Portfolio: CVC Capital Partners and Hong Kong Broadband Network

Hong Kong residents are generally blessed with good internet connections. The territory has highly sophisticated telecom market with fixed-line broadband penetration of 84.5% and average connection speeds of 63 megabytes per second - among the fastest globally. 

The local telecom sector is worth around HK$63.4 billion ($8.2 billion) a year and employs 18,000 people. Internet service providers (ISPs) account for a large part of the market. Nearly 200 ISPs are licensed to provide broadband services, notably Hutchison Telecommunications, PCCW and I-Cable Communications, and Hong Kong Broadband Network (HKBN).

It is rare for a PE firm to get the opportunity to invest in one of these big beasts, but last April CVC Capital Partners seized its chance to buy HKBN for around HK$5 billion ($644 million).

"The good thing about this business is that there is a high barrier to entry, as it takes billions of dollars to establish a network," says Roy Kuan, managing partner at CVC Asia. "When we made the acquisition, the company had already invested around $4 billion over the preceding years. If anybody wants to play in this game they have to spend that at least that much and then the process can be time-consuming."

HKBN, Hong Kong's second-largest ISP, was the local telecom subsidiary of City Telecom. It came onto the market because City Telecom wanted expand its domestic television operations - to compete with the likes of TVB - and required capital to do so. 

CVC, which had already acquired several international direct dialing (IDD) businesses in Hong Kong and Canada, was a good fit for the business. The firm acquired the asset through Metropolitan Light Company, a Cayman Islands-incorporated entity controlled, committing HK$2.65 billion in equity from its third Asia Pacific buyout fund, which closed at $4.2 billion in 2008.

The remainder of the transaction was financed through a HK$2.5 billion loan from J.P. Morgan and Standard Chartered.

Fine tuning

HKBN was already a successful business when CVC came in, having already increased its number of subscribers two-fold over the previous five years, from 683,000 in 2007 to 1.3 million by 2012. In addition, the company had demonstrated impressive revenue growth against its fixed line industry peers with a compound annual growth rate (CAGR) of 9.1% in 2012 - 2% ahead of second-placed Hutchinson Telecom Hong Kong.

So the PE firm's first priority was to keep a strong business ticking over. One way to achieve this was by retaining existing management and incentivizing them with equity interests, giving managers the opportunity to put up their own personal saving and co-invest in with CVC.

"In all of our deals we have managers co-invest with us, so in that respect this was no exception," says Alvin Lam, managing director of CVC's operations team. "What was exceptional was that the existing management wanted to take the co-investment program wider, and include a larger number of managers. We thought, ‘Sure, let's do it,' and it was very well received."

In total, 79 managers took part in the co-investment program. The terms ensure that, if the business outperforms, they will receive a greater share of the upside.
In addition to motivating existing talent, CVC also added several new managers. Given this was a carve-out from a larger company, HKBN was left with a number of key positions that needed to filling, among them chief information officer and chief marketing officer. Both were hired a locally.

"Fortunately we were able to hire these people very quickly, sourcing them both from competitors and other major corporations in Hong Kong," say Kuan. "Everybody with HKBN is from Hong Kong and it is something the company is very proud of."

Changes were also brought in further down the management structure. HKBN has half its business in Hong Kong while the other half - providing over-the-phone customer services - is based in Guangzhou. When CVC bought the firm, the Hong Kong side of the business had been divided into geographically-focused teams - each handling new subscribers, customer retention and aftercare for a specific district.

While there are merits to this entrepreneurial approach and giving employees ownership of each district, the private equity firm concluded that Hong Kong's limited size was an impediment. They switched to a functional set up with separate teams responsible for the acquisition of new subscribers, retention and aftercare throughout the territory.

Stronger connections

Despite the level of penetration in Hong Kong's broadband market, CVC also indentified several avenues of growth. One of the company's strongest points has been its metro ethernet (ME) network, which was completed in 2004 and is the largest in the world. Thanks to this network HKBN became the first ISP in the territory to offer a 1,000 megabytes per second residential fiber-to-the-home (FTTH) service.

"Most people looking in from the outside would see Hong Kong as having very high broadband penetration already, so they ask ‘How can it grow?'" says Lam. "What we found out of was that around two thirds of the market had bought so-called ‘broadband' that was actually under 20 megabytes per second because it was still over copper lines. That meant around 2 million homes could benefit from an upgrade."

Those households missing out typically receive broadband services over an ADSL (asymmetric digital subscriber line) connection, which is internet delivered over the wires of a local telephone network. ADSL download speeds can be as low as 20 megabytes per second, but in real terms this can be 2-4 megabytes per second. Upload speeds, meanwhile, can be even slower.

HKBN's FTTH service, which offers a minimum speed of 80 megabytes per second, is symmetrical so users can operate at the same speed for both downloads and uploads. Kuan notes that this is a crucial advantage in a market where services such as social media and online gaming rely on rapid upload speeds.

An additional benefit of the HKBN's FTTH service is the pricing. Because the company already has a ME network in place, HKBN allows customers to switch over to FTTH at a far lower installation cost compared to competitors. This conversion from DSL has been a major driver of growth over the past year with subscription numbers and average revenue per user (ARPU) expected to increase in 2013.

Going mobile

Another consumer trend HKBN is keen to exploit is the increasing mobility. When CVC came onboard, PCCW had stolen a march by building a network of 12,000 hotspots across Hong Kong. HKBN responded with a HK$200 million project that will see its Wi-Fi coverage expand to 15,000 hot spots over the next 18 months.
This involved the bolt-on acquisition of Y5Zone in January. The wholesale provider of wireless broadband network services operates 6,500 hot spots in Hong Kong and more than 600 in selected cities on the mainland. This deal alone took the combined HKBN-Y5Zone Wi-Fi network in Hong Kong to 7,000 hot spots.

The company's ongoing efforts in this area are being funded with the proceeds from a $450 million five-year bond offering. The unrated issue also helped HKBN pay off bank loans.

"The idea behind this is that if you are already subscriber, this is another value-add service," explains Lam. "It is good for our residential subscribers but also good for our corporate customers, notably retail companies that benefit from having a hotspot installed in their shop."

Lam adds that these initiatives to increase HKBN's subscriber base by adding value appear to be paying off. While not all the relevant figures are available, the company's EBITDA margin has jumped by 300 basis points since the acquisition.

CVC's typical holding period is 4-5 years, and HKBN is not expected to be an exception. An exit via either a trade sale or an IPO remains an option, according to Kuan, because the company is a fundamentally attractive business. And bringing faster services to a larger number of households will only make it more so.

"Hong Kong's average broadband speed maybe among the fastest in the world but we still think it is pretty slow compared to what we have to offer," Kuan says.

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• Topics
• Portfolio management
• Buyouts
• Buyout
• Hong Kong (China)
• CVC Capital Partners