be a total waste of available resources not to take advantage of that huge NOLCO, Smart obviously needs to channel some of its own revenues into Piltel this year. This is where a new marketing agreement could come into play.
 
On this account, Napoleon Nazareno, president of Smart and its parent, Philippine Long Distance Telephone Co. (PLDT), has some interesting words. "We haven't really done the level by which we would allocate the value to Piltel to take advantage of the NOLCO," he was quoted as saying. "So I am not sure if (Piltel's share price of) PhP1.90 correctly factored in the potential of Piltel."
 
Meanwhile, the reader made a second point:
 
"As for the 8% leakage, it won't necessarily materialize or, if ever, it will happen more than a few years from now. Dividends on the common shares can be delayed for a number of reasons. The most basic hurdle is that Piltel does not have retained earnings out of which to declare dividends. Since it has an accumulated deficit of over PhP50 billion, it will take six or seven years (even with the revised revenue sharing deal) before it turns positive again. Secondly, to avoid the leakage, management will pay off its debts first. Since Smart is now Piltel's biggest creditor, most of the cash used to pay down debt will accrue to the mother company. Third, Piltel still has 4.9 million Series J preferred shares outstanding all held by PLDT (not sold to Smart) which has a dividend of PhP90 each per annum and a redemption (due starting 2015) price of PhP1,000 per. Thus, on the Series J alone, Piltel can plow back nearly PhP12 billion back to PLDT."
 
This was an error on my part. It is true that Piltel, or any company for that matter, cannot distribute profits to its shareholders while it maintains a capital deficit in its books. In Piltel's case, it has a deficit of PhP59 billion as of last year in its capital account.
 
On the other point, that Smart could get out its cash flow out of Piltel through loan repayments, that is so brilliant -- the kind of thinking that I have come to expect of the people in Smart and PLDT.
 
Another outlet for the channeled cash flow from Piltel into the books of Smart and PLDT would be the Series J preferred shares issued by Piltel to PLDT. These shares have an annual cumulative divided of PhP90 per share.
 
Furthermore, Piltel may start redeeming these shares at issue value plus any unpaid dividends on the fifteenth year after issue (2015) or even earlier, upon "full repayment of the restructured indebtedness of Piltel "
 
Still, no matter how ingeniously these cash flow outlets and conduits tie in together, they all hinge on whether Piltel can generate enough revenues and cash flows.
 
"Finally, on whether or not Piltel can stand on its own two feet after the deferred tax assets are all used up, we believe that it can. Even without the change in the revenue-sharing pact, Piltel already posted a profit in Q1. Admittedly it was small at PhP8 million, but the new revenue split will accelerate the company's recovery and allow it to pay off its debts. Furthermore, the firm's subscriber base is rising faster than the industry average. This may be due to the fact that mobile penetration is reaching the lower income groups more and more. Since Piltel is focused on the low end of the market, it will most likely reap a big portion of the industry's future growth. Thus, once its debts have come down to a reasonable level, Piltel can remain profitable even without the benefit of its deferred tax assets. Some people, meanwhile, fear that the revenue-sharing scheme will revert to 50:50 once the deferred tax assets are used up. Management, however, has indicated that it will not flip-flop on this issue."
 
Piltel does not have much time before the prince possibly turns back into a frog. Its deferred tax assets would run out in 2006. After that, it would have to be valued on its own, mainly on the merits of its single brand, Talk 'N Text.
 
With this brand's focus on the low-income segment of the subscriber spectrum, Piltel needs to be, and remain, a low-cost producer.
 
With only one employee, the company obviously doesn't have much elbow room to cut costs further.
 
Its biggest costs, on the other hand, are the interconnection and revenue-sharing fees it pays to its major shareholder, Smart.
 
Piltel, thus, has no choice, but to live and die on the direct benevolence of Smart when it comes to these fees.
 
And that, to me, represents a considerable risk.

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