H3G SpA's final signing and closing dinner this month signals the arrival of the first ever fully funded pure-play 3G operator. The Eu3.2 billion debt enjoys an unprecedented level of support from majority parent Hutchison Whampoa, a factor described by lenders as crucial in getting the deal done. This marks the latest in a series of successful Hutchison-related telecoms transactions, including a financing backing UMTS build out in the UK in 2000 and the largest ever block trade, when Hutchison sold $5 billion of Vodafone shares.

Part of the Li Ka-shing group, Hutchison Whampoa is one of the largest conglomerates listed on the Hong Kong stock exchange. The last two decades have seen its interests diversify from a mainstay of ports, property and retail to embrace the more volatile sectors of energy and telecoms. The percentage of capital tied up in the latter is currently at an all-time high. This is perhaps not surprising, given its success since entering the UK mobile market in 1989 and being awarded a Fixed Telecommunications Network Service Licence in Hong Kong in 1995.

What has turned heads, however, is the enthusiasm with which the company has thrown itself behind the capital-intensive new generation of telecommunications services. The last two years have seen Hutchison dispose of lucrative European 2G assets and replace them with a portfolio of 3G licenses. Critics from several quarters claim that Hutchison has misjudged likely take-up of the technology and thus made a very expensive gamble that it might well lose. The company is on a negative ratings outlook from both Standard and Poor's and Moody's.

Frank Sixt, group finance director, Hutchison Whampoa Limited, waves away this criticism. As well as remaining a committed fan of the video technology, he points out that, ?we have a very good liquidity profile and a very good debt maturity profile. From Hutchison's point of view we have managed the risk profile of our 3G entry so that everything we are doing in the telecommunications division, including 3G investments, is basically financed by profits made from the division between 1999 and 2001.? It is certainly not struggling under anything like the debt levels of most of its 3G competitors. ?If you allow us to take into consideration cash and cash equivalents in marketable securities Hutchison's consolidated net debt to net total capital was less than 1% at 31/12/2001. I expect this ratio to remain in single digits this year.?

Feverish funding

Italian subsidiary H3G SpA's call to the market met a warm reception, with the first round of syndication coming in 50% oversubscribed. In the current telecoms climate, with caution ever the watchword, this is notable. Eu3.2 billion debt breaks down into a Eu1 billion project loan and Eu2.2 billion commencing with full recourse to Hutchison. This falls away gradually over the project life. There is also an Eu1 billion vendor finance tranche and Eu1 billion of Hutchison sub debt. Only Eu1 billion of a total Eu5.2 billion, therefore, carries full project risk. In contrast to the currently troubled Mobilcom, then, H3G SpA enjoys real and guaranteed parental support.

Securing full funding in one go is a benchmark approach in the 3G market. It reflects market conditions and probably sets the standard for large-scale 3G financings. General financing conditions have deteriorated considerably since the H3G UK deal closed in 2000. Hutchison has the controlling stake (65%) in this deal too, with DoCoMo holding 20% and KPN Mobile 15%. As was the trend at the time, they raised finance through a shorter term, non-recourse, non-amortising loan. The £2.475 billion revolving credit facility has a four-year tenor, or to be more precise, a three-year deal with one year term-out subject to full funding. In the telecoms heyday, funding was highly competitive and banks were forced to take re-financing risk. Now the table has turned and operators are having to woo lenders.

?There weren't any alternatives,? says Giorgio Moroni, CFO, H3G SpA. ?The banks made a decision that they wanted a fully funded, fully amortising transaction.?

Sixt agrees with this, but also points to the attraction of a longer maturity, ?From Hutchison's point of view, the debt profile of the whole company must be considered and it is important to have maturities sensibly staggered. So, the longer tenor on the Italian deal suits our objectives of balance sheet structuring.?

He goes on to stress the importance of structure in a long-term facility. ?There was a desire to start to build the model for project structured finance on the business going forward over its whole life. Yes, we guaranteed a portion of the facility in the project's early years, but we did so on the basis of conditions that allow our guarantee to burn off once the project achieves operational and financial milestones. This is quite typical of early cycle development project financing. We think that, although a difficult tranche to understand, it was important to get into the market with at least the first iteration of a financing that sought to define the parameters of financibility and financial success for 3G businesses in the future.?

Marc van Wuunik, head of media & telecoms, ABN Amro, emphasises that the flexibility Hutchison has demonstrated in putting together different structures for the UK and Italy transactions according to differing market conditions is a very positive and comforting sign.

There are some continuities, though, pointing to a formula that works. In both instances Hutchison has put up a subordinated loan (£375 million for H3G UK) and both have vendor finance tranches ranking pari passu to senior debt. In the Italian case, there is an additional quirk. The vendor tranche boasts a number of ECAs who have broken from their traditional domain of guaranteeing to lend as banks. The two facilities thus do not compete with and cannibalise each other.

Hutchison is big on relationship banks, describing them as very important. There are a handful that played high profile roles in UK, Italy and other recent Hutchison transactions. Some books are now starting to look full. If, as many market observers believe, the company's subsidiaries attempt to raise financings similar to the Italian structure elsewhere in Europe, they may find that some banks have had their fill of Hutchison telecoms risk.

Van Wunnik doesn't see this as a serious problem for the conglomerate and its subsidiaries, specifically Hi3G Access (60%) in Sweden and Denmark and Hutchison 3G Austria (100%). ?Hutchison limit may be a concern for some of the relationship banks but Sweden and Denmark are much smaller markets. Not all the banks need to join in all of the deals of this size.? In addition, Hutchison's partner in the joint venture, Access AB, will bring its own set of relationship banks to the table.

