Reject the bid for NWTMT
3 January 2006

New World TMT Ltd (NWTMT, 0301) was listed on 27-Oct-95 after an IPO sponsored by CLSA Ltd. Back then, the company was named New World Infrastructure Ltd and was a partial spin-off of the various port, road and power infrastructure assets of parent New World Development Co Ltd (NWD, 0017). It took its current name on 28-Nov-03, after a complicated reorganisation of the New World group in which NWTMT sold its infrastructure assets to a listed subsidiary called Pacific Ports Co Ltd, which was renamed NWS Holdings Ltd (NWSH, 0659), and NWTMT distributed its holding in NWSH to its shareholders, who received 0.587 NWSH shares (after adjustment for the subsequent 10:1 consolidation) for each NWTMT share they held. The reorganisation was completed on 29-Jan-03, leaving NWTMT holding a mixed bag of telecommunications, media and technology assets.

The largest part of those technology assets comprised stakes in PrediWave Corp (PrediWave) and affiliated companies, which are now the subject of a legal battle. According to the complaint filed on 25-May-04 in a California court by NWTMT against PrediWave, its boss Tony Qu Jianping (Mr Qu), and others, NWTMT made the following investments in PrediWave and affiliated companies:

*including shareholder loan of US$30m

At the times when these investments were made, NWTMT was such a large group that none of the investments were discloseable under the Listing Rules. According to the NWTMT complaint, all of the above companies were established by Mr Qu to provide additional technology and services to support the video-on-demand (VOD) set-top box (STB) system developed by PrediWave.

In essence, PrediWave claims to have invented the holy grail of VOD systems, what it calls the "first and only one-way VOD". It obtained two US patents, one granted on 29-Apr-03, and the other granted on 20-Apr-04. The implication of the claim is that the system can provide VOD to people without a "return path" to control the ordering or streaming of videos to the STB, and furthermore, without having dedicated streams of data from an expensive farm of central servers to each STB or "client", which creates much higher cost due to the load imposed on the servers. Hence, it was claimed, VOD can be provided without major upgrades to one-way cable TV networks, such as those found in China, or major financial outlay on server equipment.

Of course, there is no holy grail. What this really amounts to is broadcasting all the movies and other TV programs continually to the STB, which then stores the programs (or at least, the first part of the programs) on the hard drive in the STB, and when a user wants to watch a given program, the STB starts playing while it collects the rest of the program from the broadcast channel. The programs are broadcast using standard compression algorithms such as MPEG-2, and are sliced up to share the bandwidth on a given broadcast channel. The more programs that you want to have available, the larger the broadcast bandwidth required. Of course, if the STB runs out of data, it could always "interrupt" the program and play some pre-recorded adverts from its hard drive.

However, as some programs are much more popular than others, you can be more aggressive about the way they are broadcast - for example, within the limited amount of space on the STB's hard drive, you could store the first segment of the most popular movies, and then just broadcast the subsequent segments in a continuous loop. For less popular programs, you could broadcast them less often, and ask people to wait a while before they start viewing. There's a number of different ways the broadcast bandwidth could be allocated to achieve different objectives, none particularly earth-shattering, and all of them are a compromise compared to a full-blown client-server solution in which you can order any program you want from the server, and it is streamed across to your STB on demand.

Broadcast-and-store is not a revolutionary idea - if you lived in the UK anytime since the mid-1970s, you would be familiar with Ceefax and Oracle, the teletext information pages which are broadcast in a continuous loop using the "spare lines" of the TV signal - and can be buffered into memory on the TV set for subsequent viewing. And in the abstract, you could call a newspaper a "news on demand" device - the "broadcasting" consists of sending every subscriber every story in the newspaper, and then you decide which stories you actually want to read.

So in our view, there's nothing particularly clever about PrediWave or its so-called "predictive wave" system, but on the other hand, there's no reason in principle why such a broadcast-and-store system should not work, subject to the severe limitations noted, particularly the limited amount of programming that you can fit in the available broadcast channels and the size of your hard drive to pre-store programs.

