FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Report of Foreign Private Issuer
Pursuant to Rule 13a-16 or 15d-16 of
the Securities Exchange Act of 1934
For the month of October, 2005
(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 ____ Form 40-F _____
(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 ____
(If "Yes" is marked, indicate below the file number assigned to
registrant in connection with Rule 12g3-2(b): 82-__________.)
N/A
China Netcom Group Corporation (Hong Kong) Limited
Building C, No. 156, Fuxingmennei Avenue
Xicheng District
Beijing, 100031 PRC
This Form 6-K consists of:
The acquisition circular of China Netcom Group Corporation (Hong Kong) Limited
(the "Registrant"), made by the Registrant in English on September 23, 2005.
SIGNATURE
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
under-signed, thereunto duly authorized.
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
By /s/ Zhang Xiaotie
--------------------
By /s/ Oliver E Lixin
--------------------
Name: Zhang Xiaotie and Oliver E Lixin
Title: Joint Company Secretaries
Date: September 23, 2005
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THIS CIRCULAR IS IMPORTANT AND REQUIRES YOUR IMMEDIATE ATTENTION
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If you are in any doubt as to any aspect of this circular or as to the action
to be taken, you should consult your licensed securities dealer, bank manager,
solicitor, professional accountant or other professional adviser.
If you have sold or transferred all your shares in China Netcom Group
Corporation (Hong Kong) Limited, you should at once hand this circular together
with the accompanying form of proxy to the purchaser or the transferee or to
the bank, licensed securities dealer or other agent through whom the sale or
transfer was effected for transmission to the purchaser or the 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 for the sole purpose of the extraordinary general meeting of
the Company and does not constitute an invitation or offer to acquire, purchase
or subscribe for any securities.
_______________________________________________________________________________
[GRAPHIC OMITTED]
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
[GRAPHIC OMITTED]
(incorporated in Hong Kong with limited liability under the Companies Ordinance)
(Stock Code: 906)
MAJOR TRANSACTION,
CONNECTED TRANSACTION AND
CONTINUING CONNECTED TRANSACTIONS
Financial Advisers to China Netcom Group Corporation (Hong Kong) Limited
(in alphabetical order)
[GRAPHIC OMITTED] [GRAPHIC OMITTED] [GRAPHIC OMITTED]
China International Capital Citigroup Global Markets Goldman Sachs (Asia)
Corporation (Hong Kong) Limited Asia Limited L.L.C.
Independent financial adviser to the Independent Board Committee and the
Independent Shareholders
[GRAPHIC OMITTED]
Credit Suisse First Boston (Hong Kong) Limited
_______________________________________________________________________________
A notice convening an extraordinary general meeting of the Company to be held
in Nathan Room, Conrad Hotel, Hong Kong, on 25 October 2005 at 10:00 a.m., is
set out at the end of this circular. Whether or not you are able to attend the
extraordinary general meeting, you are requested to complete the accompanying
form of proxy in accordance with the instructions printed thereon and return
the same to the Company's registered office at 46th Floor, Cheung Kong Center,
2 Queen's Road Central, Hong Kong, as soon as practicable and in any event at
least 48 hours before the time appointed for holding the extraordinary general
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 extraordinary
general meeting or at any adjourned meeting should you so wish.
A letter from the independent board committee of the Company containing its
recommendation to the independent shareholders of the Company is set out on
pages 36 to 37 of this circular. A letter from CSFB, the independent financial
adviser, containing its advice to the independent board committee and the
independent shareholders of the Company is set out on pages 38 to 58 of this
circular.
23 September 2005
CONTENTS
Page
DEFINITIONS .............................................................1
LETTER FROM THE CHAIRMAN ................................................6
LETTER FROM THE INDEPENDENT BOARD COMMITTEE .............................36
LETTER FROM CSFB ........................................................38
APPENDIX I - FURTHER INFORMATION ON THE TARGET COMPANY ..................I-1
APPENDIX II - ACCOUNTANTS' REPORT OF THE TARGET GROUP ...................II-1
APPENDIX III - FINANCIAL INFORMATION OF THE GROUP .......................III-1
APPENDIX IV - FINANCIAL INFORMATION OF THE COMBINED GROUP ...............IV-1
APPENDIX V - PROFIT FORECAST ............................................V-1
APPENDIX VI - GENERAL INFORMATION .......................................VI-1
NOTICE OF THE EXTRAORDINARY GENERAL MEETING
DEFINITIONS
In this circular, unless the context otherwise requires, the following
expressions have the following meanings:
"Acquisition" the proposed acquisition by the Company of the entire
issued share capital of the Target BVI Company
pursuant to the Acquisition Agreement, as further
described in this circular
"Acquisition Agreement" the conditional sale and purchase agreement
dated 12 September 2005 entered into among the Company,
CNC BVI and China Netcom Group relating to the Acquisition
"ADSs" American depositary shares issued by Citibank, N.A.,
each representing ownership of 20 Shares, which are
listed on the New York Stock Exchange, Inc.
"Asia Netcom" Asia Netcom Corporation Limited, a wholly-owned
subsidiary of the Company
"Associates" as defined in the Hong Kong Listing Rules
"Board" or "Board of Directors" the board of Directors
"Business Day" a day (excluding Saturdays) on which banks are generally
open in Hong Kong for the transaction of normal banking
business
"China" or "PRC" the People's Republic of China (excluding,for the purpose of
this circular, Hong Kong, Macau and Taiwan)
"China Mobile" China Mobile Communications Corporation ([GRAPHIC
OMITTED]), a company established under the laws of the PRC
"China Netcom Group" China Network Communications Group Corporation, a
company established under the laws of the PRC and the
ultimate controlling shareholder of the Company
"China Telecom" China Telecommunications Corporation ([GRAPHIC OMITTED], a
company established under the laws of the PRC
"China Unicom" China United Telecommunications Corporation ([GRAPHIC
OMITTED]), a company established under the laws of the PRC
"CICC" China International Capital Corporation (Hong Kong)
Limited, which is licensed for Type 1 regulated
activity (dealing in securities), Type 4 regulated
activity (advising on securities), Type 6 regulated
activity (advising on corporate finance) and Type 9
regulated activity (asset management) under the
Securities and Futures Ordinance and financial adviser
to the Company in respect of the Acquisition
"Citigroup" Citigroup Global Markets Asia Limited, which is deemed
licensed for Type 1 regulated activity (dealing in
securities), Type 4 regulated activity (advising on
securities) and Type 6 regulated activity (advising on
corporate finance) under the Securities and Futures
Ordinance and financial adviser to the Company in
respect of the Acquisition
"CNC BVI" China Netcom Group Corporation (BVI) Limited, a
company incorporated in the British Virgin Islands
with limited liability and the direct controlling
shareholder of the Company
"CNC China" China Netcom (Group) Company Limited ([GRAPHIC
OMITTED]), formerly known as China Netcom Corporation
Limited, a company established in the PRC with limited
liability as a wholly foreign owned enterprise and a
wholly owned subsidiary of the Company
"Combined Group" the Company, its existing subsidiaries and the Target Group
"Companies Ordinance" the Companies Ordinance (Chapter 32 of the Laws of Hong Kong)
"Company" China Netcom Group Corporation (Hong Kong) Limited
([GRAPHIC OMITTED]), a company incorporated in Hong
Kong whose Shares are listed on the Hong Kong Stock
Exchange and whose ADSs are listed on the New York
Stock Exchange, Inc.
"Continuing Connected Transactions" the connected transactions described in the section
headed "Continuing Connected Transactions" of the
"Letter from the Chairman"
"CSFB" or "Independent Financial Credit Suisse First Boston (Hong Kong) Limited, which
Adviser" is deemed licensed for Type 1 regulated activity
(dealing in securities), Type 4 regulated activity
(advising on securities) and Type 6 regulated activity
(advising on corporate finance) under the Securities
and Futures Ordinance, being the independent financial
adviser to the Independent Board Committee and the
Independent Shareholders in respect of the Acquisition
and the Non-exempt Continuing Connected Transactions
"CSRC" China Securities Regulatory Commission ([GRAPHIC
OMITTED])
"Directors" the directors of the Company
"EANL" East Asia Netcom Ltd., a company incorporated in
Bermuda with limited liability and an indirect wholly
owned subsidiary of China Netcom Group
"Equity Interest Injection Agreement" the equity interest injection agreement dated 9 August 2005
entered into among the Target BVI Company, CNC BVI and
China Netcom Group
"Extraordinary General Meeting" the extraordinary general meeting of the Company to be
convened on 25 October 2005, notice of which is set
out at the end of this circular, or any adjournment thereof
"Financial Advisers" CICC, Citigroup and Goldman Sachs, being the financial
advisers to the Company in respect of the Acquisition
"GDP" gross domestic product
"Goldman Sachs" Goldman Sachs (Asia) L.L.C., which is licensed for
Type 1 regulated activity (dealing in securities),
Type 4 regulated activity (advising on securities),
Type 5 regulated activity (advising on futures
contracts), Type 6 regulated activity (advising on
corporate finance) and Type 9 regulated activity
(asset management) under the Securities and Futures
Ordinance and financial adviser to the Company in
respect of the Acquisition
"Group" the Company and its existing subsidiaries
"HK$" Hong Kong dollars, the lawful currency of Hong Kong
"HKFRS" Hong Kong Financial Reporting Standards issued by Hong Kong
Institute of Certified Public Accountants
"Hong Kong" Hong Kong Special Administrative Region of the People's Republic
of China
"Hong Kong Listing Rules" the Rules Governing the Listing of Securities on The Stock
Exchange of Hong Kong Limited
"Hong Kong Stock Exchange" The Stock Exchange of Hong Kong Limited
"Independent Board Committee" the committee of Directors, consisting of John Lawson Thornton,
Victor Cha Mou Zing, Qian Yingyi, Hou Ziqiang and Timpson Chung
Shui Ming, being all the independent non-executive Directors,
formed to advise the Independent Shareholders in respect of the
terms of the Acquisition and the Non-exempt Continuing Connected
Transactions
"Independent Shareholders" Shareholders other than China Netcom Group and its Associates
"Latest Practicable Date" 8 September 2005, being the latest practicable date prior to the
printing of this circular for ascertaining certain information
contained herein
"MII" Ministry of Information Industry of the PRC ([GRAPHIC OMITTED]),
or where the context so requires, its predecessor, the former
Ministry of Posts and Telecommunications ([GRAPHIC OMITTED])
"MOC" the Ministry of Commerce of the PRC ([GRAPHIC OMITTED)
"Non-exempt Continuing Connected continuing connected transactions contemplated underthe
Transactions" Domestic Interconnection Settlement Agreement, the International
Long Distance Voice Services Settlement Agreement, the
Engineering and Information Technology Services
Agreement and the Materials Procurement Agreement,
such transactions and agreements are further described
in the section headed "Continuing Connected
Transactions" of the "Letter from the Chairman"
"Option(s)" option(s) which have been granted under the Company's
share option scheme approved and adopted by a
resolution of the Shareholders passed on 30 September
2004
"Reorganisation" the successive steps whereby China Netcom Group
transferred the telecommunications operations in the
Target Regions and related assets and liabilities to
the Target Company, as further described in the
section headed "The Reorganisation" of the "Letter
from the Chairman"
"RMB" Renminbi, the lawful currency of the PRC
"Sallmanns" Sallmanns (Far East) Limited, a chartered surveyor and
independent property valuer to the Company
"SASAC" State-owned Assets Supervision and Administration
Commission of the State Council ([GRAPHIC OMITTED])
"Securities and Futures Ordinance" the Securities and Futures Ordinance (Chapter 571 of the Laws of
Hong Kong)
"Share(s)" ordinary shares in the Company's issued share capital
with a par value of US$0.04 per share which are listed
on the Hong Kong Stock Exchange "Shareholders" holders
of Shares
"State Council" the State Council of the PRC ([GRAPHIC OMITTED])
"Target BVI Company" China Netcom Group New Horizon Communications Corporation (BVI)
Limited ([GRAPHIC OMITTED]), a company incorporated in
the British Virgin Islands
"Target Company" China Netcom Group New Horizon Communications
Corporation Limited ([GRAPHIC OMITTED][GRAPHIC
OMITTED]), a company incorporated in the PRC and the
term "Target Company" shall, if the context so
requires, include any predecessor entity or person
carrying on its business before the Reorganisation
"Target Group" the Target BVI Company and the Target Company
"Target Regions" the regions in which the Target Company operates its
business, being Heilongjiang Province, Jilin Province,
Neimenggu Autonomous Region, and Shanxi Province of
the PRC
"Telecommunications Regulations" The PRC Telecommunications Regulations ([GRAPHIC
OMITTED]) which became effective as of 25 September
2000
"US dollars" or "US$" United States dollars, the lawful currency of the United
States of America
For your convenience and unless otherwise specified, this circular contains
translations between RMB and US dollars at RMB8.0998 = US$1.00, between RMB and
Hong Kong dollars at RMB1.0422 = HK$1.00, and between Hong Kong dollars and US
dollars at HK$7.7718 = US$1.00, the prevailing rates on 31 August 2005. The
translations are not representations that the RMB, Hong Kong dollar and US
dollar amounts could actually be converted at those rates, if at all.
LETTER FROM THE CHAIRMAN
[GRAPHIC OMITTED]
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
[GRAPHIC OMITTED]
(incorporated in Hong Kong with limited liability under the Companies Ordinance)
Executive Directors: Registered Office:
ZHANG Chunjiang (Chairman) 46th Floor
TIAN Suning (Vice Chairman and Chief Cheung Kong Center
Executive Officer) 2 Queen's Road Central
ZHANG Xiaotie Hong Kong
MIAO Jianhua
Non-Executive Directors:
JIANG Weiping
LI Liming
Jose Maria ALVAREZ-PALLETE
YAN Yixun
Independent Non-executive Directors:
John Lawson THORNTON
Victor CHA Mou Zing
QIAN Yingyi
HOU Ziqiang
Timpson CHUNG Shui Ming
23 September 2005
To the Shareholders
Dear Sir or Madam,
MAJOR TRANSACTION,
CONNECTED TRANSACTION AND
CONTINUING CONNECTED TRANSACTIONS
Acquisition of the Target BVI Company
INTRODUCTION
On 12 September 2005, the Board of Directors announced that the Company had
entered into the Acquisition Agreement, pursuant to which the Company agreed to
acquire and CNC BVI, the Company's immediate holding company, agreed to sell
the entire equity interest in the Target BVI Company for a purchase price of
RMB12,800 million (equivalent to approximately HK$12,282 million), subject to
certain conditions.
As at the Latest Practicable Date, CNC BVI beneficially owned approximately
70.49% of the issued share capital of the Company. CNC BVI is a wholly-owned
subsidiary of China Netcom Group. As such, both CNC BVI and China Netcom Group
are connected persons of the Company. The relevant applicable percentage ratios
under Rule 14.07 of the Hong Kong Listing Rules in respect of the Acquisition
exceed 25% but are below 100%. Accordingly, under the Hong Kong Listing Rules,
the Acquisition constitutes both a connected transaction and a major
transaction for the Company.
An Independent Board Committee has been established by the Company to advise
the Independent Shareholders in respect of the terms of the Acquisition and the
terms of the Non-exempt Continuing Connected Transactions. In this respect,
CSFB has been retained as the independent financial adviser to the Independent
Board Committee and the Independent Shareholders.
CICC, Citigroup and Goldman Sachs are the financial advisers to the Company in
respect of the Acquisition.
The purpose of this circular is to provide you with further information
relating to the Acquisition and the Continuing Connected Transactions and to
seek your approval of the ordinary resolutions set out in the Notice of
Extraordinary General Meeting at the end of this circular. The recommendation
from the Independent Board Committee to the Independent Shareholders is set out
on pages 36 to 37 of this circular and the letter from CSFB is set out on pages
38 to 58 of this circular.
ACQUISITION OF THE TARGET BVI COMPANY
Acquisition Agreement
Date : 12 September 2005
Parties : (1) Vendor : China Netcom Group Corporation (BVI) Limited
(2) Purchaser : China Netcom Group Corporation (Hong Kong)
Limited
(3) Warrantor : China Network Communications Group Corporation
Pursuant to the Acquisition Agreement, the Company has agreed, subject to
certain conditions, to acquire from CNC BVI the entire equity interest in the
Target BVI Company for a purchase price of RMB12,800 million (equivalent to
approximately HK$12,282 million). Upon completion of the Acquisition, the
Target BVI Company will become a wholly-owned subsidiary of the Company.
China Netcom Group has given warranties, representations and undertakings in
respect of CNC BVI's title in the Target BVI Company and the Target Company,
the operations and assets and liabilities of the Target Company and the legal
status of those companies.
The Target BVI Company holds the entire equity interest in the Target Company
which in turn owns the assets and liabilities and the business operations for
the provision of fixed-line telephone services, broadband and other
Internet-related services, and business and data communications services in the
Target Regions in the PRC. As a result of the Acqusition, the Company will
assume the bank and other loans less cash and bank deposits of the Target
Company in the amount of RMB 23,209 million (equivalent to approximately
HK$22,269 million) as of 30 June 2005. As of 30 June 2005, the Target Company
had a total of approximately 28.86 million fixed-line subscribers and
approximately 2.78 million broadband subscribers. The Target Company had
approximately 90.2% market share of fixed-line telephone services and
approximately 90.7% market share of broadband services in the Target Regions as
of 30 June 2005.
THE 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 is RMB12,800
million (equivalent to approximately HK$12,282 million), and consists of
payment of an initial cash 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 and the
prospective profit contributions by the Target Company to the Group, as well as
by reference to other financial and operational factors. The purchase price for
the Acquisition represents a multiple of approximately 6.0 times the Target
Group's forecast profit for the year ending 31 December 2005 (including an
estimated upfront connection fee of approximately RMB735 million (equivalent to
approximately HK$705 million)), which is unlikely to be less than RMB2,150
million (equivalent to approximately HK$2,063 million). In addition, the
Company will assume the bank and other loans less cash and bank deposits of the
Target Company in the amount of RMB23,209 million (equivalent to approximately
HK$22,269 million) as of 30 June 2005 as a result of the Acquisition.
The initial consideration of RMB3,000 million (equivalent to approximately
HK$2,879 million) will be satisfied on completion of the Acquisition by payment
in cash in RMB.
The deferred consideration, in the amount of RMB9,800 million (equivalent to
approximately HK$9,403 million), represents the difference between the total
consideration and the initial consideration. From the date of completion of the
Acquisition, the Company will, at half-yearly intervals, repay part of the
deferred consideration and pay interest to CNC BVI on the actual amount of
deferred consideration remaining outstanding. The repayment of deferred
consideration at each half-yearly interval will be in equal amount of RMB980
million (equivalent to approximately HK$940 million). Interest is accrued daily
and is payable at the rate of 5.265% per annum, being 10% discount to the
benchmark RMB lending rate of 5.85% per annum of commercial banks in the PRC in
respect of loans with tenure of five years as published by the People's Bank of
China and prevailing at 12:00 noon (Beijing time) on 8 September 2005, being
two Business Days immediately preceding the date of the Acquisition Agreement.
The payment of the deferred consideration and the interest payments can be made
in RMB or US dollars as agreed between CNC BVI and the Company. Any payment
made in US dollars will be based on the Federal Reserve noon-buying rate
between US dollars and RMB which is quoted as of 12:00 noon (New York City
time) on the day which is two business days immediately prior to the date of
payment.
The deferred consideration is payable within five years after the date of
completion of the Acquisition. The Company may, from time to time, prepay all
or part of the outstanding deferred consideration, at any time after completion
until the fifth anniversary of the completion of the Acquisition, without
penalty.
The Board takes the view that the consideration payable by the Company for the
Target BVI Company and the other terms of the Acquisition are fair and
reasonable. In particular, the Board is of the view that the terms of the
deferred consideration are more favourable than the usual terms of a commercial
bank loan of a similar size and term. The Board is of the view that the
Acquisition is in the interests of the Company and its investors and recommends
the Independent Shareholders to vote in favour of the ordinary resolution to
approve the Acquisition at the Extraordinary General Meeting.
FINANCING OF THE ACQUISITION
The Company intends to finance the initial consideration using existing
internal cash resources. The Company intends to finance the deferred
consideration using internal cash resources and/or proceeds from future
external financing.
CONDITIONS OF THE COMPLETION OF THE ACQUISITION
Completion of the Acquisition is conditional upon the fulfilment or waiver
(where available) of the following conditions, among others, on or before 31
December 2005 or such other date as the Company, CNC BVI and China Netcom Group
may agree:
(a) the passing of resolutions by the Independent Shareholders approving the
Acquisition and the Non-exempt Continuing Connected Transactions;
(b) there having been no material adverse change to the financial condition,
business operations, or prospects of the Target Company; and
(c) the receipt of various approvals from the relevant PRC regulatory
authorities.
Certain PRC regulatory approvals have been obtained. The Target Company
currently has a legal person business licence as a limited liability company.
Upon approval by the relevant Chinese regulatory authorities, the legal person
business licence of the Target Company will be replaced by a new one issued by
the State Administration for Industry and Commerce to reflect its status as a
wholly foreign-owned enterprise. The business of the Target Company will not be
affected by the process of issuance of such new business licence.
The Acquisition shall be completed following the fulfilment or waiver (where
applicable) of the above conditions, and is expected to take place on 31
October 2005, or such other date as may be agreed between CNC BVI, China Netcom
Group and the Company, following notification by the Company to CNC BVI and
China Netcom Group of the fulfilment or waiver of all the conditions. If any of
the above-mentioned conditions is not fulfilled or waived by 31 December 2005,
or such other date as CNC BVI, China Netcom Group and the Company may agree,
the Acquisition Agreement shall lapse.
REASONS FOR AND BENEFITS OF THE ACQUISITION
The Company is a leading fixed-line telecommunications services provider in
China and a leading international data communications services provider in the
Asia-Pacific region. Its northern service region covers the area of Beijing
Municipality, Tianjin Municipality, Hebei Province, Henan Province, Shandong
Province and Liaoning Province in China. Its southern service region covers the
area of Shanghai Municipality and Guangdong Province in China. It is also the
only telecommunications company in China that operates an extensive regional
data network and offers international data services in the Asia-Pacific region.
The Board believes that the Acquisition represents an important opportunity for
the Group to increase coverage and achieve further growth, improve its service
capabilities, capture operating synergy and improve management efficiency. In
addition, the Acquisition will allow the Company to further benefit from the
sustained growth of the telecommunications industry in China and create
long-term value to Shareholders.
(A) ..Increase coverage and achieve further growth
One of the Company's strategies is to explore external growth opportunities
through targeted mergers and acquisitions. The Acquisition will significantly
expand the geographic coverage of the Company. The Target Regions have a total
population of approximately 122 million with GDP per capita of RMB11,446 in
2004, or approximately 9.0% over China's national average, according to the
National Bureau of Statistics of China. The GDP in the Target Regions grew
approximately 13.8% between 2003 and 2004, compared with a growth rate of
approximately 9.5% during the same period for China. The 30.5 million
fixed-line subscribers in the Target Regions represented approximately 9.8% of
the total fixed-line subscribers in China in 2004. With the addition of the
operations of the Target Company, the Group's combined service area, subscriber
base, revenue and net profit will be significantly enlarged, further
solidifying the Group's position as the dominant telecommunications provider in
northern China and allowing the Group to better capture the growth potentials
in the Chinese telecommunications industry.
The table below sets out the pro forma revenues, EBITDA and net profit of the
Combined Group for the year ended 31 December 2004 and for the six months ended
30 June 2005 assuming that the Acquisition had taken place on 1 January 2004
and 1 January 2005 respectively. The following information is derived from the
unaudited pro forma combined income statements of the Combined Group for the
year ended 31 December 2004 and for the six months ended 30 June 2005, which
are included in Appendix IV to this circular.
For the year ended 31 For the six months ended 30
December 2004 June 2005
Before Acquisition After Before Acquisition After
Acquisition Acquisition
The Target Combined The Group Target Combined
Group Group Group Historical Group Group
Historical Historical (unaudited) Historical
Restated(1) audited) (audited)
(RMB in millions) (RMB in millions)
Revenues 64,922 18,616 83,538 33,724 9,712 43,436
EBITDA(2) 34,172 8,529 42,701 19,032 5,463 24,495
Profit from operations before 15,511 2,114 18,200 9,882 2,282 12,098
revaluation deficit
Deficit on revaluation of property, - (11,318) (11,318) - - -
plant and equipment
Net profit/(loss) 9,230 (6,531) 2,594 6,358 1,330 7,386
(1) Historical financial information of the Group for the year ended 31
December 2004 has been restated to reflect the impacts of the adoption of the
new and revised HKFRS which are effective for accounting periods beginning on
or after 1 January 2005.
(2) EBITDA refers to the earnings before finance costs, interest income,
dividend income, taxation, depreciation and amortisation, share of loss of
associated companies, and minority interests. EBITDA is not a measure of
financial performance or of liquidity under HKFRS because EBITDA is not
uniformly defined. EBITDA should not be considered a substitute for or superior
to the Company's results prepared under HKFRS as it cannot be used to measure
operating results and liquidity and does not represent operating cash flows. In
addition, it may not be comparable to similarly titled indicators of other
companies.
The table below sets out the subscriber bases of the Group, the Target Company,
and the Combined Group on an aggregate basis as of 31 December 2004:
Target Combined
The Group Company Group
Fixed-line subscribers (in thousands) 80,383 27,696 108,079
Including: Personal Handyphone System
("PHS") subscribers (in thousands) 15,073 7,051 22,124
Broadband subscribers (in thousands) 6,218 2,274 8,492
(B) Improve the Group's service capabilities
In the Target Regions, the Target Company is the incumbent fixed-line operator
and owns extensive local access networks and broad customer relationships.
Since the Target Regions are contiguous to the Group's current northern service
region, the Combined Group has significant advantages in servicing large and
medium corporate customers, especially those with business operations across
regions. The Combined Group can improve its service qualities and capabilities
by applying knowledge from the Group's service regions to the Target Regions
and through shared marketing strategies and expanded sales channels to better
meet customers' evolving telecommunications demands. The Combined Group will
also be able to enjoy significant cost advantages in developing and promoting
broadband and value-added services.
(C) Capture operating synergy and improve management efficiency
The Board believes that the Acquisition represents an important opportunity to
create additional shareholders' value for the Combined Group through
streamlined organisational structure, improved management efficiency, and
reduced operating cost. It is intended that, as soon as practicable after the
completion of the Acquisition, the operations, assets and liabilities of the
Target Company will be merged with those of CNC China. Thereafter, all of the
Combined Group's telecommunications businesses in China will be conducted
through CNC China. The Board believes that this streamlined organisational
structure will allow the Combined Group to better manage its business across
the combined service regions and improve management accountability. In
addition, the Board believes that the Combined Group will be able to achieve
greater economies of scale, operational efficiency and synergies from the
Acquisition by consolidating various managerial functions including strategic
and investment planning, corporate procurement, treasury and financial
management, human resources and employee training, development and maintenance
of information technology infrastructure and other general corporate services.
THE REORGANISATION
In preparation for the Acquisition, the Target Company was incorporated on 9
August 2005 as a wholly owned subsidiary of China Netcom Group and the Target
BVI Company was incorporated on 27 July 2005 as a wholly owned subsidiary of
CNC BVI. China Netcom Group's fixed-line telecommunications assets and related
liabilities (other than the international gateway and related international
network assets, as well as the inter-provincial fiber-optic network and related
assets and liabilities) in the Target Regions, were transferred to the Target
Company. Pursuant to the Equity Interest Injection Agreement, the entire equity
interest in the Target Company was injected into CNC BVI by China Netcom Group,
and then the entire equity interest in the Target Company was injected into the
Target BVI Company by CNC BVI.
After the completion of the Acquisition, the Target BVI Company, which owns the
entire equity interest of the Target Company, will become a wholly owned
subsidiary of the Company.
Subject to relevant regulatory approvals, it is intended that as soon as
practicable after the completion of the Acquisition, the operations, assets and
liabilities of the Target Company will be merged with that of CNC China by way
of merger by absorption so that all the telecommunications businesses of the
Combined Group in China will be conducted through CNC China. It is also
intended that both the Target BVI Company and the Target Company will be
liquidated.
Set out below are the shareholding structures and main operating subsidiaries
of the Company immediately prior to the Acquisition, immediately following
completion of the Acquisition and after completion of the Acquisition and the
merger by absorption.
Corporate structure immediately prior to the Acquisition
----------------------------
| China Network |
| Communications |
| Group Corporation |
| ("China Netcom Group") |
| (PRC)(3) |
----------------------------
| 100%
---------------------------- --------------------------- ---------------------------
| China Netcom Group | | | | |
| Corporation (BVI) Limited | |Five PRC Shareholders(1) | | Public Shareholders(1) |
| ("CNC BVI") | | | | |
|(British Virgin Islands)(3)| | | | |
---------------------------- --------------------------- ---------------------------
| 100% |70.49%(2) | 4.51%(2) | 25.00%
| -------------------------------------------------------
---------------------------- -------------------------
| China Netcom Group New | | China Netcom Group |
| Horizon Communications | | Corporation (Hong |
| Corporation (BVI) Limited | | Kong) Limited |
| ("Target BVI Company") | | ("Company") |
|(British Virgin Islands)(3)| | (Hong Kong)(3) |
---------------------------- -------------------------
| |
| -----------------------------
| 100% | 100% | 100%
---------------------------- ---------------------- --------------------------
| China Netcom Group New | | China Netcom (Group) | | China Netcom Corporation |
| Horizon Communications | | Company Limited | | International Limited |
| Corporation Limited | | (CNC China") | | (Bermuda)(3) |
| ("Target Company") | | (PRC)(3) | | |
| (PRC)(3) | | | | |
---------------------------- ---------------------- ---------------------------
: Operating in:(4) : Operating in:(4) |
:- Heilongjiang Province : - Beijing Municipality -----------------------
:- Jilin Province : - Tianjin Municipality | Asia Netcom |
:- Neimenggu Autonomous Region : - Hebei Province | Corporation Limited |
:- Shanxi Province : - Henan Province | ("Asia Netcom") |
: - Shandong Province | (Bermuda)(3) |
: - Liaoning Province -----------------------
: - Shanghai Muncipality
: - Guangdong Province
Corporate structure immediately following completion of the Acquisition
----------------------------
| China Network |
| Communications |
| Group Corporation |
| ("China Netcom Group") |
| (PRC)(3) |
----------------------------
| 100%
---------------------------- --------------------------- ---------------------------
| China Netcom Group | | | | |
| Corporation (BVI) Limited | | Five PRC Shareholders(1) | | Public Shareholders |
| ("CNC BVI") | | | | |
|(British Virgin Islands)(3)| | | | |
---------------------------- --------------------------- ---------------------------
| 70.49%(2) | 4.51%(2) | 25.00%
| ---------------------------------------------------------------|
|
-----------------------------------------------------
| China Netcom Group Corporation (Hong Kong)Limited)|
| ("Company") |
| (Hong Kong)(3) |
-----------------------------------------------------
| |
| |
-------------- |
| -------------------------------
| 100% | 100% | 100%
---------------------------- ---------------------- --------------------------
| China Netcom Group New | | China Netcom (Group) | | China Netcom Corporation |
| Horizon Communications | | Company Limited | | International Limited |
| Corporation (BVI) Limited | | ("CNC China") | | (Bermuda)(3) |
| ("Target BVI Company") | | (PRC)(3) | | |
|(British Virgin Islands)(3)| | | | |
---------------------------- ---------------------- ---------------------------
| : |
| : |
| 100% : - Operating in:(4) | 100%
---------------------------- : -----------------------
| China Netcom Group New | : - Beijing Municipality | Asia Netcom |
| Horizon Communications | : - Tianjin Municipality | Corporation Limited |
| Corporation Limited | : - Hebei Province | ("Asia Netcom") |
| ("Target Company") | : - Henan Province | (Bermuda)(3) |
| (PRC)(3) | : - Shandong Province -----------------------
---------------------------- : - Liaoning Province
: : - Shanghai Muncipality
: : - Guangdong Province
: Operating in:(4)
:- Heilongjiang Province
:- Jilin Province
:- Neimenggu Autonomous Region
:- Shanxi Province
Corporate structure after completion of the Acquisition and the merger by absorption
----------------------------
| China Network |
| Communications |
| Group Corporation |
| ("China Netcom Group") |
| (PRC)(3) |
----------------------------
| 100%
---------------------------- --------------------------- ---------------------------
| China Netcom Group | | | | |
| Corporation (BVI) Limited | | Five PRC Shareholders(1) | | Public Shareholders |
| ("CNC BVI") | | | | |
|(British Virgin Islands)(3)| | | | |
---------------------------- --------------------------- ---------------------------
| 70.49%(2) | 4.51%(2) | 25.00%
| ---------------------------------------------------------------|
|
-----------------------------------------------------
| China Netcom Group Corporation (Hong Kong) Limited|
| ("Company") |
| (Hong Kong)(3) |
-----------------------------------------------------
|
|
|
-------------------------------
| |
| 100% | 100%
---------------------- ---------------------------
| China Netcom (Group) | | China Netcom Corporation |
| Company Limited | | International Limited |
| ("CNC China") | | (Bermuda)(3) |
| (PRC)(3) | | |
| | | |
---------------------- ---------------------------
: |
: |
: - Operating in:(4) | 100%
: -----------------------
: - Beijing Municipality | Asia Netcom |
: - Tianjin Municipality | Corporation Limited |
: - Hebei Province | ("Asia Netcom") |
: - Henan Province | (Bermuda)(3) |
: - Shandong Province -----------------------
: - Liaoning Province
: - Shanghai Muncipality
: - Guangdong Province
:- Heilongjiang Province
:- Jilin Province
:- Neimenggu Autonomous Region
:- Shanxi Province
(1) The five PRC Shareholders, all of which are established in the PRC, are
the Chinese Academy of Sciences, Information and Network Center of the State
Administration of Radio, Film and Television, China Railways Telecommunications
Center, Shanghai Alliance Investment Limited, and Shandong Provincial
State-owned Assets Supervision and Administration Commission.
(2) All of the ordinary shares owned by the five PRC Shareholders are
registered in the name of China Netcom Group Corporation (BVI) Limited, or CNC
BVI, which holds such ordinary shares in trust for each of the five PRC
Shareholders. Consequently, the ownership percentage of the five PRC
Shareholders in the charts above reflects the aggregate beneficial interests of
these Shareholders as held through CNC BVI. The ownership percentage of CNC BVI
as indicated in the charts above reflects CNC BVI's own beneficial ownership.
(3) Indicates jurisdiction of incorporation.
(4) The provincial businesses are operated under local branch offices of CNC
China or the Target Company (as the case may be) and these local branch offices
are not legal entities.
FINANCIAL INFORMATION OF THE TARGET GROUP
The following are the combined income statements of the Target Group for each
of the three years ended 31 December 2002, 2003 and 2004 and for the six-month
periods ended 30 June 2004 and 2005, as extracted from the audited financial
statements of the Target Group prepared in accordance with HKFRS included in
Appendix II to this circular.
Year ended 31 December Six months ended 30
June
2002 2003 2004 2004 2005
RMB RMB RMB RMB RMB
million million million million million
Revenues 16,232 17,700 18,616 9,315 9,712
Operating expenses
Depreciation and amortisation (5,988) (6,317) (6,426) (3,196) (3,184)
Networks, operations and support (4,087) (3,118) (2,426) (960) (992)
Staff costs (2,602) (3,398) (3,891) (1,892) (1,759)
Selling, general and administrative expenses (2,245) (3,269) (3,311) (1,736) (1,369)
Other operating expenses (380) (537) (459) (225) (129)
Total operating expenses (15,302) (16,639) (16,513) (8,009) (7,433)
Operating profit before interest income and 930 1,061 2,103 1,306 2,279
deficit on revaluation of property, plant and
equipment
Interest income 28 16 11 5 3
Deficit on revaluation of property, plant and - - (11,318) - -
equipment
Profit/(loss) from operations 958 1,077 (9,204) 1,311 2,282
Finance costs (1,283) (1,270) (998) (500) (501)
Profit/(loss) before taxation (325) (193) (10,202) 811 1,781
Taxation 423 398 3,671 (102) (451)
Profit/(loss) for the year/period 98 205 (6,531) 709 1,330
The following are the combined balance sheets of the Target Group as at 31
December 2002, 2003 and 2004 and as at 30 June 2005, as extracted from the
audited financial statements of the Target Group prepared in accordance with
HKFRS included in Appendix II to this circular.
As at 31 December As at 30
June
2002 2003 2004 2005
RMB RMB RMB RMB
million million million million
Assets
Current assets
Cash and bank deposits 1,097 1,114 580 466
Accounts receivable 1,121 1,175 1,486 1,859
Inventories and consumables 291 209 302 273
Prepayments and other receivables 739 582 436 366
Due from ultimate holding company and fellow 141 94 714 166
subsidiaries
Total current assets 3,389 3,174 3,518 3,130
Non-current assets
Lease prepayments for land 466 450 480 437
Property, plant and equipment 44,588 47,719 42,110 39,327
Construction in progress 3,518 2,354 2,995 3,178
Intangible assets 58 91 66 121
Deferred costs 668 672 654 593
Deferred tax assets 1,663 2,076 1,410 1,143
Other non-current assets 14 11 9 -
Total non-current assets 50,975 53,373 47,724 44,799
Total assets 54,364 56,547 51,242 47,929
Liabilities and equity
Current liabilities
Accounts payable 5,632 5,409 6,472 6,091
Accruals and other payables 1,639 1,267 1,513 1,319
Short-term bank loans 10,219 15,774 15,543 16,978
Current portion of long-term bank and other loans 5,727 3,676 4,457 3,484
Due to ultimate holding company and fellow subsidiaries 1,231 1,448 1,836 1,866
Current portion of deferred revenues 2,140 2,170 2,223 1,954
Current portion of provisions 1,495 1,550 1,531 1,513
Taxation payable 105 185 165 97
Total current liabilities 28,188 31,479 33,740 33,302
Net current liabilities (24,799) (28,305) (30,222) (30,172)
Total assets less current liabilities 26,176 25,068 17,502 14,627
Non-current liabilities
Long-term bank and other loans 10,924 7,863 4,191 3,213
Deferred revenues 3,963 2,981 2,171 1,860
Provisions 1,181 1,153 1,431 1,369
Deferred tax liabilities 2,497 2,759 255 50
Other non-current liabilities 57 29 24 4
Total non-current liabilities 18,622 14,785 8,072 6,496
Total liabilities 46,810 46,264 41,812 39,798
Owners' equity 7,554 10,283 9,430 8,131
Total liabilities and equity 54,364 56,547 51,242 47,929
Prior to the completion of the Reorganisation, the Target Group has distributed
its profits for the six months ended 30 June 2005, which amounted to RMB930
million (equivalent to approximately HK$892 million), to China Netcom Group.
Further detailed information in respect of the Target Group's historical
results of operations and financial position is set out in Appendix II to this
circular.
PROSPECTIVE FINANCIAL INFORMATION
The Company and the Target Group have prepared certain prospective financial
information for the year ending 31 December 2005 in compliance with Rule
14A.56(8) and Rule 14.62 of the Hong Kong Listing Rules. Neither the Target
Group nor the Company intends to update this information during the year or to
update such information in future years, although the Directors are aware of
the requirements of Rule 13.09 notes 9 and 10 of the Hong Kong Listing Rules.
This information is necessarily based upon a number of assumptions that, while
presented with numerical specificity and considered reasonable by 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 realised. 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 V to this circular and in the absence of unforeseen
circumstances, the Target Group's forecast combined profit for the year ending
31 December 2005 (including an estimated upfront connection fee of
approximately RMB735 million (equivalent to approximately HK$705 million))
under HKFRS is unlikely to be less than RMB2,150 million (equivalent to
approximately HK$2,063 million).
The bases and assumptions for the preparation of the profit forecast is set out
in Appendix V to this circular and the texts of the letters from
PricewaterhouseCoopers, CICC, Citigroup and Goldman Sachs in respect of the
profit forecast are also set out in Appendix V to this circular.
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 31
December 2005 which would affect the prospective financial information
presented.
RELATIONSHIP WITH CNC BVI AND CHINA NETCOM GROUP
CNC BVI is a company incorporated in the British Virgin Islands and is the
immediate holding company of the Company. CNC BVI is an investment holding
company.
China Netcom Group is a state-owned enterprise established under the laws of
the PRC and is the ultimate holding company of the Company. China Netcom Group
is the second largest fixed-line telecommunications operator in China. China
Netcom Group owns and operates its fixed-line telecommunications networks, and
provides telecommunications services including fixed-line telephone, broadband
and other Internet-related services in all provinces, municipalities and
autonomous regions in China (including the Target Regions prior to the
completion of the Acquisition) that are outside the Group's existing northern
and southern service regions (which include Beijing Municipality, Tianjin
Municipality, Hebei Province, Henan Province, Shandong Province, Liaoning
Province, Shanghai Municipality and Guangdong Province).
As at the Latest Practicable Date, China Netcom Group beneficially owned 100%
of CNC BVI's issued share capital, and CNC BVI beneficially owned approximately
70.49% of the Company's issued share capital. CNC BVI and China Netcom Group
are therefore connected persons of the Company.
In connection with the initial public offering of the Company in November 2004,
China Netcom Group has, by a letter of undertakings that is legally binding
indefinitely, undertaken that it will support the Group's existing operations
and future development, including that the Company will be treated equally with
any other operators of fixed-line telephone, broadband, Internet and certain
other telecommunications services that are controlled by China Netcom Group and
the Company will have the option to provide additional telecommunications
services in the service regions that fall within China Netcom Group's scope of
business.
CONTINUING CONNECTED TRANSACTIONS
In October 2004, CNC China, a wholly-owned subsidiary of the Company, entered
into certain agreements with China Netcom Group to regulate certain ongoing
transactions between CNC China on the one hand and China Netcom Group and its
subsidiaries or Associates (other than the Group) on the other. These
transactions are continuing connected transactions of the Company under the
Hong Kong Listing Rules. In respect of some of these continuing connected
transactions, annual caps representing the maximum aggregate annual value of
consideration payable under these transactions have been set. The Group has
complied with these caps for the financial year ended 31 December 2004 and also
for the period commencing from 1 January 2005 and ending on the date of this
circular.
It is expected that after completion of the Acquisition, similar ongoing
transactions will be conducted between the Target Company on the one hand and
China Netcom Group and its subsidiaries or Associates (other than the Combined
Group) on the other. These transactions will, after completion of the
Acquisition, become continuing connected transactions of the Company. In order
to facilitate the management of all continuing connected transactions of the
Company in China after the completion of the Acquisition, the Target Company,
CNC China and China Netcom Group entered into certain connected transactions
agreements on 12 September 2005 to regulate the continuing connected
transactions between China Netcom Group and its subsidiaries or Associates
(other than the Combined Group) on the one hand and the Combined Group on the
other, in respect of the Combined Group's operations in 12 provinces,
municipalities and autonomous region in China. These agreements will replace
the existing connected transaction agreements between CNC China and China
Netcom Group if and when the Acquisition completes. These agreements are
summarised below:
Domestic Interconnection Settlement Agreement
The Target Company, CNC China and China Netcom Group entered into the Domestic
Interconnection Settlement Agreement on 12 September 2005. Pursuant to the
Domestic Interconnection Settlement Agreement, the parties agreed to
interconnect the network of China Netcom Group on the one hand and that of CNC
China and the Target Company (together with CNC China, the "Combined Operating
Group") on the other and settle the charges received in respect of domestic
long distance voice services within their respective service regions on a
quarterly basis.
For domestic long distance voice services between China Netcom Group and the
Combined Operating Group, the telephone operator in the location of the calling
party makes a settlement payment to the telephone operator in the location of
the called party at the rate of RMB0.06 per minute (in case where the call
terminates within the network of either China Netcom Group or the Combined
Operating Group) or RMB0.09 per minute (in case where the call terminates
outside the network of either China Netcom Group or the Combined Operating
Group).
The rates of RMB0.06 per minute and RMB0.09 per minute mentioned above shall be
adjusted with reference to the relevant standards, tariffs or policies
promulgated by the relevant regulatory authorities in China from time to time.
The Domestic Interconnection Settlement Agreement takes effect from the date of
completion of the Acquisition and is valid until 31 December 2007. If the
Combined Operating Group notifies China Netcom Group at least three months
prior to the expiration of the agreement of its intention to renew the
agreement, the agreement can be renewed with the same terms for further periods
of three years.
International Long Distance Voice Services Settlement Agreement
CNC China and China Netcom Group entered into the International Long Distance
Voice Services Settlement Agreement on 12 September 2005. Pursuant to the
International Long Distance Voice Services Settlement Agreement, the parties
agreed to interconnect the networks of China Netcom Group and CNC China and
settle the charges received in respect of international long distance voice
services on a quarterly basis.
For outbound international calls, China Netcom Group reimburses CNC China for
any amount it has paid to overseas telecommunications operators. The revenues
received by China Netcom Group less the amount paid to overseas
telecommunications operators are shared between China Netcom Group and CNC
China in proportion to the estimated costs incurred by China Netcom Group and
the Combined Operating Group in connection with the provision of outbound
international long distance voice services.
For inbound international calls, the revenues received by CNC China from
overseas telecommunications operators (other than the Company and its
controlled entities) less the amount paid to China Netcom Group at the rate of
RMB0.06 per minute (in case where the call terminates within the network of
China Netcom Group) or RMB0.09 per minute (in case where the call terminates
within the network of other operators) are shared between China Netcom Group
and CNC China in proportion to the estimated costs incurred by China Netcom
Group and the Combined Operating Group in connection with the provision of
inbound international long distance voice services.
The rates of RMB0.06 per minute and RMB0.09 per minute mentioned above shall be
adjusted with reference to the relevant standards, tariffs or policies
promulgated by the relevant regulatory authorities in China from time to time.
The International Long Distance Voice Services Settlement Agreement takes
effect from the date of completion of the Acquisition and is valid until 31
December 2007. If CNC China notifies China Netcom Group at least three months
prior to the expiration of the agreement of its intention to renew the
agreement, the agreement can be renewed with the same terms for further periods
of three years.
The transactions under the Domestic Interconnection Settlement Agreement and
the International Long Distance Voice Services Settlement Agreement will be
subject to reporting and announcement requirements set out in Rules 14A.45 to
14A.47 of the Hong Kong Listing Rules and the independent shareholders'
approval requirements under Rule 14A.48 of the Hong Kong Listing Rules.
Property Leasing Agreement
The Target Company, CNC China and China Netcom Group entered into the Property
Leasing Agreement on 12 September 2005. Pursuant to the Property Leasing
Agreement:
(i) the Combined Operating Group leases to China Netcom Group a total of 54
buildings and units with an aggregate floor area of approximately 4,300 square
metres located throughout the Combined Operating Group's service regions, for
use as offices and other ancillary purposes; and
(ii) China Netcom Group leases to the Combined Operating Group a total of 22
parcels of land with an aggregate site area of approximately 26,700 square
metres and 42,097 buildings and units with an aggregate floor area of
approximately 9,264,000 square metres located throughout the Combined Operating
Group's service regions, for use as offices, telecommunications equipment sites
and other ancillary purposes.
The charges payable by the Combined Operating Group and by China Netcom Group
under the Property Leasing Agreement are based on market rates or the
depreciation and maintenance charges in respect of each property, provided such
depreciation and maintenance charges shall not be higher than the market rates.
The charges are payable quarterly in arrears and are subject to review every
year to take into account the then prevailing market rates of the properties
leased in that year. Sallmanns, the independent property valuer of the Company,
has reviewed the Property Leasing Agreement, and has confirmed that the rental
charges payable by the Combined Operating Group under the Property Leasing
Agreement are no higher than prevailing market rates and the rental charges
payable by China Netcom Group under the Property Leasing Agreement are fair and
reasonable.
The Property Leasing Agreement takes effect from the date of completion of the
Acquisition and is valid until 31 December 2007. If the Combined Operating
Group notifies China Netcom Group at least three months prior to the expiration
of the agreement of its intention to renew the agreement, the agreement can be
renewed with the same terms for further periods of three years.
For the three years ended 31 December 2002, 2003 and 2004, the rental charges
that the Combined Operating Group paid to China Netcom Group amounted to RMB
43.79 million, RMB 52.56 million and RMB 316 million, respectively. For the
same periods, the rental charges paid by China Netcom Group to the Combined
Operating Group amounted to RMB 1 million, RMB 4 million and RMB 3.11 million,
respectively.
Prior to the restructuring implemented for the purpose of the Company's listing
in 2004, CNC China only leased a small number of properties (less than 2,000 in
each of the two years ended 31 December 2002 and 2003). Prior to the
Reorganisation, the Target Company also only leased a very small number of
properties. As a result of the restructuring for the Company's listing and the
Acquisition, many more properties will be leased from China Netcom Group to the
Combined Operating Group and from the Combined Operating Group to China Netcom
Group under the Property Leasing Agreement. The total rental charges payable by
the Combined Operating Group to China Netcom Group in each of the three
financial years ending 31 December 2005, 2006 and 2007 are not expected to
exceed RMB1,250 million, and the total rental charges receivable by the
Combined Operating Group from China Netcom Group in each of the three financial
years ending 31 December 2005, 2006 and 2007 are not expected to exceed RMB35
million. Accordingly, these amounts have been set as the proposed caps for this
connected transaction.
Property Sub-leasing Agreement
The Target Company, CNC China and China Netcom Group entered into the Property
Sub-leasing Agreement on 12 September 2005. Pursuant to the Property
Sub-leasing Agreement, China Netcom Group agreed to sub-let to the Combined
Operating Group a total of 84 parcels of land and 6,263 building and units
owned by and leased from independent third parties, for use as offices,
telecommunications equipment sites and other ancillary purposes.
The amounts payable by the Combined Operating Group under the Property
Sub-leasing Agreement are the same as the rental charges and other fees
(including management fees) payable by China Netcom Group to the relevant third
parties.
The Property Sub-leasing Agreement takes effect from the date of completion of
the Acquisition and is valid until 31 December 2007. If the Combined Operating
Group notifies China Netcom Group at least three months prior to the expiration
of the agreement of its intention to renew the agreement, the agreement can be
renewed with the same terms for further periods of three years.
The above property sub-leasing arrangement did not exist in respect of CNC
China prior to the restructuring implemented for the purpose of the Company's
listing in 2004. Such arrangement also did not exist in respect of the Target
Company prior to the Reorganisation. The total amount paid by the Group for
sub-let properties for the second half of the financial year ended 31 December
2004 (during which period the restructuring for the Company's listing has been
effective) was RMB 33 million. Based on the number of properties to be sub-let
under the Property Sub-leasing Agreement and the rental charges and other fees
payable under the underlying lease agreements, the total amount payable by the
Combined Operating Group to China Netcom Group for property sub-leasing in each
of the three financial years ending 31 December 2005, 2006 and 2007 is not
expected to exceed RMB100 million. Accordingly, the amount has been set as the
proposed cap for this connected transaction.
