The audacious move rattled Globe Telecom, its fiercest rival controlled by the Ayala family. The deal, it argues, is anti-competitive. Other critics warn of the dangers of one dominant player controlling the country’s telecom market.
As politicians and rivals question the merits of the deal, lost in the cacophony of deafening alarm bells is how the fortunes of PLDT’s controlling shareholder, First Pacific Co, have changed.
No one is more conscious of this change than Manuel Pangilinan, the managing director and CEO of the Hong Kong-listed group. Indeed, what a difference a decade makes. PLDT’s bid for Digitel (Digital Telecommunications), the third wheel in the Philippines’ telecom market, is all the more notable as less than 10 years ago – in May 2002 – Digitel’s owner, the Gokongwei family, mounted a high-profile attempt to wrestle control of PLDT away from First Pacific – or rather from Pangilinan.
First Pacific, controlled by Indonesia’s Salim family, was then on the brink, a victim of the economic and political turmoil in its home market during the Asian financial crisis. It reported a record loss of US$1.8 billion for the full-year 2001, a sum that wiped out the profits it made since it started in 1981. Anthoni Salim, who started First Pacific with Pangilinan and is the family’s point man in the group, responded to the dire situation by offering up the group’s Philippine assets to John Gokongwei, the Filipino-Chinese billionaire and patriarch of the Gokongwei group.
Fast forward to 2011. As the group marks 30 years, First Pacific reported record recurring profit of US$402.1 million in 2010, up 40%; turnover is up 18% to reach US$4.6 billion from US$3.9 billion a year ago. PLDT is a core part of this performance accounting for 47% of the recurring profit (US$224.1 million). First Pacific’s dividend payout in cash terms at US$99.4 million is the highest ever. Today, it controls assets with a total market value of close to US$40 billion; its market capitalization of US$3.5 billion is more than seven times what it was at its nadir in 2001.
Flurry of deal-making
PLDT’s move to consolidate Digitel is just the latest in a series of deals in the Philippines that started in 2006/2007. It entered the water business (Maylinad Water) in 2006; healthcare in 2007; tollroads (North Luzon Expressway), mining (Philex Mining) and power (Meralco) in 2008. Since then, First Pacific has invested over US$2.8 billion as it increased its stakes in these businesses. And it is looking for more deals.
The recent spate of deals is reminiscent of First Pacific in its heydays 20 years ago. At the time, First Pacific acquired companies in far-flung places including a trading company in the Netherlands (Hagemeyer); banks in California (Hibernia Bank) and Hong Kong (First Pacific Bank); a telecom distributor in Australia (Tech Pacific); a telecom company in India (Escotel Mobile); a distribution company in Thailand (Berli Jucker) and Indonesia’s then second largest pharmaceutical distributor (Darya-Varia). Indeed, for a time, it earned a rather unflattering reputation as an asset trader.
And then there were the property investments in the region including First Pacific Davies and, just as the ill winds of Asia’s financial crisis were starting to be felt in 1995, Fort Bonifacio – the 214-hectare former military base in the heart of Manila. That deal stunned the market as First Pacific paid 22% more than the closest rival bid; it proved to be the group’s most audacious bet, but it also pushed it to the edge.
In a candid and wide-ranging conversation with The Asset, Pangilinan by his own reckoning admits that the Fort Bonifacio deal was a “failure”. But, he suggests, it “was a necessary thing to do at the time”. And he adds: “We managed to keep PLDT, though. If there was going to be a trade-off, PLDT was a better company to have kept rather than Fort Bonifacio. I don’t think ever that the profits of that particular project would have approached the kind of profit levels of PLDT.”
Pangilinan is alluding to when at the height of the troubles of First Pacific in 2001 – and the borrowing cost for Fort Bonifacio was like an albatross around its corporate neck – the vast development became a sore point between him and Salim; his partner had gone ahead to strike a deal to sell to Gokongwei both Fort Bonifacio and PLDT for US$617 million.
