The Privatisation Commission appears to have been caught in the crossfire between its Advisors on the strategic management sale of Pakistan Telecommunication Company Limited, who are threatening to walk away from the deal if the government decided to break up PTCL into various entities under the garb of restructuring as proposed by the Regulator, Pakistan Telecommunication Authority (PTA).
In order to counter the detailed arguments put forth by the consortium comprising Goldman Sachs/J.P. Morgan, advising PC on privatisation of PTCL as an integrated entity, PTA has sought the help of consultants through an advertisement for hiring their services.
It can pertinently be asked: How can a regulator seek advisory services to break or even restructure a company it is legally obligated to regulate? Is there someone that has to be favoured to buy a lucrative piece--spun off from the Pakistan Telecommunication Company Limited, and, a "so called" expert is needed to rubberstamp the recommendation?
These are the questions being asked by people "who smell a rat", in the privatisation of PTCL.
The Director (Co-ordination), Pakistan Telecommunication Authority (PTA), Islamabad, has issued the Terms of Reference on PTCL restructuring and sought consultancy services to "determine the suitability of privatising PTCL, as is, or restructuring the entity prior to privatising it, and advise on the viability of the restructuring plan for PTCL.
In carrying out his assignment, the Consultant will work under the specific direction of the Restructuring Committee formed by the Government of Pakistan for the purpose of overseeing and implementing the restructuring of PTCL.
PTA will give only 15 days to the Consultant to report the following;
(a) An overview of the international and regional restructuring experiences that highlights the lessons relevant to Pakistan;
(b) The fiscal impact, pros and cons of the restructuring options for PTCL, including impact on domestic capital and international markets;
(c) Views of the stakeholders in the restructuring;
(d) Terms of Reference for follow-up assignments on PTCL restructuring;
(e) Review of the existing regulatory environment in the telecom sector.
No consultant can do all these tasks in 15 days unless he has to give his views on a report already prepared for restructuring and needing a seal of approval by an expert.
PTA has not made it clear whether the Consultant will need to have a background in all or any one of the areas which include economies/telecom sector, financial analysis and corporate restructuring.
Business Recorder understands that the necessity to have expert advice to break up PTCL into various small companies arises from the strong opposition from the Financial Advisors to the Privatisation Commission on the strategic management sale of PTCL to the break-up.
The world's leading advisory in the field of telecommunication, Goldman Sachs/J P. Morgan have advised PC to seek fresh Expressions of Interest (EOIs) for PTCL as an integrated entity.
The two giant entities were contracted by PC for the task and their views were sought on the restructuring plan being pushed by the Technology Advisory Group.
Our Islamabad correspondent adds: The detailed report from Goldman Sachs/J P. Morgan (copy obtained by BR from PC) has fully addressed each and every concern of the GOP. This report, analysing the issue, says:
"PROPOSED RESTRUCTURING PLAN" The following arguments are intended to show that the restructuring plan is impractical.
In general, the plan does not afford sufficient detail on many complex issues and displays a lack of understanding of the dynamics of an integrated telecom company.
Overall, the restructuring plan is costly and time-consuming to implement such that the overall costs will outweigh the perceived benefits.
"
Allocating assets on an exchange-by-exchange basis is extremely complex and impractical for the following reasons:
-- Telecommunications are organised hierarchically for both transmission and switching.
-- Data networks have their own hierarchies that only partly mirror those of the voice network and hence require a different level of separation.
-- Network services provided by service platforms, eg voicemail, premium rate services and free-phone, are embedded deep in the network.
-- Service activation and network provisioning processes involve complex end-to-end processes with IT systems embedded deep in the network coupled to billing and customer service systems. These interact with network elements at all levels in the network, and people servicing the network from integrated network management centers to field workers.
-- Network management systems are largely centralised in telecommunications networks and will have to be broken up.
"It should be noted that nowhere in the world has such restructuring of the local loop business been successfully implemented, and no such allocation of local loop assets on an exchange by exchange basis has ever been attempted.
1. "Even if it is assumed that PTCL will be able to accomplish the physical separation of the assets so as to create the companies envisaged in the plan, there will be difficulties in attributing assets and liabilities and transferring employees to each of the separated components.