Master Sharing Agreement
The Target Company, CNC China and China Netcom Group entered into the Master
Sharing Agreement on 12 September 2005. Pursuant to the Master Sharing
Agreement:
(a) the Combined Operating Group will provide customer relationship
management services for large enterprise customers of China Netcom Group;
(b) the Combined Operating Group will provide network management services to
China Netcom Group;
(c) the Combined Operating Group will share with China Netcom Group the
services provided by administrative and managerial staff in respect of central
management of the business operations, financial control, human resources and
other related matters of both the Combined Operating Group and China Netcom
Group;
(d) the Combined Operating Group will provide to China Netcom Group
supporting services such as billing and settlement provided by the business
support centre;
(e) China Netcom Group will provide to the Combined Operating Group
supporting services, including telephone card production, development and
related services and IC card inter-provincial and inter-network clearing
services;
(f) China Netcom Group will provide to the Combined Operating Group certain
other shared services, including advertising, publicity, research and
development, business hospitality, maintenance and property management;
(g) China Netcom Group will provide certain office space in its headquarters
to the Combined Operating Group for use as its principal executive office; and
(h) the Combined Operating Group and China Netcom Group will share the
revenues received by China Netcom Group from other operators whose networks
interconnect with the Internet backbone network of China Netcom Group and will
share the monthly connection fee that China Netcom Group pays to the State
Internet Switching Centre.
The Combined Operating Group and China Netcom Group own certain equipment and
facilities forming the Internet backbone network of China Netcom Group. This
Internet backbone network interconnect with the networks of other operators.
Such interconnection generates revenue which is settled with China Netcom Group
and shared between China Netcom Group and the Combined Operating Group under
the Master Sharing Agreement. Prior to the Master Sharing Agreement coming into
effect, the revenue generated from such interconnection was shared between the
Group and China Netcom Group although the transaction is not regulated by the
existing Master Sharing Agreement between CNC China and China Netcom Group. The
interconnection revenue received by the Group from China Netcom Group and the
connection fee paid by the Group to China Netcom Group in the second half of
2004, as well as in the first half of 2005, do not exceed the 0.1% threshold
under Rule 14A.33 of the Hong Kong Listing Rules.
The services set out in paragraphs (a) to (g) above and the revenue and fee set
out in paragraph (h) above are shared between the Combined Operating Group and
China Netcom Group on an on-going basis from time to time and the aggregate
costs incurred by the Combined Operating Group or China Netcom Group for the
provision of the services set out in paragraphs (a) to (g) above and the
revenue and fee receivable and payable by China Netcom Group as referred to in
paragraph (h) above are apportioned between the Combined Operating Group and
China Netcom Group according to their respective total assets value as shown in
their respective financial statements on an annual basis.
The costs of the services provided under the Master Sharing Agreement are not
directly related to the volumes of business or revenues of the parties. After
completion of the Acquisition, China Netcom Group's primary fixed-line
telephone business in the northern part of China will be injected into the
Combined Operating Group, and the Group's revenues will be increased as a
result. Accordingly, the Board considers that it is more appropriate for the
costs of the services, revenues and fees payable or receivable under the Master
Sharing Agreement to be shared on the basis of the parties' respective total
assets value as opposed to their respective revenues.
The Master Sharing Agreement takes effect from the date of completion of the
Acquisition and is valid until 31 December 2007. If the Combined Operating
Group notifies China Netcom Group at least three months prior to the expiration
of the agreement of its intention to renew the agreement, the agreement can be
renewed with the same terms for further periods of three years.
All of the above provision or sharing of services and revenue and fee did not
exist in respect of CNC China prior to the restructuring implemented for the
purpose of the Company's listing in 2004. Such provision or sharing of services
and revenue and fee also did not exist between the Target Company and China
Netcom Group prior to the Reorganisation. The total amount paid by the Group to
China Netcom Group for the sharing of services under paragraphs (e) to (g)
above for the second half of the financial year ended 31 December 2004 (during
which period the restructuring for the Company's listing has been effective)
was RMB 213 million and the total amount paid by China Netcom Group to the
Group for the sharing of services under paragraphs (a) to (d) above for the
same period was RMB19 million. Based on the aggregate historical expenditures
incurred for the provision of relevant services described in paragraphs (a) to
(g) above, the aggregate historical revenue generated from the interconnection
of the Internet backbone network (which interconnection revenue amounted to
approximately RMB5.98 million for the second half of 2004) and the projected
total assets values of China Netcom Group and the Combined Operating Group,
respectively, the aggregate amount receivable by the Combined Operating Group
from China Netcom Group in respect of services set out in paragraphs (a) to (d)
above and in respect of the revenue set out in paragraph (h) above in each of
the three financial years ending 31 December 2005, 2006 and 2007 is not
expected to exceed RMB180 million, and the total amount payable by the Combined
Operating Group to China Netcom Group in respect of services set out in
paragraphs (e) to (g) and in respect of the fee set out in paragraph (h) above
in each of the three financial years ending 31 December 2005, 2006 and 2007 is
not expected to exceed RMB485 million. Accordingly, these amounts have been set
as the proposed caps for this connected transaction.
Engineering and Information Technology Services Agreement
The Target Company, CNC China and China Netcom Group entered into the
Engineering and Information Technology Services Agreement on 12 September 2005
to govern the arrangements with respect to the provision of certain engineering
and information technology-related services to the Combined Operating Group by
China Netcom Group. These services include:
(a) the provision of planning, surveying and design services in relation to
telecommunications engineering projects;
(b) the provision of construction services in relation to telecommunications
engineering projects;
(c) the provision of supervision services in relation to telecommunications
engineering projects; and
(d) the provision of information technology services, including office
automation, software testing, network upgrade, new business development and
support system development.
The charges payable for engineering and information technology-related services
described above are determined with reference to market rates. In addition,
where the value of any single item of engineering design or supervision-related
service exceeds RMB0.5 million or where the value of any single item of
engineering construction-related service exceeds RMB2 million, the award of
such services will be subject to tender. The charges are settled between the
Combined Operating Group and China Netcom Group as and when the relevant
services are provided.
The Engineering and Information Technology Services Agreement takes effect from
the date of completion of the Acquisition and is valid until 31 December 2007.
If the Combined Operating Group notifies China Netcom Group at least three
months prior to the expiration of the agreement of its intention to renew the
agreement, the agreement can be renewed with the same terms for further periods
of three years.
For the three years ended 31 December 2002, 2003 and 2004, the service charges
paid by the Combined Operating Group to China Netcom Group in respect of
engineering and information technology-related services amounted to RMB3,759
million, RMB4,198 million and RMB3,821 million, respectively. Based on the
historical service charges paid by the Combined Operating Group to China Netcom
Group and the extent and volume of the engineering and information
technology-related services the Combined Operating Group expects China Netcom
Group to provide, the total amount payable by the Combined Operating Group to
China Netcom Group for provision of engineering and information
technology-related services in each of the three financial years ending 31
December 2005, 2006 and 2007 is not expected to exceed RMB4,400 million.
Accordingly, this amount has been set as the proposed cap for this connected
transaction.
Materials Procurement Agreement
The Target Company, CNC China and China Netcom Group entered into the Materials
Procurement Agreement on 12 September 2005 under which:
(a) the Combined Operating Group may request China Netcom Group to act as its
agent for the procurement of imported and domestic telecommunications equipment
and other domestic non-telecommunications equipment;
(b) the Combined Operating Group may purchase from China Netcom Group certain
products, including cables, modems and yellow pages telephone directories; and
(c) China Netcom Group will provide to the Combined Operating Group storage
and transportation services related to the procurement and purchase of
materials or equipment under the agreement.
Commission and/or charges for the domestic materials procurement services
referred to in paragraph (a) above shall not exceed the maximum rate of 3% of
the contract value. Commission and/or charges for the above imported materials
procurement services shall not exceed the maximum rate of 1% of the contract
value. The price for the purchase of China Netcom Group's products referred to
in paragraph (b) above is determined with reference to the following pricing
principles and limits:
o the government fixed price;
o where there is no government fixed price but a government guidance price
exists, the government guidance price;
o where there is neither a government fixed price nor a government guidance
price, the market price; or
o where none of the above is applicable, the price to be agreed between
the relevant parties and determined on a cost-plus basis.
Commission charges for the storage and transportation services referred to in
paragraph (c) above are determined with reference to market rates.
Payments under the Materials Procurement Agreement will be made as and when the
relevant equipment or products have been procured and delivered.
The Materials Procurement Agreement takes effect from the date of completion of
the Acquisition and is valid until 31 December 2007. If the Combined Operating
Group notifies China Netcom Group at least three months prior to the expiration
of the agreement of its intention to renew the agreement, the agreement can be
renewed with the same terms for further periods of three years.
For the three years ended 31 December 2002, 2003 and 2004, the historical
volumes of sale and purchase of equipment and products for the Combined
Operating Group amounted to RMB4,910 million, RMB4,892 million and RMB2,944
million, respectively.
Prior to the restructuring implemented for the purpose of the Company's listing
in 2004, nearly all of the products and equipment purchased by the Combined
Operating Group from China Netcom Group were made as direct purchases, where
the relevant products and materials were purchased by China Netcom Group and
then resold to the Company. Accordingly, China Netcom Group acted primarily as
principal rather than as our agent earning commissions, and no historical
figures of a comparable nature are available. Based on the historical volumes
of purchases made by the Combined Operating Group and with reference to the
level of commission charges set out in the Materials Procurement Agreement, the
total amount payable by the Combined Operating Group to China Netcom Group,
including both commissions and purchase prices, for each of the three financial
years ending 31 December 2005, 2006 and 2007 is not expected to exceed RMB2,000
million. Accordingly, this amount has been set as the proposed cap for this
connected transaction.
Ancillary Telecommunications Services Agreement
The Target Company, CNC China and China Netcom Group entered into the Ancillary
Telecommunications Services Agreement on 12 September 2005 to govern the
arrangements with respect to the provision of ancillary telecommunications
services to the Combined Operating Group by China Netcom Group. These services
include certain telecommunications pre-sale, on-sale and after-sale services
such as assembling and repairing of certain telecommunications equipment, sales
agency services, printing and invoice delivery services, maintenance of
telephone booths, customers acquisition and servicing and other customers'
services.
The charges payable for the services described above are determined with
reference to the following pricing principles and limits:
o the government fixed price;
o where there is no government fixed price but a government guidance price
exists, the government guidance price;
o where there is neither a government fixed price nor a government guidance
price, the market price; or
o where none of the above is applicable, the price to be agreed between
the relevant parties and determined on a cost-plus basis.
The service charges are settled between the Combined Operating Group and China
Netcom Group as and when the relevant services are provided.
The Ancillary Telecommunications Services Agreement takes effect from the date
of completion of the Acquisition and is valid until 31 December 2007. If the
Combined Operating Group notifies China Netcom Group at least three months
prior to the expiration of the agreement of its intention to renew the
agreement, the agreement can be renewed with the same terms for further periods
of three years.
For the three years ended 31 December 2002, 2003 and 2004, the services charges
paid by the Combined Operating Group to China Netcom Group for ancillary
telecommunications services amounted to RMB1,373 million, RMB1,880 million and
RMB789 million, respectively. Based on the historical service charges paid and
the estimated extent and volume of ancillary telecommunications services
required from China Netcom Group, the total amount payable by the Combined
Operating Group to China Netcom Group for provision of ancillary
telecommunications services in each of the three financial years ending 31
December 2005, 2006 and 2007 is not expected to exceed RMB1,200 million.
Accordingly, this amount has been set as the proposed cap for this connected
transaction.
Support Services Agreement
The Target Company, CNC China and China Netcom Group entered into the Support
Services Agreement on 12 September 2005. Under the Support Services Agreement,
China Netcom Group provides the Combined Operating Group with various support
services, including equipment leasing (other than equipment covered under the
Telecommunications Facilities Leasing Agreement) and maintenance services,
motor vehicles services, security services, basic construction agency services,
research and development services, employee training services and advertising
services and other support services.
The charges payable for the services described above are determined with
reference to the following pricing principles and limits:
o the government fixed price;
o where there is no government fixed price but a government guidance price
exists, the government guidance price;
o where there is neither a government fixed price nor a government guidance
price, the market price; or
o where none of the above is applicable, the price to be agreed between
the relevant parties and determined on a cost-plus basis.
The service charges are settled between the Combined Operating Group and China
Netcom Group as and when relevant services are provided.
The Support Services Agreement takes effect from the date of completion of the
Acquisition and is valid until 31 December 2007. If the Combined Operating
Group notifies China Netcom Group at least three months prior to the expiration
of the agreement of its intention to renew the agreement, the agreement can be
renewed with the same terms for further periods of three years.
For the three years ended 31 December 2002, 2003 and 2004, the support service
charges paid by the Combined Operating Group to China Netcom Group amounted to
RMB1,385 million, RMB1,481 million and RMB1,073 million, respectively. Based on
the historical service charges paid and the estimated extent and volume of
support services required from China Netcom Group, the total amount payable by
the Combined Operating Group to China Netcom Group for provision of support
services in each of the three financial years ending 31 December 2005, 2006 and
2007 is not expected to exceed RMB1,610 million. Accordingly, this amount has
been set as the proposed cap for this connected transaction.
Telecommunications Facilities Leasing Agreement
The Target Company, CNC China and China Netcom Group entered into the
Telecommunications Facilities Leasing Agreement on 12 September 2005, under
which:
(a) China Netcom Group leases inter-provincial fiber-optic cables within the
Combined Operating Group's service regions to the Combined Operating Group;
(b) China Netcom Group leases certain international telecommunications
resources (including international telecommunications channel gateways,
international telecommunications service gateways, international submarine
cable capacity, international land cables and international satellite
facilities) to the Combined Operating Group; and
(c) China Netcom Group leases certain other telecommunications facilities
required by the Combined Operating Group for its operations.
The rental charges for the leasing of inter-provincial fiber-optic cables,
international telecommunications resources and other telecommunications
facilities are based on the annual depreciation charges of such fiber-optic
cables, resources and telecommunications facilities provided that such charges
shall not be higher than market rates. The Combined Operating Group shall be
responsible for the on-going maintenance of such inter-provincial fiber-optic
cables and international telecommunications resources. The Combined Operating
Group and China Netcom Group shall determine and agree which party is to
provide maintenance service to the telecommunications facilities referred to in
paragraph (c) above. Unless otherwise agreed by the Combined Operating Group
and China Netcom Group, such maintenance service charges shall be borne by the
Combined Operating Group. If China Netcom Group shall be responsible for
maintaining any telecommunications facilities referred to in paragraph (c)
above, the Combined Operating Group shall pay to China Netcom Group the
relevant maintenance service charges which shall be determined with reference
to market rates. Where there are no market rates, the maintenance charges shall
be agreed between the parties and determined on a cost-plus basis. The net
rental charges and service charges due to China Netcom Group under the
Telecommunications Facilities Leasing Agreement will be settled between the
Combined Operating Group and China Netcom Group on a quarterly basis.
The Telecommunications Facilities Leasing Agreement takes effect from the date
of completion of the Acquisition and is valid until 31 December 2007. If the
Combined Operating Group notifies China Netcom Group at least three months
prior to the expiration of the agreement of its intention to renew the
agreement, the agreement can be renewed with the same terms for further periods
of three years.
The above telecommunications facilities leasing arrangement did not exist in
respect of CNC China prior to the restructuring implemented for the purpose of
the Company's listing in 2004. Such arrangement also did not exist in respect
of the Target Company prior to the Reorganisation. The total charges paid by
the Group to China Netcom Group for the lease of telecommunications facilities
for the second half of the financial year ended 31 December 2004 (during which
period the restructuring for the Company's listing has been effective) was
RMB138 million. Based on the annual depreciation charges, the current market
rates and the expected telecommunications facilities required to be leased from
China Netcom Group, the total amount payable by the Combined Operating Group to
China Netcom Group under this leasing agreement in each of the three financial
years ending 31 December 2005, 2006 and 2007 is not expected to exceed RMB600
million. Accordingly, this amount has been set as the proposed cap for this
connected transaction.
Continuing connected transactions relating to Asia Netcom
In preparation for the Company's listing in 2004, certain continuing connected
transactions were entered into between Asia Netcom, a wholly owned subsidiary
of the Company, and EANL, an indirect wholly owned subsidiary of China Netcom
Group. These continuing connected transactions relate to the purchase and lease
of telecommunications capacity by Asia Netcom from EANL and the provision of
certain management services by Asia Netcom to EANL. These continuing connected
transactions will not be affected by the Acquisition and the terms and the
annual caps applicable to such transactions will remain unchanged.
COMPLIANCE WITH THE HONG KONG LISTING RULES
Following completion of the Acquisition, the Combined Operating Group will
continue to enter into transactions described in the section headed "Continuing
Connected Transactions" above. Such transactions would constitute continuing
connected transactions for the Company under the Hong Kong Listing Rules for so
long as members of China Netcom Group remain as connected persons within the
meaning of the Hong Kong Listing Rules.
The Board (including the members of the Independent Board Committee) is of the
opinion that the terms of the Continuing Connected Transactions described in
the section headed "Continuing Connected Transactions" above have been entered
into, and will be carried out, in the ordinary and usual course of business of
the Combined Operating 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.
It is expected that, the proposed annual cap for the years 2005 to 2007 for
each category of Continuing Connected Transactions under the Master Sharing
Agreement, the Ancillary Telecommunications Services Agreement, the Support
Services Agreement and the Telecommunications Facilities Leasing Agreement, and
the proposed annual cap for the years 2005 to 2007 for charges payable by the
Combined Operating Group under both the Property Leasing Agreement and the
Property Sub-leasing Agreement and for the charges payable by China Netcom
Group under the Property Leasing Agreement, will be less than the 2.5%
threshold under Rule 14A.34 of the Hong Kong Listing Rules. Accordingly, these
transactions will be exempt from the independent shareholders' approval
requirements under the Hong Kong Listing Rules, but such transactions will
still be subject to the reporting and announcement requirements set out in
Rules 14A.45 to 14A.47 of the Hong Kong Listing Rules.
For each category of Continuing Connected Transactions under the Engineering
and Information Technology Services Agreement and the Materials Procurement
Agreement, as the proposed annual cap will exceed the 2.5% threshold under Rule
14A.34 of the Hong Kong Listing Rules, such transactions will constitute
non-exempt continuing connected transactions under Rule 14A.35 of the Hong Kong
Listing Rules and will be subject to the reporting and announcement
requirements set out in Rules 14A.45 to 14A.47 of the Hong Kong Listing Rules
and the independent shareholders' approval requirements under Rule 14A.48 of
the Hong Kong Listing Rules.
Under Rule 14A.35(2) of the Hong Kong Listing Rules, in respect of a continuing
connected transaction which is not fully exempted, a cap must be set and
disclosed. The caps for the Continuing Connected Transactions (other than those
under the Domestic Interconnection Settlement Agreement and the International
Long Distance Voice Services Settlement Agreement) for each of three years
ending 31 December 2005, 2006 and 2007 are set out below:
Continuing Connected Transactions Proposed annual cap
(RMB in millions)
Property Leasing Agreement payable by the Combined Operating Group - 1,250
payable by China Netcom Group - 35
Property Sub-leasing Agreement 100
Master Sharing Agreement payable by the Combined Operating Group - 485
payable by China Netcom Group - 180
Engineering and Information Technology Services 4,400
Agreement
Materials Procurement Agreement 2,000
Ancillary Telecommunications Services Agreement 1,200
Support Services Agreement 1,610
Telecommunications Facilities Leasing Agreement 600
Special circumstances exist for both the Domestic Interconnection Settlement
Agreement and the International Long Distance Voice Services Settlement
Agreement and no cap is proposed in respect of the settlement of domestic and
international long distance voice services for the following reasons:
(i) any growth in the domestic and international long distance voice services
will necessarily result in increased transaction volumes under the Domestic
Interconnection Settlement Agreement and the International Long Distance Voice
Services Settlement Agreement, which the Company will not be able to control as
it depends entirely on customer usage. Any caps on these transactions will
therefore potentially limit the Company's ability to conduct or expand its
business in the ordinary course; and
(ii) the settlement rates in respect of long distance voice services are
determined with reference to the relevant standard tariff or policies
promulgated by the relevant regulatory authorities in China, which are subject
to change from time to time, and the Company is not in a position to set the
settlement rates at its discretion.
The Company has applied to the Hong Kong Stock Exchange that no caps be
proposed for the transactions contemplated under the Domestic Interconnection
Settlement Agreement and the International Long Distance Voice Services
Settlement Agreement. Such transactions will be subject to the reporting and
announcement requirements set out in Rule 14A.45 to 14A.47 of the Hong Kong
Listing Rules and the independent shareholders' approval requirements under
Rule 14A.48 of the Hong Kong Listing Rules.
EXTRAORDINARY GENERAL MEETING
A notice of the Extraordinary General Meeting to be held in Nathan Room, Conrad
Hotel, Hong Kong on 25 October 2005 at 10:00 a.m., is set out at the end of
this circular. At the Extraordinary General Meeting, ordinary resolutions will
be proposed to approve the Acquisition and the Non-exempt Continuing Connected
Transactions. The vote of the Independent Shareholders at the Extraordinary
General Meeting on the resolutions approving the Acquisition and the Non-exempt
Continuing Connected Transactions shall be taken by poll.
In accordance with the Hong Kong Listing Rules, China Netcom Group, the
ultimate holding company of the Company which, through CNC BVI, was
beneficially interested in approximately 70.49% of the issued share capital of
the Company as at the Latest Practicable Date, and its Associates, will abstain
from voting on the resolutions to approve the Acquisition and the Non-exempt
Continuing Connected Transactions at the Extraordinary General Meeting.
A form of proxy for use at the Extraordinary General Meeting is enclosed with
this circular. Whether or not you are able to attend the Extraordinary General
Meeting, you are requested to complete the accompanying form of proxy in
accordance with the instructions printed thereon and return the same to the
Company's registered office at 46th Floor, Cheung Kong Center, 2 Queen's Road
Central, Hong Kong, as soon as practicable and in any event at least 48 hours
before the time appointed for holding the Extraordinary General Meeting or any
adjournment thereof. Completion and return of the form of proxy will not
preclude a Shareholder from attending and voting in person at the Extraordinary
General Meeting or any adjournment thereof should he so wishes.
RECOMMENDATION
CSFB has been retained as the independent financial adviser to advise the
Independent Board Committee and the Independent Shareholders in respect of the
terms of the Acquisition and the terms of the Non-exempt Continuing Connected
Transactions. CSFB considers that the terms of the Acquisition are on normal
commercial terms, and that the terms of the Non-exempt Continuing Connected
Transactions are on normal commercial terms and are conducted in the ordinary
and usual course of business. Furthermore, CSFB considers that the terms of the
Acquisition and the Non-exempt Continuing Connected Transactions to be fair and
reasonable from a financial perspective, so far as the Independent Shareholders
are concerned, and are in the interest of the Company and its Shareholders as a
whole. Accordingly, CSFB advises the Independent Board Committee and the
Independent Shareholders that the Independent Shareholders should vote in
favour of the Acquisition and the Non-exempt Continuing Connected Transactions.
The text of the letter from CSFB containing its advice and the principal
factors and reasons it has taken into consideration in arriving at its advice
is set out on pages 38 to 58 of this circular.
The Independent Board Committee, having taken into account the advice of CSFB,
considers that the terms of the Acquisition and the terms of the Non-exempt
Continuing Connected Transactions are fair and reasonable so far as the
Independent Shareholders are concerned, and in the interests of the Company and
its Shareholders as a whole. Accordingly, the Independent Board Committee
recommends that Independent Shareholders vote in favour of the ordinary
resolutions to be proposed at the Extraordinary General Meeting to approve the
Acquisition and the Non-exempt Continuing Connected Transactions, as detailed
in the notice of the Extraordinary General Meeting set out at the end of this
circular. The text of the letter from the Independent Board Committee is set
out on pages 36 to 37 of this circular.
ADDITIONAL INFORMATION
Your attention is also drawn to the letter from the Independent Board Committee
which sets out its recommendation to the Independent Shareholders, the letter
from CSFB which contains its advice to the Independent Board Committee and the
Independent Shareholders, and the additional information set out in the
appendices to this circular.
By Order of the Board
China Netcom Group Corporation
(Hong Kong) Limited
Zhang Chunjiang
Chairman
LETTER FROM THE INDEPENDENT BOARD COMMITTEE
[GRAPHIC OMITTED]
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
[GRAPHIC OMITTED]
(incorporated in Hong Kong with limited liability under the Companies Ordinance)
23 September 2005
To the Independent Shareholders
Dear Sir or Madam,
MAJOR TRANSACTION,
CONNECTED TRANSACTION AND
CONTINUING CONNECTED TRANSACTIONS
We refer to the circular (the "Circular") dated 23 September 2005 issued by the
Company to its Shareholders of which this letter forms part. The terms defined
in the Circular shall have the same meanings when used in this letter, unless
the context otherwise requires.
On 12 September 2005, the Board announced that the Company had entered into the
Acquisition Agreement, pursuant to which the Company agreed to acquire and CNC
BVI, the Company's immediate holding company, agreed to sell the entire equity
interest in the Target BVI Company, subject to certain conditions.
The Independent Board Committee was formed on 15 August 2005 to make a
recommendation to the Independent Shareholders as to whether or not the terms
of the Acquisition and the terms of the Non-exempt Continuing Connected
Transactions, from a financial perspective, are fair and reasonable so far as
the Independent Shareholders are concerned, and whether or not the Acquisition
and the Non-exempt Continuing Connected Transactions are in the interests of
the Company and the Shareholders as a whole. CSFB has been retained as
independent financial adviser to advise the Independent Board Committee and the
Independent Shareholders on the fairness and reasonableness of the terms of the
Acquisition and the terms of the Non-exempt Continuing Connected Transactions
from a financial perspective.
The terms and the reasons for the Acquisition (including arrangements regarding
the financing of the Acquisition) are summarised in the Letter from the
Chairman set out on pages 6 to 35 of the Circular. The terms of the Non-exempt
Continuing Connected Transactions are also summarised 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, the terms of the Non-exempt
Continuing Connected Transactions and the basis upon which their terms have
been determined. We have also considered the principal factors and reasons
taken into account by CSFB in arriving at its opinion regarding the terms of
the Acquisition and the terms of the Non-exempt Continuing Connected
Transactions as set out in the letter from CSFB on pages 38 to 58 of the
Circular, which we urge you to read carefully.
The Independent Board Committee, after taking advice from CSFB, concurs with
the views of CSFB and considers, from a financial perspective, that the terms
of the Acquisition Agreement and the terms of the Non-exempt Continuing
Connected Transactions are fair and reasonable so far as the Independent
Shareholders are concerned, and in the interests of the Company and its
Shareholders as a whole. Accordingly, the Independent Board Committee
recommends that Independent Shareholders vote in favour of the ordinary
resolutions to approve the Acquisition and the Non-exempt Continuing Connected
Transactions, as detailed in the notice of the Extraordinary General Meeting
set out at the end of the Circular.
Yours faithfully
John Lawson Thornton
Victor Cha Mou Zing
Qian Yingyi
Hou Ziqiang
Timpson Chung Shui Ming
Independent Board Committee
LETTER FROM CSFB
The following is the text of a letter, prepared for the purpose of inclusion in
this circular, received from CSFB in connection with the Acquisition and the
Non-exempt Continuing Connected Transactions. @#
[GRAPHIC OMITTED]
Credit Suisse First Boston (Hong Kong) Limited
45/F, Two Exchange Square
Central
Hong Kong
23 September 2005
The Independent Board Committee
China Netcom Group Corporation (Hong Kong) Limited
46th Floor, Cheung Kong Center
2 Queen's Road Central
Hong Kong
The Independent Shareholders
MAJOR TRANSACTION,
CONNECTED TRANSACTIONS AND
CONTINUING CONNECTED TRANSACTIONS
Acquisition of the Target BVI Company
Dear Sirs,
INTRODUCTION
We refer to the Acquisition Agreement and the Continuing Connected
Transactions, details of which are set out in the Company's circular dated 23
September 2005 (the "Circular"), which contains this letter. Terms defined in
the Circular shall have the same meanings herein, unless the context otherwise
requires.
Under the Hong Kong Listing Rules, the Acquisition constitutes both a major
transaction and a connected transaction for the Company and, pursuant to the
provisions thereof, is subject to, among other things, approval by the
Independent Shareholders at the Extraordinary General Meeting.
The Combined Group, which includes the Company and its wholly-owned subsidiary
CNC China through which the Company has contracted in several instances, on the
one hand, and China Netcom Group and its subsidiaries or Associates (other than
the Combined Group) on the other, have entered into a number of Continuing
Connected Transactions in relation to the operations of the Combined Group,
which constitute connected transactions for the Company under the Hong Kong
Listing Rules. Certain of these Continuing Connected Transactions, namely the
Domestic Interconnection Settlement Agreement, the International Long Distance
Voice Services Settlement Agreement, the Engineering and Information Technology
Services Agreement and the Materials Procurement Agreement, described in the
section entitled "Continuing Connected Transactions" of the "Letter from the
Chairman" (the "Non-exempt Continuing Connected Transactions") are subject to
approval by the Independent Shareholders at the Extraordinary General Meeting.
We have been appointed to act as the Independent Financial Advisor to advise
the Independent Board Committee and Independent Shareholders in respect of the
terms of the Acquisition and the terms of the Non-exempt Continuing Connected
Transactions, from a financial point of view. This letter has been prepared and
delivered for the purpose of assisting the Independent Board Committee in its
duty to evaluate the abovementioned aspects and for no other reasons or
purposes.
In formulating our opinion, we have reviewed, among other things, the Circular,
the Company's initial public offering prospectus dated 4 November 2004, the
Acquisition Agreement, the Engineering and Information Technology Services
Agreement, the Materials Procurement Agreement, the Domestic Interconnection
Settlement Agreement and the International Long Distance Voice Services
Settlement Agreement, as well as the information and financial projections
prepared by the Company and the Target Company relating to the Target Company.
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
management of the Company or the Target Company or otherwise reviewed by us
(which information includes, without limitation, the information cited herein),
and we have not assumed any responsibility or liability therefor, nor have we
conducted independent legal due diligence or due diligence investigation of the
business, assets, liabilities, properties, operations, condition (financial and
otherwise), results of operations, contingent liabilities, material agreements
and prospects of the Target Company and each of its subsidiaries. We have
further considered, as stated in the "Letter from the Chairman" that: (i) the
Acquisition is negotiated and entered into on an arm's length basis and on
normal commercial terms, (ii) the terms, including the purchase price are fair
and reasonable, and (iii) the Acquisition is in the best interest of the
Company and its Shareholders. The Directors have collectively and individually
accepted full responsibility for the accuracy of the information and views
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 and the agreements
relating to the Non-exempt Continuing 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 Non-exempt Continuing 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
Non-exempt Continuing 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 the management of the Company and the
Target Company as to the expected future results of operations and the
financial condition of the Company or the Target Company to which such analyses
or forecasts relate.
Our opinion is necessarily based on the legal and regulatory environment,
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 (including any material deviations from the financial analyses and
forecasts provided to us) may affect and/or change this opinion and that we do
not have any obligation to update, revise, or reaffirm this opinion.
Our opinion is also subject to the following qualifications:
(a) We are instructed as the Independent Financial Adviser to the Independent
Board Committee in relation to the Acquisition and the Non-exempt Continuing
Connected Transactions. As such, the scope of our review, and consequentially,
our opinion, is limited by reference to a financial point of view only and does
not include any statement or opinion as to the merits or otherwise of the
Acquisition, or the Non-exempt Continuing Connected Transactions from any other
point of view;
(b) We do not express any opinion or statement as to whether any similar
terms or transactions akin to the terms proposed for the Acquisition, and the
Non-exempt Continuing Connected Transactions are or might be available from any
independent third parties, nor as to whether any independent third parties
might offer similar or better terms for similar transactions;
(c) It is not possible to confirm whether or not the Acquisition and the
Non-exempt Continuing Connected Transactions are in the interests of each
individual Independent Shareholder and each Independent Shareholder should
consider his/her/its vote on the merits or otherwise of the Acquisition and the
Non-exempt Continuing Connected Transactions in his/her/its own circumstances
and from his/her/its own point of view having regard to all the circumstances
(and not only the financial perspectives offered in this letter) as well as
his/her/its own investment objectives;
(d) In preparing this letter and in giving any opinion or advice, we have
only had regard to the Acquisition and the Non-exempt Continuing Connected
Transactions in isolation, and not in connection with any other business plan
or strategy, past or present with regard to the Company or the Group as a
whole, nor have we viewed these as part of a series of other transactions or
arrangements;
(e) We express no opinion as to whether the Acquisition, or the Non-exempt
Continuing Connected Transactions will be completed nor whether they will be
successful;
(f) Nothing contained in this letter should be construed as us expressing any
view as to the trading price or market trends of any securities of the Company
at any particular time;
(g) Nothing contained in this letter should be construed as a recommendation
to hold, sell or buy any securities of the Company; and
(h) We were not requested to and did not provide advice concerning the
structure, the specific amount of the consideration, the timing, pricing, size,
feasibility, or any other aspects of the Acquisition or the Non-exempt
Continuing 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, or the Non-exempt Continuing Connected
Transactions or any related transactions.
We will receive a fee from the Company for the delivery of this opinion.
TERMS OF THE PROPOSAL
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
A. Overview
Pursuant to the Acquisition Agreement dated 12 September 2005, the Company
agreed, subject to certain conditions, to acquire from CNC BVI the entire
equity interest in the Target BVI Company for a purchase price of RMB 12,800
million (equivalent to approximately HK$12,282 million). The Target BVI Company
holds the entire equity interest in the Target Company, which in turn owns the
assets and liabilities and the business operations in the Target Regions in the
PRC. The purchase price consists of payment of an initial cash consideration of
RMB3,000 million (equivalent to approximately HK$2,879 million) payable on the
completion date of Acquisition and a deferred consideration of RMB9,800 million
(equivalent to approximately HK$9,403 million). The Company intends to finance
the initial consideration by using existing internal cash resources and the
deferred consideration by using internal cash resources and/or proceeds from
future external financing. The conditions precedent to the completion of the
Acquisition must be satisfied on or before 31 December 2005 or such other date
as agreed to by the parties. China Netcom Group has given warranties,
representations and undertakings in respect of CNC BVI's title in the Target
BVI Company and the Target Company, the operations and assets and liabilities
of the Target Company and the legal status of those companies.
We understand that the corporate structure of the Company and its principal
subsidiaries immediately after the Acquisition is set out below.
Corporate structure immediately following the completion of the Acquisition
----------------------------
| China Network |
| Communications |
| Group Corporation |
| ("China Netcom Group") |
| (PRC)(3) |
----------------------------
| 100%
---------------------------- --------------------------- ---------------------------
| China Netcom Group | | | | |
| Corporation (BVI) Limited | | Five PRC Shareholders(1) | | Public Shareholders |
| ("CNC BVI") | | | | |
|(British Virgin Islands)(3)| | | | |
---------------------------- --------------------------- ---------------------------
| 70.49%(2) | 4.51%(2) | 25.00%
| ---------------------------------------------------------------|
|
-----------------------------------------------------
| China Netcom Group Corporation (Hong Kong) Limited)|
| ("Company") |
| (Hong Kong)(3) |
-----------------------------------------------------
| |
| |
-------------- |
| -------------------------------
| 100% | 100% | 100%
---------------------------- ---------------------- --------------------------
| China Netcom Group New | | China Netcom (Group) | | China Netcom Corporation |
| Horizon Communications | | Company Limited | | International Limited |
| Corporation (BVI) Limited | | ("CNC China") | | (Bermuda)(3) |
| ("Target BVI Company") | | (PRC)(3) | | |
|(British Virgin Islands)(3)| | | | |
---------------------------- ---------------------- ---------------------------
| : |
| : |
| 100% : - Operating in:(4) | 100%
---------------------------- : -----------------------
| China Netcom Group New | : - Beijing Municipality | Asia Netcom |
| Horizon Communications | : - Tianjin Municipality | Corporation Limited |
| Corporation Limited | : - Hebei Province | ("Asia Netcom") |
| ("Target Company") | : - Henan Province | (Bermuda)(3) |
| (PRC)(3) | : - Shandong Province -----------------------
---------------------------- : - Liaoning Province
: : - Shanghai Muncipality
: : - Guangdong Province
: Operating in:(4)
:- Heilongjiang Province
:- Jilin Province
:- Neimenggu Autonomous Region
:- Shanxi Province
(1) The five PRC Shareholders, all of which are established in the PRC, are
the Chinese Academy of Sciences, Information and Network Center of the State
Administration of Radio, Film and Television, China Railways Telecommunications
Center, Shanghai Alliance Investment Limited, and Shandong Provincial
State-owned Assets Supervision and Administration Commission.
(2) All of the ordinary shares owned by the five PRC Shareholders are
registered in the name of China Netcom Group Corporation (BVI) Limited, or CNC
BVI, which holds such ordinary shares in trust for each of the five PRC
Shareholders. Consequently, the ownership percentage of the five PRC
Shareholders in the charts above reflects the aggregate beneficial interests of
these Shareholders as held through CNC BVI. The ownership percentage of CNC BVI
as indicated in the charts above reflects CNC BVI's own beneficial ownership.
(3) Indicates jurisdiction of incorporation.
(4) The provincial businesses are operated under local branch offices of CNC
China or the Target Company (as the case may be) and these local branch offices
are not legal entities.
B. The Target Company
The Target Company is a provider of fixed-line telephone services, broadband
and other Internet-related services, and business and data communications
services in the Target Regions in the PRC. The Target Regions are Heilongjiang
province, Jilin province, Neimenggu Autonomous Region and Shanxi province in
the PRC. In each of these four provinces and autonomous region, the Target
Company owns extensive local access networks and is the incumbent fixed-line
operator. As at 30 June 2005, the Target Company had a total of approximately
28.9 million fixed line subscribers and 2.8 million broadband subscribers,
representing a market share of approximately 90.2% and 90.7% respectively in
the Target Regions. Further operational information on the Target Company is
set out in Appendix I to the Circular.
We summarize below the historical (i) revenues, (ii) operating profit, and
(iii) profit / (loss) of the Target Company for each of the three years ended
December 31, 2002, 2003 and 2004, and the interim period ended 30 June 2005,
which were extracted from the audited financial statements of the Target
Company as set out in Appendix II to the Circular.
Summary historical financials
Year ended December 31, Six months ended
2002 2003 2004 June 30, 2005
(RMB million)
Revenues 16,232 17,700 18,616 9,712
Operating profit 930 1,061 2,103 2,279
Profit / (loss) for the year 98 205 (6,531) 1,330
As at 30 June 2005, the total assets and owner's equity of the Target Company
were RMB47,929 million (equivalent to approximately HK$45,988 million) and
RMB8,131 million (equivalent to approximately HK$7,802 million), respectively.
Further financial information on the Target Company is set out in Appendix II
to the Circular. As stated in the "Letter from the Chairman", the management of
the Company and the Target Company believe that, on the bases and the
assumptions set out in Appendix V and in the absence of unforeseen
circumstances, the forecast of the Target Company's combined profit after
taxation and minority interests on a reported basis, for the year ending 31
December 2005 under HKFRS is unlikely to be less than RMB2,150 million
(equivalent to approximately HK$2,063 million) on a recurring basis (excluding
an estimated upfront connection fee of approximately RMB735 million (equivalent
to approximately HK$705 million)), it is unlikely to be less than RMB1,415
million (equivalent to approximately HK$1,358 million). As stated in the letter
from the Company's Financial Advisers set out in Appendix V, the Company's
Financial Advisers are of the opinion that, based on the assumptions made by
the management of the Company and the Target Company, respectively, and on the
basis of the accounting policies and calculations reviewed by
PricewaterhouseCoopers, the profit forecast of the Target Company has been made
after due and careful enquiry. Further details of the profit forecast are set
out in Appendix V to the Circular.
C. Rationale for the Acquisition
As stated in the "Letter from the Chairman" in the Circular, the Acquisition
represents a new and important opportunity for the Company to (i) increase
coverage and achieve further growth (ii) improve the Group's service
capabilities, and (iii) capture operating synergy and improve management
efficiency 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 Acquisition is in the interest of the Company and its
Shareholders. Further details of the reasons for, and the benefits of the
Acquisition are set out in the "Letter from the Chairman" in the Circular.
D. 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 RMB12,800 million (equivalent to
approximately HK$12,282 million) 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 by the Target Company to the Group and as well
as by reference to other financial and operational factors.
As stated in the "Letter from the Chairman", the purchase price payable by the
Company for the entire equity interests in the Target Company and the other
terms of the Acquisition are fair and reasonable. In particular, the terms of
the deferred consideration are more favourable than the usual terms of a
commercial bank loan of a similar size and term.
E. Financing of the Acquisition
Under the Acquisition Agreement, the purchase price for the Acquisition of
RMB12,800 million (equivalent to approximately HK$12,282 million) will be
satisfied by the payment of an initial cash consideration and the payment of a
deferred consideration.
The initial cash consideration of RMB3,000 million (equivalent to approximately
HK$2,879 million) will be satisfied on the completion date of the Acquisition.
The Company intends to finance the initial consideration by using existing
internal cash resources.
The deferred consideration of RMB9,800 million (equivalent to approximately
HK$9,403 million) is payable in ten equal amounts at half-yearly intervals over
a five year time period from the date of completion of the Acquisition. The
Company will also pay interest at half-yearly intervals on the actual amount of
deferred consideration remaining outstanding. Interest is accrued daily and is
payable at the rate of 5.265% per annum, being 10% discount to the RMB lending
rate of 5.85% per annum of commercial banks in the PRC in respect of loans with
tenure of five years as published by the People's Bank of China and prevailing
at 12:00 noon (Beijing time) on 8 September 2005, being two Business Days
immediately preceding the date of the Acquisition Agreement. The Company
intends to finance the deferred consideration by using internal cash resources
and/or proceeds from future external financing.
The payment of the deferred consideration and the interest payments can be made
in RMB or US dollars as agreed between CNC BVI and the Company, subject to the
approvals of the relevant PRC governmental authorities. Any payment made in US
dollars will be based on the Federal Reserve noon-buying rate between US
dollars and RMB which is quoted as of 12:00 noon (New York City time) on the
day which is two business days immediately prior to the date of payment. The
Company may, from time to time, prepay all or part of the deferred
consideration, at any time after completion until the fifth anniversary of the
completion of the Acquisition, without penalty. It is noted in the "Letter from
the Chairman" that the terms of the deferred consideration are more favourable
than the usual terms of a commercial bank loan of a similar size and term.
In considering the suitability of the financing arrangement for the
Acquisition, we have considered the following factors:
o The deferred payment mechanism provides a 5 year payment period for
the deferred consideration and an early payment option without penalty, thereby
ensuring the Company considerable funding flexibility;
o The deferred payment facility provides financing at more favourable
rates than financing via debt or bank loans at present market rates;
o The deferred payment mechanism utilises the considerable cash
resources of the Company and effectively utilises available resources of the
Combined Group;
o The Company has confirmed that (a) it has sufficient internal cash
resources, which as at 30 June 2005 was approximately RMB9,229 million
(equivalent to HK$8,855 million) and external financing resources to fund the
cash payment of the initial consideration and the deferred consideration, and
(b) it has sufficient internal and external financing resources for its ongoing
operations and capital expenditure requirements.
F. Valuation of the Target Company
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.
i. Discounted cash flow analysis
We have used the DCF analysis as the primary valuation methodology as in our
view it explicitly accounts for the future financial and operating performance
of the Target Company. The methodology takes into consideration the current and
future anticipated change in the market and regulatory environment in which the
Target Company operates in, as well as its long-term business plan and
strategy, its cost structure, capital expenditure requirements and cost of
capital.
Our DCF analysis reflects the business plans and financial projections of the
Target Company and other relevant information provided by the Target Company
and the Company, as well as our discussions with the Target Company and its
representatives. We have reviewed the key assumptions and operating data of the
Target Company in the context of the overall conditions of the market in which
the Target Company operates. We have made relevant adjustments to certain
assumptions to reasonably reflect our views of the future performance of the
Target Company.
The purchase price of the Acquisition of RMB12,800 million (equivalent to
approximately HK$12,282 million) is within our DCF valuation range.
ii. Comparable company trading analysis
We have carried out a comparable company trading analysis using trading
multiples commonly used by investors as a valuation tool 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 the prospective
EBITDA information for the Target Company for the year ending 31 December 2005
is not disclosed in the Circular.
We have derived trading multiples 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 upfront connection fees. Since the
Target Company does not expect to receive such fees in the future, this income
is considered non-recurring.
As of the Acquisition Agreement date and using the reporting financials, the
purchase price of RMB12,800 million (equivalent to approximately HK$12,282
million) for the Acquisition implies a 2005E P/E ratio of approximately 6.0
times based on the forecast net profit of the Target Company of approximately
RMB2,150 million (equivalent to approximately HK$2,063 million) for the year
2005, as forecasted and stated by the Company in the "Letter from the
Chairman".
As of the Acquisition Agreement date and using the recurring financials, the
purchase price of RMB12,800 million (equivalent to approximately US$12,282
million) for the Acquisition implies a 2005E P/E ratio of approximately 9.0
times based on the forecast net profit (less amortization income of upfront
connection fee) of the Target Company of approximately RMB1,415 million
(equivalent to approximately HK$1,358 million), estimated as the forecasted
reporting net profit of RMB2,150 million (equivalent to approximately HK$2,063
million) minus the estimated amortization income of upfront connection fee of
approximately RMB735 million (equivalent to approximately HK$705 million) for
the year 2005, as forecasted and stated by the Company and comforted by
PricewaterhouseCoopers in Appendix V.
The Company, in our view, represents the most comparable company to the Target
Company based on their similar business focus and product offerings, similar
operating geographies (i.e. Northern China) and similar market position. China
Telecom Corporation Limited ("China Telecom") is also generally regarded as a
comparable company to the Company due to its similar business focus in mainland
China, although it is considerably larger and operates in the Southern and
Western region of mainland China.
Based on the 20-trading day average share price up to 12 September 2005 and
using the reporting financials, the Target Company's 2005E P/E multiple implied
by the purchase price represents a 28.8% discount and a 33.4% discount to the
Company's and China Telecom's corresponding estimated multiples, respectively.
Based on the 20-trading day average share price up to 12 September 2005 and
using the recurring financials, the Target Company's 2005E P/E multiple implied
by the purchase price represents a 17.1% discount and a 20.7% discount to the
Company's and China Telecom's corresponding estimated multiples, respectively.
Reported Recurring
financial basis financial
basis
2005E P/E(3) 2005E
P/E(3)
Target Company 6.0x 9.0x
Based on 12 September 2005 Closing Price(1)
The Company 8.5x 11.2x
China Telecom 8.7x 11.1x
(Discount/Premium) to the Company (30.3%) (18.9%)
(Discount/Premium) to China Telecom (31.6%) (18.6%)
Based on 20-Trading Day Average Closing Price(2)
The Company 8.4x 10.9x
China Telecom 8.9x 11.4x
(Discount/Premium) to the Company (28.8%) (17.1%)
(Discount/Premium) to China Telecom (33.4%) (20.7%)
(1) Closing share price of HK$13.40 and HK$2.85 for the Company and China
Telecom as of 12 September 2005.
(2) 20-trading day average share price of HK$13.12 and HK$2.93 for the
Company and China Telecom up to 12 September 2005.
(3) Forecasted net incomes for the Company and China Telecom are based on
CSFB Research estimates.
We have also compared the implied valuation multiples of the Acquisition to the
trading multiples of selected comparable companies, which includes overseas
listed Chinese wireless companies and selected telecommunications companies in
the Asia-Pacific region. These comparable companies display certain common
characteristics with the Target Company, though to a lesser degree than the
resemblance between the Company and China Telecom to the Target Company. The
implied valuation multiples of the Acquisition are reasonable when compared to
the trading multiples of the above groups of comparable companies.
iii. Comparable transaction analysis
Comparable transaction analysis should be viewed in the context of factors that
include market dynamics, competitive differences and significance of stake
acquired. The following are the recent comparable transactions in the China
telecommunication industry:
Fixed-line Sector
o China Telecom's acquisition of telecommunications assets in 10
provinces from China Telecommunications Corporation ("China Telecom Corporation
Limited Acquisitioni") announced in April 2004 ("China Telecom Acquisition 1"),
o China Telecom's acquisition of telecommunications assets in 6
provinces from China Telecommunications Corporation ("China Telecom Corporation
Limited Acquisition") announced in October 2003 ("China Telecom Acquisition
2"),
Mobile Sector(1)
o China Mobile (Hong Kong) Limited's acquisition of mobile assets in 10
provinces from China Mobile Group ("China Mobile Acquisition 1") announced
in April 2004,
o China Mobile (Hong Kong) Limited's acquisition of mobile assets in 8
provinces from China Mobile Group ("China Mobile Acquisition 2") announced in
May 2002,
o China Unicom Limited's acquisition of mobile assets in 9 provinces
from China Unicom (BVI) Limited ("China Unicom Acquisition 1") announced
in November 2003,
o China Unicom Limited's acquisition of mobile assets in 9 provinces
from China Unicom (BVI) Limited ("China Unicom Acquisition 2") announced
in November 2002.
(1) Not directly comparable sector but used as a secondary benchmark in our
analysis
Reported Recurring
financial basis financial basis
P/E(1) P/E(1)
1. Target Company 6.0x 9.0x
2. China Telecom Acquisition 1 5.8x 8.9x
3. China Telecom Acquisition 2 7.2x 11.5x
4. China Mobile Acquisition 1 9.7x 9.7x
5. China Mobile Acquisition 2 12.7x 12.7x
6. China Unicom Acquisition 1 12.8x 12.8x
7. China Unicom Acquisition 2 10.4x 10.4x
(Discount/Premium) of (1) to (2) 2.0% 1.5%
(Discount/Premium) of (1) to (3) (17.8%) (21.3%)
(Discount/Premium) of (1) to (4) (38.6%) (6.7%)
(Discount/Premium) of (1) to (5) (53.0%) (28.6%)
(Discount/Premium) of (1) to (6) (53.4%) (29.2%)
(Discount/Premium) of (1) to (7) (42.9%) (13.2%)
(1) Calculation based on forward-looking earnings, as disclosed in the
respective shareholder circulars issued in relation to the referred
transactions.
The 2005E P/E ratio implied by the purchase price of the Acquisition is
consistent with the multiples implied by the China Telecom Acquisition 1. The
2005E P/E ratio implied by the purchase price of the Acquisition and based on
the recurring financials represents a 21.3% discount to that of the China
Telecom Acquisition 2, a 6.7% discount to that of the China Mobile Acquisition
1, a 28.6% discount to that of the China Mobile Acquisition 2, a 29.2% discount
to that of the China Unicom Acquisition 1 and a 13.2% discount to that of the
China Unicom Acquisition 2. The implied valuation multiples of the Acquisition
are reasonable when compared to the implied multiples of the abovementioned
comparable transactions.
