Dr. Peng Telecom & Media Group: On Ventilator

( 18 mins)

Executive summary:

Summary
Geography	China
Sector	Telecommunications
Credit rating	Caa1/WR (Moody’s/S&P)
Report date	11-May-2020

Dr. Peng Telecom & Media Group Company Limited (Dr. Peng) is a guarantor of Dr. Peng Hong Kong Holding Limited, an issuer of USD500m bonds maturing 1^st June 2020 (CHEDRP 5.05% 6/20s). This report focuses on the liquidity situation, and the maturity extension request.

The company’s credit outlook over the next 12 months remains negative, in our view, given its weakening liquidity and the asset sale which we believe will increase execution risk and take away recurring revenue in the long run.

As we expected, Dr. Peng has approached bondholders to ask for a maturity extension. The 7-May offer of multiple installments and consent fee is more attractive to bondholders than waiting for the company to default and salvage on a recovery value of 46.6 cents on the dollar (EXHIBIT 4), which is based on the upcoming sale of the Company’s internet data center and the redemption of CNY1bn bonds in April.

The bonds traded at 55/57 on bid/ask at the time of this report and with a recovery value of 46.6 cents of the dollar, assuming the sale of the internet data center. Investors will have to go through the restructuring and risk losing its 45% of the outstanding principal and interests of CHEDRP 6/20s due on the new maturity date of 1-December-21. That said, we advise against taking a position at this juncture. On the other hand, against the bid price of 55 cents on the dollar, we believe bondholders will be able to get more than 55 cents on the dollar from going through the restructuring of the bonds (See Liquidity).

Maturity Extension Offer

As such, we also advise against selling and assign a NEUTRAL recommendation on Dr. Peng’s CHEDRP 5.05% 6/20s. The key catalysts in our view is the redemption of the CNY1bn bonds and the potential sale of the Internet data center. We will reconsider our recommendation in the event Dr. Peng manages to receive the consent to extend maturity and/or raise sufficient funds to redeem the bonds.

Dr. Peng has asked bondholders since 21-April for their consent^[1] to extend the bond maturity. The bondholder meeting in Hong Kong is set for 29-May and the consent vote due on 26-May. The key requests and incentives, updated by management on 7-May, are highlighted below:

• Maturity extension: The extension of the maturity date of CHEDRP 5.05% 6/20s (Outstanding of USD423.35m) to 1-December- 21 to coincide with the time required to complete the construction of the Pacific Light Cable Network project (PLCN) and to effect a potential sale of the cable assets
• Redemption: Three partial principal redemptions (20% (USD84.5m), 19% (USD80.2m), and 16% (USD67.6m) of the USD422.35m outstanding and accrued interest on 1-June-20, 1-October-20, and 1-March-21, respectively. The offer was sweetened from the initial offer which includes only two partial principal redemptions (12% and 15% of the outstanding on 1-June-20 and 1-Oct-20, respectively). We note that there will be no haircut on the principal. Management stated it wanted to use the available cash for the 1-June redemption and proceeds from the sale of its investments (through its Cayman-incorporated limited partnership) for the latter redemptions. We believe one of the investments could be Dr. Peng’s EnTouch, a broadband service provider in the US, which management expects the sale to be completed by 4Q’20. Management estimates the proceeds to be c. USD100m.
• Additional security: For the 1-October redemption, there will be (i) a first-ranking security over the issuer’s interests in the limited partnership and (ii) a first-ranking security over the issuer’s Hong Kong-domiciled bank account, into which the issuer expects to receive the proceeds of the sale.
• Coupon: The coupon on the bonds will be raised to 7.55% from 5.05% per annum
• Covenant amendments:
  1. Asset sale covenant will be amended to permit the sale of PLCN-related assets under the condition that net cash proceeds will be used to redeem the bonds within 120 days of the company’s receipt of that cash.
  2. Negative pledge will be amended to permit the issuer to borrow to (1) redeem the notes and (2) refinance up to USD150m of the private secured notes (due 2-Nov-20) issued by Pacific Light Data Communication (PLDC), 93%-owned by Dr. Peng, to Haitong International Securities. The proceeds of the private notes were used to fund the PLCN and other cable-related projects.
• Management proposed a consent fee of 1% of outstanding value (USD422.35m)
• The resolution can be passed by a majority of not less than 66% of the outstanding amount.

The extension request is not a surprise as we do not expect the company to be able to redeem CHEDRP 6/20s in full. We believe the offer is attractive for the following reasons:

1. The cash offer of 20 cents on the dollar plus 1% consent fee, both of which will be payable on 1-June.
2. Our prediction that, at the minimum, Dr. Peng will be able to redeem additional 19% and 16% of the principal and interest on 1-October-20 and 1-March-21 (See Liquidity)
3. Our recovery value adjustment to 46.6 cents on the dollar (from 28.9 cents in the last report on 5-February), based on the company’s latest 1Q’20 balance sheet, the redemption of CNY1bn bonds in April, and the arrangement to sell the Company’s internet data center for RMB2.3bn (See Bond Performance and Recovery).