“I would say it was not only the most difficult but the most painful period,” he recalls. “I still remember the date. It was June 4 2002. It was at a board meeting for First Pacific to officially consider the Gokongwei proposal. Anthoni was in the room trying to persuade me to support the transaction. I said, ‘No, I cannot do that’. In my mind and in my heart, I didn’t believe the proposal made sense for First Pacific.” He then told Salim: “If you really want to do it, you should have your way. I am not going to stand in the way of what you like. I’m resigning; I’ll take my chances in the Philippines.” Salim was insistent. “No, you have to stand by me,” he told Pangilinan.
There was a lot of back and forth and the board meeting was delayed by over an hour. No resolution was reached. Eventually, they decided to go into the boardroom together with Ronald Brown, who then was the legal counsel for the group. Pangilinan was then chairman of First Pacific. “I called the meeting to order and after the minutes of the last board meeting were approved, the next agenda item was the (Gokongwei) proposal. They had to ask me to leave, which made sense as I was an opponent of the proposal. It was painful. I remember I left the office and walked around [Hong Kong’s] Central [business district]… it was humiliating; it was very painful for a company I founded so many years ago.” The First Pacific board signed the memorandum of agreement with the Gokongwei group on the same day to set up a joint venture to acquire PLDT and Bonifacio Land Corp, the company that owned First Pacific’s interest in Fort Bonifacio.
Humiliated he may have been, but not defeated. With an entrenched management team at PLDT behind him, he fought against the deal every step of the way; it was a particularly awkward period in his relationship with Salim. Less than five months later, Gokongwei terminated the agreement with First Pacific citing “implementation difficulties encountered”.
Turning it around
That was then. Today, the company’s focus is planted firmly in two markets – the Philippines and Indonesia. He says the flurry of deal-making in the last four years – perhaps in contrast to the previous period – has a common thread. “They are all [investments] in infrastructure companies meant to deliver products and services for the benefit of the consumers,” he says. “Even hospitals are social infrastructure; when you build a hospital, it is to be able to deliver health services to the population.”
He adds that the advantage of investing in infrastructure companies is that the Ebitda margins are at 50% or better. The only exception is the hospitals, where Ebitda is around 18% to 20%. “That’s by and large the nature of our companies. As opposed to Hagemeyer, which was huge in terms of revenue, but when you get down to the margins and the cash flow, it’s really quite limited. The profits of Hagemeyer pale in comparison to the profits of PLDT. The quality of the First Pacific’s portfolio is much better than it was 10 or 15 years ago.”
He says there is a huge need for infrastructure in the Philippines. “How many kilometres of tollways do we have? Only about 300 kilometres,” he says. “Our technical partner for tollways, which is Egis Projects SA of France, operates more than 5,000 kilometres of road. They’re only one of several tollroad operators in Europe.”
On power and acquiring a stake in Meralco, Pangilinan explains he always wanted to enter this segment of the infrastructure market. “Our first foray was in Transco (National Transmission Corporation). We looked at it seriously and we were supposed to be one of the bidders,” he explains. “We were abandoned on the eve of the bidding by Terna SpA (the Italian technical partner). The bidding rules said that we needed a technical partner owning a minimum of 5% or 10% of the equity of the consortium. We had to look elsewhere.”
First Pacific via Metro Pacific Investments, its investment vehicle in the Philippines, considered the generation side of the power business. However, the group felt it was late as most of the plants had already been bid out. “Meralco seemed to be available to us,” he notes. “Meralco provides some synergies to our businesses, particularly to PLDT – broadband-over-power lines, smart metering, fibre optics capabilities, and so on; we felt those were compelling reasons.”
The way Pangilinan goes after target acquisitions such as Meralco, Philex and the latest Digitel deal, however, does engender a sense of unease, especially his willingness to pay top dollars for control, which is a reminder too of how aggressively he had gone after Fort Bonifacio.
Digitel’s all-share enterprise multiple of nearly 16 times is more than twice that of PLDT’s six times. He sees it differently. “Well, our weighted average price is below 200 pesos [a share] for Meralco; the share price today is about 250 pesos,” he cites as an example. “PLDT’s profits would be down for the past two years if not for Meralco’s profits.”