G. Conditions of the Acquisition
As stated in the Circular, the completion of the Acquisition is conditional
upon the fulfilment or waiver (where available) of the following conditions,
among others, on or before 31 December 2005 or such other date as the Company,
CNC BVI and China Netcom Group may agree:
o The passing of resolutions by the Independent Shareholders approving
the Acquisition and the Non-exempt Continuing Connected Transactions;
o There having been no material adverse change to the financial
condition, business operations, or prospects of the Target Company; and
o The receipt of various approvals and registrations from the relevant
PRC regulatory authorities.
Certain PRC regulatory approvals have been obtained.
H. 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 the unaudited financial
information of the Company and the unaudited pro forma financial information of
the Combined Group as set out in Appendices III and IV to the Circular.
Summary Income Statement Items
For the six months ended
June 30, 2005
Group Combined
Historical Group Pro
forma
(RMB million)
Revenues 33,724 43,436
Operating profit 9,767 12,002
Profit for the year 6,358 7,386
Summary Balance Sheet Items
As of June 30, 2005
Group Combined
Historical Group Pro
forma(1)
(RMB million)
Cash and cash equivalent(2) 9,229 6,695
Total debt 48,968 82,443
Shareholders' equity 61,484 61,484
Total capitalization(3) 127,176 164,465
Total debt / Shareholders' equity 79.6% 134.1%
Total debt / Total capitalization 38.5% 50.1%
(1) Assumes acquisition price of RMB12.8 billion and initial consideration of
RMB3.0 billion.
(2) Includes short-term investments.
(3) Includes deferred revenue
Earnings
The pro forma net income of the Combined Group for the six months ended 30 June
2005, would be approximately RMB7,386 million, which is approximately 16.2%
higher than the actual net income of the Group for the same period.
Gearing
The pro forma total debt of the Combined Group would be approximately RMB82,443
million as at 30 June 2005, representing an increase of approximately 68.4%
from the actual total debt of approximately RMB48,968 million of the Group. The
pro forma net debt (total debt less cash and cash equivalents and short-term
investments) would increase to approximately RMB75,748 million as at 30 June
2005, as a net result of financing the initial consideration with the existing
cash resources of the Group, increasing the Group's total debt by the deferred
consideration and taking on the net indebtedness of the Target Companies. The
pro forma gearing of the Combined Operating Group, defined as total debt
divided by shareholders' equity, would increase from approximately 79.6% to
approximately 134.1% as at 30 June 2005. As also noted in the above table, the
total debt/total capitalization ratio would increase from approximately 38.5%
to approximately 50.1%. The increase in the total debt/shareholders' equity
ratio and total debt/total capitalisation ratio is the result of the deferred
consideration and the assumption of the Target Company's debt. The pro forma
gearing ratios remain within the range of gearing levels of certain
telecommunication companies which we have considered for comparison purposes.
2. Continuing Connected Transaction
In October 2004, CNC China, a wholly-owned subsidiary of the Company, entered
into certain agreements with China Netcom Group to regulate certain ongoing
transactions between CNC China and China Netcom Group and its subsidiaries and
Associates. These transactions are continuing connected transactions of the
Company under the Hong Kong Listing Rules.
As a result of the Acquisition, similar ongoing transactions will be conducted
between the Target Company on the one hand and China Netcom Group and its
subsidiaries and Associates (other than the Combined Group) on the other. These
transactions are continuing connected transactions of the Company under the
Hong Kong Listing Rules. In order to facilitate the management of all
continuing connected transactions of the Company in China post the Acquisition,
the Target Company, CNC China and China Netcom Group have entered into certain
connected transactions agreements to regulate the continuing connected
transactions between China Netcom Group and its subsidiaries or Associates
(other than the Combined Group) on the one hand and the Combined Group on the
other, in respect of the Combined Group's operations in the 12 provinces,
municipalities and autonomous region in China. These agreements replace the
existing connected transaction agreements between CNC China and China Netcom
Group if and when the Acquisition completes. These agreements are:
i. Property Leasing Agreement
ii. Property Sub-leasing Agreement
iii. Master Sharing Agreement
iv. Ancillary Telecommunications Services Agreement
v. Support Services Agreement
vi. Telecommunications Facilities Leasing Agreement
vii. Engineering and Information Technology Services Agreement
viii. Materials Procurement Agreement
ix. Domestic Interconnection Settlement Agreement
x. International Long Distance Voice Services Settlement Agreement
For agreements (i) to (vi) above, the proposed annual cap for each of the
agreements will be less than the 2.5% threshold under Rule 14A.34 of the Hong
Kong Listing Rules. Accordingly, these transactions will be exempt from the
Independent Shareholders' approval requirements under the Hong Kong Listing
Rules, but such transactions will still be subject to the reporting and
announcement requirements set out in Rules 14A.45 to 14A.47 of the Hong Kong
Listing Rules.
For agreements (vii) to (viii) above, the proposed annual cap for each of the
agreements will exceed the 2.5% threshold under Rule 14A.34 of the Hong Kong
Listing Rules. Accordingly, such transactions will constitute Non-Exempt
Continuing Connected Transactions under Rule 14A.35 of the Hong Kong Listing
Rules and will be subject to the reporting and announcement requirements set
out in Rules 14A.45 to 14A.47 of the Hong Kong Listing Rules and the
Independent Shareholders' approval requirements under Rule 14A.48 of the Hong
Kong Listing Rules.
For agreements (ix) to (x) above, no caps are proposed. Under Rule 14A.35(2) of
the Hong Kong Listing Rules, in respect of a continuing connected transaction,
which is not fully exempted, a cap must be set. We understand from the Company
that a waiver from strict compliance with Rule 14A.35(2) of the Hong Kong
Listing Rules has been obtained. Such transactions will be subject to the
reporting and announcement requirements set out in Rule 14A.45 to 14A.47 of the
Hong Kong Listing Rules. The transactions contemplated under agreements (ix) to
(x) above are also subject to Independent Shareholders' approval requirements.
We set out below a summary of each of the Non-exempt Continuing Connected
Transactions. We have not reviewed the terms of the other Continuing Connected
Transaction Agreements which are not the Non-exempt Continuing Connected
Transactions (the descriptions of which are found in the "Letter from the
Chairman") and make no comments on them.
Domestic Interconnection Settlement Agreement
The Target Company, CNC China and China Netcom Group entered into the Domestic
Interconnection Settlement Agreement on 12 September 2005. This agreement
replaces the existing Interconnection Settlement Agreement between CNC China
and China Netcom Group, which covers both domestic and international long
distance settlement.
Pursuant to the Domestic Interconnection Settlement Agreement, the parties
agreed to interconnect the network of China Netcom Group on the one hand and
that of CNC China and the Target Company (together with CNC China, the
"Combined Operating Group") on the other and settle the charges received in
respect of domestic long distance voice services within their respective
service regions. The terms in the new Domestic Interconnection Settlement
Agreement are generally the same as the existing Interconnection Settlement
Agreement, apart from the settlement period that has changed from monthly to
quarterly to simplify the settlement procedure.
For domestic long distance voice services between China Netcom Group and the
Combined Operating Group, the telephone operator in the location of the calling
party makes a settlement payment to the telephone operator in the location of
the called party at the rate of RMB0.06 per minute (in case where the call
terminates within the network of either China Netcom Group or the Combined
Operating Group) or RMB0.09 per minute (in case where the call terminates
outside the network of either China Netcom Group or the Combined Operating
Group). The rates are set with reference to the relevant standards and tariffs
promulgated by the MII and will be adjusted accordingly from time to time.
The Domestic Interconnection Settlement Agreement takes effect from the date of
completion of the Acquisition and is valid until 31 December 2007. If the
Combined Operating Group notifies China Netcom Group at least three months
prior to the expiration of the agreement of its intention to renew the
agreement, the agreement can be renewed with the same terms for further periods
of three years.
We believe that it is reasonable for no cap to be proposed in respect of the
settlement of domestic long distance voice services for the following reasons:
(1) The Company will not be able to control the number of calls coming into
its network as well as the number of calls going out into China Netcom Group's
network. Any attempt to control that will potentially limit the serivces
provided to its customers.
(2) Any cap will potentially limit the growth of its long distance voice
services in China and ability to provide the same kind of services as its
competitors in China.
(3) The settlement rates in respect of long distance voice services are
determined with reference to the relevant standard tariff or policies
promulgated by the relevant regulatory authorities in China, which are subject
to change from time to time, and the Company is not in a position to set the
settlement rates at its discretion.
(4) The treatment of imposing no cap is consistent with similar
interconnection agreements in the telecommunication industry in China.
International Long Distance Voice Services Settlement Agreement
CNC China and China Netcom Group entered into the International Long Distance
Voice Services Settlement Agreement on 12 September 2005. This agreement
replaces the existing Interconnection Settlement Agreement between CNC China
and China Netcom Group, which covers both domestic and international long
distance settlement.
As a result of the restructuring prior to the initial public offering of the
Company, CNC China has been authorized to conduct the international long
distance settlement on behalf of China Netcom Group and the Company with
overseas telecommunications operators, and therefore any outbound international
calls originated or inbound international calls terminated in the China Netcom
Group coverage area would need to involve the Company.
For outbound international calls, China Netcom Group reimburses CNC China for
any amount it has paid to overseas telecommunications operators. The revenues
received by China Netcom Group less the amount paid to overseas
telecommunications operators are shared between China Netcom Group and CNC
China in proportion to the estimated costs incurred by China Netcom Group and
the Combined Operating Group in connection with the provision of outbound
international long distance voice services.
For inbound international calls, the revenues received by CNC China from
overseas telecommunications operators less the amount paid to China Netcom
Group at the rate of RMB0.06 per minute or RMB0.09 per minute depending on
whether the call terminates within or outside the network of either China
Netcom Group or the Combined Operating Group, are shared between China Netcom
Group and CNC China in proportion to the estimated costs incurred by China
Netcom Group and the Combined Operating Group in connection with the provision
of inbound international long distance voice services. The rates mentioned
above are set with reference to the relevant standards and tariffs promulgated
by the MII and will be adjusted accordingly from time to time.
The International Long Distance Voice Services Settlement Agreement takes
effect from the date of completion of the Acquisition and is valid until 31
December 2007. If CNC China notifies China Netcom Group at least three months
prior to the expiration of the agreement of its intention to renew the
agreement, the agreement can be renewed with the same terms for further periods
of three years.
We believe that it is reasonable for no cap to be proposed in respect of the
settlement of international long distance voice services for the same reasons
as for the Domestic Interconnection Settlement Agreement.
Engineering and Information Technology Services Agreement
The Target Company, CNC China and China Netcom Group entered into the
Engineering and Information Technology Services Agreement on 12 September 2005
to govern the arrangements with respect to the provision of certain engineering
and information technology-related services by China Netcom Group to the
Company and its subsidiaries. This agreement replaces the existing Engineering
and Information Technology Services Agreement between CNC China and China
Netcom Group dated 8 October 2004 if and when the Acquisition completes. The
terms in the new Engineering and Information Technology Services Agreement are
the same as the existing Engineering and Information Technology Services
Agreement.
The charges payable for the services under the agreement are determined with
reference to market rates. In addition, where the value of any single item of
engineering design or supervision-related service exceeds RMB0.5 million, or
where the value of any single item of engineering construction-related service
exceeds RMB2 million, the award of the project will be subject to a tender
process, which involving at least three parties, in accordance with the
relevant PRC laws. The Combined Operating Group shall give no priority to China
Netcom Group in the selection process, and shall have the right to choose an
independent third party as service provider. However, in the case where
comparable terms are tendered, China Netcom Group would be chosen.
The Engineering and Information Technology Services Agreement takes effect from
the date of completion of the Acquisition and is valid until 31 December 2007.
If the Combined Operating Group notifies China Netcom Group at least three
months prior to the expiration of the agreement of its intention to renew the
agreement, the agreement can be renewed with the same terms for further periods
of three years.
As stated in the "Letter from the Chairman", the Company proposes to set an
annual cap of RMB4,400 million under this agreement. The annual cap is
determined based on the approved cap obtained by the Company at its IPO in
October 2004 for the existing Engineering and Information Technology Services
Agreement between CNC China and China Netcom Group and the historical service
charges paid by the Target Company to China Netcom Group. We have benchmarked
the growth rate assumed by the Company in arriving at the annual cap against
our estimated growth rate for the Target Company and we believe that the
proposed annual cap is reasonable.
We have discussed with the Company the bases for setting the proposed annual
cap. The Company has given consideration to certain factors including the
potential growth of the Target Company, the development potential of the Target
Regions, the focus of Jilin Province and Heilongjiang Province as the targeted
development area in the North-East region by the Chinese Government and the
lack of independent third party engineering and IT service providers in the
Target Regions that can provide comparable high quality services at competitive
rates.
Materials Procurement Agreement
The Target Company, CNC China and China Netcom Group entered into the Materials
Procurement Agreement 12 September 2005 under which China Netcom Group may act
as (i) the agent for the procurement of imported and domestic
telecommunications and other domestic non-telecommunication equipment, (iii)
seller of certain products, including cables, modems and yellow pages telephone
directories, and (ii) provider of related storage and transportation services.
The new Materials Procurement Agreement replaces the existing Materials
Procurement Agreement between CNC China and China Netcom Group if and when the
Acquisition completes.
Commission for the domestic materials procurement services under (i) above
shall not exceed the maximum rate of 3% of the contract value. Commission for
imported materials procurement services under (i) above shall not exceed the
maximum rate of 1% of the contract value. The purchase price for services under
(ii) above is determined with reference to the following pricing principles and
limits in accordance to the relevant PRC law: (a) the government fixed price;
(b) where there is no government fixed price but a government guidance price
exists, the government guidance price; (c) where there is neither a government
fixed price nor a government guidance price, the market price, i.e. price
determined by business operators at their own discretion in a competitive
market; (d) where none of the above is applicable, the price to be agreed
between the relevant parties and determined on a cost-plus basis. Commission
charges for services under (iii) above are determined with reference to market
rates.
The Materials Procurement Agreement takes effect from the date of completion of
the Acquisition and is valid until 31 December 2007. If the Combined Operating
Group notifies China Netcom Group at least three months prior to the expiration
of the agreement of its intention to renew the agreement, the agreement can be
renewed with the same terms for further periods of three years.
As stated in the "Letter from the Chairman", the Company proposes to set an
annual cap of RMB2,000 million under this agreement. Based on our discussion
with the Company, the annual cap is determined based on the approved cap
obtained by the Company at its IPO in October 2004 for the existing Materials
Procurement Agreement between CNC China and China Netcom Group and the
historical service charges paid by the Target Company to China Netcom Group,
giving consideration to the potential growth of the Target Company, and the
development potential of the Target Regions. We have benchmarked the growth
rate assumed by the Company in arriving at the annual cap against our estimated
growth rate for the Target Company and we believe that the proposed annual cap
is reasonable.
For the Materials Procurement Agreement, no historical comparable figures are
available. Prior to the Company's listing restructuring in 2004, China Netcom
Group mainly acted as the principal, where it purchased and then resold
equipments to the Combined Operating Group, rather than the agent earning
commissions.
SUMMARY
After considering all of the principal factors and reasons listed above, we
draw your attention to the following key factors in arriving at our opinion:
(a) The Company's view that the Acquisition will enhance the Company's market
position, strengths and competitiveness, improve its growth prospects and
financial position, and enable it to improve its managerial and operating
efficiency;
(b) The Company's representation that the Acquisition was conducted on an
arm's length basis;
(c) The purchase price of the Acquisition: (i) is within the range of the
equity values implied by our DCF analysis, (ii) implies a reasonable multiple
compared to the relevant trading multiples of the Company and other comparable
companies, and (iii) implies a reasonable multiple compared to the multiples
implied by recent comparable telecommunication transactions in China;
(d) The Board is of the opinion that the transactions contemplated under the
Non-exempt Continuing Connected Transactions have been entered into, and will
be carried out, in the ordinary and usual course of business of the Combined
Operating Group and on normal terms and conditions;
(e) The charges under the Non-exempt Continuing Connected Transactions were
determined based on the standards or tariffs promulgated by the relevant
Chinese regulatory authorities, or by reference to market rates, or are based
on reasonable costs or on a reasonable costs-plus basis as negotiated on an
arm's length basis between the relevant parties. Furthermore, the material
terms and conditions of the Non-exempt Continuing Connected Transactions are
consistent with to the terms and conditions of the corresponding existing
Non-exempt Continuing Connected Transactions;
(f) As required by the Listing Rules, the Company has to comply with the
rules in relation to annual review of continuing connected transactions set out
in Rule 14A.37 to Rule 14A.41 of the Hong Kong Listing Rules, and that, upon
any variation or renewal of the Non-exempt Continuing Connected Transactions,
the Company shall comply in full with all applicable requirements set out in
Chapter 14A of the Hong Kong Listing Rules;
(g) The Company possesses 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. The Acquisition Agreement also includes warranties in favour of
the Company and provisions providing for liability for breach of the
warranties.
OPINION
Based on the above, we consider that the terms of the Acquisition are on normal
commercial terms, and that the terms of the Non-exempt Continuing Connected
Transactions are on normal commercial terms and are conducted in the ordinary
and usual course of business. Furthermore, we consider that the terms of the
Acquisition and the Non-exempt Continuing Connected Transactions to be fair and
reasonable from a financial perspective, so far as the Independent Shareholders
are concerned, and are in the interests of the Company and its Shareholders as
a whole.
Accordingly, we advise the Independent Board Committee and the Independent
Shareholders that the Independent Shareholders should vote in favour of the
Acquisition and the Non-exempt Continuing Connected Transactions, which terms
are set out in the "Letter from the Chairman".
This letter is provided to the Independent Board Committee and the Independent
Shareholders of the Company in connection with and for the purposes of their
evaluation of the Acquisition and the transactions contemplated under the
Non-exempt Continuing Connected Transactions. The opinion contained in this
letter is intended to provide only one of the bases on which the Independent
Board Committee may make their recommendation to the Independent Shareholders
on how to vote, and on which the Independent Shareholders may decide how to
vote, in respect of the Acquisition and the Non-exempt Continuing Connected
Transactions. This letter 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 letter 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
Credit Suisse First Boston (Hong Kong) Limited
Ravi Lambah
Managing Director
APPENDIX I FURTHER INFORMATION ON THE TARGET COMPANY
MARKET ENVIRONMENT OF THE TARGET COMPANY
The Target Regions include Heilongjiang Province, Jilin Province, Neimenggu
Autonomous Region and Shanxi Province of the PRC, which accounted for
approximately 10.3% of the total GDP of China in 2004, with a growth rate of
GDP of approximately 13.8% from 2003 to 2004. The fixed-line telephone
penetration rate in the Target Regions reached approximately 24.9% as of 31
December 2004. The fixed-line telephone penetration rate in the Target Regions
is relatively low compared to that of the Group's existing service regions. The
Company believes this presents growth potential for the Target Company.
The map below indicates the Target Regions and the existing services regions of
the Group in China. The accompanying table sets out selected demographic and
market information related to the Target Regions and the whole of China for the
year ended or as of 31 December 2004, unless otherwise indicated.
[GRAPHIC OMITTED]
Target Regions China
Population (in millions) 122 1,300
GDP per capita (RMB) 11,446 10,502
2003-2004 growth rate of GDP (%) 13.8 9.5
Fixed-line subscribers (including PHS subscribers) (in millions) 30.5 312
Fixed-line telephone penetration rate (%) 24.9 24.0
Broadband subscribers (in millions) 2.6 23.9
Sources: National Bureau of Statistics of China, the MII and provincial
telecommunications administrations.
OVERVIEW OF THE TARGET COMPANY
The Target Company is the dominant provider of fixed-line telephone services,
broadband and other Internet-related services, and business and data
communications services in the Target Regions.
The principal services of the Target Company consist of:
o fixed-line telephone services (including its PHS service), including:
- local, domestic long distance and international long distance services;
- value-added services, including caller identification, PHS short
messaging service, telephone information service and "Personalised Ring"
service; and
- interconnection services provided to other domestic telecommunications
operators;
o broadband and other Internet-related services, including broadband
access such as Digital Subscriber Line ("DSL") and Local Area Network ("LAN"),
and dial-up Internet access and other services; and
o business and data communications services, including DDN, frame
relay, ATM, IP-VPN and leased line services.
The following table illustrates a breakdown of the revenue of the Target
Company for each of the years ended 31 December 2002, 2003 and 2004 and for the
six-month periods ended 30 June 2004 and 2005.
For the year ended 31 December For the six months ended 30 June
2002 2003 2004 2004 2005
Amount Percentage Amount Percentage Amount Percentage Amount Percentage Amount Percentage
of revenue of revenue of revenue of revenue of revenue
(RMB in millions, except percentage data)
Fixed-line
telephone
services(1):
Local:
Local usage fees 5,867 36.1 6,118 34.6 6,197 33.3 3,155 33.9 3,188 32.6
Monthly fees 3,482 21.5 3,896 22.0 4,221 22.7 2,122 22.8 2,107 21.8
Upfront 203 1.3 223 1.3 230 1.2 118 1.3 118 1.3
installation
fees
Subtotal 9,552 58.9 10,237 57.9 10,648 57.2 5,395 58.0 5,413 55.7
Domestic long 2,524 15.5 2,554 14.4 2,453 13.2 1,247 13.4 1,217 12.6
distance(2)
International 134 0.8 133 0.8 113 0.6 57 0.6 51 0.5
long
distance(2)(3)
Value-added 277 1.7 579 3.3 847 4.5 396 4.3 540 5.6
services
Interconnection 864 5.3 1,183 6.7 1,582 8.5 765 8.2 876 9.0
fees from
domestic
carriers
Upfront 1,280 7.8 1,157 6.4 968 5.2 512 5.5 397 4.1
connection
fees(4)
Subtotal 14,631 90.0 15,843 89.5 16,611 89.2 8,372 90.0 8,494 87.5
Broadband and
other
Internet-related
services
Broadband 279 1.7 663 3.7 1,034 5.6 478 5.1 735 7.6
services
(including
broadband
access such as
DSL and LAN
services)
Other 214 1.4 176 1.1 114 0.6 67 0.7 42 0.4
Internet-related
services
Subtotal 493 3.1 839 4.8 1,148 6.2 545 5.8 777 8.0
Business and
data
communications
services:
Managed data 324 2.0 338 1.9 303 1.6 155 1.7 145 1.5
Leased line 609 3.8 374 2.1 270 1.5 132 1.4 169 1.7
Subtotal 933 5.8 712 4.0 573 3.1 287 3.1 314 3.2
Other services 175 1.1 306 1.7 284 1.5 111 1.1 127 1.3
Total 16,232 100.0 17,700 100.0 18,616 100.0 9,315 100.0 9,712 100.0
(1) Includes revenue from the Target Company's PHS services.
(2) Includes revenue from the Target Company's IP voice long distance
services.
(3) Includes revenue from long distance calls to Hong Kong, Macau and Taiwan.
(4) In July 2001, the upfront connection fees charged on basic telephone
access services were eliminated by the MII.The following table illustrates the
key operating data of the Target Company for each of the years ended or as of
31 December 2002, 2003, 2004 and for the six months ended or as of 30 June
2005.
For the year ended 31 December or For the six
as of 31 December months
ended or as
of 30
June 2005
2002 2003 2004
Fixed-line subscribers (in thousands) 19,205 24,459 27,696 28,857
Including: PHS subscribers (in thousands) 841 4,373 7,051 7,991
Market share of fixed-line telephone services (%)(1) 96.5 94.5 90.8 90.2
Total usage of local telephone services (inclusive of 60,333 61,898 59,074 29,656
Internet dial-up usage) (in million pulses)
Total usage of local telephone services (exclusive of 51,241 54,596 55,883 28,675
Internet dial-up usage) (in million pulses)
Domestic long distance calls (in million minutes) 5,375.0 5,972.3 6,411.4 3,384.3
International long distance calls(2) (in million 33.4 38.1 35.3 17.2
minutes)
Caller identification penetration rate (%)(3) 41.7 59.9 66.8 69.5
PHS short messages (in millions) - 63.0 716.7 822.2
Telephone information service (in million minutes) 142 243 480 262
Broadband subscribers (in thousands) 127.1 811.0 2,274.4 2,777.9
Market share of broadband services (%)(1) 100 97.1 87.9 90.7
(1) Refers to market share in Target Regions only. The market share of
fixed-line telephone services is calculated by dividing the number of the
Target Company's fixed-line subscribers as of 31 December 2002, 2003 and 2004
and 30 June 2005 by the total number of fixed-line subscribers in the Target
Regions as of such dates, as measured by the provincial telecommunications
administrations. The market share of broadband services is calculated by
dividing the number of the Target Company's total broadband subscribers as of
31 December 2002, 2003 and 2004 and 30 June 2005 by the aggregate number of
broadband subscribers in the Target Regions as of such dates, as measured by
the provincial telecommunications administrations (other than the number of
broadband subscribers in Shanxi Province as of 31 December 2003, and the number
of broadband subscribers in Shanxi Province as of 31 December 2003 was
estimated by the Target Company).
(2) Including calls to Hong Kong, Macau and Taiwan.
(3) Calculated by dividing the number of the Target Company's caller
identification service users by the total number of fixed-line subscribers of
the Target Company.
THE SERVICES OF THE TARGET COMPANY
Fixed-line telephone services (including PHS)
The Target Company is the dominant provider of fixed-line telephone services in
the Target Regions, with a market share of approximately 90.2% as of 30 June
2005, based on the number of fixed-line subscribers.
The Target Company's fixed-line telephone services consist of local telephone,
domestic long distance, international long distance, value-added and
interconnection services. The number of the Target Company's fixed-line
subscribers in the Target Regions has increased from approximately 19.21
million as of the end of 2002 to approximately 28.86 million as of 30 June
2005. Fixed-line telephone services represent the Target Company's principal
business activity. The Target Company expects that its fixed-line telephone
services will continue to provide a steady revenue stream.
The fixed-line penetration rate in the Target Regions increased from
approximately 16.3% as of the end of 2002 to approximately 24.9% as of 31
December 2004, due to the overall economic growth and growing demand for
telecommunications services. Nevertheless, such fixed-line penetration rate is
relatively low compared to that of the Company's existing service regions and
other developed countries, which provides an opportunity for future growth.
In 2000, the Target Company began to selectively build wireless local access
networks based on PHS technology to offer PHS services as a cost-effective
alternative to mobile services. Its PHS services have been introduced in most
cities in the Target Regions and were designed to provide its subscribers that
require mobility within an area with the same area code with a more
cost-effective tariff plan than traditional mobile services and access to
value-added data services. The Target Company believes that its PHS services
have contributed to the growth in its customer base, overall call volumes and
revenues, and have also mitigated the substitution effect of mobile services.
The number of its PHS subscribers has grown rapidly since this service was
introduced. As of 30 June 2005, the Target Company had approximately 7.99
million PHS subscribers, compared to approximately 0.84 million at the end of
2002.
The Target Company also operates a network of approximately 1.6 million public
telephones located in the Target Regions as of 30 June 2005 which provides
local, domestic long distance and international long distance call services,
and some of which also provide Internet services. An important contributing
factor to the demand for public telephones services is China's large and
growing migrant population.
The Target Company is seeking to stimulate continued growth in fixed-line usage
through the introduction of value-added services, such as caller
identification, PHS short messaging service, telephone information services and
"Personalised Ring" service.
The following table summarises key information regarding the Target Company's
local telephone services in the Target Regions as of 31 December 2002, 2003 and
2004 and as of 30 June 2005:
As of 31 December As of 30
June
2002 2003 2004 2005
(in thousands, except percentages)
Fixed-line subscribers(1)(2)
Residential 15,456 16,423 16,523 16,555
Business 1,922 2,480 2,621 2,709
PHS 841 4,373 7,051 7,991
Public telephones 987 1,183 1,502 1,601
Total 19,205 24,459 27,696 28,857
Market share (%)(3) 96.5 94.5 90.8 90.2
(1) Fixed-line subscribers consist of all access lines in service as well as
PHS subscribers. The Target Company calculates PHS subscribers based on number
of active telephone numbers for its PHS services. The Target Company increases
its total number of fixed-line subscribers as soon as practicable after
activation of the service. The Target Company removes a fixed-line subscriber
from the total number of fixed-line subscribers as soon as practicable after
the fixed-line subscriber deactivates the service voluntarily or three months
after the date on which the fixed-line subscriber's bill becomes overdue.
Prepaid and postpaid telephone card customers are not counted toward the Target
Company's fixed-line subscribers.
(2) Including PHS subscribers.
(3) Calculated by dividing the number of the Target Company's fixed-line
subscribers as of 31 December 2002, 2003 and 2004 and 30 June 2005 by total
number of fixed-line subscribers in the Target Regions as of such dates, as
measured by the provincial telecommunications administrations.Local telephone
services
The local telephone services of the Target Company have grown steadily in
recent years and continue to represent the largest portion of its fixed-line
telephone services in terms of revenues.
The following table sets forth information regarding usage of the Target
Company's local telephone services provided in the Target Regions for each of
the years ended 31 December 2002, 2003 and 2004 and for the six months ended 30
June 2005:
For the year ended 31 December For the
six months
ended 30
June
2002 2003 2004 2005
Total usage of local telephone services (inclusive of 60,333 61,898 59,074 29,656
Internet dial-up usage) (in million pulses)(1)
Total usage of local telephone services (exclusive of 51,241 54,596 55,883 28,675
Internet dial-up usage) (in million pulses)(1)
(1) Pulses are the billing units for calculating local telephone usage
fees. The usage of the Target Company's Internet dial-up service has declined in
the last few years due to migration to broadband services. However, if the
declining Internet dial-up usage is excluded, the usage of the Target Company's
local telephone services increased in the three years ended 31 December 2004
due to a variety of factors, including strong economic growth in its markets,
an increase in the number of fixed-line subscribers, more focused sales and
marketing efforts and new services and features.
Domestic long distance services
The Target Company offers long distance services through its traditional
networks as well as VoIP long distance services. The Target Company is the
leading provider of domestic long distance services in the Target Regions with
approximately 39.9% market share of all fixed-line and mobile operators for the
six months ended 30 June 2005. Its market share has been declining in recent
years as a result of increasing competition and the Target Company has taken
various steps to stabilise its market share in domestic long distance services.
The Target Company's VoIP domestic long distance services in the Target Regions
as a percentage of its total domestic long distance services in terms of usage
increased from approximately 34.7% as of 31 December 2002 to approximately
44.9% as of 30 June 2005, primarily due to the increased usage of its
lower-priced VoIP long distance services compared to stable usage levels for
its long distance services using its traditional networks over this period.
Furthermore, the Target Company's "IP Direct" service allows customers direct
access to its VoIP network by dialing a 5-digit access code from any fixed-line
telephone terminal without having to purchase prepaid phone cards, which
resulted in an increasing usage of VoIP service in recent years.
The following table shows the total minutes of domestic long distance calls
carried through the Target Company's long distance network and the market share
of its domestic long distance services for each of the years ended 31 December
2002, 2003 and 2004 and for the six months ended 30 June 2005:
For the year ended 31 December For the
six months
ended 30
June
2002 2003 2004 2005
Domestic long distance calls (in millions)(1)
Traditional 3,510.6 3,100.7 3,397.8 1,865.0
VoIP 1,864.4 2,871.6 3,013.6 1,519.3
Total 5,375.0 5,972.3 6,411.4 3,384.3
Market share (%)(2) 45.6 41.9 39.6 39.9
(1) Includes calls originated by prepaid phone cards users and IP subscribers
that are carried over the Target Company's long distance networks.
(2) Calculated by dividing the Target Company's domestic long distance usage
in the Target Regions for the years ended 31 December 2002, 2003 and 2004 and
the six months ended 30 June 2005 by the aggregate domestic long distance usage
of all fixed-line and mobile operators in the Target Regions for each of such
period, as measured by the provincial telecommunications administrations (other
than the traditional usage for Shanxi Province, and the traditional domestic
long distance usage of all fixed-line and mobile operators in Shanxi Province
for each of such period was estimated by the Target Company).
The increase in minutes of usage in the Target Company's domestic long distance
services in recent years is mainly due to economic development, increased
cross-regional business activities, growth in the Target Company's customer
base and new service offerings. The increase in competition may, however,
negatively affect the future growth rate of its domestic long distance
services.
International long distance services
The Target Company is the leading provider of international long distance
services in the Target Regions, with a total usage of approximately 17.22
million minutes and an approximately 43.2% market share for the overall
international long distance service in the Target Regions for the six months
ended 30 June 2005. The overall downward trend in its market share in recent
years is attributable to increased competition although for the year ended 31
December 2003, due to the substantial increase in VoIP international long
distance services usage, the Target Company's market share in that year has
increased over the previous year.
The Target Company also offers VoIP international long distance services in the
Target Regions. From the end of 2002 to 30 June 2005, VoIP international long
distance services as a percentage of the Target Company's total international
long distance services in terms of usage increased from approximately 40.2% to
approximately 44.1%, as price-sensitive customers increasingly elected to use
lower-priced VoIP international long distance services.
The following table sets forth certain information related to the usage and
market share of the Target Company's international long distance services for
each of the years ended 31 December 2002, 2003 and 2004 and for the six months
ended 30 June 2005.
For the year ended 31 December For the
six months
ended 30
June
2002 2003 2004 2005
International long distance calls (in millions)(1)
Traditional (20.0) (19.6) (19.6) (9.6)
VoIP (13.4) (18.5) (15.7) (7.6)
Total (33.4) (38.1) (35.3) (17.2)
Market share (%)(2) 50.3 54.8 45.5 43.2
(1) Includes calls originated by prepaid phone cards users and IP subscribers
that are carried over the Target Company's long distance networks and include
calls to Hong Kong, Macau and Taiwan.
(2) Calculated by dividing the Target Company's international long distance
usage in the Target Regions for the years ended 31 December 2002, 2003 and 2004
and the six months ended 30 June 2005 by the aggregate international long
distance usage of all fixed-line and mobile operators in the Target Regions for
each of such period, as measured by the provincial telecommunications
administrations (other than Shanxi Province and the international long distance
usage of all fixed-line and mobile operators in Shanxi Province for each of
such period was estimated by the Target Company).
Value-added services
In addition to basic telephone services, the Target Company offers a range of
value-added services, including caller identification, PHS short messaging
service, telephone information service, "Personalised Ring", teleconferencing,
video conferencing and voice mail, etc. Its value-added services increase total
usage on its network and average revenue per fixed-line subscriber, thus
contributing to its revenues. For the three years ended 31 December 2002, 2003
and 2004 and for the six months ended 30 June 2005, value-added services
contributed approximately RMB277 million, RMB579 million, RMB847 million and
RMB540 million, respectively to the total revenue of the Target Company. For
the same periods, value-added services contributed to approximately 1.7%, 3.3%,
4.5% and 5.6%, respectively of the total revenue of the Target Company.
The value-added services primarily utilise the Target Company's existing
network and equipment, and marketing and sales channels. Therefore, the Target
Company has incurred limited additional costs in developing and promoting its
value-added services. By substantially increasing the traffic and utilisation
of the network, the value-added services have become an important growth
component of the average revenue per subscriber, thus making substantial
contribution to the growth of the Target Company's total revenue and profit.
Furthermore, the value-added services improve customer satisfaction, which
allows the Target Company to defend its market leading position even under
pressure of intensifying competition and mobile substitution.
Value-added services are still in a relatively early stage of development in
China, and the Target Company believes that there is significant growth
potential in this area.
The following table illustrates the key operating data of the Target Company's
value-added services for each of the years ended or as of 31 December 2002,
2003 and 2004 and for the six months ended or as of 30 June 2005.
For the year ended 31 December or For the
as of 31 December six months
ended or
as of 30
June
2002 2003 2004 2005
Caller identification service penetration rate (%)(1) 41.7 59.9 66.8 69.5
PHS short messages (in millions)(2) - 63.0 716.7 822.2
Telephone information service (in million minutes) 142 243 480 262
"Personalised Ring" service subscribers (in - - 290 1,224
thousands)(3)
(1) Calculated by dividing the number of the Target Company's caller
identification service users by the total number of fixed-line subscribers of
the Target Company.
(2) The Target Company's PHS short messaging service was introduced in 2003.
(3) The "Personalised Ring" service was launched in 2004.
Caller identification service
The penetration rate of the Target Company's caller identification service in
the Target Regions has increased in the last few years due to the Target
Company's devoted efforts to promote such service. As of 31 December 2002,
2003, 2004 and 30 June 2005, the penetration rate of the Target Company's
caller identification service in the Target Regions was approximately 41.7%,
59.9%, 66.8% and 69.5%, respectively.
PHS short messaging
The Target Company's PHS short messaging service was introduced in 2003. For
each of the years ended 31 December 2003 and 2004 and for the six months ended
30 June 2005, the volume of the Target Company's PHS short messaging service
was approximately 63.0 million, 716.7 million and 822.2 million messages,
respectively.
In December 2004, the arrangements on interconnection of short messages with
China Telecom, China Mobile and China Unicom were finalised, which enabled the
Target Company's PHS subscribers to send short messages to the subscribers of
the networks of the aforesaid operators and vice versa, and such arrangements
accelerated the growth of the Target Company's PHS short messaging service.
Telephone information service
The Target Company's telephone information services allow users to access
information at its standard telephone usage rates plus information usage fees.
The Target Company also cooperates with other content and application service
providers so as to enable other specialised telephone information and
application services, such as telephone banking and telephone stock trading
services. For each of the years ended 31 December 2002, 2003, 2004 and for the
six months ended 30 June 2005, the total usage of the Target Company's
telephone information service were approximately 142 million minutes, 243
million minutes, 480 million minutes and 262 million minutes, respectively. The
Target Company intends to further expand the scope and usage of these services
and develop flexible revenue sharing arrangements with content and application
service providers.
"Personalised Ring" service
The Target Company also actively promotes the "Personalised Ring" service,
which was launched in the Target Regions at the end of 2004, and has rapidly
acquired approximately 1.22 million subscribers as of 30 June 2005.
Interconnection
The Target Company earns interconnection fees for terminating or transmitting
calls that originate from other domestic operators' networks and pays
interconnection fees to other operators in respect of calls originating from
its networks that are terminated on their networks. The Target Company earns
and pays such fees in respect of local and domestic and international long
distance calls and Internet service.
All interconnection and settlement arrangements among domestic operators in
China are governed by the Telecommunications Regulations and the rules on
interconnection arrangements and settlement promulgated by the MII.
Broadband and other Internet-related services
The Target Company is the leading provider of broadband and other
Internet-related services in the Target Regions. Broadband services represent
one of its fastest growing businesses. This growth has been driven by the
increasing affordability and rising use of personal computers and other
Internet access devices and the proliferation of content and applications, such
as online games and video-on-demand.
The following table sets forth selected information regarding the Target
Company's broadband, dial-up and dedicated Internet access services for each of
the years ended or as of 31 December 2002, 2003 and 2004 and for the six months
ended or as of 30 June 2005.
For the year ended or as of 31 For the
December six months
ended or
as of 30
June
2002 2003 2004 2005
Broadband services:(1)
DSL subscribers (in thousands) 93.1 718.9 1,529.2 1,877.9
LAN subscribers and subscribers of other services (in 34.0 92.1 745.2 900.0
thousands)
Total (in thousands) 127.1 811.0 2,274.4 2,777.9
Market share (%)(2) 100 97.1 87.9 90.7
Dial-up and dedicated Internet access services:
Dial-up online usage (in million minutes) 8,104.9 7,184.6 3,081.2 899.7
Dedicated Internet access lines in service 2,750 1,900 565 377
(1) DSL subscribers are calculated based on the number of active accounts.
LAN subscribers consist of end-users and dedicated line users. LAN end-users
are calculated based on the number of ports subscribed for. The number of LAN
dedicated line users equals total monthly fees paid by such users divided by a
set monthly revenue per user. The current set monthly revenue per user is
RMB90. The Target Company considers an account active or a service subscribed
for as soon as practicable after activations of the applicable service. A
subscriber is removed from the total number of subscribers as soon as
practicable after that subscriber deactivates the service voluntarily or three
months after the date on which that subscriber's bill becomes overdue.
(2) Calculated by dividing the number of the Target Company's broadband
subscribers as of 31 December 2002, 2003 and 2004 and 30 June 2005 by the
aggregate number of broadband subscribers in the Target Regions as of such
dates, as measured by the provincial telecommunications administrations (other
than the number of broadband subscribers in Shanxi Province as of 31 December
2003, and the number of broadband subscribers in Shanxi Province as of 31
December 2003 was estimated by the Target Company).
Broadband services
The Target Company is leveraging its extensive fixed-line network, large
customer base, experienced sales force and established brand to achieve a
leading position in the fast growing market for broadband services in China. As
of 30 June 2005, the Target Company had approximately 2.78 million broadband
subscribers and a market share of approximately 90.7% in the Target Regions,
having averaged net additional subscribers of approximately 84 thousand per
month during the six months ended 30 June 2005.
The Target Company has taken various initiatives to tailor its products and
services to meet the evolving broadband needs of its customers. In order to
increase broadband penetration rate in the Target Regions, the Target Company
has introduced a series of products with different access speeds and developed
tiered broadband usage package with different monthly payment plans to cater
for customers with different affordability and needs. In addition, in order to
further increase its revenue from broadband services, the Target Company has
developed and promoted broadband products and solutions that are suited to
various small and medium-sized enterprises. As a result, the proportion of
corporate customers and their revenue contribution to the broadband services
have been raised. The Target Company has also launched more products with high
bandwidth access and has established Internet cafe chains, thereby retaining
high-usage customers. Furthermore, the Target Company is actively working with
content providers, Internet service providers and equipment manufacturers to
facilitate the introduction of new content, value-added services, applications
and devices that will enrich the online experience of its customers so as to
increase demand for and migration to broadband services and also average
revenue per unit.
DSL services
The Target Company promotes DSL services as the primary broadband service means
for residential customers and small and medium-sized enterprise customers in
the Target Regions. In the Target Regions, where the Target Company is the
dominant fixed-line operator, the number of subscribers to its DSL services has
grown steadily in recent years, with approximately 1.88 million DSL subscribers
as of 30 June 2005, compared with approximately 93 thousand subscribers as of
the end of 2002. As of 30 June 2005, the Target Company's DSL subscribers
accounted for approximately 67.6% of its total number of broadband subscribers.
LAN services
In addition to DSL technology, the Target Company also uses Ethernet
technology-based LANs, to provide its customers with broadband services. The
Target Company has selectively rolled out LANs in high density residential and
office buildings in the Target Regions, where customers demand a high
bandwidth. As of 30 June 2005, the Target Company had approximately 0.9 million
subscribers of its LAN services, representing approximately 32.4% of its total
broadband subscribers.
Other Internet-related services
The Target Company is also one of the largest providers of dial-up Internet
access services in the Target Regions in terms of number of subscribers. It
also offers communications-intensive business customers Internet access through
dedicated lines in the Target Regions. As of 30 June 2005, the Target Company
had a total of 377 dedicated Internet access subscribers. The Target Company
bundles this service with voice and data services to provide integrated
communications solutions to its business customers.
The Target Company also operates Internet data centers, which provide
co-location and website hosting services to business customers that lease
servers, routers and other network components for Internet-related solutions.
These services are used primarily by business customers seeking to outsource
the infrastructure needed to utilise the Internet in a cost effective way.
Business and data communications services
The Target Company is the leading provider of business and data communications
services in the Target Regions. Managed data services represent a growing area
in China's telecommunications industry. The Target Company bundles the data
communications services together with fixed-line telephone services and
broadband services to attract communications-intensive business customers. The
Target Company is responding to increasing market demand in this area by
leveraging its network platforms for data transmission and by offering a broad
portfolio of services and customised solutions.
The Target Company offers managed data products, such as DDN, frame relay, ATM
and IP-VPN, and leased line products, including domestic and international
leased circuits. Its customers for these services include government entities,
large financial institutions and other domestic and multinational businesses,
ISPs and other telecommunications operators. The Target Company focuses on
diversifying its business and data communications services and products and
providing quality customer service to its large corporate and carrier
customers.
Managed data services
The Target Company provides a variety of managed data services to its business
customers, including DDN, frame relay, ATM and IP-VPN services. The Target
Company anticipates that demand for data communications services will be
fuelled by growth in the emerging services segment, which includes e-commerce,
broadband content, network applications and IP-VPN services. The Target
Company's DDN services provide high quality and reliable transmission at speeds
ranging from 9.6kbps to 2Mbps to meet the increasing demand for low- to
medium-speed transmission capacity from business customers and government
agencies. The Target Company also offers advanced high-speed data
communications services based on frame relay and ATM technologies to major
business customers, including multinational corporations, government agencies
and financial institutions. These services enable flexible and cost-effective
use of bandwidth resources and many of the Target Company's customers are
increasingly using ATM services to form VPNs to link their local area networks
in different locations.
The following table sets forth selected information regarding the managed data
services of the Target Company as of 31 December 2002, 2003 and 2004 and as of
30 June 2005.
As of 31 December As of 30
June
2002 2003 2004 2005
Number of ports
DDN 42,591 44,083 43,760 43,050
Frame relay 670 696 689 685
ATM 82 151 777 1,081
Leased bandwidth
DDN (x64kbps) 176,998 185,767 190,503 199,862
Frame relay (x128kbps) 800 855 855 845
ATM (x2Mbps) 4,096 7,473 16,678 17,250
Leased line services
The Target Company is a major provider of dedicated leased line services to
businesses, government agencies and other telecommunications operators in the
Target Regions. The Target Company leases network elements, including digital
circuits, digital trunk lines and optical fibers, to business and government
customers as well as other telecommunications operators.
As of 30 June 2005, the Target Company leased circuits totalling 12,543
(x2Mbps) in bandwidth to its customers, and an increasing percentage of its
leased circuits are of higher capacity. The following table sets forth the
respective amounts of bandwidth of the leased line services of the Target
Company provided to its business customers and carrier customers as of 31
December 2002, 2003 and 2004 and as of 30 June 2005.
As of 31 December As of 30
June
2002 2003 2004 2005
Bandwidth of leased circuits (x2Mbps)
Business customers 2,694 3,983 7,006 9,483
Carrier customers 9,192 6,456 4,211 3,060
Total 11,886 10,439 11,217 12,543
Due to the increased demand for data services, the number of business customers
increased steadily in recent years. On the other hand, as more and more carrier
customers built their own network and generally reduced the circuits leased
with the Target Company, the bandwidth of circuits leased by carrier customers
decreased through the periods indicated above.
TARIFFS
The Target Company and the Group are subject to the same regulatory framework
with respect to the tariffs of the various services offered by the Target
Company. Accordingly, the tariff structures and rates charged by the Target
Company for its various services are similar to those of the Group. For some of
the newly introduced services, such as PHS short messaging service, the tariff
has been set by the Company with the necessary tariff details filed with the
MII. For the six months ended 30 June 2005, the tariff for PHS short messaging
service ranges from RMB0.08 to RMB0.15 per message.
MARKETING, SALES, DISTRIBUTION AND CUSTOMER SERVICES
Marketing, sales, distribution and customer services initiatives
The Target Company has implemented initiatives for each of its market segments,
consisting of residential, small and medium-sized enterprise and large business
customers. The Target Company conducts sales primarily through its service
representatives and account managers, direct and third-party sales outlets,
service hotline, and its website.
The Target Company's service representatives cover particular areas and provide
consulting, upfront installation and trouble-shooting services to its
residential and small and medium-sized enterprise customers. Its account
managers, in addition to those services provided by service representatives,
also provide technical support, billing and collection services to its small
and medium-sized enterprise and large customers. Its service representatives
and account managers are evaluated based on quality of customer service
provided, number of new customers generated and revenue growth.
The Target Company also conducts sales through its own sales outlets and the
sales outlets of third parties. Its partnership with third-party distributors
enables the Target Company to more effectively market to a broader customer
base, increase market penetration and identify potential markets, while
reducing its operating expenses. As of 30 June 2005, the Target Company had
26,049 sales and marketing employees in the Target Regions. The Target Company
also had 3,388 direct sales and customer service outlets and 34,291 authorised
third-party agents in the Target Regions as of 30 June 2005.
In recent years, the Target Company has also substantially increased the amount
of residential marketing activities conducted both on its "10060" hotline and
through its website. "10060" is the nationwide telephone number for customer
service centers across China, providing comprehensive customer service for all
service offerings, including service inquiry, billing inquiry, recharge and
customer complaints.
In addition, for its high-end residential and small and medium-sized enterprise
customers, the Target Company provides tailored services through "Gold Club"
memberships. "Gold Club" members enjoy discounts on its and its partners'
products, as well as rewards programs.
The Target Company provides customised services and comprehensive solution
packages to large business customers, including international customers. For
its small and medium-sized enterprise customers, the Target Company provides
additional customised solutions for each industry.
The Target Company markets to its enterprise customers through advertising and
trade shows, online advertising, industry and regional events, sponsored
activities as well as through its partners, including its suppliers.
Trademarks
The Target Company markets its services under the "CNC" brand name and logo,
which are registered trademarks in China owned by its ultimate parent company,
China Netcom Group. Upon completion of the Acquisition, the Target Company has
the right to use these trademarks on a royalty-free basis until 2014, which is
automatically renewable at the option of the Target Company.
Billing services and credit control
The Target Company bills its residential customers on a monthly basis and
payments are usually due within a month of the last date of the billing period.
The Target Company 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 account. The Target
Company also provides specially tailored billing and collection services to its
large business customers to help them more effectively plan and monitor their
telecommunications needs.
The Target Company charges a late payment fee on subscriber accounts with
payments that are not settled by the monthly due date. The Target Company
generally deactivates services for subscribers whose accounts are more than 30
days overdue. These subscribers whose services have been deactivated must pay
all overdue amounts, including applicable late payment fees, to reactivate
their services. The Target Company will terminate a subscriber's service and
will remove him or her from the subscriber list if his or her account is
overdue for more than three months. The Target Company has implemented
subscriber registration procedures, including credit and background checking
for PHS customers to strengthen credit control. The Target Company also
actively promotes its prepaid telephone services as a means of controlling bad
debts.
NETWORK INFRASTRUCTURE
The network which the Target Company operates consists of transport networks,
service networks and support and information systems. The service networks,
which support the Target Company's basic and value-added telecommunications
services, consist of its local access networks, including PHS networks,
fixed-line telephone switch networks, Internet and data service networks and
intelligent networks. The support and information systems include Operation
Support System ("OSS") and Business Support System ("BSS") to support the
reliable and effective operation of the Target Company's networks. In addition,
the Target Company is building an information technology network and Management
Support System ("MSS") which is designed to ensure the speed and accuracy of
its internal information flow.
Transport networks
The Target Company operates an advanced, high-speed, large capacity, secure and
reliable fiber-optic transport network throughout the Target Regions. The
inter-provincial fiber-optic cables in the Target Regions, which are owned by
China Netcom Group, and operated by the Target Company, are integrated with the
Target Company's own intra-provincial transport network. This fiber-optic
network is supplemented by satellite transmissions and microwave links. The
fiber-optic transport network that the Target Company operates allows it to
more easily manage networks with enhanced reliability. In addition, the Target
Company offers a series of advanced protection technologies to customers with
varying service level requirements.
