China's Telecom Market: Slow Train to Maturity

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China's telecom service market roughly matched the country's GDP growth at 11% to reach RMB648 bn ($85 bn) in 2006. Growth was driven primarily by mobile and data communications. The leading mobile operator China Mobile strengthened its dominant position, accounting for 45% of the total telecom service revenues in 2006, while the two fixed line operators, China Telecom and China Netcom, have been suffering from a growing mobile-fixed substitution.

Mobile-fixed substitution accelerated in Q1 '07 with China Mobile further strengthening its dominant position. It reported 19.5% revenue growth. China Unicom, the other mobile carrier, reported just about 4.2% revenue growth as it continued to lose market share to China Mobile. China Telecom and Netcom have reported substantially lower growth in revenues at 2.2% and 0.2%, respectively as a result of a flat subscriber growth, as well as declining local voice traffic.

3G continues to be a focal point of the industry as the two fixed line carriers are expecting to enter into the mobile market via 3G licensing and industry restructuring. BDA believes that the delays in getting the domestic 3G standard TD-SCDMA ready for prime time will continue to push back the issuance of 3G licenses for all the three kinds of 3G technologies. BDA also believes that 3G licensing will be further delayed until late 2008 or early 2009.

Major political events could also contribute to the delay. For instance, an upcoming leadership reshuffle may slow down decision-making on industry restructuring and 3G licensing issues. The Communist Party of China (CPC) will hold its 17th National Congress (NCCPC) in September 2007. It could, in fact, be October according to some sources even the date seems to be classified as a state secret). This will be followed by another acronym-laden event-the National People's Congress (NPC), six months later, in March 2008. Any changes at the top echelon of the party leadership at the NCCPC must be ratified by the NPC in March and reflected by a corresponding reshuffle in the Cabinet. Regardless of the scope of any eventual changes, uncertainty and speculation ahead of the NCCPC is bound to generate caution and consequently have a slow-down effect on the workings of the government.

Rural Market is Key
China's mobile market is a duopoly of two mobile carriers: China Mobile and China Unicom. Net subscriber additions remain robust at 5 to 6 mn per month. China Mobile had 316.1 mn mobile subscriptions till March 2007, accounting for 68% of the total market. China Unicom operates both GSM and CDMA networks with 109.2 mn GSM and 37.7 mn CDMA subscriptions. Unicom is likely to spin off its CDMA assets and sell to China Telecom in the long-expected industry restructuring, likely to happen in 2008.

Benefiting from the delay in 3G, China Mobile continues to gain share from Unicom accounting for 80% of the incremental market in Q1 '07. China Mobile has aggressively implemented Calling-party-pays (CPP) and cut roaming charges to land-grab subscribers ahead of 3G licensing. This coupled with the entrance of more players will create more competition in the wireless market.

Driven by low penetration in the rural market as well as increasing competition, the mobile market will maintain strong growth with a CAGR of 8% over the next five years. BDA forecasts China's mobile subscribers to reach 526 mn by 2007, and 784 mn by 2011. (See Exhibit)

As a result of extremely low mobile penetration in rural areas, subscriber growth in rural markets will be the key driver for growth. Declining handset prices as well as reduced tariff charges have already reduced the entry barrier for potential subscribers. China Mobile claims that over 50% of new subscribers in 2006 have been from rural areas. BDA believes this trend will continue over the next few years.

Without access to mobile licenses, China Telecom and China Netcom have been offering a fixed wireless local loop service called PHS and have accumulated 91 mn subscribers in 2006. However, as mobile operators are offering CPP, cheaper tariffs as well as more attractive value added services, PHS is losing traction. BDA forecasts PHS subscribers will decline in 2007 when mobile tariffs further decrease, causing the user base to shrink from 91 mn in 2006 to 3 mn by 2011.

The two fixed line operators have substantially cut down investment into PHS to save capital for broadband and future 2G/3G networks.