NBT Research Update: ChinaTel Group Begins Negotiations to Expand Network in China to One Billion
.by ChinaTel Group on Thursday, September 16, 2010 at 2:35pm. NBT Research LLC
Update: ChinaTel Group, Inc. (CHTL)
September 16, 2010
Strong Buy: 2012 target $2.50-$3
Analyst: Tobin Smith, Chief Research Officer
We have spent the last few days with ChinaTel Group, Inc. CEO George Alvarez in meetings at the Rodman Renshaw Equities conference in NYC Sept 12-14th. They met with more than 2 dozen investment managers telling the CHTL story and doing 1-on-1 meetings with a number of money managers in the micro-cap, Internet and Asia-Pacific space.
The message from Mr. Alvarez and lead equity investor Tony Isaac has been simple: with the Isaac Organization Stock Purchase Agreement capital combined with the 85% vendor financing from ZTE Corp. and the expandable $30M Hana Bank credit facility, they have 150% of the capital required to finish deployment of their first 12 cities in China (over 200M population) AND first 7 cities in their Peruvian network.
Therefore Mr. Alvarez announced to me in a long conversation yesterday that “based on our strong relationship with Chinacomm, and largely due to the new long term relationship with ZTE (and its $10 billion in bank financing for equipment) we are now receiving and entertaining offers from other major 3.5Ghz spectrum holders to build similar wireless broadband networks in about 40 additional Chinese cities and over one billion Chinese citizens.”
Mr. Alvarez confirmed to me that as of yesterday, ChinaTel had received serious proposals and inquiries to finance and build an additional 41 cities in China representing an additional 700 million citizens reached. This would take the ChinaTel wireless broadband portfolio to over 70 cities in China by 2015 if these new development deals are consummated.
Although we expected other 3.5GHz spectrum holders to approach ChinaTel for their networks, the scope and scale of the interest as reported by CEO George Alvarez is significantly more than we expected. We have talked with many of the other 3.5GHZ spectrum owners in China—they evidently are more than jealous of Chinacomm’s deal with ChinaTel than I thought.
In Mr. Alvarez’s opinion, the fastest and best way to get the CHTL stock price to reflect fundamentals of the ChinaComm, PeruSat S.A. and new network development opportunities in at least 40 additional cities in China is
a) complete the 12 city Chinacomm Network and 7 city Peru equipment vendor financing and begin network operations and marketing as quickly as possible
b) Draw an additional $40-$50 million from the Isaac Stock Purchase Agreement (over $20M drawn so far on the agreement) by the end of the year for new equity commitments to additional China cities
c) Complete rest of network financing with combination of ZTE and Hana Bank financing--@ 15% down and 85% financed.
d) Pay-off the Chinacomm note for the 49% interest in Chinacomm by the end of the year (@$170M left on note) with a combination of Chinacomm debt conversion (Chinacomm owes CHTL @$70M in network deployment and equipment account receivables), Isaac cash and CHTL shares (yes Chinacomm wants to be a shareholder in CHTL—more on this shortly)
e) Take some extraordinary corporate measures to kill off the illegal naked short positions in the stock (i.e. declaring a dividend which would force naked short sellers to have to actually have custody of shares subject to a dividend)
f) Introduce some key strategic investors to NBT Capital to participate in our ChinaTel Capital Partners LLC fund to acquire/control significant majority of the equity float.
g) Expand ChinaTel’s wireless broadband network development deals along with ZTE OUTSIDE the 29 cities with Chinacomm Ltd to include other major Chinese holders of 3.5Ghz spectrum in enough cities and regions to bring the ChinaTel wireless broadband network in China to one billion people by 2015
h) Create direct EBITDA for ChinaTel from these new networks by using a new structure that makes CHTL the 51% de facto owner/operator of these new networks (and fully compatible/roamable with the Chinacomm Network ). This new structure would conform to US GAAP accounting rules so that the NON-Chinacomm Network operations would be consolidated within the CHTL income statement and NOT reported as a single net loss/gain from minority held investment like the SEC forces CHTL to report its Chinacomm joint-venture.
i) Complete the Hong Kong IPO for Chinacomm Ltd after required two years of positive and audited EBITDA are on the books…which now would be 2013 or early 2014.
