Negative For Chinese Mobile Content: 3G Launch Could Be Further Delayed

WR Hambrecht analysts James Lee and Xiaofan Zhang recently sent a note to clients in which they outline the risk of downward pressure on shares of Chinese mobile content aggregators TOM Online (TOMO), KongZhong Corp. (KONG), Linktone Ltd. (LTON), and Hurray! Holding Co. (HRAY) resulting from a delay in the issuance of 3G licenses. Their note follows:

Investment Conclusion: We believe the Chinese content aggregators could be under further pressure, as the issuance of 3G licenses will likely be delayed. The Chinese press recently reported that the 3G commercial launch may be pushed back to Q1:08. Our channel checks suggest that this scenario is likely given the politics, so the government can buy time to make a decision on the carrier-landscape, while letting TD-SCDMA technology improve without the pressure of a full-blown commercial deployment. Our sources indicated that the Chinese government will meet around the end of January to decide whether or not to delay the issuance of 3G licenses. If our assessment is correct, the mobile content aggregators TOM Online (TOMO), KongZhong Corp. (KONG), Linktone Ltd. (LTON), and Hurray! Holding Co. (HRAY) could trade down further, in our view.

Key points

• Press Reports Indicating Further Delay. The Chinese press recently reported that the issuance of 3G licenses could be delayed until Q1:08. The Beijing News cited that China Mobile will be the main carrier conducting the second round of TD-SCDMA trials starting in March 2007, which could last up to a year.

• Checks Showing Some Merit to Speculation. We checked with our channels and believe the speculation has some merit. Our sources told us that there are two possible scenarios: (1) the MII will issue 3G licenses in Q1:07 and enable commercial deployment in the near- term, or (2) the 3G trial will continue in the five Olympic cities, and China Mobile (CHL) will be the only carrier to operate the new network. With the latter scenario, the government will likely refer to the new testing period as a “soft launch” for 3G. If true, licenses for TD-SCDMA will not be issued until 2008, while the visibility for other 3G standards such as WCDMA [GSM] and CDMA2000 remains low.

• We Believe Delay Likely Due to Politics, Not Technology. We believe the second scenario is more likely to occur since the Chinese government needs to make a decision on the carrier landscape in a 3G environment. Many had speculated that the number of carriers will increase to four, with China Telecom and Netcom joining the incumbent operators China Mobile and China Unicom. However, we believe this is a complex political decision where carriers are lobbying for their own respective interest. Senior management members of the carriers are considered highly ranked government officials and therefore it is a very delicate issue for the Chinese government. With that in mind, we believe the government will likely go with the latter scenario, buying time to make a final call, while letting the home-grown technology improve without the pressure of a full-blown commercial deployment.

• Catalyst Around End of January. Our sources indicated that the Chinese government will meet around the end of January to decide whether or not to delay the issuance of 3G licenses. If our assessment is correct, the mobile content aggregators could trade down further. The group has been trading down 3-5% since the news reported, as it appears the foundation has already been shaken.

• Diminishing Bull Case. Many view that 3G is a catalyst for mobile content aggregators in China as the technology standard will enable new applications while adding new carriers that will offer mobile content. With the issuance of licenses possibly being delayed by a year, we believe this catalyst could be diminished in the near-term. As a reminder, we are neutral on 3G as we believe the new standard provides greater bandwidth, but will unlikely change the commoditized applications offered by the aggregators (i.e. ring tones, games, wall paper).

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