Some Thoughts On The PLDT’s Buyout Of Digitel

Investing without research is like playing stud poker and never looking at the cards. - Peter Lynch

The story of the week belongs no less than to the buyout of Taipan Gokongwei owned Digitel Telecommunications [DGTL] by the largest phone company and publicly listed firm Philippine Long Distance Telecommunication [TEL].

PLDT’s Buyout of DGTL Provides Bulls The Excuse To Bid Up Markets

Figure 2: Recovering Phisix Buttressed By PLDT Buyout Story

It would be inaccurate to say that the PLDT-DGTL story entirely drove the domestic market higher.

The fact that MAJOR ASEAN markets were significantly higher this week, only suggests that bullish sentiment underpinned the markets in the Philippines and among our ASEAN contemporaries.

In addition, the Phisix (red bar chart in Figure 2) has been recovering even prior to the recent spike in PLDT (black candle) share prices last week.

Figure 3: Weekly Sectoral Performance

Besides, while the service sector vastly outperformed the general market led by PLDT rival Globe Telecoms [GLO] (up 22.3%) which ironically eclipsed PLDT’s superb (16.4%) gains over the week, even if Globe had been outside the buyout story, the Phisix which surged by an astounding 6.5% was also driven by advances from the broader market.

Yes, all sectors registered positive gains (figure 3). But only the service sector posted gains far above the Phisix while the financial sector was nearly at par with that of the Phisix. All the rest underperformed.

This means that the extraordinary surge in PLDT prices has materially influenced the gains of the Phisix, given that PLDT commands the largest share in terms of market cap weightings of the Phisix basket.

In other words, the PLDT-DGTL buyout story has nudged the overall market higher. Bulls, whom have been looking for a crucial excuse to bid up the markets (as shown by the gradual ascent prior to last week), appears to have found one in the PLDT-DGTL narrative.

Figure 4: Rotational Effects In Play

Yet this week’s exemplary actions have nearly closed the year-to-date deficits of the various sectors in the Philippine Stock Exchange including the Phisix.

As of Friday’s close, the Phisix is just down 1.7% from the start of the year.

But the more important story is one of the rotational effects.

The tale of the two sectoral outperformers (service and financials) for this week is a splendid manifestation of the Livermore-Machlup model[1] in action-where stock price movements are largely or mainly influenced by inflationist policies (Machlup) which can be empirically observed by relative price actions (rotations) but results to increases in general price levels overtime (Livermore).

Both these sectors have alot of catching up to do, considering that both have lagged the general market as shown above. In short, erstwhile laggards have turned into leaders.

This is further evidenced by the turnaround in the ALL shares index which has popped to the positive zone. This also means that the broader market has been substantially outperforming key Service and Financial issues until last week.

Yet if the tailwinds should persist to fuel the bull’s newfound momentum in the coming sessions or weeks, where the former laggards, many of which constitute as the core Phisix heavyweights, should spearhead an accelerated recovery, then we should see the Phisix clamber out of the rut and possibly post hefty positive returns by the end of April.

Stake In PLDT: Taipan Gokongwei’s Dream Come True

As we earlier said, the bulls found a pretext to fillip the markets, which was through the announcement of PLDT’s buyout of rival company Gokongwei owned Digitel [DGTL].

Here are some information on the buyout as per PSE disclosure[2]

Almost the entire transactions for the buyout (or 51.5% of DGTL) will be executed and financed via share swaps.

A tender offer will be made to the minority shareholders at a ratio of 2,500 pesos or 1 PLDT share for the equivalent number of DGTL shares held—valued at 1.60 per share.

The value of transactions for the Gokongwei owned shares are at php 69.2 billion. If an all cash outlay for the minority tender will be incorporated, the transaction value would rise to php 74.1 billion. If it will be an all share swap transaction minority plus the Gokongwei group will own 13.7% of PLDT. Definitely, the tender offer will translate to somewhere in between (cash tenders or PLDT swaps).

The completion of the buyout would mean that the Gokongwei flagship company JGS summit would hold 12.8% of PLDT.

Ascertaining the derivative value per share of the PLDT’s acquisition of DGTL seems ambiguous because it includes other matters that had not been appropriately detailed—such as the treatment of DGTL’s zero coupon convertible bonds which represents an approximate 18.6 billion of shares (or php 29.76 billion @1.6 per share-my estimates) and DGTL’s intercompany cash advances of 34.1 billion.

