Getting wired
By : Charles Ward
A kilometer underground, deep in the bowels of the copper ore mine in the southwestern town of Rudna, one could be forgiven for thinking KGHM Polska Miedz an exemplar of Poland's "old economy" and its heavy industrial past.
But facing the inevitable depletion of its ore deposits by 2025, KGHM is metamorphosing, with crucial stakes in telecom firms Polkomtel (Plus GSM) and Telefonia Lokalna, as well as plans to invest heavily into media and internet projects.
Right now "we want to concentrate on copper and telecoms" as the two main elements of the firm's core business, said Marian Krzeminski, CEO and president of KGHM's management board.
But he acknowledged that in the near future, the prospect of KGHM operating predominantly as a telecom company is a realistic scenario. "We can't answer this question today, but in five years it's quite possible," Krzeminski said.
KGHM is a holding company comprising around 50 firms but is better known as the world's seventh-largest copper producer and, as a byproduct, its second largest silver producer. It is also one of Poland's blue chip stocks, with a 48% free float on the Warsaw Stock Exchange (WSE) and another 10% set to go this year in a scheduled public offering. That sale is expected to bring the Treasury Ministry around zl. 520 million ($126.8 million), said Krzysztof Urban, an analyst at Wood & Co.
But some years ago the company decided that it could no longer bank on the mining business, and decided to expand its holdings into telecoms. It now holds a 19.61% stake in mobile operator Polkomtel as well as a 50% stake in local fixed-line operator Telefonia Lokalna. Analysts said that the Polkomtel stake alone accounts for around 70% of the value of KGHM's share price. "They've finally started saying that telecoms is their second line of business," said Zbigniew Lapinski, an analyst at Deutsche Bank Research.
This year looks to be a definitive one in KGHM's transformation. While it plans to invest some zl. 600 million ($146.3 million) every year for the next five years in mining copper and silver in Poland, this year it also intends to continue liquidating loss-making subsidiaries, up its stakes in both its telecom holdings and possibly start to invest in small to medium e-commerce ventures.
"The surplus of cash generated by the core business (will be) enough to allow us to invest not only in telecoms," Krzeminski said. "It should also allow us to dominate some lasting strategic alternative to the other business."
Utterly optimistic
KGHM is in buoyant mood this year. Piotr Wozniak, an analyst at CDM Pekao Securities, said that in 2000 it is expected to post a zl. 539 million ($131.5 million) net profit and increase sales 14.1% over last year to zl. 4.96 billion ($1.14 billion). Analysts said that much of the increase is likely to stem from high world copper prices, which have a rosy outlook in 2000 after a dip in 1999. "Everywhere the climate is quite positive," Urban said. Krzeminski said that 80% of KGHM's revenue this year depends on these prices.
But at the same time, the company is going through an intense period of restructuring, reflected in its balance sheet for last year. Wozniak said KGHM posted a zl. 145.6 million ($37.3 million) net loss, down from a zl. 178.8 ($51.1 million) net profit in 1998.
Krzeminski attributed last year's loss to bringing KGHM's bottom line up to international accounting standards after it elected its new management last June. He said the company assessed various holdings and registered losses on its balance sheet to reflect the new evaluations. It also anticipated various labor costs it would have to make this year, such as pensions. Had these provisions not been made, the firm would have posted a zl. 300 million ($76.9 million) net profit, Krzeminski said. "These accounting procedures did not influence our cash flow," he said.
But in keeping with its focus on copper and telecoms, KGHM has sold about 10 holdings it no longer considers profitable, raising around zl. 100 million ($24.4 million) in the process, he said. "In our strategy we declared that other companies not directly connected with the core business would be spun off," Krzeminski said.
In addition to KGHM's zl. 3 billion ($731.7 million) capital expenditure program on its home copper market in the next five years it operates three copper ore mines in the southwestern towns of Lubin, Polkowice and Rudna, the latter being the largest and covering a total area of 101 square kilometers it intends to spend another $125 million in the same timeframe on foreign projects. Krzeminski said that currently the company has offers from Canada, Australia, Brazil, Peru, China and North Africa.
But the smaller figure for foreign investments "proves that looking for ore deposits abroad is not our top priority," Krzeminski added, and in this respect the company's wariness is understandable. Last year it suffered from negative publicity following a debacle in the Democratic Republic of Congo where it had set up shop to exploit high-grade copper and cobalt ore deposits. It pulled out, asserting a lack of infrastructure and inadequate processing technology, and was forced to set aside zl. 150 million ($38.5 million) alone in provisions for the write-off.
KGHM is currently renegotiating its contract with the Congolese government on processing the 164,000 tons of ore it has stockpiled there, Krzeminski said. But a much-discussed similar venture in Zambia is now not in the cards after the firm found the offer to be unprofitable, he said.
Branching out
Restructuring, adjusting its balance sheet and investing in mining ventures notwithstanding, KGHM is being forced to diversify. "They know that the mining business is limited," Wozniak said. And "they need to find new revenue sources to replace copper production." At the current level of production, the lifetime of the mining business runs to 2025 at the latest, Krzeminski said.
