1934 Act Registration No. 1-31517
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 6-K
Report of Foreign Issuer
Pursuant to Rule 13a-16 or 15d-16 of
the Securities Exchange Act of 1934
For the Month of October 2003
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China Telecom Corporation Limited
(Translation of registrant's name into English)
31 Jinrong Street
Beijing, China 100032
(Address of principal executive offices)
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(Indicate by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F.)
Form 20-F [X] Form 40-F [_]
(Indicate by check mark if the registrant is submitting the Form 6-K in
paper as permitted by Regulation S-T Rule 101(b)(1):_____)
(Indicate by check mark if the registrant is submitting the Form 6-K in
paper as permitted by Regulation S-T Rule 101(b)(7):_____)
(Indicate by check mark whether the registrant by furnishing the
information contained in this Form is also thereby furnishing the information to
the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of
1934.)
Yes [_] No [X]
(If "Yes" is marked, indicate below the file number assigned to the
registrant in connection with Rule 12g3-2(b):82- ______________.)
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EXHIBITS
Exhibit Number Page
-------------- ----
1.1 Announcement dated October 26, 2003 4
1.2 Shareholder's Circular dated October 27, 2003 56
FORWARD-LOOKING STATEMENTS
The Announcement and Shareholder's Circular of the Company, constituting
Exhibit 1.1 and 1.2, respectively, to this Form 6-K, contain forward-looking
statements that are, by their nature, subject to significant risks and
uncertainties. Such forward-looking statements include, without limitation, the
continued growth of the telecommunications industry in China, the development of
the regulatory environment, and the Company's ability to successfully execute
its business strategies.
Such forward-looking statements reflect the current views of the Company
with respect to future events. Actual results may differ materially from
information contained in the forward-looking statements as a result of a number
of factors, including, without limitation, any changes in the regulatory
policies of the Ministry of Information Industry and other relevant government
authorities, any changes in telecommunications and related technology and
applications based on such technology, and changes in political, economic, legal
and social conditions in China, including the Chinese government's policies with
respect to economic growth, foreign exchange, foreign investment and entry by
foreign companies into China's telecommunications market.
2
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CHINA TELECOM CORPORATION LIMITED
Date: October 30, 2003 By: /s/ Zhou Deqiang
--------------------------------------
Name: Zhou Deqiang
Title: Chairman and CEO
3
Exhibit 1.1
The Stock Exchange of Hong Kong Limited takes no responsibility for the contents
of this announcement, makes no representation as to its accuracy or completeness
and expressly disclaims any liability whatsoever for any loss howsoever arising
from or in reliance upon the whole or any part of the contents of this
announcement.
This announcement is not an offer to sell or the solicitation of an offer to buy
any securities.
"China_Telecom"
China Telecom Corporation Limited
(A joint stock limited company incorporated in the People's Republic of China
with limited liability)
DISCLOSEABLE AND CONNECTED TRANSACTIONS
SUMMARY
The Acquisition
The Company entered into the Acquisition Agreement on October 26, 2003, pursuant
to which the Company agreed to acquire, and China Telecommunications
Corporation, the Company's controlling shareholder and promoter, agreed to sell
the Target Assets, subject to certain conditions.
The Target Companies are the leading providers of wireline telecommunications
services including wireline telephone, data and Internet and leased line
services in the Target Service Areas, comprising Anhui province, Fujian
province, Jiangxi province, Guangxi Zhuang autonomous region, Chongqing
municipality and Sichuan province in the PRC. As of June 30, 2003, the Target
Group had a total of approximately 45.1 million access lines in service for its
local telephone service. The Target Group had a 98.3% market share in the Target
Service Areas in terms of the number of access lines in service as of June 30,
2003.
Consideration for the Acquisition
The Acquisition was negotiated and entered into on an arm's length basis and on
normal commercial terms. The purchase price of the Acquisition amounts to
RMB46,000 million (equivalent to approximately US$5,558 million), and will
consist of the payment of an initial cash consideration of RMB11,000 million
(equivalent to approximately US$1,329 million) on completion of the Acquisition
and the payment of a deferred consideration of RMB35,000 million (equivalent to
approximately US$4,229 million). From the date of the completion of the
Acquisition, the Company will pay interest to China Telecommunications
Corporation at half-yearly intervals on the actual amount of deferred
consideration remaining outstanding. Interest will accrue daily and, for the
first five years after completion of the Acquisition, will be payable at the
rate of 5.184% per year, being the RMB lending rate of commercial banks in the
PRC in respect of loans with tenure of more than five years of 5.76% per year as
set by the People's Bank of China and prevailing on the date of the Acquisition
Agreement, less a discount of 10%. Thereafter, the interest rate will be
adjusted accordingly on the fifth anniversary of completion of the Acquisition.
The Company intends to fund the interest payments with its internal cash
resources.
The deferred consideration is payable ten years after the date of completion of
the Acquisition. The Company may from time to time, prepay all or part of the
deferred consideration, at any time after completion until the tenth anniversary
of the completion of the Acquisition, without penalty.
China Telecommunications Corporation currently owns 77.78% of the issued share
capital of the Company. Based on the audited financial statements of the Company
prepared under IFRS, the book value of the net assets of the Listed Group as of
December 31, 2002 was approximately RMB125,008 million (equivalent to
approximately US$15,103 million). Based on the unaudited interim financial
statements of the Company prepared under IFRS, the book value of the net assets
of the Listed Group as of June 30, 2003 was approximately RMB133,595 million
(equivalent to approximately US$16,141 million). Accordingly, under the Hong
Kong Listing Rules, the Acquisition constitutes both a discloseable transaction
and a connected transaction for the Company.
Reasons for and benefits of the Acquisition
The Company believes that the Acquisition represents a new and important
opportunity for the Listed Group to strengthen its market position, improve its
growth prospects, realize operating synergies, increase its earnings and improve
its capital efficiency.
Independent Shareholders' Approval and Independent Financial Adviser
An Independent Board Committee has been established to advise the Independent
Shareholders in respect of the terms of the Acquisition, the terms of certain
Prospective Connected Transactions and the terms of certain supplemental
agreements relating to the Existing Connected Transactions. JPMorgan has been
retained as the Independent Financial Adviser to the Independent Board
Committee.
The Acquisition, certain Prospective Connected Transactions and certain
supplemental agreements relating to the Existing Connected Transactions require
the approval of the Independent Shareholders at the Extraordinary General
Meeting at which China Telecommunications Corporation and its Associates will
abstain from voting.
Financial Advisers
CICC and Morgan Stanley are the financial advisers to the Company in respect of
the Acquisition, the Prospective Connected Transactions and the supplemental
agreements relating to the Existing Connected Transactions.
Connected Transactions
After the Reorganization, the Combined Group entered into various agreements
with China Telecommunications Corporation and a number of its subsidiaries
relating to the mutual provision of ongoing telecommunications and other
services. The mutual provision of ongoing telecommunications and other services
between the Parent Group and the Combined Group will constitute connected
transactions within the meaning of the Hong Kong Listing Rules upon completion
of the Acquisition.
As these connected transactions are expected to occur on a regular and
continuous basis in the ordinary and usual course of business, the Company has
made an application to the Hong Kong Stock Exchange for a waiver from compliance
with the normal approval and disclosure requirements relating to certain
connected transactions under the Hong Kong Listing Rules. In its application,
the Company has sought a new waiver for the Combined Group from the Stock
Exchange to combine certain categories of the Existing Connected Transactions,
waiver of which were granted by the Stock Exchange in its letter dated October
28, 2002, with the corresponding categories of the Prospective Connected
Transactions so that the waiver in respect of annual monetary limits of certain
Existing Connected Transactions be aggregated. The new waiver will be effective
for two years from January 1, 2004 until December 31, 2005.
Dispatch of shareholders circular
A circular containing, amongst other things, details of the terms of the
Acquisition, the Prospective Connected Transactions and supplemental agreements
relating to Existing Connected Transactions, letters from the Independent Board
Committee and from JPMorgan, further financial and other information of the
Target Assets and a notice to shareholders of the Company convening an
Extraordinary General Meeting to approve, amongst other things, the terms of the
Acquisition, the terms of certain Prospective Connected Transactions and the
terms of certain supplemental agreements relating to the Existing Connected
Transactions will be dispatched to the shareholders of the Company as soon as
practicable.
1. ACQUISITION OF THE TARGET ASSETS
(a) The Acquisition
The Company entered into the Acquisition Agreement on October 26, 2003,
pursuant to which the Company agreed to acquire and China
Telecommunications Corporation, the Company's controlling shareholder and
promoter, agreed to sell the Target Assets, subject to certain conditions.
The Company has agreed, subject to certain conditions, to acquire from the
Parent the Target Assets for a purchase price of RMB46,000 million
(equivalent to approximately US$5,558 million). The net indebtedness of the
Target Group as of June 30, 2003 amounted to approximately RMB33,988
million (equivalent to approximately US$4,106 million). Upon completion of
the Acquisition, each of the Target Companies will become a wholly-owned
subsidiary of the Company.
The Target Assets
The Target Companies are the leading providers of wireline
telecommunications services including wireline telephone, data and Internet
and leased line services in the Target Service Areas, comprising Anhui
province, Fujian province, Jiangxi province, Guangxi Zhuang autonomous
region, Chongqing municipality and Sichuan province in the PRC. As of June
30, 2003, the Target Group had a total of approximately 45.1 million access
lines in service for its local telephone service. The Target Group had a
98.3% market share in the Target Service Areas in terms of the number of
access lines in service as of June 30, 2003.
The Company will also acquire from the Parent certain assets which are used
for network management, research and development purposes.
The Reorganization
In preparation for the Acquisition, Anhui Telecom was incorporated on
August 26, 2003, Fujian Telecom, Guangxi Telecom and Sichuan Telecom were
incorporated on August 28, 2003, Jiangxi Telecom was incorporated on
September 18, 2003 and Chongqing Telecom was incorporated on August 22,
2003, each as a wholly-owned subsidiary of China Telecommunications
Corporation. China Telecommunications Corporation's telecommunications
operations in Anhui province, Fujian province, Jiangxi province, Guangxi
Zhuang autonomous region, Chongqing municipality and Sichuan province,
together with related assets and liabilities were transferred to these
Target Companies. The assets, liabilities and operations of the Target
Group have been segregated and separately managed since December 31, 2002.
As part of the Reorganization, the Parent has undertaken to indemnify the
Target Companies for any loss or damages suffered by the Target Companies
as a result of, or related to, the Reorganization and/or in connection with
events preceding the Reorganization.
Set out below are the corporate structures of the Company and its principal
subsidiaries immediately prior to and after the Acquisition.
Corporate Structure immediately before Acquisition
"chart01"
Corporate Structure immediately after Completion of the Acquisition
"chart02"
Notes:
1. Denotes the Target Companies to be acquired pursuant to the
Acquisition.
2. As part of the reform plan of rural telecommunications services, China
Telecommunications Corporation has agreed to transfer 977,004,913
shares of the Company (representing 1.29% of the Company's issued
share capital as at the Latest Practicable Date) to Fujian Electronic
Information (Group) Co., Ltd. upon satisfaction of a number of
conditions precedent. Such transfer will not be made prior to
September 10, 2005.
(b) The Consideration
The Acquisition was negotiated and entered into on an arm's length basis
and on normal commercial terms. The purchase price of the Acquisition is
RMB46,000 million (equivalent to approximately US$5,558 million), and will
consist of payment of an initial consideration and a deferred
consideration.
The purchase price of the Acquisition was determined based on various
factors, including the quality of the assets being acquired, their growth
prospects, earnings potential, competitive advantages in their respective
markets, the prospective profit contributions of the Target Group to the
Combined Group and other relevant valuation benchmarks. The purchase price
of the Acquisition will represent a multiple of 7.2 times the Target
Group's forecast combined 2003 profit after taxation and minority interests
but before extraordinary items (the "net profits") of approximately
RMB6,352 million (equivalent to approximately US$767 million).
The initial consideration of RMB11,000 million (equivalent to approximately
US$1,329 million) will be satisfied on completion of the Acquisition by
payment in cash in RMB. The Company intends to finance all of the initial
consideration using internal cash resources, including proceeds raised from
the Global Offering. Details of the amount of proceeds used to fund the
initial consideration will be disclosed in the announcement following the
EGM to be held on December 15, 2003.
The deferred consideration represents the difference between the purchase
price and the initial consideration and amounts to RMB35,000 million
(equivalent to approximately US$4,229 million). From the date of the
completion of the Acquisition, the Company will pay interest to the Parent
at half-yearly intervals on the actual amount of deferred consideration
remaining outstanding. Interest will accrue daily and, for the first five
years after completion of the Acquisition, will be payable at the rate of
5.184% per year, being the RMB lending rate of commercial banks in the PRC
in respect of loans with tenure of more than five years of 5.76% per year
as set by the People's Bank of China and prevailing on the date of the
Acquisition Agreement, less a discount of 10%. Thereafter, the interest
rate will be adjusted accordingly on the fifth anniversary of completion of
the Acquisition. The Company intends to fund the interest payments with its
internal cash resources.
The deferred consideration is payable ten years after the date of
completion of the Acquisition. The Company may, from time to time, prepay
all or part of the deferred consideration, at any time after completion
until the tenth anniversary of the completion of the Acquisition, without
penalty.
The payment of the deferred consideration and the interest payments can be
made in RMB, or any other currencies which may in the future be agreed
between China Telecommunications Corporation and the Company, subject to
the approvals of the relevant PRC governmental authorities. Any payment
made in currencies other than RMB will be based on the exchange rates
between RMB and such currencies prevailing at 12:00 noon (Beijing time) on
October 24, 2003, being the Business Day immediately preceding the day of
the execution of the Acquisition Agreement.
(c) Conditions to Completion of the Acquisition
Completion of the Acquisition is conditional upon the fulfilment (to the
reasonable satisfaction of the Company) of the following conditions, among
others, on or before December 31, 2003 or such later date as the Company
and China Telecommunications Corporation may agree:
(i) the passing of resolutions by the Board approving the terms of the
Acquisition, the terms of the Prospective Connected Transactions and
the terms of certain supplemental agreements relating to the Existing
Connected Transactions;
(ii) the passing of ordinary resolutions by Independent Shareholders
approving the terms of the Acquisition, the terms of certain
Prospective Connected Transactions and the terms of certain
supplemental agreements relating to the Existing Connected
Transactions;
(iii) there having been no material adverse change to the financial
conditions, business operations or prospects of the Target Assets;
and
(iv) the obtaining of various approvals from relevant PRC regulatory
authorities.
If any of the above-mentioned conditions is or are not satisfied (or in the
case of (iii) above, not waived by the Company) by December 31, 2003, or
such other date as the Company and China Telecommunications Corporation may
agree, the Acquisition Agreement will lapse.
2. REASONS FOR AND BENEFITS OF THE ACQUISITION
The Acquisition represents a new and important opportunity for the Listed Group
to strengthen its market position, enhance its competitiveness, promote business
development and improve financial performance, so as to benefit further from the
sustained growth of the telecommunications industry in the PRC.
(a) Enhancement of market position
The Acquisition will expand the geographic coverage of the Company's
telecommunications operations. This expansion will further enhance the
market position and competitiveness of the Company by improving its ability
to provide long distance, managed data and other telecommunications
services that require extensive geographic coverage. The Acquisition is
also expected to significantly increase the Company's subscriber base,
revenue and net profit. The Company believes that the enhanced financial
strength resulting from such increases will enable it to better deal with
competitive pressure and capture growth opportunities.
The table below sets out selected operating and financial data of the
Target Group, the Listed Group and the pro forma data of the Combined Group
as of or for the six-month period ended June 30, 2003:
Listed Target Pro Forma
Group Group Combined
-------- -------- ---------
Access lines in service (in thousands) 62,199 45,073 107,272
Operating revenues (in RMB millions) 39,536 18,247 57,770(1)
Net profit (in RMB millions) 9,260 3,371 12,054(1)
Earnings per share (in RMB) 0.12 N/A 0.16(1)
Notes:
(1) For further details of the Combined Group's pro forma financial
information, please refer to Appendix VI to the shareholders' circular
"Pro Forma Financial Information of the combined Group".
(2) As a result of both the Target Group and the Company being under
common control prior to the Acquisition, the acquisition of the Target
Group will be considered as a "combination of entities under common
control". Under a combination of entities under common control, the
assets and liabilities of the Target Group to be acquired by the
Company will be accounted for at historical amounts in a manner
similar to a pooling-of-interests ("as-if pooling-of-interests
accounting"). In as-if pooling-of-interests accounting, the
consolidated financial statements of the Company for periods prior to
the combination will be restated to include the assets and liabilities
and results of operations of the Target Group for those periods on a
combined basis.
The purchase price in respect of the acquisition of the Target Group
will be treated as an equity transaction at the date of the
acquisition.
(b) Improvement of growth prospects
The Company believes that the Acquisition will improve the growth potential
for its telecommunications business. The total population in the Company's
Listed Service Areas was 221 million at the end of 2002 (representing 17.2%
of the total population in China at the end of 2002), while the total
population in the service areas of the Combined Group, on a pro forma
basis, would be 524 million at the end of 2002 (representing 40.8% of the
total population in China at the end of 2002). In addition, the Target
Service Areas, with sustained GDP growth and a lower-than-national-average
telephone penetration rate, present significant growth potential for
telecommunications services. For example, access lines in service and
broadband subscriber growth rates of the Target Group were stronger than
those of the Listed Group in the first six months of 2003.
Listed Target Combined
Group Group Group
-------- -------- ---------
Total population(1)(2) (in millions) 221 303 524
Penetration rate(3) 25.7% 13.4% 18.6%
Access lines in service growth(4) 9.4% 12.9% 10.8%
Broadband subscriber growth(4) 85.8% 108.3% 91.7%
Notes:
(1) As of end of 2002.
(2) Source: Data in respect of the total population in the Company's
Listed Service Areas is estimated by the Company assuming that the
growth rate of the population in the Company's Listed Service Areas in
2002 was the same as that in 2001.
(3) Determined by dividing the number of wireline access lines in service
by the total population in the relative service areas.
(4) In the first six months of 2003.
(c) Realization of operating synergy
The Company believes that the Acquisition will enable it to achieve
significant cost savings through reduction of interconnection traffic
between the Listed Group and the Parent Group. Cost savings can also be
achieved through centralized investment planning, procurement and financial
management. The Company intends to implement within the Combined Group the
business process re-engineering initiatives it has successfully implemented
in the Listed Group. Establishment of a more effective corporate governance
system is another focus of the post-Acquisition management reform efforts.
These measures are expected to achieve improved operating efficiency and
financial performance.
The network management, research and development facilities of the Parent
to be acquired by the Company are an important part of the infrastructure
necessary for the operation and development of the Company's business. The
Company currently utilizes these facilities on a cost sharing basis with
the Parent. Acquisition of these facilities will give the Company full
operational control and is expected to strengthen the Company's ability to
manage its network operations on a centralized basis and enable the Company
to better coordinate its research and development efforts.
(d) Significant earnings accretion
As set out above, assuming that the Acquisition had been completed on
January 1, 2003, the pro forma net profit of the Combined Group for the
six-month period ended June 30, 2003 would have been RMB12,054 million
(equivalent to approximately US$1,456 million), representing an increase of
30.2% of the net profit of the Company for the same period. Taking into
account the interest payment in connection with the deferred consideration
for the Acquisition and the other pro forma adjustments and on the basis
that there is no intention to issue additional shares of the Company, the
pro forma earnings per share of the Combined Group for the six-month period
ended June 30, 2003 would have been RMB0.16 (equivalent to approximately
US$0.02), representing an increase of 30.2% of the earnings per share of
the Company for the same period.
(e) Improvement of capital efficiency
The Company believes that the Acquisition will significantly improve its
return on equity. Based on the Company's audited financial statements for
2002 and unaudited interim financial statements for the six-month period
ended June 30, 2003 prepared under IFRS, the Company had a return on equity
(calculated by dividing the net profit by the average shareholders' equity)
of 7.2% for the six-month period ended June 30, 2003. Assuming that the
Acquisition had been completed on January 1, 2003, the return on equity, on
a pro forma basis, would have been 10.7% for the Combined Group for the
same period, representing an increase of 3.5 percentage points.
In addition, the Acquisition will enable the Company to optimize and
enhance its capital structure. Taking into account the deferred
consideration outstanding from the Company to the Parent and the
indebtedness of the Target Group, the Combined Group would have a higher
proportion of debt in its capital structure post the Acquisition and the
Board believes this is appropriate and desirable.
FINANCIAL INFORMATION
The following is a summary of the combined results of the Target Group for the
years ended December 31, 2001 and 2002 and the six-month period ended June 30,
2003, as extracted from the audited combined financial statements of the Target
Group prepared in accordance with IFRS included in the shareholders' circular to
be issued by the Company.
(Amounts in millions)
Six-month
period ended
Years ended December 31, June 30,
------------------------ ------------
2001 2002 2003
---------- ---------- ------------
RMB RMB RMB
Operating revenues 31,951 34,068 18,247
Operating expenses
Depreciation and amortisation (10,724) (12,123) (5,136)
Network operations and support (11,621) (12,097) (5,534)
Selling, general and administrative (4,550) (4,993) (2,602)
Other operating expenses (538) (236) (112)
---------- ---------- ------------
Total operating expenses (27,433) (29,449) (13,384)
---------- ---------- ------------
Operating profit 4,518 4,619 4,863
Deficit on revaluation of property, plant and equipment -- (14,690) --
Net finance costs (1,169) (1,512) (726)
Investment (loss)/income (9) 59 --
Share of profit from associates -- 2 --
---------- ---------- ------------
Profit/(loss) before taxation and minority interests 3,340 (11,522) 4,137
Taxation (230) 4,437 (763)
---------- ---------- ------------
Profit/(loss) before minority interests 3,110 (7,085) 3,374
Minority interests (7) (6) (3)
---------- ---------- ------------
Net profit/(loss) 3,103 (7,091) 3,371
========== ========== ============
The following is a summary of the combined balance sheets of the Target Group as
at December 31, 2001 and 2002 and June 30, 2003, as extracted from the audited
combined financial statements of the Target Group prepared in accordance with
IFRS included in the shareholders' circular to be issued by the Company.
(Amounts in millions)
December 31, June 30,
------------------- --------
2001 2002 2003
-------- -------- --------
RMB RMB RMB
ASSETS
Non-current assets
Property, plant and equipment, net 82,710 71,596 72,503
Construction in progress 9,490 7,650 8,259
Lease prepayments 518 617 620
Interests in associates 50 35 39
Investments 2,563 1 1
Deferred tax assets 1,816 2,408 2,819
Other assets 2,939 3,254 3,367
-------- -------- --------
Total non-current assets 100,086 85,561 87,608
-------- -------- --------
Current assets
Inventories 824 687 769
Accounts receivable, net 2,928 3,097 3,727
Prepayments and other current assets 2,024 1,116 1,007
Time deposits with maturity over three months 77 36 33
Cash and cash equivalents 3,815 2,262 2,323
-------- -------- --------
Total current assets 9,668 7,198 7,859
-------- -------- --------
Total assets 109,754 92,759 95,467
======== ======== ========
December 31, June 30,
------------------- --------
2001 2002 2003
-------- -------- --------
RMB RMB RMB
LIABILITIES AND OWNER'S EQUITY
Current liabilities
Short-term debt 15,087 21,161 21,011
Current portion of long-term debt 5,095 3,455 4,837
Accounts payable 9,152 7,329 7,109
Accrued expenses and other payables 5,258 6,031 6,642
Income tax payable -- -- 1,068
Current portion of finance lease obligations 203 67 66
Current portion of deferred revenues 3,970 3,878 3,640
-------- -------- --------
Total current liabilities 38,765 41,921 44,373
-------- -------- --------
Net current liabilities (29,097) (34,723) (36,514)
-------- -------- --------
Total assets less current liabilities 70,989 50,838 51,094
-------- -------- --------
Non-current liabilities
Long-term debt 14,681 12,741 10,379
Finance lease obligations 367 82 51
Deferred revenues 12,112 10,123 9,319
Deferred tax liabilities 6,110 -- 106
-------- -------- --------
Total non-current liabilities 33,270 22,946 19,855
-------- -------- --------
Total liabilities 72,035 64,867 64,228
Minority interests 48 52 53
Owner's equity 37,671 27,840 31,186
-------- -------- --------
Total liabilities and owner's equity 109,754 92,759 95,467
======== ======== ========
Further detailed information in respect of the Target Group's historical results
of operations and financial position is set out in the shareholders' circular to
be issued by the Company.
3. PROSPECTIVE FINANCIAL INFORMATION
The Target Group has prepared certain prospective financial information in
respect of themselves for the year ending December 31, 2003. There is no present
intention to update this information during the year or to publish such
information in future years, although the Directors are aware of the
requirements of paragraphs 2.10 and 2.11 of the Listing Agreement entered into
between the Company and the Stock Exchange. This information is necessarily
based upon a number of assumptions that, while presented with numerical
specificity and considered reasonable by the Company and the Target Group, are
inherently subject to significant business, economic and competitive
uncertainties and contingencies, many of which are beyond the control of the
Company or the Target Group, and upon assumptions with respect to future
business decisions which are subject to change. Accordingly, there can be no
assurance that these results
will be realized. The prospective financial information presented below may vary
from actual results, and these variations may be material.
The Company and the Target Group believe that, on the bases and the assumptions
to be disclosed in the shareholders' circular to be issued by the Company, and
in the absence of unforeseen circumstances, the Target Group's forecast combined
profit after taxation and minority interests but before extraordinary items for
the year ending December 31, 2003 under IFRS is unlikely to be less than
RMB6,352 million (equivalent to approximately US$767 million). The texts of the
letters from KPMG, CICC and Morgan Stanley in respect of the profit forecast are
set out in the shareholders' circular to be issued by the Company.
4. UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION OF THE TARGET GROUP
Certain pro forma financial information of the Target Group for the year ended
December 31, 2002 has been prepared based on the historical combined statement
of operations of the Target Group, after giving effect to the pro forma
adjustments described below, as if the transactions and arrangements described
had taken effect on January 1, 2002.
A pro forma combined balance sheet is not prepared as the effect of revaluation
of the Target Group's property, plant and equipment has been fully reflected in
its historical combined balance sheet as at December 31, 2002.
The unaudited pro forma combined financial information of the Target Group is
based on a number of assumptions, estimates, uncertainties and currently
available information. As a result of these assumptions, estimates and
uncertainties, the accompanying unaudited pro forma combined statement of
operations of the Target Group for the year ended December 31, 2002 does not
purport to describe the results of the Target Group's operations that would have
been achieved had the Reorganization and the effects of the related service
agreements taken effect on January 1, 2002, nor does it purport to predict the
Target Group's future financial position or results of operations.
The unaudited pro forma combined financial information of the Target Group
should be read in conjunction with the audited combined financial statements of
the Target Group, including notes thereto, and other financial information
included in the shareholders' circular.
Unaudited pro forma combined statement of operations for the year ended December
31, 2002
Target Group Pro Forma Target Group
Historical Adjustments Pro Forma
------------ ------------ ------------
RMB millions RMB millions RMB millions
Operating revenues 34,068 34,068
Operating expenses
Depreciation and amortisation (12,123) 2,643(1) (9,421)
59(2)
Network operations and support (12,097) (12,097)
Selling, general and
administrative (4,993) (33)(2) (5,026)
Other operating expenses (236) (236)
------------ ------------
Total operating expenses (29,449) (26,780)
------------ ------------
Operating profit 4,619 7,288
Deficit on revaluation of
property, plant and equipment (14,690) (14,690)
Net finance costs (1,512) (1,512)
Investment income 59 (59)(3) --
Share of profit from associates 2 2
------------ ------------
Loss before taxation and
minority interests (11,522) (8,912)
Taxation 4,437 (861)(4) 3,576
------------ ------------ ------------
Loss before minority interests (7,085) (5,336)
Minority interests (6) (6)
------------ ------------
Net loss (7,091) (5,342)
============ ============
Notes:
(1) In connection with the Reorganization, the property, plant and equipment of
the Target Group were revalued as at December 31, 2002 which resulted in a
net revaluation deficit of RMB13,930 million. The pro forma adjustment
reflects the reduction in depreciation charge resulting from the
revaluation of the Target Group's property, plant and equipment as if the
results of the revaluation had been recorded on January 1, 2002.
(2) In connection with the Reorganization, certain properties and buildings
associated with the wireline telecommunications business and related
operations of the Target Group were not transferred to the Target Group but
were retained by China Telecommunications Corporation. Pursuant to property
leasing agreements between the Target Group and the Parent Group, the
Target Group leases the properties and buildings from the Parent Group. The
amount to be paid by the Target Group to the Parent Group is based on
market rates, with reference to amounts stipulated by local price bureaus.
The pro forma adjustment reflects the effects of a reduction in
depreciation charge relating to these properties and buildings and an
increase in rental expense as if the Reorganization occurred and the
property leasing agreements took effect on January 1, 2002.
(3) In connection with the Reorganization, certain long-term investments and
interests in associates that are unrelated to the telecommunications
industries were not transferred to a Target Group but were retained by
China Telecommunications Corporation. The pro forma adjustment reflects a
reduction in investment income generated from these investments as if the
Reorganization occurred on January 1, 2002.
(4) The pro forma adjustment reflects the tax effect of the above pro forma
adjustments using the statutory tax rate of 33%.
5. INFORMATION ON THE TARGET ASSETS
Industry Background
The telecommunication industry in China has experienced rapid growth in recent
years. According to the MII, the total number of wireline access lines in
service increased from 144.8 million as of the end of 2000 to 214.4 million as
of the end of 2002, representing a compound annual growth rate of 21.7%.
Wireline telephone penetration rate increased from 11.4% to 16.7% during the
same period. As a result of the increasing demand for information services and
technology development, the market for data communications and Internet services
in China also experienced rapid growth during that period. The
number of Internet users in China increased from 22.5 million as of the end of
2000 to 49.7 million as of the end of 2002, representing a compound annual
growth rate of 48.6%.
The following table sets forth certain information relating to the
telecommunications and information industry in China as of the dates indicated.
Compound
Annual
As of December 31, Growth Rate
--------------------------- -----------
2000 2001 2002 (2000-2002)
------- ------- ------- -----------
China's population (in millions) 1,267 1,276 1,285 0.7%
China's GDP per capita (RMB) 7,081 7,543 8,184 7.5%
Wireline telephone
Access lines in service (in millions) 144.8 180.4 214.4 21.7%
Penetration rate(1) 11.4% 14.1% 16.7% --
Internet
Users (in millions) 22.5 33.7 49.7 48.6%
Penetration rate(1) 1.8% 2.6% 3.9% --
Note:
(1) Determined by dividing the number of access lines in service or users by
the total population of China.
Sources: Data in respect of China's population and GDP per capita, which is
calculated at current prices, are derived from information published by the
National Statistical Bureau; data in respect of wireline access lines in service
are derived from information published by the MII; data in respect of Internet
users of 2000 and 2001 are derived from information published by China Internet
Network Information Centre, or CNNIC, and that of 2002 are derived from
information published by the MII.
The Parent and the Company face competition from other telecommunications
service providers, such as China Netcom Group, China Mobile, China Unicom and
China Railcom in their wireline telephone, data, Internet, and leased line
services. All of the principal competitors are wholly or majority owned by the
Chinese government. The government encourages orderly and fair competition in
the telecommunications industry in China. Currently, providers of basic
telecommunications services must apply for a license from the MII. Only a
limited number of providers have obtained licenses to provide basic
telecommunications services in China.
Market Environment of the Target Group
The Target Service Areas accounted for 18.9% of the total GDP of China in 2002,
with a compound annual growth rate of GDP of 9.3% from 2000 to 2002. The
wireline penetration rate in the Target Service Areas reached 13.4% as of
December 31, 2002. The penetration rate in these service regions is relatively
low compared to that in the Listed Service Areas. The Board believes this will
enhance growth potential for the Company.
The table below sets out selected demographic and market information related to
these service areas and the whole country as of or for the year ended December
31, 2002, unless otherwise indicated.
Target Service
Areas China
-------------- ---------
Population (in millions) 303 1,285
GDP per capita (RMB)(1) 6,538 8,184
2000-2002 compound annual growth rate of GDP(1) 9.3% 8.2%
Wireline telephone penetration rate(2) 13.4% 16.7%
Number of Internet subscribers (in thousands) 7,569(3) 49,700(4)
Internet penetration rate(5) 2.5% 3.9%
Notes:
(1) GDP is calculated at current prices.
(2) Calculated by dividing the number of wireline access lines in service by
the relevant population.
(3) Excludes inactive subscribers, who have registered accounts with the Target
Group but have not used the Target Group's Internet access services.
(4) Includes inactive subscribers.
(5) Calculated by dividing the number of Internet subscribers by the relevant
population.
Sources: Data in respect of China's population, 2002 GDP per capita, 2000 to
2002 compound annual growth rate of GDP and wireline telephone penetration rate
of China are derived from information published by the National Statistical
Bureau and MII; data in respect of wireline access lines in service are derived
from information provided by Provincial Telecommunications Administrations in
the Target Service Areas; and data in respect of Internet users are derived from
information published by the MII.
Overview of the business of the Target Group
The Target Group is the leading provider of wireline telephone, data, Internet
and leased lines services in its service regions. The following table sets forth
the percentages of contribution by the Target Group's different services to its
total operating revenues for the periods indicated:
Six months
ended
Year ended December 31, June 30,
--------------------------- ------------
2001 2002 2003
------------ ------------ ------------
Wireline telephone services:
Local
Installation fees 1.5% 1.7% 1.8%
Monthly fees 16.0% 19.2% 20.2%
Local usage fees 36.0% 35.3% 34.3%
Domestic long distance(1) 18.6% 16.9% 16.1%
International long distance(1)(2) 1.2% 1.2% 1.1%
Interconnection 4.7% 4.6% 5.1%
Upfront connection fees 8.2% 7.5% 6.4%
------------ ------------ ------------
Sub-total 86.2% 86.4% 85.0%
Data and Internet services:
Internet(3) 2.0% 3.3% 4.6%
Managed data(4) 1.8% 1.9% 1.7%
------------ ------------ ------------
Sub-total 3.8% 5.2% 6.3%
Leased line services 3.7% 3.3% 3.1%
Other services(5) 6.3% 5.1% 5.6%
------------ ------------ ------------
Total operating revenue of
the Target Group 100.0% 100.0% 100.0%
============ ============ ============
Notes:
(1) Includes revenue from VoIP long distance services.
(2) Includes revenue from calls to Hong Kong, Macau and Taiwan.
(3) Includes revenue from dial-up, dedicated and broadband Internet access
services as well as value-added data services.
(4) Includes revenue from DDN, frame relay and ATM services.
(5) Include revenue from value-added voice services and sales and maintenance
of customer-end equipment, and lease of telecommunications network
facilities.
Wireline Telephone Services
The wireline telephone services of the Target Group consist of local telephone,
domestic and international long distance and interconnection services.
Wireline telephone services are the Target Group's main services, generating
86.4% of its total operating revenue in 2002. Revenue generated by these
services in the Target Service Areas increased from RMB27,546 million in 2001 to
RMB29,420 million in 2002 and reached RMB15,519 million in the six months ended
June 30, 2003. The demand for value-added voice and information services has
also increased in recent years. The Target Group's wireline telephone services
will continue to provide steady revenue stream and drive the overall earnings
growth of the Combined Group.
Local Telephone Services
The local telephone services in the Target Service Areas have grown
significantly in terms of number of access lines in service in recent years,
representing the largest revenue source for the wireline telephone services of
the Target Group and contributing 56.2% of its total operating revenue in 2002
and 56.3% in the six months ended June 30, 2003, as compared to 53.5% in
2001.[]Access lines. The following table sets out selected information regarding
the local telephone services of the Target Group as of the dates indicated:
As of
As of December 31, June 30,
--------------------------- --------
2000 2001 2002 2003
------- -------- -------- --------
(in thousands, except percentages)
Number of access lines in service(1):
Residential 20,800 26,166 30,165 32,663
Enterprise 3,350 3,664 3,931 3,849(2)
Public telephones 1,006 1,265 1,783 2,029
Wireless local access 283 1,260 4,049 6,532
------- -------- -------- --------
Total(3) 25,440 32,356 39,929 45,073
Wireline telephone penetration rate 8.5% 10.8% 13.4% 15.1%(4)
Market share measured by number of
access lines in service(5) 99.7% 99.3% 98.6% 98.3%
Notes:
(1) Includes ISDN lines as measured by the number of bearer channels.
(2) The decline in the number of access lines in service for enterprise
subscribers from 3.9 million ended December 31, 2002 to 3.8 million ended
June 30, 2003 is due to an elimination of inactive enterprise subscribers.
(3) The total number of access lines in service is different with the sum of
all kinds of access lines because of rounding discrepancies.
(4) Population used for calculating the penetration rate is estimated based on
the population as of the end of 2002, and assuming that the growth rate in
the first half of 2003 is the same as the growth rate in 2002.
(5) Sources: Data in respect of the number of the Target Group's access lines
in service are provided by the Target Group. Data in respect of the total
number of access lines in the Target Service Areas are derived from the
Provincial Telecommunications Administrations in the Target Service Areas.
The number of the Target Group's access lines in service has increased rapidly
from 25.4 million as of the end of 2000 to 39.9 million as of the end of 2002
and 45.1 million as of June 30, 2003. The Target Group had a 98.3% market share
in the Target Service Areas in terms of the number of access lines in service as
of June 30, 2003. The wireline penetration rate in the Target Service Areas
increased from 8.5% as of the end of 2000 to 15.1% as of June 30, 2003.
Being an extension and supplement to local wireline telephone services, wireless
local access provides personal communications at an attractive price and enjoys
strong demand in niche markets. The continued decline in the price of wireless
access equipment has made it a more profitable business. The Target Group's
wireless local access customers grew by 2.5 million in the first half of 2003.
The Target Group also operates an extensive network of public telephones in the
Target Service Areas, and the number of public telephones reached approximately
2.0 million as of the end of June 30, 2003. Public telephone services are
targeted at the large and fast growing mobile population in the Target Service
Areas. The Company believes demand for the Target Group's public telephone
services in these areas will continue to expand.
Service usage. The following table sets out certain usage information regarding
the Target Group's local telephone services for the periods indicated:
Six
months
ended
Year ended December 31, June 30,
--------------------------- --------
2000 2001 2002 2003
------- -------- -------- --------
Total usage (pulses in billions)(1)(2) 79.9 111.4 119.8 59.6
Total usage (minutes in billions)(3) 88.1 118.7 121.6 57.3
Notes:
(1) Pulses are the billing units for calculating local telephone usage fees.
The definition of a pulse for intra-district calls changed in connection
with the 2001 tariff adjustments. The pulse data for 2000 were converted
into pulses under the new definition through a statistical sampling of
calling patterns, and may be subject to certain statistical error.
(2) Include 8.1 billion pulses in 2000, 20.1 billion pulses in 2001, 19.3
billion pulses in 2002 and 6.9 billion pulses in the six months ended June
30, 2003, in respect of Internet dial-up usage generated by our Internet
subscribers and subscribers of other Internet access providers.
(3) Minutes reported were calculated from pulses through a statistical sampling
of calling patterns.
The total usage of the Target Group's local telephone services, including those
associated with voice and VoIP long distance calls, increased from 111.4 billion
pulses in 2001 to 119.8 billion pulses in 2002 and reached 59.6 billion pulses
in the six months ended June 30, 2003. Dial-up Internet usage as a percentage of
total local usage in terms of pulses, decreased from 18.0% in 2001 to 16.1% in
2002 and 11.5% in the six months ended June 30, 2003. Tariffs for the
communications fees of dial-up Internet access were much lower than the usage
fees for voice services.
Tariffs. For its local telephone services, the Target Group charges an upfront
installation fee, a fixed monthly fee and local call usage fees based on call
duration. The tariffs are regulated by the Chinese government. The local call
usage fees are either intra-district or inter-district, depending upon whether a
call is within a single service district or between service districts. In
December 2000, the Chinese government issued a notice of tariff adjustments,
which the Target Group implemented in the first half of 2001. The tariff
adjustments changed the tariff levels for many telecommunications services,
including local and long distance telephone, data and leased line services.
The following table sets out the changes in the Target Group's tariffs before
and after the tariff adjustments implemented in 2001 for local telephone
services:
Before Tariff After Tariff
Adjustments Adjustments
------------------------ -----------------------------
(RMB)
Monthly fee(1):
Residential customers 7.6-21.6 10.0-25.0
Enterprise customers 12.0-33.0 25.0-35.0
Usage fee:
0.20-0.22 for the first two
pulses (first three minutes
or less) and
Intra-district 0.18-0.20 per pulse 0.10-0.11 for each additional
(three minute intervals) pulse (one minute intervals)
Inter-district 0.20-0.50 per pulse 0.20-0.50 per pulse
(one minute intervals) (one minute intervals)
Communications fee:
Internet dial-up 0.09-0.10 per pulse 0.02 per pulse
(three minute intervals) (one minute intervals)
Note:
(1) Monthly fees for customers vary depending on whether a subscriber is
located in the provincial capital, a city, a county or rural areas.
Prior to July 2001, the Target Group charged an upfront connection fee for basic
access services. State guidance rates for connection fees for basic access
services varied from time to time and ranged from RMB100 to RMB1,000. The
connection fees were eliminated entirely in July 2001. The decrease in and
ultimate elimination of the connection fees have stimulated customer growth,
especially for residential customers. In addition, all previous surcharges on
telephone services, which were mostly levied by provincial and local
governments, were eliminated in July 2001.
Domestic Long Distance Services
The Target Group offers long distance services through its public switched
telephone network as well as VoIP long distance services. Total revenue from the
Target Group's domestic long distance services represented 16.9% of its total
operating revenue in 2002 and 16.1% in the six months ended June 30, 2003,
compared to 18.6% in 2001. The Target Group is the largest provider of domestic
long distance services in the Target Service Areas, with a 55.7% market share,
as measured by total minutes carried through, of all wireline and mobile
operators in Target Service Areas in 2002. The market share of the Target Group
decreased to 51.8% in the six months ended June 30, 2003. In addition, the
Target Group commenced offering VoIP domestic long distance services in 1999.
From 2000 to 2002, the proportion of VoIP services in total long distance usage
increased from 2.1% to 42.1%.
Service usage. The following table shows the total minutes of domestic long
distance calls carried through the Target Group's long distance network and the
market share of its domestic long distance services for the periods indicated:
Six months
ended
Year ended December 31, June 30,
--------------------------------- ----------
2000 2001 2002 2003
--------- --------- --------- ----------
Total minutes of usage
(in millions)(1) 10,657 12,070 13,168 6,790
Market share(2) 80.0% 68.2% 55.7% 51.8%
Percentage of usage via VoIP 2.1% 28.1% 42.1% 45.1%
Notes:
(1) Includes calls originated by mobile subscribers that are carried over the
Target Group's long distance networks.
(2) Sources: Data in respect of the number of domestic long distance call
minutes of the Target Group are provided by the Target Group. Data in
respect of the total number of domestic long distance call minutes in the
Target Service Areas are derived from the Provincial Telecommunications
Administrations in the Target Service Areas.
The decrease in the market share of the Target Group's domestic long distance
services from 2000 to June 30, 2003 was mainly attributable to the expansion of
mobile operators' long distance networks and their increased routing of long
distance calls placed by their mobile subscribers through their own long
distance networks as well as increased competition from other wireline long
distance service providers. Despite such competition, the total minutes of usage
of domestic long distance services of the Target Group have maintained a steady
growth through marketing and further development of distribution channels.
Tariffs. The tariff adjustments in 2001 abolished the distance-based tariff
structure, reduced the unit of billing from one minute to six seconds and
eliminated long distance call surcharges.
The following table sets out the tariffs for the Target Group's domestic long
distance telephone services before and after the tariff adjustments in 2001,
which are based on state tariff rates:
Before Tariff Adjustments After Tariff Adjustments
------------------------- --------------------------------------------------
(RMB)
Public switched telephone network services All at the unified rate of 0.07 per six seconds(1)
Intra-provincial less than 300 km 0.50-0.60 per minute(2)
Intra-provincial more than 300 km 0.60 per minute(2)
Inter-provincial less than 800 km 0.80 per minute(2)
Inter-provincial more than 800 km 1.00 per minute(2)
VoIP services(3) 0.30 per minute Not regulated
Notes:
(1) A discount rate of up to 40% applies to calls made during off-peak hours,
which are from 12:00 a.m. to 7:00 a.m. every day.
(2) A discount rate of 50% applies to calls made during off-peak hours, which
are from 9:00 p.m. to 12:00 a.m. for weekdays and from 7:00 a.m. to 12:00
a.m. on public holidays and weekends; a discount rate of 70% applies to
calls made during 12:00 a.m. to 7:00 a.m. everyday.
(3) Does not include separate usage fees for local services when a VoIP call is
placed. The local usage fee of a VoIP call is the same as the local usage
fee of an intra-district local voice call.
The tariff adjustments in 2001 also deregulated the tariffs for VoIP services.
VoIP long distance services have lower tariff rates than those for long distance
services using public switched telephone networks. However, the Target Group
also charges local usage fees on VoIP long distance calls.
International Long Distance Services
The Target Group is the largest provider of international long distance services
in its service regions, with a 65.1% market share in 2002 and a 59.0% market
share in the six months ended June 30, 2003 as measured by the total number of
outgoing call minutes generated in the Target Service Areas and carried through
international gateways of all wireline and mobile operators. The Target Group's
international long distance telephone services contributed 1.2% to its total
operating revenue in 2001 and 2002 and 1.1% in the six months ended June 30,
2003. The Target Group began offering VoIP international long distance services
in 1999, similar to its VoIP domestic long distance services in the Target
Service Areas.
Service usage. The following table sets out certain information related to the
usage and market share of the Target Group's international long distance
services, including usage of international long distance services by mobile
subscribers, for the periods indicated:
Six months
ended
Year ended December 31, June 30,
--------------------------------- ----------
2000 2001 2002 2003
--------- --------- --------- ----------
Outgoing call minutes
(in millions)(1) 122.6 155.3 168.7 77.4
Market share by outgoing
call minutes(2) 78.0% 68.2% 65.1% 59.0%
Percentage of usage via VoIP 5.1% 43.2% 64.6% 68.5%
Notes:
(1) Includes calls originated by mobile subscribers that are carried through
the international gateways of China Telecommunications Corporation.
(2) Sources: Data in respect of the number of outgoing call minutes of the
Target Group are provided by the Target Group. Data in respect of the total
number of outgoing call minutes in the Target Service Areas are derived
from the Provincial Telecommunications Administrations in the Target
Service Areas.
The market share in terms of outgoing call minutes of the Target Group's
international long distance services declined from 78.0% in 2000 to 65.1% in
2002, mainly because mobile operators established their own international
gateways and diverted international calls previously placed by their mobile
subscribers through the Parent's international gateways.
Tariffs. The tariff adjustments in 2001 reduced the basic unit of billing from
one minute to six seconds and simplified the rate schedule by abolishing the
distance-based tariff structure.
The following table sets out the international long distance tariffs of the
Target Group before and after the tariff adjustments in 2001, which are based on
state tariff rates:
Before Tariff Adjustments After Tariff Adjustments
--------------------------------------------------
(RMB)
Public switched telephone network services:
To Hong Kong, Macau and Taiwan 5.00 per minute(1) 0.20 per 6 seconds
To all international destinations 5.30-15.00 per minute(2) 0.80 per 6 seconds(3)
VoIP services(4):
To Hong Kong, Macau and Taiwan 2.50 per minute Not regulated
To all international destinations 4.80 per minute Not regulated
Notes:
(1) A discount rate of 40% applied to calls made during off-peak hours.
(2) Rates of RMB5.30-12.00 per minute applied to calls made to Asian countries
and regions and a rate of RMB15.00 per minute applied to calls to all other
international destinations. A discount rate of 40% applied to calls made
during off-peak hours.
(3) A discount rate of up to 40% applies to calls made during off-peak hours.
(4) Does not include separate usage fees for local services when a VoIP call is
placed. The local usage fee of a VoIP call is the same as the local usage
fee of an intra-district local voice call.
Since the tariff adjustments, the Target Group charges RMB1.50 per minute for
VoIP long distance calls to Hong Kong, Macau and Taiwan and RMB2.40-4.60 per
minute for VoIP long distance calls to international destinations, but offers
various incentive programs and discounts from time to time.
The Target Group offers international long distance services through the
international gateways of China Telecommunications Corporation. China
Telecommunications Corporation negotiates bilateral settlement arrangements and
rates based on the international settlement standards in the telecommunications
industry, and those settlement arrangements and rates also apply to the Target
Group.
Interconnection
All interconnection and settlement arrangements among public wireline telephone,
mobile, and Internet networks in China are governed by the Telecommunications
Regulations and the rules on interconnection arrangements and settlement
promulgated by the MII in 2001.
Subsidiaries of China Telecommunications Corporation, including the provincial
subsisting companies in the Target Service Areas, have entered into
interconnection agreements with other telecommunications service providers in
the Target Service Areas. These agreements provide for interconnection
settlement with respect to local calls and domestic and international long
distance calls involving the Target Group's networks. In connection with the
Reorganization in preparation for the Acquisition, China Telecommunications
Corporation has assigned to the Target Companies, and the Target Companies have
assumed, its rights and obligations under these agreements. The economic terms
and the settlement procedures under those agreements are in accordance with the
standards set forth in the interconnection rules and regulations.
Based on the existing interconnection arrangement between the Company and China
Telecommunications Corporation, the proposed acquisition of the Target Group
would reduce the Combined Group's interconnection revenue and expense with
respect to the traffic between the Target Group and the Listed Group, and would
increase the Combined Group's interconnection revenue and expense with respect
to the traffic between the Target Group and the Parent Group.
Value-added Voice and Information Services
Value-added voice service. In addition to basic local and long distance
services, the Target Group offers a number of value-added voice services. The
Target Group continues to leverage its extensive network resources, customer
base and distribution channels and cooperate with other service providers to
develop new revenue sources, including caller ID display, telephone information
services, telephone directory services, conference calling and toll-free
services. Caller ID display service has approximately 20.7 million users with a
penetration rate of 46.0% as of June 30, 2003 amongst the Target Group's
wireline access lines in service. The Target Group has strengthened the
promotion of value-added services, gradually introduced new products such as
call-center out-sourcing, video conferencing, 17901 direct dial VoIP, "Telephone
QQ", wireline short messaging services, and "Walk with Me". Subscribers are
becoming familiar with these branded services through active marketing by the
Target Group. The Company believes that these services allow the Company to
enhance customer satisfaction and increase its revenue after the Acquisition. As
subscribers in China become more accustomed to these value-added voice services,
the Company expects significant growth potential in this area.
Telephone information services. The Target Group has significantly expanded the
scope of its automated and operator-assisted telephone information and
applications services in recent years. The Target Group's general information
services allow users to access information at its standard telephone usage rates
plus information usage fees. The Target Group also provides other specialized
telephone information and applications services, such as telephone banking and
telephone advertising. Total usage of the telephone information services
provided by the Target Group reached 281.2 million minutes in the six months
ended June 30, 2003. The Target Group intends to further expand the scope and
usage of these services and develop flexible revenue sharing arrangements with
content and application service providers.
Telephone directory services. The Target Group publishes telephone directories,
known as Yellow Pages, in the Target Service Areas. In addition, the Target
Group has introduced online telephone directory and other related information
services. The Target Group derives advertising revenue from its printed and
on-line directories.
Data and Internet Services
The Target Group is the leading provider of data and Internet services in the
Target Service Areas. The data and Internet services of the Target Group is
supported by extensive local access networks in the Target Service Areas and the
largest nationwide fiber optic backbone transmission network jointly operated by
the Combined Group and the Parent. Revenue from the Target Group's Internet
services was RMB1,139 million in 2002, representing 3.3% of its total operating
revenue for that year, and reached RMB841 million in the six months ended June
30, 2003, representing 4.6% of its total operating revenue for that period.
Revenue from the Target Group's managed data services was RMB642 million in
2002, representing 1.9% of its total operating revenue for that year, and was
RMB308 million in the six months ended June 30, 2003, representing 1.7% of its
total operating revenue for that period.
The following table sets forth selected information regarding the data, Internet
and related services of the Target Group as of the dates or for the periods
indicated:
As of
or for
the six
months
As of or for the year ended ended
December 31, June 30,
--------------------------------------
2000 2001 2002 2003
------- ------- ------- --------
Managed data services:
Number of ports (in thousands):
DDN services 51.7 64.5 72.1 73.3
Frame relay services 2.8 5.5 9.4 10.8
ATM services 0.0 0.1 0.5 0.7
Bandwidth leased (in thousands):
DDN services (x64Kbps) 46.6 63.8 70.6 79.8
Frame relay services (x128Kbps) 2.7 7.3 15.5 18.2
ATM services (x2Mbps) 0.0 0.2 5.1 3.7
Dial-up and dedicated Internet access
services:
Dial-up subscribers (in thousands) 1,844.6 4,366.3 5,978.5 6,303.0
Dial-up on-line usage (minutes in
billions) 7.8 19.1 16.9 6.0
Dedicated Internet access lines (in
thousands) 1.8 1.8 1.5 1.2
Broadband access services (in
thousands):
DSL subscribers 1.3 36.1 303.2 688.9
FTTx + LAN subscribers -- 50.6 187.0 337.9
Others -- -- 4.5 3.8
Managed Data Services
The Target Group's managed data services include DDN, frame relay and ATM
services. The Target Group is the market leader in the managed data services in
the Target Service Areas.
DDN services. The Target Group's DDN services provide high-quality and reliable
transmission at speeds ranging from 64Kbps to 2Mbps and continue to meet the
increasing demand for low-to medium-speed transmission capacity from enterprise
customers. DDN systems are composed of optic fibers, digital transmission paths
and digital cross multiplexing nodes. DDN systems are capable of providing
high-
quality private circuits and other services at various data rates to satisfy
users' multimedia communications needs.
