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6 November 2019

China’s MNOs are deploying 5G at vast scale, but will it be profitable?

Talk of a ‘5G race’ between the USA and China has been noisy this year, and reached right to the heads of state of both countries, as one strand in their ongoing battles over trade, security and world leadership. The USA certainly ‘won’ in terms of timing, with Verizon and AT&T turning on 5G last year, despite the disadvantage of a lack of midband spectrum. That forced them to deploy first in millimeter wave spectrum (initially for fixed wireless), a choice that will force them to see their Chinese counterparts overtake comfortably in terms of scale.

Five months ago, the Chinese MNOs – China Mobile, China Unicom and China Telecom, plus new entrant China Broadcasting Network – were allocated licences in the 3.5 GHz band – the spectrum of choice for initial 5G roll-outs in most countries outside North America. This highlighted their key advantages over US operators in terms of having the basis of a strong 5G model – they did not have to spend huge sums in auctions, and they have received optimal mid-band spectrum to support high capacity augmentation of their LTE networks (which are widespread and modern, with a strong element of virtualization already supported, to ease migration to 5G).

The scale of the Chinese deployment is staggering. 5G services are already available in parts of 50 cities, including Beijing, Shanghai, Guangzhou and Shenzhen, according to the state-run news agency Xinhua. As in South Korea, where all three MNOs also launched 5G services on the same day, earlier this year, there is a high level of cooperation with the government and regulator, and with the vendor community, to drive 5G to large scale very quickly.

The three MNOs have, between them, deployed almost 86,000 5G base stations and expect to have more than 130,000 live before the end of this year. The regulator said there were 12,000 base stations live in Shanghai alone. These huge numbers are despite the fact that the operators expect to reduce cost and time to market with significant amounts of network sharing. In September, Unicom and Telecom announced a deal to build and manage a shared 5G RAN, though they will deploy their own cores.

They plan to build out 40,000 5G base stations between them by the end of the year, while Mobile expects to install about 50,000.

These huge networks may appear to have sprung up overnight, but of course, the preparation has been going on for years. The telcos work extremely closely with their vendors to develop highly customized platforms that are designed to be easily deployable and very flexible. China Mobile, for instance, has not been waiting for international standards to introduce a high degree of virtualization to its networks.

A year ago, China was estimated, by consultants at Deloitte, to have already spent $24bn more on 5G-ready infrastructure than the USA, and to have prepared 350,000 cell sites to support 5G equipment in future, compared to 30,000 in the USA.

“The United States, Japan and South Korea have all made significant strides toward 5G readiness, but none to the same extent as China. Infrastructure spend and tower density distinguish China’s leap forward and highlight the degree to which China outpaces the United States during these early stages of 5G deployment,” Deloitte wrote, remarking that the USA, in 2018, averaged 4.7 5G-ready cell sites per 10,000 people, compared to 14.1 in China. In total, China has 1.9m mobile sites, almost 10 times the USA’s 200,000 (China has four times the population and a similar land mass). For every 10 square miles, there are 0.4 sites in the US, but 5.3 in China.

And China has proven more innovative in thinking of new approaches to network funding and ownership, to support the huge scale of its 5G ambitions. The three operators have placed most of their cell sites into a joint venture, China Towers, the world’s largest towerco; and as well as the active sharing deal between Unicom and Telecom, there is an interesting approach to financing at Unicom – large web and industrial companies have taken stakes in the operator, in return for influence, and anchor tenant status in some environments, on the 5G networks they will help to fund.

A 2017 report from the GSMA concluded that China would account for 39% of the world’s 5G connections by 2025. It has pulled that estimate back just slightly – to 36%, though that would still be 600m people, or about 40% of the entire 5G global base. A new report from analysts at Jefferies predicts that 7% of Chinese citizens – 110m people – will be using 5G by 2020.

But despite this vast scale, the Chinese operators will struggle to turn millions of cell sites into improved profits. They learned that lesson when they switched on similarly ambitious national 4G networks, but failed to charge a premium for the new services, and were challenged in turning a decent return on their huge deployment costs. They certainly have more help than MNOs in free market economies, ranging from free spectrum to regulations that ease access to sites such as city infrastructure. But they do have to turn a profitable business for shareholders and invest huge sums in building these enormous networks.