Service networks
Local access networks
The Target Company has extensive local access network coverage in the Target
Regions. Its local access network covers most cities, counties and villages in
the Target Regions. With its comprehensive local access networks, the Target
Company is able to provide customised solutions to its customers.
The Target Company continues to upgrade its existing copper line local access
networks using DSL technology. The Target Company has selectively connected
additional large office buildings and business centers with broadband services
using fibre optic cables.
Fixed-line telephone switch networks
A substantial portion of the Target Company's fixed-line telephone networks has
been built in the last decade. All of its switches are digital. The network
consists of 45 local switch networks and a long distance switch network. As of
30 June 2005, the total capacity of local switches reached approximately 35.11
million lines, and the capacity of long distance switches reached approximately
14,437 (x2Mbps) in bandwidth. The Target Company adopts advanced technology to
ensure network reliability and to improve the utilisation rate of its network.
Internet and data service networks
The Target Company has developed large capacity, high quality and reliable
Internet and data networks in the Target Regions. Its Internet networks
primarily rely on switch routers with high bandwidths. They are structured with
two layers, the backbone network layer and the application layer. Its backbone
networks are meshed to achieve maximum reliability and stability. A majority of
the main routes in this layer has transmission capacity at 10Gbps, or at
2.5Gbps. As of 30 June 2005, the Target Company also had a backbone IP network
with a total bandwidth of 46,609 (x2Mbps). In addition, this network also
allows the Target Company to provide services such as IP-VPN, Internet data
center, e-commerce and video-on-demand services. The Target Company's data
network system includes a DDN network and a frame relay and ATM network. These
networks cover all cities and counties in the Target Regions. In particular,
the Target Company's ATM network allows the Target Company to provide various
access services, flexible broadband management capability and quality
end-to-end services.
Support and information systems
The Target Company's OSS provides support for the operational management and
control of its service networks, as well as resource management. It enhances
the overall management of the Target Company's networks and helps ensure
effective troubleshooting, efficient utilisation of network resources and
smooth operation of networks. The Target Company's BSS principally consists of
operation management, billing, customer service and other systems. It provides
comprehensive and integrated support for various aspects of the Target
Company's business, such as customer relationship management and tiered service
for its large business customers.
RESEARCH AND DEVELOPMENT
The Target Company's research and development requirements are primarily
fulfilled by China Netcom Group in return for a service fee that is negotiated
on a case-by-case basis. These research and development activities are focused
primarily on operational planning and development of value-added services.
COMPETITION
The Target Company competes with other telecommunications providers in
virtually all aspects of its business, including fixed-line telephone services,
broadband and other Internet-related services and business and data
communications services. The Target Company's principal competitors in China
are telecommunications carriers wholly or majority-owned by the PRC government,
including three fixed-line service providers and two licensed mobile service
providers. Since the Target Company controls most of the local access network,
including "last mile" access network in the Target Regions, it has experienced
limited competition to date in the provision of local telephone services.
However, competition may increase in the future as other licensed operators
develop their own networks, including through the use of alternative
technologies.
EMPLOYEES
The following table sets forth information regarding employees of the Target
Company as of 30 June 2005:
As of 30 June 2005
Number of Percentage
Employees of Total
Employees
(%)
Management, finance and administrative 7,361 14.5
Sales and marketing 26,049 51.5
Operations and maintenance 14,646 28.9
Others(1) 2,580 5.1
Total 50,636 100.0
(1) Includes research and development employees.
CAPITAL EXPENDITURE
The following table sets forth the Target Company's actual and planned total
capital expenditure requirements for the periods indicated:
Capital
Expenditures
(RMB in
millions)
2002 8,372
2003 7,922
2004 7,017
2005 (Planned) 6,500
2006 (Planned) 6,300
The Target Company will continue to focus on controlling its capital
expenditures and improving its network efficiency. It is expected that the
planned capital expenditures for the years 2005 and 2006 will mainly relate to
further rollout of broadband services, local access networks and transport and
switching networks.
The capital expenditure estimates above are subject to uncertainty and actual
capital expenditures in future periods may differ significantly from these
estimates. In addition, the Target Company may enter into new
telecommunications businesses in the future, which may require additional
capital expenditures.
DISCUSSION ON THE PERFORMANCE OF THE TARGET GROUP
The Target Company, capitalising on its comprehensive local networks, is the
dominant provider of fixed-line telephone services, broadband and other
Internet-related services, and business and data communications services in the
Target Regions. In addition to basic telephone services, the Target Company
offers a range of value-added services. PHS services, broadband services and
value-added services are at a stage of rapid development in China, and the
Target Company believes that there is significant growth potential in this
area.
The audited financial statements of the Target Group for the three years ended
31 December 2004 and for the six months ended 30 June 2005 are set out in
Appendix II to this circular.
The amount of cash and bank deposits held by the Target Group as at 31 December
2002, 2003 and 2004 and as at 30 June 2005 amounted to RMB1,097 million,
RMB1,114 million, RMB580 million and RMB466 million, respectively. All balances
as at 31 December 2002, 2003 and 2004 and 30 June 2005 are denominated in
Renminbi and kept in the PRC. The Target Group's source of funds is mainly
derived from its operating activities in the PRC.
As at 31 December 2002, 2003 and 2004, the Target Group carried outstanding
loans in the amount of RMB26,870 million, RMB27,313 million and RMB24,191
million, respectively. As at those dates, short-term bank loans of the Target
Group were in the amount of RMB10,219 million, RMB15,774 million and RMB15,543
million, respectively and long-term bank loans and other loans of the Target
Group were in the amount of RMB16,651 million, RMB11,539 million and RMB8,648
million, respectively. As at 30 June 2005, the Target Group carried outstanding
loans in the amount of RMB23,675 million, of which RMB16,978 million are
short-term bank loans and RMB6,697 million are long-term bank loans and other
loans.
All the short-term bank loans are unsecured as at 31 December 2002, 2003 and
2004 and as at 30 June 2005. As at 31 December 2002, 2003 and 2004 and as at 30
June 2005, the Target Group's long-term bank loans of RMB287 million, RMB273
million, RMB260 million and RMB253 million, respectively were secured by
corporate guarantees granted by China Netcom Group. In addition, as at 31
December 2002, long-term bank loans of RMB8 million were secured by corporate
guarantees granted by third parties. The interest rates of the majority of the
Target Group's bank loans were floating. As at 31 December 2002, 2003 and 2004
and as at 30 June 2005, the Target Group's banking facilities amounted to
RMB34,818 million, RMB34,568 million, RMB33,409 million and RMB33,206 million,
respectively.
As at 31 December 2002, 2003 and 2004 and as at 30 June 2005, the Target
Group's total debt to capitalisation ratio (dividing total debt of the Target
Group by the total of debt, owners' equity and balance of deferred revenue of
the Target Group) were 66.3%, 63.9%, 63.6% and 66.5%, respectively. The Target
Group's loans are denominated in Renminbi, US dollars, Japanese Yen and Euro.
The Target Group did not employ any financial instrument to hedge its loans.
As at 30 June 2005, the Target Group had not given guarantees and there was no
charge on its assets. As at the same date, the Target Group had no contingent
liabilities.
The Target Group's assets are denominated in Renminbi and there is no foreign
currency investment.
As of 30 June 2005, the Target Company had 50,636 employees, of which 7,361 are
management, finance and administrative staff, 26,049 are sales and marketing
staff, 14,646 are operations and maintenance staff and 2,580 are other staff,
including staff responsible for research and development. Employee remuneration
amounted to RMB1,759 million for the six months ended 30 June 2005. The Target
Group adopted a remuneration mechanism with a market-oriented and
performance-based approach. The Target Group has not adopted any employee share
option scheme. Upon completion of the Acquisition, the employees of the
Combined Group will be covered under the existing share option scheme of the
Company.
The Target Group's actual capital expenditure for the years 2002, 2003 and 2004
were RMB8,372 million, RMB7,922 million and RMB7,017 million, respectively and
its planned capital expenditure for the years 2005 and 2006 are RMB6,500
million and RMB6,300 million, respectively. The planned capital expenditures
will mainly relate to further rollout of broadband services, local access
networks and transport and switching networks. It is expected that the capital
expenditures will be funded using internal cash resources and/or proceeds from
future external financing of the Combined Group
APPENDIX II ACCOUNTANTS' REPORT OF THE TARGET Group
The following is a text of a report, prepared for the purpose of inclusion in
this circular, received from the independent reporting accountants,
PricewaterhouseCoopers, Certified Public Accountants, Hong Kong. As described
in the section headed "General Information" in Appendix VI, a copy of the
following accountants' report is available for inspection.
[PRICEWATERHOUSECOOPERS GRAPHIC OMITTED]
_______________________________________________________________________________
| PricewaterhouseCoopers
| 22/F, Prince's Building
| Central, Hong Kong
23 September 2005
The Directors
China Netcom Group Corporation (Hong Kong) Limited
Dear Sirs,
We set out below our report on the combined financial information relating to
China Netcom Group New Horizon Communications Corporation (BVI) Limited (the
"Target BVI Company") and its subsidiary (hereinafter collectively referred to
as the "Target Group") for each of the years ended 31 December 2002, 2003 and
2004 and the six months ended 30 June 2004 and 2005 (the "Relevant Periods")
for inclusion in the circular of China Netcom Group Corporation (Hong Kong)
Limited (the "Company") dated 23 September 2005 (the "Circular") in relation to
the proposed acquisition of the entire financial interest of the Target BVI
Company by the Company.
The Target BVI Company is currently owned by China Netcom Communications Group
Corporation ("China Netcom Group"), the Company's ultimate holding company
which is a state-owned telecommunication operator established in the People's
Republic of China (the "PRC") under the supervision and regulation of the
Ministry of Information Industry ("MII"). The Target BVI Company was
incorporated in the British Virgin Islands ("BVI") on 27 July 2005 as a limited
liability company under the British Virgin Islands International Business
Companies Act of 1984. The Target BVI Company has one subsidiary, namely China
Netcom Group New Horizon Communications Corporation Limited (the "Target
Company"), which was established in the PRC on 9 August 2005 as a limited
liability company. The purpose of the Target BVI Company and its subsidiary is
to hold and operate the fixed line telecommunications businesses of four
provinces / autonomous regions in the PRC, namely Shanxi Province, Jilin
Province, Heilongjiang Province and Inner Mongolia Autonomous Region
(collectively referred to as the "Target Regions") which were transferred to
the Target Group by China Netcom Group pursuant to a group reorganisation as
described in Note 1 of Section II below.
The Target BVI Company and its subsidiary have adopted 31 December as their
financial year end.
No audited financial statements have been prepared for the Target BVI Company
and the Target Company since their respective date of incorporation /
establishment as they were incorporated / established subsequent to 30 June
2005 and have not been involved in any significant business transactions since
incorporation / establishment other than the Reorganisation referred to herein.
For the purpose of the Reorganisation, the directors of the Target BVI Company
have prepared the combined financial statements of the fixed line
telecommunications businesses of the Target Regions for the Relevant Periods in
accordance with the relevant accounting principles and financial regulations
applicable to PRC companies (the "PRC GAAP Accounts"). Except for the six
months ended 30 June 2004 and 2005, the PRC GAAP Accounts were audited by
PricewaterhouseCoopers Zhong Tian CPAs Limited Company [GRAPHIC
OMITTED][GRAPHIC OMITTED].
For the purpose of this report, the directors of the Company have prepared the
combined financial statements for the Relevant Periods as set out in Sections I
to III ("Financial Information") in accordance with Hong Kong Financial
Reporting Standards ("HKFRS") issued by the Hong Kong Institute of Certified
Public Accountants ("HKICPA"), based on the PRC GAAP Accounts, and on the basis
set out in Note 2 of Section II below, after making adjustments as are
appropriate. In preparing the Financial Information, it is fundamental that
appropriate accounting policies are selected and applied consistently. For the
purpose of this report, we have carried out independent audit procedures on the
Financial Information in accordance with Statements of Auditing Standards
issued by HKICPA, and have examined the Financial Information and carried out
such additional procedures as are necessary in accordance with the Auditing
Guideline "Prospectuses and the Reporting Accountant" issued by HKICPA.
The directors of the Company are responsible for the preparation of the
Financial Information which is required to give a true and fair view. It is our
responsibility to form an independent opinion, based on our examination, on the
Financial Information and to report our opinion.
In our opinion, the Financial Information, for the purpose of this report, and
prepared on the basis set out in Note 2 of Section II below, gives a true and
fair view of the combined state of affairs of the Target Group as at 31
December 2002, 2003 and 2004 and 30 June 2005, and of the Target Group's
combined results and cash flows for the Relevant Periods.
(I) FINANCIAL INFORMATION
(All amounts in RMB million unless otherwise stated)
The following are the combined income statements of the Target Group for the
Relevant Periods prepared on the basis set out in Note 2 of Section II below,
after making adjustments as are appropriate.
COMBINED INCOME STATEMENTS
Years ended 31 December Six months ended 30
June
Note 2002 2003 2004 2004 2005
Revenues 6 16,232 17,700 18,616 9,315 9,712
Operating expenses
Depreciation and amortisation (5,988) (6,317) (6,426) (3,196) (3,184)
Networks, operations and support (4,087) (3,118) (2,426) (960) (992)
Staff costs 10 (2,602) (3,398) (3,891) (1,892) (1,759)
Selling, general and (2,245) (3,269) (3,311) (1,736) (1,369)
administrative expenses
Other operating expenses (380) (537) (459) (225) (129)
Total operating expenses (15,302) (16,639) (16,513) (8,009) (7,433)
Operating profit before interest 930 1,061 2,103 1,306 2,279
income and deficit on revaluation
of property, plant and equipment
Interest income 28 16 11 5 3
Deficit on revaluation of 16(c) - - (11,318) - -
property, plant and equipment
Profit/(loss) from operations 7 958 1,077 (9,204) 1,311 2,282
Finance costs 8 (1,283) (1,270) (998) (500) (501)
Profit/(loss) before taxation (325) (193) (10,202) 811 1,781
Taxation 9 423 398 3,671 (102) (451)
Profit/(loss) for the year/period 98 205 (6,531) 709 1,330
COMBINED BALANCE SHEETS
The following are the combined balance sheets of the Target Group as at 31
December 2002, 2003 and 2004 and 30 June 2005, prepared on the basis set out in
Note 2 of Section II below, after making adjustments as are appropriate.
As at 31 December As at 30
June
Note 2002 2003 2004 2005
Assets
Current assets
Cash and bank deposits 11 1,097 1,114 580 466
Accounts receivable 12 1,121 1,175 1,486 1,859
Inventories and consumables 13 291 209 302 273
Prepayments and other receivables 14 739 582 436 366
Due from ultimate holding company and 23 141 94 714 166
fellow subsidiaries
Total current assets 3,389 3,174 3,518 3,130
Non-current assets
Lease prepayments for land 15 466 450 480 437
Property, plant and equipment 16 44,588 47,719 42,110 39,327
Construction in progress 17 3,518 2,354 2,995 3,178
Intangible assets 18 58 91 66 121
Deferred costs 19 668 672 654 593
Deferred tax assets 26 1,663 2,076 1,410 1,143
Other non-current assets 14 11 9 -
Total non-current assets 50,975 53,373 47,724 44,799
Total assets 54,364 56,547 51,242 47,929
Liabilities and equity
Current liabilities
Accounts payable 20 5,632 5,409 6,472 6,091
Accruals and other payables 21 1,639 1,267 1,513 1,319
Short-term bank loans 22(a) 10,219 15,774 15,543 16,978
Current portion of long-term bank and other 22(b) 5,727 3,676 4,457 3,484
loans
Due to ultimate holding company and fellow 23 1,231 1,448 1,836 1,866
subsidiaries
Current portion of deferred revenues 24 2,140 2,170 2,223 1,954
Current portion of provisions 25 1,495 1,550 1,531 1,513
Taxation payable 105 185 165 97
Total current liabilities 28,188 31,479 33,740 33,302
Net current liabilities (24,799) (28,305) (30,222) (30,172)
Total assets less current liabilities 26,176 25,068 17,502 14,627
Non-current liabilities
Long-term bank and other loans 22(b) 10,924 7,863 4,191 3,213
Deferred revenues 24 3,963 2,981 2,171 1,860
Provisions 25 1,181 1,153 1,431 1,369
Deferred tax liabilities 26 2,497 2,759 255 50
Other non-current liabilities 57 29 24 4
Total non-current liabilities 18,622 14,785 8,072 6,496
Total liabilities 46,810 46,264 41,812 39,798
Owner's equity 7,554 10,283 9,430 8,131
Total liabilities and equity 54,364 56,547 51,242 47,929
COMBINED STATEMENTS OF CHANGES IN EQUITY
The following are the combined statements of change in equity of the Target
Group for the Relevant Periods, prepared on the basis set out in Note 2 of
Section II below, after making adjustments as are appropriate.
Revaluation Other Capital/retained Total
reserve reserve earnings
Balance as at 1 January 2002 - - 7,921 7,921
Profit for the year - - 98 98
Net distributions to owners - - (155) (155)
Movement of deferred tax recognised in equity (Note - - (310) (310)
26(i))
Balance as at 31 December 2002 - - 7,554 7,554
Balance as at 1 January 2003 - - 7,554 7,554
Profit for the year - - 205 205
Net contributions from owners - - 2,777 2,777
Movement of deferred tax recognised in equity (Note - - (253) (253)
26(i))
Balance as at 31 December 2003 - - 10,283 10,283
Balance as at 1 January 2004 - - 10,283 10,283
Loss for the year - - (6,531) (6,531)
Net contributions from owners - - 3,794 3,794
Movement of deferred tax recognised in equity (Note - - (704) (704)
26(i))
Revaluation surplus (Note 16) 3,863 - - 3,863
Revaluation tax credit (Note 26(ii)) (1,275) - - (1,275)
Balance as at 31 December 2004 2,588 - 6,842 9,430
Balance as at 1 January 2005 2,588 - 6,842 9,430
Profit for the period - - 1,330 1,330
Net contributions from owners - - 68 68
Distributions to owners - - (930) (930)
Movement of deferred tax recognised in equity (Note 1,097 843 (2,174) (234)
26 (ii),(iii))
Transfer to retained earnings (360) (13) 373 -
Net assets distributed to owners in accordance with - - (1,533) (1,533)
the reorganisation (Note 2)
Balance as at 30 June 2005 3,325 830 3,976 8,131
COMBINED STATEMENTS OF CASH FLOWS
The following are the combined cash flow statements of the Target Group for the
Relevant Periods, prepared on the basis set out in Note 2 of Section II below,
after making adjustments as are appropriate.
Years ended 31 December Six months ended 30
June
Note 2002 2003 2004 2004 2005
Cash flows from operating
activities
Net cash inflows generated from 27(a) 7,302 6,720 7,728 4,424 4,620
operations
Interest received 28 16 11 5 3
Interest paid (1,246) (1,151) (956) (509) (539)
Net cash inflow from operating 6,084 5,585 6,783 3,920 4,084
activities
Cash flows from investing
activities
Purchase of property, plant and (8,372) (7,922) (7,017) (3,022) (2,846)
equipment and construction in
progress
Sales of property, plant and - 21 30 17 8
equipment
Net decrease/(increase) in time 75 27 (8) 7 30
deposits with maturity over three
months
Net cash outflow from investing (8,297) (7,874) (6,995) (2,998) (2,808)
activities
Cash flows from financing
activities
New bank loans and other loans 14,490 16,973 14,470 11,026 11,455
Repayment of bank loans (12,816) (17,378) (18,233) (15,392) (11,601)
Capital element of finance lease (41) (39) (361) (187) (383)
payments
Net contributions received (155) 2,777 3,794 3,177 (831)
from/(distributions to) owners
Net cash inflow/(outflow) from 1,478 2,333 (330) (1,376) (1,360)
financing activities
Increase/(decrease) in cash and (735) 44 (542) (454) (84)
cash equivalents
Cash and cash equivalents at 1,781 1,046 1,090 1,090 548
beginning of year/period
Cash and cash equivalents at end 11 1,046 1,090 548 636 464
of year/period
(II) NOTES TO THE FINANCIAL STATEMENTS
1. The Target Group, its Reorganisation and Principal Activities
(a) Background of the Target Group
The Target BVI Company was incorporated in the BVI on 27 July 2005 as a limited
liability company under the British Virgin Islands International Business
Companies Act of 1984. Through China Netcom Group New Horizon Communications
Corporation Limited, its wholly owned subsidiary established in the PRC, the
Target BVI Company holds the assets and liabilities of the fixed line
telecommunications business in the Target Regions. These assets and liabilities
were injected from China Netcom Group as set out in note (b) below.
(b) Reorganisation of the Target Group
In anticipation of the proposed acquisition of the Target BVI Company by the
Company from China Netcom Group (the "Proposed Acquisition"), the Target BVI
Company and its subsidiary underwent a reorganisation as follows (the
"Reorganisation"):
(a) The net assets of the fixed line telecommunications operations of the
Target Regions, excluding certain assets and liabilities retained by China
Netcom Group as set out in (c) below, valued at RMB 9,466 million as of 31
December 2004 based on an independent valuation, were injected into China
Netcom Group New Horizon Communication Corporation Limited, the Target Company
on 9 August 2005;
(b) The entire interests in the Target Company were transferred to the Target
BVI Company, an investment holding company incorporated in the BVI and
indirectly held by China Netcom Group through China Netcom Group (BVI) Company
Limited, on 1 September 2005 for a consideration of RMB 9,466 million by way of
equity injection;
(c) China Netcom Group retained the inter-provincial optic fibers, certain
land and buildings, long term investments and certain minor current assets and
liabilities of the fixed line telecommunications business of the Target Regions
after the Reorganisation.
(c) Principal activities
After the Reorganisation, the Target Group is the dominant provider of fixed
line telephone services, broadband services, other Internet-related services,
and business and data communications services in the Target Regions.
The Target Group's operations are subject to the supervision of and regulation
by the PRC Government. The MII, pursuant to the authority delegated by the
PRC's State Council, is responsible for formulating the telecommunications
industry policies and regulations (the "Telecommunications Regulations").
Under the Telecommunications Regulations, all telecommunications operators in
the PRC must obtain a telecommunications service operating license from the MII
or from the provincial telecommunications administrations. Providers of
value-added services within a single province are required to obtain licenses
from provincial telecommunications administrations. Providers of basic
telecommunications services and providers of value-added services in two or
more provinces, autonomous regions and municipalities are required to obtain
licenses from the MII. In accordance with the approval of the MII, the Target
Company, as an indirect subsidiary of China Netcom Group, has the right to
operate the Target Group's telecommunications business in the Target Regions
under the authorisation of China Netcom Group, which holds the license required
for operating the Target Group's telecommunications businesses in the PRC.
Following the Reorganisation, China Netcom Group continues to be the holder of
the licenses for operating a telecommunications network in China, but has, with
the consent of the MII, granted the Target Group the right to operate under its
licenses, the assets described above and the related businesses.
2. Basis of presentation
As a result of the segregation and separate management of the assets and
liabilities retained by China Netcom Group upon Reorganisation beginning 30
June 2005, such assets and liabilities have been reflected as a distribution to
owner in the combined statement of owners' equity as at 30 June 2005.
Immediately before and after the Reorganisation, the Target Group and the
assets and liabilities of the Target Regions are wholly owned by China Netcom
Group. Accordingly, the Reorganisation was regarded as a group restructuring
and accounted for under merger accounting, as permitted by the Hong Kong
Statement of Standard Accounting Practice 27 ("SSAP 27") "Accounting for group
reconstructions", and the assets and liabilities injected into the Target Group
by China Netcom Group under Note 1 (a) and (b) above have been stated at
historical amounts. The combined Financial Information presents the combined
results and financial position of the Target Group as if the fixed line
telecommunications businesses were injected into the Target Group from China
Netcom Group at the beginning of the earliest periods presented.
The assets and liabilities as at 30 June 2005 retained by China Netcom Group
were as follows:
As at 30
June 2005
RMB million
Current assets 164
Lease prepayments for land (Note 15) 40
Property, plant and equipment, net (Note 16) 1,864
Construction in progress (Note 17) 215
Other non-current assets 15
Current liabilities (749)
Non-current liabilities (16)
Net amount 1,533
3. Summary of significant accounting policies
The principal accounting policies applied in the preparation of the Financial
Information are set out below. These policies have been consistently applied to
all the years/periods presented, unless otherwise stated.
3.1 Basis of preparation
The Financial Information has been prepared in accordance with Hong Kong
Financial Reporting Standards (HKFRS). The Financial Information has been
prepared under the historical cost convention, as modified by the revaluation
of certain fixed assets which are carried at fair value.
The preparation of Financial Information in conformity with HKFRS requires the
use of certain critical accounting estimates. It also requires management to
exercise its judgement in the process of applying the Target BVI Company's
accounting policies. The areas involving a higher degree of judgement or
complexity, or areas where assumptions and estimates are significant to the
Financial Information, are disclosed in Note 5.
A significant percentage of the Target Group's funding requirements is achieved
through short term borrowings. Consequently, the balance sheet indicates a
significant working capital deficit. In the past, a substantial portion of the
Target Group's short term borrowings have been rolled over upon maturity. Based
on the Target Group's history of obtaining finance, its relationships with its
bankers and its operating performance, the directors of the Target Group
consider that the Target Group will continue to be able to roll over such short
term financing, or will be able to obtain sufficient alternative sources of
financing to enable it to operate and meet its liabilities as and when they
fall due.
This is the first set of HKFRS financial statements of the Target Group. No
audited stand-alone financial statements have been prepared for the Target BVI
Company or the Target Company since their respective dates of incorporation /
establishment as they were incorporated or established since 30 June 2005 and
have not been involved in any significant transactions since incorporation /
establishment other than the Reorganisation.
3.2 Basis of Combination
As set out in Note 2 above, the Reorganisation involving the injection of
businesses from China Netcom Group into the Target Group was accounted for
using merger accounting in accordance with SSAP No.27 issued by the HKICPA. The
results and financial position of businesses combined under the Reorganisation
were included in the Financial Information as if the businesses were acquired
at the beginning of the earliest periods presented.
Subsidiaries are those entities in which the Target BVI Company, directly or
indirectly, controls the composition of the board of directors, controls more
than half the voting power or holds more than half of the issued share capital.
3.3. Segment reporting
A business segment is a group of assets and operations engaged in providing
products or services that are subject to risks and returns that are different
from those of other business segments. A geographical segment is engaged in
providing products or services within a particular economic environment that
are subject to risks and returns that are different from those of segments
operating in other economic environments. Currently, the Target Group has one
business segment, the provision of fixed line telecommunication services. The
Target Group's assets and operation are all located in the PRC. Accordingly, no
business and geographical segment information is presented.
3.4 Foreign currency translation
(a)
Functional and presentation currency
Items included in the financial statements of each of the Target Group's
entities are measured using the currency of the primary economic environment in
which the entity operates ("the functional currency") which is Renminbi.
(b)
Transactions and balances
Foreign currency transactions are translated into the functional currency using
the exchange rates prevailing at the dates of the transactions. Foreign
exchange gains and losses resulting from the settlement of such transactions
and from the translation at year-end exchange rates of monetary assets and
liabilities denominated in foreign currencies are recognised in the income
statement.
3.5. Property, plant and equipment
(a)
Construction in progress
Construction in progress represents buildings, telecommunications networks
plant, transmission and switching equipment under construction and pending
installation, and is stated at cost less impairment losses. Cost comprises
direct costs of construction including borrowing costs attributable to the
construction during the period of construction. When the asset being
constructed becomes available for use, the construction in progress is
transferred to the appropriate category of property, plant and equipment.
(b)
Other property, plant and equipment
All other property, plant and equipment are initially stated at historical cost
less depreciation and impairment losses. Historical cost includes expenditure
that is directly attributable to the acquisition of the items.
Subsequent costs are included in the asset's carrying amount or recognised as a
separate asset, as appropriate, only when it is probable that future economic
benefits associated with the item will flow to the Target Group and the cost of
the item can be measured reliably. All other repairs and maintenance are
expensed in the income statement during the financial period in which they are
incurred.
Buildings subsequent to initial recognition are stated at cost less accumulated
impairment losses and depreciated over their expected useful lives.
(c)
Revaluation
Subsequent to the revaluation carried out as at 31 December 2004, which was
based on depreciated replacement costs (Note 16), property, plant and equipment
other than buildings are carried at their revalued amounts, being the fair
values at the date of 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 together 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.
Increases in the carrying amount arising on revaluation are credited to the
valuation reserve in shareholders' equity. Decreases that offset previous
increases of the same asset are charged against revaluation reserve directly in
equity; all other decreases are expensed in the income statement. Any
subsequent increases are credited to operating profit up to the amount
previously debited. Each year the difference between depreciation based on the
revalued carrying amount of the asset expensed in the income statement and
depreciation based on the asset's original cost is transferred from revaluation
reserve to retained earnings.
(d)
Depreciation
Depreciation of property, plant and equipment is calculated using the
straight-line method to allocate cost or revalued amounts less accumulated
impairment loss to their residual values over their estimated useful lives, as
follows:
- Buildings 8-30 years
- Telecommunication network and equipment 5-10 years
- Furniture, fixtures, motor vehicles and other equipments 5-10 years
The assets' residual values and useful lives are reviewed, and adjusted if
appropriate, at each balance sheet date.
(e)
Gain or loss on sale of property, plant and equipment
The gain or loss on disposal of property, plant and equipment is the difference
between the net sales proceeds and the carrying amount of the relevant asset,
and is recognised in the income statement, except where the property, plant and
equipment is carried at valuation, the relevant portion of the revaluation
reserve realised in respect of previous valuations is transferred to retained
earnings and is shown as a movement in reserves.
(f)
Impairment
An asset's carrying amount is written down immediately to its recoverable
amount if the asset's carrying amount is greater than its estimated recoverable
amount (Note 3.7).
3.6 Intangible assets
(a)
Purchased software
Acquired computer software licences are capitalised on the basis of the costs
incurred to acquire and bring to use the specific software. These costs are
amortised using the straight-line method over their estimated useful lives
ranging from three to five years.
(b)
Sponsorship fee
Sponsorship fee to the 2008 Olympic Games is capitalised and amortised using
the straight-line method over its beneficial period of four years.
3.7. Impairment of assets
Assets that have an indefinite useful life are not subject to amortisation,
which are at least tested annually for impairment and are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. Assets that are subject to amortisation
are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount may not be recoverable. An impairment loss is
recognised for the amount by which the asset's carrying amount exceeds its
recoverable amount. The recoverable amount is the higher of an asset's fair
value less costs to sell and value in use. For the purposes of assessing
impairment, assets are grouped at the lowest levels for which there are
separately identifiable cash flows (cash-generating units).
3.8 Inventories and consumables
Inventories comprise mainly spare parts and telephone handsets and are stated
at the lower of cost and net realisable value after provision for obsolescence.
Cost is determined using the first-in, first-out (FIFO) method. Net realisable
value is the estimated selling price in the ordinary course of business, less
applicable variable selling expenses.
3.9 Accounts and other receivables
Accounts and other receivables are recognised initially at fair value and
subsequently measured at amortised cost using the effective interest method,
less provision for impairment. A provision for impairment of accounts and other
receivables is established when there is objective evidence that the Target
Group will not be able to collect all amounts due according to the original
terms of receivables. The amount of the provision is the difference between the
asset's carrying amount and the present value of estimated future cash flows,
discounted at the effective interest rate. The amount of the provision is
recognised in the income statement.
3.10 Cash and cash equivalents
Cash and cash equivalents include cash in hand, deposits held at call with
banks and time deposits with original maturities of three months or less which
are carried at cost.
3.11 Borrowings
Borrowings are recognised initially at fair value, net of transaction costs
incurred. Transaction costs are incremental costs that are directly
attributable to the acquisition, issue or disposal of a financial asset or
financial liability, including fees and commissions paid to agents, advisers,
brokers and dealers, levies by regulatory agencies and securities exchanges,
and transfer taxes and duties. Borrowings are subsequently stated at amortised
cost; any difference between the proceeds (net of transaction costs) and the
redemption value is recognised in the income statement over the period of the
borrowings using the effective interest method.
Borrowings are classified as current liabilities unless the Target Group has an
unconditional right to defer settlement of the liability for at least 12 months
after the balance sheet date.
3.12 Deferred income tax
Deferred income tax is provided in full, using the liability method, on
temporary differences arising between the tax bases of assets and liabilities
and their carrying amounts in Financial Information. However, if the deferred
income tax arises from the initial recognition of an asset or liability in a
transaction other than a business combination that at the time of the
transaction affects neither accounting nor taxable profit or loss, it is not
accounted for. Deferred income tax is determined using tax rates (and laws)
that have been enacted or substantially enacted by the balance sheet date and
are expected to apply when the related deferred income tax asset is realised or
the deferred income tax liability is settled.
Deferred income tax assets are recognised to the extent that it is probable
that future taxable profit will be available against which the temporary
differences can be utilised.
3.13 Employee benefits
(a)
Pension obligations
As stipulated by the regulations of the PRC, the Target Group participates in
basic defined contribution pension plans organised by their respective
Municipal Governments under which they are governed. The Target Group is
required to make contributions to the retirement plans at rates of 20% of the
salaries, bonuses and certain allowances of the employees. Employees are
entitled to retirement benefits equal to a fixed proportion of their salary at
their normal retirement age. The Target Group has no other material obligations
for post-retirement benefits beyond these payments as they fall due. Payments
made under these plans are expensed as incurred.
(b)
Early retirement benefits
Early retirement benefits are recognised as expenses when the Target Group
reaches agreement with the relevant employees for early retirement.
(c)
Employee housing benefits
One-off cash housing subsidies paid to employees are charged to the income
statement in the year in which it is determined that the payment of such
subsidies is probable and the amounts can be reasonably estimated (see Note
25(a)).
Full-time employees of the Target Group participate in various
government-sponsored housing funds. The Target Group contributes on a monthly
basis to these funds based on certain percentages of the salaries of the
employees. The Target Group's liability in respect of these funds is limited to
the contributions payable in each period. Contributions to these housing funds
are expensed as incurred.
3.14 Provisions
Provisions are recognised when the Target Group has a present legal or
constructive obligation as a result of past events; it is more likely than not
that an outflow of resources will be required to settle the obligation; and the
amount has been reliably estimated. Provisions are not recognised for future
operating losses.
Where there are a number of similar obligations, the likelihood that an outflow
will be required in settlement is determined by considering the class of
obligations as a whole. A provision is recognised even if the likelihood of an
outflow with respect to any one item included in the same class of obligations
may be small.
3.15 Revenue recognition
(a) The Target Group's revenues are recognised as follow:
o Revenues derived from local, domestic long distance ("DLD) and
international long distance ("ILD) telephone usage, which vary depending
on the day, the time of day, the distance and duration of the call and the
tariffs, are recognised when the services are provided to customers.
o Monthly telephone service fees are recognised in the period during
which the telephone services are provided to customers.
o Upfront connection and installation fees received are deferred and
recognised over the expected customer relationship period of 10 years. With
effect from 1 July 2001, no further upfront fees for connection were charged to
customers.
o Revenues from the sale of prepaid calling cards are deferred and
recognised as the cards are consumed by customers.
o Revenues from PHS bundled service contracts are recognised as local,
DLD, or ILD service fees according to the type of usage and on a systematic
basis to match the shorter of the pattern of usage of the PHS services by
customers and the minimum non-cancellable contract period. PHS bundled service
contracts comprise the provision of PHS services and handsets to customers,
under which customers either prepay a certain amount of service fee or commit
to spend a minimum monthly service fee for a designated period in order to
receive a free handset (see Note 3.19(b)) for the policy on cost of the
handset.
o Revenues from value-added communication services such as call
waiting, call diverting and caller number display are recognised when the
services are provided to customers.
o Revenues from the provision of broadband and other Internet-related
services and managed data services are recognised when the services are
provided to customers.
o Interconnection fees from domestic and foreign telecommunications
operators are recognised when the services are rendered as measured by the
minutes of traffic processed.
o Lease income from the leasing of lines and customer-end equipment is
recognised over the term of the lease. Lease income from other domestic
telecommunications operators and business customers for the usage of the Target
Group's fixed line telecommunications networks is measured by the number of
lines leased and the agreed upon rate per line leased. The lease arrangements
are primarily determined on a year to year basis.
(b)
Interest income
Interest income is recognised on a time proportion basis, taking into account
the principal amounts outstanding and the interest rates applicable.
3.16 Interest expenses
Interest expenses that are attributable to the acquisition, construction or
production of an asset that necessarily takes a substantial period of time to
get ready for its intended use or sale are capitalised as part of the cost of
that asset.
All other interest expenses are charged to the income statement in the
year/period in which they are incurred.
3.17 Interconnection charges@#
#@Interconnection charges represent amounts incurred for the use of other
telecommuncations operators' network for facilitating the completion of calls
that originate from the Target Group's fixed line telecommuncations networks.
Interconnection charges are recognised on an accruals basis. For
interconnection charges with domestic operators, they are accrued based on
actual amounts, while those with overseas operators are accrued based on the
Target Group's estimates.
3.18 Leases (as the lessee)
(a)
Operating lease
Leases in which a significant portion of the risks and rewards of ownership are
retained by the lessor are classified as operating leases. Payments made under
operating leases (net of any incentives received from the lessor) are expensed
in the income statement on a straight-line basis over the period of the lease.
(b)
Finance lease
Leases of assets where the Target Group has substantially all the risks and
rewards of ownership are classified as finance leases. Finance leases are
capitalised upon commencement of the lease at the lower of the fair value of
the leased assets and the present value of the minimum lease payments. Each
lease payment is allocated between the liability and finance charges so as to
achieve a constant rate on the finance balance outstanding. The corresponding
rental obligations, net of finance charges, are included in current and
non-current borrowings. The interest element of the finance cost is recognised
in the income statement over the lease period so as to produce a constant
periodic rate of interest on the remaining balance of the liability for each
period.
3.19 Deferred costs
(a)
Deferred installation costs
The direct incremental costs associated with the installation of fixed line
services are deferred and amortised to the income statement over the expected
customer relationship period of 10 years except when the direct incremental
costs exceed the corresponding upfront installation fees. In such cases, the
excess of the direct incremental costs over the installation fees are recorded
immediately as expenses in the income statement.
(b)
Customer acquisition costs
The cost of handsets given to customers under bundled service contracts are
deferred as customer acquisition costs, to the extent recoverable, and
amortised to the income statement on a systematic basis to match with the
pattern of the customer service income over the contract period.
3.20 Contingent liabilities
A contingent liability is a possible obligation that arises from past events
and whose existence will only be confirmed by the occurrence or non-occurrence
of one or more uncertain future events not wholly within the control of the
Target Group. It can also be a present obligation arising from past events that
is not recognised because it is not probable that outflow of economic resources
will be required or the amount of obligation cannot be measured reliably.
A contingent liability is not recognised but is disclosed in the notes to the
Financial Information. When a change in the probability of an outflow occurs so
that the outflow is probable, the contingent liability will then be recognised
as a provision.
A contingent asset is a possible asset that arises from past events and whose
existence will be confirmed only by the occurrence or non-occurrence of one or
more uncertain events not wholly within the control of the Target Group.
4. Financial risk management
4.1 Financial risk factors
The Target Group's activities expose it to a variety of financial risks: market
risks including currency risk and fair value interest rate risk, credit risk,
liquidity risk and cash flow interest-rate risk.
(a)
Foreign exchange risk
The Target Group has foreign currency denominated bank loans, the details of
which are disclosed in note 22 of the Financial Information.
(b)
Credit risk
The carrying amount of accounts receivable included in the balance sheet
represents the Target Group's exposure to credit risk in relation to its
financial assets. The Target Group's receivables are unsecured to the extent
they are not covered by security deposits. The Target Group believes that
adequate provision for uncollectible accounts receivable has been made.
(c)
Liquidity risk
A significant percentage of the Target Group's funding requirements is achieved
through short term borrowings, and the balance sheet indicates a significant
working capital deficit. Please refer to note 3.1 for further information.
(d)
Cash flow and fair value interest rate risk
The Target Group is exposed to changes in interest rates due to its long-term
debt obligations. The Target Group enters into debt obligations to support
general corporate purposes including capital expenditures, and working capital
needs. Borrowings at variable rates expose the Target Group to cash flow
interest rate risk. Borrowings issued at fixed rates expose the Target Group to
fair value interest rate risk. The bank loans issued at variable rates and
fixed rates are disclosed in note 22 of the Financial Information.
4.2 Fair value estimation
The nominal value less estimated credit adjustments of receivables and payables
are assumed to approximate their fair values. The fair value of financial
liabilities for disclosure purposes is estimated by discounting the future
contractual cash flows at the current market interest rate that is available to
the Target Group for similar financial instruments.
5. Critical accounting estimates and judgements
Estimates and judgements are continually evaluated and are based on historical
experience and other factors, including expectations of future events that are
believed to be reasonable under the circumstances.
The Target Group makes estimates and assumptions concerning the future. The
resulting accounting estimates will, by definition, seldom equal the related
actual results. The estimates and assumptions that have a significant risk of
causing a material adjustment to the carrying amounts of assets and liabilities
within the next financial year are discussed below:
(a)
Depreciation of property, plant and equipment
The property, plant and equipment of the Target Group are depreciated at rates
sufficient to write off their costs or revalued amounts less accumulated
impairment losses and estimated residual values over their estimated useful
lives on a straight-line basis. The Target Group reviewed the useful lives
periodically to ensure that the method and rates of deprecation are consistent
with the expected pattern of economic benefits from property, plant and
equipment. The Target Group estimates the useful lives of the property, plant
and equipment based on the historical experience with similar assets, taking
into account anticipated technological changes. The depreciation expenses in
the future periods will change if there are significant changes from previous
estimates.
(b)
Revaluation of property, plant and equipment
Property, plant and equipment of the Target Group are revalued as of 31
December 2004 on a depreciated replacement cost basis. Apart from lease
prepayments for land and buildings, which are carried at cost, other property,
plant and equipment are carried at the revalued amounts, being the fair value
at the date of revaluation, less subsequent accumulated depreciation and
impairment losses. Revaluations are performed at intervals of not more than
three years by independent valuers and, in each of the intervening years,
valuations are undertaken by executives of the Target Group. If the revalued
amounts differ significantly from the carrying amounts of the property, plant
and equipment in the future, the carrying amounts will be adjusted to the
revalued amounts. This will have an impact on the Target Group's future
results, since any subsequent decreases in valuation are set off first against
increases on earlier valuations in respect of the same item and thereafter are
charged as an expense to the income statement and any subsequent increases are
credited as income to the income statement up to the amount previously charged.
In addition, the depreciation expense in future periods will change as the
carrying amounts of such property, plant and equipment change as a result of
the revaluation.
(c)
Impairment of non-current assets
At each balance sheet date, the Target Group considers both internal and
external sources of information to assess whether there is any indication that
non-current assets, including property, plant and equipment, are impaired. If
any such indication exists, the recoverable amount of the assets is estimated
and an impairment loss is recognised to reduce the carrying amount of the asset
to its recoverable amount. Estimated recoverable amounts are determined based
on estimated discounted future cash flows of the cash-generating unit at the
lowest level to which the asset belongs. The recoverable amount is the higher
of value in use or net selling price. Such impairment losses are recognised in
the income statement, except where the asset is carried at valuation and the
impairment loss does not exceed the revaluation surplus for that same asset, in
which case the impairment loss is treated as a revaluation decrease and charged
to the revaluation reserve. Accordingly, there will be an impact to the future
results if there is a significant change in the recoverable amounts of the
non-current assets
(d)
Revenue recognition for upfront connection and installation fees
The Target Group defers the recognition of upfront customer connection and
installation fees and amortises them over the expected customer relationship
period of 10 years. The related direct incremental installation costs are
deferred and amortised over the same expected customer relationship period of
10 years, except that when the direct incremental costs exceed the
corresponding installation fees, if any, the excess amounts are immediately
written off as expenses to the income statement. The Target Group estimates the
expected customer relationship period based on the historical customer
retention experience and after factoring in the expected level of future
competition, the risk of technological or functional obsolescence to the Target
Group's services, technological innovation, and the expected changes in the
regulatory and social environment. If the Target Group's estimate of the
expected customer relationship period changes as a result of increased
competition, changes in telecommunications technology or other factors, the
amount and timing of recognition of the deferred revenues may change for future
periods.
(e)
Recognition of revenues and costs under PHS bundled service contracts
The Target Group provides PHS services, which is an extension of the local
wireline telecommunications service, to customers. Promotional packages
comprise the bundled provision of PHS services and handsets to customers, under
which customers either prepay a certain amount of service fee or commit to
spend a minimum monthly service fee for a designated period of time in order to
receive a free handset. The total revenues received or receivable are
recognised as deferred revenue. The cost of handsets provided to customers is
treated as deferred customer acqusition costs, to the extent that they are
recoverable through profits made from future services fees. Such deferred
revenue and deferred costs are amortised to the income statement on a
systematic basis to match the shorter of the pattern of usage of the related
service and the minimum non-cancellable contract period. If the pattern of the
usage of the PHS services by the customers changes in the future, the
amortisation period of the revenues and costs will change accordingly, which
will have an impact on future results.
(f)
Provison for doubtful debts
The Target Group maintains an allowance for doubtful debts for estimated losses
resulting from the inability of its customers to make the required payments.
The Target Group makes its estimates based on the aging of its accounts
receivable balances, customer creditworthiness, and historical write-off
experience. If the financial condition of its customers were to deteriorate,
actual write-offs might be higher than expected, and the Target Group would be
required to revise the basis of making the allowance and its future results
would be affected.
(g)
Estimation of fair value
The Target Group estimates the fair value of its financial liabilities for
disclosure purposes by discounting its future contractual cash flows at the
estimated current market interest rate that is available to the Target Group
for similar financial instruments. The future disclosed values will change if
there are changes in the estimated market interest rate.
6 Revenues
Revenues represent the turnover of the Target Group and are derived from the
provision of fixed line telecommunications and related services in PRC, net of
the PRC business taxes and government levies. The Target Group's revenues by
business nature can be summarised as follows:
Years ended 31 December Six months ended 30
June
2002 2003 2004 2004 2005
Revenues
Local usage fees 5,867 6,118 6,197 3,155 3,188
Monthly telephone service 3,482 3,896 4,221 2,122 2,107
Upfront installation fees 203 223 230 118 118
DLD usage fees 2,524 2,554 2,453 1,247 1,217
ILD usage fees 134 133 113 57 51
Value-added services 277 579 847 396 540
Interconnection fees 864 1,183 1,582 765 876
Upfront connection fees 1,280 1,157 968 512 397
Broadband service 279 663 1,034 478 735
Other internet-related service 214 176 114 67 42
Managed data service 324 338 303 155 145
Leased line income 609 374 270 132 169
Other services 175 306 284 111 127
Total 16,232 17,700 18,616 9,315 9,712
7 Profit/(loss) from operations
Profit/(loss) from operations is stated after charging and crediting the
following:
Years ended 31 December Six months ended 30
June
2002 2003 2004 2004 2005
Charging:
Depreciation (Note 16):
- Owned property, plant and equipment 5,942 6,188 6,169 3,074 3,045
- Leased property, plant and equipment 22 97 215 100 109
Amortisation of intangible assets (Note 18) 14 20 30 16 21
Amortisation of lease prepayments for land (Note 10 12 12 6 9
15)
Auditors' remuneration 5 3 15 2 1
Write off/loss on disposal of property, plant and 1,520 535 67 29 -
equipment (industry in networks, operations and
support expenses)
Impairment charge on property, plant and equipment - 131 - - -
(Note 16)
Impairment charge on lease prepayments for land - 18 - - -
(Note 15)
PHS subscribers acquisition cost 37 931 1,108 656 253
Cost of PHS handsets 34 54 51 13 7
Operating leases:
- Land and buildings 17 18 27 9 12
- Network and machinery 96 89 83 37 12
Interconnection charges 139 139 235 95 177
Bad debt expense 492 407 353 316 167
Foreign exchange losses 31 96 35 - -
Crediting:
Gain on disposal of property, plant and equipment - - - - 3
(included in networks operations and support
expenses)
Foreign exchange gains - - - 11 48
8 Finance costs
Years ended 31 December Six months ended 30 June
2002 2003 2004 2004 2005
Interest expenses on
- Bank and other loans wholly repayable within five years 1,397 1,273 1,058 552 563
- Bank and other loans wholly repayable after five years 27 49 26 12 11
1,424 1,322 1,084 564 574
Less: Interest expenses capitalised in construction
in progress (178) (158) (127) (56) (28)
1,246 1,164 957 508 546
Exchange loss/(gain), net 31 96 35 (11) (48)
Bank charges 6 10 6 3 3
1,283 1,270 998 500 501
Interest expenses were capitalised in construction 5.38% -5.64% 4.76% -6.77% 4.15% -4.86% 3.90% -4.86% 4.28% -4.76%
in progress using the following annual interest rates
9 Taxation
Years ended 31 December Six months ended 30 June
2002 2003 2004 2004 2005
PRC enterprise income tax ("EIT") 18 6 146 154 622
Deferred taxation (Note 26) (441) (404) (3,817) (52) (171)
Taxation charge/(credit) (423) (398) (3,671) 102 451
The provision for EIT is calculated based on the statutory income tax rate of
33% on the assessable profit of the Target Group as determined in accordance
with the relevant income tax rules and regulations in the PRC.
The reconciliation between the Target Group's actual tax charge/(credit) and
the amount which is calculated based on the weighted average statutory tax rate
is as follows:
Years ended at 31 December Six months ended 30 June
Note 2002 2003 2004 2004 2005
Profit/(loss) before taxation (325) (193) (10,202) 811 1,781
Statutory tax rate 33% 33% 33% 33% 33%
Tax calculated at the statutory tax rate (107) (64) (3,367) 268 588
Non-taxable income (i) (422) (381) (319) (169) (131)
Expenses not deductible for tax purposes 106 59 17 11 9
Others - (12) (2) (8) (15)
Tax charge/(credit) (423) (398) (3,671) 102 451
Note:
(i) Non-taxable income comprises primarily upfront connection fees charged to
customers and amortised over the customer relationship period.
10 Staff costs
Years ended 31 December Six months ended 30 June
2002 2003 2004 2004 2005
Contributions to pensions 246 261 368 220 218
Early retirement benefits (Note 25) 132 204 487 156 2
Wages, salaries and welfare 2,224 2,933 3,036 1,516 1,539
Total 2,602 3,398 3,891 1,892 1,759
11 Cash and bank deposits
As at 31 December As at 30
June
2002 2003 2004 2005
Cash and cash equivalents 1,046 1,090 548 464
Time deposits with original maturities over three months 51 24 32 2
Total cash and bank deposits 1,097 1,114 580 466
The effective interest rate on time deposits with original maturities over
three months is 0.72%. (2004: 0.72%; 2003: 0.72%; 2002: 1.42%).