On the contrary, without the consent, we believe bondholders risk Dr. Peng being forced to sell its assets at almost rock bottom prices as the global economy has not recovered. Plus, the risk of the second wave remains eminent in China. The extension also gives management time to sell their assets at a higher valuation as the Chinese economy starts to rebound. That said, we believe bondholders should try to get the most out of the negotiation with management but, in the end, we believe it is for the best interests of the bondholders to give a consent to extend the maturity.

Liquidity Update

We expect Dr. Peng to default on its DRPENG 6/20s without the maturity extension (See Liquidity). Here is the update on the liquidity situation:

1. Existing bank credit facilities: Management revealed unutilized credit facilities of RMB1.7bn last June.
2. New bank loans: Management stated it was under negotiation with Chinese banks (e.g. Bank of China, Bank of Communications, and Bank of Shanghai) on new offshore loans of up to USD250m. We also understand Dr. Peng has recently secured another USD100m credit facility from Merdeka Opportunity Fund last December. There is no other information on the undrawn portion of the new facility at the time of this report. We maintain our assumption that the Company will be able to draw down new loans of c.RMB1.75bn.
3. Equity issuance: Dr. Peng announced on 11-March it planned to sell 429.7m of new shares to Shenzgen Xinpenyun Technology and other investors, which could raise cash of c.USD105m. We understand the timing and exact terms have not been released to the public and, therefore, do not include into the liquidity calculation.
4. Asset sales:
   1. The sale of Beijing’s subscribers to China Unicom for RMB2bn, of which we assume two installments of RMB400m each could be received by the Company by 1-December-2021.
   2. Management intends to sell its Internet data center and related assets to Pins International Financial Holdings Limited for RMB2.3bn (~USD324mn) vs. a book value of RMB880m in December. The completion date could be closed on or before 30-Sep and the payment will be in installments. We are not privy to the deal but, assuming the installments will be over the 5-year period, we conservatively estimate the proceeds from September-2020 to November-2021 to be c.RMB460m.
   3. Dr. Peng entered to sell EnTouch Systems, its broadband service provider in the US, to RCN, Grande, & Wave, a Texas-based broadband cable provider owned by TPG Capital, for c.USD100m in February. Management expects the transaction to be completed by 4Q’20.
   4. Management said it would look to sell one of the 4 pairs of the undersea cables in the PLCN project for c. USD1bn each, according to management estimate; and/or

Among the 4 options above, only (a) and (c) is secured, in our view. Our base case scenario is based on (b) to happen by 4Q’20 and believe (d) will face a hurdle due to international political issues we highlighted in the last reports dated 5-February. That said, we expect net cash proceeds from the asset sales to be c.RMB2bn from the cable-related assets (RMB460m), EnTouch (RMB709m), and Beijing subscriber sale (RMB800m).

1. Customer prepayment: Management expects to receive up to USD150m in advance payments related to the PLCN project by the end of June. As the PLCN project is not progressing as planned, we elect to omit this advance payments in our calculation.
2. CNY bonds and the put situation:
   1. We understand Dr. Peng has RMB6bn of issuance quota remaining but we do not believe Dr. Peng could issue when its USD bonds are traded in the high 50s.
   2. Dr. Peng redeemed RMB998m of principal and interest of its RMB1bn 7% CNY bonds due 25-April-23 with a puttable date on 25-April-20.
   3. The next put option can be exercised on 16-June and we expect another redemption of RMB 1bn.

Adding up all the scenarios, we put together a liquidity scenario for Dr. Peng and the shortfalls management needs to raise between the time of this review and 1-December-21, which is the proposed new maturity date (EXHIBIT 1). Dr. Peng recorded EBITDA of RMB506m in 1Q’20 vs. capex of RMB582m, so we believe it is sufficiently conservative to estimate EBITDA, subtracted by interest expenses and capex, at zero until 1-December-21.

As a result, we expect a liquidity shortfall of about RMB314m on 1-December- 2021. We note that the RMB314m is not a big amount for Dr. Peng and the ability to secure advance payments of USD150m (RMB1bn) from the Company’s client would already be sufficient to fill the gap. That said, bondholders are advised to track asset sales and other cash items closely and decide whether or not to hold the bonds until 1-December-21.

EXHIBIT 1: Liquidity scenario

Source: Company data, Bondcritic

Credit Ratings

Dr. Peng’s senior unsecured debt rating by Moody’s remains Caa1 with a negative outlook. With weakening 1Q results, we believe a failure to negotiate with bondholders on the maturity extension will likely lead to a downgrade toward “SD” (selective default) when the USD bonds mature on 1-June.

