China Telecom Deal To Lift Public's Stake

Tuesday, China Telecom announced details of a two-step transaction that will give its Hong Kong-listed affiliate, China Telecom Corp. Ltd., the operations in 10 provinces that previously were owned by the parent alone.

In doing so, China Telecom becomes one of the few companies in China to expose almost all of its operations to shareholder scrutiny. Still, the public's stake will be minor. After the transaction, the public will hold just under 20% of the listed company, compared with 10.6% currently. The government's stake will fall to 70%, through its control of the parent company, from 78%. Three Chinese investment concerns hold the rest of the listed unit.

Still, says Liang Jian, a director in China Telecom's investor relations office, "The management will consider the views of the shareholders very carefully."

The privatization of China's massive state-run companies is a sensitive topic with government officials. Governments in Germany, Australia and elsewhere in recent years have sharply reduced ownership in their state-run telecommunications carriers.

A China Telecom spokesman says the company has received no indication that the Chinese government plans to further reduce its ownership. Until about 10 years ago, the company ran all telecom services in China. In a series of transactions since, the government has created five other telecom companies. In 2001, China Telecom was assigned the fixed-line operations in 20 provinces in the southern and western parts of the country, home to 839 million people. The company provides about 161 million access lines to them.

China Telecom expects to improve its growth prospects and eliminate some inefficiencies, including a sizable number of so-called related-party transactions, that were rooted in having only a portion of its assets in the listed company.

"Both operationally and financially, the company will gain by having all its operations in the listed company," said David Chin, director of corporate finance for China at UBS, one of the advisers in the transaction.

In the first step of the deal, announced last month, the listed company will ask shareholders for permission to issue 8.32 billion new shares through the summer and fall, which will dilute existing shareholders. Then, it will seek shareholder permission to use the proceeds to pay the parent company US$3.4 billion for the operations in the 10 provinces.

The practice of partial listing of assets, strikingly different from the way companies are listed in the U.S., is common in China as companies prefer only to expose their best-performing operations to shareholders.

Expectations of the purchase, and the share placement that will pay for it, have weighed recently on China Telecom's stock price.

It's unclear how investors will react to details of the announcement, which was made after the Hong Kong stock market closed. The 10 provincial businesses being added to China Telecom's listed unit posted a combined loss last year, and carry debt of 40.04 billion yuan (US$4.84 billion). But executives said they expect the businesses this year to contribute an after-tax profit, before special items, of 4.76 billion yuan.

When China Telecom went public in November 2002, shareholders purchased a stake only in its operations in Shanghai and three populous provinces.

Last fall, the company moved the assets from its operations in Chongqing, China's third-largest city, and five other provinces into the listed unit. When the newest transaction is done, all except China Telecom's fixed-line business in Tibet and some small, new operations will be in the listed unit.

China Telecom shares ended down 3.5% Tuesday at HK$2.725 (35 U.S. cents) ahead of the announcement of the transaction's details. In addition to UBS, Morgan Stanley and China International Capital Corp. are advising the company.

Write to Evan Ramstad at evan.ramstad@wsj.com and Loretta Ng at loretta.ng@dowjones.com