Regulatory cloud and heavy investments dull 3G shine
As the Hang Seng Index pushed past the 16,000 mark yesterday, stocks of mainland mobile-phone operators listed in Hong Kong were among the bull run's chief beneficiaries. China Mobile rose 3.19 per cent, and its junior sibling China Unicom closed up 4.76 per cent on the day.
China Mobile's shares have been doing especially well recently, shooting up by 12 per cent since the firm announced a 28 per cent increase in annual profits last month. It is now up more than 70 per cent over the past 12 months.
China Mobile's climb is all the more impressive considering the regulatory uncertainty that hangs over China's telecommunications sector and threatens to erode earnings for years to come.
Later this year, the telecommunications regulator is likely to hand out operator licences for third-generation (3G) mobile-phone services. But while China has four major phone companies - two fixed-line and two mobile operators - most observers expect the regulator to issue only three licences.
Industry analysts say the objective of this parsimony is to force a merger between the two weakest operators: fixed-line provider China Netcom and mobile company China Unicom.
The intended result will be to create three similarly sized national champions. Each will be licensed to provide integrated 3G and fixed broadband services. Each should be strong enough to compete successfully against any foreign competitors foolhardy enough to enter China's market as it opens up under WTO rules.
But there is a catch. At least one of the 3G licences, and possibly all three, will require the operator to provide services using the home-grown and untested TD-SCDMA technology.
Beijing is eager to establish TD-SCDMA, not only to avoid paying hefty royalties to the US and European developers of rival technologies, but also to promote the system as a potential export.
As a fixed-line operator that offers limited mobile services, China Telecom is thought the most likely candidate to be awarded a TD-SCDMA licence.
The prize is a dubious one. The unfortunate recipient will be burdened with the enormous costs of building an entirely new network from scratch, and then heavily subsidising new TD-SCDMA handsets in an effort to persuade customers to sign up. It is no surprise investors have shunned China Telecom and that its share price has underperformed its peers'.
But the risks do not stop with China Telecom. C.W. Cheung, a director at specialist telecommunications consultancy Ovum, says to spread the investment costs and lend TD-SCDMA critical mass, the other two 3G licences are also likely to require their recipients to invest in TD-SCDMA networks parallel to their other systems.
This would be especially onerous for Unicom, which faces the heavy costs of upgrading its two existing but incompatible 2G systems to 3G standards.
Mr Cheung reckons the costs of investment in 3G infrastructure and fierce competition to win subscribers will inflict at least two years of losses on licensees, which are only likely to break even in their third year at the earliest.
After that, things could improve. Unlike in Europe, where 3G has struggled to take off in relatively mature markets, mobile penetration rates in China are still relatively low and overall user figures continue to grow rapidly.
Edison Lee, the head of telecommunications research at Credit Suisse, notes that China also offers big economies of scale, which will drive down handset costs substantially. He says that if there are only three 3G operators, over time a new mobile licence could be worth US$10 billion to US$23 billion to the recipient.
Before then, China's operators will have to weather both regulatory uncertainty and heavy losses from investing in 3G networks. Either could bring share prices down with a bump.