The legal battle

While the background is interesting, the object of this article is not to determine what PrediWave and Mr Qu claimed or did not claim to NWTMT, or whether the counter-claim filed by PrediWave has any merit. The point is to look at the impact of this on the proposed privatisation of NWTMT.

NWTMT claims it agreed to purchase 200,000 STBs from PrediWave for US$435 each, a total of $87.5m, and paid another US$381,397,228 to PrediWave for additional hardware and software to operate PrediWave's system. Altogether, the claim against PrediWave amounts to over US$700m.

In NWTMT's Jun-03 annual report, it noted that its share of the PrediWave companies' losses had increased to HK$167m from $67.9m in the previous year. It also said that "major product upgrades were carried out to broaden user-attractive features and expand interactive TV network functionality" resulting in a HK$458.4m (US$58.8m) write-down on the value of "set-top box components".

After the project broke down, in the Jun-04 annual report, NWTMT made total provisions of HK$4,392m (US$563m) on its "interactive digital cable TV" business. This comprised HK$843.9m (US$108m) for deposits on STBs, $1,934m (US$248m) on investments in the PrediWave companies, $304.2m (US$39m) on loans to investees (probably including the US$30m loan to Athena), $401.2m on billing management and conditional access software and PrediWave licences, $619.2m on equipment, and $289.6m of inventory write-downs. Of the total provision of $4,392m, the investments, loans and deposits for STBs amounted to $3,082m (US$395.1m).

Furthermore, in the Jun-05 report, NWTMT made a provision of HK$376.9m (US$49m) for an investment in Intellambda Systems Inc, another company led by Mr Qu, which is not involved in the PrediWave litigation. That investment was made during the year ended 30-Jun-04.

The bottom line

As a result of all these provisions and write-downs, the shareholders funds of NWTMT stood at only HK$712m at 30-Jun-05, or about HK$0.75 per share, which is equal to the offer price that NWD has now put on the table to put minority shareholders out of their misery. However, the amount of claims against PrediWave stands at over US$700m (HK$5,425m) or about $5.70 per share.

The case against PrediWave may take a long time, and may not be successful. Even if it is successful, we don't know how much money the PrediWave companies and Mr Qu still have, and whether they will be able to honour any damages award, although at least up to 31-Dec-03, according to this announcement NWTMT, there was in excess of US$344m in the bank accounts of the PrediWave companies.

A preliminary trial date has been set for 16-Jun-06. However, it is also possible that a settlement will be reached before the case goes to trial, and that a lesser amount will be recovered by mutual agreement and without much delay. NWTMT has already spent HK$73.9m bringing this action, so it obviously believes that was a worthwhile investment. According to the circular:

"as a practical matter, mandatory settlement conferences are conducted in all cases in California unless the parties instead participate in a voluntary settlement conference...It is, therefore, probable that a settlement conference or mediation will be held in this case before trial."

Investors should regard the probability of some recovery from PrediWave as being greater than zero, but less than 100%. Even if NWTMT recovers only 10% of what it claims, it would add $0.57 or 76% to net asset value which would make the current offer look very cheap. If they recover 20%, it would add $1.14 or 152% to NAV, and so on. As recently as the Jun-05 annual report, published on 6-Oct-05, before the privatisation bid, NWTMT wrote:

"significant headway was made in the case against PrediWave Corp and its affiliates...NWTMT continues to stand by the strength of its case and expects the US judicial system to view its argument in a positive light."

Not surprisingly, in the offer document, NWD downplays the outlook for the case. Given the past behaviour of the New World group, in our opinion NWD does not deserve the benefit of the doubt. It is making the offer at a time of maximum uncertainty for investors in NWTMT, and if they accept it, then they will be excluding themselves from the benefit of any settlement in the PrediWave case. If NWD was sincere in making this offer, then it should have included a conditional deferred payment based on the outcome of the PrediWave litigation, which would allow investors to accept the offer and participate in the upside of the case. But that offer is not on the table, and so investors should reject the offer and await the outcome of the case. If there is no recovery on PrediWave, then NWD can always repeat the privatisation offer.