Let me go into each of these extraordinary new parts of the ChinaTel story separately to explain them as thoroughly as I can. Of course adding 40+ cities and 700 million additional prospective customers for $8-$12 wireless mobile broadband service would most likely DOUBLE or TRIPLE our 2015 valuation model for ChinaTel’s various operating subsidiaries depending on the size and scope of the new network projects.
Updates from CHTL and CEO George Alvarez from meetings Sept 12-14th in New York
1) Complete the 12 city Chinacomm Network and 7 city Peru equipment vendor financing and begin network operations and marketing as quickly as possible.
1.The equipment vendors and financing for Beijing and Shanghai are already complete and financed by $30M Hana Bank deal. Samsung and Huawei will supply all equipment in those cities—that deal was completed by Chinacomm Ltd. Leadership earlier this month. According to Mr. Alvarez this move keeps ZTE on their toes and is a good move politically since Huawei is a PRC majority owned company.
2.Mr. Alvarez expects to announce the equipment financing deal and purchase orders for the PeruStat S.A. subsidiary in the next few days. ZTE will provide turn-key financing (15% down/85% financed for 2.5 years no payment) and all the equipment for Peru. CHTL waiting for equipment certification by Peruvian telco agency and then final equipment deployment to begin.
3.The final ZTE equipment financing/purchase orders for the 10 additional Chinese cities is down to final strokes and will be jointly announced (ZTE and CHTL) imminently.
4.With all the equipment being co-located on existing China Mobile/China Unicom/China Telecom sites (as per China telco law) the entire 12 city initial network capex/opex budget is less than $175 million—up to 50 TIMES less costly than comparable networks for 200 million people being deployed by ClearWire in the United States.
5.All the base station equipment is pre-authorized/set-up to move from existing Wi-Max protocol to new 802.16m mobile protocol (with 40-60 Mbps speeds) and then to either TD-LTE or a dual band mode. NBT forecasts the dual band (Wi-Max/TD-LTE) will dominate by 2015—which is GREAT for CHTL as the low cost operator in China.
2) Draw an additional $40-$50 million from the Isaac Stock Purchase Agreement (over $20M drawn so far on the agreement) by the end of the year for new equity commitments to additional China cities
1.$20M+ already drawn ALL for new deployment as per the agreement
2.Isaac has agreed to draw up to $90M by end of the year
3.New wireless broadband network deals should require $20-$25M of equity financing per province—all of which would come from sale of CHTL shares to Isaac’s for $1.50 per share
4.Mr. Alvarez again confirmed Isaac bankers have confirmed “high nine figures” of equity financing capacity from the Isaac Organization—which again confirms our due diligence as well.
3) Complete rest of network financing with combination of ZTE and Hana Bank financing--@ 15% down and 85% financed.
1.ZTE deal is VERY competitive—Alvarez will 8k the deals as signed minus disclosing the actual equipment costs for competitive reasons
2.ZTE equipment in CHTL tests proved superior in every metric
3.The NEW network development deals are coming in large part due to new ZTE/CHTL partnership. The exclusive owners of 3.5 GHz spectrum in the provinces NOT covered by Chinacomm are coming to CHTL and basically saying “We want to rapidly deploy OUR provincial wireless broadband networks, and YOU guys (CHTL) are the only partners we can trust to get our network financed and operating on time…we want you to do for us what you did for Chinacomm!”
4) CHTL will completely pay-off Chinacomm for its 49% interest in Chinacomm by the end of the year (@$170M left on note).
1. With CHTL paying off the remaining balances they held with sub-contractors for 2008-2009-2010 deployment work for Chinacomm, Chinacomm now owes @$70M to ChinaTel in accounts receivable free and clear. Chinacomm has agreed to reduce the underlying note for the 49% equity purchase of Chinacomm. This is a big deal…but…
2. Chinacomm Ltd. Management ALSO informed CHTL and Mr. Alvarez that it would like to swap the remaining @$100M left on the note for a combination of CASH and CHTL stock. This change in heart reflects I think Chinacomm understands that with all the financing secure for the first 12 cities, the NEXT big deal is taking Chinacomm public in the Hong Kong IPO already approved by the PRC and Securities Agency. Chinacomm see’s the extraordinary value in what ChinaTel is building, and they want a piece of that pie. It’s the right move by Chinacomm, and it’s great for CHTL as they become even closer to their partner.
