PLDT steps up search for strategic partner

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The Philippine Long Distance Company (PLDT) is the country's incumbent telco. In November 1998 First Pacific increased its holding in PLDT to 27.4%. Now PLDT is being merged with Smart and Piltel and the company is seeking a foreign strategic partner. Manuel Pangilinan, managing director of First Pacific and president and CEO of PLDT talks to Global Telecoms Business.

The telecoms market in the Philippines was liberalized in 1994. At one stage the incumbent, the Philippine Long Distance Telephone Company (PLDT), faced nine competitors. However, only a minority of the competitors managed to comply with government demands for the installation of at least 300,000 exchange lines within three years of entry.

Smart Communications, owned by Indonesia's First Pacific, was one of the most successful new entrants, becoming the largest cellular provider in the Philippines. In November 1998 First Pacific, which already had direct and indirect stakes in PLDT, acquired a further 17.2% share of the operator for $750 million. This increased First Pacific's holding to 27.4% and gave the company a controlling interest.

First Pacific subsequently announced plans to fold Smart into PLDT. It is likely that this will involve a share swap. Piltel, another cellular operator, which has under-performed and recorded significant debts, will also be merged with PLDT through a debt restructuring plan, involving the purchase of Piltel shares. PLDT will also buy back $268 million in convertible bonds.

First Pacific has also revamped the management team at PLDT. The managing director of First Pacific, Manuel Pangilinan, was appointed president. Pangilinan is highly respected in the Philippines as Raymond Ricafort, a telecoms analyst at Merrill Lynch, explains: "Manuel Pangilinan has two reputations in the Philippines. First as a big wheeler dealer and a person who has done well in leveraging small firms that he has turned around and sold at a higher price. His second reputation comes with purely his achievements with Smart and with his other Philippine companies."

Ricafort believes that the operator is now in a much better position: "Now, even before the new management, which we perceive as a much better management, took over the company, we already liked PLDT owing to their very strong position in the industry, its profitability and high margins. Now as new management is already improving these attractive numbers and margins, we are becoming slightly more bullish on PLDT. The more we see the company writing off, the more we can see them improving operations going forward."

In addition, Ricafort believes that PLDT will benefit from Pangilinan's ability to maximize assets: "I think that his second reputation of running companies tightly and bringing out shareholder value and maximizing assets and being a value creator will remain. I think that the new management team running PLDT will be positive for shareholders owing to their ability to run a company tightly and their ability to be open to new ideas and global changes. They have one of the few management teams in the Philippines that really look at the global situation and consider how they will survive in that kind of environment, rather than look to survive on protectionist policies or government favours which could lead to protectionism."

PLDT has also appointed ABN AMRO as an advisor, as it looks for a strategic partner. In an exclusive interview with Global Telecoms Business, PLDT's president and CEO Manuel Pangilinan talks about the merger of PLDT, Piltel and Smart into one group, the search for a strategic partner and PLDT's ambitions for growth.

You were appointed President and CEO of PLDT in November 1998. What are the major challenges you face as the CEO of the largest telco in the Philippines?

I would guess that my greatest challenge is to establish a new direction for the company in light of the more competitive environment here in the Philippines and of course changes in consumer demand, technology and the competitive landscape.

I also think that change needs to be carried out in a 70-year old company in a way that maintains the values of PLDT, while at the same time introducing new methods and perspectives to the business.

Could you tell us about the ownership structure of PLDT? What synergies do you gain from bringing Smart Communications and Piltel under the same umbrella? How will this help you put together integrated packages for customers?

Well, in terms of our voting ownership of PLDT, we have approximately 27%-28% of the company. The social security system has approximately a 10% stake. Consequently 62% of the ordinary shares of the company are owned by the public. So there is a really significant public vote in PLDT.

In terms of synergies, quite a number can be derived by combining Smart, Piltel and PLDT. PLDT's core competence is in fixed. The combination between three companies means that we can operate the fixed wire business of Piltel and Smart and integrate that into the fixed line network of PLDT. In this way we can save on operating and capital expenditures moving forward, as Smart and Piltel have built switches and landlines in certain parts of the country, which we don't have to duplicate. So I would like to think that we will achieve economies of capital and operating expenditure, as we move forward.

In wireless we will obtain synergies from putting together the wireless operations of Smart and Piltel in terms of the bundling of services, common billing platforms and marketing approaches and the like. We should see the companies as part and parcel of the same telecoms group.

How important is it for PLDT to find an international strategic partner? What kind of relationship are you looking to form? Does the search for an international partner indicate a need to improve in areas such as marketing and value-added services?

