Earlier in the year I recommended City Telecom (CTEL) as an attractive Hong Kong company listed in the US as an ADR (ADRs offer an easy way to buy stock in non-US companies). However, since then the company has undergone a dramatic change. City Telecom has sold its entire telecom business to CVC, and issued a special dividend with some of the proceeds from the sale. City Telecom is now a cash-rich media start up, focused on production of TV content, such as a drama and news programming. It is interesting to see such an abrupt change from a relatively well established company, and this creates substantial risk for investors.
A Fundamental Shift
It is worth emphasizing just how extreme this change is. For any business to sell virtually all its productive assets and then take the cash to do something else (albeit in a somewhat related industry) is unusual. It is surprising that the business retains even the name City Telecom. See here for how they intend to manage their cash balance.
No Revenues From Media This Year
To underline the shift, the business does not expect to generate revenue from its new business in 2012, though it will have revenue from the legacy assets through to their time of sale, as a recent company statement states "the Multimedia Business is expected to generate revenue from 2013 onwards".
The New Media Focus
As a result the financials will look quite different going forward than they have done historically, and City Telecom has very little to do with telecoms. Any investor in City Telecom should be confident that the company's current residual cash from the disposal can be transformed into a viable content business. The company is doing just that building a 500,000 square feet media production and distribution center, hiring 400 staff and acquiring the necessary licenses. Full details are in the most recent financial report.
See here for full release.
On 11 April 2012, the Group issued a public announcement "Very Substantial Disposal and Resumption of Trading" which outlines its intended disposal of the Group's entire telecom business.
This proposed disposal, which is conditional upon the shareholders' approval, represents a proposal for the Group to exit its telecommunications related businesses in Hong Kong and Canada and to enable the Group to focus on its multimedia production and contents distribution business, including but not limited to the offer of free TV programming, multimedia and drama productions, contents distribution and other related services ("Multimedia Business") which the Group started in 2003 when HKBN launched its IP-TV (now bbTV) services.
Cash Is King
If this investment seems like an obvious short at this point, investors should remember that the company retains significant cash after the payment of the special dividend, certainly enough cash to sustain the media business for several years.
From being a stable, cash generative telecom company with a strong market position, City Telecom is now a cash burning media start up with a limited track record, no material revenue and uncertain future. Management has performed well in the past and may continue to do so in future, but as an investor the business is now very different to what it was previously and potentially less attractive with City Telecom's credentials less well established.
Risks (of taking a short position)
- City Telecom is relatively small capitalization and illiquid, taking a short position in such companies is expensive from a transaction cost standpoint.
- Senior management have performed well in the past and this move may again work out well for them
- The company appears to be trading at a discount to its cash balance, though without a post transaction balance sheet, taxation details and the cash burn involved in scaling up the content business it is hard to be certain.
- The media business could work out, management must have conviction in the strategy to sell its existing business to enter it. So in a few years City Telecom may be a well established media company.
Disclosure: I am short CTEL.