In the most recent quarter, all three MNOs delivered weak results for the first nine months of 2019, so it will be imperative that they start to show some 5G-driven improvements in the first months of their new services.

According to government figures, mobile services revenue for all three operators fell by 3.9% year-on-year in the first three quarters of the year, to CNY677bn ($95.8bn). This was offset somewhat by 9% growth in home broadband revenues, which reached CNY315bn ($44.6bn), thanks to the addition of 43m new subscribers.

But China Mobile reported a slight fall in operating revenue on the same period in 2018, to CNY567bn ($80.3bn), while mobile ARPU declined to CNY50.2 ($7.10) from CNY52.2 ($7.40). While the recent axing of domestic data roaming fees was a contributor, Mobile acknowledged there were more deep-seated issues, related to rising traffic combined with flat revenue (average monthly data consumption has grown by 116% over the past year).

Its net profit margin was 14.4% – down from 16.7% a year ago, but better than its two smaller rivals’ figures. Unicom increased its net profit by 12% in the nine-month period, but its margin is still only 4.5%. It suffered from a 6% year-on-year fall in mobile revenue and a drop in operating income, down 1.2% to CNY217.12bn ($30.7bn).

Like operators in Korea (see separate item) and elsewhere, it is looking to enterprise and IoT services to start to reverse the decline. Unicom, helped by its enterprise investors, has achieved a 41% growth in revenues from its industrial IoT business. This was a fledgling unit a year ago, but now accounts for CNY24.3bn ($3.4bn) in sales, 12% of total revenues.

Meanwhile, China Telecom’s revenue for the first nine months fell by 0.8% to CNY282.8bn ($40bn), and though EBITDA was up by 13.8%, net profit fell by 3.4% to CNY18.4bn ($2.6bn).

In the short term, the 5G launch does not look set to help boost performance. All three operators launched services priced around the same – starting at CNY128 ($18.13) for

30GB of data, and going up to about CNY599 for 300GB.  The new 5G plans are now cheaper than 4G on a per-GB basis for the lower-priced tariffs – a similar strategy to that adopted in South Korea, but certainly not commanding a 5G premium. Edison Lee, an analyst at Jefferies, wrote in a client note: “That may encourage 4G subscribers who have an ARPU of over 120 yuan to migrate to 5G.”

New Street Research analysts told clients that China Mobile was offering 5G at a 30% discount to 4G. “A 30GB 4G customer who migrated to 5G on the same plan would see their bill reduced from CNY188 to CNY128. Even a 12GB 4G customer migrating to the 30GB 5G plan would save money,” the analysts wrote.

The pricing strategy contrasts with that of the US operators, which are mainly offering 5G via their most expensive unlimited tariffs.

The MNOs are also offering introductory discounts of up to CNY600 ($85) on 5G packages, aiming to keep customers loyal ahead of the introduction of mobile number portability. This will be the latest challenge to the operators’ finances.

China has been trying to get the porting technology and process right since 2010, when MNP was first proposed, and provincial trials were completed last month. This saw more than 2.3m users switching to a different provider, with China Telecom the biggest winner (gaining 506,000 subscribers), and China Mobile the biggest loser, with a loss of 535,000. In the first half of the year, MNP helped drive monthly subscriber growth for China Telecom and China Unicom of more than 20%, but that figure is now down to just 4% as subscriber preferences stabilize.

China Unicom has launched several offers to tempt defectors, from RMB199 ($28) a month for 40GB and 1,000 voice minutes, to RMB39 for a deal that is zero-rated for services from Tencent, a Unicom shareholder and owner of social media site WeChat. This is just one example of how that novel co-investment scheme will work – several industrial and web giants have taken stakes in Unicom to improve its ability to deploy 5G competitively, and in return they get an influence over how it deploys its network and its services.

China Mobile, the market leader and most vulnerable to defection, has hit back with offers of free data for loyal users, who get more, the longer they have been subscribers to Mobile. After one week, 100m had signed up for the promotion, China Mobile said.

The new entrant, China Broadband Network, is unlikely to start offering services until the second half of next year.