But perhaps a more important factor is his belief in himself; that he is able to assemble a strong management team and that he is able to whip once lumbering undervalued assets into shape – much in the same way he unlocked the value and transformed PLDT from its dinosaur existence previously.
Thus far, he is proving critics wrong. Metro Pacific Investments doubled its recurring profit to US$85.6 million last year – albeit from a low base and helped along by the recent strengthening of the peso. Philex Mining, founded by the Filipino-Spanish mining pioneer, the late Henry Brimo, and which celebrates its 60th anniversary in 2015, is now the most profitable mining company in the country with net profits up 49% to US$88 million last year.
Pangilinan says he has become more prudent in the deployment of leverage. The investment in Digitel, he points out, is being financed at the PLDT level entirely with equity. “The focus should be more on the debts at the operating companies and the cash flow potential,” he says. “If they are not cash-flow producing companies, then we will be affected [at the holding company]. The debt levels [at the operating companies] are reasonably low so the gearing of the group is low too.”
A maturing relationship
Pangilinan says First Pacific will continue to look at other infrastructure investments. “I’m quite keen on railways because the country needs it very badly.” He also wants to invest in airports as he believes it is vital, especially in giving a good impression to foreign visitors.
After three decades, Pangilinan’s partnership with Salim seems to have matured. There is the understanding that he gets to run the Philippine part of the business while Salim grows First Pacific’s Indonesia’s food/consumer business via the Indofood group, the world’s largest instant noodle manufacturer and the second biggest contributor to the group’s business.
In September last year, Salim spun off Indofood CBP, which raised US$700 million in a successful IPO – the largest on the Jakarta Stock Exchange since 2008. It is completing the listing of another unit, Salim Ivomas Pratama, which is expected to raise over US$600 million. In 2010, the Indofood group contributed the largest increase in recurring profit to First Pacific totalling US$82.9 million, up 93% from a year ago.
With both stalwarts preoccupied with expanding into a region that is growing rapidly, they are having a much better time than a decade ago. So far, they have been astute in seizing the opportunities; they will need to be just as nimble, however, in riding the business cycle when it turns, as it always does.
The Digitel investment is an indication of an inflection point at PLDT, First Pacific’s most valuable asset. Couple that with a new competitor entering the Philippine market, Liberty Telecoms, the telecom arm of rival San Miguel Corp in partnership with Qatar Telecom, and there can be little room for complacency. In the first quarter this year, PLDT reported a net profit of 10.7 billion pesos, a decline of 6% as the intense competition squeezes its mobile phone margins.
As he peers into the future, Pangilinan knows too what First Pacific should not get involved in. “We’re definitely not good at banking and real estate,” he says. “We’ve made money in banking but I don’t think there is a natural ability; we’re not good lenders, period.”
But he would like to see First Pacific expand beyond its twin foundation of the Philippines and Indonesia. “It will certainly not be the same kind of diversification as we did in the 1990s, which in the end made it more difficult to manage.” But First Pacific, he adds, could be in Thailand, Malaysia or Vietnam. “We would probably be not as big as in the Philippines and Indonesia, but I would like to see a meaningful presence in one of these countries, limited to businesses we understand.”
And after 30 years at the helm of First Pacific, he says that he is much more focussed in terms of what he wants to do. “When you’re young, you tend to be a little more promiscuous. When an opportunity arises in the Netherlands or the US or wherever, you take it. Now, I think I’m a bit more focussed and deliberate. We probably know what we want to get into. Not to say we won’t make mistakes, but we’re a little more careful. It might not look that way to the rest of the world, but we are.”
Deconstructing the PLDT-Digitel deal
The whole business model of telco is changing away from the old legacy business of texting and voice-over
How did the Digitel deal come about?
About two years ago, we started to initiate the idea of possibly doing something with the Gokongwei family. At the time, we weren’t sure, and they weren’t sure either. There was a lack of resolve. Maybe both sides didn’t see the need or the viability of putting two companies together, so that fell through.
What were you thinking then?
At the time, it was purely exploratory. We just wanted to see what we could do to combine the two companies’ synergies. We were using ING Bank as the intermediary. But sometime last December, we initiated discussions again to find out whether or not they were interested. And they seemed to be more receptive and by January this year, it became more and more serious.