If we add both the intercompany cash advance with the estimated convertible bond equivalent, then the net value of the transaction would tally to php 63.86 billion. Thus, the variance between the broadcasted prices of the deal at php 69.2 billion and the above (cash advances plus bond convertible) or php 5.34 billion could have represented as goodwill money.

Digitel’s current outstanding shares is at 6,356,976,310 (PSE data) while the 51.5% stake involved in the PLDT buyout transaction is declared at 3,277,135,882 shares.

Simply dividing the net declared amount of php 69.2 billion with the outstanding or with the 51.5% stake or even including the 18.6 billion shares (from zero bond convertible) would result to prices far above the current share value. This is not to imply of an undervaluation, but of the black area arising from the incompleteness of the divulged or disclosed information.

The more important issue for me is that the Gokongwei group has been eyeing a significant stake in PLDT since October of 2002. The botched attempt in 2002 had been predicated on conflict of interest issues from the former’s ownership of Digitel[3].

Apparently this time around, the conflict of interest issue has been circumvented or resolved by using DGTL as the key vehicle for Gokongwei’s long wish to gain a foothold at PLDT.

I am partly puzzled by the seeming obsession of Taipan Gokongwei to secure a stake on PLDT despite some makeover in PLDT’s business model from the 2002 and today.

PLDT has branched out to the energy industry through a substantial claim on Meralco’s equity[4].

Meralco, as we have earlier written[5], epitomizes the Philippine brand of state capitalism. Meralco’s legalized monopoly translates to economic rents for the economic clients of the high echelon political patrons. Remember, Meralco’s pricing system is controlled by the Energy Regulatory Board (ERB) an agency which is directly under the Office of the President. In short, the President of the Philippines decides on how much these private sector owners of the energy monopoly franchise earns[6].

Though of course, Gokongwei’s passion for PLDT could also be due to the latter’s stranglehold of having the significant majority in the market share of the mobile business in the Philippine telecom industry.

Figure 5: nadventures.com[7] mobile market share

My naughty (outside the box) mind whispers to me that this buyout, which has its roots since 2002, could also have been incented from either flows of political money trying to find a legitimate front or that such acquisition could have operated from more from political incentives than from an economic one.

Nevertheless, my suspicions are just that...suspicions until evidence can back these up.

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[1] See Are Stock Market Prices Driven By Earnings or Inflation? January 25, 2009

[2] Digitel Telecommunications, JG Summit To Acquire Stake In PLDT In All-Share Transaction, Philippine Stock Exchange, March 29, 2011

[3] CNN.com Gokongwei still eyeing PLDT stake, October 3, 2002

[4] Philstar.com PLDT buys 20% Lopez stake in Meralco, March 14, 2009

[5] See Bubble Thoughts Over Meralco’s Bubble August 2, 2009

[6] See Has Meralco’s Takeover Been A Good Sign?, March 22, 2009

[7] Zita, Ken Philippine Telecom Brief (Network Dynamics Associates) nadventures.com

Philippine Telecom Industry: Buyouts And Mergers Don’t Kill Competition, Laws Do

“The consumers suffer when the laws of the country prevent the most efficient entrepreneurs from expanding the sphere of their activities. What made some enterprises develop into big business was precisely their success in filling best the demand of the masses.”-Ludwig von Mises

One thing we can be sure of is that the PLDT buyout of Digitel will reduce the mobile network providers to two major players (Figure 5).

This comes to fore the next important issue: Some politicians have been pondering on expanding political power to avoid “killing a strong competitor”[1] by impliedly calling for the institution of anti-trust laws.

This represents sheer hooey.

Figure 6: ITU/DOTC: Regulatory Framework On Philippine Telecoms

The path towards the monopolistic character of our telecom industry is a product of our existing laws[2]. (see figure 6)

One, there is a constitutional limitation on foreign ownership in public utilities to 40%.

Two, licenses per se are not issued to telecom service operators in the Philippines unlike many countries. Instead, operators are required of a legislative franchise (issued by Congress).

Three, another requirement is the certificate of Public Convenience and Necessity issued by the National Telecommunication Commission (NTC), and

Lastly, approval to provide telecom service via grant authority for operation also from the NTC, which usually covers a provisional period of 5 years.