Sixt himself won't commit on the subject of funding further build outs, ?I think we will see some financing activity, but you have to take a market-driven approach. We don't have a funding constraint and in fact, could have equity funded everything we have done so far anyway. We made so much money out of the last generation of wireless, there isn't a need for us to go out and capture incremental financing. Having said that, it probably makes sense, particularly in terms of the ability to attract significant vendor financing on a non-recourse basis, so why would we give that up? So yes, there may be some financing activity, particularly in relation to our projects in Sweden and Denmark.?

Hutchison launched the Orange brand, providing digital PCN services, in the UK in 1994 and then went on to form Orange Plc, which became one of the country's most successful mobile operations. Through joint ventures and subsidiaries, Orange moved into other countries in Europe including France, Germany, Belgium and Switzerland.

In November 1999, Hutchison sold its entire 44.8% stake in Orange to Mannesmann, which was subsequently bought out by Vodafone AirTouch. Concurrently, Hutchison also sold its stake in US wireless operator Voicestream to Deutsche Telekom (DT). As a result of these two deals, Hutchison ended up with stakes of 5% each in Mannesmann and DT.

The last two years have seen a number of major transactions executed in an effort to monetise these positions, which included a block trade of $5 billion in Vodafone shares in March 2000. The figures speak for themselves. Hutchison has turned a $1.5 billion investment in Orange into roughly $20 billion in trading gains and reported a $9 billion profit from the sale of Voicestream.

Sixt expands to explain why Hutchison is committed to a greenfield route for 3G. ?We took a view quite early on that the value being offered us for our interests in 2G was such that we were better off to adopt a greenfield strategy. There is obviously always an element of good fortune as well as foresight in these movements, but events have shown us to be correct.? He points to how the erosion in value of 2G assets and customer bases has raised serious financing issues for people now trying to finance growth into the next generation. Whereas Hutchison's financial strength, partly as a result of having realised those 2G assets, has given it an advantage. He stresses that, ?We don't see ourselves as the fifth entrant in a four player mobile market but rather the first entrant in a new market.?

Not everyone is convinced. ?I have a fair few concerns about the take up of 3G,? says one Hong Kong-based analyst. This sentiment is echoed by others, who point to the very large capital expenditure required. 3G is certainly a much higher risk investment than Hutchison's traditional holdings. Although enhanced data services are likely to be an integral part of communications over time, at the moment it is difficult to predict to what extent. ?There are significant business risks associated with these ventures, although financial risk is somewhat mitigated through proceeds from the sale of Vodafone.? Both Moody's and Standard and Poor's explicitly attribute the negative outlook status to 3G interests. Although no one is suggesting that the telecoms division could bankrupt the entire conglomerate, many have words of caution.

Sixt isn't buying into this, believing that 3G really is the way forward. ?Although 2.5G technology was a breakthrough in terms of moving information across mobile networks, capacity utilisation in the GSM infrastructure that GPRS technology operates on is such that it is unable to operate effectively. As a result the user experience is relatively poor. And that is where we think the differentiation with UMTS is tremendously important. Open networks, no capacity constraints, a clear ability to deliver 386Kbits/sec base functionality to all of our customers for a long period of time. We will move into a universe of truly high-speed delivered multi-media wireless applications and I think that is something that customers will resonate to.?

And he stresses that there really is no financial risk to the rest of the company. Everything being done in telecoms is basically being financed through profits raised from telecoms. Not a penny is being raised against the other divisions. ?And that is by design,? he emphasises. ?That is the one thing that was an unimpeachable discipline for us.? Attention to this is one of the reasons why Hutchison is not in Germany.

Outside of Europe, Hutchison's telecoms operations paint a slightly different picture. Subsidiary Hutchison Telecoms in Hong Kong has a UMTS licence, as does joint venture Hutchison 3G Australia (with Telecom Corporation of New Zealand) in Australia. But conditions in the Asia Pacific region are slightly different. The licence prices were nothing like as great as in Europe and in Hong Kong, the market is very small. Overall risks are therefore not so great. In Australia, existing mobile operator Hutchison Telecommunications Australia recently issued $600 million of convertible bonds, targeted for the 3G subsidiary. It is understood that 3G launch here, however, is being held back for the time being.

Hutchison also has significant 2G interests in a number of Asian markets where the mobile markets are still growing. ?There is definitely big potential for Hutchison's operations in Asia,? predicts Steve Weiss, senior vice president, structured finance, head of TMT, Asia, ABN Amro. ?They have a diverse portfolio.? India, where penetration is rising the fastest, Hutchison has a number of localised GSM partnerships. It also acquired 100% of Lanka Cellular Services Limited in Sri Lanka in 1997 and owns a paging service in Malaysia.

In Thailand, Hutchison is looking to launch a 2.85G service, which is a 1X platform on a CDMA network. ?This offers not quite the capacity and data speed equivalent of UMTS but does allow you to move substantially better in terms of customer propositions than you currently can over GPRS?, says one market observer. The company could well look to raise capital for one or more of these ventures but flexibility remains the name of the game.

Frank Sixt summarises the company's current stance. ?We have a very good liquidity and debt maturity profile. Most of the financing activity you will see from Hutchison in the short and even medium term will be in the nature of opportunistic debt refinancing. We will be watching all markets with a view to achieving price advantages where we can. And, of course, over time it makes sense to shift some of our fundamental borrowing currency base. We were the first Asian corporate borrower to go into the Euro denominated bond market back in 1999. I would expect to see more of that when conditions are apt, as well as possible activity in the sterling market. Always with the twin objectives of achieving more competitive cost of debt capital and more attractive maturity profile.?