Bankers who were working on Philippine project deals at the beginning of last year will not have forgotten the uncertainty caused by the toppling of president Joseph Estrada. From a telecoms perspective one interesting aspect of the display of people power that brought down Estrada was the use of mobile text messaging to organize opposition rallies. Filipinos are advanced users of mobile telephony despite purchasing power well below that of consumers in Singapore or Hong Kong.

The strength of Philippine mobile telecoms is, in fact, quite remarkable. According to Vesa Tontti, assistant vice-president at Citibank's Los Angeles project finance team, the overall mobile penetration rate in the country rose a staggering 66 percentage points from 8.3% at the end of 2000 to 13.8% at the end of 2001.

The telecoms market is, nevertheless, a tale of two networks. Fixed line growth is virtually stagnant ?A recent government study revealed that of the more than 6.9 million lines installed all over the country, only 3.06 million are subscribed,? says one Manila-based telecoms analyst.

As a result, traditional telephone companies like BayanTel, which borrowed heavily to finance a massive rollout of telephone lines beginning in 1997, have found themselves saddled with loans that were incurred at a time when the foreign exchange rate was only Ps 25 to US$1. Their debt burden has now ballooned given current rates of P51 to the dollar.

In contrast, Tontti says that both telecoms operators and bankers alike have been surprised by the continued growth of the Philippine mobile telecoms market. ?People expected the growth rate to start slowing down about now but preliminary statistics from Philippine telcos indicate that more new subscribers were added in December than probably any other month before.? Citibank now expects a penetration rate to reach or even exceed 17% by the end of 2002.

The trouble for bankers financing telecoms projects is the wide range in estimations for the Philippine mobile market's saturation point. ?The range of forecasts by investment banks goes from a conservative 23%,? says one financier, ?to as high as 33% in the next five to six years.? This year, however, the source believes that projects can be relatively easily banked, as long as the two key incumbents, Smart Communications and Globe Telecom, sponsor them.

Industry analysts have argued that affordability remains the key constraint in the country, considering average Philippine disposable incomes. But as far as mobile telecoms is concerned, Tontti thinks that affordability is not an overwhelming concern at the current penetration levels (still well below comparable countries like Malaysia). ?Costs to subscribers aren't that high. The average pre-paid subscriber revenue per month is about Ps500 to Ps550 a month, or about $10.?

In the fixed line sector, affordability is much more a constraint to growth. Pam Castillo, a senior executive at BayanTel says that 90% of local households have an average monthly income of only Ps10,000, making it difficult for them to own their own land line. She adds that the depreciation of the Peso against the US dollar has made fixed line telephony even more expensive since the costs just go up. ?Under the foreign currency adjustment scheme Philippine telcos use, additional costs due to the depreciation of the currency are passed on to subscribers,? she says.

In addition, time looks to be on the side of Smart and Globe. One Singapore banker says that both players have additional financing needs in 2002, ?after that,? he says, ?the two will have sufficient free cashflow to take care of capex from 2003.? Tontti agrees: ?the two have very strong operating cash flows and despite significant capital investments into their wireless networks, their additional funding needs will probably be quite limited.?

Even with a scenario of slumping subscriber growth rates, Smart and Globe are protected by the nature of their expansion program. ?Smart and Globe already have good coverage and their new projects are mainly confined to adding new capacity. That sort of capex is pretty reliable in terms of returns and is also easy to scale down should the market environment take a turn for the worse,? the Singapore banker explains.

Apart from overall market growth rates, the movement of potential new incumbents, particularly Digital Telecommunications Philippines, will be closely watched. The Philippine mobile sector is especially attractive to international banks because it is a virtual duopoly. As of the end of September 2001, Smart already had 5.4 million GSM subscribers or 43.9% market share. Sister firm Filipino Telephone Corp. (Piltel) accounted for 12.14% while Globe had 43.44% market share. ?Smart and Globe by themselves control about 87% of the market,? says one telecoms analyst. ?Add in their affiliates and the companies' investors actually control 99% of the current market,? the analyst says. Most observers, however, see little real threat from new entrants. ?The entry barriers are going to be very difficult to overcome. Smart and globe already have high subscriber volumes and very good brand recognition,? believes Tontti.

Not surprisingly, Digitel, which says it is proceeding with the soft launch of its cellular business this quarter, is having a tough time securing financing. According to one banker, the company, advised by Hypovereinsbank, aimed to have new equity capital committed by major international telecoms operators to finance the initial rollout. But no significant telco investments have yet been secured.

The company originally planned to start offering cellular services in 2001. It was then delayed to first quarter this year and afterwards to the second quarter. A senior official at Digitel denies rumours of funding difficulties. However, of its financing plans, he will only say that a scheme to offer 10-year, $200 million bonds (originally put forward last year) is still being considered. The official estimates that his company will need more than $500 million in the next three to five years to finance its foray into the cellular industry. The planned $200-million bond offer would only finance the initial phase of the wireless operations.

