Lopez Holdings


Fellow Stockholders:
Last year, in my remarks before you and in the Chairman's Letter of our printed annual report, I had the difficult task of informing you about how horrible a year 2000 had been for the Philippines and for our company. The prolonged economic slump in the region, renewed political turmoil, the flight of international capital, and our own investment mistakes - all of these contributed to the derailment of our business model. Most damaging of all, however, was the devaluation of the peso, relative to the dollar, from 26 to more than 50 pesos to a dollar. Virtually overnight, we saw our dollar-based obligations double in peso terms. We could not hedge these obligations. We could not refinance them. Nor could we pass the added costs to our customers.

As we looked forward to 2001, I said that for Benpres to continue to chart its present business course, several things would have to happen. We would need a more enlightened regulatory environment to enable us to weather the storm in our concession businesses. We would need to refinance some of our early-maturing loans, or divest of some of our assets in order to repay those loans. We would need to restructure our investment portfolio to seek a better balance between regulated and unregulated businesses and between capital intensive and knowledge-based businesses. And we would have to improve governance and drastically reduce costs. I also suggested that 2001 would probably be even more difficult for the business sector. Regrettably, events have proved me right. In a nutshell, this is what happened in 2001.

The toppling of the Estrada administration, in what is now referred to as People Power II, and Estrada's replacement by his constitutional successor Gloria Macapagal Arroyo, raised some hope that the confidence of the business sector could be restored. However, although the Arroyo administration has made significant progress toward the stabilization of the macro-economic environment and of our democratic processes, our economy has been unable to shrug off the crippling effects of a continuing Asian economic downturn, and of a slowdown in the global economy. Capital flows continued to avoid our country, and there wasn't enough locally to sustain large scale, long-gestation investments like those we have entered into. All around, the peso devaluation continued to punish us - at Bayantel, at Maynilad, at Meralco. The events and aftershocks of September 11 in New York merely dramatized and exacerbated what was already a lingering malaise. Even our main income generator, ABS-CBN, has not been spared a 34% decline in profits due to the industry downturn in advertising.

I emphasized last year that speedy reforms in the regulatory framework and environment of our concession businesses would be needed if we were to rebuild a viable business case around our existing portfolio of investments. Reforms have not moved as fast as we had hoped.

Meralco's petition for a rate increase remains pending. It is now more than eight years since Meralco was last allowed by government to raise its rates. This notwithstanding, Meralco has become a favored target by many interest groups with their own agenda. It is vilified for merely passing on to its consumers the higher cost of power purchased from National Power Corporation and other independent power suppliers.

First Gas Power's 1,000-megawatt Sta. Rita Plant entered into commercial operation last year. Meralco, however, has not been able to take full advantage of the relatively cheaper and cleaner Malampaya natural gas power produced by the Sta. Rita Plant. National Power Corporation, which owns the high-voltage transmission grid, controls how much of Sta. Rita power is to be dispatched. Thus far, Napocor has been unable or unwilling to fully dispatch Sta. Rita, citing one reason or another.

Our telecommunications subsidiary BayanTel, was hit hard by the peso's devaluation because of its foreign denominated loans and bond issues amounting to 0 million. The company had to call for a financial restructuring in 2001 with the assistance first of Bank of America and lately, as of May 2002, Credit Lyonnaise Equity Markets, Ltd. (CLSA) was brought in as financial adviser to take the place of Bank of America. The harsh realities of the business have compelled Benpres to take a sizeable loss provision of its investment in BayanTel, amounting to P9.9 billion.

Turning now to our water distribution subsidiary, Maynilad Water was finally able to secure Amendment No. 1 to its Concession Agreement in October 2001. The amendment provides relief from the extraordinary foreign exchange losses arising from the debt obligations of the government that Maynilad assumed under the Concession Agreement. Additional relief is now in process to assure the viability and bankability of the concession. But it has been slow in coming mainly because of bureaucratic resistance to change.

Let me point out, however, that we had our share of positive developments in 2001. First Philippine Holdings Corporation turned in a record profit performance amounting to P3.5 Billion. Its power generating business, after seven years of nurturing, finally began to operate to its potential. The 1,000 MW Sta. Rita plant entered into commercial operation in 2001 and has made possible the early utilization of indigenous natural gas fuel from the Camago/Malampaya gas fields. This translates to significant foreign currency savings for the country. Sta. Rita is now the cheapest power producer for Meralco that is fully compliant with the stringent emission standards set by the Clean Air Act, as well as with other globally accepted environmental and safety standards. A second 500 MW gas-turbine plant, San Lorenzo, is tracking fairly close towards its scheduled completion this month. Future prospects associated with both the privatization of Napocor and the development of downstream businesses using natural gas continue to look promising.

Our toll road project, Manila North Tollways Corporation, is finally expected to start construction shortly, after closing its US1 Million project financing package and meeting the various conditions precedent to drawdown.

Subject to creditors' consent, the Lopez Group is consolidating its ownership in SkyCable with the PLDT group's interests in Home Cable in a new company called Beyond Cable. This new company will control 60-70% of the cable television market in Metro Manila, and 80% of the provincial markets where it operates.

