In the first big consolidation in the Taiwanese telecom and media sector in five years, Morgan Stanley and Far EasTone are playing leading roles.

An investment consortium headed by Morgan Stanley Private Equity Asia (MSPE Asia) with participation by Far EasTone Telecommunications Co. (FET) announced plans on July 30 to acquire China Network Systems (CNS), Taiwan’s largest cable TV operator, in a transaction estimated to be worth US$2.45 billion.

Should the deal go through, it would be the first major consolidation in Taiwan’s telecommunications and media sector since 2010 and represent a profitable exit for MBK Partners, a private-equity firm focused on North Asia that has held a US$1.5 billion majority stake in CNS since 2006.

Completion of the deal would enable FET to package its mobile phone services with CNS’s cable and broadband businesses. That integration would allow the two companies to share costs and sell a larger range of services. “Through the strategic alliance with MSPE Asia and collaboration with CNS, our customers will get to enjoy a smart lifestyle in the future, where they can access goods and services online anytime anywhere through TVs and mobile devices,” said FET President Yvonne Li in a statement.

The move signals FET’s intention to boost its digital content capacity and expand into connected devices, analysts say. Taiwan’s second largest telecom operator has more than 2.2 million 4G customers, and expects that figure will grow to more than three million this year. “In addition to the core telecommunications business (access), FET will also be actively promoting other new businesses such as an Internet of Things platform, smart home, medical care, and in-car Internet,” said company chairman Douglas Hsu in a statement.

Two legal restrictions have shaped the structure of the deal. The first is a ceiling of 60% on foreign shareholdings in domestic telecom and media enterprises, and the second is a provision of the Telecommunications Act that prohibits political parties, government agencies, and the military from investing in domestic media enterprises, including cable operations. Because of the first requirement, 40% of the equity will be held by private domestic investors and the rest by MSPE Asia.

FET is currently ineligible to buy into CNS since government institutions – mainly pension funds – hold a 2.89% stake in the company, according to a July filing with the Taiwan Stock Exchange. FET’s contribution will therefore take the form of NT$17.12 billion (US$524.5 million) in non-convertible bonds. The deal reportedly will be funded through bond issues and equity totaling US$950 million, plus US$1.5 billion in loans from eight local banks, and is expected to close in the first quarter of 2016.

“It’s a big, complex project that has generated some negative press comment,” says a source close to the deal, who requested anonymity because the transaction is pending regulatory approval. “But it scrupulously adheres to the law and also brings a number of advantages for the cable market, capital market and viewing public.”

Benefits of the deal

For FET, “acquiring CNS is a game-changer,” says Kevin Lin, chief legal officer at Taiwan Broadband Corp., another cable operator. “It gives them the last mile [the technologies providing connection services to and from the user’s office or home] to 1.3 million households.” CNS’s 1.3 million subscribers comprise nearly one-fourth of Taiwan’s cable television market. The company is the market leader in Taipei and Kaohsiung and also has more than 250,000 broadband customers.

Lin says the acquisition will allow FET to better compete with Taiwan’s top telecom operator, Chunghwa Telecom (CHT), which he notes has access to nearly all of Taiwan’s 8 million households, and with No. 2 carrier Taiwan Mobile. Taiwan Mobile chairman Richard Tsai and his brother Daniel, chairman of Fubon Financial Holding Co., purchased an 80% stake in the cable operator kbro Co. Ltd. from the Carlyle Group in 2010 for NT$36.1 billion (US$1.19 billion), giving Taiwan’s second largest telecom firm access to kbro’s 1.2 million subscribers.

Meanwhile, Morgan Stanley is committed to upgrading CNS with the regulator’s digitization goals in mind, say sources close to the deal. That includes bringing in outside expertise, such as hiring former Comcast senior executives as advisers, developing better products and services (like a household security function), and cultivating talent. “There is an opportunity here to upgrade the infrastructure [of Taiwan’s cable TV] and make it one of the best in the world,” says one of the sources.

CNS will also benefit from improved corporate governance and controls if the deal is approved, and become a more tightly controlled company, the sources say, noting that Morgan Stanley and its subsidiaries have been subject to strict regulation by the U.S. Federal Reserve since the global financial crisis.