I think that an international partner could bring a great deal of value to the table. It is most likely that this will be a major international telco who can therefore bring new technologies that are available offshore and their own experience in their respective markets, especially in markets that have been deregulated. We could learn from that.

Of course we would also gain access to capital, which could enhance PLDT's credit standing. So I believe that many good things could be derived from a strategic partner.

In terms of the actual relationship, an investor in PLDT would be entitled to participate at board level. I guess that we would like to enter into discussions with them over their role in management.

Why did you decide to appoint ABN AMRO to help you find a strategic partner? When do you expect to reach a decision about a foreign partner?

We recommended to the board of PLDT an advisor to the company in that search and selection process, and the board approved our recommendation.

There should be some objective criteria that will drive the determination of the strategic partner that could benefit PLDT in both the short and long term.

In terms of timing, I would like to think that something should be done within the year, as we plan to go to our shareholders in late June to ask for an increase in our authorized capital that will facilitate the entrance of such a strategic partner.

Do you plan to raise capital in 1999? Will you issue new shares? Or will you issue high-yield bonds? Which banks would you use to carry out such offerings? Or would this involve the sale of a strategic stake to a foreign partner? How would these measures dilute earnings?

We said that we do intend to raise capital in 1999 by about $500 million. That will be accomplished by issuing new ordinary shares to prospective investors, both existing and perhaps new ones. We have no intention of increasing debts through bond issues.

Apart from the financial advice that we are receiving from ABN-AMRO, no bank has been appointed so far to carry out such an equity offering. The sale to a strategic partner is part and parcel of the fund raising. We would hope that these measures do not dilute earnings. Our aim is to issue these shares, particularly to a strategic partner, at a price that would not dilute earnings, but would in fact enhance earnings.

In terms of cellular, how important is it for PLDT to acquire Smart? What opportunities are there in cellular for PLDT?

Smart is the largest cellular operator in the country. It is profitable and generates significant free cash flow from its operations. I would like to think that PLDT should seriously consider acquiring Smart.

In terms of opportunities, we do have the ability to bundle services in a market segment that is growing rapidly: cellular growth will certainly exceed fixed growth. There are opportunities to make money from cellular, as is evidenced from the experience of telcos in other countries.

How many subscribers do you currently have? How do you view the competing technologies, GSM and CDMA?

In fixed PLDT has a little over 1.6 million subscribers now. Smart has 820,000 cellular subscribers. We run both GSM and CDMA systems. Smart has just launched a GSM system and Piltel has a CDMA system. The emphasis will be on GSM rather than CDMA.

Are we likely to see a PLDT-Smart share swap in 1999? If so, how will this dilute earnings for PLDT shareholders?

We would hope to complete the acquisition of Smart in 1999. Yes, you are right: the acquisition would probably be carried out through the issue of new shares to Smart's shareholders.

In terms of 1999 earnings, I expect that this deal will be completed towards the latter part of the year. So the impact on PLDT's earnings will probably be minimal. I would like to think that the impact on earnings/share will also be very minimal in 1999. The terms of the acquisition should be arranged to enhance PLDT's earnings and consequently EPS. So we will endeavour to structure the acquisition under those terms.

Will you integrate Piltel and Smart into one operation? How long will this process take? Which suppliers do you work with in cellular?

We will integrate the cellular operations of Piltel and Smart. The process should start as soon as we are able to complete the acquisition of Smart. I think that it will take one-two years before the cellular operations are fully integrated into one unit. On the Smart side, we are working with Ericsson and Nokia. On the Piltel side, we are working with Motorola and Lucent.

In your opinion how difficult will it be to merge PLDT, Smart and Piltel? How much do you expect to save on capital expenditures?

I think that the merger process will not be easy. But I would like to think that the merger process will be facilitated by a lot of goodwill internally among the management, employees and staff of all the companies to make this thing work. I am very optimistic that the merger of the three companies will in due course be successful. There is no resistance. There is no game playing.

There is a great deal of desire to form an integrated and very efficient telecoms group. I think that it is too early to quantify savings on capital expenditure, as we move forward, because they are quite separate companies at this point in time. The legal aspect should be completed this year. We aim to start the merger process by the end of the year. I think that it will take two-three years before we finally bed down the merger participants if you may.

In 1998, PLDT's net income totalled Ps1.107 billion ($25.9 million). In 1997, net income totalled Ps7.649 billion. What led to this dramatic decline?

In 1998 we placed significant provisions against revenues and receivables and also provided for operating expenses that should in our opinion be booked for 1998 figures.

