Tuesday, February 13, 2007

China 3G Status Updated and China Mobile

Last week an unofficial source has rumoured that China Mobile Limited (0941.HK NYSE: CHL) is ready to place orders to manufacturers for TD-SCDMA infrastructure network equipment valued at RMB10.4B (US$1.33B).

TD-SCDMA is China's homegrown 3G standard that like any other 3G technologies will provide high speed Internet access, seamless video and multimedia services.

Though Mr. Wang Xudong, who heads the Ministry of Information Industry (MII) still has not confirmed the 3G licensing timeline, he has openly confirmed that there will be 3G service in China for Olympics in 2008.

This week the Chinese authority has also announced that the TS-SCDMA trial network will cover 10 cities including Beijing, Shanghai, Hong Kong and other Chinese cities which co-organize the 2008 Olympics.

It is widely speculated that China Mobile will be appointed by the government to run the home grown standard. It is a dilemma to the Chinese leaders about which operator shall bear this responsibility. On one hand the country must promote and adopt the home grown standard so as to avoid or reduce the amount of royalty to be paid to US and European technology companies as what it did for 2G, so the strongest player probably is the best candidate because it has the cash flow and market power to push the standard; on the other hand any potential damage to CHL’s business is the last thing the authority wants to see.

CHL has gone up by over 40% in past 6 months, the main storyline has been around CHL’s growth potential with new 3G services. However, once it is confirmed that CHL will run TD-SCDMA, I expect there will be short to mid term pressure to the stock as the industry is saying the TD-SCDMA standard is immature and there is a lack of production scale that will result in a lowered CHL profit margin due to higher 3G handset cost subsidy.

Taking this potential risk into account, I am still positive with CHL’s mid to long term future as I believe:

  • 3G role out is a slow process with manageable CAPEX impact
  • 2.5G voice and value-added service will continue to grow healthily

My analysis as follows:

No matter which standard is being chosen, the national launch of 3G will be a slow process because there is no commercial reason to be hurry. CHL’s GSM network is still expanding rapidly, for the last 3 months in 2006, it has signed up 50M new subscribers monthly which is equivalent to an impressive monthly grow rate of over 10%.

From the figure below (source: CHL interim report), we can see that the YoY 1H06 value-added service (VAS) revenue has grown 37.1%, and over 70% of the total VAS revenue was came from SMS and voice based value-added services (e.g. IVRS service such as dialing a number for weather forecast, etc) which are of low bandwidth or voice based applications. Of the remaining 30%, they are mainly MMS traffic and ringtone download which are still not bandwidth hungry type of applications.

From all the numbers, we can conclude that valued added service revenue still has much room to grow even without the high data rate 3G technology, and the demand for high data rate service is in fact not there yet.

To further substantiate my rationale, let’s look at CHL’s deployment history of its GPRS service (the GSM version of 2.5G data service). The service was launched in China in 2001, however, as of 2004 CHL is still buying new network equipment for different provinces. It means CHL has taken a phrase by phrase role out approach instead of a national roll out in one go. The past history when Chinese companies invested heavily and blindly on capex without solid business plans was long gone. In 1H06, CHL has invested US4.1B in its profit making GSM network expansion, which is 3 times the US1.33B TD-SCDMA trial network investment it is rumored to make. I expect the build up of 3G assets will be slow and hence it shall not impose a huge downside risk to CHL’s financial performance as its 2.5G voice and VAS services will continue to grow healthily. Major 3G investment will not happen until such bandwidth hungry killer applications are identified. (by the way, as of today 3G operators worldwide still cannot identify such applications yet!)

In Vodafone’s (VOD) announcement this week about its acquisition of 67% holding in Hutchison Essar, it mentioned that mobile penetration is China is already 40% while that in India is only 10% and how the Indian market can deliver long term growth to Vodafone. However, I would look at China (CHL) as a lower hanging fruit comparing to Indian market in which the timeframe to fully materialize the potential market opportunity into profit is still unknown.