Frame relay/ATM services. The Target Group offers advanced high-speed data
communications services based on frame relay and ATM technologies. These
services enable flexible and cost-effective use of bandwidth resources. Frame
relay is a type of connection-oriented packet switching technology that employs
statistical multiplexing over a shared network. Frame relay offers both access
to a network and transmission of data across a network and is used by customers
with significant amounts of data traffic. ATM is a high bandwidth and
multiplexing technology. ATM is developed for high data rates with a high
quality of service, and can offer integrated voice, data and video services at
various data rates.
Tariffs. The Target Group determines most of the tariffs for its data services
within a price range set by the Chinese government. The Target Group generally
charges an upfront fee for installation and testing for its data services and a
fixed monthly fee. The Target Group offers various incentive programs and
discounts for the customers who wish to upgrade to higher brandwidth services.
These incentive programs and discounts have stimulated demand for data services.
The following table sets forth the monthly fees in 2002 for DDN services at the
bandwidth of 64Kbps and 2Mbps:
Monthly Fee
-----------
(RMB)
64Kbps
Intra-district 1,500
Inter-district 2,000
Intra-provincial 3,500
Inter-provincial (less than 800 km) 3,500
Inter-provincial (more than 800 km) 3,500
2Mbps
Intra-district 6,000
Inter-district 8,000
Intra-provincial 12,000
Inter-provincial (less than 800 km) 12,000
Inter-provincial (more than 800 km) 12,000
The following tables set forth the monthly fees in 2002 for frame relay and ATM
services, which include monthly fees for port access and permanent virtual
circuits, or PVCs:
Bandwidth
---------
2Mbps 10Mbps 100Mbps 155Mbps
----- ------ ------- -------
(RMB)
Monthly Fees for port access 1,000 5,000 9,000 10,000
PVC monthly fees (RMB)(1):
PVC Monthly Fees
----------------
Domestic
Bandwidth Intra-District Inter-District Long Distance
-------------- -------------- -------------
(RMB)
256Kbps 800 1,150 2,200
2Mbps 1,500 2,200 4,000
10Mbps 5,000 11,500 15,500
155Mbps 14,500 39,000 130,000
Note:
(1) One-way tariff for PVC circuits of ATM services.
Dial-up and Dedicated Internet Access Services
The Target Group is the largest provider of dial-up and dedicated Internet
access services in the Target Service Areas in terms of the number of
subscribers. The Target Group classifies its dial-up Internet access users into
registered users, non-registered users and prepaid users. The Target Group
provides a variety of dedicated Internet access services to its business and
government customers.
The dial-up Internet access subscribers of the Target Group increased from 4.4
million as of the end of 2001 to 6.0 million as of the end of 2002 and 6.3
million as of June 30, 2003. Total dial-up usage generated from the Target
Group's subscribers declined from 19.1 billion minutes in 2001 to 16.9 billion
minutes in 2002, and reached 6.0 billion minutes in the first six months in
2003. The decrease of the dial-up usage was mainly caused by the upgrade made by
some of the dial-up subscribers to broadband services.
To further develop dial-up Internet access services, the Target Group has
strengthened its content application services by introducing a new Internet
dial-up value-added business known as "D-net". Relying on the extensive dial-up
network resources, access number resources and billing channels of the Target
Group, the Target Group cooperates with Internet content providers to provide
dial-up Internet subscribers with a dedicated platform for value-added services,
thereby achieving the integration of dial-up Internet access services with the
provision of value-added services by Internet content providers. Upon its
introduction, this form of cooperation received immediate positive responses
from Internet content providers, increasing the attractiveness of service
content to dial-up subscribers and aiding the enhancement of the Target Group's
reputation with subscribers.
Dial-up Internet access services and application services have created more
subscriber interest in the Internet. Furthermore, the convenience of dial-up
Internet access also satisfies the need of certain customer groups. Due to the
interactive relationship between dial-up Internet access services and broadband
access services, the Target Group aims to balance the development between
dial-up Internet access and broadband access.
Tariffs. Registered dial-up Internet access users pay an Internet access fee as
well as a local communications fee. Dedicated Internet access users pay usage
fees for the leased dedicated lines or fiber optic access. The tariff adjustment
in 2001 reduced tariffs for dial-up Internet access service.
The following table sets forth the tariffs for the Target Group's dial-up
Internet access services before and after the tariff adjustment in 2001:
Before Tariff Adjustments After Tariff Adjustments
------------------------- ------------------------
Dial-up Internet access fees _________RMB4.00 per hour _______ RMB3.00 per hour
The following table sets forth the tariffs for the dedicated Internet
access services in 2002:
Bandwidth RMB per month
-------------
64Kbps-128Kbps 4,000
1Mbps-2Mbps 20,000
Broadband Internet Access
DSL services. The Target Group promotes DSL services as the primary broadband
Internet access means for residential customers and small- and medium-sized
enterprise customers. DSL services can be offered over copper wires and are
suitable for high-speed Internet access. The Target Group's DSL service charges
are based on bandwidth and whether the customer is a residential customer or
enterprise customer. The Target Group's service fees include an upfront
installation fee, monthly fees and overtime charges. The Target Group had
303,220 DSL subscribers as of the end of 2002 and 688,929 DSL subscribers as of
June 30, 2003.
Fiber-Ethernet access services. The Target Group offers broadband access
services through fiber optic cables that directly link Ethernet technology-based
LANs in office buildings or high value residential complexes to the Internet.
Fiber-Ethernet access uses optic fiber technology and Ethernet protocol to
connect residential users and business users to a telecommunications network and
greatly expands capacity of the access network. As of the end of 2002 and June
30, 2003, the Target Group had 186,988 customers and 337,902 customers,
respectively, using Fiber-Ethernet access services.
Wireless LAN services. The Target Group provides fast and convenient wireless
LAN services through its wireless local area networks in public places, such as
airports, hotels, conference centers and office buildings.
Broadband application services. The Target Group continues to leverage its
broadband access networks and distribution channels to develop various broadband
application services, such as distance education, distance medical services,
video conferencing, on-line games, entertainment and video-on-demand.
Cooperating with certain service providers and relying on the large subscriber
base, network resources, application platforms and the reliable supporting
system, customers management and billing channels, the Target Group has
introduced ChinaVnet to provide the content/application service providers with
billing platforms and channels and to promote to subscribers the modified and
consolidated network services provided by the content/application service
providers. ChinaVnet actively promotes the continual developments of Internet
industrial chain and creates a new business model. Through the integration of
content and application from providers and the creation of a rich and varied
Internet service for Internet subscribers, ChinaVnet will effectively promote
the rapid proliferation of broadband applications and stimulate growth in
subscriber base and revenue.
Tariffs. The following table sets forth the tariffs for DSL services in 2002:
Type of Service Connection Fee Network Fee
-------------- ----------------------------------------------------------------------
(RMB per Port) (RMB per Port)
200 per month if less than 120 hours and 4.00 per hour for every hour
Residential 400 exceeding the 120-hour limit
800 per month if less than 180 hours, and 6.00 per hour for every hour
Enterprise 1,000 exceeding the 180-hour limit
Note:
(1) Some companies would provide some packaged DSL promotion to meet the needs
of customers.
For customers connected through LANs, the Target Group charges either a monthly
network fee plus a fiber optic access fee determined by bandwidth, or a monthly
network fee plus an upfront connection fee. The following table sets forth the
guidance tariffs for its Fiber-Ethernet access services:
Type of Customer Port Bandwidth Connection Fee(1) Network Fee
-------------- ----------------- -----------
(RMB per Port) (RMB per
Port per
month)
Residential 10Mbps 400 200
100Mbps -- 300
Enterprise 10Mbps 1,000 1,000
100Mbps -- 2,000
Note:
(1) Includes registration fee, installation fee and labor expenses, but does
not include equipment fees incurred by customers
System Integration and Other Value-Added Services
The Target Group offers system integration and solution services to its
customers. Its system integration services encompass initial consulting, network
planning, network implementation, application development and maintenance. The
current development of the Target Group focuses on system integration and
information management such as network management and data mining and analysis
services.
The Target Group's Internet data centers primarily offer co-location and web
hosting services. It operates many large Internet data centers that together
provide more than 6,300 square meters of rack space. As part of those services,
the Target Group also leases to its customers various resources at these
Internet data centers, such as servers and database storage capacity. In
addition, the Target Group is developing a range of Internet-based services to
meet increasing corporate outsourcing requirements for website development and
maintenance as well as Internet-based applications.
Leased Line Services
The Target Group also provides leased line services in the Target Service Areas.
In addition to leased lines, the Target Group also leases other network elements
to business and government customers and other telecommunications service
providers. It mainly leases digital circuits, digital trunk lines and optic
fibers. The revenue from the Target Group's leased line services is mainly
derived from the lease of digital circuits. Revenue from the Target Group's
leased line services was RMB1,119 million in 2002, representing 3.3% of its
total operating revenue for that year, and reached RMB566 million in the six
months ended June 30, 2003.
The Target Group offers these services as part of its total telecommunications
solutions and markets these services to large enterprise customers and other
operators through its large enterprise customer service teams. The decline in
total digital circuits leased in 2002 and the six months ended June 30, 2003 was
primarily due to the reduction of circuits leased by mobile operators in the
Target Service Areas, as these operators develop their own network
infrastructure. Increasing demand from business and government subscribers has
partially offset the impact of such reduction.
The following table sets forth the total amounts of bandwidth of leased line
service of the Target Group as of the dates indicated:
As of
As of December 31, June 30,
---------------------- --------
Leased Digital Circuits 2000 2001 2002 2003
------ ------ ------ --------
Total bandwidth (in 2Mbps equivalents) 25,625 29,343 28,326 27,767
Tariffs. The Target Group charges monthly fees for leased lines based on tariff
rates set by the Chinese government, which vary based on bandwidth and whether
the leased line is local or long distance. Leased line tariffs have generally
decreased in recent years. The tariff adjustments in 2001 substantially reduced
tariffs for leased line services.
The following table sets forth the tariffs for 2Mbps and 155Mbps digital
circuits in 2002:
Monthly Fee
-----------
(RMB)
2Mbps
Intra-district 2,000
Inter-district 4,000
Intra-provincial(1) 6,000
Inter-provincial(1) (less than 800km) 6,000
Inter-provincial(1) (more than 800km) 6,000
155Mbps
Intra-district 44,000
Inter-district 88,000
Intra-provincial(1) 132,000
Inter-provincial(1) (less than 800km) 132,000
Inter-provincial(1) (more than 800km) 132,000
Note:
(1) Does not include the tariffs for local digital circuits and access lines.
Marketing, Distribution and Customer Services
Marketing Initiatives
The Target Group markets all of its telecommunications services under the "China
Telecom" brand name, which is one of the best-known brand names in China. The
Target Group offers a full range of differentiated services to its customers to
address their telecommunications needs. The Target Group offers individually
tailored services to its large enterprise customers, specialized services to its
small- and medium-sized enterprise customers and standardized services to its
residential customers. In addition, the Target Group plans to increase its
advertising activities to enhance customer awareness of its available services
and promote brand loyalty.
Sales, Distribution and Customer Services
Dedicated customer manager system for large enterprise customers. The Target
Group has implemented a large enterprise customer manager system. Under this
system, dedicated customer managers of the Target Group directly markets their
services to large enterprise customers. These customer managers form dedicated
management teams based on the industry background or geographical locations of
the customers. The Target Group conducts periodic performance reviews and
evaluations of the performance of the customer managers based on several
factors, including revenue growth, market share, customer satisfaction and
customer retention. To strengthen its marketing efforts, the Target Group has
increased the total number of its customer managers from 1,979 as of the end of
2002 to 2,422 as of the end of June 2003.
Community manager system. The Target Group offers integrated sales and
maintenance services to small- and medium-sized enterprise customers through its
community manager system and divides its community coverage responsibilities by
geographical area. The Target Group's community managers are responsible for
customer development and customer care. The Target Group links its compensation
mainly to the voice traffic in its coverage areas. In addition, community
managers of the Target Group are also responsible for gathering market and
demand information.
Contract system in rural areas. Under this system, the Target Group selects
certain local residents to be responsible for service promotion, customer
development, equipment maintenance and fee collection. This system enables the
Target Group to lower operational costs effectively while at the same time
satisfying the needs of its rural customers.
Customer service hotlines. The Target Group provides customer services through
its customer service hotlines with the uniform access number of "10000." These
customer service hotlines offer unified electronic-based services to the
residential and enterprise customers in the Target Service Areas. These customer
service hotlines handle service inquiries and service applications, collect bill
payments and handle customer complaints.
Billing services. The Target Group bills its residential customers on a monthly
basis and provide a range of payment choices for the convenience of its
customers, including direct-debit service, which automatically deducts the
monthly payment from the subscriber's designated bank or postal account. The
Target Group also provides specially tailored billing and collection services to
their large enterprise customers to help them more effectively plan and monitor
their telecommunications needs.
Marketing and sales agencies and other wholesale channels. The Target Group
markets its services through its own retail outlets as well as agents and
distributors. The Target Group's cooperation with third party agencies and
distributors helps it reach a broader customer base and reduce its operating
expenses. As of December 31, 2002, the Target Group had a total of 6,149
authorized third-party agencies and distributors in addition to 3,886 retail
outlets that the Target Group owned and operated directly.
The Target Group provides a range of wireline telecommunications services,
including, among others, local and long distance telephone and data services, to
government agencies and regulatory authorities at all levels as well as to many
state-owned enterprises in the Target Service Areas. A number of these
government entities and state-owned enterprises are among the largest customers
of the Target Group. The Target Group provides these services in the normal
course of business and do not offer them any special tariff discounts.
Network System
The Target Group was able to realize significant economies of scale as a result
of the extensive coverage and scale of its network. It employs a variety of
advanced technologies and suitable architecture and can be efficiently migrated
to the next generation of network technology. The Target Group's network system
is managed and operated by its experienced network management and maintenance
teams and offers flexible functionality and reliable operation. It supports a
comprehensive range of end-to-end wireline telecommunications services and
enables customized products to be delivered for a variety of telecommunications
needs.
Network Architecture
The Target Group's network system consists of transport networks, service
networks, an application layer and support networks.
Transport networks: Transport networks provide the transport functions of
voice and data signals for all of the Target Group's services.
Service networks: Service networks include wireline telephone network, data
networks, Internet network and other service networks such as intelligent
networks, and support the Target Group's basic and value-added
telecommunications services.
Application layer: The application layer provides the platform for a
variety of applications and services such as e-commerce, video-on-demand,
and on-line games.
Support networks: Support networks include signaling networks, digital
synchronous networks and network management systems and support the
reliable and effective operation of the Target Group's networks at all
levels.
Network Capacity and Technology
Local access networks. The Target Group owns extensive local access networks in
the Target Service Areas. As of December 31, 2002, the Target Group's local
access networks covered all cities, counties and rural villages in the Target
Service Areas. As part of its strategic focus on the data and Internet market,
the Target Group continues to expand its broadband local access networks
utilizing its existing copper line resources. In addition, the Target Group
continues to upgrade its existing local access lines using DSL technology. At
the same time, the Target Group is selectively connecting additional large
office buildings and business centers with fiber optic access. As of December
31, 2002, the total capacity of DSL access ports of the Target Group reached
686,306 lines. The Target Group has also selectively developed PHS networks for
wireless local telephone service to supplement its wireline access systems.
Moreover, the Target Group is developing wireless LANs in airports and other
commercial centers to provide business travellers with broadband access
services.
Transport network. The Target Group's transport system is based on an advanced,
high-speed, large-capacity, secure and reliable fiber optic network throughout
its service regions. The Target Group's fiber optic transport network is also
supplemented by satellite transmissions and digital microwave links. Its fiber
optic network had a total cable length of 263,844 kilometers in its service
regions as of the end of 2002. The Target Group's transport network is
integrated with the fiber optic network of the Parent Group outside the Target
Service Areas, which, together with the Company's current networks, forms the
largest nationwide fiber optic transport network in China, and is connected with
networks worldwide.
The Target Group's fiber optic transport network employs SDH architecture and
DWDM technology extensively, both of which allow for simpler and more easily
managed networks with enhanced reliability. The Target Group uses DWDM
technology on most of its long distance transmission routes to expand
transmission capacity. The main routes of the Target Group's backbone fiber
optic networks in its service regions have been upgraded to 10Gbps-based DWDM
systems and provide transmission bandwidth of up to 32 x 10Gbps or 160 x 10Gbps.
In addition, the Target Group has deployed self-healing, DXC, 1+1 protection and
other protection technologies and provides customers with network services of
various levels of reliability based on their requirements.
Wireline telephone networks. The Target Group's wireline telephone network has
been substantially built in the last decade utilizing digital technology. It
consists of long distance switching facilities and 69 local switching networks.
As of the end of 2002, the total capacity of local switches reached 49.8 million
lines, and the capacity of long distance toll switches reached 1.8 million
ports. In developing its wireline telephone networks, the Target Group has
adopted technologies that enable high capacity and fewer exchanges to reduce its
construction and operating costs. The Target Group has installed advanced
intelligent networks over its telephone networks. Intelligent networks combine
advanced computer technologies with traditional switching techniques to provide
flexible value-added services such as prepaid services, virtual private network
services and toll free call services.
Data and Internet networks. The Target Group has developed a large-capacity,
high-quality, reliable and extensive data and Internet network system in the
Target Service Areas. The Target Group's data and Internet networks allow it to
provide services both at the network layer, such as Internet access, managed
data and virtual private network services, and at the application layer, such as
Internet data center, e-commerce and video-on-demand services. These networks
cover all cities and counties in the Target Service Areas. The Target Group's
ATM network allows multi-service access and flexible bandwidth management and
provides high-quality, integrated end-to-end services.
The Target Group's Internet network is part of ChinaNET, the largest public
Internet network in China, operated by the Parent Group. ChinaNET deploys
mainstream Gigabyte routers as the main network
technology. Most of its backbone routes allow high-speed transmission with the
use of several 2.5Gbps circuits.
Support networks. The operation of the Target Group's wireline telephone, data
and Internet networks depends on various support networks, including a signaling
network based on a signaling technology known as Signaling System 7 protocol, a
digital synchronous network and network management systems for various networks
and services such as Internet data center, e-commerce and video-on-demand
services.
Equipment procurement. The Target Group purchases most of its network equipment
from leading international suppliers or their joint ventures in China. The
Target Group also purchases from local suppliers a variety of network equipment,
such as transport equipment and local switches. The Target Group makes most of
its purchases through competitive tenders primarily based on product and service
quality, system compatibility and price.
Research and Development
The Target Group's emphasis on research and development has enhanced a clear
vision in market direction, the development of advanced network system and the
rollout of new applications and services. The Target Group's research and
development is carried out by specialised research centers or small teams of
experts. Researchers are primarily responsible for conducting researches on
business strategies, network planning and support, new product trials and
investment decisions.
IT Systems
As a consistent corporate focus, the Target Group sought to improve operational
and management efficiency through establishing strong IT systems. IT systems
(CTG-MBOSS) include the Business Support System (BSS), Operation Support System
(OSS) and Management Support System (MSS). Implementation of IT design heralds
the technological and organizational restructuring of the IT systems. Adoption
of the Enterprise Application Integration (EAI) technology has allowed for
smooth interconnection between all major systems, enabling full information
sharing within the Company. The planned future development of the IT system is
expected to further enhance market responsiveness and improve customer service,
significantly raise operation and management levels and strengthen
competitiveness.
Organizational Reorganization and Business Process Re-engineering
Determined to maintain market leadership and improve the Target Group's
competitiveness, the Target Group continues to implement internal restructuring
and business process re-engineering measures aimed at further gearing toward a
"market-oriented, customer-centered and return-driven" business model.
The Target Group has implemented various initiatives to reorganize its
organisation and has undertaken a business process re-engineering, or BPR,
project. These BPR project aims to effect organizational and operational changes
in a number of areas, including organizational structure, network investment
process, allocation of network resources, large customer management, billing and
collection and employee evaluation and incentive scheme.
In addition, the Target Group has taken various steps to centralize and
streamline the management of its business. For example, the Target Group has
improved its capital budgeting process and centralized equipment procurement in
order to reduce the cost of network expansion and maximize return on investment.
The Target Group has also centralized network maintenance of local networks to
optimize the network maintenance system and reduce maintenance costs.
The Target Group has launched an organizational restructuring that involved all
levels of operations. A new "front-end-back-end" structure has been established
at each level to enhance market responsiveness. The front-end is composed of
"customer interface units" with related marketing functions, while at the
back-end, all network resources have been consolidated to provide the front-end
with service provisioning,
quality control, billing and operation support services. An internal Service
Level Agreement (SLA) system has been set up between the front-end and the
back-end to ensure more concerted and high quality end-to-end service delivery.
Capital Expenditure
The table below sets forth the Target Group's historical capital expenditures
for the years indicated.
Year ended December 31,
-----------------------
2001 2002
---- ----
(RMB in millions)
Total capital expenditures 18,787 16,095
The Target Group has further rationalized the allocation of its capital
expenditures in 2002. It has continued to allocate a majority of its capital
expenditures to the development of access infrastructure in order to meet the
demands of the subscriber growth and to strengthen its position as owners of the
"last mile" in the Target Service Areas. Internet and data networks are another
major area of capital expenditures as the Target Group capitalized on the
surging demand for broadband, managed data and Internet services. In addition,
the Target Group has increased expenditures for the Business Support System
(BSS), Operation Support System (OSS) and Management Support System (MSS) as
part of its effort to improve customer service quality, operating efficiency and
information disclosure.
The Board expects to fund the capital expenditure needs of the Target Group
through a combination of cash generated from operating activities, short-term
and long-term bank loans and other debt and equity financing. The Board believes
the Target Group will have sufficient resources to meet capital expenditure
requirements for the foreseeable future.
Network management and research Facilities
Apart from the Target Group, the Company will also acquire from the Parent
certain assets which are used for network management, research and development
purposes. The network management assets to be acquired from the Parent are
essential for the smooth operation of the entire China Telecom network systems.
Capabilities of the network management assets include function management,
resource allocation, performance monitoring, network security and billing. The
network management assets also provide certain value-added services, such as SLA
reporting and VPN. The research and development assets, including a research
institute located in Beijing, are used for developing new telecommunications
products and technologies. Based on an asset appraisal report prepared by an
independent appraiser appointed by the Company, the value of such assets as of
December 31, 2002 amounted to RMB432 million. There has been no material change
to the value of such assets after December 31, 2002.
6. RELATIONSHIP WITH CHINA TELECOMMUNICATIONS CORPORATION
As of the Latest Practicable Date, China Telecommunications Corporation directly
owned 77.78% of the Company's issued share capital. In connection with the
Global Offering of the Company, China Telecommunications Corporation has, by a
letter of undertakings that is legally binding indefinitely, undertaken that it
will support the Company's existing operations and future development, including
that the Company will be treated equally with any other operators of wireline
telephone, data and Internet, leased line or other related telecommunications
services that are controlled by China Telecommunications Corporation and the
Company will have the option to provide additional telecommunications services
in the service regions that fall within China Telecommunication Corporation's
scope of business.
ARRANGEMENT RELATING TO THE REORGANIZATION AND THE ACQUISITION
The following arrangement has been entered into between the Parent Group and the
Company, the performance of which will technically be considered as a connected
transaction after the Acquisition.
Amounts due to the Parent
In 1994, the Ministry of Finance obtained a loan from the World Bank (the World
Bank Loan) which was subsequently novated to the former Ministry of Posts and
Telecommunications. After a series of further novations made in conjunction with
the restructuring of the telecommunications industry by the Chinese government,
China Telecommunications Corporation became the borrower of record of the World
Bank Loan. A portion of the World Bank Loan was advanced by China
Telecommunications Corporation to, and utilized by, the provincial subsisting
companies of Jiangxi province, Guangxi Zhuang autonomous region and Sichuan
province, which also bore the costs of servicing that portion of the World Bank
Loan. In connection with the Reorganization, the parties agreed with effect from
December 31, 2002 that the Parent would assume the above-mentioned World Bank
Loan advanced to the provincial subsisting companies of Jiangxi province,
Guangxi Zhuang autonomous region and Sichuan province, in exchange for an
unsecured interest-free indebtedness of US$47.4 million due from Jiangxi
Telecom, Guangxi Telecom and Sichuan Telecom. Subsequent to December 31, 2002,
the Parent would bear the costs of servicing that portion of the World Bank
Loan.
The Company has agreed to cause the entire amount of that account payable
outstanding from Jiangxi Telecom, Guangxi Telecom and Sichuan Telecom to be
repaid to the Parent using their internal cash resources on the next business
day following the completion of the Acquisition.
CONNECTED TRANSACTIONS
As a result of the Reorganization, certain transactions entered into between the
Target Companies and the Parent Group will constitute Prospective Connected
Transactions. Specific agreements to be entered into in respect of each of the
Prospective Connected Transactions are described in this section.
The Prospective Connected Transactions set out in this section which relate to
the operations of the Target Group are identical in nature and substance to the
corresponding Existing Connected Transactions. The pricing standards and
principal terms of the Prospective Connected Transactions are also identical to
those of the Existing Connected Transactions.
The Company and the Target Group have included certain historical amounts in
respect of the Prospective Connected Transactions that occurred prior to the
Reorganization. These historical amounts are based on the Company's and the
Target Group's respective audited and unaudited financial statements. The Target
Group's audited financial statements for periods prior to January 1, 2003 were
prepared to include the operating results related to certain assets that were
retained by the Parent Group in connection with Reorganization and reflect
transactions under old pricing mechanisms that were in place before the
Reorganization. Accordingly, the historical amounts in respect of the Target
Group for the year ended December 31, 2002 should not be read as an indication
of future transaction amounts. New arrangements in relation to connected
transactions, including new pricing mechanisms as set out in the relevant
connected transaction framework agreements took effect from January 1, 2003.
Therefore the historical figures for the six months ended June 30, 2003 are
comparable to future transaction amounts in terms of pricing mechanism and basis
of reporting. However, the expenditures of the connected transactions are
incurred unevenly during a financial year, and the transaction amounts for the
six months ended June 30, 2003 shall not be used as a basis for prediction of
the transaction amounts likely to be incurred for the entire year.
1. Ongoing Connected Transactions Between the Company and China
Telecommunications Corporation
After the Reorganization, the Company entered into various agreements with
China Telecommunications Corporation and a number of its subsidiaries
relating to the mutual provision of ongoing telecommunications and other
services.
The mutual provision of ongoing telecommunications and other services
between the Parent Group and the Company will constitute connected
transactions within the meaning of the Hong Kong Listing Rules. Such
agreements include the following:
(a) Supplemental Trademark Licence Agreement
On September 10, 2002, the Company and China Telecommunications
Corporation entered into a trademark licence agreement to grant to the
Company the right to use certain trademarks owned by the Parent Group
on a royalty-free basis.
On October 26, 2003, the Company and China Telecommunications
Corporation entered into a supplemental trademark licence agreement
(the Supplemental Trademark Licence Agreement) to extend the scope of
the licensees to include the Target Companies and to amend the list of
trademarks as set out in the trademark licence agreement entered into
by the same parties on September 10, 2002. The Supplemental Trademark
Licence Agreement further extends the term of the licence from
December 31, 2004 to December 31, 2005, after which the licence will
be automatically renewed for further periods of three years unless the
Company provides three months' written notification to China
Telecommunications Corporation of its intention not to renew the
agreement at the expiration of its current term.
Pursuant to the Supplemental Trademark Licence Agreement, the Parent
has granted to the Combined Group the right to use certain trademarks
currently used by the Parent Group in the provision of its
telecommunications services on a royalty free basis.
(b) Supplemental Agreement Relating to Centralized Services,
Interconnection, Optic Fibers Leasing and Non-competition Agreement
The Company and China Telecommunications Corporation entered into a
supplemental agreement in relation to centralized services,
interconnection, optic fibers leasing and non-competition agreement on
October 26, 2003 (the Supplemental Connected Transactions Agreement)
to amend the original centralized services agreement, the
interconnection agreement, the optic fibers leasing agreement and the
non-competition agreement, all entered into by the same parties on
September 10, 2002.
Centralized Services
The Supplemental Connected Transactions Agreement modifies the scope
of the centralized services to include sharing the use and costs of
headquarters and certain network support premises and related
facilities such as air-conditioning, electricity and certain ancillary
facilities. Costs of the centralized services such as the management
of large enterprise customers, network management center, business
support center by the Company and sharing the use of headquarters,
international gateways and certain other premises together with costs
such as labor costs, depreciation of equipment and premises, daily
expenses, costs relating to maintenance and research, are to be
apportioned between the Parent and the Company per annum according to
their respective proportional income or aggregate volume of inbound
and outbound international calls, where appropriate. The Supplemental
Connected Transactions Agreement also amends the scope of
international telecommunications facilities to include international
land cables and related domestic extended portions and extends the
term of the centralized services agreement from December 31, 2004 to
December 31, 2005. Such agreement will be automatically renewed for
further periods of three years unless the Company provide three
months' written notification to the Parent of its intention not to
renew the agreement. Apart from the amendments described above, the
other terms and conditions set out in the original centralized
services agreement remain unchanged.
For the year ended December 31, 2002 and the six months ended June 30,
2003, the Target Group's portion of the costs in respect of the
centralized services set out above were RMB173 million and RMB71
million, respectively.
For the year ended December 31, 2002 and the six months ended June 30,
2003, the Listed Group's portion of costs in respect of the
centralized services set out above were RMB483 million and RMB144
million, respectively.
Interconnection
The Supplemental Connected Transactions Agreement extends the term of
the original interconnection agreement from December 31, 2004 to
December 31, 2005. The interconnection agreement will be automatically
renewed for further periods of three years unless the Company provides
three months' written notification to the Parent of its intention not
to renew the agreement. The original interconnection agreement does
not provide for early termination or non-renewal by the Parent.
Furthermore, under Article 17 of the Telecommunications Regulations, a
telecommunications operator cannot refuse to enter into
interconnection arrangements with another operator if requested. Apart
from the amendment described above, the other terms and conditions of
the original interconnection agreement remain unchanged.
Prior to the completion of the Acquisition, no such interconnection
settlement arrangement was in effect between the Parent Group and the
Target Companies, or between the Listed Group and the Target
Companies. After the completion of the Acquisition, such
interconnection arrangement will be in effect between the Parent Group
and the Combined Group.
For the year ended December 31, 2002 and the six months ended June 30,
2003, the net settlement payments made by the Listed Group to the
Parent pursuant to the original interconnection agreement were RMB385
million and RMB181 million, respectively.
Optic Fibers Leasing
The Supplemental Connected Transactions Agreement extends the term of
the original optic fibers leasing agreement from December 31, 2004 to
December 31, 2005. The optic fibers leasing agreement will be
automatically renewed for further periods of three years unless the
Company provides three months' written notification to the Parent of
its intention not to renew the agreement at the expiration of its
current term. Apart from the amendment described above, the other
terms and conditions of the original optic fibers leasing agreement
remain unchanged.
Pursuant to the Reorganization, all optic fibers required for
inter-provincial transmission within the Target Service Areas were
transferred to the relevant Target Companies. Accordingly, no leasing
arrangement for such optic fibers was put in place between the Parent
and the Target Companies after the Reorganization.
For the year ended December 31, 2002 and the six months ended June 30,
2003, the total amounts paid by the Listed Group to the Parent with
respect to optic fibers leasing were RMB102 million and RMB46 million,
respectively.
Non-Competition Agreement
To be in line with an amendment to Directory of Categorization of the
Telecommunications Services (the Directory) promulgated by the MII on
February 21, 2003, the Supplemental Connected Transactions Agreement
amends the definition of "basic telecommunications services" to
include 3G businesses. The Supplemental Connected Transactions
Agreement also amends the expression of "value-added
telecommunications services" in order to be in line with
the Directory, which contains domestic multi-parties
telecommunications service, Internet access services, Internet data
center services, Internet VPN services and VPN services within the
scope of such expression. Apart from the amendment described above,
the other terms and conditions set out in the original agreement
remain unchanged.
2. Ongoing Connected Transactions Between Subsidiaries of the Company and
Subsidiaries/Associates of China Telecommunications Corporation
After the Reorganization, certain ancillary, and mostly
non-telecommunications related businesses and assets of the Parent Group
within the Target Service Areas, continue to be operated or held by certain
subsidiaries and/or Associates of the Parent (the Provincial Subsisting
Companies). Any transactions between the Provincial Subsisting Companies
and subsidiaries of the Company would constitute connected transactions
under the Hong Kong Listing Rules.
Since the terms and conditions of the Prospective Connected Transactions
are identical to the terms and conditions of the corresponding Existing
Connected Transactions, we will not be setting out in this announcement the
commercial background, reasons and terms for such transactions which were
set out in the Company's Prospectus.
(a) Engineering Agreements
The Target Companies and the Provincial Subsisting Companies have
entered into engineering framework agreements (the Engineering
Framework Agreements) to govern the arrangements with respect to
certain engineering related services. Each Engineering Framework
Agreement will expire on December 31, 2005, but will be automatically
renewed for further periods of three years unless a Target Company
provides three months' written notification to the relevant Provincial
Subsisting Company of its intention not to renew its agreement.
The charges payable for engineering related services rendered under
the Engineering Framework Agreements shall be determined by reference
to market rates as reflected by prices obtained through a tender
process. The Target Companies do not accord any priority to any of the
Provincial Subsisting Companies to provide such services, and the
tender may be awarded to an independent third party. However, if the
terms of an offer from a Provincial Subsisting Company are at least as
favorable as those offered by another tenderer, the relevant Target
Company may award the tender to the relevant Provincial Subsisting
Company.
For the year ended December 31, 2002, the Target Group's expenditure
for engineering services made available by the Provincial Subsisting
Companies to the Target Group was RMB2,172 million. For the six months
ended June 30, 2003, the Target Group's expenditure, following the new
corporate structure and the pricing mechanism set out in the
Engineering Framework Agreements, was RMB873 million.
Currently, the Listed Group and the Provincial Subsisting Companies
have on-going arrangements in respect of engineering related services
similar to those proposed in the Engineering Framework Agreements
which form part of the Existing Connected Transactions. For the year
ended December 31, 2002 and the six months ended June 30, 2003, the
Listed Group's expenditures for corresponding engineering services
pursuant to the Existing Connected Transaction between the relevant
Provincial Subsisting Companies and each of Shanghai Telecom,
Guangdong Telecom, Jiangsu Telecom and Zhejiang Telecom were RMB3,243
million and RMB982 million, respectively.
(b) Property Leasing Agreements
Mutual leasing of properties
Pursuant to various property leasing framework agreements between the
Target Companies and the Provincial Subsisting Companies (the Property
Leasing Framework Agreements), the Target Group has leased from the
Provincial Subsisting Companies a total of 673 properties covering an
aggregate gross floor area of approximately 176,467.7 square metres
for use as its business premises, offices, equipment storage
facilities and sites for network equipment. These properties are
situated in many locations within the Target Service Areas. Pursuant
to the Property Leasing Framework Agreements and as part of the
Reorganization, the Target Companies have also leased certain
properties covering an aggregate gross floor area of approximately
99,182.9 square metres to the Provincial Subsisting Companies.
Each Property Leasing Framework Agreement will expire on December 31,
2005, but will be automatically renewed for further periods of three
years unless a Target Company provides three months' written
notification to the relevant Provincial Subsisting Company of its
intention not to renew its agreement.
The rental charge in respect of each property is based on market
rates, with reference to amounts stipulated by local price bureaus,
taking into consideration the specific needs of the telecommunications
industry when leasing properties. Rental charges are payable monthly
in arrears and subject to review every three years.
Pursuant to the Reorganization, the properties occupied by the Target
Group with defective titles were retained by the Provincial Subsisting
Companies, and such properties are now leased by the Target Group from
the Provincial Subsisting Companies. Therefore, the scope of
properties leased by the Target Group has been broadened, and no
comparable historical figures are available. For the six months ended
June 30, 2003, the Target Group's expenditure, following the new
corporate structure and the pricing mechanism set out in the Property
Leasing Framework Agreement, was RMB22 million. For the same period,
the Provincial Subsisting Companies' expenditure for the rental
charges in respect of properties leased from the Target Group was RMB8
million.
Chesterton, an independent appraiser appointed by the Company for the
purpose of the Acquisition, has reviewed the Property Leasing
Framework Agreements and has confirmed that the rental charges payable
under the Property Leasing Framework Agreements are fair and
reasonable so far as the Target Companies are concerned, and do not
exceed market rates in respect of both properties leased to and from
the Target Companies.
Currently, the Listed Group and the Provincial Subsisting Companies
have on-going arrangements in respect of mutual leasing of properties
similar to those proposed in the Property Leasing Framework Agreements
which form part of the Existing Connected Transactions. For the year
ended December 31, 2002 and the six months ended June 30, 2003, the
Listed Group's expenditures for corresponding property leasing
pursuant to the Existing Connected Transaction between the relevant
Provincial Subsisting Companies and each of Shanghai Telecom,
Guangdong Telecom, Jiangsu Telecom and Zhejiang Telecom were RMB266
million and RMB135 million, respectively. For the same period, the
Provincial Subsisting Companies' expenditures for corresponding
property leasing pursuant to the Existing Connected Transaction
between the relevant Provincial Subsisting Companies and each of
Shanghai Telecom, Guangdong Telecom, Jiangsu Telecom and Zhejing
Telecom were RMB3 million and RMB4 million, respectively.
Sub-Leasing of Third Party Properties
Following the Reorganization, the Provincial Subsisting Companies have
sub-let to the Target Group certain properties owned by and leased
from independent third parties for use as offices, retail outlets,
spare parts storage facilities and sites for network equipment (the
Third Party Properties). In order to formalize such arrangement, the
Target Companies and the Provincial Subsisting Companies have entered
into sub-leasing agreements (the Third Party Properties
Sub-leasing Agreements) which will expire on December 31, 2005, but
will be automatically renewed for further three-year periods unless a
relevant Target Company provides three months' written notification to
the relevant Provincial Subsisting Company of its intention not to
renew its agreement.
The amounts payable by the Target Group to the Provincial Subsisting
Companies under the Third Party Properties Sub-leasing Agreements are
the same as the amounts payable by the Provincial Subsisting Companies
to the relevant third parties. The rental charges for the Third Party
Properties are based on market rates negotiated between the Provincial
Subsisting Companies and the relevant third parties on an arm's length
basis.
Prior to the Reorganization, no such sub-leasing arrangement was in
effect between the Provincial Subsisting Companies and the Target
Group. For the six months ended June 30, 2003, the Target Group's
expenditure for properties sub-leasing was RMB59 million.
Chesterton, an independent appraiser appointed by the Company for the
purpose of the Acquisition, has confirmed that the rental charge
payable for each of the Third Party Properties under the Third Party
Properties Sub-leasing Agreements is fair and reasonable so far as the
Target Group is concerned, and does not exceed market rents.
Currently, the Listed Group and the Provincial Subsisting Companies
have on-going arrangements in respect of sub-leasing of third party
properties similar to those proposed in the Third Party Properties
Sub-leasing Agreements which form part of the Existing Connected
Transactions. For the year ended December 31, 2002 and the six months
ended June 30, 2003, the Listed Group's expenditures for corresponding
properties sub-leasing pursuant to the Existing Connected Transaction
between the relevant Provincial Subsisting Companies and each of
Shanghai Telecom, Guangdong Telecom, Jiangsu Telecom and Zhejiang
Telecom were RMB321 million and RMB160 million, respectively.
(c) IT Services Agreements
The Target Companies have entered into framework agreements with the
Provincial Subsisting Companies in each of the Target Service Areas
pursuant to which the Provincial Subsisting Companies have agreed to
provide the Target Group with certain information technology services
such as office automation and software adjustment (the IT Services
Framework Agreements). The agreements will expire on December 31,
2005, but will be automatically renewed for further periods of three
years unless a Target Company provides three months' written
notification to the relevant Provincial Subsisting Company of its
intention not to renew its agreement.
The Provincial Subsisting Companies are entitled to tender for the
right to provide Target Companies with IT services. The charges
payable for such IT services under the IT Services Framework
Agreements shall be determined by reference to market rates as
reflected by prices obtained through the tender process. The Target
Companies do not accord any priority to the Provincial Subsisting
Companies to provide such services, and the tender may be awarded to
an independent third party. However, if the terms of an offer from a
Provincial Subsisting Company are at least as favorable as those
offered by another tenderer, the relevant Target Company may award the
tender to the relevant Provincial Subsisting Company.
For the year ended December 31, 2002, the Target Group's expenditure
for the IT services made available by the Provincial Subsisting
Companies to the Target Group was RMB59 million. For the six months
ended June 30, 2003, the Target Group's expenditure, following the new
corporate structure and the pricing mechanism set out in the IT
Services Framework Agreements, was RMB18 million.
Currently, the Listed Group and the Provincial Subsisting Companies
have on-going arrangements in respect of IT services similar to those
proposed in the IT Services Framework Agreements which form part of
the Existing Connected Transactions. For the year ended December 31,
2002 and the six months ended June 30, 2003, the Listed Group's
expenditures for corresponding IT services pursuant to the Existing
Connected Transaction between the relevant Provincial Subsisting
Companies and each of Shanghai Telecom, Guangdong Telecom, Jiangsu
Telecom and Zhejiang Telecom were RMB151 million and RMB3 million,
respectively.
(d) Equipment Procurement Services Agreements
Pursuant to the equipment procurement framework agreements entered
into between the Target Companies and the Provincial Subsisting
Companies in each of the Target Service Areas (the Equipment
Procurement Framework Agreements), the Provincial Subsisting Companies
have agreed to provide comprehensive procurement services, including
the management of tenders, verification of technical specifications
and installation services.
Pursuant to the Equipment Procurement Framework Agreements between the
Target Companies and the Provincial Subsisting Companies, the Target
Companies may request that the Provincial Subsisting Companies act as
their agents in procuring foreign and domestic telecommunications
equipment and other domestic non-telecommunications materials. Each
Equipment Procurement Framework Agreement will expire on December 31,
2005, but will be automatically renewed for further periods of three
years unless a Target Company provides three months' written
notification to the relevant Provincial Subsisting Company of its
intention not to renew its agreement. The Target Companies may give
priority to the Provincial Subsisting Companies if the terms and
conditions of the services provided by them are at least as favorable
as those offered by independent third parties.
Commission charges for these services are calculated at the maximum
rate of:
(1) 1% of the contract value, in the case of imported
telecommunications equipment; or
(2) 1.8% of the contract value, in the case of domestic
telecommunications equipment and other domestic
non-telecommunications materials.
The Target Group believes that the above charges are the same as
market rates or those rates which it would be required to pay had it
appointed an independent third party to provide the same procurement
services.
Prior to the Reorganization certain of the Target Group's equipment
was first purchased from suppliers by the Parent Group and then resold
to the Target Group. Under those circumstances, the Parent Group acted
primarily as a principal rather than as an agent earning commissions
and therefore no historical figures of a comparable nature are
available.
For the six months ended June 30, 2003, the Target Group's expenditure
for the equipment procurement services provided by the Provincial
Subsisting Companies to the Target Group, following the new corporate
structure and the pricing mechanism set out in the Equipment
Procurement Framework Agreements, was RMB36 million.
Currently, the Listed Group and the Provincial Subsisting Companies
have on-going arrangements in respect of equipment procurement
services similar to those proposed in the Equipment Procurement
Framework Agreements which form part of the Existing Connected
Transactions. For the year ended December 31, 2002 and the six months
ended June 30, 2003, the Listed Group's expenditures for corresponding
equipment procurement pursuant to the Existing Connected Transaction
between the relevant Provincial Subsisting Companies and
each of Shanghai Telecom, Guangdong Telecom, Jiangsu Telecom and
Zhejiang Telecom were RMB78 million and RMB45 million, respectively.
(e) Community Services Agreements
The Parent Group, through the Provincial Subsisting Companies,
provides certain cultural, educational, property management, vehicles
services, health and medical services, hotel and conference services,
community and sanitary services to the Target Group. The arrangements
are set out in the community services framework agreements between the
Target Companies and the Provincial Subsisting Companies in each of
the Target Service Areas (the Community Services Framework Agreements)
which will expire on December 31, 2005, but will be automatically
renewed for further periods of three years unless terminated by either
party with at least three months' written notification to the other
party. However, if the Target Companies cannot, without incurring
significant cost and expense, obtain these services from a third party
after such termination, the Provincial Subsisting Companies cannot
terminate the provision of such services.
The Community Services Framework Agreements stipulate that the above
community services be provided at:
(1) the government-prescribed price;
(2) where there is no government-prescribed price but where there is
a government-guided price, the government-guided price applies;
(3) where there is neither a government-prescribed price nor a
government-guided price, the market price applies. The market
price is defined as the price at which the same type of services
are provided by independent third parties in the ordinary course
of business; or
(4) where none of the above is applicable, the price is to be agreed
between the relevant parties for the provision of the above
services, which shall be the reasonable cost incurred in
providing the same plus a reasonable profit margin (For this
purpose, "reasonable costs" means such costs as confirmed by both
parties after negotiations).
The Target Group believes that the services provided by the Provincial
Subsisting Companies under the Community Services Framework Agreements
will be on normal commercial terms which are no less favorable than
those provided by independent third parties.
For the year ended December 31, 2002, the Target Group's expenditure
for community services made available by the Provincial Subsisting
Companies to the Target Group was RMB359 million. For the six months
ended June 30, 2003, the Target Group's expenditure, following the new
corporate structure and the pricing mechanism set out in the Community
Services Framework Agreements, was RMB192 million.
Currently, the Listed Group and the Provincial Subsisting Companies
have on-going arrangements in respect of community services similar to
those proposed in the Community Services Framework Agreements which
form part of the Existing Connected Transactions. For the year ended
December 31, 2002 and the six months ended June 30, 2003, the Listed
Group's expenditures for corresponding community services pursuant to
the Existing Connected Transaction between the relevant Provincial
Subsisting Companies and each of Shanghai Telecom, Guangdong Telecom,
Jiangsu Telecom and Zhejiang Telecom were RMB1,291 million and RMB571
million, respectively.
(f) Ancillary Telecommunications Services Agreements
Following the Reorganization, the Provincial Subsisting Companies have
agreed to provide certain repair services to the Target Group, such as
the repair of certain telecommunications equipment, the maintenance of
fire prevention equipment and telephone booths and other customers'
services (the Ancillary Telecommunications Services) on a
non-exclusive basis.
Under the framework agreements between the Target Companies and the
Provincial Subsisting Companies in each of the Target Service Areas
for the provision of Ancillary Telecommunications Services (the
Ancillary Telecommunications Services Framework Agreements), the
Provincial Subsisting Companies have agreed to provide Ancillary
Telecommunications Services to the Target Group. Such agreements will
expire on December 31, 2005, but will be automatically renewed for
further periods of three years unless either party notifies the other
at least three months prior to the expiration of the term in writing
of its intention to terminate the relevant agreement. However, if the
Target Companies cannot, without incurring significant cost and
expense, obtain these services from a third party, the Provincial
Subsisting Companies cannot terminate the provision of such services.
The Ancillary Telecommunications Services under the Ancillary
Telecommunications Services Framework Agreements are provided in
accordance with the same pricing policy as that of the Community
Services Framework Agreements.
For the year ended December 31, 2002, the Target Group's expenditure
for Ancillary Telecommunications Services made available by the
Provincial Subsisting Companies to the Target Group was RMB220
million. For the six months ended June 30, 2003, the Target Group's
expenditure, following the new corporate structure and the pricing
mechanism set out in the Ancillary Telecommunication Services
Framework Agreements, was RMB143 million.
Currently, the Listed Group and the Provincial Subsisting Companies
have on-going arrangements in respect of ancillary telecommunications
services similar to those proposed in the Ancillary Telecommunications
Services Framework Agreements which form part of the Existing
Connected Transactions. For the year ended December 31, 2002 and the
six months ended June 30, 2003, the Listed Group's expenditure for
corresponding Ancillary Telecommunications Services pursuant to the
Existing Connected Transaction between the relevant Provincial
Subsisting Companies and each of Shanghai Telecom, Guangdong Telecom,
Jiangsu Telecom and Zhejiang Telecom were RMB1,219 million and RMB409
million, respectively.
APPLICATION FOR WAIVER
Scope of Waivers
Following the completion of the Acquisition, the Combined Group will continue to
enter into the transactions described above. Such transactions will constitute
connected transactions for the Company under the Hong Kong Listing Rules for so
long as members of the Parent Group remain as connected persons within the
meaning of the Hong Kong Listing Rules.
The Independent Board Committee is of the opinion that the Prospective Connected
Transactions and the supplemental agreements pursuant to Existing Connected
Transactions described above have been entered into, and will be carried out, in
the ordinary and usual course of business of the Combined Group and on normal
commercial terms which are fair and reasonable so far as the interests of the
Independent Shareholders of the Company are concerned.
Pursuant to the Hong Kong Listing Rules, each of the interconnection agreement,
engineering agreements, community services agreements and ancillary
telecommunications services agreements described above would normally require
full disclosure and prior approval by Independent Shareholders in the
extraordinary general meeting. It is considered that such disclosure and
approval in full compliance with the Hong Kong
Listing Rules would be impracticable. The Company has applied to the Stock
Exchange, subject to the conditions set out below, for a waiver from strict
compliance with the requirements of Chapter 14 of the Hong Kong Listing Rules,
in relation to such transactions. In its application, the Company has sought a
new waiver for the Combined Group from the Stock Exchange to combine certain
Existing Connected Transactions such as interconnection agreement, engineering
agreements, community services agreements and ancillary telecommunications
services agreements, waiver of which were granted by the Stock Exchange in its
letter dated October 28, 2002, with corresponding Prospective Connected
Transactions so that the waiver in respect of annual monetary limits of certain
Existing Connected Transactions be aggregated. The new waiver will be effective
for two years from January 1, 2004 until December 31, 2005.
Conditions of Waiver
The Stock Exchange has indicated that it will grant the waiver applied for in
relation to the interconnection agreement, engineering agreements, community
services agreements and ancillary telecommunications services agreements for the
Combined Group for two years from January 1, 2004 to December 31, 2005 on the
following conditions:
(a) Arm's length basis: The transactions as well as the respective agreements
governing such transactions shall be:
(1) entered into by the Combined Group in the ordinary and usual course of
its business; and
(2) either
(i) on normal commercial terms, or
(ii) where there is no available comparison to judge whether they are
on normal commercial terms, on terms no less favorable than
those available to or from independent third parties,
(iii) on terms that are fair and reasonable so far as the Independent
Shareholders of the Company are concerned, and
(iv) if applicable, with the annual aggregate value of each category
of the connected transactions not exceeding the relevant annual
limits.
(b) Disclosure: The Company shall disclose in its annual report details of the
transactions as required by Rule 14.25(1)(A) to (D) of the Hong Kong
Listing Rules, i. e.
(i) the date or period of the transactions;
(ii) the parties thereto and a description of their relationship;
(iii) a brief description of the transactions and the purpose of the
transactions;
(iv) the total consideration and the terms; and
(v) the nature and extent of the interest of the connected persons in the
transactions.
(c) Independent directors' review: Members of the Independent Board Committee
shall review annually the transactions and confirm, in the Company's annual
report and accounts for the year in question, that such transactions have
been conducted in the manner stated in the conditions above.
(d) Auditors' review: The auditors of the Company shall carry out review
procedures annually on the transactions and shall confirm to the Directors
of the Company in writing (with a copy to the Stock
Exchange at least 10 business days prior to the bulk print of the Company's
annual report) whether, based on those procedures, the transactions:
(1) have received the approval of the Company's Directors;
(2) have been entered into in accordance with the pricing policies as
stated in the relevant agreements, where applicable;
(3) have been entered into in accordance with the terms of the agreements
governing the transactions; and
(4) have not exceeded the annual limits specified in paragraph (f) below.
For the purpose of the above review by the auditors of the Company, the
Parent Group has undertaken to the Company to provide the auditors with
access to its accounting records, as well as (where possible) those of its
subsidiaries and Associates.
(e) Shareholders' approval: Details of the transactions are disclosed to the
Independent Shareholders who will be asked to vote in favor of an ordinary
resolution to approve the transactions and the annual limits set out in
paragraph (f) below at the Company's EGM.
(f) Annual limits:
In determining the proposed annual limits of the following categories of
connected transactions for the Combined Group, the Board has considered the
relative size of the total assets and operating revenues of the Target
Group against the Listed Group, the budget of the Combined Group in terms
of capital expenditures, general and administrative expenses and sale and
maintenance expenses. The Board (including the independent non-executive
directors) is of the view that the monetary limits are set so as to (i) not
hinder the ability of the Combined Group to conduct its business in the
ordinary and usual course and (ii) allow the Combined Group to benefit from
future growth. The aggregate annual value of the following categories of
connected transactions for the Combined Group shall not exceed the limits
set out below:
Transactions Proposed Annual Limits
----------------------
(1) Engineering agreements RMB7,020 million
(2) Community services agreements RMB3,410 million
(3) Ancillary telecommunications services
agreements RMB2,640 million
Details of the reasons for increment of the proposed annual limits for the above
connected transactions are set out in the shareholders' circular to be
dispatched to the Shareholders as soon as practicable. If any of the material
terms of the agreements referred to above are altered (unless as provided for
under the terms of the relevant agreement or arrangement) or if the Combined
Group enters into any new agreements or arrangements with any connected persons
(within the meaning of the Hong Kong Listing Rules) in the future under which
the aggregate consideration paid or payable by the Combined Group in each year
exceeds the limits referred to above, the Company will comply with the
provisions of Chapter 14 of the Hong Kong Listing Rules dealing with connected
transactions unless it applies for and obtains a separate waiver from the Stock
Exchange.