The combination of those three items severely impacted on the profit and loss position of PLDT. Now most of these are one-off, non-recurring mandatory items. On a recurring basis, we witnessed actual growth of about 3% in PLDT's profit position.

Piltel posted a loss of Ps4,121 billion in 1998. In an industry which is witnessing high levels of growth, why has Piltel posted such dramatic losses? How are you going to rectify this situation?

Again the losses of Piltel are attributable mainly to one of the provisions against receivables and over-coercive revenues, certain income that we reversed owing to the property gains in 1997 that we did not push through and complete in 1998. So we reversed that income. A significant proportion of this loss is attributable to this reversal and said provisions in the books.

On an operating basis, Piltel recorded a loss principally owing to its high debt position. I believe that it was positive on an EBIT basis, but was negative, after you report interest charges.

You asked me how we can turn things round. On the financial side we have reached agreement with the banks on debt restructuring, so that Piltel can eventually become cash flow positive and income positive over the next few years. Why has it recorded such losses? The losses are on the whole attributable to its high levels of debt and capital expenditure, because it has built a CDMA system alongside its existing analogue system. Therefore its depreciation levels are quite high. The growth in the subscriber base has not risen to a point where it has compensated for the increased expenses, both operating and interest charges.

How do you view the prospects for pre-paid in the Philippines? Surely such a service should enable you to reduce losses at Piltel?

I think that the prospects for pre-paid, especially in a tight economy, and a slow economy such as the Philippines, are bright. Piltel is the largest pre-paid card provider here in the Philippines. Increases in subscriber numbers should help to reduce the losses of Piltel.

How are you restructuring Piltel's debt? Have the discussions with Marubeni reached a conclusion? If we can talk about bad debts, what steps are you taking to reduce bad debts in future?

The talks with Marubeni have not reached a conclusion. We are engaged in very active discussions with all the creditors at this point in time. I am quite optimistic that management will be able to come to terms with them. We are taking very active steps to reduce bad debts. We have a new management team at Piltel that is looking at all the accounts one by one. There is active solicitation in terms of collection.

How do you view the regulatory environment in the Philippines? Do you think that the levels of inter-connection will be fair to new entrants and established players alike?

Well the regulatory environment here has been quite encouraging to various operators. So we think that they have been quite responsive to industry needs and the requirements of different players here in this country. I think that the regulator and industry players are continuously debating the issue of inter-connect.

Our view is that we should finalize a government policy for providing inter-connect facilities to the various carriers using our system, subject of course to a satisfactory conclusion of the terms under which those bilateral inter-connect agreements could be reached.

What are the levels of Internet penetration in the Philippines? How are you trying to tap into the data market? Which packages are you offering customers?

The Internet market here is still taking off. So I think that the penetration rate - if you quantify it on the basis of the number of users as a percentage of the population - amounts to probably less than 1% at this point in time.

We will enter the data market. This is something that we are considering very seriously. In fact PLDT is one of the largest ISPs in the country. It is only logical for the company to become involved in data transmission services as well. We have a broad range of Internet service packages.

We hope to expand the content through partnerships here in the Philippines and obtain more content from abroad. We should be able to complete the installation of the international Internet gateway by the middle of the year and thereby open the portal if you may for domestic Internet users into the international market.

Does data account for a significant percentage of revenues? Which value-added services do you intend to offer the business sector? How is PLDT trying to participate in the multimedia revolution?

Data revenues currently account for less than 10% of revenues. In terms of corporate accounts, we have a VSAT satellite infrastructure and digital fibre-optics to cater for business data transmission requirements anywhere in the world and in the Philippines So we carry a broad range of data capabilities.

At the moment our role is to provide a highway for broadcasting. As I mentioned, we have the satellite up there. We also have the largest and most expensive VSAT infrastructure in the country and a nation-wide and state-of-the are digital fibre-optic network. We can only carry broadband services for various broadcast companies here in the Philippines. This is due to existing regulations in the Philippines, which do not as yet allow for any convergence between broadcasting and telecoms.

How do you intend to improve the company's overall efficiency? According to analysts, it has some of the lowest efficiency levels in the region. How are you trying to change the company culture?

We have benchmarked PLDT against certain operating efficiency ratios of the more efficient regional telcos and also international operators. Our goal is to push PLDT to meet first of all the standards of regional telcos and eventually those of international telcos in terms of lines/employee, capex/employee, operating expenses/employee and others.

We are even looking at such operating efficiency ratios as completed calls and similar areas on a domestic and international basis. Therefore we are considering those ratios very carefully and seeing how we stand in relation to them. In many ways though, PLDT is moving in that direction already.