All balances at 31 December 2002, 2003 and 2004 and 30 June 2005 are Renminbi
denominated and kept in the PRC. The conversion of Renminbi denominated
balances into foreign currencies and the remittance of bank balances and cash
out of the PRC are subject to the rules and regulations of foreign exchange
control promulgated by the PRC government.
12 Accounts receivable
Amounts due from the provision of fixed line telecommunications services to
residential customers are due within 30 days from the date of billing.
Residential customers who have accounts overdue by more than 90 days will in
normal circumstances have their services disconnected. Accounts receivable from
other telecommunications operators and customers are due between 30 to 90 days
from the billing date.
The ageing analysis of accounts receivable based on the billing date is as
follows:
As at 31 December As at 30
June
2002 2003 2004 2005
0-30 days 935 870 1,024 1,201
31-90 days 157 248 261 371
Over 90 days 221 181 557 821
Total 1,313 1,299 1,842 2,393
Less: Allowance for doubtful debts (192) (124) (356) (534)
Net carrying amounts 1,121 1,175 1,486 1,859
The movement of allowance for doubtful debts is as follows:
As at 31 December As at 30
June
2002 2003 2004 2005
Balance at beginning of year/period (172) (192) (124) (356)
Additional provisions (271) (313) (392) (178)
Less: Amounts utilised 251 381 160 -
Balance at end of year/period (192) (124) (356) (534)
The carring value of accounts receivables approximate their fair values based
on cash flows discounted using a rate based on the borrowing rate of 5.22%
(2004: 5.22%; 2003: 5.04%; 2002: 5.04%).
Included in accounts receivable are amounts due from other state-owned
telecommunications operators amounting to RMB 299 million, RMB 413 million, RMB
489 million and RMB 607 million as at 31 December 2002, 2003 and 2004 and 30
June 2005 respectively.
13 Inventories and consumables
As at 31 December As at 30
June
2002 2003 2004 2005
Consumables 259 142 209 181
Telephone handsets and other customer end products held for resale 32 67 93 92
291 209 302 273
14 Prepayments and other receivables
As at 31 December As at 30
June
2002 2003 2004 2005
Prepaid expenses and deposits 74 126 91 46
Other receivables 665 456 345 320
739 582 436 366
Included in the prepaid expenses is deferred customer acquisition cost of RMB
28 million (2004: RMB 59 million; 2003: RMB 69 million; 2002: RMB 1 million).
The carrying values of prepayments and other receivables approximate their fair
value based on cash flows discounted using a rate based on the borrowing rate
of 5.22% (2004: 5.22%; 2003: 5.04%; 2002: 5.04%).
15 Lease prepayments for land
This represents land use rights in the PRC and their net book value is analysed
as follows:
As at 31 December As at 30
June
2002 2003 2004 2005
Held for:
Lease of over 50 years 134 134 132 123
Lease of between 10 to 50 years 298 301 335 306
Lease of less than 10 years 34 15 13 8
466 450 480 437
As at 31 December As at 30
June
2002 2003 2004 2005
Opening balance 412 466 450 480
Additions 64 14 42 6
Amortisation charge for the year/period (10) (12) (12) (9)
Distributed to owners in accordance with reorganisation - - - (40)
on 30 June 2005 (Note 2)
Impairment charge for the year/period - (18) - -
466 450 480 437
16 Property, Plant and Equipment
Buildings Telecommunication Furniture, Total
networks and fixtures,
equipment motor
vehicles
and other
equipment
Cost/valuation:
Balance at 1 January 2002 6,648 54,041 2,876 63,565
Additions 186 1,624 410 2,220
Transferred from construction in progress (Note 17) 1,155 6,074 537 7,766
Disposals (73) (2,745) (556) (3,374)
Balance at 31 December 2002 7,916 58,994 3,267 70,177
Accumulated depreciation and impairment:
Balance at 1 January 2002 (1,230) (19,278) (979) (21,487)
Depreciation charge for the year (245) (5,290) (429) (5,964)
Disposals 31 1,588 243 1,862
Balance at 31 December 2002 (1,444) (22,980) (1,165) (25,589)
Net book value at 31 December 2002 6,472 36,014 2,102 44,588
Buildings Telecommunication Furniture, Total
networks and fixtures,
equipment motor
vehicles
and other
equipment
Cost/valuation:
Balance at 1 January 2003 7,916 58,994 3,267 70,177
Additions 13 1,065 291 1,369
Transferred from construction in progress (Note 17) 1,000 7,158 575 8,733
Disposals (68) (1,021) (172) (1,261)
Balance at 31 December 2003 8,861 66,196 3,961 79,018
Accumulated depreciation and impairment:
Balance at 1 January 2003 (1,444) (22,980) (1,165) (25,589)
Impairment charge for the year (123) - (8) (131)
Depreciation charge for the year (281) (5,540) (464) (6,285)
Disposals 12 581 113 706
Balance at 31 December 2003 (1,836) (27,939) (1,524) (31,299)
Net book value at 31 December 2003 7,025 38,257 2,437 47,719
Buildings Telecommunication Furniture, Total
networks and fixtures,
equipment motor
vehicles
and other
equipment
Cost/valuation:
Balance at 1 January 2004 8,861 66,196 3,961 79,018
Additions 39 598 292 929
Transferred from construction in progress (Note 17) 414 6,657 327 7,398
Disposals (16) (137) (102) (255)
Increase as a result of revaluation - 17,140 1,503 18,643
Decrease as a result of revaluation - (21,201) (1,065) (22,266)
Balance at 31 December 2004 9,298 69,253 4,916 83,467
Accumulated depreciation and impairment:
Balance at 1 January 2004 (1,836) (27,939) (1,524) (31,299)
Depreciation charge for the year (325) (5,586) (473) (6,384)
Disposals 5 92 61 158
Increase as a result of revaluation - (13,458) (1,322) (14,780)
Decrease as a result of revaluation - 10,461 487 10,948
Balance at 31 December 2004 (2,156) (36,430) (2,771) (41,357)
Net book value at 31 December 2004 7,142 32,823 2,145 42,110
Buildings Telecommunication Furniture, Total
networks and fixtures,
equipment motor
vehicles
and other
equipment
Cost/valuation:
Balance at 1 January 2005 9,298 69,253 4,916 83,467
Additions 1 100 49 150
Transferred from construction in progress (Note 17) 231 1,766 94 2,091
Disposals (6) (2) (26) (34)
Distributed to owners in accordance with the
Reorganisation on 30 June 2005 (Note 2) (1,759) (1,242) (183) (3,184)
Balance at 30 June 2005 7,765 69,875 4,850 82,490
Accumulated depreciation and impairment:
Balance at 1 January 2005 (2,156) (36,430) (2,771) (41,357)
Depreciation charge for the period (171) (2,736) (247) (3,154)
Disposals 4 - 24 28
Distributed to owners in accordance with the 487 743 90 1,320
Reorganisation on 30 June 2005 (Note 2)
Balance at 30 June 2005 (1,836) (38,423) (2,904) (43,163)
Net book value at 30 June 2005 5,929 31,452 1,946 39,327
(a) The net book value of assets held under finance lease is as follows:
Buildings Telecommunication Furniture, Total
networks and fixtures,
equipment motor
vehicles
and other
equipment
31 December 2002 - 91 - 91
31 December 2003 - 863 33 896
31 December 2004 8 1,811 90 1,909
30 June 2005 7 1,711 84 1,802
The Target Group entered into finance lease arrangements with a related party
for certain existing property, plant and equipment in order to obtain funding
of RMB 596 million and RMB 1,150 million during the years ended 31 December
2003 and 2004 respectively. The net book value of such property, plant and
equipment included above amounted to RMB 595 million, RMB 1,638 million, and
RMB 1,542 million and the corresponding finance lease obligation amounted to
RMB 593 million, RMB 1,338 million, RMB 1,020 million as at 31 December 2003
and 2004 and 30 June 2005, respectively (see note 22(b)(ii)).
(b) The analysis of the cost or revaluation of the assets of the Target Group
is as follows:
Buildings Telecommunication Furniture, Total
networks and fixtures,
equipment motor
vehicles
and other
equipment
At 31 December 2002
Cost 7,916 58,994 3,267 70,177
Valuation - - - -
7,916 58,994 3,267 70,177
At 31 December 2003
Cost 8,861 66,196 3,961 79,018
Valuation - - - -
8,861 66,196 3,961 79,018
At 31 December 2004
Cost 9,298 - - 9,298
Valuation - 69,253 4,916 74,169
9,298 69,253 4,916 83,467
At 30 June 2005
Cost 7,765 - - 7,765
Valuation - 69,875 4,850 74,725
7,765 69,875 4,850 82,490
(c) As detailed in Note 3.5(c), except for buildings, property, plant and
equipment were carried at revalued amounts on 31 December 2004. As required by
the PRC rules and regulations relevant to the Reorganisation, each class of
property, plant and equipment and lease prepayments for land in the PRC
injected into the Target Group as at 31 December 2004, was valued by Beijing
China Enterprise Appraisal Co. Ltd. (the "PRC valuer"), independent valuers
registered in the PRC, on a depreciated replacement cost basis. The value of
such property, plant and equipment and lease prepayments for land in the PRC
injected into the Group was determined at RMB 42,879 million. The property,
plant and equipment retained by the ultimate holding company, which were
transferred based on their carrying values upon the Reorganisation, were valued
by the Directors at an amount of RMB 1,944 million as at 31 December 2004. The
impact of the revaluation was a net deficit on revaluation of the property,
plant and equipment, other than buildings, totalling RMB 7,455 million.
Following the revaluation of property, plant and equipment, the revalued amount
of such assets will serve as the tax base for such assets in future years (see
Note 26(ii)).
The lease prepayments for land (Note 15) and buildings were also revalued and
the result was a net surplus of RMB 2,553 million. Such revaluation on lease
prepayments for land and buildings has not been reflected in the Financial
Information and only serves as the tax base for lease prepayments for land and
buildings for future years (see Note 26(iii)).
The lease prepayments for land and buildings injected by China Netcom Group
were valued separately by Sallmanns, independent qualified valuers in Hong
Kong, as at 31 December 2004 on the basis of their open market value. The value
arrived at by these valuers was consistent with that arrived at by the PRC
valuer. The Target Group's lease prepayments for land and buildings are carried
at their cost less accumulated depreciation and impairment losses in the
Financial Information.
The respective carrying amount of the telecommunications networks and equipment
and furniture, motor vehicles and other equipment would have been RMB 39,881
million and RMB 2,542 million as at 31 December 2004 and RMB 38,193 million and
RMB 2,322 million as at 30 June 2005 had they been stated at cost less
accumulated depreciation.
The historical carrying amounts of the Target Group's property, plant and
equipment, as at 31 December 2004, and where applicable the corresponding
revalued amounts of these assets are as follows:
Historical Revaluation Revaluation Revalued
carrying surplus Deficit Amount
amount
At 31 December 2004
Buildings 7,142 - - 7,142
Telecommunications networks and equipment 39,881 3,682 (10,740) 32,823
Furniture, fixtures, motor vehicles and other equipment 2,542 181 (578) 2,145
49,565 3,863 (11,318) 42,110
The directors have carried out a review of the Target Group's property, plant
and equipment and concluded that there was no impairment of property, plant and
equipment as at 30 June 2005, nor was there any significant change in the value
of property, plant and equipment at that date.
17 Construction in progress
As at 31 December As at 30
June
2002 2003 2004 2005
Balance at beginning of year/period 4,768 3,518 2,354 2,995
Additions 6,516 7,569 8,039 2,489
Transferred to property, plant and equipment (Note 16) (7,766) (8,733) (7,398) (2,091)
Distributed to owners in accordance with the - - - (215)
Reorganisation on 30 June 2005 (Note 2)
Balance at end of year/period 3,518 2,354 2,995 3,178
18 Intangible assets
Purchased Sponsorship Total
software fee
Note 31 (x)
Cost:
Balance at 1 January 2002 56 - 56
Additions 24 - 24
Balance at 31 December 2002 80 - 80
Accumulated amortisation:
Balance at 1 January 2002 (8) - (8)
Amortisation for the year (14) - (14)
Balance at 31 December 2002 (22) - (22)
Net book value at 31 December 2002 58 - 58
Cost:
Balance at 1 January 2003 80 - 80
Additions 53 - 53
Balance at 31 December 2003 133 - 133
Accumulated amortisation:
Balance at 1 January 2003 (22) - (22)
Amortisation for the year (20) - (20)
Balance at 31 December 2003 (42) - (42)
Net book value at 31 December 2003 91 - 91
Cost:
Balance at 1 January 2004 133 - 133
Additions 5 - 5
Balance at 31 December 2004 138 - 138
Accumulated amortisation:
Balance at 1 January 2004 (42) - (42)
Amortisation for the year (30) - (30)
Balance at 31 December 2004 (72) - (72)
Net book value at 31 December 2004 66 - 66
Cost:
Balance at 1 January 2005 138 - 138
Additions 16 60 76
Balance at 30 June 2005 154 60 214
Accumulated amortisation:
Balance at 1 January 2005 (72) - (72)
Amortisation for the period (13) (8) (21)
Balance at 30 June 2005 (85) (8) (93)
Net book value at 30 June 2005 69 52 121
19 Deferred costs
As at 31 December As at 30
June
2002 2003 2004 2005
Balance at beginning of year/period
- Installation costs 591 615 619 592
- Others 34 53 53 62
625 668 672 654
Additions for the year/period
- Installation costs 107 98 76 29
- Others 40 29 68 2
147 127 144 31
Charge for the year/period
- Installation costs (83) (94) (103) (49)
- Others (21) (29) (59) (43)
(104) (123) (162) (92)
Balance at end of year/period
- Installation costs 615 619 592 572
- Others 53 53 62 21
668 672 654 593
20 Accounts payable
As at 31 December As at 30
June
2002 2003 2004 2005
0-30 days 1,343 2,059 2,249 1,334
31-60 days 185 267 518 494
61-90 days 309 150 298 385
91-180 days 477 372 807 1,002
Over 180 days 3,318 2,561 2,600 2,876
5,632 5,409 6,472 6,091
Included in accounts payable are amounts due to other state-owned
telecommunications operators amounting to RMB 37 million, RMB 24 million, RMB
43 million and RMB 7 million as at 31 December 2002, 2003 and 2004 and 30 June
2005 respectively.
21 Accruals and other payables
As at 31 December As at 30
June
2002 2003 2004 2005
Accrued expenses 10 13 11 21
Other payables 1,629 1,254 1,502 1,298
1,639 1,267 1,513 1,319
22 Bank and other loans
(a)
The short term bank loans were unsecured and comprise:
As at 31 December As at 30
June
Currency Interest rate 2002 2003 2004 2005
Renminbi denominated Variable 10,219 15,703 15,472 16,907
Interest
rates
ranging from
4.43% to
5.94% per
annum
US Dollar denominated Fixed - 71 71 71
Interest
rates at
3.27% per
annum
10,219 15,774 15,543 16,978
The carrying values of short term bank loans approximate their fair values
which are based on cash flows discounted using rates based on the borrowing
rates of 3.27%-5.94% (2004: 2.59%-5.94%; 2003: 3.27%-5.94%; 2002: 3.27%-5.94%).
(b)
The Target Group's long term bank loans and other loans comprise:
As at 31 December As at 30
June
Note 2002 2003 2004 2005
Bank loans (i) 16,599 10,638 7,107 5,526
Finance lease obligations (ii) 52 901 1,541 1,171
16,651 11,539 8,648 6,697
Less: Current portion (5,727) (3,676) (4,457) (3,484)
10,924 7,863 4,191 3,213
The carrying values of the current portion of long term bank loans approximate
their fair values which are based on cash flows discounted using a rate based
on the borrowing rate of 5.22% (2004: 5.22%; 2003: 5.04%; 2002: 5.04%).
(i) Long term bank loans
As at 31 December As at 30
June
2002 2003 2004 2005
Bank Loans
Unsecured 16,304 10,365 6,847 5,273
Secured 295 273 260 253
Total 16,599 10,638 7,107 5,526
Less: Current portion (5,688) (3,315) (3,736) (2,815)
Long-term loans 10,911 7,323 3,371 2,711
The Target Group's long term bank loans are repayable as follows:
As at 31 December As at 30
June
2002 2003 2004 2005
Within one year 5,688 3,315 3,736 2,815
In the second year 4,717 4,553 1,726 272
In the third to fifth year 5,310 1,969 944 1,837
After the fifth year 884 801 701 602
16,599 10,638 7,107 5,526
The Target Group's long term bank loans comprise:
Currency Interest As at 31 December As at 30
2002 rate and June
final
maturity
2003 2004 2005
Renminbi denominated Variable 14,600 8,967 5,727 4,349
interest
rates
ranging
from 2.4%
to 10.98%
per
annum
with
maturity
through 1
November
2011
US Dollar denominated Variable 1,242 986 671 652
interest
rates
ranging
from
0.19% to
8.3% per
annum
with
maturity
through 31
October 2039
Japanese Yen denominated Variable 445 463 482 330
interest
rates
ranging
from 2.3%
to 5.2%
per annum
with
maturity
through
18 June
2027
Euro denominated Variable 312 222 227 195
interest
rates
ranging
from 0.5%
to 7.35%
per annum
with
maturity
through
15 March
2034
16,599 10,638 7,107 5,526
As at 30 June 2005, bank loans of RMB 253 million (2004: RMB 260 million, 2003:
RMB 273 million, 2002: RMB 295 million) were secured by:
(i) Corporate guarantees granted by China Netcom Group to the extent of RMB
253 million at 30 June 2005 (2004: RMB 260 million, 2003: RMB 273 million,
2002: RMB 287 million); and
(ii) Corporate guarantees granted by third parties to the extent of Nil at 30
June 2005 (2004: Nil, 2003: Nil, 2002: RMB 8 million).
(ii) Finance lease obligations
As at 31 December As at 30
June
2002 2003 2004 2005
Obligation under finance leases 52 901 1,541 1,171
Less: current portion (39) (361) (721) (669)
13 540 820 502
The Target Group entered into finance lease arrangements with a related party
for certain existing property, plant and equipment in order to obtain funding
of RMB 596 million and RMB1,150 million during the years ended 31 December 2003
and 2004 respectively. The net book value of such property, plant and equipment
amounted to RMB 595 million, RMB 1,638 million, and RMB 1,542 million and the
corresponding finance lease obligation included above amounted to RMB 593
million, RMB 1,338 million, RMB 1,020 million as at 31 December 2003 and 2004
and 30 June 2005, respectively.
The Target Group's liabilities under finance leases are analyzed as follows:
As at 31 December As at 30
June
2002 2003 2004 2005
Within one year 43 375 756 692
In the second year 15 366 593 484
In the third to fifth year, inclusive - 191 251 31
58 932 1,600 1,207
Less: future finance charges on finance leases (6) (31) (59) (36)
Present value of finance lease liabilities 52 901 1,541 1,171
The present value of finance lease liabilities is as follows:
Within one year 39 361 721 669
In the second year 13 354 574 472
In the third to fifth year, inclusive - 186 246 30
52 901 1,541 1,171
The fair values of the Target Group's long term portion of long term bank loans
and other loans are as follows:
As at 31 December As at 30
June
2002 2003 2004 2005
Bank loans 10,179 6,785 3,136 2,576
Finance Leases 13 540 820 502
10,192 7,325 3,956 3,078
The fair values are based on cash
flows discounted using rates based on the
borrowing rates of 0.5%-8.30% (2004:0.19%-9.20%;
2003:0.19%-8.30%; 2002: 0.19%-8.30%). 23
Amounts due from/(to) ultimate holding
companies and fellow subsidiaries
As at 31 December As at 30
June
Note 2002 2003 2004 2005
Due from ultimate holding company (a) - 27 650 156
Due from fellow subsidiaries (a) 141 67 64 10
141 94 714 166
Due to ultimate holding company (a),(b) 69 472 520 954
Due to fellow subsidiaries (a) 1,162 976 1,316 912
1,231 1,448 1,836 1,866
Notes:
a) These are interest free, unsecured and have no fixed terms of repayment.
b) As at 30 June 2005, amounts due to ultimate holding company amounting to
RMB 436 million were waived and recognised in the Target Group's equity upon
the Reorganisation.
24 Deferred revenues
As at 31 December As at 30
June
2002 2003 2004 2005
Balance at beginning of year/period
- upfront connection fees 5,303 4,023 2,866 1,898
- upfront installation fees 1,234 1,308 1,310 1,234
- prepaid telephony services 645 772 975 1,262
7,182 6,103 5,151 4,394
Additions for the year/period
- upfront connection fees - - - -
- upfront installation fees 277 225 154 83
- prepaid telephony services 3,011 4,879 6,821 3,395
3,288 5,104 6,975 3,478
Reductions for the year/period
- upfront connection fees (1,280) (1,157) (968) (397)
- upfront installation fees (203) (223) (230) (118)
- prepaid telephony services (2,884) (4,676) (6,534) (3,543)
(4,367) (6,056) (7,732) (4,058)
Balance at end of year/period
- upfront connection fees 4,023 2,866 1,898 1,501
- upfront installation fees 1,308 1,310 1,234 1,199
- prepaid telephony services 772 975 1,262 1,114
6,103 5,151 4,394 3,814
Representing:
- Current portion 2,140 2,170 2,223 1,954
- Non-current portion 3,963 2,981 2,171 1,860
6,103 5,151 4,394 3,814
25 Provisions
One-off Total
Early cash
retirement housing
benefits subsidies
Note (b), Note (a),
3.13(b) (b)
At 1 January 2002 1,383 1,324 2,707
Additional provisions 132 - 132
Payments during the year (159) (4) (163)
At 31 December 2002 1,356 1,320 2,676
Analysis of total provisions:
Current portion 175 1,320 1,495
Non-current portion 1,181 - 1,181
1,356 1,320 2,676
At 1 January 2003 1,356 1,320 2,676
Additional provisions 204 - 204
Payments during the year (175) (2) (177)
At 31 December 2003 1,385 1,318 2,703
Analysis of total provisions:
Current portion 232 1,318 1,550
Non-current portion 1,153 - 1,153
1,385 1,318 2,703
At 1 January 2004 1,385 1,318 2,703
Additional provisions 487 - 487
Payments during the year (226) (2) (228)
At December 2004 1,646 1,316 2,962
Analysis of total provisions:
Current portion 215 1,316 1,531
Non-current portion 1,431 - 1,431
1,646 1,316 2,962
At 1 January 2005 1,646 1,316 2,962
Additional provisions 2 - 2
Payments during the period (82) - (82)
At 30 June 2005 1,566 1,316 2,882
Analysis of total provisions:
Current portion 197 1,316 1,513
Non-current portion 1,369 - 1,369
1,566 1,316 2,882
a) Certain staff quarters, prior to 1998, have been sold to the Target
Group's employees, subject to a number of eligibility requirements, at
preferential prices. In 1998, the State Council of the PRC issued a circular
which stipulated that the sale of quarters to employees at preferential prices
should be terminated. In 2000, the State Council issued a further circular
stating that cash subsidies should be made to certain eligible employees
following the withdrawal of the allocation of staff quarters. However, the
specific timetable and procedures for implementation of these policies were to
be determined by individual provincial or municipal governments based on the
particular situation of the provinces or municipality.
Based on the relevant detailed local government regulations promulgated,
certain entities within the Target Group have adopted cash housing subsidy
plans. In accordance with these plans, for those eligible employees who had not
been allocated with quarters or who had not been allocated with quarters up to
the prescribed standards before the discounted sales of quarters were
terminated, the Target Group is required to pay them one-off cash housing
subsidies based on their years of service, positions and other criteria. Based
on the available information, the Target Group estimates the required provision
for these cash housing subsidies amounts to RMB 1,324 million, which was
charged to the combined income statement in the year ended 31 December 2000
when the State Council circular in respect of cash subsidies was issued.
b) Pursuant to the Reorganisation, if the actual payments required for these
provisions differ from the amount provided as of 30 June 2005, China Netcom
Group will bear any additional payments required or will be paid the difference
if the actual payments are lower than the amount provided.
26 Deferred taxation
As at 31 As at 31 As at 31 As at 30
December December December June 2005
2002 2003 2004
Deferred tax assets
Deferred revenue and installation cost 392 385 208 204
Other temporary differences primarily allowance for 133 215 273 68
doubtful debts
Provision for early retirement provision benefits 448 457 543 28
Disposal of property, plant and equipment 681 874 - -
Property, plant and equipment depreciation - - 325 -
Unrecognised revaluation surplus - - - 831
Others 9 145 61 12
Balance at end of year/period 1,663 2,076 1,410 1,143
Deferred tax liabilities
Property, plant and equipment depreciation (2,226) (2,496) - -
Interest capitalisation (195) (227) (245) (50)
Others (76) (36) (10) -
Balance at end of year/period (2,497) (2,759) (255) (50)
The amounts
shown in
the
combined
balance
sheet
include the
following:
Deferred tax assets to be recovered after
more than 12 months 1,279 648 1,029 979
Deferred tax liabilities to be settled after
more than 12 months (2,226) (2,496) (204) (44)
Movements in deferred taxes for each of the years/periods are as follows:
Note Balance at Recognised Recognised Balance at
31 December in income in owner's 31 December
2001 statements equity 2002
Deferred tax assets
Deferred revenue and installation cost 351 41 - 392
Other temporary differences primarily 106 27 - 133
allowance for doubtful debts
Provision for early retirement provision 457 (9) - 448
benefits
Disposal of property, plant and equipment 361 320 - 681
Tax loss (i) - 310 (310) -
Others 20 (11) - 9
Balance at end of year 1,295 678 (310) 1,663
Deferred tax liabilities
Property, plant and equipment depreciation (2,076) (150) - (2,226)
Interest capitalisation (150) (45) - (195)
Others (34) (42) - (76)
Balance at end of year (2,260) (237) - (2,497)
Net balance at end of year (965) 441 (310) (834)
Note Balance at Recognised Recognised Balance at
31 December in income in owner's 31 December
2002 statements equity 2003
Deferred tax assets
Deferred revenue and installation cost 392 (7) - 385
Other temporary differences primarily 133 82 - 215
allowance for doubtful debts
Provision for early retirement provision benefits 448 9 - 457
Disposal of property, plant and equipment 681 193 - 874
Tax loss (i) - 253 (253) -
Others 9 136 - 145
Balance at end of year 1,663 666 (253) 2,076
Deferred tax liabilities
Property, plant and equipment depreciation (2,226) (270) - (2,496)
Interest capitalisation (195) (32) - (227)
Others (76) 40 - (36)
Balance at end of year (2,497) (262) - (2,759)
Net balance at end of year (834) 404 (253) (683)
Note Balance at Recognised Recognised Balance at
31 December in income in owner's 31 December
2003 statements equity 2004
Deferred tax assets
Deferred revenue and installation cost 385 (177) - 208
Other temporary differences primarily 215 58 - 273
allowance for doubtful debts
Provision for early retirement provision benefits 457 86 - 543
Disposal of property, plant and equipment 874 (874) - -
Tax loss (i) - 704 (704) -
Property, plant and equipment depreciation - 325 - 325
Others 145 (84) - 61
Balance at end of year 2,076 38 (704) 1,410
Deferred tax liabilities
Property, plant and equipment depreciation (2,496) 3,771 (1,275) -
Interest capitalisation (227) (18) - (245)
Others (36) 26 - (10)
Balance at end of year (2,759) 3,779 (1,275) (255)
Net balance at end of year (683) 3,817 (1,979) 1,155
Note Balance at Recognised Recognised Recognised Balance
31 December in income in owner's in owner's at 30
2004 statements equity equity June 2005
(ii) (iii)
Deferred tax assets
Deferred revenue and installation cost 208 5 (9) - 204
Other temporary differences primarily
allowance for doubtful debts 273 88 (293) - 68
Provision for early retirement provision benefits 543 (17) (498) - 28
Property, plant and equipment depreciation 325 95 (420) - -
Unrecognised revaluation surplus - (12) - 843 831
Others 61 3 (52) - 12
Balance at end of period 1,410 162 (1,272) 843 1,143
Deferred tax liabilities
Interest capitalisation (245) (1) 196 - (50)
Others (10) 10 - - -
Balance at end of year/period (255) 9 196 - (50)
Net balance at end of year/period 1,155 171 (1,076) 843 1,093
Notes:
(i) This represents the net tax loss carry forward of the Target Group for
the year. As the tax loss was utilised by the China Netcom Group in the same
year, the utilisation of the deferred tax assets was reflected as a
distribution to the owner in the combined statements of changes in owner's
equity.
(ii) As described in Note 16, in connection with the Reorganisation, certain
of the Target Group's telecommunications networks and equipment and furniture,
fixture, motor vehicles and other equipment were revalued as at 31 December
2004. Such revalued amounts will be used to determine the tax bases for these
assets for future years. In addition, in connection with the Reorganisation,
the tax bases of certain assets and liabilities have been adjusted to the
revalued amounts incorporated as the carrying values in the balance sheet,
except for the item described in Note (iii) below. As a result, the Target
Group's net deferred tax assets were subsequently decreased by RMB 1,076
million comprising deferred tax assets of RMB 1,272 million and deferred tax
liabilities of RMB 196 million, and this decrease was recorded as a debit to
owner's equity upon the date of the Reorganisation on 30 June 2005. RMB 1,097
million, being deferred tax liabilities originated from the revaluation surplus
of fixed assets recorded, was credited to revaluation reserves and the
remaining RMB 2,174 million deferred tax assets were debited to retained
earnings.
(iii) In addition, the Target Group's lease prepayments for land and
buildings were revalued for PRC tax purposes with a net surplus of RMB 2,553
million as at 31 December 2004 to determine the tax bases for future years.
However, the resulting revaluations of lease prepayments for land and buildings
were not incorporated in the combined financial statements. As a result, a
deferred tax asset of RMB 843 million was subsequently recorded with a
corresponding increase in owner's equity upon the Reorganisation on 30 June
2005. In the opinion of the directors, it is more likely than not that the
Target Group will realise the benefits of the deferred tax asset after making
reference to the historical taxable income of the Target Group. The revaluation
amount is transferred to retained earnings upon the corresponding realisation
of the underlying deferred tax assets. The amount of transfer to retained
earnings for the six months ended 30 June 2005 was RMB 13 million.
27 Combined cash flow statements
(a) Reconciliation of profit/(loss) before taxation to net cash flows
generated from operations:
Years ended 31 December Six months ended 30
June
2002 2003 2004 2004 2005
Profit/(loss) before taxation (325) (193) (10,202) 811 1,781
Depreciation of fixed assets and amortisation of 5,988 6,317 6,426 3,196 3,184
intangible assets
Increase in deferred revenues (1,079) (952) (757) (472) (580)
Increase/(decrease) in deferred costs (43) (48) 18 18 63
Deficit on revaluation of fixed assets - - 11,318 - -
Allowance for doubtful debts 492 407 353 316 167
Loss/(gain) on disposal of fixed assets 1,520 535 67 29 (3)
Interest income (28) (16) (11) (5) (3)
Interest expense 1,246 1,164 957 508 546
Impairment of property, plant and equipment and - 149 - - -
lease prepayments for land
Operating profit before working capital changes 7,771 7,363 8,169 4,401 5,155
Decrease/(increase) in accounts receivable (191) (385) (698) (413) (527)
Decrease/(increase) in inventories and consumables 133 83 (93) (118) 28
Decrease/(increase) in prepayments and other 744 166 (443) 104 567
receivable
Increase/(decrease) in accounts payable (323) (372) 283 (18) (631)
Increase/(decrease) in accruals and other payables (832) (135) 510 468 28
Net cash inflow generated from operations 7,302 6,720 7,728 4,424 4,620
(b) Major non-cash transactions
The Target Group entered into finance lease arrangements in respect of newly
acquired property, plant and equipment with a total capital value at the
inception of the lease of Nil, RMB 899 million, RMB 1,541 million, RMB 1,152
million and RMB 12 million for the year ended 31 December 2002, 2003 and 2004
and the six months ended 30 June 2004 and 2005.
28 Contingent liabilities
The Target Group has no contingent liabilities as at 31 December 2002, 2003 and
2004 and 30 June 2005.
29 Banking facilities
As at 31 December 2002, 2003 and 2004 and 30 June 2005, the Target Group's
banking facilities are as follows:
As at 31 December As at 30
June
2002 2003 2004 2005
Amount utilised 26,818 26,412 22,650 22,504
Amount unutilised 8,000 8,156 10,759 10,702
Aggregate banking facilities 34,818 34,568 33,409 33,206
30 Commitments
(a) Capital commitments
As at 31 December As at 30
June
2002 2003 2004 2005
Contracted but not provided for
Lease prepayments for land and buildings 27 33 90 77
Telecommunications networks and equipment 60 94 86 227
Others 3 1 6 1
90 128 182 305
(b) Operating lease commitments
The Target Group has future minimum lease payments under non-cancellable
operating leases in respect of premises and equipment as follows:
As at 31 December As at 30
June
2002 2003 2004 2005
Not later than one year 7 10 11 10
Later than one year and not later than five years 6 17 19 15
Later than five years 4 5 8 8
17 32 38 33
31 Related party transactions
Parties are considered to be related if one party has the ability, directly or
indirectly, to control the party or exercise significant influence over the
party in making financial and operating decisions. Parties are also considered
to be related if they are subject to common control or common significant
influence.
China Netcom Group, the Target Group's parent company, is a state-controlled
enterprise directly controlled by the PRC government. The PRC government is the
Company's ultimate controlling party. Neither China Netcom Group nor the PRC
government publishes financial statements available for public use.
All state-controlled enterprises, their subsidiaries, their key management and
their close family, and their employees (collectively referred as "state-owned
parties") are ultimately related parties of the Target Group. The Target Group
has extensive transactions including provision and receiving of services,
leasing of assets and obtaining finances, with these state-owned parties in its
ordinary course of business. These transactions are carried out at terms
similar to those with other non-state-owned parties and have been reflected in
the Financial Information.
The Target Group's operations are subject to the supervision of and regulation
by the PRC Government. The Ministry of Information Industry (the "MII"),
pursuant to the authority delegated by the PRC's State Council, is responsible
for formulating the telecommunications industry policies and regulations for
all telecommunication operators in China. As a state-owned telecommunication
operator, the Target Group has extensive transactions with other state-owned
telecommunication operators in its ordinary course of business. These
transactions are carried out in accordance with the rules and regulations
stipulated by the MII of the PRC Government and disclosed below.
The Target Group has extensive transactions with other members of the China
Netcom Group. As a result of this relationship, it is possible that the terms
of the transactions between the Target Group and other members of the China
Netcom Group are not the same as those that would result from transactions with
other related parties or wholly unrelated parties.
Management believes that meaningful information relative to related party
disclosures has been adequately disclosed.
Note For the year ended 31 December For the six months
ended 30 June
2002 2003 2004 2004 2005
Interconnection income
- from utlimate holding company v)b - - 2 - -
- from fellow subsidiaries v)b - - 2 - 7
- from other state-owned v)b 864 1,183 1,578 765 869
telecommunications operators
Sub total 864 1,183 1,582 765 876
Interconnection charges
- from utlimate holding company v)b - - 13 - -
- from fellow subsidiaries v)b - - 18 - 30
- from other state-owned v)b 139 139 204 95 147
telecommunications operators
Sub total 139 139 235 95 177
Rental income from properties v)a,c - - 1 - -
leased to fellow subsidiaries
Purchase of materials
- from fellow subsidiaries v)a,b,c 585 726 814 249 148
- from related company v)a,b,c 43 63 46 7 8
Sub total 628 789 860 256 156
Receipt of engineering, project
planning, design, construction and
information technology services
- from fellow subsidaries v)a 753 910 929 235 112
- from related company v)a 67 56 64 25 17
Sub total 820 966 993 260 129
Ancillary telecommunications i)
support services
- from fellow subsidaries v)a,b,c - 92 66 33 6
- from related company v)a,b,c 71 - - - -
Sub total 71 92 66 33 6
Payment of operating lease rentals
of premises
- from fellow subsidaries v)a,c 4 4 5 - 2
- from related company v)a,c 1 - - - -
Sub total 5 4 5 - 2
Support services ii)
- from fellow subsidaries v)a,b,c 401 466 230 106 34
- from related company v)a,b,c 11 969 1,127 134 192
Sub total 412 1,435 1,357 240 226
Leased line revenue
- from other state-owned v)b 514 275 172 90 174
telecommunications operators
Notes:
(i) Represents the provision of ancillary telecommunications support services
to the Target Group by fellow subsidiaries and related companies. These
services include certain telecommunications pre-sale, on-sale and after-sale
services, certain sales agency services, the printing and delivery of invoice
services, the maintenance of certain air-conditioning, fire alarm equipment and
telephone booths and other customers services.
(ii) Represents the support services provided to the Target Group by the
fellow subsidiaries and the related companies. These support services include
equipment leasing services, motor vehicles services, safety and security
services, conference services, basic construction agency services, equipment
maintenance services, employee training services, advertising services,
printing services and other support services.
(iii) As at the respective balance sheet dates, the Target Group had balances
and finance lease arrangements with certain related parties, which have been
set out in Notes 12, 20, 22(b)(ii) and 23.
(iv) The related parties represent the investees of the unlisted fellow
subsidiaries.
(v) Transactions with individual related parties before reorganisation on 30
June 2005 were priced based on one of the following three criteria:
(a) market price;
(b) prices based on government guidance; or
(c) cost plus basis.
(vi) In connection with the Reorganisation, the Target Group and China Netcom
Group entered into a number of agreements effective on the completion date of
the Proposed Acquisition with an initial term expiring on 31 December 2007. The
terms of the principal agreements are summarised as follows:
(a) The Target Group entered into Domestic Interconnection Settlement
Agreements with China Netcom Group for interconnection of domestic and
international long distance telephone calls. Pursuant to the said agreements,
the telephony operator terminating a telephone call made to its local networks
is entitled to receive a fee prescribed by MII from the operators from which
the telephone call is originated.
(b) The Target Group entered into a Property Leasing Agreement with China
Netcom Group pursuant to which the Target Group leases certain properties
to/from China Netcom Group. The rental charges are based on market rates or
depreciation charge and maintenance charge in respect of each property,
provided that such depreciation and maintenance charge shall not be higher than
the market rates.
(c) The Target Group entered into a Property Sub-leasing Agreement with China
Netcom Group pursuant to which the Target Group leases certain properties from
China Netcom Group which are owned by independent third parties. The rental
charges are based on market rates negotiated between China Netcom Group and the
relevant third parties.
(d) The Target Group entered into a Master Sharing Agreement with China
Netcom Group pursuant to which expenses associated with common corporate
services are allocated between the Target Group and China Netcom Group based on
total assets as appropriate.
(e) The Target Group entered into an Engineering and Information Technology
Services Agreement with China Netcom Group pursuant to which China Netcom Group
provides the Target Group with engineering and information technology-related
services. The amounts charged for these services are determined by reference to
market rates as reflected in prices obtained through a tender.
(f) The Target Group entered into a Materials Procurement Agreement with
China Netcom Group pursuant to which China Netcom 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 3% of the contract value of
the equipment and materials purchased from domestic suppliers or 1% of the
contract value of the equipment and materials purchased from overseas
suppliers.
(g) The Target Group entered into an Ancillary Telecommunications Services
Agreement with China Netcom Group. The ancillary telecommunications services
provided by China Netcom Group include certain telecommunications pre-sale,
on-sale and after-sale services, sales agency services and certain customer
services. Pursuant to the said agreement, China Netcom Group charges the Target
Group for these services in accordance with the following terms:
o The government fixed price;
o Where there is no government fixed price but a government guidance price
exists, the government guidance price;
o Where there is neither government fixed price nor a government guidance
price, the market price; or
o Where none of the above is applicable, the price to be agreed between the
relevant parties, and determined on a cost-plus basis.
(h) The Target Group entered into a Support Services Agreement for various
support services with China Netcom Group. The support services provided by
China Netcom Group include equipment leasing and maintenance services, motor
vehicles services, safety and security service, basic construction agency
services, research and development services, employee training services and
advertising services and other support services. Pursuant to the said
agreement, China Netcom Group charges the Target Group for these services in
accordance with the following terms:
o The government fixed price;
o Where there is no government fixed price but a government guidance price
exists, the government guidance price;
o Where there is neither government fixed price nor a government guidance
price, the market price; or
o Where none of the above is applicable, the price to be agreed between the
relevant parties, and determined on a cost-plus basis.
(i) The Target Group entered into a Telecommunications Facilities Leasing
Agreement with China Netcom Group pursuant to which the Target Group leases the
international telecommunications facilities and inter-provincial transmission
optic fibres from China Netcom Group. The lease payment is based on the
depreciation charge of the assets, provided that such charges shall not be
higher than market rates.
(vii) In addition, pursuant to the Reorganisation, China Netcom Group has
agreed to hold and maintain, for the Target Group's benefit, all licenses
received from the MII in connection with the Restructured Businesses
transferred to the Group. The licences maintained by China Netcom Group were
granted by the MII at nil or nominal costs. To the extent that China Netcom
Group incurs a cost to maintain or obtain licences in the future, the Target
BVI Company has agreed reimburse China Netcom Group for any such expense.
(viii) China Netcom Group has also agreed to indemnify the Target Group in
connection with any tax and deferred tax liabilities not recognised in the
financial statements of the Target Group and arisen from transactions prior to
the date of Reorganisation.
(ix) As at the respective balance sheet dates, China Netcom Group granted
corporate gurantee to the Target Group as set out in Note 22 (b) (i).
(x) China Netcom Group, the Target Group's ultimate holding company, entered
into an agreement (the "Sponsorship Agreement") with Beijing Organisation
Committee ("BOCOG") which designated China Netcom Group as the exclusive
fixed-line telecommunications services partner in the People's Republic of
China ("PRC") to sponsor the 2008 Beijing Olympic Games. China Netcom Group
allocated the sponsorship fee to its members based on the estimated future
benefits derived from the Sponsorship Agreement to respective members and the
Target Group have contributed a portion of the required support under the
Sponsorship Agreement through providing cash to BOCOG amounting to RMB 60
million. Accordingly, an intangible asset and a payable to the ultimate holding
company of the said amount have been recognised on the Target Group's balance
sheet.
32 Distributable reserves
As at 30 June 2005, the Target BVI Company had not been incorporated and hence
there were no reserves available for distribution as at 30 June 2005.
33 Ultimate Controlling party
The Target BVI Company's ultimate holding company is China Netcom Group which
is owned and controlled by the PRC Government.
The directors regard the PRC Government as being the ultimate controlling
party.
(III) SUBSEQUENT ACCOUNTS
No audited accounts of the Target BVI Company or any of its subsidiaries have
been prepared in respect of any period subsequent to 31 December 2004 up to
date of this report. Save as disclosed in this report, no dividend or other
distribution has been declared, made or paid by the Target BVI Company or any
of its subsidiaries in respect of any period subsequent to 30 June 2005.
Yours faithfully,
PricewaterhouseCoopers
Certified Public Accountants
Hong Kong
APPENDIX III FINANCIAL INFORMATION OF THE GROUP
The following audited consolidated balance sheets of the Group as at 31
December 2002, 2003 and 2004 and the audited consolidated income statements,
audited consolidated statements of changes in equity and audited consolidated
statements of cash flows for the years ended 31 December 2002, 2003 and 2004
are derived from the audited financial statements of the Group prepared under
HKFRS. The accompanying notes to the audited consolidated financial statements
for the years ended and as at 31 December 2002 and 2003 are included in the
prospectus of the Company dated 4 November 2004 ("the Prospectus"). The
following unaudited consolidated balance sheet of the Group as at 30 June 2005
and the unaudited consolidated income statements, unaudited consolidated
statements of changes in equity and unaudited consolidated statements of cash
flows for the six months ended 30 June 2005 are unaudited and are extracted
from the Company's 2005 interim results announcement. The Prospectus and the
Company's 2005 interim results announcement are posted on the Company's
website: www.china-netcom.com.
CONSOLIDATED BALANCE SHEETS
As at 31 December As at 30
June
2002 2003 2004 2005
RMB million RMB million RMB million RMB million
(Audited)
(Audited) (Audited) (Unaudited)
ASSETS
Current assets
Cash and bank deposits 6,802 6,316 10,053 8,790
Short-term investments 2,665 1,506 2,876 439
Accounts receivable 4,775 6,343 5,688 6,778
Inventories and consumables 1,007 1,238 941 502
Prepayments and other receivables 1,470 1,640 1,006 1,079
Due from holding companies and fellow subsidiaries 672 449 373 489
Total current assets 17,391 17,492 20,937 18,077
Non-current assets
Fixed assets 146,164 133,919 125,582 122,689
Construction in progress 17,783 15,695 8,073 9,172
Lease prepayments for land - - - 1,291
Intangible assets 273 184 316 926
Deferred costs 5,149 7,872 7,449 6,250
Deferred tax assets 2,652 2,784 2,394 2,881
Long-term investments 880 880 - -
Interests in associated companies 90 90 - -
Derivative assets - - - 2
Other non-current assets 535 618 424 11
Total non-current assets 173,526 162,042 144,238 143,222
Total assets 190,917 179,534 165,175 161,299
LIABILITIES AND EQUITY
Current liabilities
Accounts payable 13,302 14,786 14,653 13,281
Accruals and other payables 3,525 4,410 3,353 3,698
Short-term bank loans 26,371 32,217 29,339 26,425
Current portion of long-term bank and other loans 14,089 15,716 7,270 4,263
Due to holding companies and fellow subsidiaries 1,035 9,002 8,244 8,469
Current portion of deferred revenues 7,028 7,229 6,653 6,196
Current portion of provisions 3,098 3,083 2,596 2,480
Taxation payable 381 428 196 2,656
Total current liabilities 68,829 86,871 72,304 67,468
Net current liabilities (51,438) (69,379) (51,367) (49,391)
Total assets less current liabilities 122,088 92,663 92,871 93,831
Non-current liabilities
Long-term bank and other loans 29,480 22,309 21,861 18,280
Due to holding companies - 4,750 - -
Deferred revenues 15,781 14,604 11,817 10,528
Provisions 2,623 2,341 2,143 2,080
Deferred tax liabilities 10,872 4,213 1,321 1,354
Derivative liabilities - - - 83
Other non-current liabilities 1,115 1,067 564 22
Total non-current liabilities 59,871 49,284 37,706 32,347
Total liabilities 128,700 136,155 110,010 99,815
Minority interests 4 3 - -
Financed by:
Share capital 1,819 1,819 2,181 2,181
Reserves 60,394 41,557 52,984 59,303
Owners' equity 62,213 43,376 55,165 61,484
Total liabilities and equity 190,917 179,534 165,175 161,299
CONSOLIDATED INCOME STATEMENTS
Years ended 31 December Six months
ended 30
June
2002 2003 2004 2005
RMB million RMB million RMB million RMB million
(Audited) (Audited) (Audited) (Unaudited)
Revenues 54,443 59,898 64,922 33,724
Operating expenses
Depreciation and amortisation (18,808) (20,483) (18,754) (9,265)
Network, operations and support (10,578) (11,990) (11,591) (5,549)
Staff costs (6,433) (7,547) (8,041) (4,200)
Selling, general and (5,682) (7,053) (9,566) (4,402)
administrative expenses
Other operating expenses (1,521) (1,660) (1,534) (541)
Operating profit before interest 11,421 11,165 15,436 9,767
income, dividend income and
deficit on revaluation of fixed
assets
Interest income 82 79 76 87
Dividend income 78 45 17 28
Deficit on revaluation of fixed - (25,778) - -
assets
Profit/(loss) from operations 11,581 (14,489) 15,529 9,882
Finance costs (2,848) (3,026) (2,932) (1,226)
Share of loss of
- Associated companies (1) (1) (1) -
- Jointly controlled entity - (415) - -
Profit/(loss) before taxation 8,732 (17,931) 12,596 8,656
Taxation (2,212) 6,819 (3,348) (2,298)
Profit/(loss) after taxation 6,520 (11,112) 9,248 6,358
Minority interests - 1 - -
Profit/(loss) for the year/period 6,520 (11,111) 9,248 6,358
Final dividend proposed after - - 259 -
balance sheet date
Basic earnings/(losses) per share RMB1.19 RMB(2.02) RMB1.64 RMB0.96
Diluted earnings/(losses) per share RMB1.19 RMB(2.02) RMB1.63 RMB0.96
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
Audited
Share Share Capital Statutory Revaluation Other Retained Total
capital premium reserve reserve reserve reserve earnings
RMB RMB RMB RMB RMB RMB RMB RMB
million million million million million million million million
Balance as at 1 1,819 34,168 - - - - 23,219 59,206
January 2002
Profit for the - - - - - - 6,520 6,520
year
Contributions - - - - - - 507 507
from owners
Distributions to - - - - - - (4,020) (4,020)
owners
Balance at 31 1,819 34,168 - - - - 26,226 62,213
December 2002
Balance as at 1 1,819 34,168 - - - - 26,226 62,213
January 2003
Loss for the year - - - - - - (11,111) (11,111)
Distributions to - - - - - - (9,724) (9,724)
owners
Revaluation - - - - 2,982 - - 2,982
surplus
Revaluation tax - - - - (984) - - (984)
credit
Balance at 31 1,819 34,168 - - 1,998 - 5,391 43,376
December 2003
Balance as at 1 1,819 34,168 - - 1,998 - 5,391 43,376
January 2004
Profit for the - - - - - - 9,248 9,248
year
Appropriation to - - - 723 - - (723) -
statutory reserve
Movement of - - - - 846 2,355 (137) 3,064
deferred tax
recognised in
equity
Transfer to - - - - (697) (241) 938 -
retained earnings
Contributions - - - - - - 201 201
from owners
Distributions to - - - - - - (2,600) (2,600)
owners
Net assets - - - - - - (6,047) (6,047)
distributed to
owners in
accordance with
reorganisation in
connection to
global offering
Distribution to - - - - - - (1,021) (1,021)
an owner upon
assignment of loan
Transfer to - - 265 - - - (265) -
capital reserve
upon
reorganisation in
connection to
global offering
Issue of shares 362 8,582 - - - - - 8,944
through global
offering, net of
issue expenses
Balance as at 31 2,181 42,750 265 723 2,147 2,114 4,985 55,165
December 2004
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
FOR THE SIX MONTHS ENDED 30 JUNE 2005
Unaudited
Share Share Capital Statutory Revaluation Other Retained Total
capital premium reserve reserve reserve reserve earnings
RMB RMB RMB RMB RMB RMB RMB RMB
million million million million million million million million
Balance as at 31 2,181 42,750 265 723 2,147 2,114 4,985 55,165
December 2004, as
previously
reported
Effects of
adoption of new
HKFRSs:
Share-based - - 18 - - - (18) -
payment
Balance as at 31 2,181 42,750 283 723 2,147 2,114 4,967 55,165
December 2004, as
restated
Negative goodwill - - - - - - 166 166
Foreign exchange - - - - - - 1 1
contracts
Balance as at 1 2,181 42,750 283 723 2,147 2,114 5,134 55,332
January 2005 as
restated
Profit for the - - - - - - 6,358 6,358
period
Share-based - - 48 - - - - 48
payment
Dividends to - - - - - - (259) (259)
shareholders
Appropriation to - - - 3,378 - - (3,378) -
statutory reserve
Transfer to - - - - (417) (28) 445 -
retained earnings
Foreign currency - - - - - 5 - 5
translation
adjustment
Balance as at 30 2,181 42,750 331 4,101 1,730 2,091 8,300 61,484
June 2005
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended 31 December
2002 2003 2004
RMB million RMB million RMB million
(Audited) (Audited) (Audited)
Cash flows from operating activities
Net cash inflows generated from operations 28,024 28,807 29,706
Interest received 82 79 75
Dividends received 78 45 17
Interest paid (2,789) (2,668) (2,921)
Profit tax paid (1,467) (931) (7)
Net cash inflow from operating activities 23,928 25,332 26,870
Cash flows from investing activities
Purchase of fixed assets and construction in progress (25,814) (28,528) (21,239)
Sales of fixed assets 768 735 893
Sales of other investments 274 1,195 1,528
Net (increase)/decrease in time deposits with maturity over three (109) 78 13
months
Investment in Asia Netcom - (507) -
Purchase of additional interest in Asia Netcom - 55 -
Purchase of other investments (1,041) (29) (2,902)
Net cash outflow from investing activities (25,922) (27,001) (21,707)
Cash flow from financing activities
New bank loans and other loans 48,495 63,033 50,194
Repayment of bank loans (43,208) (64,614) (51,818)
Capital element of finance lease payments (88) (101) (603)
Advance from owners - 4,750 -
Contribution received from owners 507 - 201
Payment of distribution to owners (3,972) (1,806) (7,310)
Loans to fellow subsidiaries and related parties - - (1,021)
Issues of shares through Global Offering, net of issue expenses - - 8,944
Net cash inflow/(outflow) from financing activities 1,734 1,262 (1,413)
(Decrease)/increase in cash and cash equivalents (260) (407) 3,750
Cash and cash equivalents at beginning of year/period 6,950 6,690 6,283
Cash and cash equivalents at end of year/period 6,690 6,283 10,033
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
Six months
ended 30
June
2005
RMB million
(Unaudited)
Net cash inflow from operating activities 13,907
Net cash outflow from investing activities (5,737)
Net cash outflow from financing activities (9,433)
Decrease in cash and cash equivalents (1,263)
Cash and cash equivalents at beginning of period 10,033
Cash and cash equivalents at end of period 8,770
The following consolidated balance sheets of the Group as at 31 December 2004
together with the consolidated income statements of the Group for the year
ended 31 December 2004 have been restated to reflect the impact of the
adoption of the new and revised HKFRS which are effective for accounting
periods beginning on or after 1 January 2005.