Such activities require substantial time and cost commitments due to financial, tax, regulatory and legal implications associated with breaking up companies in Pakistan. The following points need to be considered:
-- PTCL is a listed entity with public shareholders. Existing shareholders are likely to demand shares in each of the new entities. Since some of these entities will have no public ownership, eg PLDB, this could cause disputes with respect to the form and nature of the restructuring plan.
-- As per the Companies Ordinance, demergers of listed companies are required to be approved by the shareholders and creditors and subsequently the scheme of arrangement will also have to be approved by the High Court.
-- The Privatisation Commission has been involved with at least one such restructuring involving two listed companies with the objective of creating two distribution and one transmission company in the energy sector since early 2003. However, the restructuring scheme is yet to be presented to the shareholders for approval.
-- It took ICI a well run multinational company, 22 months to achieve their demerger into only two companies--ICI Pakistan and Pakistan PTA.
-- The promulgation of a special statute to override the requirements of the Companies Ordinance for such a demerger may solve the timing issue from an approval perspective, but it will still not be able to solve the issue of identification of the various assets and liabilities which are to be allocated to each of the demerged entities.
"Hence, expecting the entire restructuring process to take only 18 months is unrealistic.
2. "PTCL currently has interconnect and/or network sharing agreements with mobile companies, payphone companies, internet service providers, leased line customers, etc.
These existing arrangements will have to be spread over the emergent companies making the resultant sector dynamics unnecessarily complex and subject to abuse and disputes.
Difficulties in implementation of the restructuring plan should also be viewed in light of NTC's carve-out from PTCL pursuant to the 1996 Act. To date NTC and PTCL have been unable to cement a meaningful interconnection agreement.
3. "The continuation of PTCL as a shell company with a revenue share from each of the CLLs equal to PTCL's current pre-tax profit is financially inefficient.
Firstly, by being required to ensure that PTCL's profitability remains at existing levels, the CLLs will be under extreme cost pressure and therefore will be unable to reduce consumer tariff due to competition as envisaged in the restructuring plan.
Secondly, the CLLs will be financially even more unattractive given that the substantial restructuring costs that will have to be incurred in splitting up the incumbent will be apportioned to the CLLs.
Hence it is clear that creation of CLLs will not result in reduction of consumer tariffs unless it is at the expense of CLL value erosion.
It should be noted that despite the tariff re-balancing of PTCL, the local loop business continues to be subsidised by long distance, particularly international revenues.
Given reduction in cross subsidies going forward and high restructuring costs, local call charges are more likely to increase, instead of decreasing, as incorrectly envisaged, to make the CLLs viable.
If the CLLs attempt to reduce the prices of local calls and line rentals by continuing to cross-subsidise these services from international call revenues, then there is likely to be significant erosion of international revenues from call-back and other bypass mechanisms.
Because of the ease of bypassing high international tariffs it is simply not viable to maintain unbalanced tariffs, regardless of the industry structure.
4. "An entity such as PLDB (the backbone company), which is proposed to be jointly owned by the CLLs and is envisaged to operate as a cost center, is a regressive step away from competition.
The long distance infrastructure requirements of the CLLs will need to be identified and segregated in order to determine usage and allocation of bandwidth.
The physical long distance infrastructure of PTCL will be carved out to create a nation-wide long distance backbone entity.
Furthermore, it is unclear how the stated government policy of promoting competition in the LDI sector is consistent with this approach.
Furthermore, it is not clear what kind of interconnection arrangements are envisaged between the CLLs and the PLDB and how costs will be allocated.
5. "Increase in network reliability, particularly with respect to international connectivity, can only be achieved through more investment in international fiber-optic cables and satellite redundancy.
Restructuring does not guarantee this. In fact, the structure of the long distance backbone entity is inherently uncompetitive and will most likely lead to a further erosion of network reliability as disputes between the shareholders over the amount and nature of the ongoing capital expenditure required and the amount of capacity they receive in return will almost certainly arise.
Poor service for international telecommunications can only be improved by more cable landings in Pakistan.
PTCL is a signatory to SMW4, which will provide an additional link and improve reliability of the existing network.
In addition, increased deregulation of the international telecom service market in Pakistan will encourage new entrants to enter and build new infrastructure.