Reasons for no cap for transactions contemplated under the Interconnection
Agreement
The Company submits that the value of the settlement of interconnection charges
arising from domestic long distance calls under the interconnection agreement,
should not be subject to any annual limits for the following reasons:
(a) the Company's revenue depends on growth in call revenue and in its customer
base for its various services. Any such growth in the domestic long
distance service will necessarily result in increased transaction volumes
under the interconnection agreement, which the Company will not be able to
control as it depends entirely on customer usage. Any limits on these
transactions will therefore potentially limit the Company's ability to
conduct or expand its business in the ordinary course; and
(b) the tariffs payable under the interconnection agreement is prescribed by
the MII and are subject to change from time to time.
No waivers applied for certain categories of connected transactions
Each of the transactions above other than the interconnection agreement and the
engineering agreements, community services agreements and ancillary
telecommunications services agreements are subject to Rule 14.25(1) of the Hong
Kong Listing Rules, which are on normal commercial terms in which the total
consideration or value is not expected to exceed 3% of the book value of the net
tangible assets of the Company as of June 30, 2003 and accordingly, disclosure
requirement as set out in Rule 14.25(1) of the Hong Kong Listing Rules shall
apply to each of such transactions. The Directors, including independent
non-executive directors of the Company submit that no waivers are necessary for
any of such transactions because details of the transactions as required under
Rule 14.25(1) of the Hong Kong Listing Rules are published in the Company's
annual report, accounts and press notice each year for so long as such
transactions are in place. If at any time Rule 14.25(1) of the Hong Kong Listing
Rules does not apply to any of these transactions, the Company will notify and
consult with the Stock Exchange promptly.
7. DEFINITIONS
In this announcement, unless the context otherwise requires, the following
expressions have the following meanings:
the proposed acquisition by the Company of the
"Acquisition" Target Assets pursuant to the Acquisition Agreement,
as further described in this announcement
the conditional sale and purchase agreement dated
"Acquisition Agreement" October 26, 2003 between the Company and China
Telecommunications Corporation relating to the
Acquisition
American depositary shares
"ADSs" Anhui Telecom Company Limited, a company established
with limited liability under the laws of the PRC and
currently a wholly-owned subsidiary of the Parent
"Anhui Telecom" which, upon the successful completion of the
Acquisition, will become a wholly-owned subsidiary
of the Company
has the meaning given to it by the Hong Kong Listing
"Associate" Rules
"Board" the board of directors of the Company
a day (excluding Saturdays) on which banks are
"Business Day" generally open in Hong Kong, New York and the PRC
for the transaction of normal banking business
Chesterton Petty Limited, a chartered surveyor and
"Chesterton" independent property valuer to the Company
the People's Republic of China (excluding, for the
"China or PRC" purposes of this circular, Hong Kong, Macau and
Taiwan)
China Mobile Communications Corporation, a company
"China Mobile" established under the laws of the PRC
China Network Communications Group Corporation, a
"China Netcom Group" company established under the laws of the PRC
China Railway Communication Co., Ltd., a company
"China Railcom" established under the laws of the PRC
China United Telecommunications Corporation, a
"China Unicom" company established under the laws of the PRC
China Telecommunications Corporation, a state-owned
enterprise established under the laws of the PRC on
"China Telecommunications May 17, 2000 and the controlling shareholder of the
Corporation" or "Parent" Company
Chongqing Telecom Company Limited, a company
established with limited liability under the laws of
"Chongqing Telecom" the PRC and currently a wholly-owned subsidiary of
the Parent which, upon the successful completion of
the Acquisition, will become a wholly-owned
subsidiary of the Company
China International Capital Corporation (Hong Kong)
Limited, which is licensed by the Securities and
Futures Commission for Types 1, 4 and 6 regulated
activities under the Securities and Futures
"CICC" Ordinance, being a financial adviser to the Company
in respect of the Acquisition, the Prospective
Connected Transactions and supplemental agreements
relating to the Existing Connected Transactions
"Combined Group" the Listed Group and the Target Group
the Companies Ordinance (Chapter 32 of the Laws of
"Companies Ordinance" Hong Kong)
China Telecom Corporation Limited, a joint stock
limited company incorporated in the PRC with limited
"Company" liability on September 10, 2002, whose H Shares are
listed on the Stock Exchange and whose ADSs are
listed on the New York Stock Exchange
"Directors" the directors of the Company
the connected transactions entered into between a
member of the Listed Group and Parent Group in
respect of trademark licence agreement, centralized
services agreement, interconnection agreement, optic
"Existing Connected fiber leasing agreement, engineering agreements,
Transactions" property leasing agreements, IT service agreements,
equipment procurement service agreements, community
services agreements, ancillary telecommunications
services agreements and special communications
services agreements
the waiver from the strict compliance with the
relevant requirements of the Hong Kong Listing Rules
"Existing Waiver" granted by the Stock Exchange in its letter dated
October 28, 2002 to the Company
the extraordinary general meeting of the Company to
"Extraordinary General be convened on December 15, 2003, notice of which is
Meeting" or "EGM" set out at the end of the shareholders' circular to
be dispatched by the Company, or any adjournment
thereof
CICC and Morgan Stanley, being the financial
advisers to the Company in respect of the
"Financial Advisers" Acquisition of the Target Assets from China
Telecommunications Corporation and the Prospective
Connected Transactions
Fujian Telecom Company Limited, a company
established with limited liability under the laws of
the PRC and currently a wholly-owned subsidiary of
"Fujian Telecom" the Parent which, upon the successful completion of
the Acquisition, will become a wholly-owned
subsidiary of the Company
"GDP" gross domestic product
the global offering of the Company that took place
in November 2002 in respect of 7,556,400,000 H
"Global Offering" Shares and an over-allotment option in respect of
471,010,000 H Shares
Guangdong Telecom Company Limited, a company
"Guangdong Telecom" established with limited liability under the laws of
the PRC and a wholly-owned subsidiary of the Company
Guangxi Telecom Company Limited, a company
established with limited liability under the laws of
the PRC and currently a wholly-owned subsidiary of
"Guangxi Telecom" the Parent which, upon the successful completion of
the Acquisition, will become a wholly-owned
subsidiary of the Company
overseas listed foreign invested shares in the
"H Share(s)" Company's registered capital with a par value of
RMB1.00 per share which are listed on the Stock
Exchange
"Hong Kong" Hong Kong Special Administrative Region of the PRC
the Rules Governing the Listing of Securities on the
"Hong Kong Listing Rules" Stock Exchange
the underwriters listed in the Section headed
"Hong Kong Underwriters" "Underwriting" under "Hong Kong Underwriters" of the
Company's Prospectus
International Financial Reporting Standards
"IFRS" promulgated by the International Accounting
Standards Board
the committee of Directors, consisting of Zhang
youcai, Vincent Lo Hong Sui and Shi Wanpeng, who are
independent non-executive Directors, formed to
"Independent Board advise the Independent Shareholders in respect of
Committee" the terms of the Acquisition, the terms of the
Prospective Connected Transactions and the terms of
certain supplemental agreements relating to the
Existing Connected Transactions
"Independent Financial
Adviser" JPMorgan
Shareholders other than China Telecommunications
"Independent Shareholders" Corporation
Jiangsu Telecom Company Limited, a company
"Jiangsu Telecom" established with limited liability under the laws of
the PRC and a wholly-owned subsidiary of the Company
Jiangxi Telecom Company Limited, a company
established with limited liability under the laws of
"Jiangxi Telecom" the PRC and currently a wholly-owned subsidiary of
the Parent which, upon successful completion of the
Acquisition, will become a wholly-owned subsidiary
of the Company
J.P. Morgan Securities (Asia Pacific) Limited, which
is licensed by the Securities and Futures Commission
for Types 1, 4, 6 and 7 regulated activities under
the Securities and Futures Ordinance, being the
"JPMorgan" Independent Financial Adviser to the Independent
Board Committee in respect of the Acquisition, the
Prospective Connected Transactions and certain
supplemental agreements relating to the Existing
Connected Transactions
October 24, 2003, being the latest practicable date
"Latest Practicable Date" prior to the printing of this announcement for
ascertaining certain information contained herein
the Company together with Shanghai Telecom,
Guangdong Telecom, Jiangsu Telecom and Zhejiang
Telecom and their subsidiaries from time to time.
"Listed Group" For the avoidance of doubt, references in this
announcement to the Listed Group excludes the Target
Group
Shanghai municipality, Guangdong province, Jiangsu
"Listed Service Areas" province and Zhejiang province
"MII" the Ministry of Information Industry of the PRC
"MOFCOM" the Ministry of Commerce of the PRC
Morgan Stanley Dean Witter Asia Limited, which is
licensed by the Securities and Futures Commission
for Types 1, 4, 6 and 7 regulated activities under
the Securities and Futures Ordinance, being a
"Morgan Stanley" financial adviser to the Company in respect of the
Acquisition, the Prospective Connected Transactions
and supplemental agreements relating to the Existing
Connected Transactions
National Development and Reform Commission of the
PRC (previously known as the State Development and
"NDRC" Planning Commission) China Telecommunications
Corporation and its subsidiaries. Unless otherwise
expressly stated or
the context otherwise requires, references to
"ParentGroup" "Parent Group" exclude the Company, the Company's
subsidiaries and the Target Group
the connected transactions between the Target Group
and the Parent Group described in the section headed
"Prospective Connected "Connected Transactions -- Ongoing Connected
Transactions" Transactions Between Subsidiaries of the Company and
Subsidiaries/Associates of China Telecommunications
Corporation"
the prospectus dated November 6, 2002 issued by the
"Prospectus" Company in connection
with its initial public offering
the successive steps whereby China
Telecommunications Corporation transferred the
telecommunication operations in the Target Service
"Reorganization" Areas and related assets and liabilities to the
Target Companies, as further described in the
Section headed "the Reorganization" of this
announcement
"RMB" Renminbi, the lawful currency of the PRC
Shanghai Telecom Company Limited, a company
"Shanghai Telecom" established with limited liability under the laws of
the PRC and a wholly-owned subsidiary of the Company
"Shareholders" shareholders of the Company
Sichuan Telecom Company Limited, a company
established with limited liability under the laws of
"Sichuan Telecom" the PRC, and currently a wholly-owned subsidiary of
the Parent which, upon the successful completion of
the Acquisition, will become a wholly-owned
subsidiary of the Company
China International Capital Corporation Limited,
"Sponsors" Merrill Lynch Far East Limited and Morgan Stanley
Dean Witter Asia Limited (in alphabetical order)
"State Council" the State Council of the PRC
"Stock Exchange" The Stock Exchange of Hong Kong Limited
the entire issued share capital of each of the
Target Companies and certain network management,
"Target Assets" research and development facilities currently owned
by the Parent which are to be acquired by the
Company pursuant to the Acquisition Agreement
Anhui Telecom, Fujian Telecom, Jiangxi Telecom,
"Target Companies" Guangxi Telecom, Chongqing Telecom and Sichuan
Telecom
"Target Group" the Target Companies and their subsidiaries, from
time to time
Auhui province, Fujian province, Jiangxi province,
"Target Service Areas" Guangxi Zhuang autonomous region, Chongqing
municipality and Sichuan province
"Telecommunications The PRC Telecommunications Regulations which became
Regulations" effective as of September 25, 2000
United States dollars, the lawful currency of the
"U.S. dollars" or "US$" United States of America
Zhejiang Telecom Company Limited, a company
"Zhejiang Telecom" established with limited liability under the laws of
the PRC and a wholly-owned subsidiary of the Company
For your convenience, this announcement contains translations between U.S.
dollars and RMB amounts at US$1 = RMB8.2768, the prevailing rate on the Latest
Practicable Date. The translations are not representations that the Renminbi
amounts could actually be converted into U.S. dollars at that rate, or at all.
FURTHER INFORMATION
China Telecommunications Corporation currently owns approximately 77.78% of the
issued share capital of the Company and the total purchase price for the
Acquisition is approximately 37% of the book value of the net tangible assets
value of the Company as at December 31, 2002. Accordingly, under the Listing
Rules, the Acquisition constitutes both a discloseable transaction and a
connected transaction for the Company.
An Independent Board Committee has been established to advise the Independent
Shareholders in respect of the terms of the Acquisition, the terms of the
Prospective Connected Transactions and the terms of certain supplemental
agreements relating to the Existing Connected Transactions. JPMorgan has been
retained as the Independent Financial Adviser to the Independent Board
Committee.
China Telecommunications Corporation and its Associates being connected persons
to the Acquisition, will abstain from voting on the ordinary resolutions to
approve the terms of the
Acquisition, the terms of certain Prospective Connected Transactions and the
terms of certain supplemental agreements relating to Existing Connected
Transactions.
A circular containing, amongst other things, details of the terms of the
Acquisition, the Prospective Connected Transactions and the supplemental
agreements relating to the Existing Connected Transactions, letters from the
Independent Board Committee and from JPMorgan (the independent financial
adviser), further financial and other information of the Target Companies and a
notice to shareholders of the Company convening an Extraordinary General Meeting
to approve, amongst other things, the terms of the Acquisition, the terms of
certain Prospective Connected Transactions and the terms of certain supplemental
agreements relating to the Existing Connected Transactions will be dispatched to
the Shareholders as soon as practicable.
Yours faithfully,
China Telecom Corporation Limited
Zhou Deqiang
Chairman and CEO
Beijing, October 26, 2003
Exhibit 1.2
If you are in doubt as to any aspect of this circular or as to the action to be
taken, you should consult your stockbroker or other registered dealer in
securities, bank manager, solicitor, professional accountant or other
professional adviser.
If you have sold or transferred all your shares in China Telecom Corporation
Limited, you should at once hand this circular together with the accompanying
form of proxy to the purchaser or other transferee or to the bank, stockbroker
or other agent through whom the sale was effected for transmission to the
purchaser or transferee.
The Stock Exchange of Hong Kong Limited takes no responsibility for the contents
of this circular, makes no representation as to its accuracy or completeness and
expressly disclaims any liability whatsoever for any loss howsoever arising from
or in reliance upon the whole or any part of the contents of this circular.
This circular is solely for the purpose of providing shareholders with certain
information in connection with an extraordinary general meeting of the Company
and is not an offer to sell or a solicitation of an offer to buy any securities.
Any sale of the Company's securities in the United States will be made only by
means of a prospectus relating to such securities.
\raster(100%,p)="ChinaTelecom_col"
China Telecom Corporation Limited
(A joint stock limited company incorporated in the People's
Republic of China with limited liability)
DISCLOSEABLE AND CONNECTED TRANSACTIONS
Financial Advisers to
China Telecom Corporation Limited
"CICC"
"morgan_stanley_new"
China International Capital Corporation
(Hong Kong) Limited Morgan Stanley Dean Witter Asia Limited
Independent Financial Adviser to the
Independent Board Committee
"JP_Morgan"
J.P. Morgan Securities (Asia Pacific) Limited
A letter from the Independent Board Committee of China Telecom Corporation
Limited is set out on pages 34 to 35 of this circular. A letter from JPMorgan
containing its advice to the Independent Board Committee is set out on pages 36
to 59 of this circular.
A notice dated October 27, 2003 convening an extraordinary general meeting of
the Company to be held at Beijing Nan Yue Yuan Hotel, 186 Zheng Wang Fen, Feng
Tai District, Beijing, PRC on December 15, 2003 at 10:00 a.m. is set out on
pages 147 to 149 of this circular. Whether or not you are able to attend the
meeting, you are requested to complete the enclosed form of proxy in accordance
with the instructions printed thereon as soon as practicable and in any event by
not later than 24 hours before the time appointed for holding the meeting or any
adjournment thereof. Completion and return of the form of proxy will not
preclude you from attending and voting in person at the meeting or at any
adjourned meeting should you so wish.
Page
Definitions 1
Letter from the Chairman
1. Introduction 6
2. The Acquisition 8
3. The Consideration 8
4. Conditions to Completion of the Acquisition 9
5. Reasons for and Benefits of the Acquisition 10
6. The Reorganization 12
7. Prospective Financial Information 16
8. Relationship with China Telecommunications Corporation 16
9. Arrangement Relating to the Reorganization and the Acquisition 17
10. Connected Transactions 17
11. Application for Waiver 26
12. Extraordinary General Meeting 32
13. Recommendation of the Independent Board Committee 33
14. Additional Information 33
Letter from the Independent Board Committee 34
Letter from JPMorgan to the Independent Board Committee 36
Appendix I Further Information of the Target Assets 60
Appendix II Regulations 82
Appendix III Audited Financial Statements of the Target Group 88
Appendix IV Pro Forma Financial Information of the Target Group 125
Appendix V Financial Information of the Listed Group 128
Appendix VI Pro Forma Financial Information of the Combined Group 134
Appendix VII Profit Forecast 140
Appendix VIII General Information 143
Notice of the Extraordinary General Meeting 147
In this circular, unless the context otherwise requires, the following
expressions have the following meanings:
the proposed acquisition by the Company of the
"Acquisition" Target Assets pursuant to the Acquisition Agreement,
as further described in this circular
the conditional sale and purchase agreement dated
"Acquisition Agreement" October 26, 2003 between the Company and China
Telecommunications Corporation relating to the
Acquisition
"ADSs" American depositary shares
Anhui Telecom Company Limited, a company established
with limited liability under the laws of the PRC and
"Anhui Telecom" currently a wholly-owned subsidiary of the Parent
which, upon the successful completion of the
Acquisition, will become a wholly-owned subsidiary
of the Company
has the meaning given to it by the Hong Kong Listing
"Associate" Rules
"Board" the board of directors of the Company
a day (excluding Saturdays) on which banks are
"Business Day" generally open in Hong Kong, New York and the PRC
for the transaction of normal banking business
Chesterton Petty Limited, a chartered surveyor and
"Chesterton" independent property valuer to the Company
the People's Republic of China (excluding, for the
"China" or "PRC" purposes of this circular, Hong Kong, Macau and
Taiwan)
China Mobile Communications Corporation, a company
"China Mobile" established under the laws of the PRC
China Network Communications Group Corporation, a
"China Netcom Group" company established
under the laws of the PRC
China Railway Communication Co., Ltd., a company
"China Railcom" established under the laws of the PRC
China United Telecommunications Corporation, a
"China Unicom" company established under the laws of the PRC
China Telecommunications Corporation, a state-owned
"China Telecommunications enterprise established under the laws if the PRC on
Corporation" or Parent" May 17, 2000 and the controlling shareholder of the
Company
Chongqing Telecom Company Limited, a company
established with limited liability under the laws of
"Chongqing Telecom" the PRC and currently a wholly-owned subsidiary of
the Parent which, upon the successful completion of
the Acquisition, will become a wholly-owned
subsidiary of the Company
China International Capital Corporation (Hong Kong)
Limited, which is licensed by the Securities and
Futures Commission for Types 1, 4 and 6 regulated
activities under the Securities and Futures
"CICC" Ordinance, being a financial adviser to the Company
in respect of the Acquisition, the Prospective
Connected Transactions and supplemental agreements
relating to the Existing Connected Transactions
"Combined Group" the Listed Group and the Target Group
the Companies Ordinance (Chapter 32 of the Laws of
"Companies Ordinance" Hong Kong)
China Telecom Corporation Limited, a joint stock
limited company incorporated in the PRC with limited
"Company" liability on September 10, 2002, whose H Shares are
listed on the Stock Exchange and whose ADSs are
listed on the New York Stock Exchange
"Directors" the directors of the Company
the connected transactions entered into between a
member of the Listed Group and Parent Group in
respect of trademark licence agreement, centralized
services agreement, interconnection agreement, optic
"Existing Connected" fibre leasing agreement, engineering agreements,
Transactions property leasing agreements, IT service agreements,
equipment procurement service agreements, community
services agreements, ancillary telecommunications
services agreements and special communications
services agreements
the waiver from the strict compliance with the
relevant requirements of the Hong Kong Listing Rules
"Existing Waiver" granted by the Stock Exchange in its letter dated
October 28, 2002 to the Company
the extraordinary general meeting of the Company to
"Extraordinary General be convened on December 15, 2003, notice of which is
Meeting of "EGM" set out at the end of this circular, or any
adjournment thereof
CICC and Morgan Stanley, being the financial
advisers to the Company in respect of the
Acquisition of the Target Assets from China
"Finincial Advisers" Telecommunications Corporation, the Prospective
Connected Transactions and the supplemental
agreements relating to the Existing Connected
Transactions
Fujian Telecom Company Limited, a company
established with limited liability under the laws of
"Fujian Telecom" the PRC and currently a wholly-owned subsidiary of
the Parent which, upon the successful completion of
the Acquisition, will become a wholly-owned
subsidiary of the Company
"GDP" gross domestic product
the global offering of the Company that took place
in November 2002 in respect of 7,556,400,000 H
"Global Offering" Shares and an over-allotment option in respect of
471,010,000 H Shares
Guangdong Telecom Company Limited, a company
"Guangdong Telecom" established with limited liability under the laws of
the PRC and a wholly-owned subsidiary of the Company
Guangxi Telecom Company Limited, a company
established with limited liability under the laws of
"Guangxi Telecom" the PRC and currently a wholly-owned subsidiary of
the Parent which, upon the successful completion of
the Acquisition, will become a wholly-owned
subsidiary of the Company
overseas listed foreign invested shares in the
Company's registered capital with a par value of
"H Sares(s)" RMB1.00 per share which are listed on the Stock
Exchange
"Hong Kong" Hong Kong Special Administrative Region of the PRC
the Rules Governing the Listing of Securities on the
"Hong Kong Listing Rules" Stock Exchange
the underwriters listed in the Section headed
"Hong Kong Underwriters" "Underwriting" under "Hong Kong Underwriters" of the
Company's Prospectus
International Financial Reporting Standards
"IFRS" promulgated by the International Accounting
Standards Board
the committee of Directors, consisting of Zhang
Youcai, Vincent Lo Hong Sui and Shi Wanpeng, who are
independent non-executive Directors, formed to
"Independent Board advise the Independent Shareholders in respect of
Committee" the terms of the Acquisition, the terms of the
Prospective Connected Transactions and the terms of
certain supplemental agreements relating to the
Existing Connected Transactions
"Independent Financial
Adviser" JPMorgan
Shareholders other than China Telecommunications
"independent Shareholders" Corporation
Jiangsu Telecom Company Limited, a company
"Jiangsu Telecom" established with limited liability under the laws of
the PRC and a wholly-owned subsidiary of the Company
Jiangxi Telecom Company Limited, a company
established with limited liability under the laws of
the PRC and currently a wholly-owned subsidiary of
"Jiangxi Telecom" the Parent which, upon successful completion of the
Acquisition, will become a wholly-owned subsidiary
of the Company
J.P. Morgan Securities (Asia Pacific) Limited, which
is licensed by the Securities and Futures Commission
for Types 1, 4, 6 and 7 regulated activities under
the Securities and Futures Ordinance, being the
"JPMorgan" Independent Financial Adviser to the Independent
Board Committee in respect of the Acquisition, the
Prospective Connected Transactions and certain
supplemental agreements relating to the Existing
Connected Transactions
October 24, 2003, being the latest practicable date
"Latest Practicable Date" prior to the printing of this circular for
ascertaining certain information contained herein
the Company together with Shanghai Telecom,
Guangdong Telecom, Jiangsu Telecom and Zhejiang
"Listed Group" Telecom and their subsidiaries from time to time.
For the avoidance of doubt, references in this
circular to the Listed Group exclude the Target
Group
Shanghai municipality, Guangdong province, Jiangsu
"Listed Service Areas" province and Zhejiang province
"MII" the Ministry of Information Industry of the PRC
"MOFCOM" the Ministry of Commerce of the PRC
Morgan Stanley Dean Witter Asia Limited, which is
licensed by the Securities and Futures Commission
for Types 1, 4, 6 and 7 regulated activities under
"Morgan Stanley" the Securities and Futures Ordinance, being a
financial adviser to the Company in respect of the
Acquisition, the Prospective Connected Transactions
and supplemental agreements relating to the Existing
Connected Transactions
National Development and Reform Commission of the
"NDRC" PRC (previously known as the State Development and
Planning Commission)
China Telecommunications Corporation and its
subsidiaries. Unless otherwise expressly stated or
"Parent Group" the context otherwise requires, references to
"Parent Group" exclude the Company, the Company's
subsidiaries and the Target Group
the connected transactions between the Target Group
"Prospective Connected and the Parent Group described in section 10.2 of
Transactions" the "Letter from the Chairman"
the prospectus dated November 6, 2002 issued by the
"Prospectus" Company in connection with its initial public
offering
the successive steps whereby China
Telecommunications Corporation transferred the
telecommunication operations in the Target Service
"Recorganization" Areas and related assets and liabilities to the
Target Companies, as further described in the
Section headed "the Reorganization" of this circular
"RMB" Renminbi, the lawful currency of the PRC
Shanghai Telecom Company Limited, a company
"Shanghai Telecom" established with limited liability under the laws of
the PRC and a wholly-owned subsidiary of the Company
"Shareholders" shareholders of the Company
Sichuan Telecom Company Limited, a company
established with limited liability under the laws of
the PRC, and currently a wholly-owned subsidiary of
"Sichuan Telecom" the Parent which, upon the successful completion of
the Acquisition, will become a wholly-owned
subsidiary of the Company
China International Capital Corporation Limited,
"Sponsors" Merrill Lynch Far East Limited and Morgan Stanley
Dean Witter Asia Limited (in alphabetical order)
"State Council" the State Council of the PRC
"Stock Exchange" The Stock Exchange of Hong Kong Limited
the entire issued share capital of each of the
Target Companies and certain network management,
"Target Assets" research and development facilities currently owned
by the Parent which are to be acquired by the
Company pursuant to the Acquisition Agreement
Anhui Telecom, Fujian Telecom, Jiangxi Telecom,
"Target Companies" Guangxi Telecom, Chongqing Telecom and Sichuan
Telecom
the Target Companies and their subsidiaries, from
"Target Group" time to time
Anhui province, Fujian province, Jiangxi province,
"Target Service Areas" Guangxi Zhuang autonomous region, Chongqing
municipality and Sichuan province
"Telecommunications The PRC Telecommunications Regulations which became
Regulations" effective as of September 25, 2000
United States dollars, the lawful currency of the
"U.S.dollars" or "US$" United States of America
Zhejiang Telecom Company Limited, a company
"Zhejiang Telecom" established with limited liability under the laws of
the PRC and a wholly-owned subsidiary of the Company
For your convenience, this circular contains translations between U.S.
dollars and RMB amounts at US$1 = RMB8.2768, the prevailing rate on the Latest
Practicable Date. The translations are not representations that the Renminbi
amounts could actually be converted into U.S. dollars at that rate, or at all.
"China_Telecom"
China Telecom Corporation Limited
(A joint stock limited company incorporated in the People's Republic
of China with limited liability)
Executive Directors:
Zhou Deqiang
Chang Xiaobing
Wu Andi
Zhang Jiping
Huang Wenlin
Li Ping
Wei Leping
Cheng Xiyuan
Feng Xiong
Independent Non-Executive Directors:
Zhang Youcai
Vincent Lo Hong Sui
Shi Wanpeng
Registered Office:
31 Jinrong Street, Xicheng District,
Beijing 100032, PRC
Place of business in Hong Kong:
38th Floor
Dah Sing Financial Centre
108 Gloucester Road
Wanchai, Hong Kong
October 27, 2003
To the Shareholders
Dear Sir or Madam,
DISCLOSEABLE AND CONNECTED TRANSACTIONS
ACQUISITION OF TELECOMMUNICATIONS BUSINESSES AND
ASSETS FROM CHINA TELECOMMUNICATIONS CORPORATION
1. INTRODUCTION
On October 27, 2003, the Board announced that the Company had entered into
the Acquisition Agreement, pursuant to which the Company agreed to acquire and
China Telecommunications Corporation, the Company's controlling shareholder and
promoter, agreed to sell the Target Assets, subject to certain conditions.
The purpose of this letter is to provide you with further information
relating to the Acquisition, the Prospective Connected Transactions and certain
supplemental agreements pursuant to the Existing Connected Transactions arising
from the completion of the Acquisition and to seek your approval of the ordinary
and special resolutions set out in the notice of the Extraordinary General
Meeting on pages 147 to 149 of this circular. The recommendation of the
Independent Board Committee to the Independent Shareholders is set out on pages
34 to 35 of this circular.
(a) Consideration for the Acquisition
The Acquisition was negotiated and entered into on an arm's length basis
and on normal commercial terms.
The purchase price of the Acquisition amounts to RMB46,000 million
(equivalent to approximately US$5,558 million), and will consist of the payment
of an initial cash consideration of RMB11,000 million (equivalent to
approximately US$1,329 million) on completion of the Acquisition and the payment
of a deferred consideration of RMB35,000 million (equivalent to approximately
US$4,229 million). The Board is of the view that the purchase price for the
Acquisition payable by the Company for the Target Assets is fair and reasonable,
and that the Acquisition is in the best interests of the Company and its
Shareholders.
As of the Latest Practicable Date, China Telecommunications Corporation
owned 77.78% of the issued share capital of the Company. Based on the audited
financial statements of the Company prepared under IFRS, the book value of the
net assets of the Listed Group as of December 31, 2002 was approximately
RMB125,008 million (equivalent to approximately US$15,103 million). Based on the
unaudited interim financial statements of the Company prepared under IFRS, the
book value of the net assets of the Listed Group as of June 30, 2003 was
approximately RMB133,595 million (equivalent to approximately US$16,141
million). Accordingly, under the Hong Kong Listing Rules, the Acquisition
constitutes both a discloseable transaction and a connected transaction for the
Company.
(b) Prospective Connected Transactions
After the Reorganization, a number of transactions were entered into
between (a) the Target Group on the one hand; and (b) China Telecommunications
Corporation and/or its subsidiaries/Associates (other than the Company, its
subsidiaries and the Target Group) on the other, which will constitute connected
transactions for the Company under the Hong Kong Listing Rules upon completion
of the Acquisition. Further details of such transactions are set out from pages
17 to 32 of this circular.
(c) Independent Shareholders' Approval and Independent Financial Adviser
An Independent Board Committee has been established to advise the
Independent Shareholders in respect of the terms of the Acquisition, the terms
of the Prospective Connected Transactions and the terms of certain supplemental
agreements relating to the Existing Connected Transactions. JPMorgan has been
retained as the Independent Financial Adviser to the Independent Board Committee
and a copy of its letter of advice is set out on pages 36 to 59 of this
circular.
The terms of the Acquisition, the terms of certain Prospective Connected
Transactions and the terms of certain supplemental agreements relating to the
Existing Connected Transactions require the approval of the Independent
Shareholders at the Extraordinary General Meeting at which China
Telecommunications Corporation and its Associates will abstain from voting.
(d) Financial Advisers
CICC and Morgan Stanley are the financial advisers to the Company in
respect of the Acquisition, the Prospective Connected Transactions and the
supplemental agreements relating to the Existing Connected Transactions.
2. THE ACQUISITION
The Company has agreed, subject to certain conditions, to acquire from the
Parent the Target Assets for a purchase price of RMB46,000 million (equivalent
to approximately US$5,558 million). The net indebtedness of the Target Group as
of June 30, 2003 amounted to approximately RMB33,988 million (equivalent to
approximately US$4,106 million). Upon completion of the Acquisition, each of the
Target Companies will become a wholly-owned subsidiary of the Company.
The Target Assets
The Target Companies are the leading providers of wireline
telecommunications services including wireline telephone, data and Internet
and leased line services in the Target Service Areas, comprising Anhui
province, Fujian province, Jiangxi province, Guangxi Zhuang autonomous
region, Chongqing municipality and Sichuan province in the PRC. As of June
30, 2003, the Target Group had a total of approximately 45.1 million access
lines in service for its local telephone service. The Target Group had a
98.3% market share in the Target Service Areas in terms of the number of
access lines in service as of June 30, 2003.
The Company will also acquire from the Parent certain assets which are
used for network management, research and development purposes. For further
details of such assets, see "Appendix I -- Network management and research
facilities".
3. THE CONSIDERATION
The Acquisition was negotiated and entered into on an arm's length basis
and on normal commercial terms. The purchase price of the Acquisition is
RMB46,000 million (equivalent to approximately US$5,558 million), and will
consist of payment of an initial consideration and a deferred consideration.
The purchase price of the Acquisition was determined based on various
factors, including the quality of the assets being acquired, their growth
prospects, earnings potential, competitive advantages in their respective
markets, the prospective profit contributions of the Target Group to the
Combined Group and other relevant valuation benchmarks. The purchase price of
the Acquisition will represent a multiple of 7.2 times the Target Group's
forecast combined 2003 profit after taxation and minority interests but before
extraordinary items (the "net profits") of approximately RMB6,352 million
(equivalent to approximately US$767 million).
The initial consideration of RMB11,000 million (equivalent to approximately
US$1,329 million) will be satisfied on completion of the Acquisition by payment
in cash in RMB. The Company intends to finance all of the initial consideration
using internal cash resources, including proceeds raised from the Global
Offering. Details of the amount of proceeds used to fund the initial
consideration will be disclosed in the announcement following the EGM to be held
on December 15, 2003.
The deferred consideration represents the difference between the purchase
price and the initial consideration and amounts to RMB35,000 million (equivalent
to approximately US$4,229 million). From the date of the completion of the
Acquisition, the Company will pay interest to the Parent at half-yearly
intervals on the actual amount of deferred consideration remaining outstanding.
Interest will accrue daily and, for the first five years after completion of the
Acquisition, will be payable at the rate of 5.184% per year, being the RMB
lending rate of commercial banks in the PRC in respect of loans with tenure of
more than five years of 5.76% per year as set by the People's Bank of China and
prevailing on the date of the Acquisition Agreement, less a discount of 10%.
Thereafter, the interest rate will be adjusted accordingly on the fifth
anniversary of completion of the Acquisition. The Company intends to fund the
interest payments with its internal cash resources.
The deferred consideration is payable ten years after the date of
completion of the Acquisition. The Company may, from time to time, prepay all or
part of the deferred consideration, at any time after completion until the tenth
anniversary of the completion of the Acquisition, without penalty.
The payment of the deferred consideration and the interest payments can be
made in RMB, or any other currencies which may in the future be agreed between
China Telecommunications Corporation and the Company, subject to the approvals
of the relevant PRC governmental authorities. Any payment made in currencies
other than RMB will be based on the exchange rates between RMB and such
currencies prevailing at 12:00 noon (Beijing time) on October 24, 2003, being
the Business Day immediately preceding the day of the execution of the
Acquisition Agreement.
The Board takes the view that the purchase price payable by the Company for
the Target Assets and the other terms of the Acquisition are fair and
reasonable. In particular, the Board is of the opinion that the terms of the
deferred consideration are more attractive to the Company than the usual terms
of a commercial bank loan of a similar amount and tenure. The Board is of the
view that the Acquisition is in the best interests of the Company and its
Shareholders.
4. CONDITIONS TO COMPLETION OF THE ACQUISITION
Completion of the Acquisition is conditional upon the fulfilment (to the
reasonable satisfaction of the Company) of the following conditions, among
others, on or before December 31, 2003 or such later date as the Company and
China Telecommunications Corporation may agree:
(i) the passing of resolutions by the Board approving the terms of the
Acquisition, the terms of the Prospective Connected transactions and
the terms of certain supplemental agreements relating to the Existing
Connected Transactions;
(ii) the passing of ordinary resolutions by Independent Shareholders
approving the terms of the Acquisition, the terms of certain
Prospective Connected Transactions and the terms of certain
supplemental agreements relating to the Existing Connected
Transactions;
(iii) there having been no material adverse change to the financial
conditions, business operations or prospects of the Target Assets,
and
(iv) the obtaining of various approvals from relevant PRC regulatory
authorities.
The Board has approved on October 27, 2003, the terms of the Acquisition,
the terms of the Prospective Connected Transactions and the terms of certain
supplemental agreements relating to the Existing Connected Transactions and
therefore condition (i) above has been satisfied. If any of the other
above-mentioned conditions is or are not satisfied (or in the case of (iii)
above, not waived by the Company) by December 31, 2003, or such other date as
the Company and China Telecommunications Corporation may agree, the Acquisition
Agreement will lapse.
5. REASONS FOR AND BENEFITS OF THE ACQUISITION
The Board believes that the Acquisition represents a new and important
opportunity for the Listed Group to strengthen its market position, enhance its
competitiveness, promote business development and improve financial performance,
so as to benefit further from the sustained growth of the telecommunications
industry in the PRC.
(a) Enhancement of market position
The Acquisition will expand the geographic coverage of the Company's
telecommunications operations. This expansion will further enhance the
market position and competitiveness of the Company by improving its ability
to provide long distance, managed data and other telecommunications
services that require extensive geographic coverage. The Acquisition is
also expected to significantly increase the Company's subscriber base,
revenue and net profit. The Company believes that the enhanced financial
strength resulting from such increases will enable it to better deal with
competitive pressure and capture growth opportunities.
The table below sets out selected operating and financial data of the
Target Group, the Listed Group and the pro forma data of the Combined Group
as of or for the six-month period ended June 30, 2003:
Listed Group Target Group Pro Forma Combined
------------ ------------ ------------------
Access lines in service (in thousands) 62,199 45,073 107,272
Operating revenues (in RMB millions) 39,536 18,247 57,770/(1)/
Net profit (in RMB millions) 9,260 3,371 12,054/(1)/
Earnings per share (in RMB) 0.12 N/A 0.16/(1)/
(1) For further details of the Combined Group's pro forma financial
information, please refer to Appendix VI -- Pro Forma Financial
Information of the Combined Group.
(2) As a result of both the Target Group and the Company being under
common control prior to the Acquisition, the acquisition of the
Target Group will be considered as a "combination of entities
under common control". Under a combination of entities under
common control, the assets and liabilities of the Target Group to
be acquired by the Company will be accounted for at historical
amounts in a manner similar to a pooling-of-interests ("as-if
pooling-of-interests accounting"). In as-if pooling-of-interests
accounting, the consolidated financial statements of the Company
for periods prior to the combination will be restated to include
the assets and liabilities and results of operations of the Target
Group for those periods on a combined basis. The purchase price in
respect of the acquisition of the Target Group will be treated as
an equity transaction at the date of the acquisition.
(b) Improvement of growth prospects
The Company believes that the Acquisition will improve the growth
potential for its telecommunications business. The total population in the
Company's Listed Service Areas was 221 million at the end of 2002
(representing 17.2% of the total population in China at the end of 2002),
while the total population in the service areas of the Combined Group, on a
pro forma basis, would be 524 million at the end of 2002 (representing
40.8% of the total population in China at the end of 2002). In addition,
the Target Service Areas, with sustained GDP growth and a
lower-than-national-average telephone penetration rate, present significant
growth potential for telecommunications
services. For example, access lines in service and broadband subscriber
growth rates of the Target Group were stronger than those of the Listed
Group in the first six months of 2003.
Listed Group Target Group Combined Group
------------ ------------ --------------
Total population/(1)(2)/ (in millions) 221 303 524
Penetration rate/(3)/ 25.7% 13.4% 18.6%
Access lines in service growth/(4)/ 9.4% 12.9% 10.8%
Broadband subscriber growth/(4)/ 85.8% 108.3% 91.7%
(1) As of end of 2002.
(2) Source: Data in respect of the total population in the
Company's Listed Service Areas is estimated by the Company
assuming that the growth rate of the population in the
Company's Listed Service Areas in 2002 was the same as that in
2001.
(3) Determined by dividing the number of wireline access lines
in service by the total population in the relative service
areas.
(4) In the first six months of 2003.
(c) Realization of operating synergy
The Company believes that the Acquisition will enable it to achieve
significant cost savings through reduction of interconnection traffic
between the Listed Group and the Parent Group. Cost savings can also be
achieved through centralized investment planning, procurement and financial
management. The Company intends to implement within the Combined Group the
business process re-engineering initiatives it has successfully implemented
in the Listed Group. Establishment of a more effective corporate governance
system is another focus of the post-Acquisition management reform efforts.
These measures are expected to achieve improved operating efficiency and
financial performance.
The network management, research and development facilities of the
Parent to be acquired by the Company are an important part of the
infrastructure necessary for the operation and development of the Company's
business. The Company currently utilizes these facilities on a cost sharing
basis with the Parent (see section 10.1 of this Letter "Ongoing Connected
Transactions between the Company and China Telecommunications Corporation"
for more details of the terms with respect to such cost sharing under the
centralized service agreement). Acquisition of these facilities will give
the Company full operational control and is expected to strengthen the
Company's ability to manage its network operations on a centralized basis
and enable the Company to better coordinate its research and development
efforts.
(d) Significant earnings accretion
As set out above, assuming that the Acquisition had been completed on
January 1, 2003, the pro forma net profit of the Combined Group for the
six-month period ended June 30, 2003 would have been RMB12,054 million
(equivalent to approximately US$1,456 million), representing an increase of
30.2% of the net profit of the Company for the same period. Taking into
account the interest payment in connection with the deferred consideration
for the Acquisition and the other pro forma adjustments set out in Appendix
VI to this circular and on the basis that there is no intention to issue
additional shares of the Company, the pro forma earnings per share of the
Combined Group for the six-month period ended June 30, 2003 would have been
RMB0.16 (equivalent to approximately US$0.02), representing an increase of
30.2% of the earnings per share of the Company for the same period.
(e) Improvement of capital efficiency
The Company believes that the Acquisition will significantly improve
its return on equity. Based on the Company's audited financial statements
for 2002 and unaudited interim financial statements for the six-month
period ended June 30, 2003 prepared under IFRS, the Company had a return on
equity (calculated by dividing the net profit by the average shareholders'
equity) of 7.2% for the six-month period ended June 30, 2003. Assuming that
the Acquisition had been completed on January 1, 2003, the return on
equity, on a pro forma basis, would have been 10.7% for the Combined Group
for the same period, representing an increase of 3.5 percentage points.
In addition, the Acquisition will enable the Company to optimize and
enhance its capital structure. Taking into account the deferred
consideration outstanding from the Company to the Parent and the
indebtedness of the Target Group, the Combined Group would have a higher
proportion of debt in its capital structure post the Acquisition and the
Board believes this is appropriate and desirable.
6. THE REORGANIZATION
In preparation for the Acquisition, Anhui Telecom was incorporated on
August 26, 2003, Fujian Telecom, Guangxi Telecom and Sichuan Telecom were
incorporated on August 28, 2003, Jiangxi Telecom was incorporated on September
18, 2003 and Chongqing Telecom was incorporated on August 22, 2003, each as a
wholly-owned subsidiary of China Telecommunications Corporation. China
Telecommunications Corporation's telecommunications operations in Anhui
province, Fujian province, Jiangxi province, Guangxi Zhuang autonomous region,
Chongqing municipality and Sichuan province, together with related assets and
liabilities were transferred to these Target Companies. The assets, liabilities
and operations of the Target Group have been segregated and separately managed
since December 31, 2002. As part of the Reorganization, the Parent has
undertaken to indemnify the Target Companies for any loss or damages suffered by
the Target Companies as a result of, or related to, the Reorganization and/or in
connection with events preceding the Reorganization.
Prior to the date of the Acquisition Agreement, China Telecommunications
Corporation owned 77.78% of the Company's issued shares. As part of a reform
plan approved by the State Council on the administration of rural
telecommunications services, China Telecommunications Corporation agreed to
transfer 977,004,913 shares of the Company (representing 1.29% of the Company's
outstanding shares as at the Latest Practicable Date) to Fujian Electronic
Information (Group) Co., Ltd., which is a state-owned enterprise owned and
controlled by the provincial government in Fujian province, as compensation for
the financial support it has provided historically in the construction of rural
telecommunications infrastructure in Fujian province. Such transfer will only be
made after the third anniversary of the Company's incorporation and upon
satisfication of certain conditions precedent, including the share transfer
being approved by the relevant authorities.
Set out below are the corporate structures of the Company and its principal
subsidiaries prior to and after the Acquisition.
Corporate Structure immediately before the Acquisition
"chart01"
/1/ Corporate Structure immediately after Completion of the
Acquisition
"chart02"
1 Denotes the Target Companies to be acquired pursuant to the Acquisition.
2 As part of the reform plan of rural telecommunications services, China
Telecommunications Corporation has agreed to transfer 977,004,913 shares of
the Company (representing 1.29% of the Company's outstanding shares as at
the Latest Practicable Date) to Fujian Electronic Information (Group) Co.,
Ltd. upon satisfaction of a number of conditions precedent. Such transfer
will not be made prior to September 10, 2005.
Further information of the Target Assets is set out in Appendix I.
Summary of financial data
The following table sets out certain financial data relating to the
telecommunications operations of the Target Group extracted from the Target
Group's audited IFRS financial statements which are included in Appendix III to
this circular:
Income Statement Data
Six-month
period
ended
Year ended December 31, June 30,
--------------------------- -----------
2001 2002 2003
------------ ------------ -----------
RMB RMB RMB
millions millions millions
Operating revenues 31,951 34,068 18,247
Depreciation and amortization (10,724) (12,123) (5,136)
Network operations and support (11,621) (12,097) (5,534)
Selling, general and administrative (4,550) (4,993) (2,602)
Other operating expenses (538) (236) (112)
------------ ------------ -----------
Operating profit 4,518 4,619 4,863
Deficit on revaluation of property,
plant and equipment/(1)/ -- (14,690) --
Net finance costs (1,169) (1,512) (726)
Investment (loss)/income (9) 59 --
Share of profit from associates -- 2 --
Taxation (230) 4,437 (763)
Minority interests (7) (6) (3)
------------ ------------ -----------
Net profit/(loss) 3,103 (7,091) 3,371
============ ============ ===========
----------
/1/ 14.16(9)
Balance Sheet Data
As of
As of December 31, June 30,
----------------------- -----------
2001 2002 2003
----------- --------- -----------
RMB RMB RMB
millions millions millions
Cash and cash equivalents 3,815 2,262 2,323
Property, plant and equipment, net/(1)/ 82,710 71,596 72,503
Total assets/(1)/ 109,754 92,759 95,467
Owner's equity/(1)/ 37,671 27,840 31,186
Other Financial Data
Six-month
period ended
Year ended December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Net cash from operating activities 13,887 15,056 8,290
Net cash used in investing activities (20,445) (17,965) (6,862)
Net cash from/(used in) financing
activities 5,876 1,356 (1,367)
(1) Includes the effect of the revaluation of property, plant and
equipment as of December 31, 2002. See Note 3 to the audited
financial statements of the Target Group included in Appendix III
to this circular.
7. PROSPECTIVE FINANCIAL INFORMATION
The Target Group has prepared certain prospective financial information in
respect of themselves for the year ending December 31, 2003. There is no present
intention to update this information during the year or to publish such
information in future years, although the Directors are aware of the
requirements of paragraphs 2.10 and 2.11 of the Listing Agreement entered into
between the Company and the Stock Exchange. This information is necessarily
based upon a number of assumptions (see Appendix VII) that, while presented with
numerical specificity and considered reasonable by the Company and the Target
Group, are inherently subject to significant business, economic and competitive
uncertainties and contingencies, many of which are beyond the control of the
Company or the Target Group, and upon assumptions with respect to future
business decisions which are subject to change. Accordingly, there can be no
assurance that these results will be realized. The prospective financial
information presented below may vary from actual results, and these variations
may be material.
The Company and the Target Group believe that, on the bases and the
assumptions discussed in Appendix VII and in the absence of unforeseen
circumstances, the Target Group's forecast combined profit after taxation and
minority interests but before extraordinary items for the year ending December
31, 2003 under IFRS is unlikely to be less than RMB6,352 million (equivalent to
approximately US$767 million). The texts of the letters from KPMG, CICC and
Morgan Stanley in respect of the profit forecast are set out in Appendix VII to
this circular.
8. RELATIONSHIP WITH CHINA TELECOMMUNICATIONS CORPORATION
/2/As of the Latest Practicable Date, China Telecommunications Corporation
directly owned 77.78% of the Company's issued share capital. In connection with
the Global Offering of the Company, China Telecommunications Corporation has, by
a letter of undertakings that is legally binding indefinitely, undertaken that
it will support the Company's existing operations and future development,
including that the Company will be treated equally with any other operators of
wireline telephone, data and Internet, leased line or other related
telecommunications services that are controlled by China Telecommunications
Corporation and the Company will have the option to provide additional
telecommunications services in the service regions that fall within China
Telecommunication Corporation's scope of business.
----------
/2/ 14.30(1)(d)
9. ARRANGEMENT RELATING TO THE REORGANIZATION AND THE ACQUISITION
The following arrangement has been entered into between the Parent Group
and the Company, the performance of which will technically be considered as a
connected transaction after the Acquisition.
Amounts due to the Parent
In 1994, the Ministry of Finance obtained a loan from the World Bank
(the World Bank Loan) which was subsequently novated to the former Ministry
of Posts and Telecommunications. After a series of further novations made
in conjunction with the restructuring of the telecommunications industry by
the Chinese government, China Telecommunications Corporation became the
borrower of record of the World Bank Loan. A portion of the World Bank Loan
was advanced by China Telecommunications Corporation to, and utilized by,
the provincial subsisting companies of Jiangxi province, Guangxi Zhuang
autonomous region and Sichuan province, which also bore the costs of
servicing that portion of the World Bank Loan. In connection with the
Reorganization, the parties agreed with effect from December 31, 2002 that
the Parent would assume the above-mentioned World Bank Loan advanced to the
provincial subsisting companies of Jiangxi province, Guangxi Zhuang
autonomous region and Sichuan province, in exchange for an unsecured
interest-free indebtedness of US$47.4 million due from Jiangxi Telecom,
Guangxi Telecom and Sichuan Telecom. Subsequent to December 31, 2002, the
Parent would bear the costs of servicing that portion of the World Bank
Loan.
The Company has agreed to cause the entire amount of the indebtedness
due from Jiangxi Telecom, Guangxi Telecom and Sichuan Telecom to be repaid
to the Parent using their internal cash resources on the next business day
following the completion of the Acquisition.
10. CONNECTED TRANSACTIONS
As a result of the Reorganization, certain transactions entered into
between the Target Companies and the Parent Group will constitute Prospective
Connected Transactions. Specific agreements to be entered into in respect of
each of the Prospective Connected Transactions are described in this section.
The Prospective Connected Transactions set out in this section which relate
to the operations of the Target Group are identical in nature and substance to
the corresponding Existing Connected Transactions. The pricing standards and
principal terms of the Prospective Connected Transactions are also identical to
those of the Existing Connected Transactions.
The Company and the Target Group have included certain historical amounts
in respect of the Prospective Connected Transactions that occurred prior to the
Reorganization. These historical amounts are based on the Company's and the
Target Group's respective audited and unaudited financial statements. The Target
Group's audited financial statements for periods prior to January 1, 2003 were
prepared to include the operating results related to certain assets that were
retained by the Parent Group in connection with the Reorganization and reflect
transactions under old pricing mechanisms that were in place before the
Reorganization. Accordingly, the historical amounts in respect of the Target
Group for the year ended December 31, 2002 should not be read as an indication
of future transaction amounts. New arrangements in relation to connected
transactions, including new pricing mechanisms as set out in the relevant
connected transaction framework agreements took effect from January 1, 2003.
Therefore the historical figures for the six months ended June 30, 2003 are
comparable to future transaction amounts in terms of pricing mechanism and basis
of reporting. However, the expenditures of the connected transactions are
incurred unevenly during a financial year and the transaction amounts for the
six months ended June 30, 2003 shall not be used as a basis for prediction of
the transaction amounts likely to be incurred for the entire year.
10.1 Ongoing Connected Transactions Between the Company and China
Telecommunications Corporation
After the Reorganization, the Company entered into various agreements
with China Telecommunications Corporation relating to the mutual provision
of ongoing telecommunications and other services.
The mutual provision of ongoing telecommunications and other services
between the Parent Group and the Company constitute connected transactions
within the meaning of the Hong Kong Listing Rules. Such agreements include
the following:
(a) Supplemental Trademark Licence Agreement
On September 10, 2002, the Company and China Telecommunications
Corporation entered into a trademark licence agreement to grant to the
Company the right to use certain trademarks owned by the Parent on a
royalty-free basis.
On October 26, 2003, the Company and China Telecommunications
Corporation entered into a supplemental trademark licence agreement
(the Supplemental Trademark Licence Agreement) to extend the scope of
the licensees to include the Target Companies and to amend the list of
trademarks as set out in the trademark licence agreement entered into
by the same parties on September 10, 2002. The Supplemental Trademark
Licence Agreement further extends the term of the licence from
December 31, 2004 to December 31, 2005, after which the license will
be automatically renewed for further periods of three years unless the
Company provides three months' written notification to China
Telecommunications Corporation of its intention not to renew the
agreement at the expiration of its current term.
Pursuant to the Supplemental Trademark Licence Agreement, the
Parent has granted to the Combined Group the right to use certain
trademarks currently used by the Parent in the provision of its
telecommunications services on a royalty-free basis.
(b) Supplemental Agreement Relating to Centralized Services,
Interconnection, Optic Fibers Leasing and Non-competition
Agreement
The Company and China Telecommunications Corporation entered into
a supplemental agreement in relation to centralized services,
interconnection, optic fibers leasing and non-competition agreement on
October 26, 2003 (the Supplemental Connected Transactions Agreement)
to amend the original centralized services agreement, the
interconnection agreement, the optic fibers leasing agreement and the
non-competition agreement, all entered into by the same parties on
September 10, 2002.
Centralized Services
The Supplemental Connected Transactions Agreement modifies
the scope of the centralized services to include sharing the use
and costs of headquarters and certain network support premises
and related facilities such as air-conditioning, electricity and
certain ancillary facilities. Costs of the centralized services
such as the management of large enterprise customers, network
management center, business support center by the Company and
sharing the use of headquarters, international gateways and
certain other premises together with costs such as labor costs,
depreciation of equipment and premises, daily expenses, costs
relating to maintenance and research, are to be apportioned
between the Parent and the Company per annum according to their
respective proportional income or aggregate volume of inbound and
outbound international calls, where appropriate. The Supplemental
Connected Transactions Agreement also amends the scope of
international telecommunications facilities to include
international land cables and related domestic extended portions
and extends the term of the centralized services agreement from
December 31, 2004 to December 31, 2005. Such agreement will be
automatically renewed for further periods of three years unless
the Company provide three months' written notification to the
Parent of its intention not to renew the agreement. Apart from
the amendments described above, the other terms and conditions
set out in the original centralized services agreement remain
unchanged.