The above is a manifestation of the huge structural obstacle imposed against companies wishing to enter and compete with present participants in the telecom industry.

Such regulatory labyrinth represents as the anti-competitive anti-business nature of the Philippine business climate that enables such monopolistic character to take place because it substantially raises the barriers to entry, increases the hurdle rate for investors just to comply with these web of statutes and whose success to secure license-to-operate would depend on the whims of venal politicians.

Imagine, any business entity wishing to enter and compete with the entrenched bigwigs would need huge sums of lobby money to get a franchise, and to outbid the existing companies protected by these laws, who would likewise spend enormous amounts of lobby money to oppose their entry!

And that’s not all. There are other administrative regulatory compliance costs such as the NTC requirements et. al. with which prospective new players need to deal with.

So in effect, alot of productive capital will go down the drain just to acquire licenses, pay regulatory fees, and also to oppose entry of competition! And alot of those wasted money would only go to the pockets of these grandstanding politicians and the bureaucrats. And this doesn’t even count on the productive time lost to secure licenses and to comply with such regulations.

The point is: Buyouts and mergers don’t kill competition, (anti-competition) laws do.

These politicians are barking at the wrong tree!

Yet by adding more layers of legal impediments to an environment already stultified by barriers of anti-competitive laws will only punish consumers and reward politically connected persons (Could this also be the reason why Gokongwei is very much interested with PLDT?)

What these politicians should instead do to enhance competition is to dismantle the constitutional restrictions on foreign ownership of the domestic telecom industry, liberalize investments by revoking the need for Congressional franchise, and to streamline administrative regulations. I might add that income and capital gains taxes should likewise be substantially reduced, if not abolished.

Surely, in a blink of an eye competition will flourish.

Also, for politicians to claim that they can politically impose competition is nothing but sheer absurdity.

Using monopolistic coercion to induce competition only translates to institutionalizing crony capitalism and corruption.

Investors operate on the discipline and incentives of profit and loss. An unviable project will not be undertaken by free market agents. Coercing institutions to “compete” would only translate to endowments of political privileges to ensure the viability of favoured political economic agents.

Thus, crony capitalists have little intention to please the consumers but would work steadfastly to satisfy the desires of their political masters whom they owe their economic rent privileges.

Nevertheless competition is not about the number of companies.

Competition, according to Murray Rothbard[3], is a process, whereby individuals and firms supply goods on the market without using force. To preserve "competition" does not mean to dictate arbitrarily that a certain number of firms of a certain size have to exist in an industry or area; it means to see to it that men are free to compete (or not) unrestrained by the use of force.

In short, even if there are only two players in the industry, for as long as they are free to compete without political restraints then marketplace competition will prevail. All politicians have to do is to lay their hands-off these firms.

But with the huge profits the industry has been raking (even if they have recently been declining[4]), the temptation for politicians to dip into them seems so irresistible. That’s one of the reasons why politicos have been looking at various ways to intervene and call for more regulation of the industry; remember proposals by politicos to impose free texting[5]? Or how about recent clamor to have prepaid cards registered[6] in the name of security?

For politicians, profits signify signs of evil or misconduct. Only they deserve to profit by pocketing on more revenues (legit or otherwise) by forcibly extracting or extorting from productive agents. And it is one reason why publicly listed companies would be incentivize to dampen income or profit reporting by padding on expenses (or spend on lobbies)—to keep away from the prying eyes of the envious the political class. Achieving inefficiencies translate to lost productivity which means reduced capital accumulation or wealth and more unemployment and poverty.

Like in most cases, politicians and their apologists always put up a strawman, embellished by noble intentions, to justify their interventionist desires. Yet like in most instances unintended consequences defeats such noble intentions.

We should be vigilant against these forces who always work to curb our freedom.

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[1] Inquirer.net Solons fear monopoly to rise from PLDT purchase of Digitel, March 31, 2011

[2] International Telecommunication Union (ITU) Pinoy Internet: Philippine Case Study, March 2002

[3] Rothbard, Murray N. Abolish Antitrust Laws, Mises.org

[4] Inquirer.net PH telecom companies facing tough challenges, February 26, 2011

[5] See Why Forcible “Free Texting” Will Only Lead To Increased Poverty, June 1, 2008

[6] Abs-cbnnews.com NTC powerless vs SMS rumourmongers, March 15, 2011