Towering strength?

It could herald the most significant reform in the telecom sector since the creation of a third mobile operator in 2008. Or it might end up meaning not very much at all. Such has been the bemused response to the revelation that the three telecom giants – China Mobile, China Unicom and China Telecom – have formed a new national company to hold their infrastructure assets.

Caijing scooped the rest of the domestic media last Tuesday when it announced the creation of a national tower company with registered assets of Rmb10 billion ($1.6 billion). According to the magazine, the firm will get equal footing with the existing operators, and will have a CEO appointed by the government’s powerful Central Organisation Department.

The new entity will oversee a ‘build, own and operate model’, meaning the three telcos will have to lease back their towers and base stations. Caijing says that only new base stations and towers will be included at the outset, with existing stock gradually incorporated at a later date.

Analysts greeted the news with some scepticism. Some pointed out that it could take a while for the competing telcos to come to any form of commercial agreement. And in that time, China Mobile will be rolling out its plan for 531,000 new 4G towers and base stations. About 240,000 of the total were in operation at the end of last year.

Others argue that it should be more straightforward for the three to share towers infrastructure but that it will be more difficult to incorporate core equipment like base stations, which are designed according to individual network requirements.

Caijing’s report was quickly confirmed by the three operators and the regulator, MIIT, which posted a notice on its website saying the tower company is being established “in accordance with the principles of a market economy and mixed ownership”.

Analysts are waiting for more details about how the new company is going to be structured.

But rather than reducing the industry’s capex and improving returns on invested capital, the fear is that the move could create another unwieldy giant. Hence the People’s Daily warned that a lack of competition is the main problem facing the telecommunications industry. “The government should be loosening control, not retracing its steps along a road that will just lead to the creation of yet another monopoly,” it suggested.

According to reports on Tencent News, China Mobile will have the biggest stake in the new venture, reflecting its dominant market share. Nonetheless, it looks likely to be cautious about a move that could give its rivals access to a key competitive strength – a vast 2G network that reaches even remote rural areas. Analysts estimate that China Mobile has about 800,000 towers compared to China Unicom’s 550,000 and China Telecom’s 270,000.

There is also the issue of where this leaves China Communications Services Corp (CCS), China Telecom’s infrastructure services company. China Unicom also holds a small stake in the Hong Kong-listed firm, which might be maintained as a second vehicle, bringing an element of competition to the tower sector.

CCS is certainly keen on the idea. Deng Xiaohui, its general manager in Qingdao, tells Huixi.com that the three mobile operators could save billions from pooling their resources. He estimates that the closure of 100,000 overlapping base stations could generate savings of Rmb20 billion ($3.2 billion), for instance.

Spinning off these assets could also unlock huge gains, with the South China Morning Post citing one analyst estimate that the towers could be worth up to $46.5 billion.

There are plenty of international precedents for this strategy, including in India where the operators hold their tower assets in separate companies.

The biggest player is Indus Towers, a joint venture between Bharti Airtel, Vodafone and IDEA, which has 110,000 towers. But the creation of too many Indian tower companies has led to overlapping infrastructure. Some operators – established with a mission to win multiple tenants – have ended up with just one client. Any repetition in China could risk the potential gains from the new policy: avoiding duplication of 4G capex costs between the operators, improving energy efficiency (power usage is their chief operating expense); and enabling new operators to roll out networks more quickly.

Key to understanding the policy switch is the advent of 4G. MIIT announced the first wave of 4G licences in December but has initially restricted them to China’s homegrown technology, TD-LTE. China Mobile has pioneered the standard, hoping for a better experience than its clunkier 3G standard TD-SCDMA (which made it impossible to sell a range of handsets most notably the iPhone, for instance). The policy was partially enforced to enable its rivals to gain market share with technology that was more reliable and relied on global standards. And it worked. While China Mobile was struggling with download speeds of just 2.8Mbps, China Unicom was able to offer speeds of up to 21Mbps.

The same restrictions won’t apply for TD-LTE, which is compatible with other international 4G standards. So China Mobile’s competitive potential will be unleashed once more, although heavy capex on the network – Rmb225 billion in 2014 – has weighed down its share price. It started selling China’s first 4G devices in January and has ambitions for sales of 50 million units by year-end, partly driven by iPhone sales (the device is compatible with the new network). Strong sales have also had a positive impact on Apple’s second quarter earnings.

By contrast, China Unicom and China Telecom stand to lose some of their previous advantages. China Telecom is said to have drawn the shortest straw this time around after being forced to pitch for a hybrid licence incorporating both TD-LTE and FDD-LTE technology – the latter a better-known international 4G standard. (Rather ruefully, the firm’s chairman Wang Xiaochu told reporters at the company’s annual results briefing that the company wanted to, “support national technology innovation”.) As a result, market watchers wonder if China Telecom is the driving force behind the new tower company, hoping to piggyback on China Mobile’s spending rather than having to upgrade its own 3G network, which is not fully compatible with TD-LTE.

China Unicom is also hoping for an FDD-LTE licence, with reports that it will be issued in June. It has said that it will only roll out 4G in hotspot areas, as it still wants to generate better returns from its heavy investment in 3G.

This spending pushed its net margins down to just 2.5%, raising its debt-to-EBITDA metric to 2.7 times. Improving both these ratios may be one reason why it’s keen on the tower-sharing agreement too.

Whether the new arrangements can unlock genuine value will depend on the number of tenants for each tower and the price that they are prepared to pay to lease space. In a bid to increase competition at the retail level, the government recently issued 19 licences to Mobile Virtual Network Operators (MVNO). Successful bidders included companies like Alibaba and Suning, with the first operator T.Mobile starting operations in Hangzhou last Sunday. Analysts caution that new operators will need customer bases of at least a million subscribers to break even.

Caijing says that MIIT is hoping that changing the ownership arrangements for the network’s infrastructure will force the three telcos to focus more on service innovation and international expansion. All three have suffered from competition by OTT providers (‘Over The Top’ content is delivered over the internet) such as Tencent’s WeChat, which has been eating into their text messaging revenues. China Telecom has responded with YiChat, a messaging system set up with NetEase, while China Mobile has also developed a new product, after failing to agree a revenue-sharing agreement with WeChat.

The three incumbents are also grappling with another regulatory initiative which could hurt earnings. From June 1, they will be included in a pilot programme for payment of VAT. This means that customers will pay 6% for value added services (mainly data) and 11% for basic telephony services (mostly voice), instead of the telcos paying a standard 3% business tax. Ratings agency Fitch calculates that it will cost all three operators 8%-10% in EBITDA over the next two to three years as the competitive landscape makes it doubtful they will be able to pass through the additional costs to customers. But over the longer-term Fitch thinks the changes will be earnings positive, when more of their suppliers become part of the VAT scheme and they are eligible to offset the tax with rebates.

Over the past two years, all three Chinese telecom stocks have underperformed their regional peers. News about the tower company had an immediate and positive impact, but a sustained rise in share prices is unlikely unless investors see further evidence of the operators monetising more of their data traffic. In a saturated market, new customers are relatively thin on the ground. Future profit growth will be determined by getting people to spend more on upgrading to 4G smartphones, a move that will inexorably lead to ever greater consumption of data.

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