Deal flow 2002

Expect deals of similar size ($100 to $200 million) from Smart and Globe to those in 2001 and a number of smaller deals. Citibank has already completed a Ps300 million corporate fundraising for Smart. The arranger held Ps120 million. Participants included Banco de Oro lending Ps100 million and Orix Metro Leasing & Finance Corp contributing Ps80 million.

Project finance banks say the battle win these finance mandates will be particularly keen this year. Although Citibank succeeded in winning the lead arranger roles for both Smart Communications and Globe deals in 2001, it is by no means a foregone conclusion that the bank will secure mandates from the telcos again in 2002. ?Banks are being particularly aggressive with fees this year, and even a bank like Citibank with a strong record in this market is going to have its work cut out to get the arranger positions,? says one Hong Kong financier. Why so? Largely because relatively few project finance deals are expected in the Asia in 2002 (telecoms or otherwise) compared with last year or 2000. Less because of the intrinsic attractiveness of the Philippine telecoms market.

While a foray into the banking market is also a distinct possiblity, Globe is said to be looking at a fixed income deal since interest rates are now at an all time low. Project finance bankers say that the failure of Smart's parent, Philippine Long Distance Telephone Company (PLDT) to tap the international bond markets last year should not be taken as a sign that a capital markets financing is impossible for a Philippine telecoms operators in 2002.

In late September last year, PLDT postponed its $250 million bond offering and withdrew its cash tender offers to buy back some $328.7 million worth of notes maturing in 2003 and 2004. But a Hong Kong based financier says the decision was basically the result of the unfortunate timing of the deal and the dislocation of the financial markets following the September 11 terrorist incidents in the United States. ?Don't be surprised if PLDT also tries to relaunch its own bond program this year,? says the banker.

If Smart also choses to fund its ongoing expansion activities through a bond issue, will Moody's move, lowering the outlook on PLDT's credit rating (Ba1 senior unsecured and B1 preferred), be a significant influencing factor? Bankers think not. In itself, PLDT's leverage stands out even amongst the company's Asian telco peers, but credit concerns stem mainly from the fact that PLDT has a lot of debt maturing rather than cashflow problems. More importantly for Smart, says a banker, ?It's pretty much self sufficient financially speaking.?

Smart is, in fact, well known as PLDT's crown jewel and it is with reluctance that PLDT will sell-off a portion of Smart. Again, the move is not likely to harm Smart's appeal as a bankable company, not least of all because the sale is of a minority stake in the mobile telecoms operator (at maximum, only 15% of Smart instead of the previously planned 20% will be sold). The percentage sold could be much lower because Smart's worth is increasing rapidly with subscriber growth. ?PLDT is not going to have to sell off that much of Smart to raise the cash it needs,? says a telecoms analyst. The source suggests that PLDT is aiming to raise between $300 million and $400 million from the sale of Smart stock.

Outside the bond market, export credit for Philippine telecoms deals will be essential. ?Most banks have reached their country limits for the Philippines,? says Saadia Khairi, Asia Pacific Head, Citigroup Project Finance and Structured Trade. Export credit guarantees, removing the country limit constraints, provide most international banks with their way in to Philippine financings.

But with Finnvera experiencing increasing exposure concerns in the Philippines, it has become more important for the telecoms companies to assess banks' appetite for uncovered lending. Joseph Lim, a vice-president at Credit Agricole Indosuez's Hong Kong project finance team says that DiGi's recent Malaysian deal may point the way: ?DiGi has arguably got a similar operator profile and is in a similar, growing market. In the financing the lead underwriters underwrote 60% of the commercial loan amount. The rest was insured by EKN. Philippine deals might be able to reach the same threshold, although they aren't likely to be any more aggressive,? says Lim.

Philippine banks, unlike their counterparts in Malaysia, are in no position to take up the slack. ?Philippine banks may be involved in a few local telecoms project financings, but probably only in a small way, similar to last year,? says Khairi. In 2001, Philippine banks participated in a few deals: Metropolitan Bank & Trust Co and Development Bank of the Philippines were lead managers in the 15 year, $19 million equivalent term loan portion of an overall $300 million financing for Smart.

In the past, liquidity difficulties have hindered domestic banks from lending, especially at long tenors. This situation will not change any time soon. Bradford Ti, banking analyst at Salomon Smith Barney in Manila, says that Philippine banks are suffering from a rising trend of non performing loans (they are expected to peak in the third quarter at 21%) and are cautious about new lending. A 50% discount on bad debts under an asset management scheme run in the country is also affecting the banking sector's capital adequacy.

There is some debate about whether pricing will be tighter for telecoms-related project financings in 2002. ?I expect to see pricing come off simply because we forecast fewer Asian deals this year than last. Competition is going to be more fierce for the deals that do materialize,? says a Hong Kong source. Yet telecoms appetite is still weak, a situation likely prolonged by the recent collapse of Global Crossing. Ominously for Digitel, another banker says, ?Smart and Globe are really the only two Philippine telcos that we can consider banking.?

What then would happen if Digitel were able to launch a service in 2002? According to Lim, Digitel's arrival won't take significant liquidity from Globe or Smart. ?In contrast to Digitel, Smart and Globe have positive cashflow,? says the banker.