For the year ended December 31, 2002 and the six months
ended June 30, 2003, the Target Group's portion of the costs in
respect of the centralized services set out above were RMB173
million and RMB71 million, respectively.
For the year ended December 31, 2002 and the six months
ended June 30, 2003, the Listed Group's portion of costs in
respect of the centralized services set out above were RMB483
million and RMB144 million, respectively.
Interconnection
The Supplemental Connected Transactions Agreement extends
the term of the original interconnection agreement from December
31, 2004 to December 31, 2005. The interconnection agreement will
be automatically renewed for further periods of three years
unless the Company provides three months' written notification to
the Parent of its intention not to renew the agreement. The
original interconnection agreement does not provide for early
termination or non-renewal by the Parent. Furthermore, under
Article 17 of the Telecommunications Regulations, a
telecommunications operator cannot refuse to enter into
interconnection arrangements with another operator if requested.
Apart from the amendment described above, the other terms and
conditions of the original interconnection agreement remain
unchanged.
Prior to the completion of the Acquisition, no such
interconnection settlement arrangement was in effect between the
Parent Group and the Target Companies, or between the Listed
Group and the Target Companies. After the completion of the
Acquisition, such interconnection arrangement will be in effect
between the Parent Group and the Combined Group.
For the year ended December 31, 2002 and the six months
ended June 30, 2003, the net settlement payments made by the
Listed Group to the Parent pursuant to the original
interconnection agreement were RMB385 million and RMB181 million,
respectively.
Optic Fibers Leasing
The Supplemental Connected Transactions Agreement extends
the term of the original optic fibers leasing agreement from
December 31, 2004 to December 31, 2005. The optic fibers leasing
agreement will be automatically renewed for further periods of
three years unless the Company provides three months' written
notification to the Parent of its intention not to renew the
agreement at the expiration of its current term. Apart from the
amendment described above, the other terms and conditions of the
original optic fibers leasing agreement remain unchanged.
Pursuant to the Reorganization, all optic fibers required
for inter-provincial transmission within the Target Service Areas
were transferred to the relevant Target Companies. Accordingly,
no leasing arrangement for such optic fibers was put in place
between the Parent and the Target Companies after the
Reorganization.
For the year ended December 31, 2002 and the six months
ended June 30, 2003, the total amounts paid by the Listed Group
to the Parent with respect to optic fibers leasing were RMB102
million and RMB46 million, respectively.
Non-Competition Agreement
To be in line with an amendment to the Directory of
Categorization of Telecommunications Services (the Directory)
promulgated by the MII on February 21, 2003, the Supplemental
Connected Transactions Agreement amends the definition of "basic
telecommunications services" to include 3G businesses. The
Supplemental Connected Transactions Agreement also amends the
expression of "value-added telecommunications services" in order
to be in line with the Directory, which contains domestic
multi-parties telecommunications service, Internet access
services, Internet data center services, Internet VPN services
and VPN services within the scope of such expression. Apart from
the amendment described above, the other terms and conditions set
out in the original agreement remain unchanged.
10.2 Ongoing Connected Transactions Between Subsidiaries of the Company and
Subsidiaries/Associates of China Telecommunications Corporation
After the Reorganization, certain ancillary, and mostly
non-telecommunications related businesses and assets of the Parent Group
within the Target Service Areas, continue to be operated or held by certain
subsidiaries and/or Associates of the Parent (the Provincial Subsisting
Companies). Any transactions between the Provincial Subsisting Companies
and subsidiaries of the Company would constitute connected transactions
under the Hong Kong Listing Rules.
Since the terms and conditions of the Prospective Connected
Transactions are identical to the terms and conditions of the corresponding
Existing Connected Transactions, we will not be setting out in this
circular the commercial background, reasons and terms for such transactions
which were set out in the Company's Prospectus.
(a) Engineering Agreements
/3/The Target Companies and the Provincial Subsisting Companies
have entered into engineering framework agreements (the Engineering
Framework Agreements) to govern the arrangements with respect to
certain engineering related services. Each Engineering Framework
Agreement will expire on December 31, 2005, but will be automatically
renewed for further periods of three years unless a Target Company
provides three months' written notification to the relevant Provincial
Subsisting Company of its intention not to renew its agreement.
The charges payable for engineering related services rendered
under the Engineering Framework Agreements shall be determined by
reference to market rates as reflected by prices obtained through a
tender process. The Target Companies do not accord any priority to any
of the Provincial Subsisting Companies to provide such services, and
the tender may be awarded to an independent third party. However, if
the terms of an offer from a Provincial Subsisting Company are at
least as favorable as those offered by another tenderer, the relevant
Target Company may award the tender to the relevant Provincial
Subsisting Company.
For the year ended December 31, 2002, the Target Group's
expenditure for engineering services made available by the Provincial
Subsisting Companies to the Target Group was RMB2,172 million. For the
six months ended June 30, 2003, the Target Group's expenditure,
following the new corporate structure and the pricing mechanism set
out in the Engineering Framework Agreements, was RMB873 million.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of engineering related
services similar to those proposed in the
----------
/3/ 14.30(1)(a)
14.30(1)(c)
14.30(1)(d)
14.30(1)(g)
Engineering Framework Agreements which form part of the Existing
Connected Transactions. For the year ended December 31, 2002 and the
six months ended June 30, 2003, the Listed Group's expenditures for
corresponding engineering services pursuant to the Existing Connected
Transaction between the relevant Provincial Subsisting Companies and
each of Shanghai Telecom, Guangdong Telecom, Jiangsu Telecom and
Zhejiang Telecom were RMB3,243 million and RMB982 million,
respectively.
(b) Property Leasing Agreements
Mutual leasing of properties
/4/Pursuant to various property leasing framework agreements
between the Target Companies and the Provincial Subsisting
Companies (the Property Leasing Framework Agreements), the Target
Group has leased from the Provincial Subsisting Companies a total
of 673 properties covering an aggregate gross floor area of
approximately 176,467.7 square metres for use as its business
premises, offices, equipment storage facilities and sites for
network equipment. These properties are situated in many
locations within the Target Service Areas. Pursuant to the
Property Leasing Framework Agreements and as part of the
Reorganization, the Target Companies have also leased certain
properties covering an aggregate gross floor area of
approximately 99,182.9 square metres to the Provincial Subsisting
Companies.
Each Property Leasing Framework Agreement will expire on
December 31, 2005, but will be automatically renewed for further
periods of three years unless a Target Company provides three
months' written notification to the relevant Provincial
Subsisting Company of its intention not to renew its agreement.
The rental charge in respect of each property is based on
market rates, with reference to amounts stipulated by local price
bureaus, taking into consideration the specific needs of the
telecommunications industry when leasing properties. Rental
charges are payable monthly in arrears and subject to review
every three years.
Pursuant to the Reorganization, the properties occupied by
the Target Group with defective titles were retained by the
Provincial Subsisting Companies, and such properties are now
leased by the Target Group from the Provincial Subsisting
Companies. Therefore, the scope of properties leased by the
Target Group has been broadened, and no comparable historical
figures are available. For the six months ended June 30, 2003,
the Target Group's expenditure, following the new corporate
structure and the pricing mechanism set out in the Property
Leasing Framework Agreement, was RMB22 million. For the same
period, the Provincial Subsisting Companies' expenditure for the
rental charges in respect of properties leased from the Target
Group was RMB8 million.
Chesterton, an independent appraiser appointed by the
Company for the purpose of the Acquisition, has reviewed the
Property Leasing Framework Agreements and has confirmed that the
rental charges payable under the Property Leasing Framework
Agreements are fair and reasonable so far as the Target Companies
are concerned, and do not exceed market rates in respect of both
properties leased to and from the Target Companies.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of mutual leasing
of properties similar to those proposed in
----------
/4/ 14.30(1)(a)
14.30(1)(c)
14.30(1)(d)
14.30(1)(g)
the Property Leasing Framework Agreements which form part of the
Existing Connected Transactions. For the year ended December 31,
2002 and the six months ended June 30, 2003, the Listed Group's
expenditures for corresponding property leasing pursuant to the
Existing Connected Transaction between the relevant Provincial
Subsisting Companies and each of Shanghai Telecom, Guangdong
Telecom, Jiangsu Telecom and Zhejiang Telecom were RMB266 million
and RMB135 million, respectively. For the same period, the
Provincial Subsisting Companies' expenditures for corresponding
property leasing pursuant to the Existing Connected Transaction
between the relevant Provincial Subsisting Companies and each of
Shanghai Telecom, Guangdong Telecom, Jiangsu Telecom and Zhejiang
Telecom were RMB3 million and RMB4 million, respectively.
Sub-Leasing of Third Party Properties
Following the Reorganization, the Provincial Subsisting
Companies have sub-let to the Target Group certain properties
owned by and leased from independent third parties for use as
offices, retail outlets, spare parts storage facilities and sites
for network equipment (the Third Party Properties). In order to
formalize such arrangement, the Target Companies and the
Provincial Subsisting Companies have entered into sub-leasing
agreements (the Third Party Properties Sub-leasing Agreements)
which will expire on December 31, 2005, but will be automatically
renewed for further three-year periods unless a relevant Target
Company provides three months' written notification to the
relevant Provincial Subsisting Company of its intention not to
renew its agreement.
The amounts payable by the Target Group to the Provincial
Subsisting Companies under the Third Party Properties Sub-leasing
Agreements are the same as the amounts payable by the Provincial
Subsisting Companies to the relevant third parties. The rental
charges for the Third Party Properties are based on market rates
negotiated between the Provincial Subsisting Companies and the
relevant third parties on an arm's length basis.
Prior to the Reorganization, no such sub-leasing arrangement
was in effect between the Provincial Subsisting Companies and the
Target Group. For the six months ended June 30, 2003, the Target
Group's expenditure for properties sub-leasing was RMB59 million.
Chesterton, an independent appraiser appointed by the
Company for the purpose of the Acquisition, has confirmed that
the rental charge payable for each of the Third Party Properties
under the Third Party Properties Sub-leasing Agreements is fair
and reasonable so far as the Target Group is concerned, and does
not exceed market rents.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of sub-leasing of
third party properties similar to those proposed in the Third
Party Properties Sub-leasing Agreements which form part of the
Existing Connected Transactions. For the year ended December 31,
2002 and the six months ended June 30, 2003, the Listed Group's
expenditures for corresponding properties sub-leasing pursuant to
the Existing Connected Transaction between the relevant
Provincial Subsisting Companies and each of Shanghai Telecom,
Guangdong Telecom, Jiangsu Telecom and Zhejiang Telecom were
RMB321 million and RMB160 million, respectively.
(c) IT Services Agreements
/5/The Target Companies have entered into framework agreements
with the Provincial Subsisting Companies in each of the Target Service
Areas pursuant to which the Provincial
----------
/5/ 14.30(1)(a)
14.30(1)(c)
Subsisting Companies have agreed to provide the Target Group with
certain information technology services such as office automation and
software adjustment (the IT Services Framework Agreements). The
agreements will expire on December 31, 2005, but will be automatically
renewed for further periods of three years unless a Target Company
provides three months' written notification to the relevant Provincial
Subsisting Company of its intention not to renew its agreement.
The Provincial Subsisting Companies are entitled to tender for
the right to provide the Target Companies with IT services. The
charges payable for such IT services under the IT Services Framework
Agreements shall be determined by reference to market rates as
reflected by prices obtained through the tender process. The Target
Companies do not accord any priority to the Provincial Subsisting
Companies to provide such services, and the tender may be awarded to
an independent third party. However, if the terms of an offer from a
Provincial Subsisting Company are at least as favorable as those
offered by another tenderer, the relevant Target Company may award the
tender to the relevant Provincial Subsisting Company.
For the year ended December 31, 2002, the Target Group's
expenditure for the IT services made available by the Provincial
Subsisting Companies to the Target Group was RMB59 million. For the
six months ended June 30, 2003, the Target Group's expenditure,
following the new corporate structure and the pricing mechanism set
out in the IT Services Framework Agreements, was RMB18 million.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of IT services similar
to those proposed in the IT Services Framework Agreements which form
part of the Existing Connected Transactions. For the year ended
December 31, 2002 and the six months ended June 30, 2003, the Listed
Group's expenditures for corresponding IT services pursuant to the
Existing Connected Transaction between the relevant Provincial
Subsisting Companies and each of Shanghai Telecom, Guangdong Telecom,
Jiangsu Telecom and Zhejiang Telecom were RMB151 million and RMB3
million, respectively.
(d) Equipment Procurement Services Agreements
/6/Pursuant to the equipment procurement framework agreements
entered into between the Target Companies and the Provincial
Subsisting Companies in each of the Target Service Areas (the
Equipment Procurement Framework Agreements), the Provincial Subsisting
Companies have agreed to provide comprehensive procurement services,
including the management of tenders, verification of technical
specifications and installation services.
Pursuant to the Equipment Procurement Framework Agreements
between the Target Companies and the Provincial Subsisting Companies,
the Target Companies may request that the Provincial Subsisting
Companies act as their agents in procuring foreign and domestic
telecommunications equipment and other domestic non-telecommunications
materials. Each Equipment Procurement Framework Agreement will expire
on December 31, 2005, but will be automatically renewed for further
periods of three years unless a Target Company provides three months'
written notification to the relevant Provincial Subsisting Company of
its intention not to renew its agreement. The Target Companies may
give priority to the Provincial Subsisting Companies if the terms and
conditions of the services provided by them are at least as favorable
as those offered by independent third parties.
----------
14.30(1)(d)
14.30(1)(g)
/6/ 14.30(1)(a)
14.30(1)(c)
14.30(1)(d)
14.30(1)(g)
Commission charges for these services are calculated at the
maximum rate of:
(1) 1% of the contract value, in the case of imported
telecommunications equipment; or
(2) 1.8% of the contract value, in the case of domestic
telecommunications equipment and other domestic
non-telecommunications materials.
The Target Group believes that the above charges are the same as
market rates or those rates which it would be required to pay had it
appointed an independent third party to provide the same procurement
services.
Prior to the Reorganization, certain of the Target Group's
equipment was first purchased from suppliers by the Parent Group and
then resold to the Target Group. Under those circumstances, the Parent
Group acted primarily as a principal rather than as an agent earning
commissions and therefore no historical figures of a comparable nature
are available.
For the six months ended June 30, 2003, the Target Group's
expenditure for the equipment procurement services provided by the
Provincial Subsisting Companies to the Target Group following the new
corporate structure and the pricing mechanism set out in the Equipment
Procurement Framework Agreements, was RMB36 million.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of equipment
procurement services similar to those proposed in the Equipment
Procurement Framework Agreements which form part of the Existing
Connected Transactions. For the year ended December 31, 2002 and the
six months ended June 30, 2003, the Listed Group's expenditures for
corresponding equipment procurement pursuant to the Existing Connected
Transaction between the relevant Provincial Subsisting Companies and
each of Shanghai Telecom, Guangdong Telecom, Jiangsu Telecom and
Zhejiang Telecom were RMB78 million and RMB45 million, respectively.
(e) Community Services Agreements
/7/The Parent Group, through the Provincial Subsisting Companies,
provides certain cultural, educational, property management, vehicles
services, health and medical services, hotel and conference services,
community and sanitary services to the Target Group. The arrangements
are set out in the community services framework agreements between the
Target Companies and the Provincial Subsisting Companies in each of
the Target Service Areas (the Community Services Framework Agreements)
which will expire on December 31, 2005, but will be automatically
renewed for further periods of three years unless terminated by either
party with at least three months' written notification to the other
party. However, if the Target Companies cannot, without incurring
significant cost and expense, obtain these services from a third party
after such termination, the Provincial Subsisting Companies cannot
terminate the provision of such services.
The Community Services Framework Agreements stipulate that the
above community services be provided at:
(1) the government-prescribed price;
(2) where there is no government-prescribed price but where
there is a government-guided price, the government-guided
price applies;
----------
/7/ 14.30(1)(a)
14.30(1)(c)
14.30(1)(d)
14.30(1)(g)
(3) where there is neither a government-prescribed price nor a
government-guided price, the market price applies. The
market price is defined as the price at which the same type
of services are provided by independent third parties in the
ordinary course of business; or
(4) where none of the above is applicable, the price is to be
agreed between the relevant parties for the provision of the
above services, which shall be the reasonable cost incurred
in providing the same plus a reasonable profit margin (For
this purpose, "reasonable costs" means such costs as
confirmed by both parties after negotiations).
The Target Group believes that the services provided by the
Provincial Subsisting Companies under the Community Services Framework
Agreements will be on normal commercial terms which are no less
favorable than those provided by independent third parties.
For the year ended December 31, 2002, the Target Group's
expenditure for community services made available by the Provincial
Subsisting Companies to the Target Group was RMB359 million. For the
six months ended June 30, 2003, the Target Group's expenditure,
following the new corporate structure and the pricing mechanism set
out in the Community Services Framework Agreements, was RMB192
million.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of community services
similar to those proposed in the Community Services Framework
Agreements which form part of the Existing Connected Transactions. For
the year ended December 31, 2002 and the six months ended June 30,
2003, the Listed Group's expenditures for corresponding community
services pursuant to the Existing Connected Transaction between the
relevant Provincial Subsisting Companies and each of Shanghai Telecom,
Guangdong Telecom, Jiangsu Telecom and Zhejiang Telecom were RMB1,291
million and RMB571 million, respectively.
(f) Ancillary Telecommunications Services Agreements
/8/Following the Reorganization, the Provincial Subsisting
Companies have agreed to provide certain repair services to the Target
Group, such as the repair of certain telecommunications equipment, the
maintenance of fire prevention equipment and telephone booths and
other customers' services (the Ancillary Telecommunications Services)
on a non-exclusive basis.
Under the framework agreements between the Target Companies and
the Provincial Subsisting Companies in each of the Target Service
Areas for the provision of Ancillary Telecommunications Services (the
Ancillary Telecommunications Services Framework Agreements), the
Provincial Subsisting Companies have agreed to provide Ancillary
Telecommunications Services to the Target Group. Such agreements will
expire on December 31, 2005, but will be automatically renewed for
further periods of three years unless either party notifies the other
at least three months prior to the expiration of the term in writing
of its intention to terminate the relevant agreement. However, if the
Target Companies cannot, without incurring significant cost and
expense, obtain these services from a third party, the Provincial
Subsisting Companies cannot terminate the provision of such services.
----------
/8/ 14.30(1)(a)
14.30(1)(c)
14.30(1)(d)
14.30(1)(g)
The Ancillary Telecommunications Services under the Ancillary
Telecommunications Services Framework Agreements are provided in
accordance with the same pricing policy as that of the Community
Services Framework Agreements.
For the year ended December 31, 2002, the Target Group's
expenditure for Ancillary Telecommunications Services made available
by the Provincial Subsisting Companies to the Target Group was RMB220
million. For the six months ended June 30, 2003, the Target Group's
expenditure, following the new corporate structure and the pricing
mechanism set out in the Ancillary Telecommunication Services
Framework Agreements, was RMB143 million.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of ancillary
telecommunications services similar to those proposed in the Ancillary
Telecommunications Services Framework Agreements which form part of
the Existing Connected Transactions. For the year ended December 31,
2002 and the six months ended June 30, 2003, the Listed Group's
expenditure for corresponding Ancillary Telecommunications Services
pursuant to the Existing Connected Transaction between the relevant
Provincial Subsisting Companies and each of Shanghai Telecom,
Guangdong Telecom, Jiangsu Telecom and Zhejiang Telecom were RMB1,219
million and RMB409 million, respectively.
11. APPLICATION FOR WAIVER
11.1 Scope of Waivers
Following the completion of the Acquisition, the Combined Group will
continue to enter into the transactions described in section 10 above. Such
transactions would constitute connected transactions for the Company under
the Hong Kong Listing Rules for so long as members of the Parent Group
remain as connected persons within the meaning of the Hong Kong Listing
Rules.
The Independent Board Committee is of the opinion that the terms of
the Prospective Connected Transactions and the terms of certain
supplemental agreements pursuant to the Existing Connected Transactions
described in section 10 of this circular have been entered into, and will
be carried out, in the ordinary and usual course of business of the
Combined Group and on normal commercial terms which are fair and reasonable
so far as the interests of the Independent Shareholders of the Company are
concerned.
Pursuant to the Hong Kong Listing Rules, each of the interconnection
agreement, engineering agreements, community services agreements and
ancillary telecommunications services agreements described in section 10
above would normally require full disclosure and prior approval by
Independent Shareholders at the EGM. It is considered that such disclosure
and approval in full compliance with the Hong Kong Listing Rules would be
impracticable. The Company has applied to the Stock Exchange, subject to
the conditions set out in section 11.2 below, for a waiver from strict
compliance with the requirements of Chapter 14 of the Hong Kong Listing
Rules, in relation to such transactions. In its application, the Company
has sought a new waiver for the Combined Group from the Stock Exchange to
combine certain Existing Connected Transactions such as interconnection
agreement, engineering agreements, community services agreements and
ancillary telecommunications services agreements, waivers of which were
granted by the Stock Exchange in its letter dated October 28, 2002, with
the corresponding Prospective Connected Transactions so that the waivers in
respect of annual monetary limits of certain Existing Connected
Transactions be aggregated. The new waiver will be effective for two years
from January 1, 2004 until December 31, 2005.
11.2 Conditions of Waiver
The Stock Exchange has indicated that it will grant the waiver applied
for in relation to the interconnection agreement (10.1(b)), engineering
agreements (10.2(a)), community services agreements (10.2(e)) and ancillary
telecommunications services agreements (10.2(f)) for the Combined Group for
two years from January 1, 2004 to December 31, 2005 on the following
conditions:
(a) Arm's length basis: The transactions as well as the respective
agreements governing such transactions shall be:
(1) entered into by the Combined Group in the ordinary and usual
course of its business; and
(2) either
(i) on normal commercial terms, or
(ii) where there is no available comparison to judge
whether they are on normal commercial terms, on terms
no less favorable than those available to or from
independent third parties,
(iii) on terms that are fair and reasonable so far as the
Independent Shareholders of the Company are concerned,
and
(iv) if applicable, with the annual aggregate value of each
category of the connected transactions not exceeding
the relevant annual limits.
(b) Disclosure: The Company shall disclose in its annual report
details of the transactions as required by Rule 14.25(1)(A) to
(D) of the Hong Kong Listing Rules, i. e.
(i) the date or period of the transactions;
(ii) the parties thereto and a description of their
relationship;
(iii) a brief description of the transactions and the purpose of
the transactions;
(iv) the total consideration and the terms; and
(v) the nature and extent of the interest of the connected
persons in the transactions.
(c) Independent directors' review: Members of the Independent Board
Committee shall review annually the transactions and confirm, in
the Company's annual report and accounts for the year in
question, that such transactions have been conducted in the
manner stated in conditions 1 and 2 in paragraph 11.2(a) above.
(d) Auditors' review: The auditors of the Company shall carry out
review procedures annually on the transactions and shall confirm
to the Directors of the Company in writing (with a copy to the
Stock Exchange at least 10 business days prior to the bulk print
of the Company's annual report) whether, based on those
procedures, the transactions:
(1) have received the approval of the Company's Directors;
(2) have been entered into in accordance with the pricing
policies as stated in the relevant agreements, where
applicable;
(3) have been entered into in accordance with the terms of the
agreements governing the transactions; and
(4) have not exceeded the annual limits specified in paragraph
(f) below.
For the purpose of the above review by the auditors of the
Company, the Parent Group has undertaken to the Company to
provide the auditors with access to its accounting records, as
well as (where possible) those of its subsidiaries and
Associates.
(e) Shareholders' approval: Details of the transactions are disclosed
to the Independent Shareholders who will be asked to vote in
favor of an ordinary resolution to approve the transactions and
the annual limits set out in paragraph (f) below at the Company's
EGM.
(f) Annual limits and reasons for increment:
In determining the proposed annual limits of the following categories of
connected transactions for the Combined Group, the Board has considered the
relative size of the total assets and operating revenues of the Target Group
against the Listed Group, the budget of the Combined Group in terms of capital
expenditures, general and administrative expenses and sales and maintenance
expenses. The Board (including the independent non-executive directors) is of
the view that the monetary limits are set so as to (i) not hinder the ability of
the Combined Group to conduct its business in the ordinary and usual course and
(ii) allow the Combined Group to benefit from future growth. The aggregate
annual value of the following categories of connected transactions for the
Combined Group shall not exceed the limits set out below:
Transactions Proposed Annual Limits
------------------------------------------------------- ----------------------
(1) Engineering agreements RMB7,020 million
(2) Community services agreements RMB3,410 million
(3) Ancillary telecommunications services agreements RMB2,640 million
Annual limit Proposed
under the annual limit
The Existing after the
transactions Waiver Acquisition Reasons for increment
------------ ------------ ------------- ----------------------------------------
The increase is due to (i) an increase
in the business volume of the Combined
Group following the acquisition of the
business of the Target Group by the
Company, which on a pro forma basis for
the six months ended June 30, 2003 would
have resulted in a revenue increment of
46.2%; (ii) the varied landscape of the
Target Service Areas requiring
specialized expertise to carry out
engineering work and there are very few
third parties which can offer comparable
services in terms of quality and fees;
RMB4,392 (iii) further expansion of the
million for RMB7,020 telecommunications business of the
each year million for Listed Group in 2005; and (iv) the
Engineering ended or each year Target Service Areas are generally less
agreements ending ending developed than the Listed Service Areas
December 31, December 31, and therefore there is a greater need
2002, 2003 2004 and for engineering works in the Target
and 2004. 2005. Service Areas as the business there has
greater scope for expansion. Based on
the above reasons, the annual budget
prepared by the Company and the trend of
the relevant connected transactions, the
Board expects the expenditure of the
Combined Group for engineering services
for the year ending December 31, 2003
will not be more than approximately
RMB6,400 million. The expenditure of the
engineering services is incurred
unevenly during the year and therefore
the historical transaction amount for
the six months ended June 30, 2003
cannot be used as a basis for prediction
of the transaction amount
likely to be incurred by the end of 2003.
The increase is due to (i) an increase
in the business volume of the Combined
Group following the acquisition of the
business of the Target Group by the
Company, which on a pro forma basis for
the six months ended June 30, 2003 would
have resulted in a revenue increment of
46.2%; and (ii) corresponding business
expansion of the Listed Group, the
change in operations of Shanghai Telecom
from the purchase of all office
RMB2,639 equipment to the leasing of all office
million for RMB3,410 equipment from connected persons, the
Community each year million for increase in the number of properties
services ended or each year required by the Listed Group for its
agreements ending ending business needs and the subsequent
December 31, December 31, increase in property management fees.
2002, 2003 2004 and Based on the above reasons, the annual
and 2004. 2005. budget prepared by the Company and the
trend of the relevant connected
transactions, the Board expects the
expenditure of the Combined Group for
community services for the year ending
December 31, 2003 will not be more than
approximately RMB3,100 million. The
expenditure of the community services is
incurred unevenly during the year and
therefore the historical transaction
amount for the six months ended June 30,
2003 cannot be used as a basis for
prediction of the transaction amount
likely to be incurred by the end of
2003.
The increase is due to (i) an increase
in the business volume of the Combined
Group following the acquisition of the
business of the Target Group by the
Company, which on a pro forma basis for
the six months ended June 30, 2003 would
have resulted in a revenue increment of
46.2%; (ii) the expected rapid expansion
of the customer base of the
telecommunications business of the
Listed Group over the next few years;
and (iii) due to the Reorganization of
the Target Group, certain detailed
RMB1,510 arrangements in relation to the
million for RMB2,640 provision of ancillary services are
Ancillary each year million for expected to put in place over a period
telecommuni- ended or each year of time and therefore the transaction
cations ending ending volumes of such connected transactions
services December 31, December 31, are expected to increase significantly
agreements 2002, 2003 2004 and after the year ended December 31, 2002.
and 2004. 2005. Based on the above reasons, the annual
budget prepared by the Company and the
trend of the relevant connected
transactions, the Board expects the
expenditure of the Combined Group for
ancillary telecommunications services
for the year ending December 31, 2003
will not be more than approximately
RMB2,400 million. The expenditure of the
ancillary telecommunications services is
incurred unevenly during the year and
therefore the historical transaction
amount for the six months ended June 30,
2003 cannot be used as a basis for
prediction of the transaction amount
likely to be incurred by the end of
2003.
If any of the material terms of the agreements referred to above are
altered (unless as provided for under the terms of the relevant agreement or
arrangement) or if the Combined Group enters into any new agreements or
arrangements with any connected persons (within the meaning of the Hong Kong
Listing Rules) in the future under which the aggregate consideration paid or
payable by the Combined Group in each year exceeds the limits referred to above,
the Company will comply with the provisions of Chapter 14 of the Hong Kong
Listing Rules dealing with connected transactions unless it applies for and
obtains a separate waiver from the Stock Exchange.
11.3 Reasons for no cap for transactions contemplated under the
Interconnection Agreement
The Company submits that the value of transactions referred to under
section 10.1(b), namely the settlement of interconnection charges arising
from domestic long distance calls under the interconnection agreement,
should not be subject to any annual limits for the following reasons:
(a) the Company's revenue depends on growth in call revenue and in
its customer base for its various services. Any growth in the
domestic long distance service will necessarily result in
increased transaction volumes under the interconnection
agreement, which the Company will not be able to control as it
depends entirely on customer usage. Any limits on these
transactions will therefore potentially limit the Company's
ability to conduct or expand its business in the ordinary course;
and
(b) the tariffs payable under the interconnection agreement are
prescribed by the MII and are subject to change from time to
time.
11.4 No waivers applied for certain categories of connected transactions
Each of the transactions contemplated under sections 10.1(a) and
10.1(b) (except for interconnection agreement), 10.2(b), 10.2(c) and
10.2(d) are subject to Rule 14.25(1) of the Hong Kong Listing Rules, which
are on normal commercial terms in which the total consideration or value is
not expected to exceed 3% of the book value of the net tangible assets of
the Company as of December 31, 2002 and accordingly, disclosure requirement
as set out in Rule 14.25(1) of the Hong Kong Listing Rules shall apply to
each of such transactions. The Directors, including independent
non-executive directors of the Company submit that no waivers are necessary
for any of such transactions because details of the transactions as
required under Rule 14.25(1) of the Hong Kong Listing Rules are published
in the Company's annual report, accounts and press notice each year for so
long as such transactions are in place. If at any time Rule 14.25(1) of the
Hong Kong Listing Rules does not apply to any of these transactions, the
Company will notify and consult with the Stock Exchange promptly.
12. EXTRAORDINARY GENERAL MEETING
A notice of the Extraordinary General Meeting to be held at Beijing Nan Yue
Yuan Hotel, 186 Zheng Wang Fen, Fengtai District, Beijing, PRC, on Monday,
December 15, 2003 at 10:00 a.m. is set out on pages 147 to 149 of this circular
at which ordinary and special resolutions will be proposed to approve the
Acquisition and the Prospective Connected Transactions.
In accordance with the Hong Kong Listing Rules, China Telecommunications
Corporation, the controlling shareholder of the Company, which is beneficially
interested in 77.78% of the issued share capital of the Company as of the Latest
Practicable Date, and its Associates will abstain from voting on the resolutions
to approve the Acquisition, certain Prospective Connected Transactions and
certain supplemental agreements relating to the Existing Connected Transactions
at the Extraordinary General Meeting or any adjournment thereof.
A form of proxy for use at the Extraordinary General Meeting is enclosed.
Whether or not Shareholders are able to attend the Extraordinary General
Meeting, they are requested to complete and return the enclosed form of proxy to
the Company's registered office, 31 Jinrong Street, Xicheng District, 100032,
Beijing, PRC as soon as practicable and in any event by not later than 24 hours
before the time appointed for holding the Extraordinary General Meeting.
Completion and return of the form of proxy will not preclude Shareholders from
attending and voting in person at the Extraordinary General Meeting should they
so wish.
13. RECOMMENDATION OF THE INDEPENDENT BOARD COMMITTEE
JPMorgan has been appointed as the independent financial adviser to advise
the Company's Independent Board Committee in respect of the terms of the
Acquisition, the terms of the Prospective Connected Transactions and the terms
of certain supplemental agreements pursuant to the Existing Connected
Transactions.
The Independent Board Committee, having taken into account the advice of
JPMorgan, considers the terms of the Acquisition, the terms of certain
supplemental agreements relating to the Existing Connected Transactions and the
terms of the agreements relating to the Prospective Connected Transactions, from
a financial perspective, to be fair and reasonable so far as the Independent
Shareholders are concerned. The Independent Board Committee considers the terms
of the Acquisition, the terms of certain supplemental agreements relating to the
Existing Connected Transactions and the terms of the agreements relating to the
Prospective Connected Transactions to be in the interests of the Company.
Accordingly, the Independent Board Committee recommends that the Independent
Shareholders should vote in favor of the ordinary resolutions to approve the
Acquisition, certain Prospective Connected Transactions and certain supplemental
agreements relating to Existing Connected Transactions, and the special
resolution to approve the amendments to be made to the articles of association
of the Company at the Extraordinary General Meeting. The letter from JPMorgan
containing its opinion and the principal factors and reasons taken into account
in arriving at its opinion is set out on pages 36 to 59 of this circular.
14. ADDITIONAL INFORMATION
Your attention is drawn to the letter from the Independent Board Committee
to the Independent Shareholders set out on pages 34 to 35 of this circular, the
letter from JPMorgan, the independent financial adviser to the Company's
Independent Board Committee in respect of the terms of the Acquisition, the
terms of certain supplemental agreements relating to the Existing Connected
Transactions and the terms of the agreements relating to the Prospective
Connected Transactions, and to the information set out in the appendices to this
circular.
By Order of the Board
China Telecom Corporation Limited
Zhou Deqiang
Chairman and CEO
\raster(100%,p)="China_Telecom"
China Telecom Corporation Limited
(A joint stock limited company incorporated in the People's Republic of
China with limited liability)
Independent Board Committee
Zhang Youcai
Vincent Lo Hong Sui
Shi Wanpeng
October 27, 2003
To the Independent Shareholders
Dear Sir or Madam,
DISCLOSEABLE AND CONNECTED TRANSACTIONS
We refer to the circular (the "Circular") dated October 27, 2003 issued by
the Company to its Shareholders of which this letter forms part. Terms defined
in the Circular shall have the same meanings when used in this letter, unless
the context otherwise requires.
On October 27, 2003, the Board announced that the Company had entered into
the Acquisition Agreement, pursuant to which the Company agreed to acquire, and
China Telecommunications Corporation agreed to sell, the Target Assets, subject
to certain conditions.
The Independent Board Committee was formed on September 10, 2003 to make a
recommendation to the Independent Shareholders as to whether, in its view, the
terms of the Acquisition, the terms of certain supplemental agreements relating
to the Existing Connected Transactions and the terms of the Prospective
Connected Transactions, from a financial perspective, are fair and reasonable so
far as the Independent Shareholders are concerned. JPMorgan has been retained as
independent financial adviser to advise the Independent Board Committee on the
fairness and reasonableness of the terms of the Acquisition, the terms of
certain supplemental agreements relating to Existing Connected Transactions and
the terms of the Prospective Connected Transactions from a financial
perspective.
The terms and the reasons for the Acquisition are summarized in the Letter
from the Chairman set out on pages 6 to 33 of the Circular. The terms of the
supplemental agreements relating to the Existing Connected Transactions and the
agreements relating to the Prospective Connected Transactions are also
summarized in the Letter from the Chairman.
As your Independent Board Committee, we have discussed with the management
of the Company the reasons for the Acquisition, certain supplemental agreements
relating to the Existing Connected Transactions and the Prospective Connected
Transactions and the basis upon which their terms have been determined. We have
also considered the key factors taken into account by JPMorgan in arriving at
its opinion regarding the terms of the Acquisition, the terms of certain
supplemental agreements relating to the Existing Connected Transactions and the
terms of the agreements relating to the Prospective Connected Transactions as
set out in the letter from JPMorgan on pages 36 to 59 of the Circular, which we
urge you to read carefully.
The Independent Board Committee concurs with the views of JPMorgan,
independent financial adviser to the Independent Board Committee, and considers
that the terms of the Acquisition, the terms of certain supplemental agreements
relating to the Existing Connected Transactions and the terms of the agreements
relating to the Prospective Connected Transactions, from a financial
perspective, are fair and reasonable so far as the Independent Shareholders are
concerned. The Independent Board Committee, having also held the aforesaid
discussion with the management of the Company, considers that the Acquisition is
in the interests of the Company. Accordingly, the Independent Board Committee
recommends the Independent Shareholders to vote in favor of ordinary resolutions
numbered 1 to 2 and the special resolution numbered 3 set out in the notice of
the Extraordinary General Meeting at the end of the Circular.
Yours faithfully
Zhang Youcai
Vincent Lo Hong Sui
Shi Wanpeng
Independent Board Committee
"JP_Morgan_BW"
J.P. Morgan Securities (Asia Pacific) Limited
Chater House, 28/F
8 Connaught Road
Central
Hong Kong
October 27, 2003
To the Independent Board Committee of
China Telecom Corporation Limited (the "Company")
Dear Sirs:
DISCLOSEABLE AND CONNECTED TRANSACTIONS
Acquisition of Telecommunications Businesses and Assets from
China Telecommunications Corporation
INTRODUCTION
We refer to the Acquisition Agreement, certain supplemental agreements
relating to the Existing Connected Transactions and the Prospective Connected
Transactions, details of which are set out in the Company's circular dated
October 27, 2003 (the "Circular") which contains this letter. Terms defined in
the Circular shall have the same meanings herein, unless the context otherwise
requires.
The Acquisition constitutes a discloseable and connected transaction for
the Company under the Hong Kong Listing Rules and, pursuant to Rule 14.26 of the
Hong Kong Listing Rules, is subject to, among other things, approval by the
Independent Shareholders at the Extraordinary General Meeting.
The Target Group on the one hand, and the Parent and/or its
subsidiaries/Associates (other than the Company, its subsidiaries, and the
Target Group) on the other, have entered into a number of Prospective Connected
Transactions in relation to the operations of the Target Group, which will
constitute connected transactions for the Company under the Hong Kong Listing
Rules. We note that it is stated in the "Letter from the Chairman" contained in
the Circular that the Prospective Connected Transactions are identical in nature
and substance to the corresponding Existing Connected Transactions.
As the Company expects the Prospective Connected Transactions to be
conducted regularly and continuously in the ordinary and usual course of
business, and on normal commercial terms, the Company has applied to the Stock
Exchange for a new waiver from strict compliance with the normal approval and
disclosure requirements relating to connected transactions under the Hong Kong
Listing Rules. The new waiver (the "Waiver") will be in respect of the Combined
Group, and will cover both the Existing Connected Transactions and the
Prospective Connected Transactions so that the applicable annual monetary limits
of the Existing Connected Transactions and the Prospective Connected
Transactions may be aggregated. The Stock Exchange has indicated that the
granting of the Waiver, which when granted is expected to be effective from
January 1, 2004 until December 31, 2005, will be subject to, among other things,
(i) approval by the Independent Shareholders at the Extraordinary General
Meeting and (ii) the Company complying with such other conditions stated in the
"Letter from the Chairman" on pages 27 to 31 of the Circular.
We have been appointed to act as the Independent Financial Advisor to the
Independent Board Committee to consider whether the terms of the Acquisition,
the Supplemental Agreements (as defined herein) and the Prospective Connected
Transactions are fair and reasonable from a financial point of view insofar as
the Independent Shareholders are concerned. We are not opining on, and our
opinion does not in any manner address, the Company's underlying business
decision to undertake the Acquisition and enter into the transactions
contemplated under the Supplemental Agreements and the Prospective Connected
Transactions. This letter has been prepared and delivered in accordance with the
requirements of the Hong
Kong Listing Rules for the purpose of assisting the Independent Board Committee
in their duties to evaluate the above mentioned aspects and for no other reasons
or purposes.
In formulating our opinion, we have reviewed, among other things, the
Circular, the Prospectus, the Acquisition Agreement, the Supplemental Trademark
License Agreement, the Supplemental Connected Transactions Agreement, the
Engineering Framework Agreements, the Property Leasing Framework Agreements, the
Third Party Properties Sub-leasing Agreements, the IT Services Framework
Agreements, the Equipment Procurement Framework Agreements, the Community
Services Framework Agreements, the Ancillary Telecommunications Services
Framework Agreements, as well as the information and financial projections
prepared by the Company and the Target Companies relating to the Target Assets.
As used herein, the term "Supplemental Agreements" means the Supplemental
Trademark License Agreement and the Supplemental Connected Transactions
Agreement.
In arriving at our opinion, we have relied upon and assumed, without
independent verification, the accuracy and completeness of all information that
was publicly available or was furnished to us by, or on behalf of, the Company
or the Target Companies or otherwise reviewed by us (which information includes,
without limitation, the information cited herein), and we have not assumed any
responsibility or liability therefor. The Board has indicated that no material
facts have been omitted and the Board is not aware of any facts or circumstances
which would render the information provided and the representations made to us
untrue, inaccurate or misleading in any material respect. The Directors have
collectively and individually accepted full responsibility for the accuracy of
the information contained in the Circular and have confirmed, having made all
reasonable enquiries that, to the best of their knowledge and belief, there are
no other facts the omission of which would make any statement in the Circular
misleading.
We have also assumed that each of the Acquisition Agreement, the
Supplemental Agreements and the agreements relating to the Prospective Connected
Transactions is enforceable against each of the parties thereto in accordance
with its terms and that each of the parties will perform, and will be able to
perform, its obligations thereunder, and as otherwise described in the Circular,
in full when due. We have further assumed that all material governmental,
regulatory or other consents and approvals necessary for the completion of the
Acquisition and the entering into of the transactions contemplated under the
Supplemental Agreements and the Prospective Connected Transactions will be
obtained without any adverse effect on the Company or on the contemplated
benefits of the Acquisition and the transactions contemplated under the
Supplemental Agreements and the Prospective Connected Transactions to the
Company. We have not conducted any valuation or appraisal of any assets or
liabilities, nor have any such valuations or appraisals been provided to us. In
relying on financial analyses and forecasts provided to us, we have assumed that
they have been reasonably prepared based on assumptions reflecting the best
currently available estimates and judgments by management as to the expected
future results of operations and the financial condition of the Company or the
Target Companies to which such analyses or forecasts relate.
Our opinion is necessarily based on the legal and regulatory environment
and economic market and other conditions as in effect on, and the information
made available to us as at, the date hereof. It should be understood that
subsequent developments may affect this opinion and that we do not have any
obligation to update, revise, or reaffirm this opinion.
In addition, we were not requested to and did not provide advice concerning
the structure, the specific amount of the consideration, or any other aspects of
the Acquisition, the Supplemental Agreements or the Prospective Connected
Transactions, or to provide services other than the delivery of this opinion. We
did not participate in negotiations with respect to the terms of the
Acquisition, the Supplemental Agreements or the Prospective Connected
Transactions or any related transactions.
We will receive a fee from the Company for the delivery of this opinion.
PRINCIPAL FACTORS AND REASONS
In arriving at our opinion, we have taken into consideration each of the
principal factors and reasons set out below. Our conclusions are based on the
results of all analyses taken as a whole.
(1) The Acquisition
(i) Overview
On October 27, 2003, the Board of Directors announced that the
Company entered into the Acquisition Agreement, pursuant to which and
subject to certain conditions, the Company agreed to acquire, and
China Telecommunications Corporation, the Company's controlling
shareholder and promoter, agreed to sell, the Target Assets for a
purchase price of RMB46,000 million (equivalent to approximately
US$5,558 million). We understand from the Company that (i) the
conditions precedent to the completion of the Acquisition must be
satisfied on or before December 31, 2003 or such other date as agreed
to by the parties, (ii) the purchase price consists of an initial
consideration of RMB11,000 million (equivalent to approximately
US$1,329 million) and a deferred consideration of RMB35,000 million
(equivalent to approximately US$4,229 million), (iii) the Company
intends to finance 100% of the initial consideration using internal
cash resources, (iv) the deferred consideration is payable ten years
after the date of completion of the Acquisition, and (v) the net
indebtedness of the Target Group as at June 30, 2003 amounted to
approximately RMB33,988 million (equivalent to approximately US$4,106
million).
We understand that the corporate structure of the Company and its
principal subsidiaries immediately after the Acquisition is as set out
below.
Corporate structure immediately after completion of the
Acquisition
"chart02"
1 Denotes the Target Companies to be acquired pursuant to the
Acquisition.
2 As part of the reform plan of rural telecommunications
services, China Telecommunications Corporation has agreed to
transfer 977,004,913 shares of the Company (representing
1.29% of the Company's outstanding shares as at the Latest
Practicable Date) to Fujian Electronic Information (Group)
Co., Ltd. upon satisfaction of a number of conditions
precedent. Such transfer will not be made prior to September
10, 2005.
(ii) The Target Assets
The Target Companies are the leading providers of wireline
telecommunications services including wireline telephone, data and
Internet and leased line services in the Target Services Areas,
comprising Anhui province, Fujian province, Jiangxi province, Guangxi
Zhuang autonomous region, Chongqing municipality and Sichuan province
in the PRC. As at June 30, 2003, the Target Group had a total of
approximately 45.1 million access lines in service for its local
telephone service, with a market share of approximately 98.3% in the
Target Service Areas in terms of the number of access lines in service
as at June 30, 2003. Further operational information on the Target
Group is set out in Appendix I to the Circular.
The Company will also acquire from the Parent certain assets used
for network management, research and development purposes. Further
details of such assets are set out in Appendix I to the Circular under
"Network management and research facilities".
We summarize below the historical (i) operating revenues, (ii)
operating profit, and (iii) net profit of the Target Group for each of
the two years ended December 31, 2001 and 2002, and the six months
ended June 30, 2003, which were extracted from the audited financial
statements of the Target Group as set out in Appendix III to the
Circular. It should be noted that the net loss for 2002 was caused by
a deficit arising from an asset revaluation in relation to the
Reorganization, as required by the relevant PRC rules and regulations
with respect to the Reorganization. The property, plant and equipment
of the Target Group as at December 31, 2002 were revalued for each
asset class on a depreciated replacement cost basis by China
Enterprise Appraisal Co., Ltd, an independent valuer registered in the
PRC. The surplus on revaluation of certain property, plant and
equipment totaling RMB760 million (equivalent to approximately US$91.8
million) was credited to the revaluation reserve while the deficit
arising from the revaluation of certain property, plant and equipment
totaling RMB14,690 million (equivalent to approximately US$1,774.8
million) was recognized as an expense for the year ended December 31,
2002.
Six-month
Year ended December 31, period ended
----------------------- ------------
June 30,
2001 2002 2003
---------- ---------- ------------
Operating revenues
RMB million 31,951 34,068 18,247
US$ million 3,860 4,116 2,205
Operating profit
RMB million 4,518 4,619 4,863
US$ million 546 558 588
Net profit/(loss)
RMB million 3,103 (7,091) 3,371
US$ million 375 (857) 407
As at June 30, 2003, the total assets and owner's equity of the
Target Group were RMB95,467 million (equivalent to approximately
US$11,534 million) and RMB31,186 million (equivalent to approximately
US$3,768 million), respectively. Further financial information on the
Target Group is set out in Appendix III to the Circular.
As stated in the "Letter from the Chairman", the Company and the
Target Group believe that, on the bases and the assumptions set out in
Appendix VII and in the absence of unforeseen circumstances, the
combined forecast of the Target Group's net profit for the year ending
December 31, 2003 under IFRS is unlikely to be less than RMB6,352
million (equivalent to approximately or US$767 million). Further
details of the profit forecast are set out in Appendix VII to the
Circular.
(iii) Rationale for the Acquisition
As stated in the "Letter from the Chairman" in the Circular, the
Board is of the opinion that the Acquisition represents a new and
important opportunity for the Listed Group to strengthen its market
position, enhance its competitiveness, promote business development
and improve financial performance, so as to benefit further from the
sustained growth of the telecommunications industry in the PRC. As
stated in the "Letter from the Chairman", the Board is of the opinion
that the Acquisition is in the best interests of the Company and its
Shareholders. Further details of the reasons for the Acquisition are
set out in the "Letter from the Chairman" in the Circular.
(iv) Basis of the Consideration
As noted in the "Letter from the Chairman", the Acquisition was
negotiated and entered into on an arm's length basis and on normal
commercial terms. We understand that the purchase price of RMB46,000
million (equivalent to approximately US$5,558 million) was determined
after having considered various factors, including the quality of the
assets being acquired, their growth prospects, earnings potential,
competitive advantages in their respective markets, the prospective
profit contributions of the Target Group to the Combined Group and
other relevant valuation benchmarks. The net indebtedness of the
Target Assets amounted to RMB33,988 million (equivalent to
approximately US$4,106 million) as at June 30, 2003.
The Acquisition Agreement includes warranties in favour of the
Company and provisions providing for liability for breach of the
warranties, pre-completion undertakings from the Parent and
circumstances in which the Company may rescind the Acquisition
Agreement.
(v) Financing of the Acquisition
Under the Acquisition Agreement, the purchase price for the
Acquisition of RMB46,000 million (equivalent to approximately US$5,558
million) will be satisfied by the payment of an initial consideration
by cash of RMB11,000 million (equivalent to approximately US$1,329
million) upon completion of the Acquisition and the payment of a
deferred consideration of RMB35,000 million (equivalent to
approximately US$4,229 million). We understand from the Company that
in determining the initial consideration and the deferred
consideration amounts, it took into consideration the Combined Group's
current and future cash needs for operations as well as strategic
investments. The Board believes that such an arrangement should not
cause material negative impact to the Company's business.
The Company intends to finance all of the initial consideration
using internal cash resources, including proceeds raised from the
Global Offering. Based on the unaudited interim financial statements
of the Company prepared under IFRS, the cash and cash equivalents held
by the Listed Group as at June 30, 2003 were approximately RMB17,835
million (equivalent to approximately US$2,155 million). The Company
confirmed that it has sufficient internal resources to fund the
initial consideration for the Acquisition without a material negative
impact on its ongoing operations and capital expenditure requirements.
The deferred consideration is payable ten years after the date of
completion of the Acquisition. The Company intends to finance the
deferred consideration using internally generated cash and/or external
fund raising.
From the date of the completion of the Acquisition, the Company
will pay interest to the Parent at half-yearly intervals on the actual
amount of deferred consideration remaining outstanding. Interest will
accrue daily and, for the first five years after completion of the
Acquisition, interest will be payable at the rate of 5.184% per year,
being the RMB lending rate of commercial banks in the PRC in respect
of loans with tenure of more than five years of 5.76% per year as set
by the People's Bank of China and prevailing on the date of the
Acquisition Agreement, less a discount of 10%. On the fifth
anniversary of completion of the Acquisition, the interest rate will
be adjusted once for the remaining five years on the same basis as the
initial interest rate. The Company intends to fund the interest
payments with its internal cash resources.
The Company may make early payment of all or part of the deferred
consideration, from time to time, at any time from completion until
the tenth anniversary of the Acquisition, without penalty.
It is noted in the "Letter from the Chairman" that the Board is
of the opinion that the terms of the deferred consideration are more
attractive to the Company than the usual terms of a commercial bank
loan of a similar amount and tenure.
We consider that the terms for the financing of the Acquisition
are fair and reasonable, from a financial point of view, insofar as
the Independent Shareholders are concerned, based on the following
factors:
(i) the Company has confirmed that it has (a) sufficient cash
resources, which as at June 30, 2003 was approximately
RMB17,835 million (equivalent to approximately US$2,155
million), to fund the cash payment of the initial
consideration, and (b) sufficient internal and external
financing resources for its ongoing operations and capital
expenditure requirements;
(ii) the deferred consideration mechanism provides for a 10 year
payment period without prepayment penalty, thereby
providing the Company with considerable flexibility in
future capital raising and potential capital structure
optimization; and
(iii) the Board is of the opinion that the interest cost of
financing through the deferred consideration mechanism,
being 90% of the applicable PBOC rate, is more attractive
to the Company than the usual terms of a commercial bank
loan of a similar amount and tenure.
(vi) Valuation of the Target Assets
We have analyzed the purchase price of the Acquisition using
three valuation methodologies: (i) the discounted cash flow ("DCF")
analysis, (ii) the comparable company trading analysis, and (iii) the
comparable transaction analysis. Based on these analyses, we consider
that the purchase price of the Acquisition is fair and reasonable from
a financial point of view insofar as the Independent Shareholders are
concerned.
(a) Discounted cash flow analysis
We have used the DCF analysis as the primary valuation
methodology as in our view it best reflects the future cashflows
of the Target Assets, taking into consideration the
characteristics of the market in which the Target Assets
operates, competition in the sector, regulatory environment, and
the business plan, cost structure and capital requirements of the
Target Assets.
Our DCF analysis reflects the business plans and financial
projections of the Target Assets and other relevant information
provided by, or on behalf of, the Company, as well as our
discussions with the Company and its representatives. We have
reviewed the key assumptions and operating data of the Target
Assets in the context of the overall conditions of the market in
which the Target Assets operates. We have made downward
adjustments to certain assumptions to reasonably reflect our
conservative views of the future performance of the Target
Assets.
The purchase price of the Acquisition of RMB46,000 million
(equivalent to approximately US$5,558 million) is at a discount
to our DCF valuation range.
(b) Comparable company analysis
We have conducted a comparable company analysis using
trading ratios commonly used in the telecommunications industry,
in particular price/earnings ("P/E") ratio. We have considered in
our analysis, but have not relied on, the enterprise value/EBITDA
ratio, another commonly used valuation metric, as EBITDA
information for the Target Group has not been disclosed.
