Telecom Streetfighters

China's privatizing giants battle it out as investors worry

The introduction of competition in China's fixed-line telecommunications was supposed to be an orderly affair. After the country's state-owned monopoly carrier, China Telecom, was split in half, the two new companies were to float shares on exchanges in New York and Hong Kong. Then, with the discipline imposed by private capital, the siblings would build up the country's communications infrastructure and provide its citizens with world-class service.

Now, as China approaches the first of those initial public offerings, the optimistic script is falling apart. What was to be a bit of gentlemanly sparring is starting to look more like a streetfight, as the two offshoots--China Telecom Group in the south and China Netcom Group in the north--gear up to woo each others' customers and steal market share on the rival's home turf. "It was meant to be friendly competition," says Andrew Chetham, an analyst with researchers Gartner Inc. in Hong Kong. Instead, he says, "the gloves are off."

The fight for supremacy will heat up in early November, when 20% of China Telecom shares start trading. The company hopes to raise up to $3.7 billion in the offering. As for the rest of the shares, the state-controlled parent company will retain 69%, and three Chinese provincial investment companies will hold the rest. The listed company, called China Telecom Corp., remains a subsidiary of China Telecom Group. It has 53 million lines in Shanghai and three wealthy provinces along China's coast. China Netcom Group is expected to list shares in a similar subsidiary later but hasn't yet released any details.

When Chinese officials cooked up the privatization process, one goal was to keep the two carriers from competing too aggressively in each other's territory. "The biggest fear of the regulators is duplicate infrastructure," says Craig Watts, an analyst with Norson Telecom Consulting in Beijing. "The government has an interest in preventing [operators] from wasting taxpayer money."

But you can't have capitalism without competition--and that's what China is getting. China Telecom plans to spend roughly half its IPO gains on new infrastructure, some of it on China Netcom's turf in Beijing. And Netcom, which was an independent data communications company before the government merged it into the northern part of the old China Telecom, already has operations in the south. "We are competing with [China Telecom] by bringing things like broadband" into the south, says China Netcom Group Vice-President Edward Tian. China Telecom officials declined to comment.

The two fixed-line operators aren't the only players in the game. Under the agreement China signed when it joined the World Trade Organization, foreign carriers will be able to own up to 49% of Chinese phone companies by 2007. Any new entrants will find themselves in competition with China's two big cellular operators, China Mobile and China Unicom, which are battling fiercely for customers and are planning to get into fixed-line services as well. And the fixed-line operators are eager to offer mobile services of their own, so large cities may soon have as many as four competing cellular operators.

Already, consumers are starting to see prices drop. The upfront cost of getting a line has fallen from $120 last year to less than $30 today, and rates for domestic long-distance calls have dropped by two thirds since early 2001. Four companies now offer voice calls over the Internet--a technology that is far cheaper than traditional phone networks--which also has brought down prices.

All this competition has investors wondering whether the China Telecom IPO is worth gambling on. Revenues from fixed-line operations throughout China actually shrank 8.3% last year, to $18 billion, even though the Chinese economy grew more than 7%. China Telecom's own earnings plunged 64% last year, to $831 million, as sales fell 2%, to $8.3 billion. This year, earnings are expected to grow 10%, to $915 million, on sales of $9 billion, says Edward Fung, an analyst with Kim Eng Ong Asia Securities. But the stock "is not very attractive," Fung says. "It's an expensive utility." It may get a lot less expensive as China's telecom rumble heats up.

By Bruce Einhorn in Hong Kong, with Dexter Roberts in Beijing

— With assistance by Dexter Roberts

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