CONSOLIDATED BALANCE SHEETS
As at 31 As at 30
ecember 2004 June 2005
RMB million RMB million
(Restated) (Unaudited)
ASSETS
Current assets
Cash and bank deposits 10,053 8,790
Short-term investments 2,876 439
Accounts receivable 5,688 6,778
Inventories and consumables 941 502
Prepayments and other receivables 1,006 1,079
Due from holding companies and fellow subsidiaries 373 489
Total current assets 20,937 18,077
Non-current assets
Property, plant and equipment 124,787 122,689
Construction in progress 7,602 9,172
Lease repayments for land 1,266 1,291
Intangible assets 316 926
Deferred costs 7,449 6,250
Deferred tax assets 2,394 2,881
Derivative assets - 2
Other non-current assets 424 11
Total non-current assets 144,238 143,222
Total assets 165,175 161,299
LIABILITIES AND EQUITY
Current liabilities
Accounts payable 14,653 13,281
Accruals and other payables 3,353 3,698
Short-term bank loans 29,339 26,425
Current portion of long-term bank and other loans 7,270 4,263
Due to holding companies and fellow subsidiaries 8,244 8,469
Current portion of deferred revenues 6,653 6,196
Current portion of provisions 2,596 2,480
Taxation payable 196 2,656
Total current liabilities 72,304 67,468
Net current liabilities (51,367) (49,391)
Total assets less current liabilities 92,871 93,831
Non-current liabilities
Long-term bank and other loans 21,861 18,280
Deferred revenues 11,817 10,528
Provisions 2,143 2,080
Deferred tax liabilities 1,321 1,354
Derivative liabilities - 83
Other non-current liabilities 564 22
Total non-current liabilities 37,706 32,347
Total liabilities 110,010 99,815
Financed by:
Share capital 2,181 2,181
Reserves 52,984 59,303
Owners' equity 55,165 61,484
Total liabilities and equity 165,175 161,299
CONSOLIDATED INCOME STATEMENTS
For the year For the six For the six
ended 31 months ended months ended
December 2004 30 June 2004 30 June 2005
RMB million RMB million RMB million
(Restated) (Audited) (Unaudited)
Revenues 64,922 32,498 33,724
Operating expenses
Depreciation and amortisation (18,754) (9,552) (9,265)
Network, operations and support (11,591) (5,167) (5,549)
Staff costs (8,059) (4,294) (4,200)
Selling, general and administrative expenses (9,566) (4,199) (4,402)
Other operating expenses (1,534) (724) (541)
Total operating expenses (49,504) (23,936) (23,957)
Operating profit before interest income dividend income 15,418 8,562 9,767
Interest income 76 32 87
Dividend income 17 7 28
Profit from operations 15,511 8,601 9,882
Finance costs (2,932) (1,604) (1,226)
Share of loss of associated companies (1) (1) -
Profit before taxation 12,578 6,996 8,656
Taxation (3,348) (2,121) (2,298)
Profit for the year/period 9,230 4,875 6,358
The details of the changes of accounting policies are set out in the Interim
Announcement. The impact of the change to accounting policies on the Group's
profit before taxation was as follows:
For the six For the
months ended 30 year
June 2004 ended 31
December
2004
RMB million RMB
million
HKFRS 2 - 18
Decrease in profit before taxation
for the period/year - 18
The following notes to the financial statements are extracted from the
Company's 2004 annual report and should be read in conjunction with the
audited consolidated financial statements included in such annual report.
1 The group, its reorganisation and principal activities
Background of the group
China Netcom Corporation (Hong Kong) Limited (the "Company") was incorporated
in the Hong Kong Special Administrative Region ("Hong Kong") of the People's
Republic of China ("PRC") on October 22, 1999 as a limited liability company
under the Hong Kong Companies Ordinance. Prior to a reorganisation conducted
for the listing of the shares of the Company (the "Reorganisation"), the
Company's ultimate holding company was China Netcom (Holdings) Company Limited
("China Netcom Holdings").
China Netcom Holdings was previously owned by four state-owned enterprises and
became the Company's holding company in December 2000. The Company, through
its principal operating subsidiary China Netcom (Group) Limited ("CNC China"),
is engaged in the provision of fixed line telecommunication services through
different regional branch offices in the PRC. In March 2003, the Company along
with two co-investors through Asia Netcom Corporation Limited ("Asia Netcom"),
being a 51% owned jointly controlled entity of the Company at that time,
acquired the Asia-Pacific submarine cable assets and related physical network
assets and liabilities, from Asia Global Crossing Ltd. On December 31, 2003,
the Company further purchased the remaining 49% interests in Asia Netcom held
by the other co-investors and became the sole owner of Asia Netcom.
Reorganisation of the group
In anticipation of the listing of the Company's shares and American Depository
Shares ("ADSs") on The Stock Exchange of Hong Kong and the New York Stock
Exchange Inc. respectively (the "Global Offering"), China Netcom Holdings and
China Network Communications Group Corporation (the "China Netcom Group") both
being state owned enterprises under the supervision and regulation of the
Ministry of Information Industry ("MII"), underwent the Reorganisation which
was effective for accounting purposes on June 30, 2004 (see Note 2).
Immediately after the Reorganisation, the ultimate holding company of the
Company was China Netcom Group.
China Netcom Group, the Company's current ultimate holding company, was
established by the State Council of the PRC in May 2002. Under a comprehensive
industry restructuring plan relating to the fixed line telecommunication
sector in China approved by the State Council in November 2001, the fixed line
telecommunications businesses originally operated by China Telecommunication
Corporation ("China Telecom Group") were split into northern and southern
operations. In May 2002, China Netcom Group took over the northern part fixed
line telecommunication operations in 10 provinces, municipalities and
autonomous regions.
The Reorganisation undertaken in anticipation of the listing of the Company
comprised the following:
(a) China Netcom Group acquired the entire interest in China Netcom Holdings
from its four state owners and became the ultimate holding company of the
Group;
(b) The Company's principal operating subsidiary, namely CNC China,
transferred all of its assets and liabilities in the PRC telecommunications
operations to China Netcom Group, and assets and liabilities of the PRC fixed
line telecommunications operations previously owned by both China Netcom Group
and the Company were combined in the respective provinces, municipalities and
autonomous regions;
(c) After excluding certain assets and liabilities which were retained by
China Netcom Group as set out in (f) (i) below, the net assets of the
telecommunications operations of 8 PRC provinces and municipalities, namely
Beijing Municipality, Tianjin Municipality, Hebei Province, Henan Province,
Shandong Province, Liaoning Province, Shanghai Municipality and Guangdong
Province (collectively referred to as the "Eight Service Regions"), which had
been valued at RMB43,012 million, based on an independent valuation, were
injected into the Company in consideration of approximately 5,442 million
ordinary shares (21,769 million shares before share consolidation, see Note
32(b) for details) of the Company (the "Asset Injection").
(d) Certain Asia-Pacific submarine cable assets and related physical network
assets and liabilities were transferred from Asia Netcom to China Netcom
Group.
(e) The Company and its subsidiaries (the "Group"), immediately after the
Reorganisation, contained the assets and liabilities related to: (i) fixed
line telecommunication operations in the Eight Service Regions; and (ii) fixed
line telecommunication operations in the Asia-Pacific region operated by Asia
Netcom (collectively the "Restructured Businesses").
(f) China Netcom Group, immediately after the Reorganisation, retained or held
the following assets and liabilities: (i) certain assets and liabilities of
the Eight Service Regions including fixed assets, mainly inter-provincial
optic fibers, investments in associated companies, long-term investments, bank
balances and borrowings and those attributable to certain minor ancillary
telecommunications services; (ii) all assets and liabilities of the fixed line
telecommunication operations outside the Eight Service Regions; (iii) all
non-core businesses representing businesses other than the principal
communications services operations in the Group's northern and southern
service regions and primarily include procurement of materials, equipment
maintenance services, engineering, project planning and design and operations
of certain social facilities and (iv) the Asia-Pacific submarine cable assets
and related physical network transferred from Asia Netcom (collectively the
"Retained Businesses").
The above reorganisation procedures primarily resulted in a net effect of (i)
the transfer from China Netcom Group to the Company of the assets and
liabilities of the telecommunications operations in the Eight Service Regions,
which were previously owned by China Netcom Group prior to the Reorganisation;
and (ii) the transfer from the Company to China Netcom Group of certain assets
and liabilities of the telecommunications operations outside the Eight Service
Regions and the Asia-Pacific submarine cable assets and related physical
network, which were previously owned by the Group prior to the Reorganisation.
The shares of the Company were listed on The Stock Exchange of Hong Kong
Limited on November 17, 2004 and the ADSs of the Company were listed on The
New York Stock Exchange Inc. on November 16, 2004.
Principal activities
After the Reorganisation, the Group is a dominant provider of fixed line
telephone services, broadband, other Internet-related services, and business
and data communications services in six northern municipalities and provinces,
namely Beijing Municipality, Tianjin Municipality, Hebei Province, Henan
Province, Shandong Province and Liaoning Province in the PRC. The Group also
provides telecommunications services to selected business and residential
customers in a southern municipality and a southern province, namely Shanghai
Municipality and Guangdong Province in the PRC. In addition, the Group
operates a network and offers international data services throughout the Asia
Pacific countries and regions.
After the Reorganisation, the Group's principal services consist of:
o fixed line telephone services (including the personal handy phone system
(PHS) services), comprising:
- local, domestic long distance and international long distance services;
- value-added services, including caller identity, telephone information
services; and
- interconnection services provided to other domestic telecommunications
service providers including the fellow subsidiary owned by China Netcom
Group operating outside the Eight Service Regions;
o broadband services and other Internet-related services;
o business and data communications services, including integrated regional
data and voice communications services; and
o international services consisting of international voice services,
including international inbound calls destined for the PRC or transit
through the PRC or other Asia-Pacific countries and regions, and leased
line, Internet access, managed data and other telecommunications services
provided to business and carrier customers located outside the PRC.
The Group's PRC operations are subject to the supervision of and regulation by
the PRC Government. The MII, pursuant to the authority delegated by the PRC's
State Council, is responsible for formulating the telecommunications industry
policies and regulations (the "Telecommunications Regulations").
Under the Telecommunications Regulations, all telecommunications operators in
the PRC must obtain a telecommunications service operating license from the
MII or from the provincial telecommunications administrations. Providers of
value-added services within a single province are required to obtain licenses
from provincial telecommunications administrations. Providers of basic
telecommunications services and providers of value-added services in two or
more provinces, autonomous regions and municipalities are required to obtain
licenses from the MII. In accordance with the approval of the MII, CNC China,
the Group's principal operating subsidiary in China, as an indirect subsidiary
of China Netcom Group, has the right to operate the Group's telecommunications
business in Eight Service Regions under the authorisation of China Netcom
Group, which holds the license required for operating the Group's
telecommunications businesses in the PRC.
Following the Reorganisation, China Netcom Group continues to be the holder of
the licenses for operating a telecommunications network in China, but has,
with the consent of the MII, granted CNC China the right to operate under its
licenses, the assets described above and the related business. The Company is
the holder of licenses that are necessary to own and operate the assets that
are outside the PRC described above in such key countries and regions such as
Hong Kong, Japan, Singapore and Korea.
2 Basis of presentation
The Reorganisation was effective for accounting purposes on June 30, 2004,
which was the date on which the Company and China Netcom Group signed the
legally binding agreements that identified (i) all specific assets and
liabilities under the Asset Injection to be transferred to the Company from
China Netcom Group and (ii) the specific assets and liabilities to be
transferred from Asia Netcom to China Netcom Group.
China Netcom Group and China Netcom Holdings were both state-owned enterprises
before and after the Reorganisation, and the acquisition of China Netcom
Holdings by China Netcom Group was carried out under the directive of the
State Council. Accordingly, the Reorganisation was regarded as a common
control transaction and accounted for using merger accounting, as permitted by
the Hong Kong Statement of Standard Accounting Practice 27 "Accounting for
group reconstructions", and the assets and liabilities injected into the
Company by China Netcom Group under Note 1 (c) above have been stated at
historical amounts. The consolidated financial statements present the
consolidated results and financial position of the Group as if China Netcom
Holdings and China Netcom Group had been merged throughout the periods
presented and as if the Restructured Businesses were injected into the Company
from China Netcom Group at the beginning of the earliest periods presented or
when such businesses were acquired by the Group or China Netcom Group,
whichever is later. The consolidated financial statements do not include the
results and financial position of businesses previously owned by China Netcom
Group outside the Eight Service Regions which had been retained by China
Netcom Group upon the Reorganisation.
Prior to the consummation of the Reorganisation, the assets and liabilities of
the PRC telecommunications operations, both within and outside the Eight
Service Regions of the Company held through CNC China, the Company's principal
operating subsidiary, had been historically under common management and
control. Therefore, the Group's consolidated income statements for the years
ended December 31, 2003 and 2004 and consolidated balance sheets as at
December 31, 2003 include the entire consolidated financial data of the PRC
operations of CNC China up to the effective date of the Reorganisation
although the assets and liabilities of operations of CNC China outside the
Eight Service Regions had been transferred to China Netcom Group under the
Reorganisation as set out in Note 1 above. In addition, the consolidated
balance sheet as at December 31, 2003 also includes the assets and liabilities
of the Eight Service Regions in the PRC which had been retained by China
Netcom Group under the Reorganisation (see Note 1 (f) (i) above) and the
assets and liabilities that were transferred from Asia Netcom to China Netcom
Group under the Reorganisation (see Note 1 (f) (iv) above) as those assets and
liabilities were part of the telecommunications operations and were not
separately managed throughout the periods presented. The above assets and
liabilities retained by, or transferred to, China Netcom Group but included in
the financial statements as at year ended December 31, 2003 and the amounts of
such assets and liabilities distributed to owners on June 30, 2004 as a result
of the Reorganisation were as follows:
As at
June 30, 2004 December 31, 2003
RMB million RMB million
Assets and liabilities:
Current assets 1,915 2,637
Fixed assets, net
- Land and buildings 10,169 10,276
- Telecommunications networks and equipment 6,760 7,089
- Furniture, fixtures, motor vehicles and
other equipment 251 216
17,180 17,581
Construction in progress 1,401 2,057
Interest in associated companies and
long-term investments 969 970
Other non-current assets 281 396
Current liabilities (5,830) (7,618)
Non-current loans and other borrowings (5,153) (4,979)
Other non-current liabilities (4,716) (4,833)
Net assets 6,047 6,211
For the six months For the
ended June 30, and year ended
the year ended December
December 31, 31,
2004 2003
RMB million RMB million
Revenues 479 802
Operating expenses, mainly comprising:
Depreciation and amortisation (276) (240)
Networks, operations and support (272) (409)
Staff costs (64) (65)
Selling, general and administrative (138) (257)
Other operating income/(expenses) 28 (71)
Finance costs (248) (496)
Loss for the period/year (486) (740)
Accounting principles and standards
The financial statements have been prepared in accordance with Hong Kong
Financial Reporting Standards ("HKFRS") issued by the Hong Kong Institute of
Certified Public Accountants ("HKICPA") and accounting principles generally
accepted in Hong Kong. They have been prepared under the historical cost
convention modified by the revaluation of certain fixed assets and the marking
to fair values of certain investments as explained in the principal accounting
policies below in Note 3 below, and on a going concern basis.
The HKICPA has issued a number of new and revised HKFRSs which are effective
for accounting periods beginning on or after January 1, 2005. The Group has not
early adopted these new and revised HKFRSs in the financial statements for the
year ended December 31, 2004. The Group has commenced an assessment of the
impact of these new and revised HKFRSs, but is not yet in a position to state
whether these new and revised HKFRSs would have a significant impact on its
results of operations and financial position.
A significant percentage of the Group's funding requirements is achieved
through short term borrowings. Consequently, the balance sheet indicates a
significant working capital deficit. In the past, a substantial portion of the
Group's short term borrowings have been rolled over upon maturity. Based on the
Group's history of obtaining finance, its relationships with its bankers and
its operating performance, the directors consider that the Group will continue
to be able to roll over such short term financing, or will be able to obtain
sufficient alternative sources of financing to enable it to operate and meet
its liabilities as and when they fall due.
3 Principal accounting policies
The principal accounting policies adopted in the financial statements are set
out below:
(a) Basis of consolidation
As set out in Note 2 above, the Reorganisation involved the injection of
businesses from the Group's ultimate holding company into the Group and was
accounted for using merger accounting in accordance with SSAP No.27 issued by
the HKICPA. The results and financial position of businesses merged under the
Reorganisation were included in the consolidated financial statements as if the
businesses were acquired at the beginning of the earliest periods presented or
the date that such businesses were acquired by the Group or China Netcom Group
whichever was later.
Acquisitions of subsidiaries from third parties are accounted for using
purchase accounting. The results and financial positions of such subsidiaries
acquired or disposed of during the year are included in the consolidated income
statements from the effective date of acquisition or up to the effective date
of disposal, as appropriate.
All significant intercompany transactions and balances within the Group are
eliminated on consolidation.
Minority interests represent the interests of outside shareholders in the
operating results and net assets of
subsidiaries.
(b) Subsidiaries
Subsidiaries are those entities in which the Company, directly or indirectly,
controls the composition of the board of directors, controls more than half the
voting power, or holds more than half of the issued share capital.
In the Company's balance sheet, the investment in subsidiaries are stated at
cost less provision for impairment losses. The results of subsidiaries are
accounted for by the Company on the basis of dividends received and receivable.
(c) Jointly controlled entities
A jointly controlled entity is a joint venture which involves the establishment
of a corporation, partnership or other entity in which each venturer has an
interest. A joint venture is a contractual arrangement whereby the Group and
other parties undertake an economic activity which is subject to joint control
and none of the participating parties has unilateral control over the economic
activity. A jointly controlled entity controls the assets of the joint venture,
incurs liabilities and expenses and earns income. It may enter into contracts
in its own name and raise finance for the purposes of the joint venture
activity. Each venturer is entitled to a share of the results of the jointly
controlled entity under the equity method of accounting.
The consolidated income statements include the Group's share of the results of
jointly controlled entities under the equity method of accounting.
(d) Associated companies
An associated company is a company, not being a subsidiary or a jointly
controlled entity, in which an equity interest is held for the long-term and
significant influence is exercised in its management.
The consolidated income statements include the Group's share of the results of
associated companies for the year, and the consolidated balance sheets include
the Group's share of the net assets of the associated companies and any
unamortised goodwill (net of accumulated amortisation) on acquisition.
Equity accounting is discontinued when the carrying amount of the investment in
an associated company reaches zero, unless the Group has incurred obligations
or guaranteed obligations in respect of the associated company.
(e) Revenue recognition
(i) The Group's revenues are recognized as follows:
o Revenues derived from local, domestic long distance ("DLD") and
international long distance ("ILD") telephone usage, which vary depending on the
day, the time of day, the distance and duration of the call and the tariffs, are
recognised when the services are provided to customers.
o Monthly telephone service fees are recognised in the period during which
the telephone services are provided to customers.
o Upfront connection and installation fees received are deferred and
recognised over the expected customer relationship period of 10 years. With
effect from July 1, 2001, no further upfront fees for connection were charged
to customers.
o Revenues from the sale of prepaid calling cards are deferred and
recognised as the cards are consumed by customers.
o Revenues from PHS bundled service contracts are recognised as local,
DLD, or ILD service fees according to the type of usage and on a systematic
basis to match the pattern of usage of the PHS services by customers. PHS
bundled service contracts comprise the provision of PHS services and handsets
to customers, under which customers either prepay a certain amount of service
fee or commit to spend a minimum monthly service fee for a designated period in
order to receive a free handset (see Note 3(t)(ii) for the policy on cost of
the handset).
o Revenues from value-added communication services such as call waiting,
call diverting and caller number display are recognised when the services are
provided to customers.
o Revenues from the provision of broadband and other Internet-related
services and managed data services are recognised when the services are
provided to customers.
o Interconnection fees from domestic and foreign telecommunications
operators are recognised when the services are rendered as measured by the
minutes of traffic processed.
o Lease income from the leasing of lines and customer-end equipment is
recognised over the term of the lease. Lease income from other domestic
telecommunications operators and business customers for the usage of the
Group's fixed line telecommunications networks is measured by the number of
lines leased and the agreed upon rate per line leased. The lease arrangements
are primarily determined on a year to year basis.
(ii) Interest income
Interest income is recognised on a time proportion basis, taking into account
the principal amounts outstanding and the interest rates applicable.
(iii) Dividend income
Dividend income is recognised when the right to receive payment is established.
(f) Interest expenses
Interest expenses that are attributable to the acquisition, construction or
production of an asset that necessarily takes a substantial period of time to
get ready for its intended use or sale are capitalised as part of the cost of
that asset.
All other interest expenses are charged to the consolidated income statements
in the year in which they are incurred.
(g) Interconnection charges
Interconnection charges represent amounts incurred for the use of other
telecommunications operators' networks for facilitating the completion of calls
that originate from the Group's fixed line telecommunications networks.
Interconnection charges are recognised on an accrual basis. For interconnection
charges with domestic operators and the fellow subsidiaries of the Group, they
are accrued based on actual amounts, while those with overseas operators are
accrued based on the actual amounts, if known, or the Group's estimates.
(h) Translation of foreign currencies
Transactions in foreign currencies are translated at exchange rates ruling at
the transaction dates. Monetary assets and liabilities expressed in foreign
currencies at the balance sheet dates are translated at rates of exchange
ruling at the balance sheet dates. Exchange differences arising in these cases
are dealt with in the consolidated income statement.
The balance sheets of subsidiaries and associated companies expressed in
foreign currencies are translated at the rates of exchange ruling at the
balance sheet dates and the respective income statement accounts are translated
at the average exchange rates for the year. Exchange differences are dealt with
as a movement in reserves.
(i) Cash and cash equivalents
Cash and cash equivalents, comprising cash on hand, deposits held at call with
banks and cash investments with original maturities of three months or less are
carried at cost.
(j) Accounts receivable
Accounts receivable are carried at original amounts less provisions for
doubtful debts. The provision for doubtful debts is recorded if there is
objective evidence that the Group will not be able to collect all amounts due
according to the original term of the accounts receivable.
(k) Inventories and consumables
Inventories comprise mainly telephone handsets and are stated at the lower of
cost and net realisable value on a first-in, first-out basis, after provisions
for obsolescence.
Consumables consist of materials and supplies used in maintaining the Group's
telecommunication networks and are charged to the income statement when brought
into use. Consumables are valued at cost less any provision for obsolescence.
(l) Fixed assets
(i) Construction-in-progress
Construction-in-progress represents buildings, telecommunications networks
plant, transmission and switching equipment under construction and pending
installation, and is stated at cost less any provision for impairment losses.
Cost comprises direct costs of construction including borrowing costs
attributable to the construction during the period of construction. When the
asset being constructed becomes available for use, the construction-in-progress
is transferred to the appropriate category of fixed assets.
(ii) Other fixed assets
Fixed assets are initially stated at cost less accumulated depreciation and
accumulated impairment losses. Major costs incurred in restoring fixed assets
to their normal working condition are charged to the income statement as
incurred. Improvements are capitalised and depreciated over their expected
useful lives.
Land and buildings, subsequent to initial recognition, are stated at cost less
accumulated impairment losses and are depreciated over their expected useful
lives.
Subsequent to the revaluation carried out as at December 31, 2003, which was
based on depreciated replacement costs (Note 18), fixed assets other than land
and buildings are carried at their revalued amounts, being the fair values at
the date of revaluation, less subsequent accumulated depreciation and
impairment losses. When an item of fixed asset is revalued, any accumulated
depreciation at the date of the revaluation is restated proportionately
together 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.
(iii) Revaluations
Revaluations on fixed assets other than land and buildings will be performed at
intervals of not more than three years by independent valuers; in each of the
intervening years valuations will be undertaken by executives of the Group.
Increases in valuation are credited to the revaluation reserve. Decreases in
valuation are first set off against any revaluation surplus arising from
earlier valuations in respect of the same item and thereafter are debited to
operating profit. Any subsequent increases are credited to operating profit up
to the amount previously debited.
(iv) Depreciation
Fixed assets are depreciated at rates sufficient to write off their costs or
revalued amounts less accumulated impairment losses and estimated residual
values over their estimated useful lives on a straight-line basis. The
principal useful lives are as follows:
Land over the term of the lease, being 10-50 years
Buildings 8-30 years
Telecommunications networks
and equipment 5-10 years
Furniture, fixtures, motor
vehicles and other equipment 5-10 years
The useful lives are reviewed periodically to ensure that the methods and rates
of depreciation are consistent with the expected pattern of economic benefits
from fixed assets.
(v) Gain or loss on sale of fixed assets
The gain or loss on disposal of a fixed asset is the difference between the net
sales proceeds and the carrying amount of the relevant asset, and is recognised
in the income statement, except where the fixed asset is carried at valuation,
the relevant portion of the revaluation reserve realised in respect of previous
valuations is transferred to retained earnings and is shown as a movement in
reserves.
(m) Impairment of assets
At each balance sheet date, both internal and external sources of information
are considered to assess whether there is any indication that assets are
impaired. If any such indication exists, the recoverable amount of the asset is
estimated and where relevant, an impairment loss is recognised to reduce the
asset to its recoverable amount. Estimated recoverable amounts are determined
based on estimated discounted future cash flows of the cash-generating unit at
the lowest level to which the asset belongs. The recoverable amount is the
higher of value in use or net selling price. Such impairment losses are
recognised in the income statement, except where the asset is carried at
valuation and the impairment loss does not exceed the revaluation surplus for
that same asset, in which case the impairment loss is treated as a revaluation
decrease and charged to the revaluation surplus.
(n) Assets under leases
(i) Finance leases
Leases that substantially transfer to the Group all of the risks and rewards of
ownership of assets are accounted for as finance leases. Finance leases are
capitalised at the inception of the lease at the lower of the fair value of the
leased assets or the present value of the minimum lease payments. Each lease
payment is allocated between the capital and finance charges so as to achieve a
constant rate on the capital balances outstanding. The corresponding rental
obligations, net of finance charges, are included in long-term liabilities. The
finance charges are charged to the income statement over the lease periods.
Assets held under finance leases are depreciated over the shorter of their
estimated useful lives or the lease periods.
(ii) Operating leases
Leases where substantially all of the risks and rewards of ownership of the
assets remain with the leasing company are accounted for as operating leases.
Payments made under operating leases, net of any incentives received from the
leasing company, are charged to the income statement on a straight-line basis
over the lease periods.
(o) Intangible assets
(i) Goodwill
Goodwill represents the excess of the cost of an acquisition over the fair
value of the Group's share of the net assets of the acquired subsidiary,
jointly controlled entity or associated company, at the date of acquisition.
Goodwill on acquisitions is included in intangible assets and is amortised
using the straight-line method over its estimated useful life of not more than
20 years.
(ii) Negative goodwill
Negative goodwill represents the excess of the fair value of the Group's share
of the net assets acquired over the cost of acquisition. Negative goodwill is
presented in the same balance sheet classification as goodwill. Negative
goodwill, not exceeding the fair values of the non-monetary assets acquired, is
recognised in the income statement over the remaining weighted average useful
life of those assets; negative goodwill in excess of the fair values of those
non-monetary assets is recognised in the income statement immediately.
(iii) Purchased software
Expenditure on purchased software is capitalised and amortised using the
straight-line method over the expected useful lives of the software, which vary
from three to five years.
(p) Investments
(i) Long-term investments
Long-term investments comprise unlisted investment securities that are held for
long term purposes. Such investments are stated at cost less any provision for
impairment losses.
(ii) Short-term investments
Short-term investments comprise listed securities held for trading purposes and
are carried at fair value. At each balance sheet date, the net unrealised gains
or losses arising from the changes in fair value of short-term investments are
recognised in the income statement. Profits or losses on disposal of short-term
investments, representing the difference between the net sales proceeds and the
carrying amounts, are recognised in the income statement as they arise.
(q) Provisions
Provisions are recognised when the Group has a present legal or constructive
obligation as a result of past events, it is probable that an outflow of
resources will be required to settle the obligation, and a reliable estimate of
the amount can be made. Where the Group expects a provision to be reimbursed,
the reimbursement is recognised as a separate asset but only when the
reimbursement is virtually certain.
(r) Employee benefits
(i) Pension obligations
(a) As stipulated by the regulations of the PRC, the subsidiaries in the PRC
participate in basic defined contribution pension plans organised by their
respective municipal governments under which they are governed. The Group is
required to make contributions to the retirement plans at rate of 20% of the
salaries, bonuses and certain allowances of the employees. Employees in the PRC
are entitled to retirement benefits equal to a fixed proportion of their salary
at their normal retirement age. The Group has no other material obligation for
post-retirement benefits beyond these payments as they fall due. Payments made
under these plans are expensed as incurred.
(b) The Group also operates a mandatory provident fund scheme ("the MPF
scheme") under the Hong Kong Mandatory Provident Fund Schemes Ordinance for
employees employed under the jurisdiction of the Hong Kong Employment
Ordinance. The MPF scheme is a defined contribution retirement scheme
administered by independent trustees. Under the MPF scheme, the employer and
its employees are each required to make contributions to the scheme at 5 per
cent. of the employees' relevant income, subject to a cap of monthly relevant
income of HK$20,000.
(ii) Early retirement benefits
Early retirement benefits are recognised as expenses when the Group reaches
agreement with the relevant employees for early retirement.
(iii) Employee housing benefits
One-off cash housing subsidies paid to employees are charged to the
consolidated income statements in the year in which it is determined that the
payment of such subsidies is probable and the amounts can be reasonably
estimated (see Note 30(a)).
Full-time employees of the Group participate in various government-sponsored
housing funds. The Group contributes on a monthly basis to these funds based on
certain percentages of the salaries of the employees. The Group's liability in
respect of these funds is limited to the contributions payable in each period.
Contributions to these housing funds are expensed as incurred.
(iv) Share option scheme
Share options are granted to directors and to certain employees at the
directors' discretion. When the options are exercised, no change is recorded to
the income statement and the proceeds received net of any transaction costs are
credited to share capital (nominal value) and share premium.
(s) Deferred taxation
Deferred taxation is provided in full, using the liability method, on temporary
differences arising between the tax bases of assets and liabilities and their
carrying amounts in the financial statements. Taxation rates enacted or
substantially enacted at the balance sheet date are used to determine deferred
taxation. Deferred tax assets are recognised to the extent that it is probable
that future taxable profit will be available against which the temporary
differences can be utilised.
(t) Deferred costs
(i) Deferred installation costs
The direct incremental costs associated with the installation of fixed line
services are deferred and amortised to the income statement over the expected
customer relationship period of 10 years except when the direct incremental
costs exceed the corresponding upfront installation fees. In such cases, the
excess of the direct incremental costs over the installation fees is recorded
immediately as expenses in the income statement.
(ii) Customer acquisition costs
The cost of handsets given to customers under bundled service contracts and
related commissions paid to distributors are deferred as customer acquisition
costs and amortised to the income statement on a systematic basis to match with
the pattern of the customer service income over the contract period.
(iii) Prepaid network capacities
Prepayments for the network capacities purchased on an indefeasible rights to
use ("IRU") basis are capitalised and amortised over the corresponding lease
period.
(iv) Discount on foreign currency exchange forward contracts
The unamortised portion of the discount on foreign currency exchange forward
contracts (see Note(w)) is recognised as deferred cost.
(u) Contingent liabilities
A contingent liability is a possible obligation that arises from past events
and whose existence will only be confirmed by the occurrence or non-occurrence
of one or more uncertain future events not wholly within the control of the
Group. It can also be a present obligation arising from past events that is not
recognised because it is not probable that an outflow of economic resources
will be required or the amount of obligation cannot be measured reliably.
A contingent liability is not recognised but is disclosed in the notes to the
financial statements. When a change in the probability of an outflow occurs so
that the outflow is probable, the contingent liability will then be recognised
as a provision.
A contingent asset is a possible asset that arises from past events and whose
existence will be confirmed only by the occurrence or non-occurrence of one or
more uncertain events not wholly within the control of the Group.
(v) Segmental reporting
Business segments provide services that are subject to risks and returns that
are different from other business segments. Geographical segments provide
services within a particular economic environment that is subject to risks and
returns that differ from those of components operating in other economic
environments. Currently the Group has one business segment, the provision of
fixed line telecommunications services. Less than 10% of the Group's assets and
operations are located outside the PRC. Accordingly, no business and
geographical segment information is presented.
(w) Foreign currency exchange forward contracts
A foreign currency exchange forward contract is an agreement to exchange
different currencies at a specified future date and at a specified rate. A
non-speculative foreign currency exchange forward contract is one which is
designated and effective as a hedge of a net investment in a foreign entity, of
a foreign currency asset, or of a net monetary asset or liability. All other
foreign currency exchange forward contracts, or parts of foreign currency
exchange forward contracts in excess of the amount hedged, are speculative.
Where a foreign currency exchange forward contract is non-speculative and used
as a hedge of a net monetary asset or liability, the gain or loss on the
contract, being the foreign currency amount of the contract multiplied by the
difference between the spot rate at the balance sheet date and the spot rate at
the date of inception of the contract or at an intervening balance sheet date,
is taken to the income statement. The discount or premium on the contract,
being the foreign currency amount of the contract multiplied by the difference
between the contracted forward rate and the spot rate at the date of inception
of the contract, is amortised over the period of the contract. In the balance
sheet, unamortised discounts are recorded within deferred costs and unamortised
premiums are recorded within deferred revenues.
Where a foreign currency exchange forward contract is speculative, the gain or
loss, being the foreign currency amount of the contract multiplied by the
difference between the forward rate for the balance of the contract at the
balance sheet date and either the contracted forward rate or the forward rate
used at an intervening balance sheet date, is credited or charged to the income
statement at each intervening balance sheet date.
(x) Earnings/(loss) per share ("EPS") and per ADS
Basic EPS is computed by dividing net profit/(loss) attributable to ordinary
shareholders by the weighted average number of ordinary share outstanding
during the year.
Diluted EPS is computed by dividing net profit/(loss) attributable to
shareholders by the weighted average number of ordinary and dilutive ordinary
equivalent shares outstanding during the year. Ordinary equivalent shares
consist of ordinary shares issuable upon the exercise of outstanding stock
options using the treasure stock method.
Earnings/(loss) per ADS is computed by multiplying the EPS by 20, which is the
number of shares represented by each ADS.
4 Revenues
Revenues represent the turnover of the Group and are derived from the provision
of fixed line telecommunications and related services, net of the PRC business
taxes and government levies. The Group's revenues by nature can be summarised
as follows:
Years ended December 31,
2004 2003
RMB million RMB million
Revenues
Local usage fees 18,661 18,567
Monthly telephone service 13,743 12,580
Upfront installation fees 1,338 1,044
DLD usage fees 8,813 8,871
ILD usage fees 1,302 1,410
Value-added services 2,146 1,516
Interconnection fees 4,915 3,797
Upfront connection fees 3,378 3,965
Broadband and other Internet-related service 5,418 3,507
Managed data service 1,526 1,279
Leased line income 2,321 2,509
Other services 1,361 853
Total 64,922 59,898
The Group's revenues by geographical location of the customers can be
summarised as follows:
Years ended December 31,
2004 2003
RMB million RMB million
Domestic telecommunications services (Being revenues
generated from customers located in the PRC)
Local usage fees 18,661 18,567
Monthly telephone service 13,743 12,580
Upfront installation fees 1,338 1,044
DLD usage fees 8,813 8,871
ILD usage fees 1,121 1,410
Value-added services 2,146 1,516
Interconnection fees 3,903 2,580
Upfront connection fees 3,378 3,965
Broadband and Internet-related service 5,058 3,493
Managed data service 1,217 1,215
Leased line income 1,825 2,446
Other services 1,076 832
Subtotal 62,279 58,519
International telecommunications services (Being revenues generated from
customers located outside the PRC, including Hong Kong and Macau Special
Administrative Regions and Taiwan)
ILD usage fees 181 -
Interconnection fees 1,012 1,217
Broadband and other Internet-related service 360 14
Managed data service 309 64
Leased line income 496 63
Other services 285 21
Subtotal 2,643 1,379
Total 64,922 59,898
5 Profit/(loss) from operations
Profit/(loss) from operations is stated after charging or crediting the
following:
Years ended December 31,
2004 2003
RMB million RMB million
Charging
Deficit on revaluation of certain fixed assets (Note 18(c)) - 25,778
Depreciation:
- Owned fixed assets 18,451 20,298
- Leased fixed assets 174 86
Loss on disposal of fixed assets (included in networks
operations and support expenses) 145 1,689
Amortisation of intangible assets (Note 20) 129 99
Contributions to pension plans (included in staff costs) 813 790
Early retirement benefits (included in staff costs) 206 132
Cost of inventories 374 327
Operating leases:
- Land and buildings 571 117
- Network and machinery 1,542 630
Interconnection charges 2,411 1,874
Bad debt expense 832 619
Auditors' remuneration 18 -
Unrealised loss on short-term investments 4 -
Unrealised foreign exchange losses 70 142
Crediting
Realised gain on disposal of short-term investments - 1
Unrealised gain on short-term investments - 7
6 Finance costs
Years ended December 31,
2004 2003
RMB million RMB million
Interest expenses on
- Bank and other loans wholly repayable within five years 3,127 3,340
- Bank and other loans wholly repayable after more than five years 88 125
3,215 3,465
Less: Interest expenses capitalised in construction-in-progress (421) (621)
2,794 2,844
Exchange loss, net 70 142
Bank charges 50 20
Amortisation of discount on foreign currency exchange forward contracts 18 20
2,932 3,026
Interest expenses were capitalised in construction in progress using the 3.69%-5.45% 3.68%-5.51%
following annual interest rates
7 Taxation
Years ended December 31,
2004 2003
RMB million RMB million
PRC enterprise income tax ("EIT") 2,786 940
Deferred taxation (Note 31) 562 (7,775)
Share of taxation attributable to jointly controlled entity - 16
Taxation charges/(credit) 3,348 (6,819)
The provision for EIT is calculated based on the statutory income tax rate of
33% on the assessable profit of each of the entities now comprising the Group
in the PRC as determined in accordance with the relevant income tax rules and
regulations in the PRC.
Taxation on profits derived from certain subsidiaries and the jointly
controlled entity outside the PRC, including Hong Kong, has been calculated on
the estimated assessable profit at the rates of taxation ranging from 17.5% to
30%, prevailing in the countries in which those entities operates.
The reconciliation between the Group's actual tax charge/(credit) and the
amount which is calculated based on the weighted average statutory tax rate is
as follows:
Years ended December 31,
2004 2003
RMB million RMB million
Profit/(loss) before taxation 12,596 (17,931)
Weighted average statutory tax rate 33.00% 33.00%
Tax calculated at the weighted average statutory tax rate 4,157 (5,917)
Non-taxable income (Note below) (1,264) (1,309)
Expenses not deductible for tax purposes 252 207
Tax losses not recognised/(utilised) 356 246
Others (153) (46)
Tax charge/(credit) 3,348 (6,819)
Note: Non-taxable income comprises primarily upfront connection fees charged to
customers and amortised over the customer relationship period.
8 Profit/(loss) attributable to shareholders
(a) For the year ended December 31, 2004, profit attributable to shareholders
included a loss of RMB41 million (2003: a profit of RMB19 million) which has
been dealt with in the financial statements of the Company.
(b) One of the Company's subsidiaries (refer to Note 22) CNC China was
registered as foreign investment enterprises in the PRC. In accordance with the
Articles and Association of CNC China, it is required to provide for certain
statutory reserves, namely, general reserve and staff bonus and welfare fund,
which are appropriated from profits after tax but before dividend distribution.
CNC China is required to allocate at least 10% of their profits after tax
determined under PRC GAAP to the general reserve fund until the cumulative
amounts reach 50% of the registered capital. The statutory reserve can only be
used, upon obtained from the relevant authority, to offset accumulated losses
or increase capital.
Accordingly, CNC China appropriated approximately RMB723 million (2003: Nil) to
the general reserve fund for the year ended December 31, 2004.
9 Final dividend proposed after balance sheet date
2004
HKD
million
Final dividend proposed after the balance sheet date of HK$0.037 per share 245
The final dividend proposed after the balance sheet date has not been
recognised as a dividend payable as of December 31, 2004 but will be reflected
as appropriation of retained profits in the financial statements for the year
ending December 31, 2005.
10 Earnings/(loss) per share
Basic earnings/(loss) per share is computed using the weighted average number
of ordinary shares outstanding during the year. Diluted earnings/(loss) per
share is computed using the weighted average number of ordinary shares and
potential ordinary shares outstanding during the year.
The following table sets forth the computation of basic and diluted net
earnings/(loss) per share:
Years ended December 31,
2004 2003
(in RMB millions, except
share and per share data)
Numerator:
Profit/(loss) for the year 9,248 (11,111)
Denominator:
Weighted average number of ordinary shares outstanding and shares used in 5,622,685,175 5,492,258,218
computing basic earnings/(loss) per share
Weighted average number of potential ordinary shares:
Diluted equivalent shares arising from convertible Preference Shares 5,140,036 -
Diluted equivalent shares arising from share options 2,209,241 -
Shares used in computing diluted earnings/(loss) per share 5,630,034,452 5,492,258,218
Basic earnings/(loss) per share RMB 1.64 RMB (2.02)
Diluted earnings/(loss) per share RMB 1.63 RMB (2.02)
The diluted loss per share for the year ended December 31, 2003 is the same as
the basic loss per share as all potential ordinary shares are anti-dilutive.
All the number of shares stated above have taken into consideration the effect
of the share consolidation conducted on September 7, 2004 as set out in note
32(a).
11 Staff cost including directors' remunerations
Years ended December 31,
2004 2003
RMB million RMB million
Wages, salaries and welfare 7,022 6,625
Contributions to pensions 813 790
Early retirement benefits 206 132
Total 8,041 7,547
12 Directors' and senior management's emoluments
(a) Directors' emoluments
The following table sets out the emoluments paid to the Company's directors
during the years:
Years ended December 31,
2004 2003
RMB million RMB million
Fees 1 -
Basic salaries, housing allowances, other allowances and benefits in kind 7 3
Contributions to retirement schemes - -
8 3
Directors' fees disclosed above include HK$312,500 (2003: Nil) paid to
independent non-executive direcrtors. The number of directors whose emoluments
fell within the following bands are set out as follows:
Years ended December 31,
2004 2003
Nil - RMB 1,060,000 (equivalent of HK$1,000,000) 12 14
RMB 1,060,001 - RMB 3,710,000 (equivalent of HK$3,500,000) - -
RMB 3,710,001 - RMB 4,240,000 (equivalent of HK$4,000,000) 1 -
(b) Five highest paid individuals
The five individuals whose emoluments were the highest for the years ended
December 31, 2004 (2003: one) include three directors whose emoluments are
reflected in the analysis presented above. The emoluments payable to the
remaining individuals are as follows:
Years ended December 31,
2004 2003
RMB million RMB million
Basic salaries, housing allowances, other allowances and benefits in kind 3 3
Contributions to retirement schemes - -
3 3
The number of the remaining individuals whose emoluments fell within the
following bands is set out as follows:
Years ended December 31,
2004 2003
Nil - RMB 1,060,000 (equivalent of HK$1,000,000) 1 4
RMB1,060,001 - RMB 2,650,000 (equivalent of HK$2,500,000) - -
RMB 2,650,001- RMB 3,180,000 (equivalent of HK$3,000,000) 1 -
(c) None of the directors and 5 highest paid individuals received any fees,
bonuses, inducements, or compensation for loss of office, or waived any
emoluments during 2003 and 2004 .
13 Cash and bank deposits
Years ended December 31,
2004 2003
RMB million RMB million
Cash and cash equivalents 10,033 6,283
Time deposits with original maturities over three months 20 33
Total cash and bank deposits 10,053 6,316
Included in the cash and bank deposits as at the end of each of December 31,
2003 and 2004 are Renminbi denominated balances kept in the PRC amounting to
RMB 5,631 million and RMB 1,868 million, respectively. The conversion of
Renminbi denominated balances into foreign currencies and the remittance of
bank balances and cash out of the PRC are subject to the rules and regulation
of foreign exchange control promulgated by the PRC government.
14 Short-term investments
The Group and the Company's short-term investments comprise primarily
investments in listed debt securities and investment funds.
15 Accounts receivable
Amounts due from the provision of fixed line telecommunications services to
residential and business customers are due within 30 days from the date of
billing. Residential and business 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 90 days
from the billing date.
The ageing analysis of accounts receivable based on the billing date is as
follows:
As at December 31,
2004 2003
RMB million RMB million
0-30 days 4,479 5,232
31-90 days 861 876
Over 90 days 1,404 1,286
Total 6,744 7,394
Less: Allowance for doubtful debts (1,056) (1,051)
Net carrying amounts 5,688 6,343
The movement of allowance for doubtful debts is as follows:
As at December 31,
2004 2003
RMB million RMB million
Balance at beginning of year 1,051 629
Additional provisions 852 558
Less: Amounts utilised (798) (136)
Distributed to owners in accordance with Reorganisation (49) -
Balance at end of year 1,056 1,051
16 Inventories and consumables
As at December 31,
2004 2003
RMB million RMB million
Consumables, at cost 607 993
Telephone handsets and other customer end-products held for resale, at cost 334 245
941 1,238
17 Prepayments and other receivables
Group As at December 31, Company As at December 31,
2004 2003 2004 2003
RMB million RMB million RMB million RMB million
Prepaid expenses and deposits 546 648 8 -
Other receivables 460 992 8 -
1,006 1,640 16 -
18 Fixed assets
Land and Telecommu- Furniture, Total
buildings nications fixtures,
networks and motor
equipment vehicles
and other
equipment
RMB million RMB million RMB million RMB million
Cost/valuation:
Balance at January 1, 2003 27,121 190,535 7,761 225,417
Additions 393 2,381 307 3,081
Acquired through Asia Netcom (Note 35(c)) - 3,298 - 3,298
Transferred from construction in progress (Note 19) 1,892 24,062 1,286 27,240
Disposals (408) (5,676) (498) (6,582)
Increase as a result of revaluation - 6,456 655 7,111
Decrease as a result of revaluation - (40,124) (2,034) (42,158)
Balance at December 31, 2003 28,998 180,932 7,477 217,407
Accumulated depreciation:
Balance at January 1, 2003 (4,852) (71,392) (3,009) (79,253)
Charge for the year (716) (18,520) (1,148) (20,384)
Acquired through Asia Netcom (Note 35(c)) - (261) - (261)
Disposals 103 3,622 434 4,159
Increase as a result of revaluation - (3,693) (436) (4,129)
Decrease as a result of revaluation - 15,696 684 16,380
Balance at December 31, 2003 (5,465) (74,548) (3,475) (83,488)
Net book value at December 31, 2003 23,533 106,384 4,002 133,919
Cost/valuation:
Balance at January 1, 2004 28,998 180,932 7,477 217,407
Additions 200 115 234 549
Transferred from construction in progress (Note 19) 1,479 24,160 1,561 27,200
Disposals (51) (812) (75) (938)
Distributed to owners in accordance with Reorganisation (12,827) (9,265) (325) (22,417)
Balance at December 31, 2004 17,799 195,130 8,872 221,801
Accumulated depreciation:
Balance at January 1, 2004 (5,465) (74,548) (3,475) (83,488)
Charge for the year (756) (16,791) (1,078) (18,625)
Disposals 2 591 64 657
Distributed to owners 2,658 2,505 74 5,237
Balance at December 31, 2004 (3,561) (88,243) (4,415) (96,219)
Net book value at December 31, 2004 14,238 106,887 4,457 125,582
(a) The net book value of assets held under finance lease is as follows:
Land and Telecommu- Furniture, Total
buildings nications fixtures,
networks and motor
equipment vehicles
and other
equipment
RMB million RMB million RMB million RMB million
At December 31, 2003 - 715 2 717
At December 31, 2004 - 1,763 7 1,770
During the year ended December 31, 2004, the Group entered into a finance lease
arrangement with a related party with certain existing fixed assets to obtain
funding of RMB1,085 million. The net book value of such fixed assets included
above amounted to RMB954 million and the corresponding finance lease obligation
amounted to RMB1,070 million as at December 31, 2004 (see note 27(b)(ii)).