3.Mr. Alvarez informs me they are negotiating the value of CHTL stock and will pay-off the remaining $100M with Isaac cash (which goes into the deployment budget) and CHTL stock—the percentage based on how well they do negotiatiing CHTL stock price with Chinacomm. I would NOT expect $1.50 a share—more like .75 to $1 a share makes most sense.
4.Mr. Alvarez also informs me he intends to stop the Isaac stock purchase agreement at $205M—instead of full $640M deal with all warrants in. THIS means the shares that they would have sold to Isaac will be used to pay off Chinacomm note…and THAT means our forecast of fully diluted shares of CHTL remain at 650-670M shares fully diluted (and that included 133M shares for exercised warrants at $1 a share.)
Owning the 49% of Chinacomm FREE and CLEAR will go a long way to improving the market value of CHTL stock—and when audited Chinacomm revenues and EBITDA begin to appear from the 12-city deployment valuation comps with OTHER 4G networks—ala Clearwire—will most likely be quite beneficial toward CHTL.
5) Mr. Alvarez and I talked about CHTL taking extraordinary corporate measures to kill off the illegal naked short positions in the stock. One very good idea from a Morgan Stanley exec: simply declare and pay a one cent dividend. Legitimately short shareholders would have to pay this dividend to people they borrowed their stock from—that’s not the trick. The trick is that declaring a dividend would force naked short sellers to have to actually have legal custody of shares subject to a dividend—even illegal short sellers can’t get around this provision. If the company paid a dividend to someone who illegally shorted the stock they would be subject to major legal and FINRA penalties I am told. Not to mention out a penny a share for their imaginary shares. Mr. Alvarez has got his legal team on the job—and will let us know shortly if they are going to proceed.
6) Introduce some key strategic investors to NBT Capital to participate in our ChinaTel Capital Partners LLC fund to acquire/control significant majority of the equity float. Mr. Alvarez and Colin Tay—founders of CHTL—are favorably disposed to our ChinaTel Capital Partners LLC fund for obvious reasons. Both are helping us contact key strategic investors for our fund.
7) THIS is the big news. As previously discussed in this report, CHTL’s partnership with ZTE and their work to date with Chinacomm Ltd has brought a number of “major network development deals” to ChinaTel OUTSIDE the 29 cities with Chinacomm. Mr. Alvarez reports that many major holders of 3.5Ghz spectrum in China have approached CHTL over the last few months to bring the ChinaTel wireless broadband network in China to one billion people by 2015.
We have expected this new business to happen as there are a dozen or more major holders of 3.5 GHz spectrum in China that have been waiting to see how the ChinaComm Network was working out. As we suspected, now that ZTE and ChinaTel are working together, ZTE’s $10Billion line of credit from the Export/Import Bank of China and ChinaTel’s engineering and deployment credibility make for an extremely powerful value proposition for those Chinese companies that hold spectrum reaching an additional 700 million bandwidth hungry Chinese.
Mr. Alvarez forecasts that they will have at least a few of these new network development agreements signed and financed BEFORE the end of the year.
Tripling the footprint of ChinaTel 4G wireless broadband network footprint would roughly triple the EBITDA earning power of these ChinaTel assets. When individual deals are announced we will create a financial forecast for each one as they are going to done COMPLETELY different than the Chinacomm deal.
8) These new regional wireless broadband networks come AFTER the China Telco Act of 2008. The big part of the act was to merge a number of telcos into the Big 3 –and left Chinacomm as the #4 China telco and the ONLY pure play wireless telco with 29 cities of spectrum AND 34,000 kilometers of fiber as well. The act also allows a different ownership structure—and THIS is how CHTL will take advantage. Each network will be owned 49% by spectrum holder, 49% by CHTL and 2% by ZTE. ZTE will defer its 2% vote to CHTL—making CHTL the control 51% de facto owner/operator of these new networks. This new structure would conform to US GAAP accounting rules so that these new network operations would be consolidated within the CHTL income statement and NOT reported as a single net loss/gain from minority held investment like the SEC forces CHTL to report its Chinacomm joint-venture.
This new structure is perhaps the biggest news for CHTL shareholders as it now implies that a majority of CHTL subsidiary EBITDA (40 cities vs. 29 cities in the non-consolidated Chinacomm JV) will be reported on its public financials. THIS change insures CHTL revenues will get analyzed and modeled by both Wall Street and industry analysts…BIG important change.