In fact, the uncertainty over the PrediWave situation is so great that PriceWaterhouseCoopers, the auditors, have been unable to form an opinion for the last two years ending 30-Jun-05 on whether the accounts give a true and fair view of the state of affairs of NWTMT.

The fibre optic network

Another cloud over NWTMT is its payments in 2002 to a "PRC entity" of HK$1,531m as a deposit for the right to buy up to 70% of a fibre optic backbone network for a total price of HK$2,563m. The 2003 annual report provides the best overview of its PrediWave and TMT investments. At page 31, the network is described as a China-wide 32,068km 8-core G-652 grade fibre capable of operating at G-655 rates of 12.8 terabits per second (i.e. 1.6 Tb per core), based on field tests. The report said that the network would become the backbone infrastructure for PrediWave. The counterparties to this deal have not been disclosed, but we guess the network in some way involves fibre laid along the railway tracks of China. A similar deal involving a similar length of cable was done by the CITIC group. The network probably looks something like this.

On 23-Jun-04, just a month after it filed the case against PrediWave, NWTMT requested to withdraw from the acquisition of the network, and on 3-Sep-04 the counterparties agreed to return the deposits, loans and other amounts totalling HK$2,160m by 30-Nov-04. They have not yet done so, but NWTMT says that in return for extending the deadline to 30-Nov-05, it was granted security over the 70% stake in the network and is confident of getting its money or the network, so no provision has been made. On 22-Nov-05 the repayment deadline was extended to 30-May-06. The directors have had the network professionally valued and are of the view that the amounts owing are "fully recoverable".

Loans from NWD

NWTMT is also reliant on loans from a "fellow subsidiary" which the offer document names for the first time as New World Finance Co Ltd (NWF), which amounted to $2,337m at 30-Jun-05, very similar to the amount it is due to receive back from the unnamed PRC parties on the fibre optic network. The total revolving credit facility of HK$3,250m has been extended to 31-Mar-07. NWF is wholly-owned by NWD.

As NWD and NWF are connected parties, NWTMT cannot grant any security to the lender, so it would be difficult for NWD to pull the plug because it would rank alongside the other creditors of NWTMT in a liquidation, or possibly behind them if the loan is subordinated, and apart from anything else, the outcry from minority shareholders at the parent putting the listed company into liquidation would be enormous. They might want to know why the directors allowed NWTMT made such massive deposits in the first place in a sector where it is still illegal for foreign investors to own more than 49%.

However, there is a risk that NWTMT could launch a rights issue in which NWD would in effect capitalise its loan. No such threat of either calling in the loan or launching a rights issue was contained in the offer document.

The vote, and AIG

The largest minority shareholder in NWTMT, with 10.17%, is AIG Asian Infrastructure Fund II, which received its shares on 30-Apr-02 upon the mandatory conversion of a 3-year convertible bond issued in Apr-99, at a conversion price of HK$12 per share. That conversion was before the distribution of 0.587 shares in NWSH, then worth $1.82 and now worth about $6.63 (all prices ex-dividend), but AIG will still be taking a major hit if they let the deal go through at $0.75 per share. Although AIG could block the deal, so could other holders - it only takes 10% of the independent shareholders, or about 4.53%, to vote against.

The meeting on Friday 13-Jan-06 is fast approaching, so there is no time to lose. Reject the offer and tell NWD you will wait until the PrediWave case is resolved and the accounts are again in a state on which the auditors can give an opinion. Contact your bank, broker or custodian, and Vote NOW.

© Webb-site.com, 2006

Organisations in this story

• NEW WORLD DEVELOPMENT COMPANY LIMITED
• NEW WORLD TMT LIMITED
• PrediWave Corporation

People in this story

• Qu, Tony Jianping

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