We have calculated trading ratios using both reporting
financials (including both recurring and non-recurring items) as
well as recurring financials. The difference between the two sets
of the financials represents the amortization income in relation
to previously received up-front connection fees. Since the Target
Group does not expect to receive such fees in the future, this
income is considered non-recurring.
Using the reporting financials, the purchase price of
approximately RMB46,000 million (equivalent to approximately
US$5,558 million) for the Acquisition implies a 2003E P/E ratio
of 7.2 times based on the forecast net profit of the Target Group
of approximately RMB6,352 million (equivalent to approximately
US$767 million) in 2003, as forecasted and stated by the Company
in the "Letter from the Chairman".
Using the recurring financials, the purchase price of
approximately RMB46,000 million for the Acquisition implies a
2003E P/E ratio of 11.5 times based on the forecast net profit of
the Target Group of approximately RMB4,000 million (equivalent to
approximately US$483 million) in 2003. Such forecast net profit
is equal to the excess of the forecast reporting net profit for
2003 over the amount of the amortization income in relation to
the historical up-front connection fees for the first six months
of 2003 (as set out in Appendix III to the Circular), annualized
for the full year.
As set out in the table below, based on reporting and
recurring financials separately, these multiples represent a
32.1% discount and a 25.3% discount, respectively, to the
Company's corresponding estimated multiples of 2003. If the
actual net profit of the Target Companies in 2003 is lower and
that of the Company does not change, these multiples will
represent a lower discount. We view the Company as the best
comparable company to the Target Group given that they are both
large wireline telecommunications companies in China which share
similar characteristics, including business focus, product
offerings, market position, technology platforms, regulatory
environment and characteristics of subscriber base.
Reporting Recurring
financial basis financial basis
--------------- ----------------
P/E 2003E P/E 2003E
--------------- ----------------
1 China Telecom Corporation
Limited 10.6 15.4
2 Target Group 7.2 11.5
Premium/(discount) of (2)
to (1) (32.1)% (25.3)%
Notes:
(1) Share prices of comparable companies used are the
closing prices as at October 24, 2003, which is the
Latest Practicable Date.
(2) Forecast 2003 EPS for comparable companies are based on
major brokers' estimates.
In addition, we have also compared the implied valuation
multiples of the Acquisition to the trading ratios of selected
comparable companies, which are further divided into two broad
categories: overseas listed Chinese wireless companies and
selected telecommunications companies in the Asia Pacific region.
These comparable companies display certain common characteristics
with the Target Group, though to a lesser degree than the
resemblance between the Company and the Target Group. The
overseas listed Chinese wireless providers, namely China Mobile
(Hong Kong) Limited and China Unicom Limited, are the only other
public listed Chinese telecommunications companies that are
commonly used by investors as valuation references for the
Company due to their similar geographical presence and exposure
to similar profile of telecom service customers and
macro-economic drivers in China. The selected regional
telecommunications companies possess similarities with the Target
Group with respect to their business focus, product offerings,
market position in their respective markets and operational
scale. The implied valuation multiples of the Acquisition are
reasonable when compared to the trading multiples of the above
groups of comparable companies.
(c) Comparable transaction analysis
Comparable transaction analysis must be viewed in the
context of factors that include market dynamics, competitive
differences and significance of stake acquired. In our view and
for the same reasons as stated in the above paragraph, the most
comparable transactions for the Acquisition are China Mobile
(Hong Kong) Limited's acquisition of mobile assets in 8 provinces
("China Mobile Assets") from China Mobile Group in May 2002 and
China Unicom Limited's acquisition of mobile assets in 9
provinces ("Unicom Assets") from China Unicom (BVI) Limited in
November 2002.
Transaction year forecast
-------------------------
P/E
-------------------------
1. China Mobile Assets 12.7
2. Unicom Assets 10.4
3. Target Group (reporting financials) 7.2
4. Target Group (recurring financials) 11.5
Premium/(discount) of (4) to (1) (9.4)%
Premium/(discount) of (4) to (2) 10.6%
The acquisition year (2003) P/E ratio implied by the
purchase price of the Acquisition represents a 9.4% discount to
that of the acquisition of the China Mobile Assets, and a 10.6%
premium to that of the acquisition of the Unicom Assets. The
implied valuation multiples of the Acquisition are reasonable
when compared to the implied multiples of the above comparable
transactions.
(vii) Conditions of the Acquisition
As stated in the Circular, completion of the Acquisition is
conditional upon fulfillment (to the reasonable satisfaction of the
Company), or, in the case of (iii) below, waiver of various conditions
including, among others: (i) the passing of the resolutions by the
Board approving the terms of the Acquisition, the terms of the
Prospective Connected Transactions and the terms of certain
supplemental agreements relating to Existing Connected Transactions,
(ii) the passing of ordinary resolutions by Independent Shareholders
approving the terms of the Acquisition, the terms of certain
Prospective Connected Transactions and the terms of certain
supplemental agreements relating to the Existing Connected
Transactions, (iii) there having been no material adverse change to
the financial conditions, business operations or prospects of the
Target Assets, and (iv) the obtaining of various approvals from
relevant PRC regulatory authorities.
Further details of the conditions to the completion of the
Acquisition are set out in the "Letter from the Chairman" on page 9 of
the Circular.
(viii) Pro forma financial effects to the Company
We have conducted various analyses on the potential financial
effects of the Acquisition on the Company, which were extracted from
or prepared based on the unaudited financial information of the Listed
Group and unaudited pro forma financial information of the Combined
Group as set out in Appendices V and VI to the Circular. It should be
noted that the pro forma figures in the Circular were prepared by the
management of the Listed Group and the Target Group, on the bases and
assumptions as set out in the respective sections of the Appendices to
the Circular.
We summarize in the table below the key financial information of
the Company before and after the completion of the Acquisition, which
we have used in our analysis of the potential financial effects of the
Acquisition on the Company:
Six-month period ended June 30, 2003
before and after the completion
of the Acquisition
------------------------------------
Listed Group Combined Group
------------------- --------------
Operating revenues/1/
RMB million 39,536 57,770
US$ million 4,777 6,980
Operating profit/1/
RMB million 12,198 17,164
US$ million 1,474 2,074
Net profit/(loss)/1/
RMB million 9,260 12,054
US$ million 1,119 1,456
EPS/1/
RMB 0.12 0.16
US$ 0.015 0.019
Total debt
RMB million 23,534 94,878
US$ million 2,843 11,463
Shareholder's equity
RMB million 133,595 119,213
US$ million 16,141 14,403
Total capitalization
RMB million 158,304 215,319
US$ million 19,126 26,015
Total debt/Total capitalization 14.9% 44.1%
1. Based on reporting financials
(a) Earnings
The pro forma earnings per share of the Combined Group for
the six months ended June 30, 2003, would be approximately
RMB0.16 (equivalent to approximately US$0.019), which is
approximately 30.2% higher than the actual earnings per share of
the Listed Group for the same period.
(b) Shareholder's Equity
The pro forma shareholder's equity of the Combined Group as
at June 30, 2003, would be approximately RMB119,213 million
(equivalent to approximately US$14,403 million) compared to
RMB133,595 million (equivalent to approximately US$16,141
million) of the Listed Group as at the same date.
(c) Gearing
The pro forma total debt of the Combined Group would be
approximately RMB94,878 million (equivalent to approximately
US$11,463 million) as at June 30, 2003, representing an increase
of about 303.2% from the total debt of approximately RMB23,534
million (equivalent to approximately US$2,843 million) of the
Listed Group at the same date. On a pro forma basis, the total
debt to total capitalization ratio would increase from 14.9% to
approximately 44.1%, which remains at a reasonable level compared
to certain other telecommunications companies which we looked at
for comparison purposes.
(ix) Arrangements relating to Reorganization
Pursuant to the Reorganization, an account payable of US$47.4
million due from the Target Group to the Parent was created. As the
maintenance of this account payable would have constituted a connected
transaction after the completion of the Acquisition, the Company has
undertaken to the Stock Exchange to cause the entire amount of the
account payable of US$47.4 million to be repaid to the Parent using
their internal cash resources on the next business day following the
completion of the Acquisition. We believe that the repayment of the
above mentioned account payable to the Parent will not have a material
negative impact on the Company's financial position. Further details
of the account payable and its repayment are set out in the "Letter
from the Chairman" on page 17 of the Circular.
(2) The Supplemental Agreements and the Prospective Connected Transactions
As a result of the Acquisition and in order to allow certain services
to be provided as between the Target Assets and the Parent Group post the
Acquisition, the Target Group has entered into certain operating and other
agreements with the Parent and/or its subsidiaries/Associates (other than
the Company, its subsidiaries, and the Target Group). As stated in the
"Letter from the Chairman" in the Circular, the Prospective Connected
Transactions are identical in nature and substance to the corresponding
Existing Connected Transactions. The Prospective Connected Transactions
will constitute connected transactions for the Company under the Hong Kong
Listing Rules and require the approval of the Independent Shareholders of
the Company.
As, among other things, noted in the "Letter from the Chairman" in the
Circular, the Independent Board Committee is of the opinion that the
Prospective Connected Transactions have been entered into, and will be
carried out, in the ordinary and usual course of business of the Combined
Group and on normal commercial terms which are fair and reasonable so far
as the interests of the Independent Shareholders are concerned. The Company
expects the transactions contemplated under the interconnection agreement,
engineering agreements, community services agreements and ancillary
telecommunications services agreements to occur on a regular and continuous
basis in the ordinary and usual course of business. The Company has applied
to the Stock Exchange for the Waiver, which is expected to combine certain
Existing Connected Transactions such as interconnection agreement,
engineering agreements, community services agreements and ancillary
telecommunications services agreements, waivers of which were granted by
the Stock Exchange in its letter dated October 28, 2002, with the
corresponding Prospective Connected Transactions so that the waivers in
respect of annual monetary limits of certain Existing Connected
Transactions may be aggregated with those of the corresponding Prospective
Connected Transactions. The Prospective Connected Transactions which do not
fall within the above will be
governed by Rule 14.25(1) of the Hong Kong Listing Rules. Under Rule
14.25(1) of the Hong Kong Listing Rules, the Company is required to make a
press announcement disclosing each transaction and publish details of the
transactions in the Company's published annual report and accounts for so
long as such transaction is in place. The Stock Exchange has indicated that
the granting of the Waiver, which when granted is expected to be effective
from January 1, 2004 until December 31, 2005, will be subject to, among
other things, (i) approval by the Independent Shareholders at the
Extraordinary General Meeting and (ii) the Company complying with such
other conditions stated in the "Letter from the Chairman" on pages 27 to 31
of the Circular.
It should be noted that certain services under the Prospective
Connected Transactions are charged in accordance with the tariffs/standards
set or guided by the Chinese regulatory authorities. Where the charges are
not set or guided by the Chinese regulatory authorities, they are based on
market rates charged by independent third party providers for the same or
similar services in the ordinary and usual course of business or obtained
through a public tender process, or are based on reasonable cost or
reasonable cost plus a reasonable margin as negotiated on an arm's length
basis between the relevant parties. In respect of the Prospective Connected
Transactions, the Listed Group and/or the Target Group have received
undertakings from the Parent Group that the terms of the services provided
to the Listed Group and/or the Target Group will not be less favourable
than the same or similar services provided to any third parties. With
respect to certain services under the Prospective Connected Transactions,
the Listed Group and/or the Target Group have also agreed that if the terms
of the offers from independent third party providers are not more favorable
than that from the Parent Group, the Listed Group and/or the Target Group
may accord priority to the Parent Group to provide such services. We
understand from the Company that this forms an important basis for the
Listed Group and/or the Target Group in entering into the Prospective
Connected Transactions.
Furthermore, it should be noted that the Prospective Connected
Transactions listed under category (a) below are merely an extension of the
existing arrangements between the Company and the Parent, which have been
fully disclosed in the Company's Prospectus and in respect of which a
waiver has already been obtained at the time of its initial public
offering. Although certain amendments have been made to the original
agreements, such amendments do not materially change the nature of the
terms of these agreements. Further, although the Prospective Connected
Transactions under category (b) below are entered into as new agreements,
similar arrangements for the existing operating subsidiary(ies) of the
Company (as the case may be) already exist and were fully disclosed in the
Prospectus and in respect of which a waiver has already been obtained at
the time of the Company's initial public offering.
We set out below a summary of each of the Supplemental Agreements and
the Prospective Connected Transactions.
(a) Ongoing connected transactions between the Company and the Parent
In anticipation of the Acquisition, the Company has entered into
various agreements with the Parent relating to the mutual provision of
ongoing telecommunications and other services.
(i) Supplemental Trademark License Agreement
On October 26, 2003, the Company and the Parent entered into
the Supplemental Trademark License Agreement in relation to the
trademark license agreement entered into by the same parties on
September 10, 2002, which granted to the Combined Group the right
to use certain trademarks currently used by the Parent in the
provision of its telecommunications services on a royalty-free
basis. The Supplemental Trademark License Agreement extends the
scope of the licensees to include the Target Companies and
expands the list of trademarks as set out in the original
trademark license agreement to include additional trademarks.
Furthermore, the Supplemental Trademark License Agreement extends
the term of the original license from December 31, 2004 to
December 31, 2005, after which the license will be automatically
renewed for further periods of three years unless the Company
provides three months' written notification to the Parent of its
intention not to renew the agreement at the expiration of the
current term of the agreement. Further information on the
original agreement and the supplemental agreement is set out in
the Prospectus and the "Letter from the Chairman" in the
Circular, respectively.
(ii) Supplemental Agreement Relating to Centralized Services, Interconnection,
Optic Fibres Leasing and Non-competition Agreement
On October 26, 2003, the Company and the Parent entered into
the Supplemental Connected Transactions Agreement in relation to
the centralized services agreement, the interconnection
agreement, the optic fibre leasing agreement and the
non-competition agreement entered into by the same parties on
September 10, 2002. The Supplemental Connected Transactions
Agreement extends the scope of the four agreements to cover the
Target Companies where the provisions of these four agreements
are applicable to the Company's subsidiaries existing at any one
time.
Centralized services
The Supplemental Connected Transactions Agreement
modifies the scope of the centralized services to include
sharing the use and costs of headquarters and certain
network support premises and related facilities such as
air-conditioning, electricity and certain ancillary
facilities, amends the scope of international
telecommunications facilities to include international land
cables, and related domestic extended portions and extends
the terms of the original centralized services from December
31, 2004 to December 31, 2005. Apart from the above, there
are no other amendments to the terms and conditions of the
original centralized services agreement.
The costs of the centralized services such as the
management of large enterprise customers, network management
center, business support center by the Company and sharing
the use of headquarters, international gateways and certain
other premises together with costs such as labor costs,
depreciation of equipment and premises, daily expenses,
costs relating to maintenance and research shall be
apportioned between the Parent and the Company on a per
annum basis according to the proportion of their respective
incomes. Income is an appropriate basis for
allocating such costs because the above services benefit the
entire businesses of the Parent and the Company. The costs
of international telecommunications facilities shall be
apportioned between the Parent and Company on a per annum
basis based on the proportion of their respective call
volumes. Call volume is an appropriate basis for allocating
such costs because it reflects the extent of each party's
usage of the shared facilities. Further information on the
original agreement and the supplemental agreement, including
the historical amounts of such connected transaction, is set
out in the Prospectus and the "Letter from the Chairman" of
the Circular, respectively.
Interconnection
The Supplemental Connected Transactions Agreement
extends the term of the original interconnection agreement
from December 31, 2004 to December 31, 2005. Apart from the
above, there are no other amendments to the terms and
conditions of the original interconnection agreement.
The formula for settlement under the interconnection
agreement shall be based on the net volume of calls between
the parties multiplied by the government prescribed
settlement fee, which is currently RMB0.06 per minute. Such
a settlement method is consistent with the standard practice
of the industry. Further information on the original
agreement and the supplemental agreement, including the
historical amounts of such connected transaction, is set out
in the Prospectus and the "Letter from the Chairman" in the
Circular, respectively.
Optic fibres leasing
The Supplemental Connected Transactions Agreement
extends the term of the original optic fibres leasing
agreement from December 31, 2004 to December 31, 2005. Apart
from the above, there are no other amendments to the terms
and conditions of the original optic fibres leasing
agreement.
The leasing cost of the optic fibres shall be equal to
the 10-year depreciation amount for the optic fibres
calculated on the basis of the carrying value of the optic
fibres, which is consistent with the Company's own
depreciation policy for optic fibres. Further information on
the original agreement and the supplemental agreement,
including the historical amounts of such connected
transaction, is set out in the Prospectus and the "Letter
from the Chairman" of the Circular, respectively.
Non-competition agreement
To be in line with an amendment to the Directory of
Categorization of Telecommunication Services (the
"Directory") promulgated by the MII on February 21, 2003,
the Supplemental Connected Transactions Agreement amends the
definition of "basic telecommunication services" to include
3G businesses. Furthermore, it also amends the meaning of
the expression "value-added telecommunications services" in
order to bring it in line with the Directory. Apart from the
above, there are no other material amendments to the terms
and conditions of the original letter of undertakings.
Further information on the original agreement and the
supplemental agreement is set out in the Prospectus and the
"Letter from the Chairman" in the Circular, respectively.
(b) Ongoing connected transactions between subsidiaries of the
Company and subsidiaries/Associates of the Parent
After the Reorganization, certain ancillary, and mostly
non-telecommunications related businesses and assets of the Parent
Group within the Target Service Areas, continue to be operated or held
by certain subsidiaries and/or Associates of the Parent (the
"Provincial Subsisting Companies"). The Target Companies have entered
into various agreements with the Provincial Subsisting Companies
relating to the provision of certain services by the latter.
(i) Engineering agreements
The Target Companies and the Provincial Subsisting Companies
have entered into the Engineering Framework Agreements to govern
the arrangements with respect to certain engineering related
services. The terms of the agreements have retrospective effect
from January 1, 2003 and are to expire on December 31, 2005, but
will be automatically renewed for further periods of three years
unless a Target Company provides three months' written
notification to the relevant Provincial Subsisting Company of its
intention not to renew its agreement.
The charges payable for engineering related services
rendered shall be determined by reference to market rates as
reflected by prices obtained through the tender process.
According to the relevant PRC regulations and under the Company's
internal policy, whenever the value of any engineering design and
supervision project exceeds RMB500,000, or the value of any
engineering construction project exceeds RMB2 million, the award
of the project is required to be the subject of a tender process
(with a minimum of three parties tendering bids) in accordance
with relevant laws. The Target Companies do not accord any
priority to any of the Provincial Subsisting Companies to provide
such services, and the tender may be awarded to an independent
third party. However, if the terms of an offer from a Provincial
Subsisting Company are at least as favourable as those offered by
another tenderer, the Target Companies may give priority to the
Provincial Subsisting Company. Penalty charges will be payable by
the Target Company if it fails to settle the fee payable under
the agreement when such fee becomes due.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of engineering
related services similar to those proposed in the Engineering
Framework Agreements which form part of the Existing Connected
Transactions. Further information on the ongoing and prospective
arrangements, including the historical amounts of such connected
transaction, is set out in the Prospectus and the "Letter from
the Chairman" in the Circular, respectively.
(ii) Property leasing agreements
The Target Companies and the Provincial Subsisting Companies
have entered into the Property Leasing Framework Agreements to
govern the arrangements with respect to the leasing of properties
by the Target Group from the Provincial Subsisting Companies and
by the Provincial Subsidiary Companies from the Target Companies.
The terms of the agreements have retrospective effect from
January 1, 2003 and are to expire on December 31, 2005, but will
be automatically renewed for further periods of three years
unless a Target Company provides three months' written
notification to the relevant Provincial Subsisting Company of its
intention not to renew its agreement.
The rental charges in respect of each property shall be
based on market rates, with reference to amounts stipulated by
local price bureaus, taking into consideration the specific needs
of the telecommunications industry when leasing the relevant
properties. Rental charges are subject to review every three
years. Penalty charges will be payable by the tenant if it fails
to settle the rental charge payable under the agreement when such
rental charge becomes due.
As stated in the "Letter from the Chairman", Chesterton, an
independent appraiser appointed by the Company for the purpose of
the Acquisition, has reviewed the Property Leasing Framework
Agreements and has confirmed that the rental charges payable
under the Property Leasing Framework Agreements are fair and
reasonable so far as the Target Companies are concerned, and do
not exceed market rates in respect of both properties leased to
and from the Target Companies.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of mutual leasing
of properties similar to those proposed in the Property Leasing
Framework Agreements and they form part of the Existing Connected
Transactions. Further information on the ongoing and prospective
arrangements, including the historical amounts of such connected
transaction, is set out in the Prospectus and the "Letter from
the Chairman" in the Circular, respectively.
(iii) Sub-leasing of third party properties
The Target Companies and the Provincial Subsisting Companies
have entered into the Third Party Properties Sub-leasing
Agreement to govern the arrangements relating to third-party
property sub-leases by the Target Group from the Provincial
Subsisting Companies. The terms of the agreements have
retrospective effect from January 1, 2003 and are to expire on
December 31, 2005, but will be automatically renewed for further
three-year periods unless a relevant Target Company provides
three months' written notification to the relevant Provincial
Subsisting Company of its intention not to renew its agreement.
The amounts payable by the Target Group to the Provincial
Subsisting Companies shall be the same as the amounts payable by
the Provincial Subsisting Companies to the relevant third
parties. The Provincial Subsisting Companies represent that they
will not make any profit from such sub-leases, and the rental
charges for the Third Party Properties are negotiated between the
Provincial Subsisting Companies and the relevant third parties on
an arm's length basis.
As stated in the "Letter from the Chairman", Chesterton, an
independent appraiser appointed by the Company for the purpose of
the Acquisition, has confirmed that the rental charge payable for
each of the Third Party Property under the Third Party Properties
Sub-leasing Agreements is fair and reasonable so far as the
Target Group is concerned, and does not exceed market rents.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of mutual leasing
of properties similar to those proposed in the Third Party
Properties Sub-leasing Framework Agreements which form part of
the Existing Connected Transactions. Further information on the
ongoing and prospective arrangements, including the historical
amounts of such connected transaction, is set out in the
Prospectus and the "Letter from the Chairman" of the Circular,
respectively.
(iv) IT service agreements
The Target Companies and the Provincial Subsisting Companies
have entered into the IT Services Framework Agreements in each of
the Target Service Areas to govern the arrangements with respect
to provision of certain IT services to the Target Group by the
Provincial Subsisting Companies. The terms of the agreements have
retrospective effect from January 1, 2003 and are to expire on
December 31, 2005, but will be automatically renewed for further
periods of three years unless a Target Company provides three
months' written notification to the relevant Provincial
Subsisting Company of its intention not to renew its agreement.
The charges payable for IT services rendered shall be
determined by reference to market rates as reflected by prices
obtained through the tender process (with a minimum of three
parties tendering bids) in accordance with relevant laws. The
Target Companies does not accord any priority to any of the
Provincial Subsisting Companies to provide such services, and the
tender may be awarded to an independent third party. However, if
the terms of an offer from a Provincial Subsisting Company are at
least as favourable as those offered by a third-party tenderer,
the Target Companies may give priority to the Provincial
Subsisting Company. Penalty charges will be payable by the Target
Company if it fails to settle the charge payable under the
agreement when such charge becomes due.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of IT services
similar to those proposed in the IT Services Framework Agreements
and they form part of the Existing Connected Transactions.
Further information on the ongoing and prospective arrangements,
including the historical amounts of such connected transaction,
is set out in the Prospectus and the "Letter from the Chairman"
in the Circular, respectively.
(v) Equipment procurement service agreements
The Target Companies and the Provincial Subsisting Companies
have entered into the Equipment Procurement Framework Agreements
in each of the Target Service Areas to govern the arrangements
with respect to provision of certain equipment procurement
services to the Target Group by the Provincial Subsisting
Companies. The terms of the agreements have retrospective effect
from January 1, 2003 and are to expire on December 31, 2005, but
will be automatically renewed for further periods of three years
unless a Target Company provides three months' written
notification to the relevant Provincial Subsisting Company of its
intention not to renew its agreement.
The commission charges for these services are calculated at
the maximum rate of: (i) 1% of the contract value, in the case of
imported telecommunications equipment; or (ii) 1.8% of the
contract value, in the case of domestic telecommunications
equipment and other domestic non-telecommunications materials.
Furthermore, if the terms of an offer from a Provincial
Subsisting Company are at least as favorable as those offered by
a third-party tenderer, the Target Companies may give priority to
the Provincial Subsisting Company. Penalty charges will be
payable by the Target Company if it fails to settle the
commission payable under the agreement when such commission
becomes due.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of equipment
procurement services similar to those
proposed in the Equipment Procurement Framework Agreements and
they form part of the Existing Connected Transactions. Further
information on the ongoing and prospective arrangements,
including the historical amounts of such connected transaction,
is set out in the Prospectus and the "Letter from the Chairman"
in the Circular, respectively.
(vi) Community services agreements
The Target Companies and the Provincial Subsisting Companies
have entered into the Community Services Framework Agreements in
respect of each of the Target Service Areas to govern the
arrangements relating to the provision of certain community
services to the Target Group by the Provincial Subsisting
Companies. The terms of the agreements have retrospective effect
from January 1, 2003 and are to expire on December 31, 2005, but
will be automatically renewed for further periods of three years
unless terminated by either party with at least three months'
written notification to the other party. However, if the Target
Companies cannot, without incurring significant cost and expense,
obtain these services from a third party after such termination,
the Provincial Subsisting Companies cannot terminate the
provision of such services.
The above community services are provided at:
(1) the government-prescribed price;
(2) where there is no government-prescribed price but where
there is a government-guided price, the
government-guided price applies;
(3) where there is neither a government-prescribed price
nor a government-guided price, the market price,
defined as the prices offered by independent third
parties for providing same type of services in the
ordinary course of business; or
(4) where none of the above is applicable, the price is to
be agreed between the relevant parties, which shall be
the reasonable cost incurred in providing the services
plus a reasonable profit margin (for this purpose,
"reasonable costs" means such costs as confirmed by
both parties after negotiations).
Furthermore, if the terms of an offer from a Provincial
Subsisting Company are at least as favorable as those offered by
a third-party tenderer, the Target Companies may give priority to
the Provincial Subsisting Company. Penalty charges will be
payable by the Target Company if it fails to settle the fee
payable under the agreement when such fee becomes due.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of community
services similar to those proposed in the Community Services
Framework Agreements and they form part of the Existing Connected
Transactions. Further information on the ongoing and prospective
arrangements, including the historical amounts of such connected
transaction, is set out in the Prospectus and the "Letter from
the Chairman" in the Circular, respectively.
(vii) Ancillary telecommunications services agreements
The Target Companies and the Provincial Subsisting Companies
have entered into the Ancillary Telecommunications Services
Framework Agreements in respect of each of the Target Service
Areas to govern the arrangements relating to the provision of the
Ancillary Telecommunications Services to the Target Group by the
Provincial Subsisting Companies. The terms of the agreements have
retrospective effect from January 1, 2003, and are to expire on
December 31, 2005, but will be automatically renewed for further
periods of three years unless terminated by either party with at
least three months' written
notification to the other party. However, if the Target Companies
cannot, without incurring significant cost and expense, obtain
these services from a third party, the Provincial Subsisting
Companies cannot terminate the provision of such services.
The pricing policy of the Ancillary Telecommunications
Services Framework Agreement is the same as that of the Community
Services Framework Agreement. Furthermore, if the terms of an
offer from a Provincial Subsisting Company are at least as
favourable as those offered by a third-party tenderer, the Target
Companies may give priority to the Provincial Subsisting Company.
Penalty charges will be payable by the Target Company if it fails
to settle the fee payable under the agreement when such fees
becomes due.
Currently, the Listed Group and the Provincial Subsisting
Companies have on-going arrangements in respect of ancillary
telecommunications services similar to those proposed in the
Ancillary Telecommunications Services Framework Agreements and
they form part of the Existing Connected Transactions. Further
information on the ongoing and prospective arrangements,
including the historical amounts of such connected transaction,
is set out in the Prospectus and the "Letter from the Chairman"
in the Circular, respectively.
The Stock Exchange has indicated that one of the conditions for granting
the Waiver is that, if applicable, the annual aggregate value of each category
of the connected transactions in 2004 and 2005 does not exceed the relevant
annual limits proposed by the Company set out below:
(i) Engineering agreements -- not exceeding RMB7,020 million for the
Combined Group (previously RMB4,392 million for the Listed Group);
(ii) Community Services agreements -- not exceeding RMB3,410 million for
the Combined Group (previously RMB2,639 million for the Listed
Group);
(iii) Ancillary Telecommunications Services agreements -- not exceeding
RMB2,640 million for the Combined Group (previously RMB1,510 million
for the Listed Group).
No upper limit will be imposed (as previously granted) for the
interconnection agreement. As stated in the "Letter from the Chairman", each of
the transactions contemplated under the other agreements is on normal commercial
terms in which the total consideration or value is not expected to exceed 3% of
the book value of the net tangible assets of the Company as at December 31,
2002. Under Rule 14.25(1) of the Hong Kong Listing Rules, the Company is
required to make a press announcement disclosing each transaction and publish
details of the transaction in the Company's published annual report and accounts
for so long as such transaction is in place.
We have discussed with the management the basis for setting the respective
monetary limits for the Prospective Connected Transactions, as well as the
reasons for not imposing a monetary limit on certain Prospective Connected
Transactions.
The Company is of the following view with respect to the monetary limit for
the provision of engineering related services pursuant to the engineering
agreements. The increase of the relevant existing monetary limits is due to (i)
an increase in the business volume of the Combined Group following the
acquisition of the business of the Target Group by the Company, which on a pro
forma basis for the six months ended June 30, 2003 would have resulted in a
revenue increment of 46.2%, (ii) the varied landscape of the Target Service
Areas required specialized expertise to carry out engineering work and there are
very few third parties which can offer comparable services in terms of quality
and fees, (iii) further expansion of the telecommunications business of the
Listed Group in 2005, and (iv) the Target Service Areas are generally less
developed than the Listed Service Areas and therefore there is a greater need
for engineering works in the Target Service Areas as the business there has
greater scope for expansion.
The Company is of the following view with respect to the monetary limit for
the provision of community services pursuant to the community services
agreements. The increase of the relevant existing monetary limits is due to (i)
an increase in the business volume of the Combined Group following the
acquisition of the business of the Target Group by the Company, which on a pro
forma basis for the six months ended June 30, 2003 would have resulted in a
revenue increment of 46.2%, and (ii) corresponding business expansion of the
Listed Group, the change in operations of Shanghai Telecom from the purchase of
all office equipment to the leasing of all office equipment from connected
persons, the increase in the number of properties required by the Listed Group
for its business needs and the subsequent increase in property management fees.
The Company is of the following view with respect to the monetary limit for
the provision of ancillary services pursuant to the ancillary telecommunications
services agreements. The increase of the relevant existing monetary limits is
due to (i) an increase in the business volume of the Combined Group following
the acquisition of the business of the Target Group by the Company, which on a
pro forma basis for the six months ended June 30, 2003 would have resulted in a
revenue increment of 46.2%, (ii) the rapid expansion of the customer base of the
telecommunications business of the Listed Group over the next few years, and
(iii) due to the Reorganization of the Target Group, certain detailed
arrangements in relation to the provision of ancillary services are expected to
be put in place over a period of time and therefore the transaction volumes of
such connected transactions are expected to increase rapidly after the year
ended December 31, 2002.
We note that it is stated in the "Letter from the Chairman" contained in
the Circular that (i) in determining the proposed annual limits of the
Prospective Connected Transactions for the Combined Group, the Board has
considered the relative size of the total assets and operating revenues of the
Target Group against the Listed Group, the budget of the Combined Group in terms
of capital expenditures, general and administrative expenses and sales and
maintenance expenses, and (ii) the Board is of the view that the monetary limits
are set so as to (a) not hinder the ability of the Combined Group to conduct its
business in the ordinary and usual course and (b) allow the Combined Group to
benefit from future growth. Based solely on the Board's view, as stated in the
"Letter from the Chairman", we consider the above monetary limits to be
reasonable in the circumstances insofar as the Independent Shareholders are
concerned.
With respect to the lack of a monetary limit for services to be provided
pursuant to the interconnection agreement (under the Supplemental Connected
Transactions Agreement), the Company has informed us that the volume of the
provided services will depend on the actual usage volume by the customers of the
Listed Group and the Parent Group, which is beyond the control of the Company.
In addition, we understand that the pricing standard under the interconnection
agreement has been set by reference to the relevant rates prescribed by the
Chinese regulatory authorities, and that the Company will also be required to
comply with certain requirements in relation to such connected transactions
(including the disclosure of details of such connected transactions in the
Company's annual reports and reviews by the independent directors and the
auditors of the Company). Based on the foregoing, we consider that, in the
context of the Waiver, the lack of a monetary limit for services to be provided
pursuant to the interconnection agreement is reasonable insofar as the
Independent Shareholders are concerned.
We consider that the terms of the Supplemental Agreements and the terms of
the Prospective Connected Transactions are fair and reasonable from a financial
point of view insofar as the Independent Shareholders are concerned based on:
(i) the Board has represented that the transactions contemplated under
the Supplemental Agreements and the Prospective Connected
Transactions are expected to be conducted in the ordinary and usual
course of business, and on normal commercial terms;
(ii) the charges of the transactions contemplated under the Supplemental
Agreements and the Prospective Connected Transactions were determined
based on one of the following methods: tariffs/standards set or
guided by the Chinese regulatory authorities, or by reference to
market
rates, or are based on reasonable cost or reasonable cost plus
reasonable margin as negotiated on an arm's length basis between the
relevant parties;
(iii) the Listed Group and/or the Target Group have received undertakings
from the Parent Group that the terms of the services provided to the
Listed Group and/or the Target Group will not be less favourable than
the same or similar services provided to any third parties, where
such third parties exist;
(iv) the independent appraiser, Chesterton, has confirmed that the rental
charges payable under relevant lease and sub-lease agreements are
fair and reasonable so far as the Target Group is concerned, and do
not exceed market rates; and
(v) the Prospective Connected Transactions are identical in nature and
substance to the corresponding Existing Connected Transactions.
SUMMARY
Having considered the above principal factors and reasons, we draw your
attention to the following key factors in arriving at our opinion (based on the
results of all analyses taken as a whole):
(a) the Board's view that the Acquisition will enhance the Company's
market position, improve its growth prospect, enable it to achieve
significant operating synergy, result in substantial earnings
accretion and improve its capital efficiency;
(b) the representation made by the Board that the Acquisition was
negotiated and entered into on an arm's length basis and on normal
commercial terms, the purchase price payable by the Company for the
Target Assets and the other terms of the Acquisition are, in the
Board's opinion, fair and reasonable as well as the terms of the
deferred consideration are more attractive to the Company than the
usual terms of a commercial bank loan of a similar amount and tenure,
and the Acquisition is in the best interests of the Company and its
Shareholders;
(c) the valuation of the Target Assets implied by the purchase price of
the Acquisition and net debt assumed for the Acquisition: (i) is at a
discount to the range of our DCF analysis, (ii) represents a discount
to the relevant trading multiples of the Company and is reasonable
when compared to those of other comparable companies, and (iii) is
reasonable in the context of multiples implied by recent comparable
transactions;
(d) the Board is of the opinion that the transactions contemplated under
the Supplemental Agreements and the Prospective Connected
Transactions have been entered into, and will be carried out, in the
ordinary and usual course of business of the Combined Group and on
normal commercial terms;
(e) the pricing of the Prospective Connected Transactions and the
Existing Connected Transactions were determined based on one of the
following methods: tariffs/standards set or guided by the Chinese
regulatory authorities, or by reference to market rates, or are based
on reasonable cost or reasonable cost plus reasonable margin as
negotiated on an arm's length basis between the relevant parties.
Furthermore, the Prospective Connected Transactions are identical in
nature and substance to the corresponding Existing Connected
Transactions;
(f) the Waiver, when approved by the Exchange, is expected to be (i)
effective until December 31, 2005 and (ii) subject to, among other
things, the Company complying with such other conditions stated in
the "Letter from the Chairman" on pages 27 to 31 of the Circular;
(g) if any of the values of the Prospective Connected Transactions
exceeds the relevant monetary limits or if any of the terms of the
agreements related to the transactions, or the nature of the
transaction is altered (unless as provided for under the terms of the
relevant agreement) or if the Combined Group enters into any new
agreements with connected persons in the future, the Company will
need to comply fully with all the relevant provisions of Chapter 14
of the Hong Kong Listing Rules dealing with connected transactions;
(h) the Acquisition Agreement includes warranties in favor of the Company
and provisions providing for liability for breach of the warranties;
and
(i) the Company has the right to terminate the Acquisition Agreement if,
among other events, a material adverse change takes place at any time
after signing of the Acquisition Agreement and before the completion
of the Acquisition.
OPINION
Based upon and subject to the foregoing, we consider as the date hereof
that the terms of the Acquisition, the Supplemental Agreements and the
Prospective Connected Transactions are fair and reasonable, from a financial
point of view, insofar as the Independent Shareholders are concerned.
This letter is provided to the Independent Board Committee of the Company
in connection with and for the purposes of its evaluation of the Acquisition,
the transactions contemplated under the Supplemental Agreements and the
Prospective Connected Transactions. This opinion may not be disclosed, referred
to, or communicated (in whole or in part) to any third party for any purpose
whatsoever except with our prior written approval. This opinion may be
reproduced in full in the Circular but may not otherwise be disclosed publicly
in any manner without our prior written approval.
Yours faithfully,
For and on behalf of
J.P. Morgan Securities (Asia Pacific) Limited
Todd R. Marin
Managing Director
/9/Industry Background
The telecommunication industry in China has experienced rapid growth in
recent years. According to the MII, the total number of wireline access lines in
service increased from 144.8 million as of the end of 2000 to 214.4 million as
of the end of 2002, representing a compound annual growth rate of 21.7%.
Wireline telephone penetration rate increased from 11.4% to 16.7% during the
same period. As a result of the increasing demand for information services and
technology development, the market for data communications and Internet services
in China also experienced rapid growth during that period. The number of
Internet users in China increased from 22.5 million as of the end of 2000 to
49.7 million as of the end of 2002, representing a compound annual growth rate
of 48.6%.
The following table sets forth certain information relating to the
telecommunications and information industry in China as of the dates indicated.
----------
/9/14.30(5)
14.14(4)
14.16(7)
14.16(8)
As of December 31, Compound Annual
Growth Rate
------------------------ ---------------
2000 2001 2002 (2000-2002)
----- ------ ------- ---------------
China's population (in millions) 1,267 1,276 1,285 0.7%
China's GDP per capita (RMB) 7,081 7,543 8,184 7.5%
Wireline telephone
Access lines in service (in
millions) 144.8 180.4 214.4 21.7%
Penetration rate/(1)/ 11.4% 14.1% 16.7% --
Internet
Users (in millions) 22.5 33.7 49.7 48.6%
Penetration rate/(1)/ 1.8% 2.6% 3.9% --
(1) Determined by dividing the number of access lines in service or users
by the total population of China.
Sources: Data in respect of China's population and GDP per capita, which is
calculated at current prices, are derived from information published by the
National Statistical Bureau; data in respect of wireline access lines in
service are derived from information published by the MII; data in respect
of Internet users of 2000 and 2001 are derived from information published
by China Internet Network Information Centre, or CNNIC, and that of 2002
are derived from information published by the MII.
The Parent and the Company face competition from other telecommunications
service providers, such as China Netcom Group, China Mobile, China Unicom and
China Railcom in their wireline telephone, data, Internet, and leased line
services. All of the principal competitors are wholly or majority owned by the
Chinese government. The government encourages orderly and fair competition in
the telecommunications industry in China. Currently, providers of basic
telecommunications services (see Appendix II, "Regulations -- Licensing" for
definitions of "basic telecommunications services") must apply for a license
from the MII. Only a limited number of providers have obtained licenses to
provide basic telecommunications services in China.
Market Environment of the Target Group
The Target Service Areas accounted for 18.9% of the total GDP of China in
2002, with a compound annual growth rate of GDP of 9.3% from 2000 to 2002. The
wireline penetration rate in the Target Service Areas reached 13.4% as of
December 31, 2002. The penetration rate in these service regions is relatively
low compared to that in the Listed Service Areas. The Board believes this will
enhance growth potential for the Company.
The map below indicates the Target Service Areas, which consist of Anhui
province, Fujian province, Jiangxi province, Guangxi Zhuang autonomous region,
Chongqing municipality and Sichuan province, as well as the Listed Service
Areas. The accompanying table sets out selected demographic and market
information related to these service areas and the whole country as of or for
the year ended December 31, 2002, unless otherwise indicated.
\raster(95%,p)="China_Map"
Target
Service
Areas China
------- --------
Population (in millions) 303 1,285
GDP per capita (RMB)/(1)/ 6,538 8,184
2000-2002 compound annual growth rate of GDP/(1)/ 9.3% 8.2%
Wireline telephone penetration rate/(2)/ 13.4% 16.7%
Number of Internet subscribers (in thousands) 7,569/(3)/ 49,700/(4)/
Internet penetration rate/(5)/ 2.5% 3.9%
(1) GDP is calculated at current prices.
(2) Calculated by dividing the number of wireline access lines in service
by the relevant population.
(3) Excludes inactive subscribers, who have registered accounts with the
Target Group but have not used the Target Group's Internet access
services.
(4) Includes inactive subscribers.
(5) Calculated by dividing the number of Internet subscribers by the
relevant population.
Sources: Data in respect of China's population, 2002 GDP per capita, 2000
to 2002 compound annual growth rate of GDP and wireline telephone
penetration rate of China are derived from information published by the
National Statistical Bureau and MII; data in respect of wireline access
lines in service are derived from information provided by Provincial
Telecommunications Administrations in the Target Service Areas; and data in
respect of Internet users are derived from information published by the
MII.
Overview of the business of the Target Group
The Target Group is the leading provider of wireline telephone, data,
Internet and leased lines services in its service regions. The following table
sets forth the percentages of contribution by the Target Group's different
services to its total operating revenues for the periods indicated:
Six months
Year ended ended
------------------------ ----------
December 31, June 30,
------------------------ ----------
2001 2002 2003
---------- ---------- ----------
Wireline telephone services:
Local
Installation fees 1.5% 1.7% 1.8%
Monthly fees 16.0% 19.2% 20.2%
Local usage fees 36.0% 35.3% 34.3%
Domestic long distance/(1)/ 18.6% 16.9% 16.1%
International long distance/(1)(2)/ 1.2% 1.2% 1.1%
Interconnection 4.7% 4.6% 5.1%
Upfront connection fees 8.2% 7.5% 6.4%
---------- ---------- ----------
Sub-total 86.2% 86.4% 85.0%
Data and Internet services:
Internet/(3)/ 2.0% 3.3% 4.6%
Managed data/(4)/ 1.8% 1.9% 1.7%
---------- ---------- ----------
Sub-total 3.8% 5.2% 6.3%
Leased line services 3.7% 3.3% 3.1%
Other services/(5)/ 6.3% 5.1% 5.6%
---------- ---------- ----------
Total operating revenue
of the Target Group 100.0% 100.0% 100.0%
========== ========== ==========
(1) Includes revenue from VoIP long distance services.
(2) Includes revenue from calls to Hong Kong, Macau and Taiwan.
(3) Includes revenue from dial-up, dedicated and broadband Internet access
services as well as value-added data services.
(4) Includes revenue from DDN, frame relay and ATM services.
(5) Include revenue from value-added voice services and sales and maintenance of
customer-end equipment, and lease of telecommunications network facilities.
Wireline Telephone Services
The wireline telephone services of the Target Group consist of local
telephone, domestic and international long distance and interconnection
services.
Wireline telephone services are the Target Group's main services,
generating 86.4% of its total operating revenue in 2002. Revenue generated by
these services in the Target Service Areas increased from RMB27,546 million in
2001 to RMB29,420 million in 2002 and reached RMB15,519 million in the six
months ended June 30, 2003. The demand for value-added voice and information
services has also increased in recent years. The Target Group's wireline
telephone services will continue to provide steady revenue stream and drive the
overall earnings growth of the Combined Group.
Local Telephone Services
The local telephone services in the Target Service Areas have grown
significantly in terms of number of access lines in service in recent years,
representing the largest revenue source for the wireline telephone services of
the Target Group and contributing 56.2% of its total operating revenue in 2002
and 56.3% in the six months ended June 30, 2003, as compared to 53.5% in 2001.
Access lines. The following table sets out selected information regarding
the local telephone services of the Target Group as of the dates indicated:
As of
As of December 31, June 30,
------------------- ------------
2000 2001 2002 2003
------------------- ---------- ----------- ------------
(in thousands,
except percentages)
Number of access lines in service/(1)/:
Residential 20,800 26,166 30,165 32,663
Enterprise 3,350 3,664 3,931 3,849/(2)/
Public telephones 1,006 1,265 1,783 2,029
Wireless local access 283 1,260 4,049 6,532
------------------- ---------- ----------- ------------
Total/(3)/ 25,440 32,356 39,929 45,073
Wireline telephone penetration rate 8.5% 10.8% 13.4% 15.1%/(4)/
Market share measured by number of
access lines in service/(5)/ 99.7% 99.3% 98.6% 98.3%
(1) Includes ISDN lines as measured by the number of bearer channels.
(2) The decline in the number of access lines in service for enterprise
subscribers from 3.9 million ended December 31, 2002 to 3.8 million
ended June 30, 2003 is due to an elimination of inactive enterprise
subscribers.
(3) The total number of access lines in service is different with the sum
of all kinds of access lines because of rounding discrepancies.
(4) Population used for calculating the penetration rate is estimated
based on the population as of the end of 2002, and assuming that the
growth rate in the first half of 2003 is the same as the growth rate
in 2002.
(5) Sources: Data in respect of the number of the Target Group's access
lines in service are provided by the Target Group. Data in respect of
the total number of access lines in the Target Service Areas are
derived from the Provincial Telecommunications Administrations in the
Target Service Areas.
The number of the Target Group's access lines in service has increased
rapidly from 25.4 million as of the end of 2000 to 39.9 million as of the end of
2002 and 45.1 million as of June 30, 2003. The Target Group had a 98.3% market
share in the Target Service Areas in terms of the number of access lines in
service as of June 30, 2003. The wireline penetration rate in the Target Service
Areas increased from 8.5% as of the end of 2000 to 15.1% as of June 30, 2003.
Being an extension and supplement to local wireline telephone services,
wireless local access provides personal communications at an attractive price
and enjoys strong demand in niche markets. The continued decline in the price of
wireless access equipment has made it a more profitable business. The Target
Group's wireless local access customers grew by 2.5 million in the first half of
2003.
The Target Group also operates an extensive network of public telephones in
the Target Service Areas, and the number of public telephones reached
approximately 2.0 million as of the end of June 30, 2003. Public telephone
services are targeted at the large and fast growing mobile population in the
Target Service Areas. The Company believes demand for the Target Group's public
telephone services in these areas will continue to expand.
Service usage. The following table sets out certain usage information
regarding the Target Group's local telephone services for the periods indicated:
Six months
ended
Year ended December 31, June 30,
----------------------- ----------
2000 2001 2002 2003
----- ------ ------ ----------
Total usage (pulses in billions)/(1),(2)/ 79.9 111.4 119.8 59.6
Total usage (minutes in billions)/(3)/ 88.1 118.7 121.6 57.3
(1) Pulses are the billing units for calculating local telephone usage
fees. The definition of a pulse for intra-district calls changed in
connection with the 2001 tariff adjustments. The pulse data for 2000
were converted into pulses under the new definition through a
statistical sampling of calling patterns, and may be subject to
certain statistical error. See "-Tariffs" for the respective
definitions of a pulse before and since the 2001 tariff adjustments.
(2) Includes 8.1 billion pulses in 2000, 20.1 billion pulses in 2001, 19.3
billion pulses in 2002 and 6.9 billion pulses in the six months ended
June 30, 2003, in respect of Internet dial-up usage generated by our
Internet subscribers and subscribers of other Internet access
providers.
(3) Minutes reported were calculated from pulses through a statistical
sampling of calling patterns.
The total usage of the Target Group's local telephone services, including
those associated with voice and VoIP long distance calls, increased from 111.4
billion pulses in 2001 to 119.8 billion pulses in 2002 and reached 59.6 billion
pulses in the six months ended June 30, 2003. Dial-up Internet usage as a
percentage of total local usage in terms of pulses, decreased from 18.0% in 2001
to 16.1% in 2002 and 11.5% in the six months ended June 30, 2003. Tariffs for
the communications fees of dial-up Internet access were much lower than the
usage fees for voice services.
Tariffs. For its local telephone services, the Target Group charges an
upfront installation fee, a fixed monthly fee and local call usage fees based on
call duration. The tariffs are regulated by the Chinese government. The local
call usage fees are either intra-district or inter-district, depending upon
whether a call is within a single service district or between service districts.
In December 2000, the Chinese government issued a notice of tariff adjustments,
which the Target Group implemented in the first half of 2001. The tariff
adjustments changed the tariff levels for many telecommunications services,
including local and long distance telephone, data and leased line services. See
Appendix II "Regulations -- Tariff Setting."
The following table sets out the changes in the Target Group's tariffs
before and after the tariff adjustments implemented in 2001 for local telephone
services:
Before Tariff
Adjustments After Tariff Adjustments
---------------------- -------------------------------------------------------------------
(RMB)
Monthly fee/(1)/:
Residential
customers 7.6-21.6 10.0-25.0
Enterprise
customers 12.0-33.0 25.0-35.0
Usage fee:
0.18-0.20 per pulse 0.20-0.22 for the first two pulses (first three minutes or less)and
Intra-district (three minute 0.10-0.11 for each additional pulse
intervals) (one minute intervals)
Inter-district 0.20-0.50 per pulse 0.20-0.50 per pulse
(one minute intervals) (one minute intervals)
Communications
fee:
0.09-0.10 per pulse
Internet dial-up (three minute 0.02 per pulse
intervals) (one minute intervals)
(1) Monthly fees for customers vary depending on whether a subscriber is
located in the provincial capital, a city, a county or rural areas.
Prior to July 2001, the Target Group charged an upfront connection fee for
basic access services. State guidance rates for connection fees for basic access
services varied from time to time and ranged from RMB100 to RMB1,000. The
connection fees were eliminated entirely in July 2001. The decrease in and
ultimate elimination of the connection fees have stimulated customer growth,
especially for residential customers. In addition, all previous surcharges on
telephone services, which were mostly levied by provincial and local
governments, were eliminated in July 2001.
Domestic Long Distance Services
The Target Group offers long distance services through its public switched
telephone network as well as VoIP long distance services. Total revenue from the
Target Group's domestic long distance services represented 16.9% of its total
operating revenue in 2002 and 16.1% in the six months ended June 30, 2003,
compared to 18.6% in 2001. The Target Group is the largest provider of domestic
long distance services in the Target Service Areas, with a 55.7% market share,
as measured by total minutes carried through, of all wireline and mobile
operators in Target Service Areas in 2002. The market share of the Target Group
decreased to 51.8% in the six months ended June 30, 2003. In addition, the
Target Group commenced offering VoIP domestic long distance services in 1999.
From 2000 to 2002, the proportion of VoIP services in total long distance usage
increased from 2.1% to 42.1%.
Service usage. The following table shows the total minutes of domestic long
distance calls carried through the Target Group's long distance network and the
market share of its domestic long distance services for the periods indicated:
Six months ended
Year ended December 31, June 30,
------------------------- ----------------
2000 2001 2002 2003
------ ------- ------ ----------------
Total minutes of usage (in
millions)/(1)/ 10,657 12,070 13,168 6,790
Market share/(2)/ 80.0% 68.2% 55.7% 51.8%
Percentage of usage via VoIP 2.1% 28.1% 42.1% 45.1%
(1) Includes calls originated by mobile subscribers that are carried over
the Target Group's long distance networks.
(2) Sources: Data in respect of the number of domestic long distance call
minutes of the Target Group are provided by the Target Companies. Data
in respect of the total number of domestic long distance call minutes
in the Target Service Areas are derived from the Provincial
Telecommunications Administrations in the Target Service Areas.
The decrease in the market share of the Target Group's domestic long
distance services from 2000 to June 30, 2003 was mainly attributable to the
expansion of mobile operators' long distance networks and their increased
routing of long distance calls placed by their mobile subscribers through their
own long distance networks as well as increased competition from other wireline
long distance service providers. Despite such competition, the total minutes of
usage of domestic long distance services of the Target Group have maintained a
steady growth through marketing and further development of distribution
channels.
Tariffs. The tariff adjustments in 2001 abolished the distance-based tariff
structure, reduced the unit of billing from one minute to six seconds and
eliminated long distance call surcharges.
The following table sets out the tariffs for the Target Group's domestic
long distance telephone services before and after the tariff adjustments in
2001, which are based on state tariff rates:
Before Tariff Adjustments After Tariff Adjustments
------------------------- ---------------------------------------
(RMB)
Public switched telephone network All at the unified rate of 0.07 per six
services seconds/(1)/
Intra-provincial less than 300 km 0.50-0.60 per minute/(2)/
Intra-provincial more than 300 km 0.60 per minute/(2)/
Inter-provincial less than 800 km 0.80 per minute/(2)/
Inter-provincial more than 800 km 1.00 per minute/(2)/
VoIP services/(3)/ 0.30 per minute Not regulated
(1) A discount rate of up to 4 0% applies to calls made during off-peak
hours, which are from 12:00 a.m. to 7:00 a.m. every day.
(2) A discount rate of 50% applies to calls made during off-peak hours,
which are from 9:00 p.m. to 12:00 a.m. for weekdays and from 7:00 a.m.
to 12:00 a.m. on public holidays and weekends; a discount rate of 70%
applies to calls made during 12:00 a.m. to 7:00 a.m. everyday.
(3) Does not include separate usage fees for local services when a VoIP
call is placed. The local usage fee of a VoIP call is the same as the
local usage fee of an intra-district local voice call.