(b) The analysis of the cost or revaluation of the assets of the Group is as
follows:
Land and Telecommu- Furniture, Total
buildings nications fixtures,
networks and motor
equipment vehicles
and other
equipment
RMB million RMB million RMB million RMB million
At December 31, 2003
Cost 28,998 - - 28,998
Valuation - 180,932 7,477 188,409
28,998 180,932 7,477 217,407
At December 31, 2004
Cost 17,799 - - 17,799
Valuation - 195,130 8,872 204,002
17,799 195,130 8,872 221,801
The Group's land and buildings are primarily located in the PRC and held on
leases of primarily between 10 to 50 years.
(c) As detailed in Note 3 (I) (ii), except for land and buildings, fixed assets
were carried at revalued amounts on December 31, 2003. As required by the PRC
rules and regulations relevant to the Reorganisation, each class of fixed
assets in the PRC injected into the Group as at December 31, 2003, was valued
by Beijing China Enterprise Appraisal Co. Ltd. (the "PRC valuer"), independent
valuers registered in the PRC, on a depreciated replacement cost basis. The
value of such fixed assets in the PRC injected into the Group was determined at
RMB122,456 million. The fixed assets retained by the ultimate holding company,
which were transferred based on their carrying values upon the Reorganisation,
were valued by the Directors at an amount of RMB17,581 million as at December
31, 2003. The impact of the revaluation was a net deficit on revaluation of the
fixed assets, other than land and buildings, totalling RMB 22,796 million. Such
revalued amounts serve as the tax base for such assets for future years
following the revaluation (see Note 31).
The land and buildings were also revalued and the result was a net surplus of
RMB 6,967 million. Such revaluation on land and buildings serves as the tax
base for land and buildings for future years following the revaluation, and has
not been incorporated in the consolidated financial statements (see Note
31(ii)).
The land and buildings injected by China Netcom Group were valued separately by
Sallmanns, independent qualified valuers in Hong Kong, as at December 31, 2003
on the basis of their open market value. The value arrived at by these valuers
was consistent with that arrived at by the PRC valuers. The Group's land and
buildings are carried at their cost less accumulated depreciation and
impairment losses in the consolidated financial statements.
The respective carrying amount of the telecommunications networks and equipment
and furniture, fixtures, motor vehicles and other equipment would have been RMB
128,049 million and RMB 5,133 million as at December 31, 2003 and RMB 101,433
million and RMB 4,103 million as at December 31, 2004 had they been stated at
cost less accumulated depreciation.
The historical carrying amounts of the Group's fixed assets, as at December 31,
2003, and where applicable the corresponding revalued amounts of these assets
are as follows:
Historical Revaluation Revaluation Revalued
carrying surplus deficit Amount
amount
RMB million RMB million RMB million RMB million
At December 31, 2003
Land and buildings 23,533 - - 23,533
Telecommunications networks and equipment 128,049 2,763 (24,428) 106,384
Furniture, fixture, motor vehicles and other equipment 5,133 219 (1,350) 4,002
156,715 2,982 (25,778) 133,919
The directors have carried out a review of the Group's fixed assets and
concluded that there was no impairment of fixed assets as at December 31, 2004,
nor was there any significant change in the value of fixed assets at that date.
At December 31, 2003 and 2004, the net book value of fixed assets pledged as
security for the Group's long term bank and other loans amounted to RMB 2,668
million and RMB 22 million respectively.
19 Construction in progress
As at December 31,
2004 2003
RMB million RMB million
Balance at beginning of year 15,695 17,783
Additions 20,979 25,152
Transferred to fixed assets (Note 18) (27,200) (27,240)
Distributed to owners in accordance with the Reorganisation on June 30, 2004 (1,401) -
Balance at end of year 8,073 15,695
20 Intangible assets
Goodwill/ Purchased Total
(Negative software
goodwill)
RMB million RMB million RMB million
Cost:
Balance at January 1, 2003 3 660 663
Additions - 191 191
Negative goodwill on acquisition of certain entities of Asia (296) - (296)
Global Crossing through Asia Netcom (See note below)
Acquisition of additional 49% interest in Asia Netcom (Note 115 - 115
35(c))
Balance at December 31, 2003 (178) 851 673
Accumulated amortisation:
Balance at January 1, 2003 (2) (388) (390)
Amortisation for the year - (99) (99)
Balance at December 31, 2003 (2) (487) (489)
Net book value at December 31, 2003 (180) 364 184
Cost:
Balance at January 1, 2004 (178) 851 673
Additions - 261 261
Balance at December 31, 2004 (178) 1,112 934
Accumulated amortisation:
Balance at January 1, 2004 (2) (487) (489)
Amortisation for the year 14 (143) (129)
Balance at December 31, 2004 12 (630) (618)
Net book value at December 31, 2004 (166) 482 316
Note:
On March 10, 2003, Asia Netcom, the Group's 51% jointly controlled entity at
that time, acquired certain entities from Asia Global Crossing (details see
Note 35(c)). The unamortised negative goodwill of RMB 296 million arising from
the aforementioned acquisition has been consolidated into the Group through
Asia Netcom upon the acquisition of the remaining 49% interest of Asia Netcom,
which became a wholly owned subsidiary of the Group on December 31, 2003.
21 Deferred costs
As at December 31,
2004 2003
RMB million RMB million
Balance at beginning of year
- Installation costs 4,708 4,408
- Customer acquisition costs 1,370 44
- Prepaid networks capacities 1,248 383
- Discount on foreign currency exchange forward contracts 77 97
- Others 469 217
7,872 5,149
Additions for the year
- Installation costs 634 1,455
- Customer acquisition costs 1,940 1,666
- Prepaid network capacity
- additions 254 16
- acquired through Asia Netcom (Note 35(c)) - 870
- Discount on foreign currency exchange forward contracts - -
- Others 425 431
3,253 4,438
Charge for the year
- Installation costs (1,068) (1,155)
- Customer acquisition costs (2,006) (340)
- Prepaid network capacities (119) (21)
- Discount on foreign currency exchange forward contracts (18) (20)
- Others (291) (179)
(3,502) (1,715)
Distributed to owners in accordance with Reorganisation on June 30, 2004
- Prepaid network capacity (61) -
- Others (113) -
(174) -
Balance at end of year
- Installation costs 4,274 4,708
- Customer acquisition costs 1,304 1,370
- Prepaid network capacities 1,322 1,248
- Discount on foreign currency exchange forward contracts 59 77
- Others 490 469
7,449 7,872
22 Investments in subsidiaries
Company
As at December 31,
2004 2003
RMB million RMB million
Investment in subsidiaries, at cost 37,509 1,387
As at December 31, 2004, the Company direct and indirect interests in the
following principal subsidiaries, all of which are private companies:
Company name Place and date of Issued and fully Percentage of Principal activities
incorporation/ paid up/registered equity interest and place of
establishment capital attributable to the operation
Group
Directly held:
China Netcom (Group) PRC August 6, 1999 Registered capital 100% Provision of
Company Limited of RMB150 million networks
(formerly know as communication
"China Netcom services in the PRC
Corporation Limited")
(note(a))
China Netcom Bermuda October 12,000 ordinary 100% Investment holding
Corporation 15, 2002 shares of US$1.00 in Bermuda
International Limited each
(note(b))
Indirectly held:
Asia Netcom Bermuda October 120,000,000 ordinary 100% Investment holding
Corporation Limited 15, 2002 shares of US$ 0.01 in Bermuda
(note(c)) each
China Netcom (Hong Hong Kong May 2, 1,000 ordinary 100% Provision of
Kong) Operations 2001 shares of US$1.00 networks
Limited (note(d)) each communication
services
Notes:
(a) This company is a wholly owned foreign enterprise established in the PRC.
The accounts of this company for the years ended December 31, 2003 and 2004
were audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company.
(b) This company adopted March 31 as its financial year end, which is not
coterminous with the year end of the Group. No audited accounts have been
prepared for this company because there are no statutory requirements to
prepare accounts in its jurisdiction.
(c) This company previously adopted March 31 as its financial year end, which
was changed to December 31 during 2003. The accounts for the period from
October 15, 2002 to March 31, 2003 and April 1, 2003 to December 31, 2003 were
audited by PricewaterhouseCoopers.
(d) This company adopted March 31 as its financial year end, which is not
coterminous with the year end of the Group. The accounts of this company for
the years ended March 31, 2002 and 2003 were audited by PricewaterhouseCoopers.
23 Long-term Investments and interests in associated companies
Long-term investments and interests in associated companies were unlisted
equity investments, which were transferred to China Netcom Group upon
Reorganisation on June 30, 2004.
24 Foreign currency exchange forward contracts
The Group has entered into certain foreign currency exchange forward contracts
with banks, which are non-speculative and used to manage the risk of cetain of
the Group's borrowings denominated in foreign currencies. The respective
foreign currency exchange forward contract receivable and payable balances
which are included in other non-current assets and other non-current
liabilities are as follows:
As at December 31,
2004 2003
RMB million RMB million
Receivable 408 469
Payable 533 588
25 Accounts payable
As at December 31,
2004 2003
RMB million RMB million
0-30 days 6,122 7,480
31-60 days 1,833 554
61-90 days 925 414
91-180 days 2,115 2,494
Over 180 days 3,658 3,844
14,653 14,786
26 Accruals and other payables
Group Company
As at December 31, As at December 31,
2004 2003 2004 2003
RMB million RMB million RMB million RMB million
Accrued expenses 1,569 2,949 140 5
Other payables 1,784 1,461 - -
3,353 4,410 140 5
27 Bank and other loans
(a) As at December 31, 2004, the short term bank loans were unsecured and
comprise:
Currency Interest rate and As at December 31,
2004 final maturity
2003
RMB million RMB million
Renminbi denominated Interest 29,220 32,098
rates ranging
from 4.54% to
5.02% per
annum with
maturity
through Dec.
30, 2005
US Dollar denominated Interest 119 119
rates ranging
from 2.59% to
3.98% per
annum with
maturity
through Nov.
29, 2005
29,339 32,217
(b) The Group's long term bank and other loans comprise:
As at December 31,
Note 2004 2003
RMB million RMB million
Bank and other loans (i) 27,571 37,281
Finance lease obligations (ii) 1,560 744
29,131 38,025
Less: Current portion (7,270) (15,716)
21,861 22,309
(i) Long term bank and other loans
As at December 31,
2004 2003
RMB million RMB million
Loans
Unsecured 25,228 33,713
Secured 2,343 3,568
Total 27,571 37,281
Less: Current portion (7,060) (15,426)
Long-term loans 20,511 21,855
The Group's long term bank and other loans (excluding finance lease
liabilities) were repayable as follows:
As at December 31,
2004 2003
RMB million RMB million
Within one year 7,060 15,426
In the second year 6,550 11,513
In the third to fifth year 11,196 8,644
After the fifth year 2,765 1,698
27,571 37,281
The Group's long term bank and other loans comprise:
As at December 31,
Currency Interest rate and 2004 2003
final maturity
RMB million RMB million
Bank loans
Renminbi denominated Interest 23,776 32,870
rates ranging
from 4.5% to
6.1% per
annum with
maturity
through Oct.
20, 2014
US Dollar denominated Interest 2,552 1,920
rates ranging
from 2.1% to
5.0% per
annum with
maturity
through Dec.
31, 2040
Japanese Yen denominated Interest 860 877
rates ranging
from 2.1% to
2.6% per
annum with
maturity
through Oct.
20, 2022
Euro denominated Interest 383 392
rates ranging
from 2% to
5.94% per
annum with
maturity
through Jun.
30, 2023
27,571 36,059
Other loans
US Dollar denominated Interest - 1,222
rates at 1%
per month
with maturity
through Sep.
2006
27,571 37,281
As at December 31, 2004, secured loans and bank loans totalled RMB 2,343
million (2003: RMB 3,568 million) which were secured by the following:
(i) Certain fixed assets amounting to RMB 22 million (2003: RMB 2,668 million)
in respect of loans amounting to RMB 3 million (2003: RMB 16 million);
(ii) Corporate guarantees granted by China Netcom Group to the extent of RMB
1,888 million (2003: RMB 1,047 million); and
(iii) Corporate guarantees granted by third parties to the extent of RMB
452 million (2003: RMB 483 million).
Besides, other loans amounting to RMB 1,222 million at December 31, 2003
representing finance arrangements with certain vendors, which were secured by
certain cable systems, property and contracts owned by the Group had been all
transferred to China Netcom Group upon the Reorganisation on June 30, 2004.
(ii)
Finance lease obligations
As at December 31,
2004 2003
RMB million RMB million
Obligation under finance leases 1,560 744
Less: current portion (210) (290)
1,350 454
During the year ended December 31, 2004, the Group entered into a finance lease
arrangement with a related party (see note 18 (a)). The lease obligation
payable to the related party as at December 31, 2004 amounted to RMB 1,070
million.
The Group's liabilities under finance leases are analysed as follows:
As at December 31,
2004 2003
RMB million RMB million
Within one year 390 305
In the second year 662 211
In the third to fifth year, inclusive 580 250
After the fifth year - -
1,632 766
Less: future finance charges on finance leases (72) (22)
Present value of finance lease liabilities 1,560 744
The present value of finance lease liabilities is as follows:
Within one year 210 290
In the second year 776 206
In the third to fifth year, inclusive 574 248
After the fifth year - -
1,560 744
28 Amount due from/(to) holding companies and fellow subsidiaries
As at December 31,
Note 2004 2003
RMB million RMB million
Current
Due from holding companies (a) 136 399
Due from fellow subsidiaries (a) 237 50
373 449
Profits distribution payable to ultimate holding company (a) (8,244) (9,002)
Non-current
Due to holding companies
- intermediate holding company (a),(c) - (3,000)
- ultimate holding company (b),(c) - (1,750)
- (4,750)
Note:
(a) These are interest free, unsecured and have no fixed terms of repayment.
(b) The amount due to the ultimate holding company amounting to RMB 1,750
million as at the end of December 31, 2003 was unsecured, and carried interest
at 4.6% per annum.
(c) These balances were waived and recognised into the Group's equity upon the
Reorganisation. 29 Deferred revenues
As at December 31,
2004 2003
RMB million RMB million
Balance at beginning of year
- upfront connection fees 10,390 14,355
- upfront installation fees 6,691 6,456
- advances from network capacity sales 2,050 27
- prepaid telephony services 2,702 1,971
21,833 22,809
Additions for the year
- upfront connection fees - -
- upfront installation fees 1,051 1,279
- advances from network capacity sales
- additions 242 -
- acquired through Asia Netcom (Note 35 (c)) - 2,032
- prepaid telephony services 11,815 9,790
13,108 13,101
Reductions for the year
- upfront connection fees (3,378) (3,965)
- upfront installation fees (1,338) (1,044)
- advances from network capacity sales (114) (9)
- prepaid telephony services (11,592) (9,059)
(16,422) (14,077)
Distributed to owners in accordance with Reorganisation on June 30, 2004
- advances from network capacity sales (5) -
- prepaid telephony services (44) -
(49) -
Balance at end of year
- upfront connection fees 7,012 10,390
- upfront installation fees 6,404 6,691
- advances from network capacity sales 2,173 2,050
- prepaid telephony services 2,881 2,702
18,470 21,833
Representing:
- Current portion 6,653 7,229
- Non-current portion 11,817 14,604
18,470 21,833
30 Provisions
Early One-off cash Total
retirement housing
benefits subsidies
RMB million RMB million RMB million
Note 3(r)(ii) Note (a)
At January 1, 2004 2,754 2,670 5,424
Additional provisions 206 - 206
Payments during the year (414) (477) (891)
At December 31, 2004 2,546 2,193 4,739
Analysis of total provisions:
Current portion 403 2,193 2,596
Non-current portion 2,143 - 2,143
2,546 2,193 4,739
(a) Certain staff quarters have been sold to its employees, subject to a
number of eligibility requirements, at preferential prices. In 1998, the State
Council of the PRC issued a circular which stipulated that the sale of quarters
to employees at preferential prices should be terminated. In 2000, the State
Council issued a further circular stating that cash subsidies should be made to
certain eligible employees following the withdrawal of allocation of staff
quarters. However, the specific timetable and procedures of implementation of
these policies were to be determined by individual provincial or municipal
government based on the particular situation of the provinces or municipality.
Based on the relevant detailed local government regulations promulgated,
certain entities within the Group have adopted cash housing subsidy plans. In
accordance with these plans, for those eligible employees who had not been
allocated with quarters or who had not been allocated with quarters up to the
prescribed standards before the discounted sales of quarters were terminated,
the Group is required to pay them one-off cash housing subsidies based on their
years of service, positions and other criteria. Based on the available
information, the Group estimated the required provision for these cash housing
subsidies amounting to RMB 2,818 million, which was charged to the consolidated
income statement in the year ended December 31, 2000 when the State Council
circular in respect of cash subsidies was issued. Pursuant to the
Reorganisation, if the actual payments required for these one-off housing
subsidies differ from the amount provided as of June 30, 2004, China Netcom
Group will bear any additional payments required or will be paid the difference
if the actual payments are lower than the amount provided.
31 Deferred taxation
Movements of the deferred tax and liability are as follows:
Balance at Recognised Recognised Recognised Balance at
December in income in equity in equity December
31, 2003 statement 31, 2004
RMB million RMB million RMB million RMB million RMB million
Note (i) Note (ii)
Deferred tax assets
Deferred revenue, primarily advances 559 (46) (513) - -
from customers
Other temporary differences primarily 465 81 (420) - 126
allowance for doubtful debts
Unrecognised revaluation surplus and - (241) - 2,355 2,114
deficit (note(ii))
Provision for early retirement provision 974 25 (945) - 54
benefits
Disposal of fixed assets 703 (70) (633) - -
Others 83 86 (69) - 100
Balance at end of year 2,784 (165) (2,580) 2,355 2,394
Deferred tax liabilities
Revenue recognition (712) 133 579 - -
Fixed assets depreciation (2,347) (450) 2,797 - -
Deferred costs (245) 114 131 - -
Interest capitalization (832) (142) (270) - (1,244)
Others (77) (52) 52 - (77)
Balance at end of year (4,213) (397) 3,289 - (1,321)
The amounts shown in the consolidated balance sheet include
the following:
Deferred tax assets to be recovered 1,760 1,968
after more than 12 months
Deferred tax liabilities to be settled (3,501) (1,114)
after more than 12 months
Notes:
(i) As described in Note 18, in connection with the Reorganisation, certain of
the Group's telecommunications networks and equipment and furniture, fixture,
motor vehicles and other equipment were revalued as at December 31, 2003. Such
revalued amounts will be used to determine the tax bases for these assets for
future years. In addition, in connection with the Reorganisation, the tax bases
of certain assets and liabilities have been adjusted to the revalued amounts
incorporated as the carrying values in the balance sheet, except for the item
described in Note (ii) below. As a result, the Group's net deferred tax
liabilities were subsequently reduced by RMB709 million (comprising deferred tax
assets of RMB2,580 million and deferred tax liabilities of RMB3,289 million),
and this reduction was recorded as a credit to owner's equity upon the date of
the Reorganisation on June 30, 2004. Among the RMB709 million net reduction of
deferred tax liabilities, RMB846 million, being deferred tax liabilities
originated from the revaluation surplus of fixed assets recorded, was credited
to revaluation reserves and the remaining RMB137 million deferred tax assets
were debited to retained earnings.
(ii) In addition, the Group's land and buildings were revalued for PRC tax
purposes with a net surplus of RMB6,967 million as at December 31, 2003 to
determine the tax bases for future years. However, the resulting revaluations of
land and buildings were not incorporated into the consolidated financial
statements. As a result, a deferred tax asset of RMB2,355 million was
subsequently recorded with a corresponding increase in owner's equity upon the
Reorganisation on June 30, 2004. In the opinion of the directors, it is more
likely than not the Group will realize the benefits of the deferred tax asset
after making reference to the historical taxable income of the Group. The
revaluation asset is being transferred to retained earnings upon the
corresponding realisation of the underlying deferred tax assets. The amount of
transfer from revaluation reserve to retained earnings for the year ended
December 31, 2004 was RMB241 million.
32 Share capital
AUTHORISED
Ordinary shares of US$0.04 Convertible preference shares of US$0.04 Total
each (note (c))
No. of shares US$ RMB No. of shares US$ RMB US$ RMB
million million million
At January 1 25,000,000,000 1,000,000,000 8,277 7,741,782 309,671 3 1,000,309,671 8,280
December 31,
2003 and
December 31,
2004
ISSUED
Ordinary shares of US$0.04 Convertible preference shares of US$0.04 Total
each (note (c))
No. of shares US$ RMB No. of shares US$ RMB US$ RMB
million million million
At January 1 5,492,258,218 219,690,329 1,816 7,741,782 309,671 3 220,000,000 1,819
and 31
December 2003
(note (b))
Conversion of 7,741,782 309,671 3 (7,741,782) (309,671) (3) - -
convertible
preference
shares
(note (c))
Issue of 1,093,529,000 43,741,160 362 - - - 43,741,160 362
shares through
Global
Offering
(note (d))
At December 6,593,529,000 263,741,160 2,181 - - - 263,741,160 2,181
31, 2004
Notes:
(a) Pursuant to an ordinary resolution dated September 1, 2004, the authorised
share capital of the Company was increased to US$1,000,000,000 by creating an
additional 99,600,000,000 shares of US$0.01 each. Pursuant to an ordinary
resolution passed on September 7, 2004, every four issued and unissued shares
of US$0.01 each were consolidated into one new share of US$0.04 each. Following
the creation of 99,600,000,000 additional shares and the share consolidation,
the authorised share capital of the Company is RMB8,277 million divided into
25,000,000,000 shares of US$0.04 each, of which 5,492,258,218 shares were in
issue and fully paid. The shares after the share consolidation rank par in all
respects with each other. All references to the share capital of the Company in
this report have been adjusted retrospectively to take into account the
increase in authorised share capital and share consolidation. Besides, the
increase in authorised capital is applied respectively in connection with
presentation of share capital of the consolidated balance sheets as detailed in
notes below.
(b) The share capital presented in the consolidated balance sheet at January 1,
2003 represents (i) the share capital of the Company, including the shares as
at January 1, 2003 totalling 50,000,000 ordinary shares and (ii) shares issued
for the Asset Injection arising from the Reorganisation totalling 5,442,258,218
ordinary shares described in note 1 above. The shares described in (ii) are
deemed to have been issued on January 1, 2003 under the Reorganisation for
mergers accounting provision of Hong Kong SSAP No.27. The difference between
the nominal value of the shares described in (ii) and the value of the net
assets injected into the Company under the Asset Injection, totalling
approximately RMB31 billion, is reflected as share premium as at January 1,
2003.
(c) All preference shares were converted into ordinary shares of the Company on
August 30, 2004.
(d) On December 8, 2004, the Company completed its Global Offering as follows:
(i) issue of an aggregate of 950,895,000 shares of US$0.04 each at HK$8.48 per
share on The Stock Exchange of Hong Kong Limited ("HKSE") and at US$21.82
(HK$169.60) per ADS on the New York Stock Exchange Inc., on Nov. 17 and Nov. 16
respectively; and
(ii) issue of 142,634,000 shares of US$0.04 each at HK$8.48 by way of a placing
among professional and institutional investors on December 8, 2004 upon the
full exercise of an over-allotment option.
The listing proceeds of the aforementioned Global Offering of shares, net of
share issue expenses of HK$650 million (equivalent to RMB689 million) amounted
to approximately HK$8,438 million (equivalent to RMB8,944 million). The
resulting share premium amounted to approximately HK$8,096 million (equivalent
to RMB8,582 million).
33 Share option scheme
A share option scheme was approved pursuant to a directors' resolution on
September 30, 2004 ("Share Option Scheme"). Share options are granted to
directors of the Company and to certain employees of the Group at the directors'
discretion. Share option can be exercised at least 18 months from the later of
the date of grant or the date of the listing of the shares of the Company on the
Hong Kong Stock Exchange and subject to certain vesting schedules.
On October 22, 2004, 158,640,000 share options with exercise price of HK$8.40
each were granted to certain directors of the Company and certain employees of
the Group. The total number of ordinary shares that are available for issuance
upon the exercise of options granted pursuant to this scheme may not exceed 10%
of the total number of issued ordinary shares. The Company may, however, seek
separate approvals from its shareholders for granting options beyond the 10%
limit. The scheme will be valid and effective for a period of six years and no
options may be granted pursuant to this scheme following the expiration of the
scheme. Pursuant to the Company's share option plan, the Company granted
158,640,000 options to certain of its directors and employees, immediately
prior to the closing of its global offering, to subscribe for its ordinary
shares at the initial public offering price under the Hong Kong public
offering, excluding brokerage and trading fees, and transaction and investor
compensation levies. The options granted under this plan has a vesting period
of 42 months from the date of listing of our shares and will expire six years
from the date of grant. Details of the share options granted immediately prior
to the closing of the global offering and the movement during the year are
summarised as follows:
NO. OF SHARE OPTIONS
Date of grant Outstanding Granted No. of Exercised Lapsed Cancelled Outstanding Subscription Option
as at during the directors during the during during the as at price per period
January 1, period and period the period period December share of
2004 employees 31, 2004 the Company
HK$
22/10/2004 - 158,640,000 456 - 920,000(a) - 157,720,000 8.40 157,720,000
(a) A director resigned during the year and the options granted to him lapsed
on the date of resignation in accordance with the terms of the share option
scheme.
34 Reserves - Company
Share Capital Retained Total
premium Reserve earnings
RMB million RMB million RMB million RMB million
At January 1, 2003 2,771 - 172 2,943
Profit for the year - - 19 19
At December 31, 2003 2,771 - 191 2,962
Issue of shares under Asset Injection in accordance with 31,397 2,982 - 34,379
Reorganisation
Distributions to owners in accordance with Reorganisation - - (359) (359)
Loss for the year - - (41) (41)
Distribution to an owner upon assignment of loan prior to - - (1,021) (1,021)
the Global Offering (Note a)
Issue of shares through Global Offering (net of issue 8,582 - - 8,582
expenses)
At December 31, 2004 42,750 2,982 (1,230) 44,502
(a) Pursuant to the promissory note (the "Note") signed by Group Wealth Finance
Limited ("Group Wealth"), a fellow subsidiary owned by CNC BVI, the Company's
immediate holding company, dated July 27, 2004, Group Wealth has borrowed an
amount of US$123,301,980 (RMB1,020,644,470) from Asia Netcom, and used these
funds to acquire the right to receive the outstanding debt payments owed by East
Asia Netcom Limited, a fellow subsidiary, from the vendors to the aggregate
amount of approximately US$123 million on July 29, 2004.
Subsequently, on September 30, 2004, CNC BVI instructed Group Wealth to assign
the loan to the Company. Accordingly, upon such assignment, the amount
receivable from Group Wealth of the said amount is effectively waived and the
Company recorded such assignment as an equity distribution to CNC BVI.
35 Consolidated cash flow statements
(a) Reconciliation of profit/(loss) before taxation to net cash flows generated
from operations
Years ended December 31,
2004 2003
RMB million RMB million
Profit/(loss) before taxation 12,596 (17,931)
Depreciation of fixed assets and amortisation of intangible assets 18,754 20,483
Amortisation of deferred revenues (16,422) (14,309)
Deferred costs expensed in the income statements 3,484 1,927
Deficit on revaluation of fixed assets - 25,778
Allowance for doubtful debts 832 619
Loss on disposal of fixed assets 145 1,689
Dividend income (17) (45)
Share of loss from associated companies and jointly controlled entities 1 416
Interest income (76) (79)
Interest expense 2,794 2,844
Discount on foreign currency exchange forward contracts 18 20
Realised (gain) on disposal of short-term investments - (1)
Unrealised loss/(gain) on short-term investments 4 (7)
Unrealised foreign exchange losses 70 142
Operating profit before working capital changes 22,183 21,546
Increase in accounts receivable (312) (1,779)
Decrease/(increase) in inventories and consumables 201 (231)
(Increase)/decrease in prepayments and other receivable (62) 270
Increase in deferred costs and other non-current assets (3,158) (3,494)
Increase in accounts payable 1,229 1,883
(Decrease) in accruals and other payables (3,483) (457)
Increase in deferred revenues 13,108 11,069
Net cash inflow generated from operations 29,706 28,807
(b) Major non-cash transactions
During 2004, the Group entered into finance lease arrangements in respect of
newly acquired fixed assets with a total capital value at the inception of the
lease of RMB409 million (2003: RMB276 million).
During 2004, the immediate holding company assigned a loan to the Company which
resulted in a direct charge to the Company's equity, see note 34(a) for
details.
(c) Acquisition of Asia Global Crossing through Asia Netcom The Group acquired
100% of certain entities previously controlled by Asia Global Crossing through
Asia Netcom by way of two acquisitions. On March 10, 2003, the Group injected
RMB507 million into Asia Netcom, a 51% owned jointly controlled entity which
acquired the entire interest in certain entities, which own and operate an
Asia-Pacific region cable network providing city-to-city connectivity, data
communications and IP-based services, previously controlled by Asia Global
Crossing. On December 31, 2003, the Group acquired the remaining 49% of the
equity of Asia Netcom for a total cost of RMB525 million. From March 10, 2003
to December 31, 2003, Asia Netcom was accounted for as a jointly controlled
entity. On December 31, 2003, Asia Netcom became a wholly owned subsidiary of
the Company and was consolidated into the Group's financial statements. The net
assets acquired and the net cash inflow in respect of the purchase of the
remaining 49% interest in Asia Netcom, which has a group of subsidiaries, is
analysed as follows:
As at
December
31, 2003
RMB
million
Net assets acquired at their respective estimated fair values
Fixed assets 3,037
Deferred costs 870
Other non-current assets 157
Cash and bank deposits 580
Accounts receivables and other current assets 442
Accounts payable and other current liabilities (1,207)
Advances from network capacity sales (2,032)
Bank and other loans (1,011)
Net assets 836
49% of net assets 410
Goodwill (note 20) 115
Satisfied by Cash 525
Cash consideration (525)
Cash and bank deposits acquired 580
Net cash inflow in respect of the purchase of subsidiaries 55
36 Contingent liabilities
(a) Guarantees
Group Company
As at December 31, As at December 31,
2004 2003 2004 2003
RMB million RMB million RMB million RMB million
Guarantees for US dollar denominated bank loans 63 125 - -
of third parties
On December 8, 2000, a subsidiary of the Company entered into an agreement to
provide a guarantee to a subsidiary of China Mobile for a foreign currency
borrowing. The guarantee arose from the assumption of responsibilities by both
parties as part of the legacy arrangements of their predecessor companies
commonly controlled by the state government.
The guarantee obligation is limited to the outstanding loan and accrued
interest amount payable by the subsidiary of China Mobile which is due to be
settled by September 2005. As at December 31, 2003 and 2004, the outstanding
balances of the borrowing, including interest payable, were US$15.1 million
(RMB125 million) and US$7.6 million (RMB 63 million) respectively.
The directors are of the opinion that the possibility of the guaranteed party
defaulting on the outstanding balance of the borrowing is remote, hence no
provisions have been made for the guarantee.
(b) National Audit Office ("NAO") audit
During the year, the NAO has completed its audit on the ultimate holding
company, China Netcom Group, including all of its business operations, assets
and liabilities prior to the Reorgnisation. Substantial assets and liabilities
currently comprising the Group were injected by China Netcom Group in
accordance with the Reorgnisation. China Netcom Group has informed the
directors that no significant matters have been raised to China Netcom Group by
the NAO as a result of its audit. Accordingly the directors are of the opinion
that there is no matter concerning the Group that qualifies for disclosure in
its consolidated financial statements in relation to the NAO audit.
37 Banking facilities
As at December 31, 2003 and 2004, the Group's banking facilities are
as follows:
Group Company
As at December 31, As at December 31,
2004 2003 2004 2003
RMB million RMB million RMB million RMB million
Amount utilised 56,910 69,498 - -
Amount unutilised 13,590 10,952 - -
Aggregate banking facilities 70,500 80,450 - -
38 Commitments
(a) Capital commitments
Group Company
As at December 31, As at December 31,
2004 2003 2004 2003
RMB million RMB million RMB million RMB million
Contracted but not provided for
- Land and buildings 47 220 - -
- Telecommunications networks and equipment 986 1,971 - -
1,033 2,191 - -
Authorised but not contracted for
- Land and buildings 2 213 - -
- Telecommunications networks and equipment 1,778 4,626 - -
1,780 4,839 - -
(b) Operating lease commitments
The Group has future minimum lease payments under non-cancellable operating
leases in respect of premises and equipment as follows:
Group Company
As at December 31, As at December 31,
2004 2003 2004 2003
RMB million RMB million RMB million RMB million
Not later than one year 793 463 - -
Later than one year and not later than five years 1,129 770 - -
Later than five years 1,510 297 - -
3,432 1,530 - -
39 Related party transactions
Parties are considered to be related if one party has the ability, directly or
indirectly, to control the party or exercise significant influence over the
party in making financial and operating decisions. Parties are also considered
to be related if they are subject to common control or common significant
influence.
(a) Transaction before Reorganisation on June 30,2004 The directors consider
that the following related party transactions were carried out in the normal
course of business of the Group and at terms mutually agreed between the Group
and the respective related parties.
Period from 2003
January 1,
2004 to June
30, 2004
prior to
Reorganisation
Note RMB million RMB million
Rental income from properties leased to related companies (v)(a), (v)(c) 2 4
Purchase of materials
- from fellow subsidiaries (v)(a), (v)(c) (528) (2,365)
- from related companies (v)(a), (v)(c) (670) (1,738)
(1,198) (4,103)
Receipt of engineering, project planning, design,
construction and information technology services
- from fellow subsidiaries (v)(a), (v)(b) (321) (1,714)
- from related companies (v)(a), (v)(b) (564) (1,517)
(885) (3,231)
Ancillary telecommunications support services (iii)
- from fellow subsidiaries (v)(a), (v)(c) (207) (1,021)
- from related companies (v)(a), (v)(c) (232) (767)
(439) (1,788)
Payment of operating lease rentals of premises
- from fellow subsidiaries (v)(a), (v)(c) (7) (13)
- from related companies (v)(a), (v)(c) (5) (35)
(12) (48)
Support services (iv)
- from fellow subsidiaries (v)(a), (v)(c) (187) (1,028)
- from related companies (v)(a), (v)(c) (149) (510)
(336) (1,538)
(b) Transaction after Reorganisation on June 30,2004
Period after
Reorganisation
from July 1,
2004 to
December 31,
2004
Note RMB million
Interconnection fee received from ultimate holding company (vi)(a) 144
Interconnection fee paid to ultimate holding company (vi)(a) (167)
Payment of operating lease rentals of premises from fellow (vi)(b) (299)
subsidiaries
Payment of operating sub-lease rentals of premises from fellow (vi)(c) (33)
subsidiaries
Common corporate services income received from ultimate holding (vi)(d) 19
company
Common corporate services expense paid to ultimate holding company (vi)(d) (213)
Receipt of engineering, project planning, design, construction and (vi)(e)
information technology services
- from fellow subsidiaries (1,935)
- from related companies (7)
(1,942)
Purchase of materials (vi)(f)
- from fellow subsidiaries (780)
- from related companies (106)
(886)
Ancillary telecommunications support services (vi)(g)
- from fellow subsidiaries (281)
- from related companies (3)
(284)
Support services (vi)(h)
- from fellow subsidiaries (520)
- from related companies (211)
(731)
Payment of operating lease rentals of telecommunications (vi)(i) (138)
facilities to fellow subsidiaries
Payment for purchase of long-term telecommunications capacity to (vi)(j) (173)
ultimate holding company
Payment for lease of long-term telecommunications capacity to (vi)(k) (28)
ultimate holding company
Management fee received from ultimate holding company (vi)(l) 28
Notes:
(i) As at the respective balance sheet dates, the Group had balances with
certain related parties, which have been set out in Notes 27(b)(ii) and 28.
(ii) The related companies represent the investees of the unlisted fellow
subsidiaries.
(iii) Represents the provision of ancillary telecommunications support services
to the Group by the fellow subsidiaries and the related companies. These
services include certain telecommunications pre-sale, on-sale and after-sale
services, certain sales agency services, the printing and delivery of invoice
services, the maintenance of certain air-conditioning, fire alarm equipment and
telephone booths and other customers services.
(iv) Represents the support services provided to the Group by the fellow
subsidiaries and the related companies. These support services include
equipment leasing services, motor vehicles services, safety and security
services, conference services, basic construction agency services, equipment
maintenance services, employee training services, advertising services,
printing services and other support services.
(v) Transactions with individual related parties before reorganisation on June
30, 2004 were priced based on one of the following three criteria:
(a) market price;
(b) prices based on government guidance; or
(c) cost plus basis.
(vi) In connection with the Reorganisation, the Group and China Netcom Group
entered into a number of agreements effective on or after July 1, 2004 with an
initial term expiring on December 31, 2006. The terms of the principal
agreements are summarised as follows:
(a) The Group entered into an Interconnection Settlement Agreement with China
Netcom Group for interconnection of domestic and international long distance
telephone calls. Pursuant to the said agreement, the telephony operator
terminating a telephone call made to its local networks is entitled to receive
a fee prescribed by MII from the operator from which the telephone call is
originated.
(b) The Group entered into a Property Leasing Agreement with China Netcom Group
pursuant to which the Group leases certain properties to/from China Netcom
Group. The rental charges are based on either market rates or depreciation
charge and maintenance charge in respect of each property, provided that such
depreciation and maintenance charge shall not be higher than the market rates.
(c) The Group entered into Property Sub-leasing Agreement with China Netcom
Group pursuant to which the Group leases certain properties from China Netcom
Group which are owned by independent third parties. The rental charges are
based on market rates negotiated between China Netcom Group and the relevant
third parties.
(d) The Group entered into a Master Service Sharing agreement with China Netcom
Group pursuant to which expenses associated with common corporate services are
allocated between the Group and China Netcom Group based on revenues as
appropriate.
(e) The Group entered into an Engineering and Information Technology Services
Agreement with China Netcom Group pursuant to which China Netcom Group provides
the Group with engineering and information technology-related services. The
amounts charged for these services are determined by reference to market rates
as reflected in prices obtained through a tender.
(f) The Group entered into a Materials Procurement Agreement with China Netcom
Group pursuant to which China Netcom Group provides the Group with the
procurement of equipment and materials. The amount charged for this service is
based on a percentage not exceeding 3% of the contract value of the equipment
and materials purchased from domestic suppliers or 1% of the contract value of
the equipment and materials purchased from overseas suppliers.
(g) The Group entered into an Ancillary Telecommunications Services Agreement
with China Netcom Group. The ancillary telecommunications services provided by
China Netcom Group include certain telecommunications pre-sale, on-sale and
after-sale services, sales agency services and certain customer services.
Pursuant to the said agreement, China Netcom Group charges the Group for these
services in accordance with the following terms:
o Government prescribed price;
o Where there is no government prescribed price but there is a government
guided price, the government guided price will apply;
o Where there is neither government prescribed price nor a government guided
price the market price will apply;
o 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.
(h) The Group entered into a Support Services Agreement for various support
services with China Netcom Group. The support services provided by China Netcom
Group include equipment leasing and maintenance services, motor vehicles
services, safety and security service, basic construction agency services,
research and development services, employee training services and advertising
services and other support services. Pursuant to the said agreement, China
Netcom Group charges the Group for these services in accordance with the
following terms:
o Government prescribed price;
o Where there is no government prescribed price but there is a government
guided price, the government guided price will apply;
o Where there is neither government prescribed price nor a government guided
price the market price will apply;
o 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.
(i) The Group entered into a Telecommunications Facilities Leasing Agreement
with China Netcom Group pursuant to which the Group leases the international
telecommunications facilities and inter-provincial transmission optic fibres
from China Netcom Group. The lease payment is based on the depreciation charge
of the assets.
(j) The Group entered into a Capacity Purchase Agreement with East Asia Netcom
Limited ("EANL"), a wholly owned subsidiary of China Netcom Group, pursuant to
which the Group receives certain amounts of long-term telecommunications
capacity from China Netcom Group at market prices as set out in the Capacity
Purchase Agreement.
(k) The Group entered into a Capacity Lease Agreement with EANL, pursuant to
which the Group leases certain amounts of capacity of China Netcom Group's
telecommunications network at market rates as set out in the Capacity Lease
Agreement.
(l) The Group entered into a Management Services Agreement with EANL, pursuant
to which the Group provides certain management services to China Netcom Group
either on a cost reimbursement basis or on the basis of cost plus reasonable
profits not exceeding the market price as set out in the Management Service
Agreement.
(vii) In addition, pursuant to the Reorganisation, China Netcom Group has
agreed to hold and maintain, for the Group's benefit, all licenses received
from the MII in connection with the Restructured Businesses transferred to the
Group. The licences maintained by China Netcom Group were granted by the MII at
nil or nominal costs. To the extent that China Netcom Group incurs a cost to
maintain or obtain licences in the future, the Company has agreed reimburse
China Netcom Group for any such expense.
(viii) China Netcom Group has also agreed to indemnify the Group in
connection with any tax and deferred tax liabilities not recognised in the
financial statements of the Group and arisen from transactions prior to the
date of Reorganisation.
(ix) During the year, the Group entered into a finance lease arrangement with a
related party (see note 18(a)).
(x) During the year, a fellow subsidiary borrowed a loan from the Group and the
loan payable from the fellow subsidiary was assigned to the Group at the
instruction of its immediate holding company, which resulted in a direct charge
to the Company's equity, please refer to note 34(a) for details.
40 Significant subsequent events
After the balance sheet date, the directors proposed a final dividend. Further
details are disclosed in note 9.
41 Ultimate holding company
The directors regard China Netcom Group, a state-owned company established in
the PRC, as being the ultimate holding company.
42 Approval of financial statements
The financial statements were approved by the Board of Directors on April 6,
2005.
APPENDIX IV FINANCIAL INFORMATION OF THE COMBINED GROUP
Unaudited Pro Forma Combined Financial Statements
1 BACKGROUND INFORMATION OF THE TARGET GROUP
Target BVI Company was incorporated in the British Virgin Islands ("BVI") on 27
July 2005 as a limited liability company under the British Virgin Islands
International Business Companies Act 1984. The Target BVI Company is currently
owned by China Netcom Group, the Company's ultimate holding company and a
state-owned enterprise established in the PRC. Through the Target Company, its
wholly-owned subsidiary established in the PRC, the Target BVI Company holds
the assets and liabilities and the business operations for the provision of
fixed-line telephone services, broadband and other Internet-related services,
and business and data communications services in four provinces or autonomous
regions in the PRC, namely, Shanxi Province, Jilin Province, Heilongjiang
Province and Neimenggu Autonomous Region which were transferred from China
Netcom Group through a reorganisation.
2 INTRODUCTION TO THE UNAUDITED PRO FORMA combined FINANCIAL INFORMATION OF
THE COMBINED GROUP
The accompanying unaudited pro forma financial information of the Combined
Group has been prepared to illustrate the effect of the Acquisition at a
consideration of RMB12.8 billion. The consideration will be satisfied by cash
in 11 instalments. The initial consideration of RMB3 billion will be satisfied
on completion of the Acquisition and the deferred consideration of RMB 9.8
billion, being the difference between the total consideration and the initial
consideration, is interest bearing at 5.265% per annum and is fully repayable
within five years after the date of completion of the Acquisition.
The accompanying unaudited pro forma combined balance sheet of the Combined
Group as at 30 June 2005 gives effect to the Acquisition as if it had been
consummated on 30 June 2005.
The accompanying unaudited pro forma combined income statements for the year
ended 31 December 2004 and for the six months ended 30 June 2005 of the
Combined Group give effect to the Acquisition as if it had taken place on 1
January 2004 and 1 January 2005 respectively.
In connection with the Reorganisation, the lease prepayments for land and
property, plant and equipment of the Target Group were revalued at RMB42,879
million as of 31 December 2004 as required by the relevant PRC rules and
regulations. The Target Group expects that the revaluation of fixed assets will
have a material impact on its overall results of operations as the Acquisition
will be accounted for under the purchase method of accounting. Accordingly, the
accompanying unaudited pro forma income statements of the Combined Group has
been adjusted to give effect to the revaluation as if the Acquisition had been
consummated on 1 January 2004 and on 1 January 2005 respectively.
The accompanying unaudited pro forma financial information of the Combined
Group is prepared based upon the historical financial information of the Target
Group as set out in Appendix II to this circular and the consolidated financial
statements of the Group after giving effect to the pro forma adjustments
described in the accompanying notes. The historical income statement of the
Group for the year ended 31 December 2004 presented in the published audited
financial statements for the year ended 31 December 2004 has been restated to
reflect the impacts of the adoption of the new and revised HKFRS which are
effective for accounting periods beginning on or after 1 January 2005. The
restated income statement of the Group for the year ended 31 December 2004 has
been presented in the Company's 2005 interim results announcement dated 12
September 2005 as supplementary financial information and Appendix III to this
circular.
Narrative descriptions of the pro forma adjustments 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.
The unaudited pro forma financial information of the Combined Group is based on
a number of assumptions, estimates, uncertainties and currently available
information, and is provided for illustrative purposes. Accordingly, as a
result of the uncertain nature of the accompanying unaudited pro forma
financial information of the Combined Group, it may not give a true picture of
the actual financial position or results of the Combined Group's operations
that would have been attained had the Acquisition actually occurred on the
dates 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 Accountants' Report of the Target Group as set out
in Appendix II to this circular, the financial information of the Group as set
out in Appendix III to this circular and other financial information included
elsewhere in this circular.
3 UNAUDITED PRO FORMA COMBINED BALANCE SHEET AS AT 30 JUNE 2005
The accompanying unaudited pro forma combined balance sheet of the Combined
Group as at 30 June 2005 gives effect to the Acquisition as if it had been
consummated on 30 June 2005.
The Target Pro forma Note Combined
Group Group adjustments Group
Historical Historical Pro forma
RMB RMB RMB RMB
million million million million
Assets
Current assets
Cash and bank deposits 8,790 466 (3,000) (c) 6,256
Short-term investments 439 - - 439
Accounts receivable 6,778 1,859 - 8,637
Inventories and consumables 502 273 - 775
Prepayments and other receivables 1,079 366 - 1,445
Due from holding companies and fellow subsidiaries 489 166 - 655
Total current assets 18,077 3,130 (3,000) 18,207
Non-current assets
Lease prepayments for land 1,291 437 1,878 (a) 3,606
Property, plant and equipment 122,689 39,327 644 (a) 162,660
Construction in progress 9,172 3,178 - 12,350
Intangible assets 926 121 2,978 (b) 4,025
Deferred costs 6,250 593 - 6,843
Deferred tax assets 2,881 1,143 (831) (a) 3,193
Derivative assets 2 - - 2
Other non-current assets 11 - - 11
Total non-current assets 143,222 44,799 4,669 192,690
Total assets 161,299 47,929 1,669 210,897
Liabilities and equity
Current liabilities
Accounts payable 13,281 6,091 - 19,372
Accruals and other payables 3,698 1,319 - 5,017
Short-term bank loans 26,425 16,978 - 43,403
Current portion of long-term bank and other loans 4,263 3,484 - 7,747
Due to holding companies and fellow subsidiaries 8,469 1,866 1,960 (d) 12,295
Current portion of deferred revenues 6,196 1,954 - 8,150
Current portion of provisions 2,480 1,513 - 3,993
Taxation payable 2,656 97 - 2,753
Total current liabilities 67,468 33,302 1,960 102,730
Net current liabilities (49,391) (30,172) (4,960) (84,523)
Total assets less current liabilities 93,831 14,627 (291) 108,167
Non-current liabilities
Long-term bank and other loans 18,280 3,213 - 21,493
Due to holding companies - - 7,840 (d) 7,840
Deferred revenues 10,528 1,860 - 12,388
Provisions 2,080 1,369 - 3,449
Deferred tax liabilities 1,354 50 - 1,404
Derivative liabilities 83 - - 83
Other non-current liabilities 22 4 - 26
Total non-current liabilities 32,347 6,496 7,840 46,683
Total liabilities 99,815 39,798 9,800 149,413
Financed by:
Share capital 2,181 - - 2,181
Reserves 59,303 8,131 (8,131) (e) 59,303
Owner's equity 61,484 8,131 (8,131) 61,484
Total liabilities and equity 161,299 47,929 1,669 210,897
Notes to the unaudited pro forma combined balance sheet of the Combined Group
A description of the unaudited pro forma adjustments is as follows.
(a) The adjustment represents the fair value adjustments of Target Group's
lease prepayments for land and property, plant and equipment under the purchase
method of accounting as if the Acquisition had taken place on 30 June 2005.
Accordingly, the deferred tax assets previously recognised by the Target Group
arising from the revaluation of lease prepayment for land and building not
recognised in the financial statement would be reversed.
(b) The adjustment represents the recognition of goodwill as a result of the
Acquisition as if the Acquisition had taken place on 30 June 2005. Goodwill
represents the excess of the total purchase consideration of RMB 12.8 billion
and the estimated fair value of the identifiable assets and liabilities of the
Target Group as at 30 June 2005.
For the purpose of preparing the unaudited combined balance sheet of the
Combined Group after the completion of the Acquisition, the estimated net fair
value of the identifiable assets and liabilities of the Target Group as at 30
June 2005 based on the historical cost basis modified by the revaluation of
lease prepayments for land and plant, property and equipment are applied in the
calculation of the estimated goodwill arising from the Acquisition. Based on
the preliminary assessment made by the Directors, no intangible assets would be
recognised upon Acquisition. As a formal valuation of the identifiable assets
and liabilities, including the intangible assets of the Target Group, will be
undertaken on completion of the Acquisition, intangible assets may be
recognised and the net fair value of the identifiable assets and liabilities
may be substantially different from their fair value used in the preparation of
the unaudited combined balance sheet presented above, the actual goodwill
arising from the Acquisition may be different from the estimated goodwill shown
in this Appendix.
(c) In connection with the Acquisition, an initial cash consideration of RMB 3
billion will be paid by the Company to CNC BVI on completion of the
Acquisition. The adjustment reflects the payment of the initial cash
consideration as if the Acquisition had taken place on 30 June 2005.
(d) In connection with the Acquisition, a deferred consideration of RMB 9.8
billion, representing the difference between the total consideration and the
initial consideration described in note (c) above, is payable by the Company to
CNC BVI within five years after the date of completion of the Acquisition. The
adjustment reflects the deferred consideration payable as if the Acquisition
had taken place on 30 June 2005.
(e) The adjustment represents the elimination of the owners' equity of the
Target Group as at 30 June 2005.
4 UNAUDITED PRO FORMA COMBINED INCOME STATEMENT FOR THE YEAR ENDED 31
DECEMBER 2004
The accompanying unaudited pro forma combined income statement for the year
ended 31 December 2004 of the Combined Group gives effect to the Acquisition as
if it had taken place on 1 January 2004.