Well aware of that deadline, a few years ago KGHM decided to become a major player in telecom companies. In Telefonia Lokalna, founded in 1997, KGHM and the Polish Power Grid (PSE) hold 50% stakes each, while in Polkomtel it has a 19.61% stake. Polski Koncern Naftowy (PKN) also holds 19.61% in the firm, while U.S.-U.K.-German giant Vodafone AirTouch and Teledenmark both hold 19.25% each. PSE and its subsidiary Telenergo hold around 19% together while smaller shareholders hold the remainder, Urban said.
Polkomtel remains the jewel in the crown despite the smaller stake and KGHM aims to take control of the company. "It's the top (Polish) mobile firm, the most innovative and extremely focused on business clients," Wozniak said.
And KGHM is anticipating a higher stake sooner or later as the mobile operator prepares to expand its range of services. "There should be some decisions about an equity increase and maybe we will be able to increase our stake," Krzeminski said. However, he would not disclose any information on the timing.
This year coal firm Weglokoks is scheduled to shed its approximate 4% stake in the mobile operator, Lapinski said. If KGHM can wrest control of the stake, "it will have a substantial psychological impact and it will start to consolidate" its holdings in the firm, he said. Wozniak said that KGHM aims to increase its stake to 33% in two years by purchasing either part of PKN's stake, or part of both PKN's and PSE's stakes and then reducing it to 25% before a scheduled initial public offering (IPO) in Polkomtel.
"Until the IPO, KGHM can increase its holding in Polkomtel using every opportunity that exists," Krzeminski said.
But he added that KGHM's chances of getting a hold of the firm are slim although its stake is a "core holding" and it is in Polkomtel for the long haul. "It seems very unlikely that we will take control" because all the major shareholders in the company view their stakes as long-term investments, he said. Moreover, any increase in its holdings will be accompanied by equal increases from the other strategic partners, he said. "Large shareholders will participate every time in transactions (within) Polkomtel," Krzeminski said. And "there will always be proportional stakes."
Krzeminski was more decisive, though, about KGHM's future in local fixed-line operator Telefonia Lokalna. This year Lokalna intends to spend zl. 700 million ($170.7 million) on rolling out its subscriber network, which it hopes to increase to 120,000 by the end of the year from 40,000 at the end of 1999, Wozniak said. Along with Netia, last March it won a license for the Warsaw area to challenge Telekomunikacja Polska's (TPSA) monopoly.
Krzeminski said his firm wants full control of Lokalna and that it is currently in talks with PSE over a buyout. "We think that a 50/50 holding in this company is not the best solution," he said. "We have some capital that could be invested in this business, and we would invest it only on condition that we would take full control."
Furthermore, KGHM has long-term designs on the company's potential. "With further liberalization of the market expected, we think that by 2003 we should be able to consolidate Telefonia Lokalna with other major operators," Krzeminski said. However, he added that he did not exclude the sale of KGHM's stake to PSE.
While Wozniak said the price of the stake is currently subject to negotiation, he added that 50% in Lokalna is worth around zl. 140 million ($34.1 million). However, any bidder would likely pay around zl. 150 million ($36.6 million).
KGHM has a better chance than PSE of full ownership, Wozniak said. Due to the contract, if PSE does not want to sell its stake, it will be forced to buy KGHM's, he said. But at present PSE does not have enough income to finance its own debt sufficiently and therefore no funds to finance Lokalna's development or buy out KGHM, Wozniak said. Conversely, KGHM, with a healthy cash position and a debt-to-equity ratio of 60%, is in a viable position to do both, he said.
Life after telecoms
However, telecoms is not the only area for expansion, although it does provide KGHM with a platform to go into information technology. Krzeminski said that the firm's projected cash surplus and its debt position will allow it over the next four years to invest in small to medium IT companies via its venture and investment funds, such as Dolnoslaska Spolka Inwestycyjna (DSI).
Rather than teaming up with the more prominent blue chips on the WSE, such as Softbank, Prokom and Optimus, "the analysts of this project say there is a large number of small companies with very good ideas," Krzeminski said. "The studies on this market show that some of these projects" which include e-commerce ventures such as business-to-business services "are very dynamic, with 100% growth." He said that KGHM funds would finance firms that still have problems getting loans and are too small to tap public markets.
Furthermore, he added that the firm's aspirations to broaden into IT could converge with Polkomtel's products for businesses. "Polkomtel is a good base for selling these products," Krzeminski said.
KGHM also plans to invest zl. 25 million ($6.1 million) in a new family-oriented television company, Telewizja Familijna, alongside other investors such as PKN. Despite the difficulty experienced by other companies, such as Nasza Telewizja, in breaking into the fiercely competitive TV market, Krzeminski was confident of the venture's eventual success, although he would not reveal when the company will get off the ground.
"Zl. 25 million is a very small amount compared to our investments in telecoms," he said. But after favorable research surveys undertaken by market research company OBOP, "we took a look at the management of Telewizja Familijna and we came to the conclusion that they are professional, expert, and there's a big chance of success." He added that, similar to its IT projects, its investment funds will finance the company and that they will continue to review other projects in media and the internet.