The tariff adjustments in 2001 also deregulated the tariffs for VoIP
services. VoIP long distance services have lower tariff rates than those for
long distance services using public switched telephone networks. However, the
Target Group also charges local usage fees on VoIP long distance calls.
International Long Distance Services
The Target Group is the largest provider of international long distance
services in its service regions, with a 65.1% market share in 2002 and a 59.0%
market share in the six months ended June 30, 2003 as measured by the total
number of outgoing call minutes generated in the Target Service Areas and
carried through international gateways of all wireline and mobile operators. The
Target Group's international long distance telephone services contributed 1.2%
to its total operating revenue in 2001 and 2002 and 1.1% in the six months ended
June 30, 2003. The Target Group began offering VoIP international long distance
services in 1999, similar to its VoIP domestic long distance services in the
Target Service Areas.
Service usage. The following table sets out certain information related to
the usage and market share of the Target Group's international long distance
services, including usage of international long distance services by mobile
subscribers, for the periods indicated:
Six months
Year ended December 31, ended June 30,
------------------------ --------------
2000 2001 2002 2003
------ ------ ------ --------------
Outgoing call minutes (in millions)/(1)/ 122.6 155.3 168.7 77.4
Market share by outgoing call minutes/(2)/ 78.0% 68.2% 65.1% 59.0%
Percentage of usage via VoIP 5.1% 43.2% 64.6% 68.5%
(1) Includes calls originated by mobile subscribers that are carried
through the international gateways of China Telecommunications
Corporation.
(2) Sources: Data in respect of the number of outgoing call minutes of the
Target Group are provided by the Target Group. Data in respect of the
total number of outgoing call minutes in the Target Service Areas are
derived from the Provincial Telecommunications Administrations in the
Target Service Areas.
The market share in terms of outgoing call minutes of the Target Group's
international long distance services declined from 78.0% in 2000 to 65.1% in
2002, mainly because mobile operators established their own international
gateways and diverted international calls previously placed by their mobile
subscribers through the Parent's international gateways (see section 10.1
"On-going Connected Transactions Between the Company and China
Telecommunications Corporation -- (b) Supplemental Agreement Relating to
Centralized Services, Interconnection, Optic Fibers Leasing and Non-competition
Agreement -- Centralized Services" of the Letter from the Chairman.).
Tariffs. The tariff adjustments in 2001 reduced the basic unit of billing
from one minute to six seconds and simplified the rate schedule by abolishing
the distance-based tariff structure.
The following table sets out the international long distance tariffs of the
Target Group before and after the tariff adjustments in 2001, which are based on
state tariff rates:
Before Tariff Adjustments After Tariff Adjustments
-------------------------- ------------------------
(RMB)
Public switched telephone network services:
To Hong Kong, Macau and Taiwan 5.00 per minute/(1)/ 0.20 per 6 seconds
To all international destinations 5.30-15.00 per minute/(2)/ 0.80 per 6 seconds/(3)/
VoIP services/(4)/:
To Hong Kong, Macau and Taiwan 2.50 per minute Not regulated
To all international destinations 4.80 per minute Not regulated
(1) A discount rate of 40% applied to calls made during off-peak hours.
(2) Rates of RMB5.30-12.00 per minute applied to calls made to Asian
countries and regions and a rate of RMB15.00 per minute applied to
calls to all other international destinations. A discount rate of 40%
applied to calls made during off-peak hours.
(3) A discount rate of up to 40% applies to calls made during off-peak
hours.
(4) Does not include separate usage fees for local services when a VoIP
call is placed. The local usage fee of a VoIP call is the same as the
local usage fee of an intra-district local voice call.
Since the tariff adjustments, the Target Group charges RMB1.50 per minute
for VoIP long distance calls to Hong Kong, Macau and Taiwan and RMB2.40-4.60 per
minute for VoIP long distance calls to international destinations, but offers
various incentive programs and discounts from time to time.
The Target Group offers international long distance services through the
international gateways of China Telecommunications Corporation. China
Telecommunications Corporation negotiates bilateral settlement arrangements and
rates based on the international settlement standards in the telecommunications
industry, and those settlement arrangements and rates also apply to the Target
Group.
Interconnection
All interconnection and settlement arrangements among public wireline
telephone, mobile, and Internet networks in China are governed by the
Telecommunications Regulations and the rules on interconnection arrangements and
settlement promulgated by the MII in 2001. See Appendix II "Regulations --
Interconnection."
Subsidiaries of China Telecommunications Corporation, including the
provincial subsisting companies in the Target Service Areas, have entered into
interconnection agreements with other telecommunications service providers in
the Target Service Areas. These agreements provide for interconnection
settlement with respect to local calls and domestic and international long
distance calls involving the Target Group's networks. In connection with the
Reorganization in preparation for the Acquisition, China Telecommunications
Corporation has assigned to the Target Companies, and the Target Companies have
assumed, its rights and obligations under these agreements. The economic terms
and the settlement procedures under those agreements are in accordance with the
standards set forth in the interconnection rules and regulations, which are
described in more detail in Appendix II "Regulations -- Interconnection."
Based on the existing interconnection arrangement between the Company and
China Telecommunications Corporation, the proposed acquisition of the Target
Group would reduce the Combined Group's interconnection revenue and expense with
respect to the traffic between the Target Group and the Listed Group, and would
increase the Combined Group's interconnection revenue and expense with respect
to the traffic between the Target Group and the Parent Group. Please refer to
Appendix VI for pro forma adjustments with respect to interconnection revenue
and expense of the Combined Group.
Value-added Voice and Information Services
Value-added voice service. In addition to basic local and long distance
services, the Target Group offers a number of value-added voice services. The
Target Group continues to leverage its extensive network resources, customer
base and distribution channels and cooperate with other service providers to
develop new revenue sources, including caller ID display, telephone information
services, telephone directory services, conference calling and toll-free
services. Caller ID display service has approximately 20.7 million users with a
penetration rate of 46.0% as of June 30, 2003 amongst the Target Group's
wireline access lines in service. The Target Group has strengthened the
promotion of value-added services, gradually introduced new products such as
call-center out-sourcing, video conferencing, 17901 direct dial VoIP, "Telephone
QQ", wireline short messaging services (\raster(90%,p)="c09") and "Walk with
Me". Subscribers are becoming familiar with these branded services through
active marketing by the Target Group. The Company believes that these services
allow the Company to enhance customer satisfaction and increase its revenue
after the Acquisition. As subscribers in China become more accustomed to these
value-added voice services, the Company expects significant growth potential in
this area.
Telephone information services. The Target Group has significantly expanded
the scope of its automated and operator-assisted telephone information and
applications services in recent years. The Target Group's general information
services allow users to access information at its standard telephone usage rates
plus information usage fees. The Target Group also provides other specialized
telephone information and applications services, such as telephone banking and
telephone advertising. Total usage of the telephone information services
provided by the Target Group reached 281.2 million minutes in the six months
ended June 30, 2003. The Target Group intends to further expand the scope and
usage of these services and develop flexible revenue sharing arrangements with
content and application service providers.
Telephone directory services. The Target Group publishes telephone
directories, known as Yellow Pages, in the Target Service Areas. In addition,
the Target Group has introduced online telephone directory and other related
information services. The Target Group derives advertising revenue from its
printed and on-line directories.
Data and Internet Services
The Target Group is the leading provider of data and Internet services in
the Target Service Areas. The data and Internet services of the Target Group is
supported by extensive local access networks in the Target Service Areas and the
largest nationwide fiber optic backbone transmission network jointly operated by
the Combined Group and the Parent. Revenue from the Target Group's Internet
services was RMB1,139 million in 2002, representing 3.3% of its total operating
revenue for that year, and reached RMB841 million in the six months ended June
30, 2003, representing 4.6% of its total operating revenue for that period.
Revenue from the Target Group's managed data services was RMB642 million in
2002, representing 1.9% of its total operating revenue for that year, and was
RMB308 million in the six months ended June 30, 2003, representing 1.7% of its
total operating revenue for that period.
The following table sets forth selected information regarding the data,
Internet and related services of the Target Group as of the dates or for the
periods indicated:
As of or
for the
six months
As of or for the year ended
ended December 31, June 30,
------------------------------ ----------
2000 2001 2002 2003
-------- -------- -------- ----------
Managed data services:
Number of ports (in thousands):
DDN services 51.7 64.5 72.1 73.3
Frame relay services 2.8 5.5 9.4 10.8
ATM services 0.0 0.1 0.5 0.7
Bandwidth leased (in thousands):
DDN services (x64Kbps) 46.6 63.8 70.6 79.8
Frame relay services (x128Kbps) 2.7 7.3 15.5 18.2
ATM services (x2Mbps) 0.0 0.2 5.1 3.7
Dial-up and dedicated Internet
access services:
Dial-up subscribers (in thousands) 1,844.6 4,366.3 5,978.5 6,303.0
Dial-up on-line usage
(minutes in billions) 7.8 19.1 16.9 6.0
Dedicated Internet access lines
(in thousands) 1.8 1.8 1.5 1.2
Broadband access services
(in thousands):
DSL subscribers 1.3 36.1 303.2 688.9
FTTx + LAN subscribers -- 50.6 187.0 337.9
Others -- -- 4.5 3.8
Managed Data Services
The Target Group's managed data services include DDN, frame relay and ATM
services. The Target Group is the market leader in the managed data services in
the Target Service Areas.
DDN services. The Target Group's DDN services provide high-quality and
reliable transmission at speeds ranging from 64Kbps to 2Mbps and continue to
meet the increasing demand for low-to medium-speed transmission capacity from
enterprise customers. DDN systems are composed of optic fibers, digital
transmission paths and digital cross multiplexing nodes. DDN systems are capable
of providing high-quality private circuits and other services at various data
rates to satisfy users' multimedia communications needs.
Frame relay/ATM services. The Target Group offers advanced high-speed data
communications services based on frame relay and ATM technologies. These
services enable flexible and cost-effective use of bandwidth resources. Frame
relay is a type of connection-oriented packet switching technology that employs
statistical multiplexing over a shared network. Frame relay offers both access
to a network and transmission of data across a network and is used by customers
with significant amounts of data traffic. ATM is a high bandwidth and
multiplexing technology. ATM is developed for high data rates with a high
quality of service, and can offer integrated voice, data and video services at
various data rates.
Tariffs. The Target Group determines most of the tariffs for its data
services within a price range set by the Chinese government. The Target Group
generally charges an upfront fee for installation and testing for its data
services and a fixed monthly fee. The Target Group offers various incentive
programs and discounts for the customers who wish to upgrade to higher
brandwidth services. These incentive programs and discounts have stimulated
demand for data services.
The following table sets forth the monthly fees in 2002 for DDN services at
the bandwidth of 64Kbps and 2Mbps:
Monthly Fee
-----------
(RMB)
64Kbps
Intra-district 1,500
Inter-district 2,000
Intra-provincial 3,500
Inter-provincial (less than 800 km) 3,500
Inter-provincial (more than 800 km) 3,500
2Mbps
Intra-district 6,000
Inter-district 8,000
Intra-provincial 12,000
Inter-provincial (less than 800 km) 12,000
Inter-provincial (more than 800 km) 12,000
The following tables set forth the monthly fees in 2002 for frame relay and
ATM services, which include monthly fees for port access and permanent virtual
circuits, or PVCs:
Bandwidth
---------
2Mbps 10Mbps 100Mbps 155Mbps
--------- --------- --------- ---------
(RMB)
Monthly Fees for port access 1,000 5,000 9,000 10,000
PVC monthly fees (RMB)/(1)/:
PVC Monthly Fees
----------------
Bandwidth Intra-District Inter-District Domestic Long Distance
--------- -------------- -------------- ----------------------
(RMB)
256Kbps 800 1,150 2,200
2Mbps 1,500 2,200 4,000
10Mbps 5,000 11,500 15,500
155Mbps 14,500 39,000 130,000
(1) One-way tariff for PVC circuits of ATM services.
Dial-up and Dedicated Internet Access Services
The Target Group is the largest provider of dial-up and dedicated Internet
access services in the Target Service Areas in terms of the number of
subscribers. The Target Group classifies its dial-up Internet access users into
registered users, non-registered users and prepaid users. The Target Group
provides a variety of dedicated Internet access services to its business and
government customers.
The dial-up Internet access subscribers of the Target Group increased from
4.4 million as of the end of 2001 to 6.0 million as of the end of 2002 and 6.3
million as of June 30, 2003. Total dial-up usage generated from the Target
Group's subscribers declined from 19.1 billion minutes in 2001 to 16.9 billion
minutes in 2002, and reached 6.0 billion minutes in the first six months in
2003. The decrease of the dial-up usage was mainly caused by the upgrade made by
some of the dial-up subscribers to broadband services.
To further develop dial-up Internet access services, the Target Group has
strengthened its content application services by introducing a new Internet
dial-up value-added business known as "D-net". Relying on the extensive dial-up
network resources, access number resources and billing channels of the Target
Group, the Target Group cooperates with Internet content providers to provide
dial-up Internet subscribers with a dedicated platform for value-added services,
thereby achieving the integration of dial-up Internet access services with the
provision of value-added services by Internet content providers. Upon its
introduction, this form of cooperation received immediate positive responses
from Internet content providers, increasing the attractiveness of service
content to dial-up subscribers and aiding the enhancement of the Target Group's
reputation with subscribers.
Dial-up Internet access services and application services have created more
subscriber interest in the Internet. Furthermore, the convenience of dial-up
Internet access also satisfies the need of certain customer groups. Due to the
interactive relationship between dial-up Internet access services and broadband
access services, the Target Group aims to balance the development between
dial-up Internet access and broadband access.
Tariffs. Registered dial-up Internet access users pay an Internet access
fee as well as a local communications fee. Dedicated Internet access users pay
usage fees for the leased dedicated lines or fiber optic access. The tariff
adjustment in 2001 reduced tariffs for dial-up Internet access service.
The following table sets forth the tariffs for the Target Group's dial-up
Internet access services before and after tariff adjustments in 2001:
Before Tariff After Tariff
Adjustments Adjustments
---------------- ----------------
Dial-up Internet access fees RMB4.00 per hour RMB3.00 per hour
The following table sets forth the tariffs for the dedicated Internet
access services in 2002:
Bandwidth RMB per month
-------------
64Kbps-128Kbps 4,000
1Mbps-2Mbps 20,000
Broadband Internet Access
DSL services. The Target Group promotes DSL services as the primary
broadband Internet access means for residential customers and small- and
medium-sized enterprise customers. DSL services can be offered over copper wires
and are suitable for high-speed Internet access. The Target Group's DSL service
charges are based on bandwidth and whether the customer is a residential
customer or enterprise customer. The Target Group's service fees include an
upfront installation fee, monthly fees and overtime charges. The Target Group
had 303,220 DSL subscribers as of the end of 2002 and 688,929 DSL subscribers as
of June 30, 2003.
Fiber-Ethernet access services. The Target Group offers broadband access
services through fiber optic cables that directly link Ethernet technology-based
LANs in office buildings or high value residential complexes to the Internet.
Fiber-Ethernet access uses optic fiber technology and Ethernet protocol to
connect residential users and business users to a telecommunications network and
greatly expands capacity
of the access network. As of the end of 2002 and June 30, 2003, the Target Group
had 186,988 customers and 337,902 customers, respectively, using Fiber-Ethernet
access services.
Wireless LAN services. The Target Group provides fast and convenient
wireless LAN services through its wireless local area networks in public places,
such as airports, hotels, conference centers and office buildings.
Broadband application services. The Target Group continues to leverage its
broadband access networks and distribution channels to develop various broadband
application services, such as distance education, distance medical services,
video conferencing, on-line games, entertainment and video-on-demand.
Cooperating with certain service providers and relying on the large
subscriber base, network resources, application platforms and the reliable
supporting system, customers management and billing channels, the Target Group
has introduced ChinaVnet to provide the content/application service providers
with billing platforms and channels and to promote to subscribers the modified
and consolidated network services provided by the content/application service
providers. ChinaVnet actively promotes the continual developments of Internet
industrial chain and creates a new business model. Through the integration of
content and application from providers and the creation of a rich and varied
Internet service for Internet subscribers, ChinaVnet will effectively promote
the rapid proliferation of broadband applications and stimulate growth in
subscriber base and revenue.
Tariffs. The following table sets forth the tariffs for DSL services in
2002:
Type of
Service Connection Fee Network Fee
----------- -------------- ---------------------------------------------------
(RMB per Port) (RMB per Port)
200 per month if less than 120 hours and 4.00 per
Residential 400 hour for every hour exceeding the 120-hour limit
800 per month if less than 180 hours, and 6.00 per
Enterprise 1,000 hour for every hour exceeding the 180-hour limit
(1) Some companies would provide some packaged DSL promotion to meet the
needs of customers.
For customers connected through LANs, the Target Group charges either a
monthly network fee plus a fiber optic access fee determined by bandwidth, or a
monthly network fee plus an upfront connection fee. The following table sets
forth the guidance tariffs for its Fiber-Ethernet access services:
Type of Customer Port Bandwidth Connection Fee/(1)/ Network Fee
---------------- -------------- ------------------- -------------------------
(RMB per Port) (RMB per Port per month)
Residential 10Mbps 400 200
100Mbps -- 300
Enterprise 10Mbps 1,000 1,000
100Mbps -- 2,000
(1) Includes registration fee, installation fee and labor expenses, but
does not include equipment fees incurred by customers
System Integration and Other Value-Added Services
The Target Group offers system integration and solution services to its
customers. Its system integration services encompass initial consulting, network
planning, network implementation, application development and maintenance. The
current development of the Target Group focuses on system integration and
information management such as network management and data mining and analysis
services.
The Target Group's Internet data centers primarily offer co-location and
web hosting services. It operates many large Internet data centers that together
provide more than 6,300 square meters of rack space. As part of those services,
the Target Group also leases to its customers various resources at these
Internet data centers, such as servers and database storage capacity. In
addition, the Target Group is developing a range of Internet-based services to
meet increasing corporate outsourcing requirements for website development and
maintenance as well as Internet-based applications.
Leased Line Services
The Target Group also provides leased line services in the Target Service
Areas. In addition to leased lines, the Target Group also leases other network
elements to business and government customers and other telecommunications
service providers. It mainly leases digital circuits, digital trunk lines and
optic fibers. The revenue from the Target Group's leased line services is mainly
derived from the lease of digital circuits. Revenue from the Target Group's
leased line services was RMB1,119 million in 2002, representing 3.3% of its
total operating revenue for that year, and reached RMB566 million in the six
months ended June 30, 2003.
The Target Group offers these services as part of its total
telecommunications solutions and markets these services to large enterprise
customers and other operators through its large enterprise customer service
teams. The decline in total digital circuits leased in 2002 and the six months
ended June 30, 2003 was primarily due to the reduction of circuits leased by
mobile operators in the Target Service Areas, as these operators develop their
own network infrastructure. Increasing demand from business and government
subscribers has partially offset the impact of such reduction.
The following table sets forth the total amounts of bandwidth of leased
line service of the Target Group as of the dates indicated:
As of
As of December 31, June 30,
------------------------------------ ----------
Leased Digital Circuits 2000 2001 2002 2003
-------------------------- ---------- ---------- ---------- ----------
Total bandwidth (in 2Mbps
equivalents) 25,625 29,343 28,326 27,767
Tariffs. The Target Group charges monthly fees for leased lines based on
tariff rates set by the Chinese government, which vary based on bandwidth and
whether the leased line is local or long distance. Leased line tariffs have
generally decreased in recent years. The tariff adjustments in 2001
substantially reduced tariffs for leased line services.
The following table sets forth the tariffs for 2Mbps and 155Mbps digital
circuits in 2002:
Monthly Fee
-----------
(RMB)
2Mbps
Intra-district 2,000
Inter-district 4,000
Intra-provincial/(1)/ 6,000
Inter-provincial/(1)/ (less than 800km) 6,000
Inter-provincial/(1)/ (more than 800km) 6,000
155Mbps
Intra-district 44,000
Inter-district 88,000
Intra-provincial/(1)/ 132,000
Inter-provincial/(1)/ (less than 800km) 132,000
Inter-provincial/(1)/ (more than 800km) 132,000
(1) Does not include the tariffs for local digital circuits and access
lines.
Marketing, Distribution and Customer Services
Marketing Initiatives
The Target Group markets all of its telecommunications services under the
"China Telecom" brand name, which is one of the best-known brand names in China.
The Target Group offers a full range of differentiated services to its customers
to address their telecommunications needs. The Target Group offers individually
tailored services to its large enterprise customers, specialized services to its
small- and medium-sized enterprise customers and standardized services to its
residential customers. In addition, the Target Group plans to increase its
advertising activities to enhance customer awareness of its available services
and promote brand loyalty.
Sales, Distribution and Customer Services
Dedicated customer manager system for large enterprise customers. The
Target Group has implemented a large enterprise customer manager system. Under
this system, dedicated customer managers of the Target Group directly markets
their services to large enterprise customers. These customer managers form
dedicated management teams based on the industry background or geographical
locations of the customers. The Target Group conducts periodic performance
reviews and evaluations of the performance of the customer managers based on
several factors, including revenue growth, market share, customer satisfaction
and customer retention. To strengthen its marketing efforts, the Target Group
has increased the total number of its customer managers from 1,979 as of the end
of 2002 to 2,422 as of the end of June 2003.
Community manager system. The Target Group offers integrated sales and
maintenance services to small- and medium-sized enterprise customers through its
community manager system and divides its community coverage responsibilities by
geographical area. The Target Group's community managers are responsible for
customer development and customer care. The Target Group links its compensation
mainly to the voice traffic in its coverage areas. In addition, community
managers of the Target Group are also responsible for gathering market and
demand information.
Contract system in rural areas. Under this system, the Target Group selects
certain local residents to be responsible for service promotion, customer
development, equipment maintenance and fee collection. This system enables the
Target Group to lower operational costs effectively while at the same time
satisfying the needs of its rural customers.
Customer service hotlines. The Target Group provides customer services
through its customer service hotlines with the uniform access number of "10000."
These customer service hotlines offer unified electronic-based services to the
residential and enterprise customers in the Target Service Areas. These customer
service hotlines handle service inquiries and service applications, collect bill
payments and handle customer complaints.
Billing services. The Target Group bills its residential customers on a
monthly basis and provides a range of payment choices for the convenience of its
customers, including direct-debit service, which automatically deducts the
monthly payment from the subscriber's designated bank or postal account. The
Target Group also provides specially tailored billing and collection services to
their large enterprise customers to help them more effectively plan and monitor
their telecommunications needs.
Marketing and sales agencies and other wholesale channels. The Target Group
markets its services through its own retail outlets as well as agents and
distributors. The Target Group's cooperation with third party agencies and
distributors helps it reach a broader customer base and reduce its operating
expenses. As of December 31, 2002, the Target Group had a total of 6,149
authorized third-party agencies and distributors in addition to 3,886 retail
outlets that the Target Group owned and operated directly.
The Target Group provides a range of wireline telecommunications services,
including, among others, local and long distance telephone and data services, to
government agencies and regulatory authorities at all levels as well as to many
state-owned enterprises in the Target Service Areas. A number of these
government entities and state-owned enterprises are among the largest customers
of the Target Group. The Target Group provides these services in the normal
course of business and do not offer them any special tariff discounts.
Network System
The Target Group was able to realize significant economies of scale as a
result of the extensive coverage and scale of its network. It employs a variety
of advanced technologies and suitable architecture and can be efficiently
migrated to the next generation of network technology. The Target Group's
network system is managed and operated by its experienced network management and
maintenance teams and
offers flexible functionality and reliable operation. It supports a
comprehensive range of end-to-end wireline telecommunications services and
enables customized products to be delivered for a variety of telecommunications
needs.
Network Architecture
The Target Group's network system consists of transport networks, service
networks, an application layer and support networks.
. Transport networks: Transport networks provide the transport functions
of voice and data signals for all of the Target Group's services.
. Service networks: Service networks include wireline telephone network,
data networks, Internet network and other service networks such as
intelligent networks, and support the Target Group's basic and
value-added telecommunications services.
. Application layer: The application layer provides the platform for a
variety of applications and services such as e-commerce,
video-on-demand, and on-line games.
. Support networks: Support networks include signaling networks, digital
synchronous networks and network management systems and support the
reliable and effective operation of the Target Group's networks at all
levels.
Network Capacity and Technology
Local access networks. The Target Group owns extensive local access
networks in the Target Service Areas. As of December 31, 2002, the Target
Group's local access networks covered all cities, counties and rural villages in
the Target Service Areas. As part of its strategic focus on the data and
Internet market, the Target Group continues to expand its broadband local access
networks utilizing its existing copper line resources. In addition, the Target
Group continues to upgrade its existing local access lines using DSL technology.
At the same time, the Target Group is selectively connecting additional large
office buildings and business centers with fiber optic access. As of December
31, 2002, the total capacity of DSL access ports of the Target Group reached
686,306 lines. The Target Group has also selectively developed PHS networks for
wireless local telephone service to supplement its wireline access systems.
Moreover, the Target Group is developing wireless LANs in airports and other
commercial centers to provide business travellers with broadband access
services.
Transport network. The Target Group's transport system is based on an
advanced, high-speed, large-capacity, secure and reliable fiber optic network
throughout its service regions. The Target Group's fiber optic transport network
is also supplemented by satellite transmissions and digital microwave links. Its
fiber optic network had a total cable length of 263,844 kilometers in its
service regions as of the end of 2002. The Target Group's transport network is
integrated with the fiber optic network of the Parent Group outside the Target
Service Areas, which, together with the Company's current networks, forms the
largest nationwide fiber optic transport network in China, and is connected with
networks worldwide.
The Target Group's fiber optic transport network employs SDH architecture
and DWDM technology extensively, both of which allow for simpler and more easily
managed networks with enhanced reliability. The Target Group uses DWDM
technology on most of its long distance transmission routes to expand
transmission capacity. The main routes of the Target Group's backbone fiber
optic networks in its service regions have been upgraded to 10Gbps-based DWDM
systems and provide transmission bandwidth of up to 32 x 10Gbps or 160 x 10Gbps.
In addition, the Target Group has deployed self-healing, DXC, 1+1 protection and
other protection technologies and provides customers with network services of
various levels of reliability based on their requirements.
Wireline telephone networks. The Target Group's wireline telephone network
has been substantially built in the last decade utilizing digital technology. It
consists of long distance switching facilities and 69 local switching networks.
As of the end of 2002, the total capacity of local switches reached 49.8 million
lines, and the capacity of long distance toll switches reached 1.8 million
ports. In developing its wireline telephone networks, the Target Group has
adopted technologies that enable high capacity and fewer exchanges to reduce its
construction and operating costs. The Target Group has installed advanced
intelligent networks over its telephone networks. Intelligent networks combine
advanced computer technologies with traditional switching techniques to provide
flexible value-added services such as prepaid services, virtual private network
services and toll free call services.
Data and Internet networks. The Target Group has developed a
large-capacity, high-quality, reliable and extensive data and Internet network
system in the Target Service Areas. The Target Group's data and Internet
networks allow it to provide services both at the network layer, such as
Internet access, managed data and virtual private network services, and at the
application layer, such as Internet data center, e-commerce and video-on-demand
services. These networks cover all cities and counties in the Target Service
Areas. The Target Group's ATM network allows multi-service access and flexible
bandwidth management and provides high-quality, integrated end-to-end services.
The Target Group's Internet network is part of ChinaNET, the largest public
Internet network in China, operated by the Parent Group. ChinaNET deploys
mainstream Gigabyte routers as the main network technology. Most of its backbone
routes allow high-speed transmission with the use of several 2.5Gbps circuits.
Support networks. The operation of the Target Group's wireline telephone,
data and Internet networks depends on various support networks, including a
signaling network based on a signaling technology known as Signaling System 7
protocol, a digital synchronous network and network management systems for
various networks and services such as Internet data center, e-commerce and
video-on-demand services.
Equipment procurement. The Target Group purchases most of its network
equipment from leading international suppliers or their joint ventures in China.
The Target Group also purchases from local suppliers a variety of network
equipment, such as transport equipment and local switches. The Target Group
makes most of its purchases through competitive tenders primarily based on
product and service quality, system compatibility and price.
Research and Development
The Target Group's emphasis on research and development has enhanced a
clear vision in market direction, the development of advanced network system and
the rollout of new applications and services. The Target Group's research and
development is carried out by specialised research centers or small teams of
experts. Researchers are primarily responsible for conducting researches on
business strategies, network planning and support, new product trials and
investment decisions.
IT Systems
As a consistent corporate focus, the Target Group sought to improve
operational and management efficiency through establishing strong IT systems. IT
systems (CTG-MBOSS) include the Business Support System (BSS), Operation Support
System (OSS) and Management Support System (MSS). Implementation of IT design
heralds the technological and organizational restructuring of the IT systems.
Adoption of the Enterprise Application Integration (EAI) technology has allowed
for smooth interconnection between all major systems, enabling full information
sharing within the Company. The planned future development of the IT system is
expected to further enhance market responsiveness and improve customer service,
significantly raise operation and management levels and strengthen
competitiveness.
Organizational Reorganization and Business Process Re-engineering
Determined to maintain market leadership and improve the Target Group's
competitiveness, the Target Group continues to implement internal restructuring
and business process re-engineering measures aimed at further gearing toward a
"market-oriented, customer-centered and return-driven" business model.
The Target Group has implemented various initiatives to reorganize its
organization and has undertaken a business process re-engineering, or BPR,
project. These BPR project aims to effect organizational and operational changes
in a number of areas, including organizational structure, network investment
process, allocation of network resources, large customer management, billing and
collection and employee evaluation and incentive scheme.
In addition, the Target Group has taken various steps to centralize and
streamline the management of its business. For example, the Target Group has
improved its capital budgeting process and centralized equipment procurement in
order to reduce the cost of network expansion and maximize return on investment.
The Target Group has also centralized network maintenance of local networks to
optimize the network maintenance system and reduce maintenance costs.
The Target Group has launched an organizational restructuring that involved
all levels of operations. A new "front-end-back-end" structure has been
established at each level to enhance market responsiveness. The front-end is
composed of "customer interface units" with related marketing functions, while
at the back-end, all network resources have been consolidated to provide the
front-end with service provisioning, quality control, billing and operation
support services. An internal Service Level Agreement (SLA) system has been set
up between the front-end and the back-end to ensure more concerted and high
quality end-to-end service delivery.
Capital Expenditure
The table below sets forth the Target Group's historical capital
expenditures for the years indicated.
Year ended December 31,
-----------------------
2001 2002
----------------------- ------
(RMB in millions)
Total capital expenditures 18,787 16,095
The Target Group has further rationalized the allocation of its capital
expenditures in 2002. It has continued to allocate a majority of its capital
expenditures to the development of access infrastructure in order to meet the
demands of the subscriber growth and to strengthen its position as owners of the
"last mile" in the Target Service Areas. Internet and data networks are another
major area of capital expenditures as the Target Group capitalized on the
surging demand for broadband, managed data and Internet services. In addition,
the Target Group has increased expenditures for the Business Support System
(BSS), Operation Support System (OSS) and Management Support System (MSS) as
part of its effort to improve customer service quality, operating efficiency and
information disclosure.
The Board expects to fund the capital expenditure needs of the Target Group
through a combination of cash generated from operating activities, short-term
and long-term bank loans and other debt and equity financing. The Board believes
the Target Group will have sufficient resources to meet capital expenditure
requirements for the foreseeable future.
Network management and research Facilities
Apart from the Target Group, the Company will also acquire from the Parent
certain assets which are used for network management, research and development
purposes. The network management assets to be acquired from the Parent are
essential for the smooth operation of the entire China Telecom network systems.
Capabilities of the network management assets include function management,
resource allocation, performance monitoring, network security and billing. The
network management assets also provide certain
value-added services, such as SLA reporting and VPN. The research and
development assets, including a research institute located in Beijing, are used
for developing new telecommunications products and technologies. Based on an
asset appraisal report prepared by an independent appraiser appointed by the
Company, the value of such assets as of December 31, 2002 amounted to RMB432
million. There has been no material change to the value of such assets after
December 31, 2002.
/10/Overview
The telecommunications industry in China is subject to extensive government
regulation. A number of central government authorities have regulatory
responsibilities for various aspects of the telecommunications industry. These
authorities primarily include:
The MII, which is responsible for, among other things:
formulating and enforcing industry policies and regulations as
well as technical standards;
granting telecommunications service licenses;
supervising the operations and quality of service of
telecommunications service providers;
allocating and administering telecommunications resources such as
spectrum and numbers;
together with other relevant regulatory authorities, formulating
tariff standards for telecommunications services;
formulating interconnection and settlement arrangements between
telecommunications networks; and
maintaining fair and orderly market competition among service
providers.
Provincial communications administrations under the MII, which oversee
the implementation of the Ministry's regulations and exercise
regulatory authorities delegated by the Ministry within their
respective provinces.
The NDRC, which, together with the MII, sets government guidance
tariffs for certain telecommunications services. The actual tariffs
charged by providers of telecommunications services are determined by
provincial communications administrations, together with the price
bureaus of the provinces, autonomous regions or centrally administered
municipalities where those providers operate. See the Section headed
"Tariff Setting" below. It also approves investment and finance
projects exceeding certain capital expenditure amounts as well as
foreign investment projects exceeding certain investment amounts.
In order to provide a uniform regulatory framework to encourage the orderly
development of the telecommunications industry, the Chinese government is in the
process of drafting a telecommunications law. The Company expects that, if and
when the telecommunications law is adopted by the Standing Committee of the
National People's Congress, the highest state legislative body in China, it will
become the basic telecommunications statute and provide a regulatory framework
for the telecommunications industry in China.
Telecommunications Regulations
----------
/10/ 14.30(5)
China's State Council promulgated the Telecommunications Regulations, which
became effective as of September 25, 2000. The Telecommunications Regulations
are substantially consistent with, and are primarily intended to streamline and
clarify, the existing rules and policies for the telecommunications industry.
They provide the primary regulatory framework for China's telecommunications
industry in the interim period prior to the finalization and adoption of the
telecommunications law.
The Telecommunications Regulations are intended to develop a transparent
and fair regulatory environment to encourage fair and orderly competition and
development in the telecommunications industry. The Telecommunications
Regulations address all key aspects of telecommunications operations, including,
among others, entry into the telecommunications industry, network
interconnection, telecommunications resource allocation, tariffs and service
standards.
Licensing
The Telecommunications Regulations adopt the existing regulatory
distinction between basic and value-added telecommunications services. Basic
telecommunications services include, among others, wireline local and domestic
long distance telephone services, international telecommunications services, IP
telephone services, mobile communications services (including 3G businesses),
satellite communications services, Internet backbone and other data network
transmission services, digital trunked communication services, and domestic
telecommunications facility services. Value-added telecommunications services
include, among others, value-added services provided over wireline telephone
networks (e.g., telephone information, call center, voice mail and video
conferencing services), value-added services provided over mobile networks,
value-added services provided over Internet networks (e.g., Internet data center
and Internet access and content services) and value-added services provided over
other data networks (e.g., computer information, e-mail and electronic data
interchange services). Providers of any basic telecommunications services as
well as providers of value-added services in two or more provinces in China must
apply for licenses from the MII. In accordance with the approval of the MII, the
Target Companies derive their exclusive rights to operate their businesses from
their status as subsidiaries controlled by China Telecommunications Corporation,
which holds the licenses required for operating telecommunications businesses.
The State Council has promulgated the Administrative Regulations on
Telecommunications Companies with Foreign Investment, which became effective on
January 1, 2002. According to those regulations, enterprises with foreign
investment may operate basic and value-added telecommunications businesses
subject to the approval of the MII and the MOFCOM. Certain limitations have been
placed on the registered capital of, and maximum foreign shareholdings in, such
enterprises.
The table below summarizes the foreign ownership and geographic
restrictions for telecommunications joint ventures in China:
Foreign Ownership Percentage and Geographic Restrictions for Foreign-Invested
Telecommunications Enterprises
As of December 31,
Sector 2001 2002 2003 2004 2005 2006 2007
----------- ---------- ----------- ------------ ----------- --------- ----------- -----------
Wireline 25% 35% 49%
(3 cities)/(1)/ (17 cities)/(2)/ (nationwide)
Mobile 25% 35% 49% 49%
(3 cities)/(1)/ (17 cities)/(2)/ (17 cities)/(2)/ (nationwide)
Value-added 30% 49% 50%
(3 cities)/(1)/ (17 cities)/(2)/ (nationwide)
Paging 30% 49% 50%
(3 cities)/(1)/ (17 cities)/(2)/ (nationwide)
(1) The initial three cities are Beijing, Shanghai and Guangzhou.
(2) The 17 cities are Beijing, Chengdu, Chongqing, Dalian, Fuzhou,
Guangzhou, Hangzhou, Nanjing, Ningbo, Qingdao, Shanghai, Shenyang,
Shenzhen, Xiamen, Xian, Taiyuan and Wuhan.
The MII has promulgated the Measures on Administration of Telecommunication
Business Licenses, which became effective on January 1, 2002. Those regulations
apply to the application for, and examination and approval of,
telecommunications business licenses in China.
Tariff Setting
The levels and categorization of most of the Combined Group's current
tariffs are subject to regulation by various government authorities, including
the MII, the NDRC, and, at the local level, the relevant provincial
communications administrations and price bureaus. Under the Telecommunications
Regulations, telecommunications tariffs are categorized into government fixed
tariffs, government guidance tariffs and market based tariffs.
Currently, the monthly fee and usage fee for wireline local telephones
services are determined by the relevant provincial communications
administrations and provincial price bureaus, based on a guidance tariff range
set by the MII in consultation with the NDRC. Tariffs for all domestic and
international long distance service using public switched telephone networks,
leased lines and other basic telecommunications services are fixed jointly by
the MII and the NDRC. Tariffs for telecommunications services in respect of
which effective competition has already developed, as determined by the MII
according to the market conditions, may be set by the service providers. The
Target Companies derive a substantial portion (in excess of 70%) of their
revenues from services that are subject to government guidance tariffs and
government fixed tariffs. Currently, the MII allow tariffs for VoIP, Internet
access services and certain value-added services provided over wireline
telephone networks, such as telephone information, caller identification, voice
mail and video conferencing services, to be set by service providers.
There is uncertainty with respect to how the MII would make a determination
regarding effective competition as the MII has not publicly disclosed the
criteria it uses for determining whether a certain type of service should be
subject to market based tariffs. Under the Telecommunications Regulations, cost
should be the primary basis for tariff setting, but the tariff level should also
take into account social and economic development, the development of the
telecommunications industry and consumers' ability to afford the services. The
MII has not provided a timetable for tariff deregulation or indicated that
service providers will eventually be permitted to freely set all tariffs.
Over the past few years, the Chinese government has adjusted the tariffs
for telecommunications services, including the elimination of connection fees in
July 2001. See the section headed "Appendix I -- Wireline Telephone Services."
In general, the Company expects these adjustments to stimulate the overall usage
of its telecommunications services. The Company also expects that increased
flexibility in setting certain tariffs will allow it to better respond to
changes in market demand and competitive conditions.
The Chinese government retains the ultimate authority to adopt changes to
tariffs. However, the Telecommunications Regulations require the government to
hold public hearings before setting or changing mandatory or guidance tariff
rates, which are attended by, among others, telecommunications operators and
consumers.
Interconnection
Under the Telecommunications Regulations and the Administrative Rules on
Interconnection between the Public Telecommunications Networks promulgated by
the MII in May 2001, major telecommunications operators in China cannot refuse
requests for interconnection and must enter into interconnection agreements upon
request by other service providers. Interconnection agreements must be
filed with the MII. Interconnection agreements may not be terminated
unilaterally without prior approval by the MII.
The Telecommunications Regulations further provide that the technical
standards and settlement methods for network interconnections be formulated by
the MII. The Rules on the Settlement of Communication Fees between
Telecommunications Networks promulgated by the MII in March 2001 provide in
detail revenue sharing methods and settlement mechanisms between
telecommunications network operators. Such revenue sharing methods are reviewed
by the government periodically. In accordance with these regulations, Parent
Group has entered into various interconnection agreements with other
telecommunications service providers, including China Mobile, China Unicom,
China Netcom Group and China Railcom.
The following table sets forth selected interconnection revenue sharing and
settlement arrangements for local calls before and after the regulatory
adjustment in 2001:
Network From
Which Calls Network At Which New Settlement
Originated Calls Terminated Old Settlement Arrangement Arrangement
------------ ---------------- -------------------------- --------------
(1) Mobile operator (1) Mobile
Mobile Wireline local collects the cellular operator
network network usage charge from its collects the
subscribers cellular usage
charge
from its
subscribers
(2) Mobile operator pays (2) Mobile
RMB0.05 per minute to operator
wireline operator pays RMB0.06
per minute to
wireline
operator
Wireline Mobile network No revenue sharing or No revenue
local settlement sharing or
network settlement
The following table sets forth selected interconnection revenue sharing and
settlement arrangements for public switched telephone network domestic long
distance calls before and after the regulatory adjustment in 2001:
Network From
Which Calls Network At Which New Settlement
Originated Calls Terminated Old Settlement Arrangement Arrangement
------------ ---------------- -------------------------- --------------
(1) RMB0.14 per minute for
operator at area A, the RMB0.06 per
Wireline or rest of the long distance minute for
mobile network tariff for operator C operator A,
at area B, RMB0.06 per
through the long minute for
Wireline or distance network operator B,
mobile at of operator C (2) No settlement between the rest of
area A operator C and operator the long
on the terminating end distance
at area B tariff for
operator C
The following table sets forth selected interconnection revenue sharing and
settlement arrangements for VoIP domestic long distance calls before and after
the regulatory adjustment in 2001:
Network From
Which Calls Network At Which New Settlement
Originated Calls Terminated Old Settlement Arrangement Arrangement
------------ ---------------- -------------------------- --------------
(1) Operator C
collects the
VoIP long
distance
charges from
its
subscribers
Wireline Wireline local No revenue sharing or (2) Operator C
local or or mobile settlement pays RMB0.06
mobile network at per minute to
network at area B through operator B on
area A the VoIP network the
of operator C terminating
end
(3) No
settlement
between
operator C and
operator A on
the
originating
end
Effective November 1, 2002 the MII has unified the minimum level of the
termination rate for international calls, including for this purpose calls from
Hong Kong, Macau and Taiwan, terminating in China. Such termination rate is
required to be no less than US$0.17 per minute, but can be higher depending on
negotiations between the carriers.
Technical Standards
The MII sets industry technical standards for telecommunications terminal
and interconnection-related equipment used in the public telecommunications
networks. A network access license from the MII and other relevant regulatory
authorities is required for all such equipment. Most of the standards set by the
MII conform to standards recommended by the International Telecommunications
Union and other international telecommunications standards organizations.
Capital Investment
To ensure the orderly development of telecommunications infrastructure and
services, the State Council authorizes the MII to approve any plan to establish
a nationwide telecommunications network or a network involving a total capital
investment of RMB50 million to RMB200 million. The State Council also authorizes
the NDRC, to exercise responsibility over the approval of specific aspects of
such investment
projects. Any investment project with total capital investment in excess of
RMB200 million must obtain approval from the State Council.
Telecommunications Resources
The MII is responsible for the administration and allocation of
telecommunications resources in China, including radio frequencies and
telecommunications network numbers. The use of these resources by
telecommunications service providers is subject to the approval of the MII or
the relevant provincial communications administrations and a usage fee payable
to the Chinese government. However, the standards for usage fees of
telecommunications network numbers have not yet been stipulated and it is not
clear when telecommunications service providers, including the Target Group,
will be required to pay such fees.
Quality of Service
Under the Telecommunications Regulations, the MII and the relevant
provincial communications administration have the responsibility of supervising
and monitoring the quality of services provided by telecommunications service
providers in China. Under the Telecommunications Regulations, customers of
telecommunications service providers have the right to submit their complaints
to the MII and the relevant provincial communications administration or other
relevant government authorities.
Universal Services
Under the Telecommunications Regulations, telecommunications service
providers in China are required to fulfill universal service obligations in
accordance with relevant regulations to be promulgated by the Chinese
government, and the MII has been given authority by the Chinese government to
delineate the scope of its universal service obligations. The MII may also
select universal service providers through a tendering process. The MII,
together with government finance and pricing authorities, is also responsible
for formulating administrative rules relating to the establishment of a
universal service fund and compensation schemes for universal services. These
rules have not yet been promulgated and there are currently no specific
regulatory requirements relating to the provision of universal services in
China.
\raster(100%,p)="KPMGlogo100"
To the Board of Directors of China Telecom Corporation Limited
(Incorporated in The People's Republic of China with limited liability)
We have audited the accompanying combined financial statements of Anhui
Telecom, Fujian Telecom, Jiangxi Telecom, Guangxi Telecom, Chongqing Telecom and
Sichuan Telecom and their subsidiaries (collectively referred to as "the Target
Group") on pages 89 to 124 which have been prepared in accordance with
International Financial Reporting Standards promulgated by the International
Accounting Standards Board.
RESPECTIVE RESPONSIBILITIES OF MANAGEMENT AND AUDITORS
The Target Group's management are responsible for the preparation of
financial statements which give a true and fair view. In preparing financial
statements which give a true and fair view it is fundamental that appropriate
accounting policies are selected and applied consistently, that judgments and
estimates are made which are prudent and reasonable and that the reasons for any
significant departure from applicable accounting standards are stated.
It is our responsibility to form an independent opinion, based on our
audit, on those financial statements and to report our opinion solely to you, as
a body, in accordance with our agreed terms of
engagement, and for no other purpose. We do not assume responsibility towards or
accept liability to any other person for the contents of this report.
BASIS OF OPINION
We conducted our audit in accordance with Statements of Auditing Standards
issued by the Hong Kong Society of Accountants. An audit includes examination,
on a test basis, of evidence relevant to the amounts and disclosures in the
financial statements. It also includes an assessment of the significant
estimates and judgements made by the Target Group's management in the
preparation of the financial statements, and of whether the accounting policies
are appropriate to the Target Group's circumstances, consistently applied and
adequately disclosed.
We planned and performed our audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance as to whether the financial
statements are free from material misstatement. In forming our opinion we also
evaluated the overall adequacy of the presentation of information in the
financial statements. We believe that our audit provides a reasonable basis for
our opinion.
OPINION
In our opinion, the combined financial statements give a true and fair view
of the state of affairs of the Target Group as at December 31, 2001 and 2002 and
June 30, 2003 and of the Target Group's results and cash flows for each of the
years in the two-year period ended December 31, 2002 and for the six-month
period ended June 30, 2003 and have been properly prepared in accordance with
International Financial Reporting Standards promulgated by the International
Accounting Standards Board.
KPMG
Certified Public Accountants
Hong Kong, China
October 23, 2003
/11/COMBINED BALANCE SHEETS
(Amounts in millions)
December 31, June 30,
---------------- --------
Note 2001 2002 2003
---- ------- ------ --------
RMB RMB RMB
ASSETS
Non-current assets
Property, plant and equipment,
net 3 82,710 71,596 72,503
Construction in progress 4 9,490 7,650 8,259
Lease prepayments 518 617 620
Interests in associates 5 50 35 39
Investments 6 2,563 1 1
Deferred tax assets 7 1,816 2,408 2,819
Other assets 16 2,939 3,254 3,367
------- ------ ------
Total non-current assets 100,086 85,561 87,608
------- ------ ------
Current assets
Inventories 8 824 687 769
Accounts receivable, net 9 2,928 3,097 3,727
Prepayments and other current
assets 10 2,024 1,116 1,007
Time deposits with maturity
over three months 77 36 33
Cash and cash equivalents 11 3,815 2,262 2,323
------- ------ --------
Total current assets 9,668 7,198 7,859
------- ------ --------
Total assets 109,754 92,759 95,467
======= ====== ========
The notes on pages 95 to 124 form part of these financial statements.
----------
/11/ 14.30(5)
COMBINED BALANCE SHEETS
(Amounts in millions)
December 31, June 30,
----------------- --------
Note 2001 2002 2003
----- ------- ------- --------
RMB RMB RMB
LIABILITIES AND OWNER'S EQUITY
Current liabilities
Short-term debt 12 15,087 21,161 21,011
Current portion of long-term debt 12 5,095 3,455 4,837
Accounts payable 13 9,152 7,329 7,109
Accrued expenses and other payables 14 5,258 6,031 6,642
Income tax payable -- -- 1,068
Current portion of finance lease
obligations 15 203 67 66
Current portion of deferred revenues 16 3,970 3,878 3,640
------- ------- --------
Total current liabilities 38,765 41,921 44,373
------- ------- --------
Net current liabilities (29,097) (34,723) (36,514)
------- ------- --------
Total assets less current liabilities 70,989 50,838 51,094
------- ------- --------
Non-current liabilities
Long-term debt 12 14,681 12,741 10,379
Finance lease obligations 15 367 82 51
Deferred revenues 16 12,112 10,123 9,319
Deferred tax liabilities 7 6,110 -- 106
------- ------- --------
Total non-current liabilities 33,270 22,946 19,855
------- ------- --------
Total liabilities 72,035 64,867 64,228
Minority interests 48 52 53
Owner's equity 37,671 27,840 31,186
------- ------- --------
Total liabilities and owner's equity 109,754 92,759 95,467
======= ======= ========
Approved and authorised for issue by China Telecommunications Corporation on
October 23, 2003.
Zhou Deqiang Chang Xiaobing Wu Andi
--------------- ---------------------- ----------------------
General Manager Deputy General Manager Deputy General Manager
The notes on pages 95 to 124 form part of these financial statements.
COMBINED STATEMENTS OF OPERATIONS
(Amounts in millions)
Six-month
period
Years ended ended
December 31, June 30,
----------------- ---------
Note 2001 2002 2003
---- ------- ------- ---------
RMB RMB RMB
Operating revenues 17 31,951 34,068 18,247
Operating expenses
Depreciation and amortisation (10,724) (12,123) (5,136)
Network operations and support (11,621) (12,097) (5,534)
Selling, general and administrative (4,550) (4,993) (2,602)
Other operating expenses 18 (538) (236) (112)
------- ------- ---------
Total operating expenses 19 (27,433) (29,449) (13,384)
------- ------- ---------
Operating profit 4,518 4,619 4,863
Deficit on revaluation of property, plant
and equipment 3 -- (14,690) --
Net finance costs 20 (1,169) (1,512) (726)
Investment (loss)/income (9) 59 --
Share of profit from associates -- 2 --
------- ------- ---------
Profit/(loss) before taxation and minority
interests 3,340 (11,522) 4,137
Taxation 21 (230) 4,437 (763)
------- ------- ---------
Profit/(loss) before minority interests 3,110 (7,085) 3,374
Minority interests (7) (6) (3)
------- ------- ---------
Net profit/(loss) 3,103 (7,091) 3,371
======= ======= =========
The notes on pages 95 to 124 form part of these financial statements.
COMBINED STATEMENTS OF OWNER'S EQUITY
(Amounts in millions)
Retained
earnings/ Total
Revaluation Other owner's owner's
Note reserve reserves capital equity
---- ----------- -------- --------- -------
RMB RMB RMB RMB
Balance as at January 1, 2001 -- -- 32,539 32,539
Net profit -- -- 3,103 3,103
Contributions from owner -- -- 4,307 4,307
Distributions to owner -- -- (2,040) (2,040)
Assets distributed to owner 1 -- -- (238) (238)
----------- -------- --------- -------
Balance as at December 31, 2001 -- -- 37,671 37,671
Net loss -- -- (7,091) (7,091)
Contributions from owner -- -- 1,482 1,482
Distributions to owner -- -- (2,221) (2,221)
Assets distributed to owner in
connection with the Restructuring 1 -- -- (5,189) (5,189)
Revaluation surplus 3 760 -- -- 760
Recognition of deferred tax assets 7 -- 2,408 -- 2,408
Elimination of net deferred tax
liabilities 7 -- -- 20 20
----------- -------- --------- -------
Balance as at December 31, 2002 760 2,408 24,672 27,840
Net profit -- -- 3,371 3,371
Contributions from owner -- -- 52 52
Distributions to owner -- -- (77) (77)
Deferred tax on amortisation of
land use rights realised -- (24) 24 --
----------- -------- --------- -------
Balance as at June 30, 2003 760 2,384 28,042 31,186
=========== ======== ========= =======
The notes on pages 95 to 124 form part of these financial statements.
COMBINED STATEMENTS OF CASH FLOW
(Amounts in millions)
Six-month
period
Years ended ended
December 31, June 30,
----------------- ---------
Note 2001 2002 2003
---- ------- ------- ---------
RMB RMB RMB
Net cash from operating activities (a) 13,887 15,056 8,290
------- ------- ---------
Cash flows from investing activities
Capital expenditure (20,015) (17,638) (6,878)
Purchase of investments (327) (129) (4)
Lease prepayments (145) (303) (11)
Proceeds from disposal of property, plant
and equipment 79 64 28
Increase in time deposits with maturity
over three months (57) (27) (26)
Maturity of time deposits with maturity
over three months 20 68 29
------- ------- ---------
Net cash used in investing activities (20,445) (17,965) (6,862)
------- ------- ---------
Cash flows from financing activities
Capital element of finance lease payments (40) (476) (32)
Proceeds from bank debt 25,489 36,233 18,889
Repayments of bank debt (21,011) (33,800) (20,050)
Cash distributions to minority interests -- (2) (2)
Cash contributions from owner 3,757 1,284 52
Cash distributions to owner (2,319) (1,883) (224)
------- ------- ---------
Net cash from/(used in) financing
activities 5,876 1,356 (1,367)
------- ------- ---------
Net (decrease)/increase in cash and cash
equivalents (682) (1,553) 61
Cash and cash equivalents at beginning of
year/period 4,497 3,815 2,262
------- ------- ---------
Cash and cash equivalents at end
of year/period 3,815 2,262 2,323
======= ======= =========
The notes on pages 95 to 124 form part of these financial statements.