MBK Partners has profited handsomely from its investment in CNS, according to The Wall Street Journal. Dividends paid out by CNS have surpassed the private-equity fund’s purchase price, allowing MBK to make sizeable payouts to its own investors, The Journal reported in July.

Exiting has proven difficult, though. MBK first tried to sell its CNS stake in 2010 for US$2.4 billion to the Want Want Group, a Taiwanese conglomerate that owns a large food business heavily invested in China, as well as hotels, hospitals, real estate, and media interests. Its media portfolio includes the daily Chinese-language newspapers China Times and Want Daily, the magazine China Times Weekly, CtiTV, and China Television.

As Taiwan’s National Communications Commission (NCC) reviewed the deal, Want Want’s pro-Beijing chairman Tsai Eng-meng sparked opposition with blunt language advocating Taiwan’s annexation by China. In a January 2012 interview with The Washington Post, he said, “Whether you like it or not, unification [with China] is going to happen sooner or later. I really hope that I can see that.”

Still, the NCC granted conditional approval for the acquisition in July 2012. Those conditions stipulated that Tsai and his family relinquish management of CTiTV’s news channel, and that China Television change the programming on its digital news channel and establish an “independent news-editing mechanism.” When Want Want refused, the NCC rejected the deal.

“Want Want’s China ties definitely raised concerns with regulators,” says a businessperson familiar with the matter. But that wasn’t the only – or necessarily even the primary – reason why the deal was rejected, the businessperson says. Since the conglomerate already has a large media portfolio, “the government was more worried that Want Want would become too powerful if it took over CNS.”

Taiwanese snack and beverage maker Ting Hsin International Group was the next to bid for CNS, offering MBK more than US$2 billion for its majority stake in August 2014. Ting Hsin sought to acquire CNS to boost the prospects of its subsidiary, Taiwan Star Cellular, in the digital convergence market, analysts say.

The Wei family, which owns Ting Hsin, has no other media interests, which was expected to help them get the green light from regulators. But in October last year, Taiwan’s Ministry of Health and Welfare revealed that Ting Hsin’s two edible-oil making companies had added lard intended for animal feed to their cooking-oil products to lower costs. The ensuing scandal forced chairman Wei Ying-chuan to resign and Tsing Hin’s bid for CNS cratered.

The road to approval

Regulatory approval for the sale of CNS to the consortium led by MSPE Asia and FET will be needed by the NCC, Investment Commission of the Ministry of Economic Affairs, and the Fair Trade Commission. One consideration in such cases is whether any of the funding is coming from Chinese sources; according to the prospective investors’ announcement, the only money from outside Taiwan will be from Morgan Stanley Asia’s private equity fund.

Under the deal, FET would hold the bonds for seven years, but the company has indicated its intention to switch to holding shares if the law restricting government investment is changed. The NCC has proposed easing the restrictions to allow firms with up to 5% of their shares held by political parties, government agencies, or the military to invest in local media companies. The proposal is part of a package of amendments to the Cable Radio and Television Act that is still undergoing legislative review.

“The law against government investment is widely regarded as nonsensical as applied to the cable industry,” say sources familiar with the deal. The ban may be reasonable for media companies that control content, they agree. “But a cable TV company is just a pipe, a distributor. It doesn’t pick content. And under the proposed structure, Far EasTone will have no board members and no management control.”

After the collapse of two previous bids for CNS, it will be considered a positive sign for Taiwan’s private-equity market, and capital market in general, if the current deal goes through. Uncertainty about investors’ ability to exit has been cited as a major reason why PE firms have shied away from the Taiwan market in recent years.

In fact, since the global financial crisis Taiwan has been among Asia’s worst performers in attracting private-equity investment. “The PE [private equity] market has been icy for a while,” notes an industry source. “There is a perception in Taiwan that PE funds just buy and sell companies. But they actually improve the companies’ operations in many ways, and for the funds, cable is a very stable business with a steady cash flow. It would be a good thing for PE in Taiwan if this deal is approved.”