5. "Creating a separate entity, PTSL, for services such as billing, is also impractical and its effects undesirable.
Billing is a core function of a telecommunications company and as such cannot be out-sourced to a central provider of billing services.
One of the main challenges within a customer-focused telecom provider is the prioritisation of IT development resources, for example to make changes to the billing system in order to accommodate a new product or service.
Externalising this function from the business that serves the end customer will disable the company's ability to be customer-focused and lead to resource contention, PTSL will also have a monopoly in provision of such services, which is undesirable in itself.
6. "Ufone is a core asset of PTCL and its spin-off will reduce the attractiveness of PTCL to potential bidders for the integrated telco.
In addition, the current small size of Ufone is insufficient to create substantial value to the shareholders through a spin-off.
It will also remove the opportunity for fixed-mobile integration and synergistic value creation for the shareholders.
Regional examples of successful fixed-mobile integration include: Smart by PLDT in Philippines, Celcom for Telekom Malaysia, Telkomsel for PT Telkom in Indonesia, Satelindo for Indosat in Indonesia and BSNL Cellular for BSNL in India.
In addition, in many countries where the mobile business was demerged from the fixed-line business, the fixed-line operator is trying to integrate with the mobile business to protect long-term profitability, for example, France Telecom has recently acquired the remaining shares of its Orange mobile subsidiary and now owns close to 100% of the company.
7. "Slow rollout of mobile telephony by Ufone is largely due to the slow and bureaucratic process of approval for capital expenditure.
This obstacle will automatically disappear when the incumbent is privatised as the new private sector entity will be able to respond much more quickly and will have recourse to the public capital markets for funding of network expansions.
8. "Restructuring is not a solution for increasing tele-density, particularly in rural areas. This is because the profit-motivated, but unprofitable, CLLs may not find it immediately feasible to undertake the large capital expenditure required to provide fixed line and other services to rural areas.
An integrated telecom company with multiple revenue streams and sizeable cash flows is much better placed than smaller, more fragmented companies with limited revenue streams and smaller cash flows, to support the rollout of telecommunications to rural areas.
A case in point is BSNL in India, which has been able to achieve ambitious fixed line rollout targets due to flexibility in utilising cash flows it generates from its local loop business.
9. "Poor customer service is a feature of all state-owned enterprises. World-wide experience shows that, over time, customer service automatically improves after privatisation through the need to maintain the customer relationship and prevent defection to new entrants. Restructuring by itself does not solve this problem.
10. "PTCL currently does not differentiate between consumers and has few products for different market sectors.
This is mainly an organisational issue and can be rectified through an increase in the quality of management of the company.
This can be brought about through privatisation allowing the privatised entity to implement global telecommunications management best practices and organisation structures.
Coupled with deregulation and the introduction of new technologies, the incumbent will be forced to become more customer-focused over time.
11. "The issue of PTCL's natural monopoly, though real, will be mitigated by privatisation, regulation of market dominance by PTA, sector deregulation through new entrants, and the introduction of new technologies such as Wireless Local Loop, in the long run.
The proposed re-structuring plan does not in itself solve the problem of local loop monopoly because the 5 CLLs will still be monopolists within their own exchange areas, even if these areas are small.
For this reason the proposed solution has not been implemented, or to our knowledge seriously considered as a solution to the problem of local loop monopoly.
Instead regulators have adopted two quite different techniques to break the local loop monopoly of incumbents: infrastructure based competition and local-loop unbundling.
12. "The splitting of the large labour force of PTCL between the new entities would in itself be a major task.
Allocation of employees to each new entity will be a time-consuming and cumbersome process, given different types of employees and the strength of employee unions.
13. "Overstaffing is an issue that needs to be addressed in any scenario and many solutions to this problem exist other than restructuring of PTCL.
It has been the Government's endeavour to delay any rationalisation of the employment levels till after privatisation unlike the strategy adopted in government owned banks.
14. "The regulatory framework that exists today in the telecommunications sector has principally come about because of the initiative for the privatisation of PTCL.
The framework was developed after a long and drawn out process of iterative consultations between the Ministry of Communication (now Ministry of IT&T), the PTA and PTCL and their advisors.