COMBINED STATEMENTS OF CASH FLOW
(Amounts in millions)
(a) Reconciliation of profit/(loss) before taxation and minority interests to
net cash from operating activities
Six-month
period
Years ended ended
December 31, June 30,
----------------- ---------
2001 2002 2003
------- ------- ---------
RMB RMB RMB
Profit/(loss) before taxation and minority
interests 3,340 (11,522) 4,137
Adjustments for:
Depreciation and amortisation 10,724 12,123 5,136
Deficit on revaluation of property, plant and
equipment -- 14,690 --
Provision for doubtful accounts 234 280 142
Investment loss/(income) 9 (59) --
Share of profit from associates -- (2) --
Interest income (67) (34) (12)
Interest expense 1,842 1,880 910
Unrealised foreign exchange (gains)/losses (27) 61 31
Loss on retirement and disposal of property,
plant and equipment 1,006 1,252 333
Decrease/(increase) in accounts receivable 598 (449) (772)
(Increase)/decrease in inventories (3) 137 (82)
Decrease/(increase) in prepayments and other
current assets 706 738 (15)
Increase in other non-current assets (478) (315) (113)
Increase/(decrease) in accounts payable 62 349 (5)
(Decrease)/increase in accrued expenses and
other payables (1,240) (166) 541
Decrease in deferred revenues (1,080) (2,081) (1,042)
------- ------- ---------
Cash generated from operations 15,626 16,882 9,189
Interest received 67 34 12
Interest paid (1,806) (1,919) (911)
Investment income received -- 59 --
------- ------- ---------
Net cash from operating activities 13,887 15,056 8,290
======= ======= =========
The notes on pages 95 to 124 form part of these financial statements.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
1. PRINCIPAL ACTIVITIES, ORGANISATION AND BASIS OF PRESENTATION
Principal activities
Anhui Telecom Company Limited ("Anhui Telecom"), Fujian Telecom
Company Limited ("Fujian Telecom"), Jiangxi Telecom Company Limited
("Jiangxi Telecom"), Guangxi Telecom Company Limited ("Guangxi Telecom"),
Chongqing Telecom Company Limited ("Chongqing Telecom") and Sichuan Telecom
Company Limited ("Sichuan Telecom") (hereinafter individually referred to
as the "Target Company" and together with their subsidiaries collectively
referred to as the "Target Group") are engaged in the provision of wireline
telecommunications and related services in Anhui Province, Fujian Province,
Jiangxi Province, Guangxi Zhuang Autonomous Region, Chongqing Municipality
and Sichuan Province of the People's Republic of China (the "PRC"),
respectively. The Target Group offers a comprehensive range of wireline
telecommunications services to residential and business customers,
including local, domestic long distance ("DLD") and international long
distance ("ILD") telephone services, Internet and managed data, leased
line, and other related services.
The operations of the Target Group are subject to the supervision and
regulation by the PRC government. The Ministry of Information Industry,
pursuant to the authority delegated to it by the PRC's State Council, is
responsible for formulating the telecommunications industry policies and
regulations, including the regulation and setting of tariff levels for
basic telecommunications services, such as local and long distance
telephone services, managed data services, leased line and interconnection
arrangements.
Organisation
Anhui Telecom, Fujian Telecom, Jiangxi Telecom, Guangxi Telecom,
Chongqing Telecom and Sichuan Telecom were incorporated in the PRC as
wholly-owned subsidiaries of China Telecommunications Corporation ("China
Telecom"), a state-owned enterprise which is under the supervision and
regulation of the Ministry of Information Industry, on August 26, 2003,
August 28, 2003, September 18, 2003, August 28, 2003, August 22, 2003 and
August 28, 2003 respectively, as part of the reorganisation (the
"Restructuring") of China Telecom. China Telecom and its subsidiaries other
than the Target Group are hereinafter referred to as "China Telecom Group".
Pursuant to the Restructuring, China Telecom transferred to each of
the Target Companies the wireline telecommunications business and related
operations in Anhui Province, Fujian Province, Jiangxi Province, Guangxi
Zhuang Autonomous Region, Chongqing Municipality and Sichuan Province
together with the related assets and liabilities (the "Predecessor
Operations") in consideration for the entire equity interests in each of
the Target Companies. As discussed below, certain assets historically
associated with the Predecessor Operations were not transferred to the
Target Group but were retained by China Telecom in connection with the
Restructuring.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
1. PRINCIPAL ACTIVITIES, ORGANISATION AND BASIS OF PRESENTATION
Organisation
China Telecom was initially established in May 2000 to operate the
PRC's nationwide wireline telecommunications network as part of the
restructuring of the PRC's telecommunications industry. In November 2001,
pursuant to a further industry restructuring plan approved by the State
Council, China Telecom's wireline telecommunications networks and related
operations in 10 northern provinces, municipalities and autonomous regions
of the PRC were transferred to China Netcom Group. China Telecom retained
the wireline telecommunications networks and related operations of 21
provinces, municipalities and autonomous regions of the PRC, including the
Predecessor Operations. In accordance with this industry restructuring
plan, China Telecom and China Netcom Group own 70% and 30%, respectively,
of the nationwide inter-provincial optic fibres. In connection with this
industry restructuring, the Target Group transferred inter-provincial optic
fibres of RMB238 million to China Netcom Group effective December 31, 2001.
Such transfer has been reflected as a distribution to owner in the combined
statements of owner's equity as at December 31, 2001.
Basis of presentation
Since China Telecom controlled the Predecessor Operations transferred
to the Target Group before the Restructuring and continues to control the
Target Group after the Restructuring, the accompanying combined financial
statements have been prepared as a reorganisation of businesses under
common control in a manner similar to a pooling-of-interests. Accordingly,
the assets and liabilities transferred to the Target Group have been
recognised at historical amounts. The combined financial statements for
each of the years in the two-year period ended December 31, 2002 and for
the six-month period ended June 30, 2003 present the results of the Target
Group as if the Target Group had been in existence throughout the period
from January 1, 2001 to June 30, 2003 and as if the Predecessor Operations
were transferred to the Target Group from China Telecom as at the earliest
date presented. In addition, the combined financial statements include the
results related to certain assets historically associated with the
Predecessor Operations that were not transferred to the Target Group and
were retained by China Telecom in connection with the Restructuring. The
assets retained by China Telecom primarily related to investments in
non-telecommunications industries and properties and, as at December 31,
2002, consisted of the following:
RMB millions
Property, plant and equipment, net 1,286
Construction in progress 222
Interests in associates and long-term investments 3,078
Other assets, primarily cash and cash equivalents
and lease prepayments 603
------------
5,189
============
NOTES TO THE COMBINED FINANCIAL STATEMENTS
1. PRINCIPAL ACTIVITIES, ORGANISATION AND BASIS OF PRESENTATION
Basis of presentation
In preparing the combined financial statements, the assets and
liabilities, revenues and expenses of the Predecessor Operations are
reflected in the accompanying combined financial statements. In addition,
for periods up to December 31, 2002, the accompanying combined financial
statements have been prepared to include certain assets historically
associated with the Predecessor Operations that were retained by China
Telecom. As a result of the segregation and separate management of these
assets by China Telecom beginning December 31, 2002, the assets retained by
China Telecom have been reflected as a distribution to owner in the
combined statements of owner's equity as at December 31, 2002.
Management believes that all historical costs of operations have been
reflected in the combined financial statements. Expenses that were
specifically identified to the Predecessor Operations, including the costs
of ancillary, social and supporting services provided to the Predecessor
Operations by China Telecom and its affiliates, are reflected in the
combined financial statements. Expenses associated with corporate services
provided by China Telecom (consisting primarily of corporate headquarter
administrative expenses) were allocated based on revenues to companies
within China Telecom, including the Predecessor Operations. The amount of
corporate administrative expenses allocated to the Target Group for the
years ended December 31, 2001 and 2002 and for the six-month period ended
June 30, 2003 was RMB274 million, RMB173 million and RMB71 million,
respectively. Management believes that the method of allocation of
corporate administrative expenses presents a reasonable basis of estimating
what the Target Group's expenses would have been on a stand-alone basis for
the periods presented.
2. SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of preparation
The accompanying combined financial statements have been prepared in
accordance with International Financial Reporting Standards ("IFRS")
promulgated by the International Accounting Standards Board ("IASB"). IFRS
includes International Accounting Standards ("IAS") and interpretations.
The accompanying combined financial statements are prepared on the
historical cost basis as modified by the revaluation of certain property,
plant and equipment (Note 3).
The preparation of the combined financial statements in accordance
with IFRS requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the combined financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. The accounting policies
described below have been consistently applied by the Target Group.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES
(b) Basis of consolidation
A subsidiary is an enterprise controlled by the Target Group. Control
exists when the Target Group has the power, directly or indirectly, to
govern the financial and operating policies of an enterprise so as to
obtain benefits from its activities.
The financial results of subsidiaries are included in the combined
financial statements from the date that control commences until the date
that control ceases, and the share attributable to minority interests is
deducted from or added to the income before minority interests. All
significant intercompany balances and transactions and any unrealised
gains/losses arising from intercompany transactions are eliminated on
consolidation.
An associate is a company, not being a subsidiary, in which the Target
Group exercises significant influence over its management. Significant
influence is the power to participate in the financial and operating policy
decisions of the investee but is not control over those policies.
The combined statements of operations include the Target Group's share
of the results of its associates for the period. In the combined balance
sheets, interests in associates are stated at the Target Group's
attributable share of net assets.
(c) Translation of foreign currencies
The functional and reporting currency of the Target Group is Renminbi
("RMB"). Foreign currency transactions during the period are translated
into RMB at the applicable rates of exchange quoted by the People's Bank of
China ("PBOC rates") prevailing on the transaction dates. Foreign currency
monetary assets and liabilities are translated into RMB at the applicable
PBOC rates at the balance sheet date.
Exchange differences, other than those capitalised as construction in
progress, are recognised as income or expense in the combined statements of
operations. For the periods presented, no exchange differences were
capitalised.
(d) Cash and cash equivalents
Cash and cash equivalents comprise cash at bank and in hand and time
deposits with original maturities of three months or less when purchased.
Cash equivalents are stated at cost, which approximates fair value. None of
the Target Group's cash and cash equivalents is restricted as to
withdrawal.
(e) Accounts receivable
Accounts receivable are stated at cost less allowance for doubtful
accounts. An allowance for doubtful accounts is provided based upon the
evaluation of the recoverability of these accounts at the balance sheet
date.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES
(f) Inventories
Inventories consist of materials and supplies used in maintaining the
wireline telecommunications network and goods for resale. Materials and
supplies are valued at cost less a provision for obsolescence.
Inventories that are held for resale are stated at the lower of cost
and net realisable value. Net realisable value is the estimated selling
price in the ordinary course of business less the estimated costs of
completion and the estimated costs necessary to make the sale.
(g) Property, plant and equipment
Property, plant and equipment are initially recorded at cost less
accumulated depreciation and impairment losses (Note 2(k)). The cost of an
asset comprises its purchase price, any directly attributable costs of
bringing the asset to working condition and location for its intended use
and the cost of borrowed funds used during the period of construction.
Expenditure incurred after the asset has been put into operation is
capitalised only when it increases the future economic benefits embodied in
the item of property, plant and equipment. All other expenditure including
the cost of repairs and maintenance, is expensed as it is incurred.
Subsequent to the revaluation carried out as at December 31, 2002,
which was based on depreciated replacement costs (Note 3), property, plant
and equipment are carried at revalued amount, being the fair value at the
date of the revaluation, less subsequent accumulated depreciation and
impairment losses. When an item of property, plant and equipment is
revalued, any accumulated depreciation at the date of the revaluation is
restated proportionately with the change in the gross carrying amount of
the asset so that the carrying amount of the asset after revaluation equals
its revalued amount. The separate classes into which the Target Group
groups assets for the revaluation are buildings and improvements;
telecommunications network plant and equipment; and furniture, fixture,
motor vehicles and other equipment. When an item of property, plant and
equipment is revalued, the entire class of property, plant and equipment to
which that asset belongs is revalued simultaneously. When an asset's
carrying amount is increased as a result of a revaluation, the increase is
credited directly to owner's equity under the component of revaluation
reserve. However, a revaluation increase is recognised as income to the
extent that it reverses a revaluation decrease of the same asset previously
recognised as an expense. When an asset's carrying amount is decreased as a
result of a revaluation, the decrease is recognised as an expense in the
combined statements of operations. However, a revaluation decrease is
charged directly against any related revaluation surplus to the extent that
the decrease does not exceed the amount held in the revaluation reserve in
respect of that same asset. Revaluations are performed with sufficient
regularity such that the carrying amount does not differ materially from
that which would be determined using fair value at the balance sheet date.
Revaluations are performed annually on items which experience significant
and volatile movements in fair value while items which experience
insignificant movements in fair value are revalued every three years.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES
(g) Property, plant and equipment
Assets acquired under leasing agreements which effectively transfer
substantially all the risks and benefits incidental to ownership from the
lessor to the lessee are classified as finance leases. Assets under finance
leases are initially recorded at amounts equivalent to the present value of
the minimum lease payments (computed using the rate of interest implicit in
the lease) which approximate the fair value at the inception of the lease.
The net present value of the future minimum lease payments is recorded
correspondingly as a finance lease obligation. Assets under finance leases
are amortised over their estimated useful lives. The carrying amount of
assets under finance leases as at December 31, 2001 and 2002 and June 30,
2003 was RMB606 million, RMB187 million and RMB169 million, respectively.
Gains or losses arising from the retirement or disposal of property,
plant and equipment are determined as the difference between the net
disposal proceeds and the carrying amount of the asset and are recognised
as income or expense in the combined statements of operations on the date
of disposal. On disposal of a revalued asset, the related revaluation
surplus is transferred from the revaluation reserve to retained earnings.
Depreciation is provided to write off the cost/revalued amount of each
asset over its estimated useful life on a straight-line basis, after taking
into account its estimated residual value, as follows:
Depreciable life
----------------
Buildings and improvements 8 to 30 years
Telecommunications network plant, transmission
and switching equipment 6 to 10 years
Furniture, fixture, motor vehicles and other equipment 4 to 10 years
(h) Lease prepayments
Lease prepayments represent land use rights paid to the PRC's land
bureau. Land use rights are carried at cost and are amortised on a
straight-line basis over the respective periods of the rights which range
from 20 years to 70 years.
(i) Construction in progress
Construction in progress represents buildings, telecommunications
network plant, transmission and switching equipment and other equipment
under construction and pending installation, and is stated at cost less
impairment losses (Note 2(k)). Cost comprises direct costs of construction
as well as interest charges, and foreign exchange differences on related
borrowed funds to the extent that they are regarded as an adjustment to
interest charges, during the period of construction. Capitalisation of
these costs ceases and the construction in progress is transferred to
property, plant and equipment when the asset is substantially ready for its
intended use.
No depreciation is provided in respect of construction in progress.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES
(j) Investments
Investments in non-marketable equity securities are stated at cost
less provision for impairment losses (Note 2(k)). A provision is made
where, in the opinion of management, the carrying amount of the investments
exceeds its recoverable amount.
(k) Impairment
The carrying amounts of the Target Group's long-lived assets,
including property, plant and equipment, are reviewed periodically in order
to assess whether the recoverable amounts have declined below the carrying
amounts. These assets are tested for impairment whenever events or changes
in circumstances indicate that their recorded carrying amounts may not be
recoverable. When such a decline has occurred, the carrying amount is
reduced to the recoverable amount. The recoverable amount is the greater of
the net selling price and the value in use. The amount of the reduction is
recognised as an expense in the combined statements of operations. In
determining the value in use, expected future cash flows generated by the
assets are discounted to their present value. For the periods presented, no
impairment losses on long-lived assets were recognised in the combined
statements of operations.
(l) Revenue recognition
The Target Group's revenues are principally derived from the provision
of local, DLD and ILD telephone services which consist of (i) usage charges
for telephone services, which vary depending on the day, the time of day,
distance and duration of the telephone call, (ii) a monthly telephone
service fee, (iii) service activation and installation fees, and (iv)
charges for value-added telecommunications services, such as call waiting,
call diverting and caller number display. The Target Group records wireline
service revenues over the periods they are earned as follows:
(i) Revenues derived from local, DLD and ILD telephone usage are
recognised as the services are provided.
(ii) Upfront fees received for activation of wireline services and
wireline installation charges are deferred and recognised over
the expected customer relationship period. The related direct
incremental customer acquisition costs are deferred to the
extent of the upfront fees and are amortised over the same
expected customer relationship period.
(iii) Monthly telephone service fees are recognised in the month
during which the telephone services are provided to customers.
(iv) Revenues from sale of prepaid calling cards are recognised as
the cards are used by customers.
(v) Revenues derived from value-added telecommunications services
are recognised when the services are provided to customers.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES
(l) Revenue recognition
Other related wireline telecommunications service revenues are
recognised as follows:
(i) Revenues from the provision of Internet and managed data
services are recognised when the services are provided to
customers.
(ii) Interconnection fees from domestic telecommunications operators
are recognised when the services are rendered as measured by the
minutes of traffic processed.
(iii) Lease income from operating leases is recognised over the term
of the lease.
(iv) Sale of customer-end equipment is recognised on delivery of the
equipment to customers and when the significant risks and
rewards of ownership and title have been transferred to the
customers.
(m) Advertising and promotion expense
The costs for advertising and promoting the Target Group's wireline
telecommunications services are expensed as incurred. Advertising and
promotion expense, which is included in selling, general and administrative
expenses, was RMB390 million and RMB537 million for the years ended
December 31, 2001 and 2002 respectively, and RMB287 million for the
six-month period ended June 30, 2003.
(n) Net finance costs
Net finance costs comprise interest income on bank deposits, interest
expense on borrowings, and foreign exchange gains and losses. Interest
income from bank deposits is recognised on a time proportion basis that
takes into account the effective yield on the asset.
Interest costs incurred in connection with borrowings are expensed as
incurred, except to the extent that they are capitalised as being directly
attributable to the construction of an asset which necessarily take a
substantial period of time to get ready for its intended use.
(o) Research and development expense
Research and development expenditure is expensed as incurred. For the
years ended December 31, 2001 and 2002 and for the six-month period ended
June 30, 2003, research and development expense was RMB17 million, RMB16
million and RMB4 million, respectively.
(p) Employee benefits
The Target Group's contributions to defined contribution retirement
plans administered by the PRC government are recognised as an expense in
the combined statements of operations. Further information is set out in
Note 25.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES
(q) Provisions
A provision is recognised in the combined balance sheet when the
Target Group has a legal or constructive obligation as a result of a past
event, and it is probable that an outflow of economic benefits will be
required to settle the obligation.
(r) Income tax
Income tax comprises current and deferred tax. Current tax is
calculated on the taxable income for the year by applying the applicable
tax rates. Deferred tax is provided using the balance sheet liability
method, providing for all temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the
amounts used for taxation purposes. The amount of deferred tax is
calculated on the basis of the enacted tax rates that are expected to apply
in the period when the asset is realised or the liability is settled. The
effect on deferred tax of any changes in tax rates is charged or credited
to the combined statements of operations. A deferred tax asset is
recognised only to the extent that it is probable that future taxable
income will be available against which the asset can be utilised. Deferred
tax assets are reduced to the extent that it is no longer probable that the
related tax benefit will be realised.
(s) Dividends
Dividends are recognised as a liability in the period in which they
are declared.
(t) Segmental reporting
A business segment is a distinguishable component of the Target Group
that is engaged in providing products or services and is subject to risks
and rewards that are different from those of other segments. For the
periods presented, the Target Group has one operating segment which is the
provision of wireline telecommunications services. All the Target Group's
operating activities are carried out in the PRC.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
3. PROPERTY, PLANT AND EQUIPMENT, NET
Furniture,
fixture,
Telecomm- motor
unications vehicles
Buildings and network plant and other
improvements and equipment equipment Total
------------- ------------- ------------ ------------
RMB millions RMB millions RMB millions RMB millions
Cost:
Balance at January 1, 2001 10,901 92,449 5,510 108,860
Additions 192 2,651 631 3,474
Transferred from construction in progress 1,771 14,608 403 16,782
Disposals (890) (2,354) (525) (3,769)
Distribution to owner -- (311) -- (311)
------------- ------------ ------------ ------------
Balance at December 31, 2001 11,974 107,043 6,019 125,036
------------- ------------ ------------ ------------
Accumulated depreciation:
Balance at January 1, 2001 (2,178) (29,352) (2,199) (33,729)
Depreciation charge for the year (443) (9,468) (813) (10,724)
Written back on disposals 185 1,585 284 2,054
Distribution to owner -- 73 -- 73
------------- ------------ ------------ ------------
Balance at December 31, 2001 (2,436) (37,162) (2,728) (42,326)
------------- ------------ ------------ ------------
Net book value at December 31, 2001 9,538 69,881 3,291 82,710
============= ============ ============ ============
Cost/valuation:
Balance at January 1, 2002 11,974 107,043 6,019 125,036
Additions 291 2,613 157 3,061
Transferred from construction in progress 2,100 12,119 433 14,652
Disposals (425) (3,512) (475) (4,412)
Revaluation (449) (27,165) (2,212) (29,826)
Distribution to China Telecom in
connection with the Restructuring (1,454) (197) (239) (1,890)
------------- ------------ ------------ ------------
Balance at December 31, 2002 12,037 90,901 3,683 106,621
------------- ------------ ------------ ------------
Accumulated depreciation:
Balance at January 1, 2002 (2,436) (37,162) (2,728) (42,326)
Depreciation charge for the year (489) (10,813) (821) (12,123)
Written back on disposals 208 2,323 393 2,924
Revaluation 1,088 13,046 1,762 15,896
Distribution to China Telecom in
connection with the 322 158 124 604
------------- ------------- ------------ ------------
Restructuring
Balance at December 31, 2002 (1,307) (32,448) (1,270) (35,025)
------------- ------------- ------------ ------------
Net book value at December 31, 2002 10,730 58,453 2,413 71,596
============= ============= ============ ============
Cost/valuation:
Balance at January 1, 2003 12,037 90,901 3,683 106,621
Additions 64 842 166 1,072
Transferred from construction in progress 624 4,498 210 5,332
Disposals (18) (694) (97) (809)
------------- ------------- ------------ ------------
Balance at June 30, 2003 12,707 95,547 3,962 112,216
------------- ------------- ------------ ------------
Accumulated depreciation:
Balance at January 1, 2003 (1,307) (32,448) (1,270) (35,025)
Depreciation charge for the period (247) (4,589) (300) (5,136)
Written back on disposals 8 350 90 448
------------- ------------- ------------ ------------
Balance at June 30, 2003 (1,546) (36,687) (1,480) (39,713)
------------- ------------- ------------ ------------
Net book value at June 30, 2003 11,161 58,860 2,482 72,503
============= ============= ============ ============
NOTES TO THE COMBINED FINANCIAL STATEMENTS
3. PROPERTY, PLANT AND EQUIPMENT, NET
As required by the relevant PRC rules and regulations with respect to the
Restructuring, the property, plant and equipment of the Target Group as at
December 31, 2002 were revalued for each asset class by Beijing China Enterprise
Appraisal Co., Ltd, independent valuers registered in the PRC, on a depreciated
replacement cost basis. The value of the property, plant and equipment was
determined at RMB71,596 million. Such amount will serve as the tax base of such
assets for future years (Note 7). The surplus on revaluation of certain
property, plant and equipment totalling RMB760 million was credited to the
revaluation reserve while the deficit arising from the revaluation of certain
property, plant and equipment totalling RMB14,690 million was recognised as an
expense for the year ended December 31, 2002. The reduction in the carrying
amount was primarily the result of a market decline in the replacement cost of
certain network switching equipment during the years prior to 2002. The net
deficit on the revaluation of the property, plant and equipment of RMB13,930
million was reflected in the combined balance sheet of the Target Group as at
December 31, 2002.
The historical carrying amounts of the Target Group's property, plant and
equipment as at December 31, 2002 and the revalued amounts of these assets were
as follows:
Historical
carrying Revaluation Revaluation Revalued
amount surplus deficit amount
------------ ------------ ------------ ------------
RMB millions RMB millions RMB millions RMB millions
Buildings and improvements 10,091 704 (65) 10,730
Telecommunications network
plant and equipment 72,572 -- (14,119) 58,453
Furniture, fixture, motor vehicles
and other equipment 2,863 56 (506) 2,413
------------ ------------ ------------ ------------
85,526 760 (14,690) 71,596
============ ============ ============ ============
4. CONSTRUCTION IN PROGRESS
December 31, June 30,
--------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Balance at beginning of year/period 10,959 9,490 7,650
Additions 15,313 13,034 5,941
Transferred to property, plant and
equipment (16,782) (14,652) (5,332)
Distribution to China Telecom in
connection with the Restructuring -- (222) --
------------ ------------ ------------
Balance at end of year/period 9,490 7,650 8,259
============ ============ ============
NOTES TO THE COMBINED FINANCIAL STATEMENTS
5. INTERESTS IN ASSOCIATES
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Share of net assets 50 35 39
============ ============ ============
The Target Group's interests in associates are accounted for under the
equity method and are individually and in aggregate not material to the Target
Group's financial conditions or results of operations for all periods presented.
The Target Group's associates are established in the PRC and are not traded
on any stock exchange. In connection with the Restructuring, interests in
associates of RMB48 million were distributed to China Telecom as at December 31,
2002.
6. INVESTMENTS
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Unlisted equity investments 2,563 1 1
============ ============ ============
Unlisted equity investments mainly represent the Target Group's various
interests in PRC private enterprises which are mainly engaged in the
construction, equipment manufacturing and import/export trading industries.
These investments are accounted for at cost, less provision for any impairment.
The Target Group has no investments in marketable securities. In connection with
the Restructuring, investments of RMB3,030 million were distributed to China
Telecom as at December 31, 2002.
7. DEFERRED TAX ASSETS AND LIABILITIES
Deferred tax assets and deferred tax liabilities are attributable to the
items set out below:
Assets Liabilities Net balance
------------------------------ ------------------------------- -------------------------------
December 31, June 30, December 31, June 30, December 31, June 30,
------------------- -------- -------------------- -------- -------------------- --------
2001 2002 2003 2001 2002 2003 2001 2002 2003
-------- -------- -------- -------- -------- -------- -------- -------- --------
RMB RMB RMB RMB RMB RMB RMB RMB RMB
millions millions millions millions millions millions millions millions millions
Current
Provisions, primarily
for receivables 362 -- 83 -- -- -- 362 -- 83
Non-current
Property, plant and
equipment -- -- 36 (5,190) -- -- (5,190) -- 36
Deferred revenues and
installation costs 1,454 -- 316 (920) -- (106) 534 -- 210
Land use rights -- 2,408 2,384 -- -- -- -- 2,408 2,384
-------- -------- -------- -------- -------- -------- -------- -------- --------
Deferred tax
assets/(liabilities) 1,816 2,408 2,819 (6,110) -- (106) (4,294) 2,408 2,713
======== ======== ======== ======== ======== ======== ======== ======== ========
NOTES TO THE COMBINED FINANCIAL STATEMENTS
7. DEFERRED TAX ASSETS AND LIABILITIES
A valuation allowance on deferred tax assets is recorded if it is more
likely than not that some portion or all of the deferred tax assets will not be
realised through the recovery of taxes previously paid and/or future taxable
income. The allowance is subject to ongoing adjustments based on changes in
circumstances that affect the Target Group's assessment of the realisability of
the deferred tax assets. The Target Group has reviewed its deferred tax assets
as at December 31, 2001 and 2002 and June 30, 2003. Based on projections for
future taxable income over the periods which the deferred tax assets are
deductible, management believes that it is more likely than not the Target Group
will realise the benefits of these temporary differences. Therefore, no
valuation allowances were provided for the years ended December 31, 2001 and
2002 and for the six-month period ended June 30, 2003 in respect of deferred tax
assets arising from temporary differences.
Movements in deferred taxes for each of the years in the two-year period
ended December 31, 2002 and for the six-month period ended June 30, 2003 are as
follows:
Balance at Recognised Recognised Balance at
January 1, in statement in owner's December 31,
Note 2001 of operations equity 2001
---- ------------ ------------- ------------ ------------
RMB millions RMB millions RMB millions RMB millions
Current
Provisions, primarily
for receivables 302 60 -- 362
Non-current
Property, plant and
equipment (4,427) (763) -- (5,190)
Deferred revenues and
installation costs 368 166 -- 534
Tax loss (i) -- 307 (307) --
------------ ------------- ------------ ------------
Net deferred tax
liabilities (3,757) (230) (307) (4,294)
============ ============= ============ ============
(Note 21)
Balance at Recognised Recognised Balance at
January 1, in statement in owner's December 31,
Note 2001 of operations equity 2001
---- ------------ ------------- ------------ ------------
RMB millions RMB millions RMB millions RMB millions
Current
Provisions, primarily
for receivables (ii) 362 7 (369) --
Non-current
Property, plant and
equipment (ii) (5,190) 4,203 987 --
Deferred revenues and
installation costs (ii) 534 64 (598) --
Tax loss (i) -- 163 (163) --
Land use rights (iii) -- -- 2,408 2,408
------------ ------------- ------------ ------------
Net deferred tax
(liabilities)/assets (4,294) 4,437 2,265 2,408
============ ============= ============ ============
(Note 21)
NOTES TO THE COMBINED FINANCIAL STATEMENTS
7. DEFERRED TAX ASSETS AND LIABILITIES
Balance at Recognised Recognised Balance at
January 1, in statement in owner's June 30,
2001 of operations equity 2001
------------ ------------- ------------ ------------
RMB millions RMB millions RMB millions RMB millions
Current
Provisions, primarily
for receivables -- 83 -- 83
Non-current
Property, plant and
equipment -- 36 -- 36
Deferred revenues and
installation costs -- 210 -- 210
Land use rights 2,408 (24) -- 2,384
------------ ------------- ------------ ------------
Net deferred tax assets 2,408 305 -- 2,713
============ ============= ============ ============
(Note 21)
Note:
(i) Represents net tax loss carry forward of the Target Group for the
year. As the tax loss was utilised by China Telecom in the same tax
year, the utilisation of the deferred tax asset was reflected as a
distribution to owner.
(ii) As described in Note 3, in connection with the Restructuring, the
Target Group's property, plant and equipment were revalued as at
December 31, 2002. Such revalued amount will serve as the tax base
for these assets for future years. In addition, in connection with
the Restructuring, the tax bases of the Target Group's assets and
liabilities that gave rise to the temporary differences above have
been adjusted to conform to the related financial carrying amounts.
As a result, the timing differences that gave rise to the net
deferred tax liabilities relating to the items above were eliminated.
The reduction in net deferred tax liabilities of RMB20 million as at
December 31, 2002 was reflected as a credit to owner's equity.
(iii) In connection with the Restructuring, the Target Group's land use
rights, which as at December 31, 2002 had a carrying amount of RMB617
million, were revalued as required by the relevant PRC rules and
regulations. The revalued amount of the land use rights has been
determined at RMB7,913 million. Such amount will serve as the tax
base for future years. The land use rights were not revalued for
financial reporting purposes and accordingly, a deferred tax asset of
RMB2,408 million was created with a corresponding increase in owner's
equity. Based upon projections of future taxable income, management
believes it is more likely than not the Target Group will realise the
benefits of the deferred tax asset.
8. INVENTORIES
Inventories represent:
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Materials and supplies 622 524 484
Goods for resale 202 163 285
------------ ------------ ------------
824 687 769
============ ============ ============
NOTES TO THE COMBINED FINANCIAL STATEMENTS
9. ACCOUNTS RECEIVABLE, NET
Accounts receivable, net, are analysed as follows:
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Accounts receivable 3,538 3,665 4,434
Less: Allowance for
doubtful accounts (610) (568) (707)
------------ ------------ ------------
2,928 3,097 3,727
============ ============ ============
Amounts due from the provision of wireline telecommunications services to
residential and business customers are due within 30 days from the date of
billing. Customers who have accounts overdue by more than 90 days will have
their services disconnected. Accounts receivable from other telecommunications
operators and customers are due between 30 to 60 days from the billing date.
The following table summarises the changes in the allowance for doubtful
accounts for each of the years in the two-year period ended December 31, 2002
and for the six-month period ended June 30, 2003:
Six-month period
Years ended December 31, ended June 30,
-------------------------- ----------------
2001 2002 2003
------------ ------------ ----------------
RMB millions RMB millions RMB millions
At beginning of year/period 549 610 568
Provision for doubtful accounts 234 280 142
Accounts receivable written off (173) (322) (3)
------------ ------------ ----------------
At end of year/period 610 568 707
============ ============ ================
Ageing analysis of accounts receivable from telephone and Internet
subscribers is as follows:
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Current, within 1 month 1,924 2,088 2,456
1 to 3 months 425 449 538
4 to 12 months 205 265 309
More than 12 months 400 297 391
------------ ------------ ------------
2,954 3,099 3,694
Less: Allowance for
doubtful accounts (605) (562) (700)
------------ ------------ ------------
2,349 2,537 2,994
============ ============ ============
NOTES TO THE COMBINED FINANCIAL STATEMENTS
9. ACCOUNTS RECEIVABLE, NET
Ageing analysis of accounts receivable from other telecommunications
operators and customers is as follows:
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Current, within 1 month 216 215 212
1 to 3 months 197 128 301
4 to 12 months 90 154 142
More than 12 months 81 69 85
------------ ------------ ------------
584 566 740
Less: Allowance for doubtful accounts (5) (6) (7)
------------ ------------ ------------
579 560 733
============ ============ ============
10. PREPAYMENTS AND OTHER CURRENT ASSETS
Prepayments and other current assets represent:
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Amounts due from China Telecom Group 181 138 195
Prepayments in connection with
construction work and equipment
purchases 447 299 167
Prepaid expenses and deposits 255 187 211
Other receivables 1,141 492 434
------------ ------------ ------------
2,024 1,116 1,007
============ ============ ============
11. CASH AND CASH EQUIVALENTS
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Cash at bank and in hand 3,812 2,254 2,321
Time deposits with maturity within
three months 3 8 2
------------ ------------ ------------
3,815 2,262 2,323
============ ============ ============
NOTES TO THE COMBINED FINANCIAL STATEMENTS
12. SHORT-TERM AND LONG-TERM DEBT
Short-term debt comprises:
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Bank loans 15,087 21,161 21,011
============ ============ ============
Weighted average interest rate of the Target Group's short-term debt was
5.8%, 5.2% and 4.7% as at December 31, 2001 and 2002 and June 30, 2003,
respectively.
Long-term debt comprises:
December 31, June 30,
-------------------- ---------
Interest rates and final maturity 2001 2002 2003
-------------------------------------------------- --------- --------- ---------
RMB RMB RMB
millions millions millions
Bank loans
Renminbi Interest rates ranging from 2.4% to 9.7% per annum
denominated with maturities through 2007 16,431 13,781 13,043
US Dollars Interest rates ranging from 2.5% to 9.2% per annum
denominated with maturities through 2038 2,689 1,739 1,486
Japanese Yen Interest rates ranging from 2.5% to 2.6% per annum
denominated with maturities through 2022 204 215 210
Euro denominated Interest rates ranging from 0.5% to 8.1% per annum
with maturities through 2032 338 436 465
Other currencies 78 17 12
--------- --------- ---------
19,740 16,188 15,216
Other loans
Renminbi Interest rates ranging from 3.6% to 5.0% per
denominated annum 36 8 --
--------- --------- ---------
Total long-term debt 19,776 16,196 15,216
Less: current portion (5,095) (3,455) (4,837)
--------- --------- ---------
Non-current portion 14,681 12,741 10,379
========= ========= =========
Bank loans of RMB35 million as at December 31, 2001, RMB26 million as at
December 31, 2002 and RMB22 million as at June 30, 2003 were secured by certain
of the Target Group's property, plant and equipment. The net book value of the
property, plant and equipment pledged as security amounted to RMB3 million as at
December 31, 2001, RMB3 million as at December 31, 2002 and RMB3 million as at
June 30, 2003.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
12. SHORT-TERM AND LONG-TERM DEBT
The aggregate maturities of the Target Group's long-term debt subsequent to
December 31, 2002 are as follows:
RMB millions
2003 3,455
2004 6,300
2005 3,850
2006 1,518
2007 170
Thereafter 903
------------
16,196
============
The aggregate maturities of the Target Group's long-term debt subsequent to
June 30, 2003 are as follows:
RMB millions
2003 -- subsequent to June 30, 2003 2,064
2004 5,427
2005 4,186
2006 2,265
2007 409
2008 92
Thereafter 773
------------
15,216
============
The Target Group's short-term and long-term debts do not contain any
financial covenants. As at December 31, 2001 and 2002 and June 30, 2003, the
Target Group had available credit facilities which it can draw upon of RMB939
million, RMB6,445 million and RMB5,135 million respectively.
13. ACCOUNTS PAYABLE
Accounts payable are analysed as follows:
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Third parties 8,530 6,574 6,354
China Telecom Group 622 755 755
------------ ------------ ------------
9,152 7,329 7,109
============ ============ ============
Amounts due to China Telecom Group are repayable in accordance with normal
commercial terms.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
13. ACCOUNTS PAYABLE
Ageing analysis of accounts payable is as follows:
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Due within 1 month or on demand 1,775 1,505 1,499
Due after 1 month but within 3 months 744 1,017 908
Due after 3 months but within 6 months 1,946 1,367 1,275
Due after 6 months 4,687 3,440 3,427
------------ ------------ ------------
9,152 7,329 7,109
============ ============ ============
14. ACCRUED EXPENSES AND OTHER PAYABLES
Accrued expenses and other payables represent:
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Distributions payable to China Telecom 246 196 49
Amounts due to China Telecom Group 223 570 669
Accrued expenses 4,469 4,703 5,289
Customer deposits and receipts in
advance 320 562 635
------------ ------------ ------------
5,258 6,031 6,642
============ ============ ============
15. FINANCE LEASE OBLIGATIONS
Obligations under finance leases are analysed as follows:
December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Within 1 year 203 67 66
Between 1 to 2 years 216 73 49
Between 2 to 3 years 209 18 9
------------ ------------ ------------
Minimum lease payments 628 158 124
Less: finance charges related to
future periods (58) (9) (7)
------------ ------------ ------------
Present value of minimum lease
payments 570 149 117
Less: current portion (203) (67) (66)
------------ ------------ ------------
Non-current portion 367 82 51
============ ============ ============
NOTES TO THE COMBINED FINANCIAL STATEMENTS
16. DEFERRED REVENUES
Deferred revenues represent the unearned portion of upfront connection fees
and installation fees received from customers and the unused portion of calling
cards. Connection fees and installation fees are amortised over the expected
customer relationship period of 10 years. Beginning July 1, 2001, connection
fees were no longer collected from new customers.
Six-month
period ended
Years ended December 31, June 30,
--------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Balance at beginning of year/period 17,162 16,082 14,001
Additions for the year/period
connection fees 604 -- --
installation fees 1,091 1,027 569
calling cards 2,016 1,630 522
------------ ------------ ------------
3,711 2,657 1,091
------------ ------------ ------------
Reduction for the year/period
amortisation of connection fees (2,606) (2,536) (1,174)
amortisation of installation fees (484) (580) (323)
usage of calling cards (1,701) (1,622) (636)
------------ ------------ ------------
Balance at end of year/period 16,082 14,001 12,959
============ ============ ============
Representing:
Current portion 3,970 3,878 3,640
Non-current portion 12,112 10,123 9,319
------------ ------------ ------------
16,082 14,001 12,959
============ ============ ============
Included in other non-current assets are capitalised direct incremental
costs associated with the installation of wireline services. As at December 31,
2001 and 2002 and June 30, 2003, the unamortised portion of these costs was
RMB2,792 million, RMB3,074 million and RMB3,163 million, respectively.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
17. OPERATING REVENUES
Operating revenues represent revenues from the provision of wireline
telecommunications services, net of PRC business tax and government levies. The
components of the Target Group's operating revenues are as follows:
Six-month
period ended
Years ended December 31, June 30,
--------------------------------------- ------------
Note 2001 2002 2003
----------- ------------ ------------ ------------
RMB millions RMB millions RMB millions
Upfront connection fees (i) 2,606 2,536 1,174
Upfront installation fees (ii) 484 580 323
Monthly fees (iii) 5,114 6,538 3,683
Local usage fees (iv) 11,498 12,041 6,264
DLD (iv) 5,949 5,758 2,941
ILD (iv) 393 409 200
Internet (v) 650 1,139 841
Managed data (vi) 575 642 308
Interconnections (vii) 1,502 1,558 934
Leased line (viii) 1,178 1,119 566
Others (ix) 2,002 1,748 1,013
------------ ------------ ------------
31,951 34,068 18,247
============ ============ ============
Note:
(i) Represent the amortised amount of the upfront fees received for the
initial activation of wireline services.
(ii) Represent the amortised amount of the upfront fees received for
installation of wireline services.
(iii) Represent amounts charged to customers each month for their use of
the Target Group's telephone services.
(iv) Represent usage fees charged to customers for the provision of
telephone services.
(v) Represent amounts charged to customers for the provision of Internet
access services.
(vi) Represent amounts charged to customers for the provision of managed
data transmission services.
(vii) Represent amounts charged to other domestic telecommunications
operators for delivery of calls connecting to the Target Group's
wireline telecommunications networks.
(viii) Represent lease income from other domestic telecommunications
operators and business customers for the usage of the Target Group's
wireline telecommunications networks and is
measured by the number of lines leased and the agreed upon rate
per line leased. The lease arrangements are primarily on a year
to year basis.
(ix) Represent primarily revenues from provision of value-added
telecommunications services to customers, sale and repairs and
maintenance of customer-end equipment, and lease of
telecommunications network facilities.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
18. OTHER OPERATING EXPENSES
Other operating expenses consist of:
Six-month
period ended
Years ended December 31, June 30,
--------------------------------------- ------------
Note 2001 2002 2003
----------- ------------ ------------ ------------
RMB millions RMB millions RMB millions
Interconnection charges (i) 507 220 104
Donations 4 5 2
Others 27 11 6
------------ ------------ ------------
538 236 112
============ ============ ============
Note:
(i) Interconnection charges represent amounts incurred for the use of
other domestic telecommunications operators' networks for facilitating
the completion of calls that originate from the Target Group's
wireline telecommunications networks.
19. TOTAL OPERATING EXPENSES
Total operating expenses include personnel expenses of RMB4,185 million and
RMB4,400 million for the years ended December 31, 2001 and 2002 respectively,
and RMB2,671 million for the six-month period ended June 30, 2003.
20. NET FINANCE COSTS
Net finance costs comprise:
Six-month
period ended
Years ended December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Interest expense incurred 1,842 1,880 910
Less: Interest expense capitalised* (564) (426) (218)
------------ ------------ ------------
Net interest expense 1,278 1,454 692
Interest income (67) (34) (12)
Foreign exchange losses 4 102 48
Foreign exchange gains (46) (10) (2)
------------ ------------ ------------
1,169 1,512 726
============ ============ ============
* Interest expense was capitalised in
construction in progress at the
following rates per annum 5.1% to 5.8% 4.4% to 5.1% 4.2% to 5.1%
============ ============ ============
NOTES TO THE COMBINED FINANCIAL STATEMENTS
21. TAXATION
Taxation in the combined statement of operations comprises:
Six-month
period ended
Years ended December 31, June 30,
-------------------------- ------------
2001 2002 2003
------------ ------------ ------------
RMB millions RMB millions RMB millions
Provision for PRC income tax -- -- 1,068
Deferred taxation (Note 7) 230 (4,437) (305)
------------ ------------ ------------
230 (4,437) 763
============ ============ ============
For the years ended December 31, 2001 and 2002, no income tax payments were
made as the Target Group did not have assessable income for PRC income tax
purpose.
A reconciliation of the expected tax with the actual tax expense/(benefit)
is as follows:
Six-month
period ended
Years ended December 31, June 30,
------------------------------------- ------------
Note 2001 2002 2003
--------- ------------ ------------ ------------
RMB millions RMB millions RMB millions
Profit/(loss) before
taxation and minority
interests 3,340 (11,522) 4,137
============ ============ ============
Expected PRC income tax
expense/(benefit) at
statutory tax rate of 33% (i) 1,102 (3,802) 1,365
Non-deductible expenses (ii) 178 258 19
Non-taxable income (iii) (1,050) (893) (621)
------------ ------------ ------------
Income tax 230 (4,437) 763
============ ============ ============
Note:
(i) The provision for PRC current income tax is based on a statutory rate
of 33% of the assessable income of the Target Group as determined in
accordance with the relevant income tax rules and regulations of the
PRC for all periods presented.
(ii) Amounts represent personnel and other miscellaneous expenses in
excess of statutory deductible limits for tax purpose.
(iii) Amounts primarily represent connection fees which are not subject to
income tax.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
22. COMMITMENTS AND CONTINGENCIES
Operating lease commitments
The Target Group leases business premises through non-cancellable
operating leases. These operating leases do not contain provisions for
contingent lease rentals. None of the rental agreements contain escalation
provisions that may require higher future rental payments nor impose
restrictions on dividends, additional debt and/or further leasing. As at
December 31, 2002, future minimum lease payments under non-cancellable
operating leases having initial or remaining lease terms of more than one
year are payable in periods as follows:
RMB millions
2003 30
2004 20
2005 14
2006 9
2007 8
Thereafter 22
------------
Total minimum lease payments 103
============
As at June 30, 2003, future minimum lease payments under
non-cancellable operating leases having initial or remaining lease terms of
more than one year, which include the new lease agreements with China
Telecom Group (Note 24), are payable in periods as follows:
RMB millions
2003 -- subsequent to June 30, 2003 117
2004 201
2005 197
2006 13
2007 13
2008 12
Thereafter 26
------------
Total minimum lease payments 579
============
Total rental expense in respect of operating leases charged to the combined
statements of operations for the years ended December 31, 2001 and 2002 and for
the six-month period ended June 30, 2003 was RMB62 million, RMB79 million and
RMB97 million, respectively.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
22. COMMITMENTS AND CONTINGENCIES
Capital commitments
As at December 31, 2002 and June 30, 2003, the Target Group had
capital commitments as follows:
December 31, June 30,
2002 2003
------------ ------------
RMB millions RMB millions
Authorised and contracted for Properties 296 281
Telecommunications network plant and equipment 4,334 4,228
------------ ------------
4,630 4,509
============ ============
Authorised but not contracted for Properties 1,123 804
Telecommunications network plant and equipment 8,930 5,721
------------ ------------
10,053 6,525
============ ============
Contingent liabilities
(a) The Target Group has been advised by its PRC lawyers that, except for
liabilities constituting or arising out of or relating to the business
transferred to the Target Group in the Restructuring, no other
liabilities were assumed by the Target Group, and the Target Group is
not jointly and severally liable for other debts and obligations
incurred by China Telecom Group prior to the Restructuring.
(b) As at December 31, 2001 and 2002 and June 30, 2003, guarantees given
to banks in respect of banking facilities granted to third parties
were RMB611 million, RMB151 million and RMB158 million, respectively.
The Target Group monitors the conditions that are subject to the
guarantees to identify whether it is probable that a loss has
occurred, and recognise any such losses under guarantees when those
losses can be estimated. As at December 31, 2001 and 2002 and June 30,
2003, it was not probable that the Target Group would be required to
make payments under these guarantees. Thus no liability was accrued
for losses related to the Target Group's obligations under these
guarantee arrangements.
Legal contingencies
The Target Group is a defendant in certain lawsuits as well as the
named party in other proceedings arising in the ordinary course of
business. While the outcomes of such contingencies, lawsuits or other
proceedings cannot be determined at present, management believes that any
resulting liabilities will not have a material adverse effect on the
financial position or operating results of the Target Group.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
23. CONCENTRATION OF RISKS
Credit and concentration risks
The carrying amounts of cash and cash equivalents, time deposits,
accounts receivable, advances and other receivables represent the Target
Group's maximum exposure to credit risk in relation to financial assets.
The majority of the Target Group's accounts receivable relate to provision
of telecommunications services to residential and corporate customers
operating in various industries. The Target Group performs ongoing credit
evaluations of its customers' financial condition and generally does not
require collateral on accounts receivable. The Target Group maintains an
allowance for doubtful accounts and actual losses have been within
management's expectations.
The Target Group has a diversified base of customers. No single
customer contributed more than 10% of the Target Group's revenues for all
periods presented.
The Target Group does not have concentrations of available sources of
labour, services, franchises, licenses or other rights that could, if
suddenly eliminated, severely impact its income. The Target Group invests
its cash with several large state-owned financial institutions in the PRC.
Currency risk
Substantially all of the revenue-generating operations of the Target
Group are transacted in RMB, which is not fully convertible into foreign
currencies. On January 1, 1994, the PRC government abolished the dual rate
system and introduced a single rate of exchange as quoted by the People's
Bank of China. However, the unification of the exchange rate does not imply
convertibility of RMB into United States dollars or other foreign
currencies. All foreign exchange transactions must take place either
through the People's Bank of China or other institutions authorised to buy
and sell foreign exchange or at a swap center. Approval of foreign currency
payments by the People's Bank of China or other institutions requires
submitting a payment application form together with suppliers' invoices,
shipping documents and signed contracts.
Interest rate risk
The interest rates and terms of repayment of the Target Group's debts
are disclosed in Note 12.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
24. RELATED PARTY TRANSACTIONS
Companies are considered to be related if one company has the ability,
directly or indirectly, to control the other company or exercise significant
influence over the other company in making financial and operating decisions.
Companies are also considered to be related if they are subject to common
control or common significant influence.
The Target Group conducts business with enterprises directly or indirectly
owned or controlled by the PRC government ("state-owned enterprises").
Furthermore, the PRC government itself represents a significant customer of the
Target Group both directly through its numerous authorities and indirectly
through its numerous affiliates and other organisations. The Target Group
considers that the provision of wireline telecommunications services to the PRC
government authorities and affiliates and other state-owned enterprises are
activities in the ordinary course of business in the PRC and has not disclosed
such services as related party transactions.
The Target Group is part of a larger group of companies under China Telecom
and has significant transactions and relationships with members of China
Telecom. Because of these relationships, it is possible that the terms of these
transactions are not the same as those that would result from transactions among
wholly unrelated parties. Under IFRS, state-owned enterprises, other than China
Telecom and its affiliates, are not disclosed as related parties. Related
parties refer to enterprises over which China Telecom is able to exercise
control or significant influence.
The principal related party transactions with China Telecom Group, which
were carried out in the ordinary course of business, are as follows:
Six-month
period
ended
Years ended December 31, June 30,
---------------------------------- ----------
Note 2001 2002 2003
---------- ---------- ---------- ----------
RMB RMB RMB
millions millions millions
Purchases of telecommunications
equipment and materials (i) 1,040 1,288 36
Construction, engineering
and information
technology services (ii) 1,520 2,231 891
Provision of community services (iii) 230 359 192
Provision of ancillary services (iv) 136 220 143
Operating lease expenses (v) 3 5 22
Note:
(i) Represent purchases of telecommunications equipment and materials
from China Telecom Group.
(ii) Represent provision of network construction, engineering and
information technology services to the Target Group by China Telecom
Group.
(iii) Represent amounts paid and payable by the Target Group to China
Telecom Group in respect of cultural, educational, hygiene and other
community services.
(iv) Represent amounts paid and payable by the Target Group to China
Telecom Group in respect of ancillary services such as repairs and
maintenance of telecommunications equipment and facilities and
certain customer services.
(v) Represent amounts paid and payable to China Telecom Group for
operating leases in respect of business premises.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
24. RELATED PARTY TRANSACTIONS
Management of the Target Group is of the opinion that the above
transactions with related parties were conducted in the ordinary course of
business and has confirmed that the above transactions will continue in the
future after the Restructuring.
In connection with the Restructuring, the Target Group and China Telecom
Group entered into a number of agreements effective January 1, 2003 with an
initial term expiring on December 31, 2005. These agreements will impact the
results of operations of the Target Group beginning January 1, 2003. The terms
of the principal agreements are summarised as follows:
(1) The Target Group has entered into agreements with China Telecom Group
pursuant to which China Telecom Group provides the Target Group with
construction, design, equipment installation, testing and engineering
project management services. In addition, the Target Group has entered
into information technology service agreements with China Telecom
Group pursuant to which China Telecom Group provides the Target Group
with certain information technology services including office
automation and software modification. The amounts to be charged for
these services are determined by reference to market rates as
reflected in prices obtained through a tender.
(2) The Target Group has entered into property leasing agreements with
China Telecom Group pursuant to which the Target Group leases certain
business premises and storage facilities from China Telecom Group. The
rental charges are based on market rates, with reference to amounts
stipulated by local price bureaus.
(3) The Target Group has entered into agreements with China Telecom Group
pursuant to which China Telecom Group provides the Target Group with
the procurement of equipment and materials. The amount charged for
this service is based on a percentage not exceeding 1.8% of the
contract value of the equipment and materials purchased.
(4) The Target Group has entered into community services agreements for
cultural, educational, hygiene and other community services with China
Telecom Group. In addition, the Target Group has entered into
ancillary services agreements with China Telecom Group. The ancillary
services provided by China Telecom Group include repairs and
maintenance of telecommunications equipment and facilities and certain
customer services. Pursuant to these agreements, China Telecom Group
charges the Target Group for these services in accordance with the
following terms:
government prescribed price;
where there is no government prescribed price but where there is
a government guided price, the government guided price will
apply;
where there is neither a government prescribed price nor a
government guided price, the market price will apply;
where none of the above is available, the price is to be agreed
between the relevant parties, which shall be based on the cost
incurred in providing the services plus a reasonable profit
margin.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
24. RELATED PARTY TRANSACTIONS
Pursuant to the Restructuring, China Telecom has agreed to hold and
maintain, for the Target Group's benefit, all licenses received from the
Ministry of Information Industry in connection with the Predecessor Operations
transferred to the Target Group. The licenses maintained by China Telecom were
granted by the Ministry of Information Industry at zero or nominal cost. To the
extent that China Telecom incurs a cost to maintain or obtain licenses in the
future, the Target Group will reimburse China Telecom for the expenses it
incurs.