Unfortunately, these positive developments will not be enough to sustain us through 2002. The economy has yet to attain a growth momentum. Consecutive years of adverse business conditions and results have taken their toll on us. We have tried to shop certain assets, Bayantel's landline network, for example. These efforts have, however, been frustrated by the low appetite across the market for merger and acquisition activity over the past two years. Midway through 2001, it was abundantly clear to us that a total review of the company's financial condition and business operations was in order.

Accordingly, in the latter half of 2001, we engaged Credit Suisse First Boston as financial adviser, and the law firms of Skadden, Arps, Slate, Meagher & Flom and Quiason Makalintal Barot Torres & Ibarra as legal advisors to assist us in developing a plan that will enable Benpres to address its upcoming liabilities and restore Benpres' long-term financial health. As a result of the review, a Balance Sheet Management Plan was formulated ("Plan") which proposed that over the medium to long term, Benpres should scale down its borrowings, strategically downsize its portfolio of investments and emerge from the Plan with a business base and risk profile that we can sustain and manage for profit. Over the shorter term, the Plan would require that Benpres would inevitably be subjected to an element of financial belt-tightening, cost cutting and minimal investments. The Plan may also require Benpres to consider rescheduling some of its obligations to match the longer-term nature of its assets, as well as to allow Benpres time to execute an orderly asset divestment program. However, prudence dictates that we ensure that we will be around to fight another day. Personally, I feel a sense of dj vu. Fifteen years ago, after the EDSA Revolution, I returned to First Philippine Holdings and was confronted with an apparently hopeless situation because the company was practically bankrupt. But I refused to throw in the towel. Instead I decided to dig in and with the help of everyone in the company, we gradually brought First Holdings back on its feet, so that today, it is the picture of financial health and stability. Benpres is not in the same precarious situation that First Holdings was then. There is no apparent hopelessness in our situation. And I am confident we will succeed in our present endeavor, with your patience and support, and that Benpres will emerge a leaner, less leveraged and more focused entity.

A brief presentation of the Plan by our Financial Adviser, Credit Suisse First Boston, will follow my opening remarks. One of its components relates to the tollroad project and you may already have heard that First Holdings has completed its due diligence on the possibility of acquiring our 70% interest in First Philippine Infrastructure Development Corporation, the principal project sponsoring company behind the rehabilitation and expansion of the North Luzon Expressway. Earlier this year, First Holdings engaged JP Morgan Chase, Price Waterhouse, the international law firm of Trautman Sanders and the Philippine law firm of Puno & Puno to establish a third party valuation for the project and to determine the contractual and legal framework for a project buyout. Shortly, Benpres will be engaging the services of its own financial adviser to provide its own third-party valuation of the project, after which negotiations with First Holdings are expected to commence. It is clearly of the highest concern for us that all decisions and actions taken in connection with this possible buyout are fully transparent to all interested parties, and that the outcome of negotiations is a transaction that will be fair and attractive to the shareholders of both companies.

For us to sustain the Maynilad Water project, it is essential that counterpart equity for the project must be found to enable us to secure a 0 Million project term loan. And so, we have also engaged the services of Credit Lyonnais Securities Asia, or "CLSA", to help us identify and attract new investors into Maynilad Water to enable us to raise the required counterpart equity, equity that Benpres is now unable to provide.

These initiatives we are pursuing in regard to the tollroad project and Maynilad may effectively dilute us out of ownership and management control of these projects. But I do not consider that as necessarily a bad thing for Benpres. Let me explain why.

When Benpres was formed in 1993 as the flagship listed vehicle for the Lopez group of companies, its mission was to preserve and continue the Lopez business philosophy, namely, the provision of high quality public services to the Filipino people who are entitled to the best we can deliver while at the same time creating value for all the stakeholders of the business. In the light of what has happened over the past five years, however, we have begun to question if this philosophy can sensibly be pursued over a wide range of public utilities in our present political, social and economic environment.

If, as an investor, I take on the function of providing a public service to the consuming public, there are certain responsibilities and risks that I immediately assume:

  • First, I must design and install a combination of facilities and processes that will produce and deliver what the consuming public wants, in accordance with acceptable standards of quality and reliability.
  • Second, I must price the service or product at a level that the consuming public can afford, but also at a level that will enable me to sustain the service and earn a reasonable return for my stockholders.
  • Third, I should expect that my investment will be tied up for a long period. Essential services never offer quick paybacks.
  • Fourth, because of the inadequacies of our capital market, I should expect to have to rely on foreign-currency denominated borrowings for the rates and tenors required and accept the attendant foreign exchange risks. We have all become familiar with these risks in the past few years.
  • Fifth, because essential services invariably fall under some form of government regulation, I should expect that the process of adjusting the price of the service to changes in its true cost will not always be timely and efficient.
  • Finally, because the lead time to increasing capacity is often measured in years, I must take the risk of assuming the rates of demand growth and invest in creating new capacity in anticipation of that growth.

