China Industry Reorganization Sets Stage for Shift in Spending

By: Svetlana Grant, Consultant; Leslie Arathoon, VP of Research, Pyramid Research
(Business News & Technology News, 3 Jul 2008)

On May 23, 2008, the Chinese government kicked off a long-rumored reorganization of the telecom industry. The plan is to merge the six existing mobile and fixed network operators into three integrated fixed-mobile providers:

- China Mobile, currently the market leader with 70 percent of mobile market revenue, is buying a fixed operator, China Tietong (formerly China Railcom);

- Fixed-line incumbent China Telecom is entering the mobile sector, buying the CDMA operations of the second mobile provider, China Unicom;

- China Unicom is buying China Network Communications (Netcom) in an all-share deal, integrating GSM and fixed-line services.

The objective of the restructuring is to level the playing field in China by creating three companies with roughly equal sets of assets. In reality, it means strengthening the competitors of China Mobile, which has benefited from fixed-mobile substitution and the migration of voice to mobile networks, trends that have already caused both the number of access lines and profits to decline for fixed operators. Fixed incumbent China Telecom will be strengthened by entering the mobile CDMA market, which will give it a chance to prop up the shrinking fixed-line customer base through bundling, cross-selling and new converged services. In a similar fashion, China Unicom and Netcom will also gain as a result of the restructuring, although they will face challenges in integrating equally strong divisions.

For equipment manufacturers, these changes pose a set of serious questions: will the mergers lead to lower capex levels, and how will the restructuring change the direction of network development?

We believe total capex for 2008 will remain unchanged from the previously announced plans, most prominently China Mobile's plan to boost its capex to $18.5 billion in 2008 from $13.8 billion in 2007 (Exhibit 1).


Exhibit 1: Main Chinese operators’ Capex plans for 2008



Source: Operators, Pyramid Research


Starting in 2009, however, the restructuring will lead to several important shifts in spending patterns, most important of which will be growing investment in next-generation broadband networks. This will translate into higher levels of Capex in 2009—forecast to reach $33 billion.

Here are some of the outcomes we expect from the restructuring of the telecom market in China:
- At long last, investment in 3G network deployments will accelerate.
All three unified operators will likely receive 3G licenses—licenses that the government has held off awarding for several years as it waited for the homegrown 3G technology TD-SCDMA to be developed. When the licensing finally goes ahead (it is currently expected to take place in the fall this year), the rollout of new 3G networks will start to drive mobile Capex, which until now has been fuelled mostly by mobile network optimization and GPRS/CDMA upgrades.

- The last-mile broadband network will receive higher levels of investment as China Telecom and China Netcom/Unicom start expanding into areas where the other is already established. China Telecom currently owns fixed-line assets in China's southern provinces, China Netcom in northern provinces. We expect these two operators to invest more than $4.1 billion in broadband in 2008.

- Total transmission network Capex will get a boost. Both China Telecom and China Netcom will be working to expand their network capacity to support a growing number of broadband subscribers, of which they had more than 55 million at the end of 2007. This will especially be the case in provinces where they are not currently present.

- In the medium to long term, investment in IP core networks will become an important driver of capex, since the integration of fixed and mobile arms will lead operators to deploy unified IP core networks and a new generation of billing and operating support systems. With a view to providing such FMC services as IP Centrex to business customers, China Telecom and China Netcom/Unicom have already started IMS trials.

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