Two telecommunications companies from opposite sides of the Chinese border working on a deal cloaked in mystery and intrigue - for the past two months, Hong Kong’s financial community has been talking about little else. Since Hong Kong’s PCCW revealed it was in talks over the sale of a stake in its dominant fixed-line business, PCCW-HKT Telephone, to state-owned China Netcom, analysts have been specu lating over the precise structure of the deal. With the two companies refusing to go beyond a 10-line statement issued in May, the rumour mill has gone into overdrive. Some observers maintained the deal would be an outright sale of the whole of PCCW to provide Netcom with a “backdoor listing” in Hong Kong. “Wrong,” said others, this was an attempt by Richard Li, the entrepreneur who splashed out US$28bn to buy Hong Kong Telecom in 2000, to repay PCCW’s debts and fund future ventures. “Not so,” said a third group, the deal was a bold move by Beijing to control a vital part of the infrastructure of the former British colony. Amid the cacophony, the outline of a deal that could revolutionise Hong Kong’s telecoms industry and reshape the relationships between its companies and their Chinese rivals is beginn ing to emerge. PCCW and China Netcom declined to comment, but industry watchers say an option being seriously considered involves an equity swap between the two businesses. Under this scenario, Netcom would acquire a controlling stake in PCCW-HKT for cash and give PCCW equity in a Chinese joint venture. In particular, the two companies would co-operate i n southern China, where Netcom has begun to compete with state-owned rival China Telecom. Netcom, formed in 2002 through a merger of northern reaches of the old fixed-line telecoms monopoly and data service companies, is keen to grow in affluent areas such as Shanghai and Guangdong province, currently dominated by China Telecom. An alliance with PCCW could provide the Chinese company with the technical and managerial expertise to take the fight to China Telecom. Under existing rules, PCCW would only be able to acquire a 25 per cent stake in the Chinese venture, rising to 49 per cent from 2006. However, even a minority stake would enable PCCW to steal a march on the competition by becoming the first international telecoms group with substantial operations in China. The heavy cost of fixed-line network construction means competition between Netcom and China Telecom for the mass consumer market in voice telephony is unlikely to be fierce. Both companies are initially focusing on offering value-added services and winning easy-to-connect customers, such as residents in new housing complexes and companies in modern office blocks. Netcom also hopes to win a share of broadband internet services in China - a market PCCW has helped to develop in Hong Kong. Such a deal would also allow Mr Li to move on from an ill-fated acquisition - PCCW’s shares have lost 96 per cent of their value since 2000 - while keeping an interest in both China a nd telecoms. The question is just how much cash and how big an equity interest PCCW is likely to get. With PCCW-HKT’s enterprise value estimated at some HK$40bn (US$5.1bn), a sale of a majority st ake would be enough to repay a large part of PCCW’s net debt of US$3.8bn. However, analysts such as Voon San Lai at BNP Paribas Peregrine expect Netcom to pay a discount to PCCW-HKT’s enterprise value due to the limited growth prospects of Hong Kong’s fixed -line market. Valuing PCCW’s stake in a China joint venture could prove more difficult as the business will not be included in the forthcoming Hong Kong listing of some of Netcom’s assets. “Any purchase by Netcom will most likely be funded by cash cum shares [but] we think non-marketable China Netcom shares are unattractive,” said Kelvin Ho, an analyst at Nomura. With Mr Li, an entrepreneur with a penchant for the unexpected, in personal charge of the Netcom talks, a sale of the whole business cannot be ruled out. But out of the mystery and the rumours, a deal that would give Netcom a way into Hong Kong and give PCCW a much sought-after ticket to China, is taking shape. China Netcom has applied to Hong Kong and New York regulators for a listing that could raise up to $2bn, according to people close to the deal. The filing, which was expected, is the first s tep towards the initial public offering. Goldman Sachs, Citigroup and China International Capital Corporation are underwriting the deal. They declined to comment yesterday. Additional reporting by Mure Dickie in Beijing