25. EMPLOYEE BENEFITS PLAN
As stipulated by the regulations of the PRC, the Target Group participates
in various defined contribution retirement plans organised by municipal and
provincial governments for its employees. The Target Group is required to make
contributions to the retirement plans at rates ranging from 17% to 22% of the
salaries, bonuses and certain allowances of its employees. A member of the plan
is entitled to a pension equal to a fixed proportion of the salary prevailing at
the member's retirement date. The Target Group has no other material obligation
for the payment of pension benefits associated with these plans beyond the
annual contributions described above. The Target Group's contributions for the
year ended December 31, 2001 and 2002 and for the six-month period ended June
30, 2003 were RMB352 million, RMB468 million and RMB262 million, respectively.
26. FAIR VALUES OF FINANCIAL INSTRUMENTS
Financial assets of the Target Group include cash and cash equivalents,
time deposits, investments, accounts receivable, amounts due from China Telecom
Group, advances and other receivables. Financial liabilities of the Target Group
include debts, accounts payable, amounts due to China Telecom Group, accrued
expenses and other payables. The Target Group does not hold nor issue financial
instruments for trading purposes.
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of IAS 32 and IAS 39.
Fair value estimates, methods and assumptions, set forth below for the Target
Group's financial instruments, are made solely to comply with the requirements
of IAS 32 and IAS 39 and should be read in conjunction with the Target Group's
combined financial statements and related notes. The estimated fair value
amounts have been determined by the Target Group using market information and
valuation methodologies considered appropriate. However, considerable judgment
is required to interpret market data to develop the estimates of fair values.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts the Target Group could realise in a current market exchange. The use
of different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts.
NOTES TO THE COMBINED FINANCIAL STATEMENTS
26. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following summarises the major methods and assumptions used in
estimating the fair values of the Target Group's financial instruments.
Long-term debt: The fair values of long-term indebtedness are estimated by
discounting future cash flows using current market interest rates offered to the
Target Group for debt with substantially the same characteristics and
maturities. As at December 31, 2001 and 2002 and June 30, 2003, the carrying
amounts and fair values of the Target Group's long-term debt were as follows:
December 31, 2001 December 31, 2002 June 30, 2003
------------------- ------------------- -------------------
Carrying Fair Carrying Fair Carrying Fair
amount value amount value amount value
-------- -------- -------- -------- -------- --------
RMB RMB RMB RMB RMB RMB
millions millions millions millions millions millions
Long-term debt 19,776 20,102 16,196 16,486 15,216 15,452
======== ======== ======== ======== ======== ========
Long-term investments are unlisted equity interests and there are no quoted
market prices for such interests in the PRC. Accordingly, a reasonable estimate
of fair value could not be made without incurring excessive costs.
The fair values of all other financial instruments approximate their
carrying amounts due to the short-term maturity of these instruments.
/12/INTRODUCTION TO UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION OF THE
TARGET GROUP
Anhui Telecom, Fujian Telecom, Jiangxi Telecom, Guangxi Telecom, Chongqing
Telecom and Sichuan Telecom (individually referred to as the "Target Company"
and together with their subsidiaries collectively referred to as the "Target
Group") were incorporated in the PRC on August 26, 2003, August 28, 2003,
September 18, 2003, August 28, 2003, August 22, 2003 and August 28, 2003
respectively, as part of the reorganisation (the "Restructuring") of China
Telecommunications Corporation ("China Telecom", and together with its
subsidiaries other than the Target Group and China Telecom Corporation Limited
are hereinafter referred to as "China Telecom Group"). Pursuant to the
Restructuring, which was effective December 31, 2002, China Telecom transferred
to each of the Target Companies the wireline telecommunications and related
operations in Anhui Province, Fujian Province, Jiangxi Province, Guangxi Zhuang
Autonomous Region, Chongqing Municipality and Sichuan Province together with the
related assets and liabilities (the "Predecessor Operations") in consideration
for the entire equity interests in each of the Target Companies. In preparing
the Target Group's combined financial statements, the assets and liabilities,
revenues and expenses of the Predecessor Operations are reflected in the
combined financial statements. In addition, the combined financial statements
include certain assets historically associated with the Predecessor Operations
that were not transferred to the Target Group and retained by China Telecom.
These assets primarily related to investments in non-telecommunications
industries and properties. As a result of the segregation and separate
management of these assets by China Telecom beginning December 31, 2002, the
assets retained by China Telecom have been reflected as a distribution to China
Telecom in the combined statements of owner's equity as at December 31, 2002.
----------
/12/14.30(5)
Since the Restructuring, the Target Group and China Telecom Group have
entered into new agreements for a range of services which may be required and
requested by either party. The Restructuring, as well as other related events,
will have an impact on the Target Group's results of operations. The
accompanying unaudited pro forma combined financial information of the Target
Group is based upon the historical combined financial statements of the Target
Group prepared in accordance with IFRS after giving effect to the pro forma
adjustments described in the accompanying notes, as if the Restructuring and
other related events had been in effect on January 1, 2002.
A narrative description of the pro forma effects of the Restructuring that
are (i) directly attributable to the transactions; (ii) expected to have a
continuing impact on the Target Group; and (iii) factually supportable, are
summarised in the accompanying notes to the unaudited pro forma combined
financial information of the Target Group. The expected effects of the new
service agreements (other than the property leasing agreements) in connection
with the Restructuring are not reflected in the pro forma combined financial
information for the year ended December 31, 2002 because the effects of such
change cannot be factually supported, reasonably estimated and/or do not result
in any material change to the results of operations. Since the actual effects of
the Restructuring and of the new service agreements have been reflected in the
Target Group's historical financial data for the six-month period ended June 30,
2003, no pro forma financial information is prepared for that period.
The unaudited pro forma combined financial information of the Target Group
is based on a number of assumptions, estimates, uncertainties and currently
available information. As a result of these assumptions, estimates and
uncertainties, the accompanying unaudited pro forma combined statement of
operations of the Target Group for the year ended December 31, 2002 does not
purport to describe the results of the Target Group's operations that would have
been achieved had the Restructuring and the effects of the related service
agreements taken effect on January 1, 2002, nor does it purport to predict the
Target Group's future financial position or results of operations.
The unaudited pro forma combined financial information of the Target Group
should be read in conjunction with the audited combined financial statements of
the Target Group, including notes thereto, and other financial information
included elsewhere in this circular.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2002
Target Target
Group Pro Forma Group
Historical Adjustments Pro Forma
---------- ----------- ---------
RMB RMB RMB
millions millions millions
Operating revenues 34,068 34,068
Operating expenses
Depreciation and amortisation (12,123) 2,643/(1)/ (9,421)
59/(2)/
Network operations and support (12,097) (12,097)
Selling, general and administrative (4,993) (33)/(2)/ (5,026)
Other operating expenses (236) (236)
---------- ---------
Total operating expenses (29,449) (26,780)
---------- ---------
Operating profit 4,619 7,288
Deficit on revaluation of property,
plant and equipment (14,690) (14,690)
Net finance costs (1,512) (1,512)
Investment income 59 (59)/(3)/ --
Share of profit from associates 2 2
---------- ---------
Loss before taxation and minority
interests (11,522) (8,912)
Taxation 4,437 (861)/(4)/ 3,576
---------- ----------- ---------
Loss before minority interests (7,085) (5,336)
Minority interests (6) (6)
---------- ---------
Net loss (7,091) (5,342)
========== =========
See accompanying notes to unaudited pro forma combined financial information of
the Target Group.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION OF THE TARGET GROUP
(1) In connection with the Restructuring, the property, plant and equipment of
the Target Group were revalued as at December 31, 2002 which resulted in a
net revaluation deficit of RMB13,930 million. The pro forma adjustment
reflects the reduction in depreciation charge resulting from the
revaluation of the Target Group's property, plant and equipment as if the
results of the revaluation had been recorded on January 1, 2002.
(2) In connection with the Restructuring, certain properties and buildings
associated with the Predecessor Operations were not transferred to the
Target Group but were retained by China Telecom. Pursuant to property
leasing agreements between the Target Group and China Telecom Group, the
Target Group leases the properties and buildings from China Telecom Group.
The amount to be paid by the Target Group to China Telecom Group is based
on market rates, with reference to amounts stipulated by local price
bureaus. The pro forma adjustment reflects the effects of a reduction in
depreciation charge relating to these properties and buildings and an
increase in rental expense as if the Restructuring occurred and the
property leasing agreements took effect on January 1, 2002.
(3) In connection with the Restructuring, certain long-term investments and
interests in associates that are unrelated to the telecommunications
industries were not transferred to a Target Group but were retained by
China Telecom. The pro forma adjustment reflects a reduction in investment
income generated from these investments as if the Restructuring occurred on
January 1, 2002.
(4) The pro forma adjustment reflects the tax effect of the above pro forma
adjustments using the statutory tax rate of 33%.
/13/The following consolidated balance sheets of China Telecom Corporation
Limited (together with its subsidiaries are referred to as the "Listed Group")
as at December 31, 2001 and 2002, and the consolidated statements of income,
shareholders' equity, and cash flow for the years ended December 31, 2001 and
2002 are extracted from the audited financial statements of the Listed Group
prepared under IFRS. The following consolidated balance sheet as at June 30,
2003 and the consolidated statements of income, shareholders' equity and cash
flow of the Listed Group for the six-month period ended June 30, 2003 are
extracted from the unaudited interim financial statements of the Listed Group
prepared under IFRS. All such financial information should be read in
conjunction with the audited and unaudited consolidated financial statements and
accompanying notes, which are included in the Listed Group's annual and interim
reports mailed to you or otherwise available on request from China Telecom
Corporation Limited.
----------
/13/14.30(5)
CONSOLIDATED BALANCE SHEETS
Audited Unaudited
------------------- --------------
As at December 31, As at June 30,
------------------- --------------
2001 2002 2003
-------- -------- --------------
RMB RMB
millions millions RMB millions
ASSETS
Non-current assets
Property, plant and equipment, net 138,623 149,165 145,344
Construction in progress 23,274 20,319 22,706
Lease prepayments 2,638 2,644 2,630
Interests in associates 417 429 429
Investments 446 270 261
Deferred tax assets 4,059 5,118 5,322
Other assets 5,749 6,405 6,386
-------- -------- --------------
Total non-current assets 175,206 184,350 183,078
Current assets
Inventories 1,413 1,066 1,153
Accounts receivable, net 5,608 5,961 7,431
Prepayments and other current assets 2,752 1,736 1,747
Time deposits with maturity over
three months 473 1,316 405
Cash and cash equivalents 3,882 16,423 17,835
-------- -------- --------------
Total current assets 14,128 26,502 28,571
-------- -------- --------------
Total assets 189,334 210,852 211,649
======== ======== ==============
CONSOLIDATED BALANCE SHEETS --- (CONTINUED)
Audited Unaudited
------------------- --------------
As at December 31, As at June 30,
------------------- --------------
2001 2002 2003
-------- -------- --------------
RMB RMB
millions millions RMB millions
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Short-term debt 18,827 19,175 16,745
Current portion of long-term debt 3,621 2,219 1,852
Accounts payable 14,919 14,399 11,850
Accrued expenses and other payables 11,672 10,266 12,056
Income tax payable 212 3,842 2,036
Current portion of finance lease
obligations 38 -- --
Current portion of deferred revenues 8,155 7,726 6,972
-------- -------- --------------
Total current liabilities 57,444 57,627 51,511
-------- -------- --------------
Net current liabilities (43,316) (31,125) (22,940)
Total assets less current
liabilities 131,890 153,225 160,138
Non-current liabilities
Long-term debt 7,101 4,853 4,937
Finance lease obligations 11 -- --
Deferred revenues 26,353 21,612 19,580
Deferred tax liabilities -- 618 851
-------- -------- --------------
Total non-current liabilities 33,465 27,083 25,368
-------- -------- --------------
Total liabilities 90,909 84,710 76,879
Minority interests 940 1,134 1,175
Shareholders' equity
Share capital -- 75,614 75,614
Reserves 97,485 49,394 57,981
-------- -------- --------------
Total shareholders' equity 97,485 125,008 133,595
-------- -------- --------------
Total liabilities and shareholders'
equity 189,334 210,852 211,649
======== ======== ==============
CONSOLIDATED STATEMENTS OF INCOME
Audited Unaudited
------------------- ----------------
Years ended Six-month period
December 31, ended June 30,
------------------- ----------------
2001 2002 2003
-------- -------- ----------------
RMB RMB RMB
millions millions millions
Operating revenues 68,546 75,496 39,536
Operating expenses
Depreciation and amortisation (19,451) (20,882) (10,859)
Network operations and support (20,269) (20,131) (9,693)
Selling, general and administrative (9,401) (10,468) (5,476)
Other operating expenses (1,327) (2,637) (1,310)
-------- -------- ----------------
Total operating expenses (50,448) (54,118) (27,338)
-------- -------- ----------------
Operating profit 18,098 21,378 12,198
Deficit on revaluation of property,
plant and equipment (11,930) -- --
Net finance income/(costs) 293 (632) (176)
Investment income 310 4 2
Share of profit from associates 22 35 --
-------- -------- ----------------
Profit before taxation and minority
interests 6,793 20,785 12,024
Taxation 69 (3,855) (2,743)
-------- -------- ----------------
Profit before minority interests 6,862 16,930 9,281
Minority interests 21 (66) (21)
-------- -------- ----------------
Profit attributable to shareholders 6,883 16,864 9,260
======== ======== ================
Basic earnings per share (in RMB) 0.10 0.24 0.12
======== ======== ================
CONSOLIDATED STATEMENTs OF SHAREHOLDERS' EQUITY
Statutory Total
Revalua- common Share-
Share Capital Share tion Surplus welfare Other Retained holder'
capital reserve premium reserve reserve fund reserves earnings equity
-------- -------- -------- -------- -------- --------- -------- -------- --------
RMB RMB RMB RMB RMB RMB RMB RMB RMB
millions millions millions millions millions millions millions millions millions
(Audited)
Balance as at January 1, 2001 -- -- -- -- -- -- -- 101,619 101,619
Net profit -- -- -- -- -- -- -- 6,883 6,883
Contributions from China Telecom -- -- -- -- -- -- -- 3,003 3,003
Distributions to China Telecom -- -- -- -- -- -- -- (15,835) (15,835)
Assets distributed to China
Telecom in connection with the
Restructuring -- -- -- -- -- -- -- (11,285) (11,285)
Revaluation surplus -- -- -- 4,154 -- -- -- -- 4,154
Recognition of deferred tax assets -- -- -- -- -- -- 4,059 -- 4,059
Elimination of net deferred tax
liabilities -- -- -- -- -- -- -- 4,887 4,887
-------- -------- -------- -------- -------- --------- -------- -------- --------
Balance as at December 31, 2001 -- -- -- 4,154 -- -- 4,059 89,272 97,485
Capitalisation as share capital
upon incorporation of the Company 68,317 20,955 -- -- -- -- -- (89,272) --
Issue of shares, net of issuing
expenses of RMB796 million 7,297 -- 3,362 -- -- -- -- -- 10,659
Net profit -- -- -- -- -- -- -- 16,864 16,864
Appropriations -- -- -- -- 8,121 1,624 -- (9,745) --
Revaluation surplus realised -- -- -- (10) -- -- -- 10 --
Deferred tax on amortisation of
land use rights realised -- -- -- -- -- -- (75) 75 --
-------- -------- -------- -------- -------- --------- -------- -------- --------
Balance as at December 31, 2002 75,614 20,955 3,362 4,144 8,121 1,624 3,984 7,204 125,008
======== ======== ======== ======== ======== ========= ======== ======== ========
(Unaudited)
Balance as at January 1, 2003 75,614 20,955 3,362 4,144 8,121 1,624 3,984 7,204 125,008
Net profit -- -- -- -- -- -- -- 9,260 9,260
Dividends -- -- -- -- -- -- -- (673) (673)
Revaluation surplus realised -- -- -- (4) -- -- -- 4 --
Deferred tax on amortisation of
land use rights realised -- -- -- -- -- -- (52) 52 --
-------- -------- -------- -------- -------- --------- -------- -------- --------
Balance as at June 30, 2003 75,614 20,955 3,362 4,140 8,121 1,624 3,932 15,847 133,595
======== ======== ======== ======== ======== ========= ======== ======== ========
CONSOLIDATED STATEMENTS OF CASH FLOW
Audited Unaudited
-------------------------- ------------
Six-month
period ended
Years ended December 31, June 30,
-------------------------- ------------
Note 2001 2002 2003
---- ----------- ------------ ------------
RMB RMB RMB
millions millions millions
Net cash from operating activities (a) 32,761 37,102 14,516
----------- ------------ ------------
Cash flows from investing activities
Capital expenditure (34,610) (28,169) (11,347)
Purchase of investments (290) (50) (4)
Lease prepayments (437) (74) (17)
Proceeds from disposal of property, plant and equipment 72 41 18
Increase in time deposits with maturity over three months (473) (1,312) (168)
Maturity of time deposits with maturity over three months 339 469 1,079
----------- ------------ ------------
Net cash used in investing activities (35,399) (29,095) (10,439)
----------- ------------ ------------
Cash flows from financing activities
Proceeds from initial public offering,
net of issuing expenses -- 10,659 --
Capital element of finance lease payments (305) (49) --
Proceeds from bank debt 21,423 25,749 17,900
Repayments of bank debt (16,979) (29,278) (20,585)
Cash (distributions to)/contributions from minority
interests -- (12) 20
Cash contributions from China Telecom 3,003 -- --
Cash distributions to China Telecom (14,483) (2,535) --
----------- ------------ ------------
Net cash (used in)/from financing activities (7,341) 4,534 (2,665)
----------- ------------ ------------
Net (decrease)/increase in cash and cash equivalents (9,979) 12,541 1,412
----------- ------------ ------------
Cash and cash equivalents at beginning
of year/period 13,861 3,882 16,423
----------- ------------ ------------
Cash and cash equivalents at end
of year/period 3,882 16,423 17,835
=========== ============ ============
CONSOLIDATED STATEMENTS OF CASH FLOW -- (CONTINUED)
(a) Reconciliation of profit before taxation and minority interests to net cash
from operating activities
Audited Unaudited
-------------------------- ------------
Six-month
period ended
Years ended December 31, June 30,
-------------------------- ------------
Note 2001 2002 2003
---- ----------- ------------ ------------
RMB RMB RMB
millions millions millions
Profit before taxation and minority interests 6,793 20,785 12,024
Adjustments for:
Depreciation and amortisation 19,451 20,882 10,859
Deficit on revaluation of property, plant and equipment 11,930 -- --
Provision for doubtful accounts 186 345 319
Investment income (310) (4) (2)
Share of profit from associates (22) (35) --
Interest income (246) (140) (119)
Interest expense 1,415 1,321 616
Unrealised foreign exchange (gains)/losses (325) 227 (28)
Loss on retirement and disposal of property, plant
and equipment 1,720 410 109
Decrease/(increase) in accounts receivable 1,336 (698) (1,789)
(Increase)/decrease in inventories (99) 347 (87)
(Increase)/decrease in prepayments and other current assets (550) 1,149 (50)
(Increase)/decrease in other non-current assets (1,139) (588) 50
Increase/(decrease) in accounts payable 1,231 (78) (417)
(Decrease)/increase in accrued expenses and other payables (373) 157 818
Decrease in deferred revenues (3,691) (5,170) (2,786)
----------- ------------ ------------
Cash generated from operations 37,307 38,910 19,517
Interest received 246 140 119
Interest paid (1,408) (1,315) (613)
Investment income received 255 33 13
Income tax paid (3,639) (666) (4,520)
----------- ------------ ------------
Net cash from operating activities 32,761 37,102 14,516
=========== ============ ============
/14/INTRODUCTION TO UNAUDITED PRO FORMA FINANCIAL INFORMATION OF THE COMBINED
GROUP
The accompanying unaudited pro forma financial information of the Combined
Group, as defined below, has been prepared giving effect to China Telecom
Corporation Limited's proposed acquisition of the
----------
/14/ 14.30(6)
14.16(8)
entire equity interests in Anhui Telecom, Fujian Telecom, Jiangxi Telecom,
Guangxi Telecom, Chongqing Telecom and Sichuan Telecom (collectively and
together with their subsidiaries are referred to as the "Target Group") and
certain network management and research and development facilities from China
Telecommunications Corporation ("China Telecom") for a total purchase price of
RMB46,000 million (the "Acquisition"). China Telecom Corporation Limited (the
"Company") and together with its subsidiaries are referred to as the "Listed
Group". The purchase price will be satisfied by an initial cash payment of
RMB11,000 million and a deferred consideration of RMB35,000 million. The
deferred consideration is interest-bearing and repayable within 10 years. As a
result of both the Target Group and the Company being under common control prior
to the Acquisition, the acquisition of the Target Group will be considered as a
"combination of entities under common control". Under a combination of entities
under common control, the assets and liabilities of the Target Group to be
acquired by the Company will be accounted for at historical amounts in a manner
similar to a pooling-of-interests ("as-if pooling-of-interests accounting"). In
as-if pooling-of-interests accounting, the consolidated financial statements of
the Company for periods prior to the combination will be restated to include the
assets and liabilities and results of operations of the Target Group for those
periods on a combined basis (the "Combined Group"). The purchase price in
respect of the acquisition of the Target Group will be treated as an equity
transaction at the date of the acquisition.
The accompanying unaudited pro forma statements of income of the Combined
Group for the year ended December 31, 2002 and for the six-month period ended
June 30, 2003 give effect to the Acquisition as if the Acquisition had been
consummated on January 1, 2002 and January 1, 2003, respectively. The unaudited
pro forma statement of income of the Combined Group for the year ended December
31, 2002 has been further adjusted to give effect to certain events relating to
the Restructuring (as defined in Appendix IV to this circular) as if the
Restructuring had taken place on January 1, 2002. The accompanying unaudited pro
forma balance sheet of the Combined Group as at June 30, 2003 gives effect to
the Acquisition as if the Acquisition had been consummated on June 30, 2003.
The unaudited pro forma financial information of the Combined Group is
based upon the historical combined financial statements of the Target Group and
the consolidated financial statements of the Listed Group after giving effect to
the pro forma adjustments described in the accompanying notes to the pro forma
financial information of the Combined Group. A narrative description of the pro
forma effects of the Acquisition and the Restructuring that are (i) directly
attributable to the transactions; (ii) expected to have a continuing impact on
the Combined Group; and (iii) factually supportable, are summarised in the
accompanying notes to the unaudited pro forma financial information of the
Combined Group. As described in Appendix IV, the expected effects of the new
service agreements (other than the property leasing agreements) in connection
with the Restructuring are not reflected in the pro forma statement of income
for the year ended December 31, 2002 because the effects of such change cannot
be factually supported, reasonably estimated and/or do not result in any
material change to the results of operations. Since the actual effects of the
Restructuring and of the new service agreements have been reflected in the
Target Group's historical financial data for the six-month period ended June 30,
2003, no pro forma adjustments in respect of the effects of the Restructuring
are required for the Combined Group's pro forma statement of income for that
period.
The unaudited pro forma financial information of the Combined Group is
based on a number of assumptions, estimates, uncertainties and currently
available information. As a result of these assumptions, estimates and
uncertainties, the accompanying unaudited pro forma financial information of the
Combined Group does not purport to describe the actual financial position or
results of the Combined Group's operations that would have been achieved had the
Acquisition been consummated, and the Restructuring taken effect as at the date
or the beginning of the year/period indicated herein. Further, the accompanying
unaudited pro forma financial information of the Combined Group does not purport
to predict the Combined Group's future financial position or results of
operations.
The unaudited pro forma financial information of the Combined Group should
be read in conjunction with the audited combined financial statements of the
Target Group, including the notes thereto, the financial information of the
Listed Group and other financial information included elsewhere in this
circular.
UNAUDITED PRO FORMA BALANCE SHEET OF THE COMBINED GROUP
AS AT JUNE 30, 2003
Combined
Target Group Listed Group Pro Forma Group
Historical Historical Adjustments Pro Forma
------------ ------------ ------------ ------------
RMB millions RMB millions RMB millions RMB millions
ASSETS
Non-current assets
Property, plant and equipment, net 72,503 145,344 432/(1)/ 218,279
Construction in progress 8,259 22,706 30,965
Lease prepayments 620 2,630 3,250
Interests in associates 39 429 468
Investments 1 261 262
Deferred tax assets 2,819 5,322 8,141
Other assets 3,367 6,386 9,753
------------ ------------ ------------
Total non-current assets 87,608 183,078 271,118
------------ ------------ ------------
Current assets
Inventories 769 1,153 1,922
Accounts receivable, net 3,727 7,431 11,158
Prepayments and other current assets 1,007 1,747 2,754
Time deposits with maturity over three months 33 405 438
Cash and cash equivalents 2,323 17,835 (11,000)/(1)/ 9,158
------------ ------------ ------------ ------------
Total current assets 7,859 28,571 25,430
------------ ------------ ------------
Total assets 95,467 211,649 296,548
============ ============ ============
UNAUDITED PRO FORMA BALANCE SHEET OF THE COMBINED GROUP --- (CONTINUED)
AS AT JUNE 30, 2003
Combined
Target Group Listed Group Pro Forma Group
Historical Historical Adjustments Pro Forma
------------ ------------ ------------ ------------
RMB millions RMB millions RMB millions RMB millions
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Short-term debt 21,011 16,745 37,756
Current portion of long-term debt 4,837 1,852 6,689
Accounts payable 7,109 11,850 18,959
Accrued expenses and other payables 6,642 12,056 18,698
Income tax payable 1,068 2,036 3,104
Current portion of finance lease obligations 66 -- 66
Current portion of deferred revenues 3,640 6,972 10,612
------------ ------------ ------------
Total current liabilities 44,373 51,511 95,884
------------ ------------ ------------
Net current liabilities (36,514) (22,940) (70,454)
------------ ------------ ------------
Total assets less current liabilities 51,094 160,138 200,664
------------ ------------ ------------
Non-current liabilities
Long-term debt 10,379 4,937 35,000/(2)/ 50,316
Finance lease obligations 51 -- 51
Deferred revenues 9,319 19,580 28,899
Deferred tax liabilities 106 851 957
------------ ------------ ------------
Total non-current liabilities 19,855 25,368 80,223
------------ ------------ ------------
Total liabilities 64,228 76,879 176,107
Minority interests 53 1,175 1,228
Shareholders' equity
Share capital -- 75,614 75,614
Reserves 31,186 57,981 (10,568)/(1)/ 43,599
------------ ------------ ------------ ------------
(35,000)/(2)/
Total shareholders' equity 31,186 133,595 119,213
------------ ------------ ------------
Total liabilities and shareholders' equity 95,467 211,649 296,548
============ ============ ============
See accompanying notes to unaudited pro forma financial information of the
Combined Group.
UNAUDITED PRO FORMA STATEMENT OF INCOME OF THE COMBINED GROUP
FOR THE SIX-MONTH PERIOD ENDED JUNE 30, 2003
Target Listed Combined
Group Group Pro Forma Group
Historical Historical Adjustments Pro Forma
---------- ---------- ----------- ---------
RMB RMB RMB RMB
millions millions millions millions
Operating revenues 18,247 39,536 (13)/(3)/ 57,770
Operating expenses
Depreciation and amortisation (5,136) (10,859) (25)/(1)/ (16,020)
Network operations and support (5,534) (9,693) (15,227)
Selling, general and
administrative (2,602) (5,476) (8,078)
Other operating expenses (112) (1,310) 141/(3)/ (1,281)
---------- ---------- ----------- ---------
Total operating expenses (13,384) (27,338) (40,606)
---------- ---------- ---------
Operating profit 4,863 12,198 17,164
Net finance costs (726) (176) (57)/(1)/ (1,866)
(907)/(2)/
Investment income -- 2 2
Share of profit from associates ---------- ---------- ---------
-- -- --
---------- ---------- ---------
Profit before taxation and
minority interests 4,137 12,024 15,300
Taxation (763) (2,743) 284/(7)/ (3,222)
---------- ---------- ----------- ---------
Profit before minority
interests 3,374 9,281 12,078
Minority interests (3) (21) (24)
---------- ---------- ---------
Net profit 3,371 9,260 12,054
========== ========== =========
Basic earnings per share (in
RMB) 0.12 0.16
========== =========
Weighted average number of
shares 75,614 75,614
(in millions) ========== =========
See accompanying notes to unaudited pro forma financial information of the
Combined Group.
UNAUDITED PRO FORMA STATEMENT OF INCOME OF THE COMBINED GROUP
FOR THE YEAR ENDED DECEMBER 31, 2002
Pro Forma
adjustments
giving
effect to Pro Forma
certain adjustments
Target events of the Target Listed giving Combined
Group Restructuring Group Group effect to the Group
Historical Pro Forma Pro Forma Historical Acquisition Pro Forma
---------- ------------- ---------- ---------- ------------- ---------
RMB RMB RMB RMB RMB RMB
millions millions millions millions millions millions
Operating revenues 34,068 34,068 75,496 (40)/(3)/ 109,524
Operating expenses
Depreciation and
amortisation (12,123) 2,643/(4)/ (9,421) (20,882) (50)/(1)/ (30,353)
59/(5)/
Network operations
and support (12,097) (12,097) (20,131) (32,228)
Selling, general
and administrative (4,993) (33)/(5)/ (5,026) (10,468) (15,494)
Other operating
expenses (236) (236) (2,637) 346/(3)/ (2,527)
---------- ---------- ---------- ------------- ---------
Total operating
expenses (29,449) (26,780) (54,118) (80,602)
---------- ---------- ---------- ---------
Operating profit 4,619 7,288 21,378 28,922
Deficit on
revaluation of
property, plant and
equipment (14,690) (14,690) -- (14,690)
Net finance costs (1,512) (1,512) (632) (121)/(1)/ (4,079)
(1,814)/(2)/
Investment income 59 (59)/(6)/ -- 4 4
Share of profit
from associates 2 2 35 37
---------- ---------- ---------- ---------
(Loss)/profit
before taxation and
minority interests (11,522) (8,912) 20,785 10,194
Taxation 4,437 (861)/(7)/ 3,576 (3,855) 554/(7)/ 275
---------- ------------- ---------- ---------- ------------- ---------
(Loss)/profit
before minority
interests (7,085) (5,336) 16,930 10,469
Minority interests (6) (6) (66) (72)
---------- ---------- ---------- ---------
Net (loss)/profit (7,091) (5,342) 16,864 10,397
========== ========== ========== =========
Basic earnings per
share (in RMB) 0.24 0.15
========== =========
Weighted average
number of shares
(in millions) 69,242 69,242
========== =========
See accompanying notes to unaudited pro forma financial information of the
Combined Group.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION OF THE COMBINED GROUP
(1) In connection with the Acquisition, an initial cash payment of RMB11,000
million will be made from internal resources of the Listed Group. The pro
forma balance sheet adjustment reflects the payment of the initial cash
consideration and the increase in property, plant and equipment related to
the purchase of the network management and research and development
facilities as if the Acquisition had been consummated on June 30, 2003. The
pro forma income statement adjustment reflects the reduction in interest
income in respect of the cash paid for the initial consideration and the
additional depreciation charge in respect of the purchase of network
management and research and development facilities as if the Acquisition
had been consummated as at the beginning of the year/period indicated
herein. The historical operating expenses related to the network management
and research and development facilities shared by the Target Group and the
Listed Group have been reflected in their respective historical financial
data presented herein.
(2) In connection with the Acquisition, a deferred consideration of RMB35,000
million will be payable by the Company to China Telecom. The pro forma
balance sheet adjustment reflects the deferred consideration payable as if
the Acquisition had been consummated on June 30, 2003. The pro forma income
statement adjustment reflects the additional interest expense in respect of
the deferred consideration at 5.184% per annum as if the Acquisition had
been consummated as at the beginning of the year/period indicated herein.
(3) Following the completion of the Acquisition, the formula of interconnection
settlement between China Telecom Corporation Limited and China Telecom
Group will change such that the settlement is based on the net volume of
telephone calls originating from the Combined Group to China Telecom Group
and vice versa multiplied by settlement fees as stipulated in the
Interconnection Agreement between China Telecom Corporation Limited and
China Telecom. The pro forma income statement adjustment reflects the
expected effect of the change of the interconnection settlement formula on
the interconnection revenue and expenses as if the Acquisition had been
consummated as at the beginning of the year/period indicated herein.
(4) In connection with the Restructuring, the property, plant and equipment of
the Target Group were revalued as at December 31, 2002 which resulted in a
net revaluation deficit of RMB13,930 million. The pro forma adjustment
reflects the reduction in depreciation charge resulting from the
revaluation of the Target Group's property, plant and equipment as if the
results of the revaluation had been recorded on January 1, 2002.
(5) In connection with the Restructuring, certain properties and buildings
associated with the Predecessor Operations were not transferred to the
Target Group but were retained by China Telecom. Pursuant to property
leasing agreements between the Target Group and China Telecom Group, the
Target Group leases the properties and buildings from China Telecom Group.
The amount to be paid by the Target Group to China Telecom Group is based
on market rates, with reference to amounts stipulated by local price
bureaus. The pro forma adjustment reflects the effects of a reduction in
depreciation charge relating to these properties and buildings and an
increase in rental expense as if the Restructuring occurred and the
property leasing agreements took effect on January 1, 2002.
(6) In connection with the Restructuring, certain long-term investments and
interests in associates that are unrelated to the telecommunications
industries were not transferred to the Target Group but were retained by
China Telecom. The pro forma adjustment reflects a reduction in investment
income generated from these investments as if the Restructuring occurred on
January 1, 2002.
(7) The pro forma adjustment reflects the tax effect of the above pro forma
adjustments using the statutory tax rate of 33%.
/15/The forecast on the combined profit after taxation and minority
interests but before extraordinary items of the Target Group for the year ending
December 31, 2003 is set out in the section headed "Letter from the Chairman --
Prospective Financial Information".
(A) BASES AND ASSUMPTIONS
The management of the Company and the Target Group have prepared the
forecast on the combined profit after taxation and minority interests but before
extraordinary items of the Target Group for the year ending December 31, 2003.
The management of the Company and the Target Group are not currently aware of
any extraordinary items which have arisen or are likely to arise in respect of
the year ending December 31, 2003. The forecast has been prepared on a basis
consistent in all material respects with the accounting policies currently
adopted by the Target Group as summarized in Appendix III and has been based on
the following principal assumptions:
(1) there will be no material changes in existing political, legal,
regulatory, fiscal or economic conditions in the PRC, Hong Kong, or
any other territory in which the Target Group currently operates or
which are otherwise material to the Target Group's revenues;
(2) there will be no material changes in legislation or regulations
governing the telecommunications industry in the PRC, Hong Kong or any
other country or territory in which the Target Group operates or which
the Target Group has arrangements or agreements with, which would
materially affect the business or operations of the Target Group;
(3) inflation, interest rates or foreign currency exchange rates will not
differ materially from those prevailing as of the date of this
circular;
(4) there will be no material changes in the bases or rates of taxation
appropriate to the Target Group, except as otherwise disclosed in this
circular; and
(5) based on information currently available, there will be no tariff
reduction that will have a material adverse effect on the Target
Group's business.
----------
/15/14.15(1)(a)
App. 1B
para. 29(2)
(B) LETTERS
/16/Set out below are the text of the letters received from KPMG, and from
the Company's Financial Advisers in connection with the forecast of the profit
after taxation and minority interests but before extra ordinary items of the
Target Group for the year ending December 31, 2003 and prepared for the purpose
of inclusion in this circular.
\raster(100%,p)="KPMGlogo100"
8th Floor
Prince's Building
10 Chater Road
Hong Kong
October 27, 2003
The Directors China Telecom Corporation Limited
China International Capital Corporation (Hong Kong) Limited
Morgan Stanley Dean Witter Asia Limited
Dear Sirs,
We have reviewed the accounting policies and calculations adopted in
arriving at the forecast (the "Forecast") of the combined profit after taxation
and minority interests but before extraordinary items of Anhui Telecom Company
Limited, Fujian Telecom Company Limited, Jiangxi Telecom Company Limited,
Guangxi Telecom Company Limited, Chongqing Telecom Company Limited and Sichuan
Telecom Company Limited (together with their subsidiaries are collectively
referred to as the "Target Group") for the year ending December 31, 2003, for
which the directors of the Company (the "Directors") and the management of the
Target Group (the "Management") are solely responsible, as set out in the
circular dated October 27, 2003 issued by China Telecom Corporation Limited. The
Forecast is based on the results of the Target Group for the six months ended
June 30, 2003 and a forecast of the Target Group's results for the remaining six
months of the year ending December 31, 2003.
In our opinion, so far as the accounting policies and calculations are
concerned, the Forecast has been properly compiled on the bases and assumptions
made by the Directors and the Management as set out in Part A of Appendix VII to
the circular and is presented on a basis consistent in all material respects
with the accounting policies adopted by the Target Group as set out in its
audited financial statements, the text of which is set out in Appendix III to
the circular.
Yours faithfully
KPMG
Certified Public Accountants
\raster(55%,p)="CICC"
\raster(73%,p)="morgan_stanley_new"
China International Capital Corporation Morgan Stanley Dean Witter Asia Limited
(Hong Kong) Limited 30th Floor
Suite 2307, 23rd Floor Three Exchange Square
One International Financial Centre Central
1 Harbour View Street Hong Kong
----------
/16/ 14.15(1)(b)
Central
Hong Kong
October 27, 2003
The Directors
China Telecom Corporation Limited
31 Jinrong Avenue
Beijing 100032
P.R.C
Dear Sirs
We refer to the forecast of the combined profit after taxation and minority
interests but before extraordinary items of Anhui Telecom, Fujian Telecom,
Jiangxi Telecom, Guangxi Telecom, Chongqing Telecom and Sichuan Telecom and
their respective subsidiaries (the Target Group), for the year ending December
31, 2003, as set out in the section headed "Letter from the Chairman --
Prospective Financial Information" of the circular dated October 27, 2003 issued
by China Telecom Corporation Limited (the Company).
We have discussed with you the bases and assumptions upon which the profit
forecast has been made. We have also considered the letter dated October 27,
2003 addressed to you and us from KPMG regarding the accounting policies and
calculations upon which the forecast has been made.
On the basis of the assumptions made by the management of the Company and
the Target Group, respectively, and on the basis of the accounting policies and
calculations reviewed by KPMG, we are of the opinion that the profit forecast,
for which the management of the Company and the Target Group are solely
responsible, has been made after due and careful enquiry.
Yours faithfully,
Yours faithfully, For and on behalf of
For and on behalf of MORGAN STANLEY DEAN WITTER
CHINA INTERNATIONAL CAPITAL CORPORATION ASIA LIMITED
(HONG KONG) LIMITED
Bi Mingjian Jia Jonathan Zhu
Managing Director Managing Director
/17/1. RESPONSIBILITY STATEMENT
This circular includes particulars given in compliance with the Hong Kong
Listing Rules for the purpose of giving information with regard to the Company.
The Directors collectively and individually accept full responsibility for the
accuracy of the information contained in this circular and confirm, having made
all reasonable enquiries, that to the best of their knowledge and belief there
are no other facts the omission of which would make any statement herein
misleading.
2. DISCLOSURE OF INTERESTS
/18/As of the Latest Practicable Date:
----------
/17/14.16(3)
14.30(2)
App. 1B
para.2
/18/ 14.16(3)
14.30(2)
(i) none of the Directors or chief executive of the Company had any
interest in any shares, underlying shares or debentures of the Company
or any of its associated corporations (with the meaning of Part XV of
the Securities and Futures Ordinance) which are (1) required to be
notified to the Company and the Stock Exchange pursuant to Divisions 7
and 8 of Part XV of the Securities and Futures Ordinance (including
interests and short positions which he is taken or deemed to have
under such provisions of Securities and Futures Ordinance), (2)
required, pursuant to section 352 of the Securities and Futures
Ordinance, to be entered in the register referred to therein, or (3)
required, pursuant to the Model Code for Securities Transactions by
Directors of Listed Companies to be notified to the Company and the
Stock Exchange;
(ii) the Company has not granted its Directors, chief executives or their
respective spouses or children below 18 any rights to subscribe for
its equity securities or debt securities;
/19/(iii) none of the Directors was materially interested in any contract
or arrangement entered into by any member of the Listed Group since
December 31, 2002, being the date to which the latest published
audited financial statements of the Company were made up or subsisting
at the date of the circular, and which was significant in relation to
the business of the Listed Group taken as a whole;
/20/(iv) none of the Directors or any professional advisers named in paragraph
9 of this Appendix had since December 31, 2002, being the date to
which the latest published audited financial statements of the Company
were made up, any direct or indirect interest in any assets which have
been acquired or disposed of by or leased to any member of the Listed
Group, or are proposed to be acquired or disposed of by or leased to
any member of the Listed Group.
3. SUBSTANTIAL SHAREHOLDERS
/21/As of the Latest Practicable Date, so far as is known to the Directors,
the following persons were, directly or indirectly, interested in 5 per cent. or
more of the issued share capital carrying rights to vote at general meetings of
the Company:
Name of the Shareholder No. of Shares Percentage of Shares held
------------- -------------------------
China Telecommunications
Corporation 58,809,120,182 77.78%
Guangdong Rising Assets
Management Co., Ltd. 5,658,608,387 7.48%
Save as disclosed herein, there is no person known to the Directors or
chief executive of the Company who, as of the Latest Practicable Date, has an
interest or short position in the shares and underlying shares of the Company
which would fall to be disclosed to the Company under the provisions of
Divisions 2 and 3 of Part XV of the Securities and Futures Ordinance, or, who
is, directly or indirectly, interested in 5 per cent or more of the nominal
value of any class of share capital carrying rights to vote in all circumstances
at general meetings of any other member of the Listed Group.
4. LITIGATION
----------
App. 1B
para. 38(1)
/19/14.16(3)
14.30(2)
App. 1B
para. 40(2)
/20/14.16(3)
14.30(2)
App. 1B
para. 40(1)
/21/App. 1B
para. 38(2)
/22/No member of the Target Group or the Listed Group is engaged in any
litigation or arbitration of material importance and there is no litigation or
claim of material importance known to the Directors to be pending or threatened
by or against any member of the Target Group or the Listed Group.
5. SERVICE CONTRACTS
/23/Each of the Directors has entered into a service contract with us for a
term ending on September 9, 2005 subject to removal by the shareholders in
general meeting and termination by either party giving not less than three
months' written notice to the other party.
Save for the above, as of the Latest Practicable Date, none of the
Directors had entered into any service contract with the Company or any member
of the Listed Group (excluding contracts expiring or determinable by the
employer within one year without payment of compensation (other than statutory
compensation)).
6. MATERIAL CONTRACTS
The following contracts (including contracts not entered into in the
ordinary course of business) have been entered into by members of the Listed
Group/Target Group within the two years immediately preceding the date of this
circular, and are or may be material:
(a) the reorganization agreement (in Chinese) dated September 10, 2002
between China Telecommunications Corporation and the Company, pursuant
to which China Telecommunications Corporation transferred to the
Company some of its assets, rights and liabilities in connection with
certain telecommunications businesses;
(b) the non-competition agreement dated September 10, 2002 entered into
between the Company and the Parent regarding the regulation of
competition issues between the Company and the Parent;
(c) the letter of undertakings dated September 10, 2002 entered into
between the Company and the Parent regarding certain undertakings
given to the Company by the Parent referred to in the Section headed
"Relationship with the China Telecommunications Corporation" of this
circular;
(d) the trademark licence agreement dated September 10, 2002 entered into
between the Company and the Parent regarding the licensing of logo and
certain trademarks referred to in the Section headed "Business --
Connected Transactions" on pages 95 to 96 of the Company's Prospectus;
(e) the supplemental trademark licence agreement dated October 26, 2003
entered into between the Company and the Parent referred to in the
Section headed "Connected Transactions" of this circular;
(f) the community services agreements entered into in October 2002 between
the subsidiaries of the Company and each of the four provincial
subsisting companies regarding the provision of certain community
services referred to in the Section headed "Connected Transactions" on
pages 103 to 104 of the Company's Prospectus;
----------
/22/14.16(3)
App. 1B
para. 33
/23/14.30(2)
App. 1B
para. 39
14.16(3)
14.16(11)
(g) the supplemental agreements dated October 26, 2003 relating to
extension of terms of the community services agreements entered into
in October 2002 between the subsidiaries of the Company and each of
the four provincial subsisting companies;
(h) the community services agreements entered into in October 26, 2003
between the Provincial Subsisting Companies and the Target Companies
regarding the provision of certain community services referred to in
the Section headed "Connected Transactions" of this circular;
(i) the Hong Kong underwriting agreement dated October 24, 2002 entered
into between the Company, the Sponsors and the Hong Kong Underwriters;
(j) the Hong Kong underwriting agreement dated November 5, 2002 entered
into between the Company, the Sponsors and the Hong Kong Underwriters
referred to in the Section headed "Underwriting -- Underwriting
Arrangements and Expenses" on page 164 of the Company's Prospectus;
and
(k) the acquisition agreement dated October 26, 2003 entered into between
the Company and the Parent regarding the Acquisition referred to in
the Section headed "Letter from the Chairman -- Acquisition" of this
circular.
7. MATERIAL ADVERSE CHANGE
/24/The Directors are not aware of any material adverse change in the
financial or trading position of the Listed Group since December 31, 2002, being
the date of the latest published audited financial statements of the Company.
8. CONSENTS
/25/CICC, Morgan Stanley, JPMorgan, KPMG and Chesterton have given and have
not withdrawn their respective written consents to the issue of this circular
with the inclusion of their reports and letters (if any), as the case may be,
and references to their names in the form and context in which they respectively
appear.
As at the Latest Practicable Date, none of CICC, Morgan Stanley, JPMorgan,
KPMG and Chesterton had any shareholding in any member of the Listed Group and
none of them has any right, whether legally enforceable or not, to subscribe for
or nominate persons to subscribe for securities of any member of the Listed
Group.
----------
/24/14.16(3)
14.30(2)
App. 1B
para. 2
/25/14.16(3)
14.30(2)
App. 1B
para. 5(2), (3)
9. QUALIFICATIONS OF EXPERTS
/26/The following are the qualifications of the professional advisers who
have given opinions or advice contained in this circular:
Names Qualifications
--------------
licensed by the Securities and Futures Commission for
CICC Types 1, 4 and 6 regulated activities under the
Securities and Futures Ordinance
licensed by the Securities and Futures Commission for
Morgan Stanley Types 1, 4, 6 and 7 regulated activities under the
Securities and Futures Ordinance
JPMorgan (independent licensed by the Securities and Futures Commission
financial adviser) for Types 1, 4, 6 and 7 regulated activities under
the Securities and Futures Ordinance
KPMG Certified Public Accountants
Chesterton Chartered surveyor
Haiwen & Partners PRC legal advisers
10. MISCELLANEOUS
/27/(a) The Company Secretary is Li Ping, MBA.
(b) The registered office and head office of the Company is 31 Jinrong
Street, Xicheng District, Beijing 100032, PRC
11. DOCUMENTS AVAILABLE FOR INSPECTION
/28/Copies of the following documents will be available for inspection at
Freshfields Bruckhaus Deringer, 11th Floor, Two Exchange Square, Hong Kong
during normal business hours on any business day from the date of this circular
until November 11, 2003:
(a) the Acquisition Agreement;
(b) the memorandum and articles of association of the Company;
(c) the material contracts referred to under the paragraph headed
"Material Contracts" in this Appendix;
(d) the connected transactions agreements referred to in the section
headed "Connected Transactions" in the "Letter from the Chairman" of
this circular;
(e) the letters of consent referred to in paragraph 8 of this Appendix;
----------
/26/14.16(3)
14.30(2)
App. 1B
para. 5(1)
/27/ 14.16(3)
App. 1B
para. 35
para. 36
/28/14.16(3)
14.30(2)
App. 1B
para. 43
(f) the letters relating to the profit forecast of the Target Group, the
texts of which are set out in Appendix VII to this circular;
(g) the letter from JPMorgan dated October 27, 2003, the text of which is
set out on pages 36 to 59 of this circular.
\raster(100%,p)="China_Telecom"
China Telecom Corporation Limited
(A joint stock limited company incorporated in the People's Republic of
China with limited liability)
NOTICE IS HEREBY GIVEN that an Extraordinary General Meeting of the members
of China Telecom Corporation Limited (the "Company") will be held at 10:00 a.m.
on December 15, 2003 at Beijing Nan Yue Yuan Hotel, 186 Zheng Wang Fen, Feng Tai
District, Beijing, PRC for the purposes of considering and, if thought fit,
passing, with or without modifications, the following resolutions:
ORDINARY RESOLUTIONS
1. "THAT the conditional sale and purchase agreement dated October 26,
2003 (the "Acquisition Agreement") between the Company and China
Telecommunications Corporation, a copy of which has been initialled by
the chairman of this meeting (the "Chairman"), pursuant to which,
inter alia, China Telecommunications Corporation has agreed to sell,
and the Company has agreed to purchase, the Target Assets at a
purchase price of RMB46,000 million comprising:
(a) RMB11,000 million payable in cash at completion of the
Acquisition; and
(b) RMB35,000 million to be paid on the date falling ten years from
completion of the Acquisition
is hereby generally and unconditionally approved and the directors of
the Company are hereby authorized to do all such further acts and
things and execute such further documents and take all such steps
which in their opinion as may be necessary, desirable or expedient to
implement and/or give effect to the terms of the Acquisition
Agreement."
2. "THAT subject to the passing of Ordinary Resolutions No.1 set out in
the notice convening the Extraordinary General Meeting of which this
Resolution is proposed, the prospective connected transactions set out
in sections 10.1(b) (in relation to the interconnection agreement),
10.2(a), 10.2(e) and 10.2(f) as described in the paragraph headed
"Connected Transactions" under the section "Letter from the Chairman"
of the circular of the Company dated October 27, 2003, which the
Company expects to occur on a regular and continuous basis in the
ordinary and usual course of business of the Company, its subsidiaries
and the Target Group, as the case may be, together with the Combined
Group's relevant upper limits are hereby approved and the directors of
the Company are hereby authorized to do all such further acts and
things and execute such further documents and take all such steps
which in their opinion may be necessary, desirable or expedient to
implement and/or give effect to the terms of such prospective
connected transactions and such supplemental agreements relating to
the Existing Connected Transactions."
SPECIAL RESOLUTION
3. "THAT (i) subject to the passing of Ordinary Resolution No. 1 set out
in the notice convening the Extraordinary General Meeting of which
this Resolution is proposed, it is hereby approved that the Service
Areas of the Company stipulated in Article 13 of the Articles of
Association of the Company is amended from "four provinces (autonomous
regions, municipality directly under the central government), namely
Shanghai, Guangdong, Jiangsu and Zhejiang" to "ten provinces
(municipalities directly under the central government/autonomous
region), namely Shanghai, Guangdong, Jiangsu, Zhejiang, Anhui, Fujian,
Jiangxi, Guangxi, Chongqing and Sichuan", to reflect the change in the
Service Areas of the Company as a result of the Acquisition referred
to in the Ordinary Resolution No. 1 set out above, and the directors
of Company are hereby authorized to take all actions which in their
opinion are necessary or desirable to complete the procedures for the
approval and/or registration or filing of the aforementioned
amendments to the articles of association.
By Order of the Board
Li Ping
Company Secretary
October 27, 2003.
Notes:
1. Capitalised terms used in this Notice shall have the same meanings ascribed
to such terms in the Company's circular to shareholders dated October 27,
2003.
2. Buyers who submit the share transfer application forms to the Company's
share registrar before 4:00 p.m. on November 14, 2003 (Friday) and then
registered as Shareholders on the register of members of the Company are
entitled to attend the extraordinary general meeting.
3. Each shareholder entitled to attend and vote at the extraordinary general
meeting may appoint one or more proxies to attend and vote on his behalf at
the extraordinary general meeting. A proxy need not be a shareholder. Each
shareholder who wishes to appoint one or more proxies should first review
the shareholders' circular of the Company, which is expected to be
despatched to shareholders on or before Wednesday, October 29, 2003.
4. To be valid, the form of proxy together with the power of attorney or other
authorization document (if any) signed by the authorized person or
notarially certified power of attorney must be delivered to the Office of
the Board for holders of domestic shares and to the Computershare Hong Kong
Investor Services Limited for holders of H shares not less than 24 hours
before the designated time for the holding of the extraordinary general
meeting. Completion and return of a form of proxy will not preclude a
shareholder from attending in person and voting at the extraordinary
general meeting if he so wishes.
The address of the share registrar for the Company's H Shares is as
follows:
Computershare Hong Kong Investor Services Limited
Rooms 1712-1716
17th Floor, Hopewell Centre
183 Queens Road East, Wanchai, Hong Kong
5. A proxy of a shareholder may vote by hand or vote on a poll, but a proxy of
a shareholder who has appointed more than one proxy may only vote on a
poll.
6. The registration procedure for attending the extraordinary general meeting
is as follows:
(a) shareholders attending the extraordinary general meeting in person or
by proxy are required to present their identity certification. If the
attending shareholder is a corporation, its legal representative or
person authorized by the board or other decision making authority is
required to present a copy of the relevant resolution of the board or
other decision making authority approving it is the legal or duly
authorized representative in order to attend the extraordinary general
meeting on behalf of such corporation; and
(b) shareholders intending to attend the extraordinary general meeting "in
person or by proxy" are required to return the attendance slip via
hand delivery, mail or fax to the Secretariat on or before Monday,
November 24, 2003.
7. The extraordinary general meeting is expected to last for half a day and
shareholders (in person or by proxy) attending the extraordinary general
meeting shall be responsible for their own transportation and accommodation
expenses.
8. The address of the Office of the Board is as follows:
31 Jinrong Street
Xicheng District, Beijing 100032
PRC
Contact person: Li Ping
Telephone: (8610) 6642 8166
Fax: (8610) 6601 0728