TELECOMS: Shriveling Spending Hints at Telco Merger

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Bottom line: New signals that China’s 3 telcos are reducing their spending could presage a rumored consolidation of the trio into 2, with China Telecom and Unicom the most likely to be merged.

China telcos rope in spending

The latest sign of a potential shake-up in China’s stodgy telecoms sector came late last week, when global networking equipment giant Ericsson (Nasdaq: ERIC) attributed reorganization and weak spending by the nation’s big 3 carriers as a major factor behind its disappointing quarterly results. Despite expectation that China’s big 3 carriers would spend heavily on 4G this year, actual amounts so far have been relatively modest from the trio of China Mobile (HKEx: 941; NYSE: CHL), China Unicom (HKEx: 762; NYSE: CHU) and China Telecom (HKEx: 728; NYSE: CHA).

The unexpected spending slowdown could be the latest sign that Beijing is planning an industry overhaul, following reports that first emerged last month of a possible consolidation of the 3 current mobile carriers into just 2. Such a move would reflect Beijing’s disappointment at the failure of China’s state-run carriers to become global innovators over the last decade, even after receiving monopoly rights over a market that has become the world’s largest for mobile and broadband services.

The telecoms regulator should move quickly ahead with such a consolidation plan if it is really under consideration, and could even consider such a plan if it hasn’t yet. Doing so would send a strong signal that the big state-run carriers could ultimately be demoted to simple network owners and operators. That would pave the way for a vibrant field of more entrepreneurial and innovative private companies to offer services, under a series of reforms now in the pilot program stages.

China has become the world’s largest telecoms services market over the last decade, in a remarkable transformation that has brought mobile service to most of the country’s 1.3 billion people. And yet despite the huge market, the big 3 carriers have failed to develop many blockbuster products to offer over their networks. Instead, the biggest successes have mostly come from private companies like Tencent (HKEx: 700) and Momo (Nasdaq: MOMO).

The carriers’ lackluster record was continuing unabated when the telecoms regulator, the Ministry of Industry and Information Technology (MIIT), engineered a change in August that saw the top executives for China Telecom and Unicom change places. That shuffle was followed a month later by an analyst’s forecast that the rotation might be paving the way for a merger of the smaller of China’s 3 carriers into a single company, reducing the number of national operators to 2.

Signals from Ericsson last week seemed to provide more evidence that change might be coming. The world’s largest telecoms equipment supplier reported third-quarter results that fell short of market forecasts, saying reorganizations at the Chinese carriers had hurt its performance. (English article) That came after China’s telecoms equipment spending fell 20 percent in this year’s second quarter, even though many had predicted the number would rise due to big spending on 4G networks.

Lackluster Spending

Data from the 3 carriers paints a more detailed picture of the spending slowdown. China Mobile previously said it had budgeted 200 billion yuan ($31 billion) for capital expenditures in 2015, but only spent 69.7 billion yuan in the first half. Meantime, combined capital spending by Unicom and China Telecom totaled a relatively modest 64 billion yuan in the first half of the year. That amount was up 43 percent from 2014, but many had expected the pair to boost their spending by much more after receiving long-awaited licenses to offer commercial 4G services early this year.

All those signals seem to point to a major spending slowdown that is probably being engineered by the MIIT. Such a move could be aimed at a future consolidation of the country’s network infrastructure, which is already quite vast, and focusing instead on building up innovative products and services to run on those networks.

The MIIT has already shown signs of letting private companies like JD.com (Nasdaq: JD) and Alibaba (NYSE: BABA) play a bigger role in the sector with its nearly 2-year-old virtual network operator (VNO) pilot program, which lets private companies sell wireless service under their own brands by leasing capacity from the big carriers. More recently regulators have also shown signs of giving more freedom to private companies to build their own network infrastructure, and to offer video services over the desktop and mobile Internet.

Such moves show Beijing finally realizes China will need to give a much bigger role to the private sector if it ever hopes to become a global leader in telecoms products and services. A merger of China Telecom and Unicom would be another important step in that direction by reducing reliance on the big state-run companies to provide innovative consumer services. Instead, these big companies could be relegated to the simpler and relatively straightforward business of simply owning and operating big telecoms networks.

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