China Telcos Lower Costs, Set Stage For Rally?

Includes: CHA, CHL, CHU
by: Doug Young

A rally for shares of China's 3 major telcos early this week is raising the interesting question of whether an extended uptick is coming for these 3 companies, which are facing several developments that could help to lower costs and boost revenues, raising their profits. Media are citing the newest of those developments, the formation of an infrastructure joint venture between the trio, as the main driver for the Monday rally in shares of China Mobile (HKEx: 941; NYSE: CHL), China Unicom (HKEx: 762; NYSE: CHU) and China Telecom (HKEx: 728; NYSE: CHA). But the bigger story is a number of major factors at play, all of which could help these 3 stodgy state-run firms boost their profits.

Let's begin with a look at the Monday rally for the companies' New York traded American Depositary Shares (ADSs), which all jumped by 3 percent or more. Unicom rose the most, rallying 5.1 percent to its highest level since October. (English article) China Mobile and China Telecom also rose strongly, gaining 3 percent and 3.7 percent respectively. Hong Kong-listed shares of China Mobile continued their rally in early Tuesday trade, though China Telecom and Unicom shares were largely unchanged.

The most likely cause for the Monday rally was simultaneous announcements by all 3 telcos late last week that they would form an infrastructure joint venture. (English article) The deal had been rumored for the last couple of months, and would see the trio pool their base stations into a single company that would lease space back to the 3 carriers. (previous post)

The new joint venture, China Communications Facilities Services Corp, would own the actual towers where mobile carriers mount their antennas, and would have registered capital of 10 billion yuan ($1.6 billion). Such base station operators are already common in the west, as they greatly reduce costs by allowing multiple carriers to put their antennas in a single location. In the past when carriers owned their own base stations, each would have to find their own locations - a far more costly process forcing everyone to find and develop their own sites.

The formation of this joint venture should not only help all 3 companies to reduce their costs, but will also help them improve their coverage by giving them access to a wider range of sites. Frankly speaking, I'm surprised this didn't happen sooner since it has been common in the west for years, where the move was market-driven. But of course nothing in China's telecoms space is market driven, and it probably took the regulator's intervention to force this deal to happen.

Government intervention is also taking place elsewhere in the space, following separate reports last month that the 3 telcos have been ordered by the government to sharply curtail their promotional spending. (previous post) That move was aimed at forcing the companies to simultaneously rein in aggressive promotions that have become a regular feature in the China telecoms landscape. Such promotions were becoming increasingly destructive, since most of China's 1.3 billion people already subscribe to mobile service. Thus the telcos have become focused on using aggressive tactics to steal customers from each other rather than signing up new subscribers.

All of the government's behind-the-scenes moves come as China rolls out 4G mobile services, with China Mobile already offering service and Unicom and China Telecom expected to launch service soon. That drive will prompt massive spending on new infrastructure, but will also bring in big new revenue from Chinese mobile users who are fond of web surfing, video streaming and using other data-intensive features on their phones. All of those signs look good for the telcos bigger profit picture in the year ahead, potentially setting the stage for a longer-term rally for their shares.

Bottom line: A new infrastructure joint venture and reduced promotional spending, combined with the roll-out of 4G, could set the stage for strong profit growth for China's 3 telcos in the next 2 years.

Disclosure: None.