Government and society, in turn, must assume certain responsibilities in my regard:

  • First, Government must ensure an even playing field and see to it that the rules by which public utilities must operate and compete are fairly and consistently applied over time.
  • Second, it must provide enlightened regulators who, while protecting the rights of the consuming public, will also ensure that providers of public service are able to operate to a business model that will enable them to sustain their businesses and earn a reasonable return.
  • Third, itt is equally vital that that the regulatory process, which is designed to protect the interest of all parties, should not be politicized. The executive and legislative branches of government should allow the regulator to do his job properly and without political pressure or intervention, although this may be asking for the impossible under present circumstances.
  • Fourth, consumers must be prepared to pay the true price for any service provided to them, based on the true and transparent cost of providing that service. Public service providers are not in a position to provide massive subsidies to specific classes of consumers.
  • Firth, consumers must also be prepared to support the creation of reserve capacity to cover constant fluctuations in demand. They should be mindful of the fact that it takes years to bring new capacity on stream, and that without adequate reserves, shortages and outages will be suffered.
  • Finally, neither the government nor the consuming public can sit back and tacitly condone the theft or pilferage of essential services. As much as the service provider, it is the duty of government and civil society to proactively discourage theft of any kind.

In a real sense, therefore, essential services, or what we more commonly refer to as public utilities, is a long-term partnership between the investor, government and the consumers. And it is a partnership that requires transparency, trust and mutual support. The question is, is there a basis for such a partnership in our country today?

Our experience of the past five years suggests that the evolutionary process toward a more responsive and fair regulatory environment has progressed very slowly. We have had to pay dearly for having overestimated the strength and efficacy of the regulatory process,

In the case of telecommunications, having deregulated the industry and invited new players to invest in modernizing the country's telephone system, government failed to ensure an even playing field for new entrants. Instead, it turned a blind eye to restrictive interconnection practices of the dominant incumbent provider.

In the case of water distribution, having been forced to privatize the industry mainly because of its long history of failure to provide satisfactory service, needed reforms to make the private concessions viable are still to be completed. Moreover, certain government commitments such as the supply of additional water have been delayed.

And when the economy is performing poorly, it appears that providers of essential public services become society's favorite whipping boys, regardless of the quality of service they provide, and any effort to pass on the true cost of providing the service is deemed oppressive. There appears to be an emerging populist view that providers of essential services should not be allowed to profit from their activity because, advocates argue, such profits come at the expense of consumers who are largely poor and oppressed. Rather than provide an essential dose of sobriety, politicians and journalists alike join the ranks of detractors as a means of gaining cheap political points or short-term higher newspaper circulation.

Unfortunately, we cannot sustain quality public services at a loss. Businesses will exist only if they are able to serve the needs of their customers. But businesses will also exist only if their stockholders earn a reasonable rate of return on their capital. Otherwise, capital will migrate to wherever it can earn a better return.

I must admit that our experience, particularly in Bayantel and Maynilad, compels us to rethink our philosophy, the pursuit of which has gained us involvement in several major public utilities at the same time. Our current circumstances may compel us to sell down or sell out of projects like the tollroad and Maynilad. Looking beyond, however, I believe that we must re-focus on the core businesses that carried us to our position of prominence, namely, media and television on the one hand, and power generation and distribution, on the other. These are the businesses we know best and where we can recognize our best opportunities. They are the businesses in which we have an established track record. They are the solid foundation upon which we can rebuild. Everything else, we are prepared to divest, as we lean out our business and organization.

At this point, I would like to remind our stockholders that before martial law, Meralco customers enjoyed among the lowest electricity rates in Asia if not in the world, as revealed in a United Press International survey in 1971. This enviable situation was due to the fact that Meralco controlled its generation, transmission and distribution facilities so that it could plan and optimize the way it operated. Meralco also enjoyed a high capacity factor in its entire system because industry and commerce were concentrated in the Metropolitan Manila Area, which resulted in economies of scale and lower cost of production, the benefits of which were all passed on to its customers in terms of lower electricity rates.

Today, it is doubtful whether Meralco can even be fully integrated again, but nevertheless, our objective remains the same, that the combined generation and distribution facilities under the control of the Benpres Group will work for the lowest possible electricity rates for the 3.5 million Meralco customers, and one day these low rates will happen once the NPC transmission lines allow our new natural gas-fired Sta. Rita and San Lorenzo power plants in Batangas to be dispatched at 83% of their capacity or better, and the cross-subsidy that Meralco customers are currently forced to provide to the rest of the country is also removed by NPC. At that point, Meralco rates can go down by at least one peso per KWH.

In closing, I thank you once again for your continuing faith and support. That we have problems, I cannot and will not deny. That it will take much and prolonged effort to solve them and recreate value for the company, that too, I will not deny. But the word "surrender" does not exist in my vocabulary. As your chairman, let me assure you that as long as I have my health, there will be no lack of determination, decisiveness and persistence on my part to pursue what is needed for both survival and subsequent growth of this company. Have no doubt about this commitment.

Thank you and good morning.

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CONTACT US

Lopez Holdings Corporation (formerly Benpres Holdings Corporation)
4/F Benpres Building, Exchange Road, 1605 Pasig City, Philippines

  • Trunkline: (632) 449-2345
  • Fax: (632) 634-3009
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