NiQ Lai: With CVC’s support, we are now investing for telecom
growth. At HKBN we will open up the throttle and let the market
innovate with bandwidth-hogging applications
Talk to operators around the world and most of them will say the last thing they want to be is operators of dumb pipes. And then they will start grumbling about how the over-the-top content providers are stealing their lunch.
There’s one notable exception: Hong Kong Broadband Network, which became an independent company, majority owned by private equity, in April 2012.
“At HKBN, what we are passionate about is big fat dumb pipes,” says NiQ Lai, the former banker who is chief financial officer of the company. He goes on: “We are not interested in creating our own content. Rather we embrace working with over-the-top content providers.”
HKBN loves bandwidth-hogging applications for its big fat pipes. The minimum bandwidth you can buy from HKBN is 100 megabits a second — and that costs the equivalent of just US $23 a month. For the equivalent of $10 more, a total of $33 a month, you can upgrade to a gigabit.
“We have over 600,000 customers with 100 megabits and above,” says Lai. “We are by far the leading carrier for 100 megabits and above services.”
Both those services — 100 megabits and one gig — are symmetric. It is “among the best value in the world. It’s a non-linear price relationship moving from 100 megabits to 1 gigabit. You get ten times the speed for 40% extra price. When people buy our 1 gigabit service, it’s like getting water from a fire hydrant.”
HKBN was founded by Ricky Wong, an entrepreneur who revolutionised the Hong Kong telecoms market in the early 1990s by breaking the incumbent’s monopoly over international direct dial. The broadband venture was the second phase of his entrepreneurial career, “turning Hong Kong into the fibre oasis it is today”, he says.
But in April 2012, Wong’s company, City Telecom, sold HKBN to private equity investor CVC Capital Partners for HK $5.1 billion — equivalent to about US $650 million.
CVC is one of the largest private equity firms in the world, managing over $44 billion in funds, with a portfolio of around 60 companies with more than 400,000 employees.
About half of CVC’s purchase price came from equity commitments from funds that the private equity company advises; the rest is debt commitments from JPMorgan Chase and Standard Chartered.
The sale took place because Wong has moved on to the next phase of his career, “better content and video for the global Chinese market”, says Lai. “This third phase is very different from the dumb pipes business. You need a lot of money for making content, and that would have squeezed the cash out of HKBN. In short, content and dumb pipes are two very distinct business and — similar to water and oil — do not mix well. Hence the sell off to CVC.”
According to documents filed in April when the CVC deal was announced, City Telecom has applied for a Hong Kong broadcasting licence and plans to build a multimedia centre, due to be complete in April 2014. The statement added: “The multimedia business of the group is a large-scale and long term project requiring very significant financial resources and commitments (which is expected to be in the region of not less than HK $2.5 billion over the next for years).”
So Wong’s determination to move into content led the HKBN team to look for new owners. “We went through a very detailed process. Over the years we’ve had many, many discussions with a wide range of suitors, including numerous private equity firms and various global carriers,” says Lai. “CVC turned out to be the best fit”, not just for Wong but also for HKBN’s management team and the 2,800 staff — whom HKBN calls “talents” — who will stay with the telecoms company.
“We needed to find a buyer with the right outlook, and a way of realising value for Ricky,” adds Lai, not just CFO but also HKBN’s head of talent engagement. He and the telecoms team are passionate and enthusiastic about those big fat dumb pipes. “I often walk around the streets of Hong Kong over the weekends and take pictures of my family standing on our HKBN fibre manhole covers,” he says.
“With CVC’s support, we are now investing for telecom growth — whereas, being part of the old group, our telecom cash flow would be been extracted to fund the new content business,” he says. “We are very excited by the growth prospects for our space. Now, with CVC’s support, we have the autonomy and the finance to turn our dreams into reality.”
The investment is not just by CVC alone. “We now have 61 HKBN managers who are also co-owners of 13% of our company. We pooled together HK $165 million, typically one to two years of our salaries. We offered the deal to 80 executives and 61 took up the option. That’s a very high take-up rate.”
How did they afford it? “The lucky thing about China and Hong Kong is the saving rate is very high. It’s a cultural thing,” he says. “Plus many people did very well with their City Telecom stock options over the past years and they are putting these gains into HKBN.”
But, he accepts, “one to two years’ salary is a very material number, which requires family support to decide upon”. That means “this is a very strong sign of commitment from the team”, he says.
“Other companies elsewhere in the world probably couldn’t have done this — people don’t often have one or two years of disposable income to invest even if they have the desire to do so. Our colleagues discussed this investment opportunity with their spouses, their parents and families as part of the decision process. You really have to have high confidence in yourself, the management team and CVC to make this kind of commitment.”
The staff investors have to be sure, because won’t be able to get their money back if they leave, he warns. “If people leave, be it termination or voluntary, their investment stays in the company until CVC exits and they are paid the lower of cost or market,” says Lai.
“For people to make money, they must contribute to the company through the period until CVC’s exit. It’s not like buying shares in a listed company where you can freely trade in and out.” And, “a typical private equity investment is three to five years before exit. It’s a milestone for us to work towards.”
Several months after completion, what now? Around 85% of households in Hong Kong have broadband but fewer than half of those — about 40% of the total — have fibre. That’s a high number in world terms, but Lai believes there is an opportunity there.
But what will they need it for? “Our approach is that you can’t predefine innovation. At HKBN we will open up the throttle and let the market innovate with bandwidth-hogging applications. It’s like electricity.” Early electric power companies used the number of light bulbs as their measure of consumption, “but they didn’t envisage microwave ovens, electric blankets, 62-inch TVs, and so on”, he says.
“What we are selling is the equivalent of a Porsche 911 for the price of a Toyota Corolla. The questions about whether you need the extra speed become irrelevant as the value proposition is just overwhelming.”
Over the past few years HKBN has gradually climbed up the Hong Kong telecoms league. “We are now the clear number-two carrier in residential revenue terms and we are bigger than numbers three and four combined. We have leapfrogged our way to a very solid number two position.”
And the company is profitable: “We are the most profitable in terms of return on assets. And we’re the fastest growing in terms of market share. In short, we are harvesting the benefits of our over decade of investing over HK $4 billion into our fibre network.”
The company reached positive free cash flow in 2007 after losing money in the first seven years and it is now “over the hump of our capex investment profile”.
The last financial report when HKBN was part of CTI, a listed company, showed a profit of HK $350 million and an 18% return on equity. “As we are now a private company, we no longer report publicly our financials,” says Lai, adding: “Since then we’ve further grown in terms of net profitability.”
It is a model Lai and his colleagues want to take outside of Hong Kong? He’s consistently said no over the years, and repeats that: “We are very happy with the growth opportunities in Hong Kong. It’s about fibre in a highly dense community. Our business is about making our home, Hong Kong, a better place.”
But that doesn’t mean the company isn’t looking for new opportunities within Hong Kong: “We always look for disruptive opportunities,” he says. “We always look for ways that we can do things differently to deliver disruptive value to our society.”
He contrasts the company with the walled-garden approach of many. “We encourage open-garden over-the-top content,” he says. “Our point is we make a very decent return from the monthly fee we charge our customers and we don’t mind OTT players also making money with us. In fact, we need OTT players to help fill the massive big fat dumb pipes that we offer — otherwise there will be no need to switch from legacy copper to our fibre.”
That is a lesson that many other telecoms operators worldwide could learn from.
NiQ Lai will be talking about the CVC buy-out of HKBN at the Global Telecoms Business financial conference in London on 22 May 2013.
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