Was Digitel starting to hurt your business with its low-tariff strategy and was it therefore not sustainable for the industry as a whole?
I wouldn’t say it was not sustainable for us. PLDT managed to keep its profits up over the past two to three years. We’ve lost market share in terms of some numbers, but Globe Telecom lost more to Sun [Digitel’s brand]. We’ve managed to keep our share of revenue at around 59%. I think Digitel managed to gain share of wallet at the expense of Globe.
What do you think made them more receptive to do a deal this time around?
This would be my own interpretation why they would want to have some kind of a combination with us. The penetration rate in the Philippines is very high, about 94% based on the number of SIMs. If I were they – and us as well – with respect to what we would call the legacy business in cellular, obviously there’s a limit of maybe 110%. So the scope for further growth in the industry is packed already. This, as well as the fact that ARPU (average revenue per user) is continuing to drop and margins are getting eroded, must be of concern to the industry players.
Also, the whole business model of telco is changing away from the old legacy business of texting and voice-over to data and broadband internet. You don’t just jump from one technology space to another without investing a lot of money in broadband, data internet and a whole slew of digital fibre optic data nationwide. You need to invest in cable and satellite facilities as well. The Philippines is quite unique in the sense that the internet content is quite US-driven. So it’s really more users downloading from the US than us uploading over to the US or other countries to sell the content.
The texting phenomenon is unique in the sense that the content driving this was self-generated. When I send you a text, you don’t pay anybody any royalties. But when you download music or videos from somebody, you have to pay for that. If it’s from the US, you have to pay for the use of both domestic and international facilities.
So it must have given them some pause as to if there is a cap to their business in the next year or two. They would have had to invest a significant amount of capital to move to the broadband space. Digitel was only profitable in the last two years. On the whole, I think it made sense for both parties.
This second time around, did they send back fairly positive feedback?
It was a faint signal at first; it was like a voice from outer space, so we had to send more satellites.
This deal is also interesting because nine years ago you were on the opposite sides of a battle.
Yes. Obviously, I’m quite familiar with that story. Let me tell you the truth: a few weeks after that saga ended, John [Gokongwei] invited us to dinner at Lance’s [Gokongwei, son of John] home. We had dinner with his family. It was a gracious gesture on their part, to say “Look, no hard feelings. Just as in show business, this is just work; nothing personal”. We took it well; that was a huge gesture on his part. We’re also too busy to be harbouring any animosity to anybody. You could sense on their side, it’s the same thing. There were a lot of positive vibrations we felt about this deal with them. At the end, I think they finally felt good about it too. It made sense and now they are our partners. I think it’s great.
Do you think changes to the business on both sides after nine years also drove this deal and perhaps because John Gokongwei is no longer as hands-on?
He might disagree with you!
In many ways, we took separate paths. They’ve gone into the airline industry and other businesses, which we didn’t go into. John Gokongwei is still a huge presence, as he should be. He’s the patriarch of the family. James [Gokongwei, John’s brother] is a good executive. He’s tough but a sensible businessman. Lance is the heir apparent and he is a huge credit to the group. He’s very bright and sensible, a worthy successor, I would say, to John Gokongwei.
How protracted were the negotiations?
It took us five to six weeks from the time people said go. About mid-February, we sent out the preliminary term sheet to them and they agreed in principle to the basic framework of the deal. Manila’s a leaky boat and everybody felt if we’re going to do this, let’s do this as quickly as we can – come to determination whether there’s a deal or not. We felt that we should move with some speed and to their credit, I think both parties did. So we were working flat out day in and day out.
How different was the valuation from what was finally agreed?
You know how it works; it’s the same all over the world. There’s haggling and when it came to the documentation there were some heated moments, etc. That’s part of the rich tapestry of deal-making.
How do you feel about the price?
It’s fair to both sides otherwise a deal would not have been struck. They’re very sensible, tough negotiators. At the very least, we were able to stop – for the industry, for them, for us, for Globe, for any new entrants – any significant further deterioration of margins. I think that would be helpful to the business.