Initiation of the restructuring plan as envisaged will require alteration of the deregulation policy and existing regulatory regime.
An extremely robust regulatory regime must be in place prior to any restructuring in order for it to have any chance of success.
Any half measures on the process, including the regulatory aspect, may create long-term bottlenecks, which will hinder the development and privatisation of the telecom sector in Pakistan.
15. "PTCL's capitalisation has a significant weighting on the stock market. Any unwelcome news with respect to the privatisation process/implementation, of the restructuring plan will destroy the recent increase in investor confidence in the stock.
A fall in the stock price of PTCL will have a detrimental effect on the stock market, and hence the country.
"GLOBAL TRENDS IN THE TELECOM SECTOR" With radical changes in the landscape for global telecommunication operators, a significant number of players world-wide are focused towards consolidation in their own markets as it enables them to de-risk operations, create a greater footprint through larger scale and provides exposure to faster growing segments such as mobile communications.
These facts are clearly illustrated in the following empirical data points:
Global Examples of Telecom Sector Restructuring implemented through asset split that resulted in failure or value destruction.
NORTH AMERICA: USA:
1. "To break AT&T's monopoly, businesses were divided into long distance and local access.
2. "Seven Regional Bell Operating Companies (RBOCs) were created to control local access.
3. "Market forces led to consolidation and only 4 RBOCs remain.
4. "Most Competitive Local Exchange Carriers (CLECs), which were set up to compete against the RBOCs have either filed for Chapter 11 or have been acquired by the existing RBOCs.
5. "Existing RBOCs have cellular business in most of the areas, where they offer local loop services, they have benefited from convergence of telecom services and are bundling fixed line voice, cellular, broadband and data applications.
6. "They are now building a nation-wide long distance infrastructure AT&T, which is left with a long distance and International business has the highest free cash flow yield (19.1%) of all wire-line telecom operators in North America driven largely by the lack of growth and has formed into an acquisition target for the RBOCs bringing the original decision to split to a full circle.
ASIA: INDIA:
1. "India was divided into several circles for the purpose of allocating fixed line and cellular licenses.
2. "Despite strong bidder interest from large strategic investors, several of the regional cellular operators are not viable financially today and the only successful operators such as Bharti, BSNL and Reliance are the integrated telecom operators with pan-Indian presence and who have benefited from economies of scale.
3. "It is also noteworthy that amongst the licensees awarded to the private sector, so far only the largest and the most integrated operator, Bharti, has been able to tap equity capital markets in 2002 (over 9 years after the first award of license) successfully and prove its story to investors.
ASIA: KOREA:
1. "The incumbent KT Corp forced sector consolidation in 2000 by acquiring HansolM.com and subsequently merged with its own cellular subsidiary KT Freetel.
2. "KT Corp did the transaction to increase size of its mobile business to capture value from the rapidly growing Korean mobile sector and limit the impact of a stable or shrinking fixed line business.
ASIA: PHILIPPINES:
1. "In 1995, Philippines was divided into 11 sections and companies were required to roll out fixed line if they wanted to operate cellular services.
2. "Only 3 of the 7 such licensed operators were able to survive and others went bankrupt due to inefficient economies of scale for both fixed line and cellular businesses.
3. "There has been no growth in the fixed line services due to limited investment for the last several years. The bad history of bankrupt local operators continues to create problems in raising capital even for the surviving companies.
ASIA: INDONESIA:
1. "In 1996-97, Indonesia had initially adopted the path of dividing the incumbent's fixed-line business in 7 regions with the aim of fostering competition and improving tele-density.
2. "The split divisions failed to contribute sizeably and most of them needed to be purchased (and the employees transferred) back by PT Telkom, the incumbent, in 2001-02 to make the fixed line sector viable in the country.
Recent examples of integration and acquisition of mobile business by the incumbent operator and consolidation to create greater footprint and scale.
"Telekom Malaysia forced a sector consolidation by acquiring the largest Malaysian cellular Company, as it wanted to get exposure to the fast growing cellular market and reduce impact of fixed-mobile substitution.
3. "France Telecom, the incumbent in France, which is under threat in its fixed line market due to severe deregulation, is planning to acquire 100% of its growing mobile subsidiary Orange and de-list Orange.