The Target Pro forma Note Combined
Group Group adjustments Group
Historical Historical Pro forma
Restated
(e)
RMB RMB RMB RMB
million million million million
Revenues 64,922 18,616 - 83,538
Operating expenses
Depreciation and (18,754) (6,426) 618 (a) (24,562)
amortisation
Network, operations and (11,591) (2,426) - (14,017)
support
Staff costs (8,059) (3,891) - (11,950)
Selling, general and (9,566) (3,311) - (12,877)
administrative expenses
Other operating expenses (1,534) (459) - (1,993)
Total operating expenses (49,504) (16,513) 618 (65,399)
Operating profit before 15,418 2,103 618 18,139
interest income, dividend
income and deficit on
revaluation of property,
plant and equipment
Interest income 76 11 (43) (b) 44
Dividend income 17 - - 17
Deficit on revaluation of - (11,318) - (11,318)
property, plant and
equipment
Profit/(loss) from operations 15,511 (9,204) 575 6,882
Finance costs (2,932) (998) (490) (c) (4,420)
Share of loss of associated (1) - - (1)
companies
Profit/(loss) before taxation 12,578 (10,202) 85 2,461
Taxation (3,348) 3,671 (190) (d) 133
Profit/(loss) for the year 9,230 (6,531) (105) 2,594
5 UNAUDITED PRO FORMA COMBINED INCOME STATEMENT FOR THE SIX MONTHS ENDED 30
JUNE 2005
The accompanying unaudited pro forma combined income statement for the six
months ended 30 June 2005 of the Combined Group gives effect to the Acquisition
as if it had taken place on 1 January 2005.
The Target Pro forma Note Combined
Group Group adjustments Group
Historical Historical Pro forma
RMB RMB RMB RMB
million million million million
Revenues 33,724 9,712 - 43,436
Operating expenses
Depreciation and amortisation (9,265) (3,184) (44) (a) (12,493)
Network, operations and support (5,549) (992) - (6,541)
Staff costs (4,200) (1,759) - (5,959)
Selling, general and administrative expenses (4,402) (1,369) - (5,771)
Other operating expenses (541) (129) - (670)
Total operating expenses (23,957) (7,433) (44) (31,434)
Operating profit before interest income and 9,767 2,279 (44) 12,002
dividend income
Interest income 87 3 (22) (b) 68
Dividend income 28 - - 28
Profit from operations 9,882 2,282 (66) 12,098
Finance costs (1,226) (501) (258) (c) (1,985)
Profit before taxation 8,656 1,781 (324) 10,113
Taxation (2,298) (451) 22 (d) (2,727)
Profit for the period 6,358 1,330 (302) 7,386
Notes to the unaudited pro forma combined income statements of the Combined
Group
A description of the unaudited pro forma adjustments is as follows.
(a) For the unaudited pro forma combined income statement for the year ended 31
December 2004, the adjustment represents the reduction in depreciation and
amortisation resulting from the fair value adjustments on the lease prepayments
for land and property, plant and equipment of the Target Group under the
purchase method of accounting as if the Acquisition had taken place on 1
January 2004.
For the unaudited pro forma combined income statement for the period ended
30 June 2005, the adjustment represents the increase in depreciation and
amortisation resulting from the fair value adjustments on the lease prepayments
for land and property, plant and equipment of the Target Group under the
purchase method of accounting as if the Acquisition had taken place on 1 January
2005.
(b) The adjustment reflects the reduction in interest income for the initial
cash consideration described in note (c) in Section 3 above to be taken from
the internal resources of the Group as if the Acquisition had taken place on 1
January 2004 and 1 January 2005.
(c) The adjustment represents the interest expenses charged on the deferred
consideration described in note (d) in Section 3 above at 5.265% per annum as
if the Acquisition had taken place on 1 January 2004 and 1 January 2005. The
interest expense is not deductible for taxation purposes.
(d) The adjustment represents the tax effect of the pro forma adjustment
described above.
(e) The historical income statement of the Group for the year ended 31 December
2004 presented in the published audited financial statements for the year ended
31 December 2004 has been restated to reflect the impacts of the adoption of
the new and revised HKFRS which are effective for accounting periods beginning
on or after 1 January 2005. The restated income statement of the Group for the
year ended 31 December 2004 has been presented in the Company's 2005 interim
results announcement dated 12 September 2005 as supplementary financial
information and Appendix III to this circular.
6 REPORT ON THE UNAUDITED PRO FORMA FINANCIAL INFORMATION OF THE COMBINED
GROUP
The following is the text of a report, prepared for the sole purpose of
inclusion in this circular, received from the independent reporting
accountants, PricewaterhouseCoopers, Certified Public Accountants, Hong Kong.
[PRICEWATERHOUSECOOPERS LETTERHEAD GRAPHIC OMITTED]
23 September 2005
The Directors
China Netcom Group Corporation (Hong Kong) Limited
Dear Sirs,
We report on the unaudited pro forma financial information of the Combined
Group (as defined below) set out in Appendix IV to the circular of China Netcom
Group Corporation (Hong Kong) Limited (the "Company", and together with its
existing subsidiaries the "Group") dated 23 September 2005 (the "Circular") in
connection with the proposed acquisition of China Netcom Group New Horizon
Communications Corporation (BVI) Limited and its subsidiary China Netcom Group
New Horizon Communications Corporation Limited (collectively the "Target
Group", and together with the Group the "Combined Group"). The unaudited pro
forma financial information has been prepared by the directors of the Company,
for illustrative purposes only, to provide information about how the proposed
acquisition of the Target Group resulting in the formation of the Combined
Group might have affected the income statements of the Group for the year ended
31 December 2004 and the six months ended 30 June 2005 and the balance sheet as
of 30 June 2005.
RESPONSIBILITIES
It is the responsibility of the directors of the Company to prepare the
unaudited pro forma financial information in accordance with Rule 4.29 of the
Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong
Limited ("the Hong Kong Listing Rules").
It is our responsibility to form an opinion, as required by Rule 4.29 of the
Hong Kong Listing Rules, on the unaudited pro forma financial information and
to report our opinion to you. We do not accept any responsibility for any
reports previously given by us on any financial information used in the
compilation of the unaudited pro forma financial information beyond that owed
to those to whom those reports were addressed by us at the dates of their
issue.
BASIS OF OPINION
We conducted our work with reference to the Statements of Investment Circular
Reporting Standards and Bulletin 1998/8 "Reporting on pro forma financial
information pursuant to the Listing Rules" issued by the Auditing Practices
Board in the United Kingdom, where applicable. Our work, which involved no
independent examination of any of the underlying financial information,
consisted primarily of comparing the unadjusted financial information with the
source documents, considering the evidence supporting the adjustments and
discussing the unaudited pro forma financial information with the directors of
the Company.
Our work does not constitute an audit or review in accordance with Statements
of Auditing Standards issued by the Hong Kong Institute of Certified Public
Accountants, and accordingly, we do not express any such assurance on the
unaudited pro forma financial information.
The unaudited pro forma financial information has been prepared on the bases
set out in Appendix IV to the Circular for illustrative purposes only and,
because of its nature, it may not be indicative of the financial position of
the Combined Group at any future date and the results of the Combined Group for
any future periods.
OPINION
In our opinion:
(a) the unaudited pro forma financial information has been properly compiled by
the directors of the Company on the basis stated;
(b) such basis is consistent with the accounting policies of the Group; and
(c) the adjustments are appropriate for the purposes of the unaudited pro forma
financial information as disclosed pursuant to Rule 4.29 of the Hong Kong
Listing Rules.
Yours faithfully
PricewaterhouseCoopers
Certified Public Accountants
Hong Kong
7 INDEBTEDNESS
Borrowings
At the close of business on 31 July 2005, being the latest practicable date for
the purpose of this indebtedness statement, the Combined Group had the
following outstanding borrowings:
Short-term debts
Interest rate RMB million
and final
maturity
Short-term bank loans
Renminbi denominated Interest 42,015
rates ranging
from 4.70% to
5.02% per
annum with
maturity
through 15
July 2006
US dollar denominated Interest 219
rates ranging
from 3.58% to
4.70% per
annum with
maturity
through 29
November 2005
Current portion of long-term bank loans and finance lease 7,490
obligations
49,724
Long-term debts
Interest rate RMB million
and final
maturity
Long-term bank loans
Renminbi denominated Interest 20,071
rates ranging
from 0.50% to
10.08% per
annum with
maturity
through 1
November 2011
US dollar denominated Interest 1,737
rates ranging
from 0.50% to
8.00% per
annum with
maturity
through 31
December 2039
Japanese Yen denominated Interest 895
rates ranging
from 2.12% to
2.60% per
annum with
maturity
through 18
June 2027
Euro denominated Interest 454
rates ranging
from 0.50% to
7.35% per
annum with
maturity
through 15
March 2034
Finance lease obligations 2,421
Current portion of long-term bank loans and finance lease (7,490)
obligations
18,088
All the short term bank loans as at 31 July 2005 were unsecured. Among the
long-term bank loans as of 31 July 2005, RMB1,019 million were secured, of
which RMB724 million is secured by corporate guarantee granted by China Netcom
Group. The remaining balance is secured by corporate guarantee granted by third
parties.
As of 31 July 2005, long-term bank loans of RMB1 million were secured by
certain property, plant and equipment of the Combined Group. The net book value
of such property, plant and equipment amounted to RMB3 million as of 31 July
2005.
Contractual obligations and commercial commitments
The following table sets forth the Combined Group's contractual obligations as
of 31 July 2005:
Total Not later Later than Later than
than one one year five years
year and not
later than
five years
(RMB in millions)
Short-term debt 42,234 42,234 - -
Capacity purchase payable 241 21 57 163
Long-term debt 25,578 7,490 14,979 3,109
Operating lease commitments 1,285 487 584 214
Capital commitments 3,309 3,058 251 -
Total contractual cash obligations 72,647 53,290 15,871 3,486
The following table sets forth the Combined Group's other commercial
commitments as of 31 July 2005:
Total Not later Later than Later than
than one one year five years
year and not
later than
five years
(RMB in millions)
Guarantees for US dollar denominated bank loans of third 277 277 - -
parties
Total commercial commitments 277 277 - -
The Directors confirm that there are no material changes in indebtedness and
contingent liabilities of the Combined Group since 31 July 2005.
Disclaimer
Save as aforesaid and apart from intra-group liabilities, the Combined Group
did not have, at the close of business on 31 July 2005, outstanding liabilities
or any mortgages, charges, debentures, loan capital issued and outstanding or
authorised or otherwise created but unissued, bank overdrafts, loans,
liabilities under acceptance or other similar indebtedness, hire purchase and
finance lease commitments or any guarantees or other material contingent
liabilities.
8 WORKING CAPITAL
The Directors are of the opinion that after taking into account the internal
resources of the Combined Group and the sources of financing available to the
Combined Group, the Combined Group will, following the completion of the
Acquisition, have sufficient working capital for its present requirements.
APPENDIX V PROFIT FORECAST
The Target Group's forecast combined profit for the year ending 31 December
2005 under HKFRS is set out in the section headed "Prospective Financial
Information" in the Letter from the Chairman.
1 BASES AND ASSUMPTIONS
The forecast combined profit of the Target Group for the year ending 31
December 2005 was prepared by the directors of the Company and the management
of the Target Group based on the audited combined financial information of the
Target Group for the six months ended 30 June 2005 and the forecast of the
combined financial information of the Target Group for the remaining six months
of the year ended 31 December 2005. 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 31 December 2005.
The profit forecast has been prepared on a basis consistent in all material
respects with the accounting policies currently adopted by the Target Group as
summarised in Appendix II to this circular and 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 territories
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.
2 LETTERS
Set out below are the texts of the letters received by the Directors from
PricewaterhouseCoopers, the independent reporting accountants of the Company,
and from the Financial Advisers in connection with the profit forecast for the
year ending 31 December 2005 and prepared for the purpose of inclusion in this
circular:
(1) Letter from PricewaterhouseCoopers
[PRICEWATERHOUSECOOPERS LETTERHEAD GRAPHIC OMITTED]
23 September 2005
The Directors
China Netcom Group Corporation (Hong Kong) Limited
Dear Sirs,
We have reviewed the calculations of and accounting policies adopted in
arriving at the forecast of the combined profit for the year ending 31 December
2005 of China Netcom Group New Horizon Communications Corporation (BVI) Limited
and its subsidiary China Netcom Group New Horizon Communications Corporation
Limited (collectively the "Target Group") (the "Profit Forecast") as set out in
the section headed "Prospective Financial Information" in the Letter from the
Chairman in the circular (the "Circular") dated 23 September 2005 issued by
China Netcom Group Corporation (Hong Kong) Limited (the "Company") to its
shareholders.
We conducted the work in accordance with the Auditing Guideline 3.341 on
"Accountants' report on profit forecasts" issued by the Hong Kong Institute of
Certified Public Accountants.
The Profit Forecast, for which the directors of the Company and the management
of the Target Group are solely responsible, has been prepared by the directors
of the Company and the management of the Target Group based on the audited
combined financial information of the Target Group for the six months ended 30
June 2005 and the forecast of the combined financial information of the Target
Group for the remaining six months of the year ending 31 December 2005.
In our opinion, the Profit Forecast, so far as the calculations and accounting
policies are concerned, has been properly compiled on the bases and assumptions
made by the directors of the Company and the management of the Target Group as
set out in Appendix V to the Circular, and is presented on a basis consistent
in all material respects with the accounting policies presently adopted by the
Target Group as set out in our Accountants' Report dated 23 September 2005, the
text which is set out in Appendix II to the Circular.
Yours faithfully,
PricewaterhouseCoopers
Certified Public Accountants
Hong Kong
(2) Letter from the Financial Advisers
[CICC GRAPHIC OMITTED] [CITIGROUP GRAPHIC OMITTED]
China International Capital Citigroup Global Markets
Corporation (Hong Kong) Limited Asia Limited
[GOLDMAN SACHS GRAPHIC OMITTED]
Goldman Sachs (Asia)
L.L.C.
23 September 2005The Directors
China Netcom Group Corporation (Hong Kong) Limited
46th Floor
Cheung Kong Center
2 Queen's Road Central
Hong Kong
Dear Sirs,
We refer to the forecast of the combined profit for the year ending 31 December
2005 of China Netcom Group New Horizon Communications Corporation (BVI) Limited
and China Netcom Group New Horizon Communications Corporation Limited
(collectively the "Target Group") (the "Forecast") as set out in the circular
dated 23 September 2005 issued by China Netcom Group Corporation (Hong Kong)
Limited (the "Company") to its shareholders.
We have discussed with you the bases and assumptions upon which the Forecast
has been made. We have also considered the letter dated 23 September 2005
addressed to you from PricewaterhouseCoopers 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, and on
the bases of the accounting policies and calculations reviewed by
PricewaterhouseCoopers, we are of the opinion that the 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
China International Capital Citigroup Global Markets
Corporation (Hong Kong) Asia Limited
Limited Stephen M. Winningham
Shirley Chen Managing Director
Managing Director
Yours faithfully,
For and on behalf of
Goldman Sachs (Asia)
L.L.C.
Xiaoyin Zhang
Executive Director
APPENDIX VI GENERAL INFORMATION
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
As at Latest Practicable Date, the following Directors and chief executive of
the Company had, or were deemed to have, interests or short positions in the
shares, underlying shares or debentures of the Company or any of its associated
corporations (within the meaning of Part XV of the Securities and Futures
Ordinance) which were required to be notified to the Company and the Hong Kong
Stock Exchange pursuant to Divisions 7 and 8 of Part XV of the Securities and
Futures Ordinance (including interests and short positions which they were
deemed or taken to have under such provisions of the Securities and Futures
Ordinance), or which are required, pursuant to section 352 of the Securities
and Futures Ordinance to be entered in the register referred to therein, or
which are required, pursuant to the Model Code for Securities Transactions by
Directors of Listed Issuers contained in the Hong Kong Listing Rules, to be
notified to the Company and the Hong Kong Stock Exchange.
Name of Directors Number and No. of
description of underlying
equity Shares
derivatives involved
in the
Options
Zhang Chunjiang 920,000 920,000
Options (Note)
Tian Suning (also the chief executive officer) 920,000 920,000
Options (Note)
Zhang Xiaotie 800,000 800,000
Options (Note)
Miao Jianhua 700,000 700,000
Options (Note)
Jiang Weiping 700,000 700,000
Options (Note)
Li Liming 700,000 700,000
Options (Note)
Yan Yixun 590,000 590,000
Options (Note)
Keith Rupert Murdoch 590,000 590,000
Options (Note)
Total 5,920,000
Note:
The Options were all granted on 22 October 2004 under the share option scheme
approved and adopted by a resolution of the Shareholders passed on 30 September
2004. Grantees of such Options are entitled to exercise the Options at a price
of HK$8.40 per Share in the following periods:
(i) in respect of 40% of the Options granted, from 17 May 2006 to 16 November
2010;
(ii) in respect of a further 30% of the Options granted, from 17 May 2007 to 16
November 2010; and
(iii) in respect of the remaining 30% of the Options granted, from 17 May 2008
to 16 November 2010.
Save as disclosed above, as at the Latest Practicable Date, none of the
Directors nor the chief executive of the Company had or was deemed to have any
interests or short positions in the shares, underlying shares or debentures of
the Company or any of its associated corporations (within the meaning of Part
XV of the Securities and Futures Ordinance) which were required to be notified
to the Company and the Hong Kong Stock Exchange pursuant to Divisions 7 and 8
of Part XV of the Securities and Futures Ordinance (including interests and
short positions which they were deemed or taken to have under such provisions
of the Securities and Futures Ordinance), or which were required, pursuant to
section 352 of the Securities and Futures Ordinance to be entered in the
register referred to therein, or which are required, pursuant to the Model Code
for Securities Transactions by Directors of Listed Issuers contained in the
Hong Kong Listing Rules, to be notified to the Company and the Hong Kong Stock
Exchange.
China Netcom Group is the ultimate holding company of the Company who, through
CNC BVI, was beneficially interested in approximately 70.49% of the issued
share capital of the Company as at the Latest Practicable Date. The executive
Directors also hold executive positions with China Netcom Group. Details of the
shareholding of China Netcom Group in the Company are set out in the paragraph
headed "Substantial Shareholders" in this Appendix. Save as disclosed herein,
none of the Directors is a director or employee of a company which has, or is
deemed to have, an interest or short position in the Shares or underlying
Shares 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.
None of the Directors is materially interested in any contract or arrangement
subsisting as at the Latest Practicable Date which is significant in relation
to the business of the Combined Group taken as a whole.
Since 31 December 2004, the date to which the latest published audited
consolidated financial statements of the Group were made up, none of the
Directors nor any experts named in the paragraph headed "Qualification of
experts" in this Appendix has any direct or indirect interest in any assets
which have been acquired or disposed of by or leased to any member of the
Combined Group, or are proposed to be acquired or disposed of by or leased to
any member of the Combined Group.
3 SUBSTANTIAL SHAREHOLDERS
So far as is known to the Directors and the chief executive of the Company, as
at the Latest Practicable Date, the following corporations had, or were deemed
to have, interests or short positions in the Shares or underlying Shares which
would fall to be disclosed to the Company and the Hong Kong Stock Exchange
under the provisions of Divisions 2 and 3 of Part XV of the Securities and
Futures Ordinance, or who was, directly or indirectly, interested in 10% or
more of the nominal value of any class of share capital carrying rights to vote
in all circumstances at general meetings of any member of the Combined Group:
Number of Shares interested Percentage
of total
issued
share
directly Indirectly capital (%)
Name of substantial shareholder
China Netcom Group - 4,945,148,000(1)(2) 75.0
CNC BVI 4,647,449,014(1) 297,698,986(1)(2) 75.0
Telef|$$|Aaonica Internacional, S.A. 329,676,450 - 5.0
Notes:
(1) China Netcom Group beneficially owns 4,647,449,014 Shares held by its
wholly-owned subsidiary, CNC BVI and one share held by CNC Cayman, Limited
("CNC Cayman"), a wholly-owned subsidiary of CNC BVI. The percentage of total
issued share capital beneficially held by China Netcom Group is 70.49%.
(2) China Netcom Group is deemed under the Securities and Futures Ordinance to
be interested in 297,698,985 Shares held by CNC BVI as trustee on behalf of
certain Shareholders.
Save as disclosed above, as at the Latest Practicable Date, the Directors and
the chief executive of the Company were not aware of any other person who had,
or was deemed to have, an interest or short position in the Shares and
underlying Shares, which would fall to be disclosed to the Company and the Hong
Kong Stock Exchange under the provisions of Divisions 2 and 3 of Part XV of the
Securities and Futures Ordinance, or, who was, directly or indirectly,
interested in 10% or more of the nominal value of any class of share capital
carrying rights to vote in all circumstances at general meetings of any member
of the Group, or any options in respect of such capital.
4 LITIGATION
As at the Latest Practicable Date, no member of the Combined Group was engaged
in any litigation, arbitration or claim of material importance and no
litigation, arbitration or claim of material importance is known to the
Directors to be pending or threatened against any member of the Combined Group.
5 SERVICE CONTRACTS
As at the Latest Practicable Date, none of the Directors had entered into, or
proposed to enter into, any service contract with the Company or any member of
the Combined Group (excluding contracts expiring or determinable by the
employer within one year without payment of compensations (other than statutory
compensation)).
The aggregate of the remuneration payable to and benefits in kind receivable by
the Directors will not be varied in consequence of the Acquisition.
6 MATERIAL ADVERSE CHANGE
As at the Latest Practicable Date, the Directors were not aware of any material
adverse change in the financial or trading position of the Group since 31
December 2004, being the date to which the latest published audited
consolidated financial statements of the Group were made up.
7 CONSENT
CICC, Citigroup, Goldman Sachs, PricewaterhouseCoopers and CSFB 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 12 September 2005, CSFB group companies had a beneficial interest in
30,034,200 Shares (representing approximately 0.456% of the issued share
capital of the Company). In addition, CSFB had a short position of 853,000
Shares (representing approximately 0.013% of the issued share capital of the
Company).
Save as disclosed above, none of CICC, Citigroup, Goldman Sachs,
PricewaterhouseCoopers and CSFB is beneficially interested in the share capital
of any member of the Group and none of them has any right, whether legally
enforceable or not, to subscribe for or to nominate persons to subscribe for
securities in any member of the Group.
8 QUALIFICATIONS OF EXPERTS
The following are the qualifications of the professional advisers who have
given opinions or advice contained in this circular:
Names Qualifications
CICC a licensed corporation for type 1 (dealing in
securities), type 4 (advising on securities),
type 6 (advising on corporate finance) and type
9 (asset management) regulated activities under
the Securities and Futures Ordinance
Citigroup a deemed licensed corporation for type 1
(dealing in securities), type 4 (advising on
securities) and type 6 (advising on corporate
finance) regulated activities under the
Securities and Futures Ordinance
Goldman Sachs a licensed corporation for type 1 (dealing in
securities), type 4 (advising on securities),
type 5 (advising on futures contracts), type 6
(advising on corporate finance) and type 9
(asset management) regulated activities under
the Securities and Futures Ordinance
PricewaterhouseCoopers Certified public accountants a deemed licensed
CSFB corporation for Type 1 (dealing in securities),
Type 4 (advising on securities) and Type 6
(advising on corporate finance) regulated
activities under the Securities and Futures
Ordinance
9 MATERIAL CONTRACTS
The following contracts (not being contracts entered into in the ordinary
course of business) have been entered into by members of the Group within the
two years immediately preceding the date of this circular, and are or may be
material:
(a) the Acquisition Agreement;
(b) the Cooperation Agreement dated 15 September 2005 entered into between
China Netcom Group and CNC China, pursuant to which CNC China agreed to provide
telecommunications goods and services with a monetary value not exceeding
RMB480 million to Beijing Organization Committee for the Games of the XXIX
Olympiad for the 2008 Beijing Olympic Games. As consideration, CNC China is
entitled to the right and opportunity to conduct products-related marketing
activities by using the 2008 Olympics composite logo and sponsorship logo as
provided for under the Sponsorship Agreement entered into between China Netcom
Group and Beijing Organization Committee for the Games of the XXIX Olympiad;
(c) the Memorandum of Understanding dated 21 July 2005 entered into between the
Company and Telef|$$|Aaonica, S.A. pursuant to which the Company and
Telef|$$|Aaonica, S.A. shall establish a board strategic alliance and shall
explore possible areas of co-operation which would confer mutual benefit to
both parties;
(d) ten agreements entered into between China Netcom Group, the Target Company,
the Company and CNC China referred to in the section headed "Letter from the
Chairman - Continuing connected transactions";
(e) the Underwriting Agreement dated 3 November 2004 entered into among the
Company, China Netcom Group, CNC BVI, CICC, Citigroup, Goldman Sachs and the
other underwriters in relation to the initial public offering of the Shares in
Hong Kong and the U.S. and International Underwriting Agreement dated 10
November 2004 entered into among the Company, China Netcom Group, certain
Shareholders, CICC, Citigroup, Goldman Sachs and the other underwriters in
relation to the international offering and the U.S. offering of Shares;
(f) the Interconnection Settlement Agreement dated 8 October 2004 entered into
between CNC China and China Netcom Group under which CNC China and China Netcom
Group agreed to interconnect their respective networks and settle the charges
received in respect of domestic and international long distance voice services
within their respective service regions;
(g) the Property Leasing Agreement dated 8 October 2004 entered into between
CNC China and China Netcom Group under which (i) CNC China agreed to lease
properties to China Netcom Group for use as offices and other ancillary
purposes; and (ii) China Netcom Group agreed to lease properties to CNC China
for use as offices, telecommunications equipment sites and other ancillary
purposes;
(h) the Property Sub-leasing Agreement dated 8 October 2004 entered into
between CNC China and China Netcom Group under which China Netcom Group agreed
to sub-let properties to CNC China for use as offices, telecommunications
equipment sites and other ancillary purposes;
(i) the Master Services Sharing Agreement dated 8 October 2004 entered into
between CNC China and China Netcom Group regarding the provision and sharing of
various services between CNC China and China Netcom Group;
(j) the Engineering and Information Technology Services Agreement dated 8
October 2004 entered into between CNC China and China Netcom Group regarding
the provision of engineering and information technology-related services to CNC
China by China Netcom Group;
(k) the Materials Procurement Agreement dated 8 October 2004 entered into
between CNC China and China Netcom Group under which (i) CNC China may request
China Netcom Group to act as its agent for the procurement of imported and
domestic telecommunications equipment and other domestic non-telecommunications
equipment; (ii) CNC China may purchase from China Netcom Group certain
products, including cables, modems and yellow pages telephone directories; and
(iii) China Netcom Group will provide to CNC China storage and transportation
services related to the procurement and purchase of materials or equipment
under the agreement;
(l) the Ancillary Telecommunications Services Agreement dated 8 October 2004
entered into between CNC China and China Netcom Group regarding the provision
of ancillary telecommunications services to CNC China by China Netcom Group;
(m) the Support Services Agreement dated 8 October 2004 entered into between
CNC China and China Netcom Group regarding the provision of various support
services by China Netcom Group to CNC China, including equipment leasing and
maintenance services, motor vehicles services, safety and security services,
basic construction agency services, research and development services, employee
training services and advertising services and other support services;
(n) the Telecommunications Facilities Leasing Agreement dated 8 October 2004
entered into between CNC China and China Netcom Group under which China Netcom
Group agreed to lease inter-provincial fiber-optic cables and certain
international telecommunications resources to CNC China;
(o) the Trademark Licensing Agreement dated 8 October 2004 entered into among
CNC China, China Netcom Group and the Company regarding the licensing of the
Company's logo and certain trademarks from China Netcom Group on a royalty free
basis to CNC China and the Company;
(p) the Restructuring Agreement dated 6 September 2004 entered into among CNC
China, China Netcom Group and the Company regarding the restructuring of the
businesses and operations previously owned by, or transferred to, the Company;
(q) the Non-competition Agreement dated 6 September 2004 entered into among CNC
China, China Netcom Group and the Company in relation to the non-competition
undertaking by China Netcom Group;
(r) the Letter of Undertakings dated 5 September 2004 given by China Netcom
Group to the Company in relation to certain undertakings given by China Netcom
Group in favour of the Company for extending support to the Company's existing
operations and future development;
(s) the Capacity Purchase Agreement dated 30 June 2004 entered into between
Asia Netcom and EANL, pursuant to which Asia Netcom and its subsidiaries will
receive from EANL and its subsidiaries a certain amount of long-term
telecommunications capacity on the submarine network;
(t) the Capacity Lease Agreement dated 30 June 2004 entered into between Asia
Netcom and EANL, pursuant to which, among other things, Asia Netcom and its
subsidiaries lease from EANL and its subsidiaries a fixed amount of capacity on
EANL's telecommunications network, and may order additional lease capacity from
EANL and its subsidiaries;
(u) the Management Services Agreement dated 30 June 2004 entered into between
Asia Netcom and EANL, pursuant to which Asia Netcom and its subsidiaries will
provide EANL and its subsidiaries with certain services, including government
and corporate affairs services, treasury services, financial services,
information technology services, legal and corporate secretarial services, tax
services, payment services, and comprehensive engineering and operation
services in relation to the submarine network;
(v) the Debenture dated 29 July 2004 entered into among Asia Netcom Asia
Pacific Limited, Asia Netcom Asia Pacific Commercial Limited and Asia Netcom
Hong Kong Limited as Chargors and Industrial and Commercial Bank of China
(Asia) Limited as Security Trustee pursuant to which each of the Chargors
charges all its rights, title and interest in and to the properties listed in
the Debenture in favor of the Security Trustee as trustee for the benefit of
the finance parties in a facility agreement dated 2 December 2003;
(w) the Deed of Mortgage of Shares dated 29 July 2004 entered into between Asia
Netcom as Mortgagor and Industrial and Commercial Bank of China (Asia) Limited
as Security Trustee under which Asia Netcom mortgages and charges by way of
first fixed charge all its rights, title and interest, present and future in
and to the shares listed in the Deed of Mortgage of Shares to the Security
Trustee as trustee for the benefit of the finance parties as defined in a
facility agreement dated 2 December 2003;
(x) the Debenture dated 29 July 2004 entered into between Asia Netcom Services
(S) Pte. Ltd., Asia Netcom Corporation (Singapore) Pte. Limited, Asia Netcom
Singapore Pte. Ltd. and Southeast Asia Netcom (Singapore) Pte. Ltd. as Chargors
and Industrial and Commercial Bank of China (Asia) Limited as Security Trustee
in which each of the Chargors charges and agrees to charge, inter alia, by
first fixed legal charge all its rights, title and interest in and to the real
property described the Debenture in favor of the Security Trustee as trustee
for the benefit of the finance parties in a facility agreement dated 2 December
2003;
(y) the Group Share Mortgage dated 29 July 2004 entered into among Asia Netcom,
Asia Netcom Corporation (Singapore) Pte. Limited and Asia Netcom Singapore Pte.
Ltd. as Mortgagors and Industrial and Commercial Bank of China (Asia) Limited
as Security Trustee in which each Mortgagor, among other things, mortgages and
charges by way of first fixed charge all its rights, title and interest present
and future in and to the assets of each Mortgagor from time to time subject to
the security interest described in the Group Share Mortgage, to the Security
Trustee as trustee for the benefit of the finance parties in a facility
agreement dated 2 December 2003;
(z) the Assignment of Building Agreement dated 29 July 2004 entered into
between Asia Netcom Singapore Pte. Ltd. as Assignor and Industrial and
Commercial Bank of China (Asia) Limited as Security Trustee in which, inter
alia, the Assignor assigns and agrees to assign absolutely all the present and
future rights, title, interests, benefits, advantages, permits and licences
which the Assignor has and the Assignor's rights to the issue of the lease as
defined in the Assignment of Building Agreement to the Security Trustee in
consideration of the availability of a term loan facility of up to
US$150,000,000 to Asia Netcom under a facility Agreement dated 2 December 2003.
(aa) the Share Pledge Agreement dated 28 July 2004 entered into among Asia
Netcom Corporation (Singapore) Pte. Ltd. as the Pledgor, the seven financial
institutions listed in the Share Pledge Agreement as Pledgees and Industrial
and Commercial Bank of China (Asia) Limited as Security Trustee pursuant to
which the Pledgor pledges by way of first priority pledge all of its rights,
titles, interests and benefits in the shares of various companies listed in the
Share Pledge Agreement to the Pledgees and the Pledgees accept such pledge as
collateral security for Asia Netcom's due and punctual payment, performance and
discharge in full of the secured obligations as defined in a facility agreement
dated 2 December 2003;
(bb) the Amended and Restated Facility Agreement dated 27 July 2004 entered
into among Asia Netcom as Borrower, the seven banks named in the Amended and
Restated Facility Agreement as Lenders, Industrial and Commercial Bank of China
(Asia) Limited as Arranger and Industrial and Commercial Bank of China (Asia)
Limited as Facility Agent whereby the Lenders agree to make available to the
Borrower a term loan facility of up to US$150,000,000;
(cc) the Group Subordination Deed dated 27 July 2004 entered into between Asia
Netcom as Subordinated Lender and Industrial and Commercial Bank of China
(Asia) Limited as Security Trustee whereby the Subordinated Lender agrees,
among other things, that the subordinated indebtedness owing to it is and shall
remain subordinated and shall not be repaid or repayable except with the prior
written consent of the Security Trustee;
(dd) the Group Subordination Deed dated 27 July 2004 entered into among the
Company, China Netcom Corporation International Limited as Subordinated
Lenders, Asia Netcom as Borrower and Industrial and Commercial Bank of China
(Asia) Limited as Security Trustee pursuant to which each of the Subordinated
Lenders agrees, among other things, that the subordinated indebtedness owing to
it is and shall remain subordinated and shall not be repaid or repayable except
with the prior written consent of the Security Trustee;
(ee) the Debenture dated 27 July 2004 entered into between Asia Netcom as
Chargor and Industrial and Commercial Bank of China (Asia) Limited as Security
Trustee pursuant to which the Chargor creates fixed and floating charges over
its assets and undertakings in favor of the Security Trustee as trustee for the
benefit of the finance parties in a facility agreement dated 2 December 2003;
(ff) the Group Assignment of Insurances dated 27 July 2004 entered into among
Asia Netcom as Borrower, EANL as Assignors and Industrial and Commercial Bank
of China (Asia) Limited as Security Trustee pursuant to which each of the
Borrower and Assignor mortgages, charges and agrees to charge, among other
things, all of the rights, title, interest and benefit of the Borrower and each
Assignor in and to the insurances in favor of the Security Trustee as trustee
for the benefit of the finance parties in a facility agreement dated 2 December
2003;
(gg) the Security Assignment dated 27 July 2004 entered into between Asia
Netcom as Assignor and Industrial and Commercial Bank of China (Asia) Limited
as Security Trustee under which the Assignor assigns absolutely by way of
security all of its rights, title and interest described in the Security
Assignment to the Security Trustee in consideration of a facility agreement
dated 2 December 2003;
(hh) the Charge Over Deposit Account dated 27 July 2004 entered into between
Asia Netcom as Chargor and Industrial and Commercial Bank of China (Asia)
Limited as Security Trustee under which the Chargor irrevocably charges by way
of first floating charge all the rights, title, interest and benefit of the
Chargor in and to a deposit account to the Security Trustee as trustee for the
benefit of the finance parties in a facility agreement dated 2 December 2003;
(ii) the Charge Over Accounts dated 27 July 2004 entered into between Asia
Netcom as Chargor and Industrial and Commercial Bank of China (Asia) Limited as
Security Trustee under which the Chargor irrevocably charges by way of first
fixed charge all the rights, title, interest and benefit of the Chargor in and
to charged accounts to the Security Trustee as trustee for the benefit of the
finance parties in the facility agreement dated 2 December 2003;
(jj) the Deed of Mortgage of Shares in Asia Netcom dated 27 July 2004 entered
into between China Netcom Corporation International Limited as Mortgagor and
Industrial and Commercial Bank of China (Asia) Limited as Security Trustee
under which, among other things, the Mortgagor mortgages and charges by way of
first fixed charge the assets of the Mortgagor subject to the security interest
described in the Deed of Mortgage of Shares in Asia Netcom as trustee for the
benefit of the finance parties in a facility agreement dated 2 December 2003;
(kk) the Guarantee and Indemnity dated 27 July 2004 entered into between the
Company as Guarantor and Industrial and Commercial Bank of China (Asia) Limited
as Security Trustee in which the Guarantor unconditionally and irrevocably
guarantees, among other things, as a continuing obligation, the due and
punctual payment and performance of the guaranteed obligations defined in the
Guarantee and Indemnity in the currency in which the same is payable under the
terms of a facility agreement to the Security Trustee as trustee for the
benefit of the finance parties in the facility agreement dated 2 December 2003;
(ll) the Share Purchase and Exchange Agreement dated 11 June 2004 and its
amendment agreement dated 20 July 2004 entered into among the Company, CNC BVI
and CNC Fund, L.P. under which CNC Fund, L.P. sold 6,400,000 ordinary shares of
US$0.01 each and 30,967,127 of Series A preference shares of US$0.01 each of
the Company to CNC BVI;
(mm) the Share Purchase and Sale Agreement dated 30 June 2004 entered into
between Asia Netcom and CNC Network Corporation Limited pursuant to which Asia
Netcom sold all its shares in EANL to CNC Network Corporation Limited and
caused certain restructuring to take place within Asia Netcom and its
subsidiaries prior to or contemporaneously with the closure of such sale;
(nn) the Assignment and Novation Agreement dated 30 June 2004 entered into
among Asia Netcom, the Company and CNC Network Corporation Limited pursuant to
which CNC Network Corporation Limited's obligation to pay US$43,362,136.00
under a note issued by CNC Network Corporation Limited to Asia Netcom (as
consideration for the sale by Asia Netcom of EANL) is novated to the Company;
(oo) the Asset Injection Agreement dated 29 June 2004 entered into among China
Netcom Group, CNC BVI, CNC China and the Company pursuant to which China Netcom
Group transferred certain assets, businesses and related liabilities in China
firstly to CNC BVI, then to the Company and finally to CNC China and in
consideration of which, the Company issued 21,769,032,873 ordinary shares of
US$0.01 each in the Company to CNC BVI;
(pp) the Agreement for Transfer of Assets and Liabilities dated 23 June 2004
entered into between CNC China and China Netcom Group pursuant to which CNC
China transferred all of its assets and liabilities in the China to China
Netcom Group;
(qq) the Share Purchase Agreement dated 2 December 2003 entered into among the
Company, SBAIF Asia Netcom (Cayman) Holdings, China Netcom Corporation
International Limited and Asia Netcom pursuant to which SBAIF Asia Netcom
(Cayman) Holdings sold 29,400,000 shares of Asia Netcom to China Netcom
Corporation International Limited, Asia Netcom and the Company; and
(rr) the Share Purchase Agreement dated 2 December 2003 entered into among the
Company, Newbridge Asia Netcom (Cayman) Holdings, China Netcom Corporation
International Limited and Asia Netcom pursuant to which Newbridge Asia Netcom
(Cayman) Holdings sold 29,400,000 shares of Asia Netcom to China Netcom
Corporation International Limited, Asia Netcom and the Company.
10 COMPETING INTEREST
China Netcom Group is engaged in fixed-line telecommunications business and
other related businesses in the PRC and Asia-Pacific which are similar to that
of the Company. The executive Directors also hold executive positions with
China Netcom Group. On 6 September 2004, China Netcom Group, the Company and
CNC China entered into a non-competition agreement, under which China Netcom
Group undertakes not to compete with the Company without the Company's prior
written consent.
Apart from the above, none of the Directors nor its associates is or was
interested in any business, apart from the Company's business, that competes or
competed or is or was likely to compete, either directly or indirectly, with
the Company's business.
11 PROCEDURES FOR DEMANDING A POLL AT THE EXTRAORDINARY GENERAL MEETING
In accordance with the Hong Kong Listing Rules, any vote taken at the
Extraordinary General Meeting to approve the Acquisition and the Non-exempt
Continuing Connected Transactions must be taken by poll. According to article
70 of the articles of association of the Company, a resolution put to the vote
of the meeting shall be decided on a show of hands unless (before or on the
declaration of the result of the show of hands or on the withdrawal of any
other demand for a poll) a poll is demanded by:
(a) the chairman of the meeting; or
(b) at least three Shareholders present in person (or in the case of a member
being a corporation, by its duly authorised representative) or by proxy and
entitled to vote at the meeting; or
(c) any Shareholder or Shareholders present in person (or in the case of a
member being a corporation, by its duly authorised representative) or by proxy
and representing in the aggregate not less than one-tenth of the total voting
rights of all Shareholders having the right to attend and vote at the meeting;
or
(d) any Shareholder or Shareholders present in person (or in the case of a
member being a corporation, by its duly authorised representative) or by proxy
and holding shares conferring a right to attend and vote at the meeting on
which there have been paid up sums in the aggregate equal to not less than
one-tenth of the total sum paid up on all shares conferring that right.
A poll shall be taken at such time (being not later than thirty days after the
date of the demand) and in such manner (including the use of ballot or voting
papers or tickets) as the chairman of the Extraordinary General Meeting may
appoint. On a poll, every Shareholder present at the Extraordinary General
Meeting shall be entitled to one vote for every fully paid-up Share of which he
is the holder. The result of such poll shall be deemed for all purposes to be
the resolution of the meeting at which the poll was so directed or demanded.
12 MISCELLANEOUS
(a) The joint company secretaries of the Company are Zhang Xiaotie and Oliver
E Lixin. Mr. E is also the qualified accountant of the Company appointed
pursuant to Rule 3.24 of the Hong Kong Listing Rules. Mr. E is a fellow member
of the Association of Chartered Certified Accountants.
(b) The registered office of the Company is at 46th Floor, Cheung Kong Center,
2 Queen's Road Central, Hong Kong.
(c) Computershare Hong Kong Investor Services Limited, the share registrar of
the Company in Hong Kong, is at Rooms 1712-1716, 17th Floor Hopewell Centre,
183 Queen's Road East, Wanchai, Hong Kong.
(d) The English text of this circular and form of proxy shall prevail over the
Chinese text.
13 DOCUMENTS AVAILABLE FOR INSPECTION
Copies of the following documents will be available for inspection at
Linklaters, 10th Floor, Alexandra House, Chater Road, Hong Kong during normal
business hours on any Business Day from the date of this circular until 7
October 2005 and at the Extraordinary General Meeting:
(a) the Acquisition Agreement;
(b) the Equity Interest Injection Agreement;
(c) the memorandum and articles of association of the Company;
(d) the audited consolidated financial statements of the Group for the two
years ended 31 December 2003 and 2004;
(e) the material contracts referred to in the paragraph headed "Material
contracts" in this Appendix;
(f) the letters of consent from CICC, Citigroup, Goldman Sachs,
PricewaterhouseCoopers and CSFB referred to in the paragraph headed "Consent" in
this Appendix;
(g) the letter from CSFB dated 23 September 2005, the text of which is set out
on pages 38 to 58 of this circular;
(h) the accountants' report from PricewaterhouseCoopers dated 23 September
2005, the text of which is set out in Appendix II to this circular;
(i) the report from PricewaterhouseCoopers on the unaudited pro forma
financial information of the Combined Group dated 23 September 2005, the text of
which is set out in Appendix IV to this circular; and
(j) the letters from PricewaterhouseCoopers and the Financial Advisers both
dated 23 September 2005, the texts of which are set out in Appendix V to this
circular.
NOTICE OF THE EXTRAORDINARY GENERAL MEETING
[CNC GRAPHIC OMITTED]
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
[CHINESE TRANSLATION GRAPHIC OMITTED]
(incorporated in Hong Kong with limited liability
under the Companies Ordinance)
NOTICE IS HEREBY GIVEN that an Extraordinary General Meeting of the
shareholders of China Netcom Group Corporation (Hong Kong) Limited (the
"Company") will be held at 10:00 a.m. on 25 October 2005, in Nathan Room,
Conrad Hotel, Hong Kong for the purposes of considering and, if thought fit,
passing, with or without modifications, the following resolutions as Ordinary
Resolutions:
Ordinary Resolutions
1. "THAT the conditional sale and purchase agreement dated 12 September 2005
(the "Acquisition Agreement") entered into among the Company, China Netcom
Group Corporation (BVI) Limited ("CNC BVI") and China Network Communications
Group Corporation ("China Netcom Group"), a copy of which has been initialled
by the chairman of this meeting and for the purpose of identification marked
"A", pursuant to which, inter alia, CNC BVI has agreed as legal and beneficial
owner to sell, and the Company has agreed to purchase, the entire issued share
capital of China Netcom Group New Horizon Communications Corporation (BVI)
Limited, which holds the entire equity interest in China Netcom Group New
Horizon Communications Corporation Limited which in turn owns the assets and
liabilities and the business operations for the provision of fixed-line
telephone services, broadband and other Internet-related services in
Heilongjiang Province, Jilin Province, Neimenggu Autonomous Region and Shanxi
Province in the People's Republic of China, at a consideration of RMB12,800
million, comprising an initial consideration of RMB3,000 million payable in
cash to CNC BVI and a deferred consideration of RMB9,800 million payable within
five years after completion of the acquisition contemplated under the
Acquisition Agreement, be and is hereby generally and unconditionally approved
and the directors of the Company be and are hereby authorised 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 the Acquisition Agreement."
2. "THAT subject to the passing of Ordinary Resolution No.1 set out in the
notice convening the Extraordinary General Meeting at which this Resolution is
proposed, the continuing connected transactions contemplated under the
Engineering and Information Technology Services Agreement and the Materials
Procurement Agreement, as described in the paragraph headed "Continuing
Connected Transactions" under the section "Letter from the Chairman" of the
circular of the Company dated 23 September 2005, together with the relevant
annual caps be and are hereby approved and the directors of the Company be and
are hereby authorised 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 continuing connected transactions."
3. "THAT subject to the passing of Ordinary Resolution No.1 set out in the
notice convening the Extraordinary General Meeting at which this Resolution is
proposed, the continuing connected transactions contemplated under the Domestic
Interconnection Settlement Agreement and the International Long Distance Voice
Services Settlement Agreement, as described in the paragraph headed "Continuing
Connected Transactions" under the section "Letter from the Chairman" of the
circular of the Company dated 23 September 2005 and for which continuing
connected transactions no annual caps have been proposed, be and are hereby
approved and the directors of the Company be and are hereby authorised 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 continuing connected
transactions."
By Order of the Board
Zhang Xiaotie Oliver E Lixin
Joint Company Secretaries
Hong Kong, 23 September 2005
Registered office
46th Floor, Cheung Kong Center
2 Queen's Road Central
Hong Kong
Notes:
1. A member entitled to attend and vote at the Extraordinary General Meeting
is entitled to appoint one or more proxies to attend and, on a poll, vote in his
stead. A proxy need not be a member of the Company.
2. A form of proxy for use at the meeting is enclosed. In order to be valid, a
form of proxy together with any power of attorney or other authority, if any,
under which it is signed, or a notarially certified copy of such power of
authority, must be deposited at the Company's registered office at 46th Floor,
Cheung Kong Center, 2 Queen's Road Central, Hong Kong, at least 48 hours before
the time appointed for holding the Extraordinary General Meeting. Completion
and return of the form of proxy will not preclude a member from attending and
voting in person at the meeting or at any adjourned meeting should a member so
wish.
3. In accordance with the Rules Governing the Listing of Securities on The
Stock Exchange of Hong Kong Limited, voting on the above ordinary resolutions
will be taken by poll.
[CNC GRAPHIC OMITTED]
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
(incorporated in Hong Kong with limited liability
under the Companies Ordinance)
(Stock Code: 906)
Form of proxy for the Extraordinary General Meeting
to be held on 25 October 2005
I / We (Note 1) _____________________________________________________________ of
________________________________________________________________________________
being the registered holder(s) of___________________________ Shares(Note 2) of
US$0.04 each in the share capital of the above-named Company HEREBY APPOINT THE
CHAIRMAN OF THE EXTRAORDINARY GENERAL MEETING (Note 3) or ______________________
________________________________________________________________________________
of __________________________________________________________________________ as
my/our proxy to attend and act for me/us at the Extraordinary General Meeting
(and any adjournment thereof) of the said Company to be held at Nathan Room,
Conrad Hotel, Hong Kong on 25 October 2005, at 10 a.m. for the purposes of
considering and, if thought fit, passing the Resolutions as set out in the
Notice of the Extraordinary General Meeting and at such Extraordinary General
Meeting (and at any adjournment thereof) to vote for me/us and in my/our name(s)
in respect of the Resolutions as indicated below (Note 4).
FOR AGAINST
ORDINARY RESOLUTION 1
ORDINARY RESOLUTION 2
ORDINARY RESOLUTION 3
Dated this day of 2005 Signed (Note 5)
Notes :
1. Full name(s) and address(es) to be inserted in BLOCK CAPITALS.
2. Please insert the number of shares registered in your name(s) to which
this proxy relates. If no number is inserted, this form of proxy will be deemed
to relate to all the shares in the Company registered in your name(s).
3. If any proxy other than the Chairman of the Extraordinary General Meeting
is preferred, strike out the words `THE CHAIRMAN OF THE EXTRAORDINARY GENERAL
MEETING' and insert the name and address of the proxy desired in the space
provided. A member may appoint one or more proxies to attend and vote in his
stead. ANY ALTERATION MADE TO THIS FORM OF PROXY MUST BE INITIALLED BY THE
PERSON WHO SIGNS IT.
4. IMPORTANT: IF YOU WISH TO VOTE FOR THE RESOLUTIONS, TICK THE APPROPRIATE
BOX MARKED "FOR". IF YOU WISH TO VOTE AGAINST THE RESOLUTIONS, TICK THE
APPROPRIATE BOX MARKED "AGAINST". Failure to complete any or all the boxes will
entitle your proxy to cast his votes at his discretion. Your proxy will also be
entitled to vote at his discretion on any resolution properly put to the
Extraordinary General Meeting other than those referred to in the Notice of the
Extraordinary General Meeting.
5. This form of proxy must be signed by you or your attorney duly authorised
in writing or, in the case of a corporation, must be either executed under its
common seal or under the hand of an officer or attorney or other person duly
authorised to sign the same.
6. In the case of joint holders of any shares, any one of such joint holders
may vote at the Extraordinary General Meeting, either personally or by proxy,
in respect of such shares as if he were solely entitled thereto. However, if
more than one of such joint holders is present at the Extraordinary General
Meeting, either personally or by proxy, the vote of the joint holder whose name
stands first in the Register of Members and who tenders a vote, whether in
person or by proxy, will be accepted to the exclusion of the votes of the other
joint holder(s).
7. To be valid, this form of proxy together with the power of attorney (if
any) or other authority under which it is signed (if any) or a notarially
certified copy thereof, must be deposited at the registered office of the
Company at 46th Floor, Cheung Kong Center, 2 Queen's Road Central, Hong Kong
not less than 48 hours before the time for holding the Extraordinary General
Meeting or any adjournment thereof (as the case may be).
8. The proxy need not be a member of the Company but must attend the
Extraordinary General Meeting in person to represent you.
9. Completion and delivery of the form of proxy will not preclude you from
attending and voting at the Extraordinary General Meeting if you so wish. In
such event, the instrument appointing a proxy shall be deemed to be revoked.