The separation of ownership and management in modern capitalism creates the potential for conflict between the objectives of owners and those of managers. If we assume that owners are primarily interested in maximizing shareholder wealth, then clearly these owners would want the firm's managers to identify and pursue profitable investments, and ignore unprofitable ones. Given limits to capital that can be deployed, owners would want the managers to identify the most profitable mix of investments that could be financed and to delete from the list of investments those that would not meet this criteria. In examining the strategy of Hong Kong Telecommunication's management, you should think like an owner. In other words, your primary concern should be evaluating whether and to what extent Hong Kong Telecommunication's management is acting in accordance with the maximization of shareholder value.

During the last fiscal year, which closed March 31, 1998, Hong Kong Telecommunications (HKT) earned about US$2.19 billion in revenue from international long distance telephone service (ILDTS), almost half the company's total revenue for the fiscal year. HKT had been using its profits from ILDTS to subsidize low-priced and unprofitable local telephone service. In 1999, HKT lost its monopoly over ILDTS in the Hong Kong Special Administrative Region (its sole market). Telecom analysts predict that HKT faces a drop in ILDTS revenues of nearly 50% over the next two years, as a result of the 1999 deregulation of ILDTS in Hong Kong Special Administrative Region (henceforth Hong Kong SAR). Faced with the prospect of losing its monopoly, Hong Kong Telecommunications (HKT) management has been seeking alternative sources of revenue. They hope to more than compensate for lost revenues and earnings due to the lost monopoly. At least four distinct possibilities exist: 1) HKT will lose revenues and earnings due to the competition for ILDTS; 2) HKT management will find enough new sources of revenues to maintain current levels of revenues and earnings; 3) HKT management will find new sources of revenues but these revenue sources will fail to generate earnings sufficient to mitigate the lost ILDTS profits, thus resulting in flat revenues and lower profits; 3) HKT management will find more profitable ventures, even if the total revenues for HKT fall, thus resulting in higher profitability with flat or even falling revenues; 4) HKT management will find new ventures that prove more beneficial to the company's top and bottom line than the old ILDTS business, resulting in rising revenues and rising profits. Are there any other possibilities?

HKT management has developed a plan that would transform the company from a stodgy telecommunications giant to a broadbased internet, media, telecommunications, and property management company. A key element of this transformation has been the development of a broadband multimedia network based on sophisticated asynchronous transfer mode (ATM) technology. This broadband multimedia network could be used to carry the full spectrum of data, including internet and multimedia information content. HKT will charge companies for use of this broadband network at a rate of approximately $26 per megabit-per-second (Mbps), less than the current cost to companies of leasing dedicated telecommunications lines. HKT will also offer interactive multimedia services (IMS), including broadband video on demand (VOD). The company hopes to sign up 300,000 users of VOD by the year 2000. Currently it has 100,000 applicants, with 70,000 users already wired to receive the service. This is on schedule and indicates that, despite past failures of VOD in Europe, there is some prospect of HKT having more success in Hong Kong.

HKT has also applied for a license to provide cable television services. As in the case of ILDTS, cable service is set to be deregulated this year. Wharf Holdings (rapidly becoming HKT's arch rival --- it owns the primary competitor to HKT in ILDTS) had held the monopoly over cable services in Hong Kong. HKT expects that it will gain approval to provide cable television services by April of 1999, at the earliest, but anticipates that this could provide a new and lucrative revenue stream for the company. Will these new services mitigate the loss in revenues from long distance services resulting from the 1999 deregulation of long distance telecommunications? There is already a price war heating up between HKT and its rivals, particularly the aforementioned subsidiary of Wharf Holdings. HKT has not only slashed the price of ILDTS (by one-third) but has also lowered local calling rates. Is this the appropriate strategy? Does HKT have any choice?

HKT has also attempted to lower its operating costs but with limited success. It tried to force employees to take lower wages but this created such a furor that the company backed down and had to settle for lowering the bonuses paid to employees. Can HKT compete with upstart telecoms who are able to hire cheaper laborers than HKT? If HKT's current employees are inflexible about any downward adjustment in their wages and salaries is there anything the company can or should do to force greater flexibility? Should HKT accept its current wage and salary structure as a given and seek alternative ways to maintain competitiveness?

HKT management and board of directors has decided to expand its business into property management. HKT has no experience in this area, although it has proven lucrative for many Hong Kong conglomerates. Management has expressed the objective of generating as much as 10 percent of company revenues from property management within ten years. What would be the rationale for expanding into property management? Does HKT management run the risk of losing its focus by not "sticking to its knitting," as the saying goes?

What would be your overall strategy if you were CEO of HKT? (In thinking about this question, you do not have to make shareholder value your primary consideration.)

What factors are important to determining the value of HKT as it transforms?

To what extent do you think we can rely on past financial data to determine the future value of HKT?

Is HKT's management increasing or reducing its options by the particular set of investment choices that have been made?

How have the "risks" associated with owning HKT equity changed over time?

LINKS

Go to Disclosure Financial Ratios for Hong Kong Telecommunications

Go to Hoover's Online for Financial Data on Hong Kong Telecommunications

A short profile from Yahoo.com -- includes company news and statisitics.

Hong Kong Telecom web page.

Go to Hoover's Online for Information on Hong Kong Telecom -- includes financial information, news and a short profile.

 

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