1Q Result Updates

Profitability

Dr. Peng’s FY19 and 1Q20 revenues both declined YoY to RMB6bn and RMB1.3bn, respectively, on declining subscriber numbers and a price war with three state-owned competitors. FY19 EBITDA was RMB1.6bn versus our forecast of RMB2bn. The EBITDA margin during FY19 dropped to 25.3% from 37.9% during FY18 but rebounded to 37.9% during 1Q20. The delay on the commercialization of the PLCN project also hurt the top-line revenue.

Though we believe the company’s EBITDA margin remains at a healthy level, our worry comes from the following:

• Declining top-line revenues: A loss of “bread and butter” revenues will continue while revenues from data center, service agreements, and undersea cables remain uncertain.
• Restructuring scenario: We believe a majority of amortization and depreciation expenses could be virtually worthless if the Company were to be acquired or restructured. We said in the last report that Dr. Peng’s goodwill is on a decline. The Company took a massive RMB5.4bn of asset impairment charges in FY19 on goodwill and fixed assets from the restructuring of its Beijing subsidiaries, including Great Wall Broadband Network (Great Wall). We understand the impairment charges are related to the debt-to-equity swap to strengthen the balance sheet of Great Wall. Its once leading brand in China’s broadband industry is not the case any longer. Despite the comfort that the company’s EBITDA remains healthy, we do not believe the Company’s EBITDA is valid for the calculation of the Company’s enterprise value (EV).

Liquidity

Dr. Peng’s liquidity problem is the reason why the Company could default in an upcoming debt maturity wall in 2020, in our view. Its current ratio in March was 0.3x versus 0.2x in December. Cash covered only 0.4x of short-term debt. The need to spend on Capex and declining top-line revenue has made Dr. Peng’s free cashflow negative, -RMB304m during the first 3 months of 2020 versus -2.9bn in FY19. Cash conversion cycle improved to 174 days in March from 122 days during FY19 but we believe the improvement is irrelevant considering the debt maturity wall of RMB5.9bn by this June.

Asset trend

Asset restructuring during FY19 reduced Dr. Peng to RMB15.9bn from RMB22.9bn last September. Cash position was RMB1.8bn compared to RMB752mn in December and RMB1.9bn last September. Dr. Peng’s assets are increasingly financed by debt as a debt-to-assets ratio has risen steadily from 18.5% in FY17 to 30.5% during the first 9 months of FY19 to 44.7% in 1Q’20.

Leverage

Total debt-to-EBITDA multiple was 3.5x in March versus 3.5x in December and 2.8x last September. Total debt in March was RMB7.1bn of which c.RMB1.4bn are secured debt. The total debt-to-EBITDA level of 3.5x remains above the CCC+ rating category. In our view, the problem with Dr. Peng is not about the size of the debt or even the cashflow but rather the liquidity to service the debt.

Capitalization

Dr. Peng’s total debt-to-total capitalization, excluding minority interests was 90.3% versus 50% last September on the asset impairment charges which reduced the equity of the Company. The ratio is now in-line with its CCC+ rating, in our view. The Company has a quite sizeable amount of intangibles and deferred assets, some of which we doubt it could monetize. A high amount of intangibles and deferred assets also erode the Company’s equity quality, in our view. Subtracting total capitalization with minority interests, intangibles, and deferred assets, we can see further deterioration of the total debt-to-total capitalization ratio to 98.9% in March versus 62.6% in September.

Bond Performance and Recovery

Dr. Peng’s USD bond price dropped to 55.6 cents on the dollar (1,393% yield-to-maturity) at the time of this review versus 60 cents (EXHIBIT 2) when we last reviewed the bonds on 5-February. We believe the market remains convinced that Dr. Peng will not be able to redeem its USD bonds in whole on 1-June.

EXHIBIT 2: Bond performance

Source: Bondlinc

Dr. Peng’s stock, listed at the Shanghai Stock Exchange, has, however, traded up since the middle of February (EXHIBIT 3). With a rising yield of the bonds, we believe the rising stock price reflects the rising probability of management’s success in negotiating with bondholders, and in keeping the company’s shares traded on SSE. Without looking at stock valuation, we believe the bondholder’s consent simply will give a lifeline to the company.

EXHIBIT 3: Stock performance

Source: aastocks.com

Should the maturity extension request fail to win support of 66% of the outstanding, we expect the Company to declare bankruptcy which could lead to the following scenarios:

• Restructuring as a going concern: As mentioned, we believe the buyers of Dr. Peng’s operations will not use EBITDA multiple. Instead, it will start with a pro-forma EBIT for FY20, based on 1Q’20 results of c. RMB728m (which leads to EV of RMB 3.6bn (at 5 EV/EBITDA multiple) and work up to the book value of assets as per the liquidation exercise (EXHIBIT 1).
• Liquidation: In-case there is no buyer of the defaulted company, the company will be going into liquidation which we see the maximum recovery value of 46.6 cents on the dollar, based on its latest financial statements in March, RMB1bn redemption of CNY bonds in April, and the upcoming sale of the Company’s internet data center for RMB2.3bn.

EXHIBIT 4: Recovery value in June

Source: Bondcritic, Company data

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