China's Telecom Restructuring
Many observers are in two minds about the latest round of telecom restructuring in China announced last week. While there is recognition as to the benefits of more competition, the financial losses suffered by China Mobile shareholders, and the use of government fiat to carry out the restructuring, is causing plenty of raised eyebrows.
The Chinese government's approach transcends shareholders' concerns with short-term financial returns and is clearly aimed at reining in a market operator that has had too much power, for too long. For a long time, China Mobile's shareholders have benefited immensely, but at the expense of the broader market. The changes should result in more competition, better services and lower prices for the largest mobile phone market in the world.
China Mobile is a gargantuan enterprise, and as the principal mobile phone player, it has essentially had a license to print money. It dwarfs the other mobile and landline players: China Mobile's 2007 turnover was 3.6 times China Unicom's (the mobile phone provider supposedly acting as China Mobile's competitor), 4.3 times China Netcom's (the fixed-line and internet supplier in the north of the country) and 2 times that of China Telecom (which provides fixed-line and internet services to the southern part of the country.) And it's not just the top line. China Mobile is also very profitable compared to its Chinese peers, with a return-on-equity (ROE) of 25%, compared to China Unicom's 11.5%, China Netcom's 15%, and 11% for China Telecom. Nor has that impressive ROE been built on a mountain of debt. Debt-to-common-equity ratios show China Mobile on 9.5 times; China Unicom on 3.97 times; China Telecom on 47.6 times; and China Netcom on 65 times.
In other words, China Mobile has benefited enormously from its dominant position—as have its shareholders. China Mobile's share price has moved up in an almost unbroken line since its 2002 listing at HK$20 to its current level of HK$115.
So it's not too surprising that rivals and regulators are now kicking up a fuss. The fixed-line players don't have mobile phone licenses in a global environment where voice and data services have long been converging on to mobile phone platforms. The problem is especially acute in China because a new generation of young people and rural users is jumping straight to the mobile phone, and ignoring landlines completely. As a result, the growth figures of China Telecom and China Netcom make dispiriting reading for their managers and shareholders. For China Netcom, earnings per share (EPS) dropped 1.15% in 2007 and at China Telecom they are down 15%. In contrast, the mobile phone players are doing much better. China Mobile's EPS was up 31% last year, while China Unicom's EPS went up 136%—even though China Unicom has been held back by running two different mobile phone standards.
So, now it appears that the government has clipped China Mobile's wings. Analysts' views about the action are somewhat mixed, however. JPMorgan has forecast a negative effect on China Mobile's share price caused by the 'asymmetrical regulations'. This term is borrowed from the Korean market, where the government has carried out similar anti-monopoly policies and refers to the powerful incumbent being forced to slow growth—through caps on market share, for example.
But surprisingly, very few analysts have put a 'sell' on China Mobile. A quick look (as of May 30) at 28 leading Hong Kong analysts' recommendations posted on Bloomberg shows just one having a sell call: Helen Zhu of Goldman Sachs. That could mean the government will have to do more. Zhu puts a HK$105 discounted cash flow-based 12-month price target on the stock. The price prior to the news was HK$125, and the share price touched HK$160 late last year, despite the credit crunch.
Clearly, the effort to level the playing field by the three regulators—the Ministry of Industries and Information (MII), the National Development and Reform Commission (NDRC) and the Ministry of Finance—are laudable.
But how is one supposed to respond to the news of the management reshuffle? Not for the first time, the government is sending top officials from one firm off to another. In this case, China Unicom is sending two top officials to China Telecom. This may make sense, since China Telecom will be acquiring the CDMA mobile phone assets of China Unicom (just as China Netcom and China Unicom will jointly run Unicom's GSM network). Thus, the managers can help with integration. Zhang Chunjiang of China Netcom is going over to China Mobile, possibly to help with the integration of China Tietong, a smaller fixed-line operator that the mobile giant will acquire as part of the restructuring.
Still, it's difficult to assess these moves. The regulator certainly doesn't encourage managers to identify themselves with their firms. That could be the point: the managers and their political masters see themselves as working for the good of the country—as they should, given they are civil servants. Being moved around at regular intervals to prevent the growth of strong loyalties is a practice that dates from imperial times, but it's slightly odd to see it in a 21st century economy—and is a reminder of the fusion between state and business that you frequently get in China.
China Mobile has been thrown a bone, namely unlisted China Tietong, a fixed-line operator, which it looks as if it might have picked up for free. However, it's not clear how this will be revenue enhancing for China Mobile—the fixed-line business is slowing in any case, and with China Tietong being a relative newcomer to the game, some analysts fear the unit will simply soak up capex.
There is also the issue of technology. Here again, China Mobile looks like the loser, with the government seemingly insisting that it continue its development of TD-SCDMA, China's untested, home-grown 3G technology. Its rivals will take on mature, foreign 3G technologies.
What will be the effect on shareholders of the listed Chinese carriers? The moves could be seen as related-party transactions, given they are all owned by the Chinese government. So will the moves be held up to special scrutiny?
The answer is likely 'no'. Hong Kong minority shareholder activist David Webb points out that the Hong Kong listing rules specifically exempt Chinese government-related entities from the usual laws regarding related-party transactions—despite the companies all being owned by the Chinese government. Were the transactions to be classified as related-party transactions, the outcome would be much more uncertain for the Chinese companies and authorities, since the majority shareholders would be forced to abstain from voting on the issue.
Indeed, independent shareholders look unlikely to have any say at all. Major changes ordered by the restructuring (defined as 'large acquisitions', 'very substantial acquisitions', or 'very substantial disposals' by the Hong Kong regulator), require approval by a simple majority of votes cast in an extraordinary general meeting. But the Chinese side will easily win this, since the government wisely only sells around 25% of its shares to outside investors.
In the short term at least, shareholders won't be too happy. China Mobile's shares have already tumbled. But the government's restructuring should ensure the healthy long-term growth of the market and that will create a bigger pie for everyone, as opposed to one company taking an ever larger slice.