4. "China Mobile, China Unicom and China Telecom (listed companies) are seeking pan-China coverage by buying network assets from their unlisted parent entities, which would give them higher scale to launch next generation services.
"Global trends effectively demonstrate the detrimental impact of disintegration as a mode of privatisation and it convincingly leans towards convergence and integration as the optimal strategy.
BENEFITS OF AN INTERNATIONAL TELECOM PARTNER: "A global telecom player, operating under its best practice approach, will conduct the following initiatives for the efficient development of PTCL and Pakistan's telecom sector:
1. "Strong corporate governance and financial discipline.
2. "Accelerate infrastructure development to boost Pakistan's economy.
3. "Transfer knowledge/technology in engineering, finance, procurement, marketing, sales, product development, CRM and IT to enhance service quality and network reach.
4. "Introduce billing and customer care systems
5. "Optimise property portfolio and redevelop its operating, finance, purchasing and HR procedures and manuals.
6. "Develop redundant submarine cable reach and connectivity."
IN SUMMATION THE CONSORTIUM HAS GIVEN THE FOLLOWING CONCLUSIONS:
1. "Restructuring PTCL is not a viable solution to achieving any of the objectives of the government as highlighted in the Plan, ie reducing monopoly power, increasing competition and tele-density.
We would like to state that the Plan is at best a concept paper based on an incomplete understanding of an integrated telecommunications company.
We would like to emphasise that there is no successful precedent for the type of restructuring suggested in the Plan.
Furthermore, you should be aware that most global telecom companies are currently in the process of consolidating and/or reintegrating their businesses. The Plan is in contradiction to this global trend.
2. "A restructuring of PTCL will not only derail the privatisation process as it stands today but will prevent the privatisation process of the telecom sector from taking off until such time as the restructuring is complete (if ever) and market has reached a new competitive equilibrium.
3. "Implementation of the Plan will require a substantial revision of the Deregulation Policy and will entail a re-establishment of the existing regulatory framework of the telecom sector, which has been developed over the last decade.
It should be noted that this midstream policy change could seriously impact the credibility of the reform process being followed by the Government and could have wider implications for general investor confidence particularly in the telecom sector.
4. "Any news that may indicate that the PTCL privatisation has been deferred as a consequence of a restructuring is likely to adversely impact the company's stock price.
Given PTCL's weighting in the KSE index, a fall in the stock price will have a detrimental impact on the equity market in general."
FURTHER, THE CONSORTIUM SAYS: "We are cognisant of the fact that PTCL's privatisation as an integrated incumbent has been difficult and has historically not generated interest from reputed international strategic operators.
"However, given the recent improvement in Pakistan's economic conditions and the region's geopolitical situation, there is renewed serious interest in PTCL.
As you are aware, lately several globally recognised operators have shown their interest in the integrated entity.
For instance, SingTel, an incumbent operator in Singapore, offering full range of telecom services (eg fixed, mobile, satellite, international, data, etc), has recently demonstrated strong interest to acquire PTCL as an integrated entity.
In addition, Telekom Malaysia has recently visited Pakistan and it is expected that Turkcell will be visiting shortly.
"We feel that Pakistan's telecom sector is at a critical juncture whereby the transition of the sector into a deregulated and competitive environment is contingent on a successful privatisation of an integrated PTCL.
We strongly believe that an internationally reputed telecom operator will be able to successfully transform PTCL into a market-oriented competitive telecom company and will be able to achieve the Government's objectives for PTCL and the telecom sector as stated in the deregulation policy.
"Based on the above, the FAC strongly advises the GOP to continue along the path of selling PTCL as an integrated entity given strong investor interest at this stage.
This will send a positive signal to the international investor community that Pakistan is an attractive investment destination.
As mentioned earlier initiating a restructuring of PTCL at this stage is not advisable. It would also be worthwhile to mention that in the event the GOP decides to pick the restructuring route, it is unlikely that the present consortium would be in a position to continue to act on behalf of the GOP in this transaction as we do not believe that the consortium should be party to any actions which it believes will be detrimental for PTCL, the telecom sector and for Pakistan in general."