We perceive opportunities to enhance revenues by offering a broader range of services and products. There are opportunities to reduce operating costs. This is something that we are doing right now, in terms of headcount, advertising and other expenses. We have opportunities to save on capex through this merger between companies. We can throttle capital expenditures, because we have some surplus capacity in the system, especially once we have absorbed Smart and Piltel.

So capital expenditure should be mitigated starting in the year 2000. We are trying to change the company culture mainly by example. We don't believe that this should be achieved through radical surgery, but rather by example. We believe in explaining to the management and staff here why certain changes are necessary. We like to build these changes through consensus and leadership by example.

Will you have to reduce the number of employees significantly over the next year? Is the company undergoing a radical restructuring programme?

The company already has a continuous voluntary manpower reduction programme. So we will just continue this programme over the next few years. No radical restructuring programme as such is being undertaken.

Is PLDT disposing of non-strategic assets such as real estate?

We are disposing of real estate right now. We have taken a look at this area and identified the first batch of real estate that is not required by our operations. This is a continuous programme that we have launched.

Can you describe your capacity utilization improvement and network rationalization programmes? How successful have they been so far? What are the core changes?

We perform a constant review of capacity utilization and rationalization, assessing where the lines are located and where market demand is located. So we try to marry supply with demand in specific geographic areas, because in certain instances the demand is there, but there are no working lines. In other areas we have the working lines, but demand is already covered. So to some extent we should be able to rationalize the network in that way.

In terms of the network architecture, we are in discussions with all our major suppliers, Siemens, Alcatel and NEC and receive proposals from them over the best way of rationalizing the network architecture to make it more efficient and reduce capital expenditure, as we go forward. I think that it is too early to determine how successful it has been, but I would like to think that we will be in due time be able to rationalize the network of PLDT, together with the networks of Smart and Piltel.

How do you view the convergence of broadcasting and telecoms?

I would like to think that PLDT's participation in the convergence of broadcasting and telecoms is inevitable. The market and technology imperatives and consumer demand imperatives will drive convergence eventually. I believe that legislation will have to be realistic and recognize this development. All the imperatives will persuade the legislators to allow such convergence.

In fact I think that our government has a paper that allows for comments on precisely such convergence in future. We have no choice. We must participate in the convergence process, because we are the largest telecoms player. I would like to think that PLDT will play a significant role in promoting such convergence. We will be a key driver in that process because the Internet platform is a viable approach to the convergence of data, video and voice.

What are your opinions on rate rebalancing? Do you think that it is a level playing field? Do you think that the NTC will approve rebalancing for local metered service? How are you trying to redesign tariff schemes?

Yes. I think that this is something that the industry needs for two reasons. Firstly the local metered scheme is equitable to everyone, because you pay for what you use. Secondly rate rebalancing is important as international accounting rates go down, as will international revenues.

Therefore, we should support and subsidize domestic requirements which are going down. There is a need for rebalancing. It will have to be a level playing field: whatever applies to PLDT should apply to other players in the industry.

I think that in due time we can persuade the government to approve the local metered scheme. We are trying to redesign tariff schemes in a way that is responsive to consumer needs. I think that it is still early days to predict how that redesign will happen.

What are PLDT's regional ambitions? Do you have any ambitions to become a regional hub for international traffic? Do you plan to expand PLDT's reach?

No. We don't have any regional ambitions at the moment. We are heavily focused on the Philippines. We would like to become a regional hub in future. That is one of the things that we would like to talk about to a strategic investor in terms of the value that they can bring to the table in making PLDT a regional hub for their international traffic.

What do you perceive to be the prospects for satellite communications? How well is Mabuhay Philippines Satellite performing? How does it fit in with your cellular operation?

Well I think that in the long term prospects should be OK. In the short term, there is significant surplus capacity of transponders in the region. So we have to be very competitive. Mabuhay is performing reasonably well in the circumstances. It does fit in with our cellular operation, as we could use that to transmit signals on a country-wide basis.

What are your hopes and ambitions for the company over the next few years? What trends do you see emerging in Asian telecoms over the next five years?

I would like to see PLDT as the preferred provider of voice, video and data in the Philippines and be a quality company that everyone could emulate and admire in terms of quality management, quality service, price and coverage that our consumers want.

In terms of trends, basically I see four trends - the convergence of fixed, wireless, Internet/data transmission and of course broadcasting. We want to be a quality company that provides quality service to consumers and also be very profitable for our shareholders.