9) I got more clarity on the Hong Kong IPO for Chinacomm/ChinaTel joint venture. As they Hong Kong exchange now requires two year of positive and audited EBITDA, we now forecast an IPO completion in 2013 or early 2014. We had previously forecast first half 2012-early 2013 depending on how fast the Chinacomm Network deployment ramped up. Since this would be the primary liquidity event for the PRC and for Chinacomm management, this is a major priority for all involved. With Chinacomm owning a decent amount of ChinaTel (from the JV purchase note pay-off) we will reforecast ChinaTel’s ownership position of the Chinacomm Network assuming 10% of shares sold to the public in Hong Kong.
The IPO for CHTL shareholders is quite valuable in that
¦the capital raised will pay off most if not all debt assumed for the first 12 cities
¦repayment of debt and equity capital raised will finance the remaining 17 cities along with cash flow from operations
MOST important for CHTL shareholders, however, is that ANY difference between the Hong Kong value of ChinaComm Network and CHTL’s ownership percentage value will be “arbed” or priced out of the US CHTL shares. This would occur when arb hedge funds would short the Hong Kong shares and go “long” the CHTL shares until the miss-pricing came out of the CHTL stock.
Summary
I know this is a lot of material…but ChinaTel’s goal to build the largest 4G wireless broadband network in the world have been strongly strengthened by this set of important strategic moves.
When the ZTE equipment contract and purchase orders are done we will hold a conference call with George Alvarez and perhaps Tony Isaac shortly thereafter to add additional light to these major announcements.
At .30-.50 a share we believe investors are getting an extraordinary opportunity to in effect purchase a never ending “call option” on ChinaTel’s capability to build and finance up to 70 cities of wireless mobile broadband in China. Call options expire—this “virtual option” never expires.
In many ways this “call option” on China wireless broadband is really a “one decision” investment: Do you think with $8-$12 a month all you can eat 20-40Mbps wireless mobile broadband there will be MORE or LESS consumers of wireless broadband in the top 70 cities/regions of China?
If you think more, then owning CHTL stock at these prices is like a 4 year never expiring option on its growth. If you think there will be LESS Chinese consuming applications over mass market affordable wireless broadband in the next 3 years—less Skype, less TV, less video, less music, less movies, less video games—then you are missing the key fundamental driver of China Internet consumption: availability and affordability.
Only about 400 million Chinese use the Internet now—and it’s primarily via cell phone. With the explosion of laptops, iPads and tablets, and of course smart phones—data consumption goes up 100X every time a Chinese citizen in what is not up to its top 70 cities purchases a digital appliance or PC.
As another 200-300 million Chinese move into the middle class—earning around $3500-$4000 per household a year—they will purchase flat screen TV’s, PCs, laptops and all the other digital gadgets that require broadband connectivity to use.
It is the migration to the Mobile Internet—growing twice as fast as the initial desktop Internet wave—that is creating this enormous opportunity for ChinaTel and its wireless network engineering expertise and experience in China.
As the ONLY way for investors to play this gigantic wave—ChinaTel Group we continue to believe will see the enormous discount to its true private market value removed from the stock price.
We continue to value its share of the 12 city network at around $2.50 a share, and with full 19 city deployment and post-IPO in Hong Kong we value CHTL’s 650M shares at over $6 a share.
And THAT valuation does not include Peru operations—which should add $1.50-$2 a share at full build out. And of course that valuation does NOT include any NEW China provincial network deals.
If ANY one asks me why I continue to rate CHTL stock as the stock opportunity of the 21st century, I encourage you to reread this report and review the pro-forma forecasts on www.chinatelgroup.com web site for both the 12 cities in China and & 7cities in Peru.
From here we will need to ADD another 17 cities in China and then add any new 51% network development deals as they are consummated.
I am highly confident that when additional cities/networks are added to the 29 city ChinaComm Network and PeruSat S.A. assets, we will see the discounted present value of these assets (using 2015 as the baseline year) FAR exceed $18-20 a share for ChinaTel Group, Inc with 650 million shares outstanding.
If anyone has a problem with how we do that math, we will shortly publish a full 29 city forecast and discounted to present value capital table.
Tobin Smith, Chief Research Officer
NBT Research LLC
AI
