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Chinese telco merger would create massive 5G economies of scale

Telcos and governments round the world are taking a long hard look at the economics of the impending 5G roll-outs, and in many cases, looking for ways to soften the capex blow and so accelerate availability of new services. There are two main schools of thinking – open the market up to share the cost burden with new entrants or new telco partners; or lower the barriers to consolidation, so that the existing MNOs can maximize their economies of scale and not face what Korea has called “excessive competition” in 5G.

There are contrasting approaches. The European Union and its member governments are generally slow to push either approach, keeping the barriers both to new entrants, and to telco M&A, high. By contrast, China is harnessing all the advantages of being a planned economy to support both routes to accelerated 5G. The investment of several large industrial players in China Unicom a year ago – taking stakes to revive the ailing operator, in return for an influence over the shape of its 5G platforms – is the most ambitious example in this industry of co-investment to share risk and reward.

At the time, that investment strategy for Unicom was seen as an alternative to the often-mooted plan of merging it with China Telecom, to create a stronger counterweight to China Mobile and to enable better economies of scale ahead of 5G. But now, Bloomberg reports that the plan to merge the two smaller operators is back on the table. If successful, the merger would create the world’s largest telco by subscriber numbers, with 584m customers, which would reduce consumer choice in China, but almost certainly speed up 5G roll-out as two giants battled it out for the world’s biggest market. That, in turn, could bring forward the date of 2025, predicted last year by the GSMA, when China would account for 39% of the world’s 5G connections.

According to a recent report from Deloitte, ‘5G: The chance to lead for a decade‘, China has already invested $24bn more than the USA in 5G-ready infrastructure, so while large-scale commercial 5G services are not expected in China for about a year after the first (mainly fixed wireless) roll-outs in the USA, Chinese operators are in a position to leapfrog quickly.

According to another study, by Analysys Mason, China is the top country for 5G readiness because of its proactive government policies and industry momentum. And yet another analyst, Bing Duan of Nomura Asset Management, believes China will invest RMB1.4 trillion ($200bn) on 5G over the next 5-7 years, 70% more than it spend on 4G.

A merger of Unicom and Telecom could enhance China’s readiness considerably, and reduce those projected spending sums, creating vast economies of scale and deployment efficiencies, on top of those already targeted by the consolidation of many of the towers of all three MNOs, within the China Tower joint venture. (China Tower’s own shares fell, because of the reduced number of operators which would pay for space on its masts.)

“5G success is one of the most important goals to China and the merger is the perfect solution to what China wants to achieve,” Edison Lee, an analyst at Jefferies Hong Kong, told Bloomberg. “As we head into another step up in the US-China trade war, we believe the State Council would be more eager to think fresh and more radically about how to accelerate 5G roll-out.”

However, while the deepening tensions between the two countries are very focused on hi-tech, including 5G – and generate the most headlines – the thinking behind a telco merger will go far deeper than that. National pride in China has often driven big visions, but actual operator roll-outs are grounded in commercial realities. A more cost-efficient way to expand infrastructure and active networks rapidly will improve the business case for the smaller MNOs, which will otherwise struggle to fund the effort to keep up with China Mobile – especially Telecom, which though it was financially more stable than Unicom, lacks the latter’s deep-pocketed investors.

Unicom and Telecom already have an infrastructure sharing alliance, announced in 2016, which enabled them to reduce capex by about RMB3bn ($451m) between them last year by sharing the build of 4G and optical networks. They have been collaborating on deploying 60,000 LTE base stations and 14,500 kilometers of optical fiber. And both companies, as well as China Mobile, lease towers from China Tower. All three MNOs placed many of their towers in this venture at the end of 2016, and a year later, China Mobile was leasing 1m towers, 30% of its total, from China Tower; while China Telecom was leasing 550,000, or 55% of its total.

While the two smaller operators, and the national 5G program, would benefit from consolidation, there would be losers too. Recently listed China Tower, other providers of infrastructure and backhaul, and the two MNOs’ suppliers, would all face a reduced addressable market. The local equipment vendors, led by Huawei and ZTE, would be particularly hit by efforts to consolidate Unicom’s and Telecom’s network deployments, at a time when they are facing bans or restrictions in selling to major foreign markets such as the USA and Australia.

On the surface, China Mobile would suffer too, from facing a larger and better equipped rival. However, the government has been applying policies which actively favor Unicom and Telecom in recent years, and so Mobile could benefit from the removal of those policies. In particular, it would welcome a level playing field – or even some favors – in the 5G spectrum allocations, which will initially be in the 3.5 GHz band.

The supporters of the innovative rescue plan for Unicom – which involved investments from Internet giants Tencent, Baidu, JD.com and Alibaba, and from other industrial players – may see the value of their stakes bounce back if merger reports are confirmed. The stock of China United, Unicom’s parent company, has fallen by 19% since the new financing was announced, but it leapt by almost 5% on the talk of a merger. It is not clear how the future ownership would be structured, though in terms of pushing creative approaches to 5G investment, it would be good to see the industrial firms’ involvement preserved.

Under the plan, a 35% stake in Unicom was sold to a group of 14 strategic investors (its own employees were also able to buy shares). They participated in an RMB78bn ($11.7bn) share sale, purchasing 10.9bn shares, or 35%, in the operator, at a price of RMB6.80 per share.

This was part of a broader government plan of injecting new growth and innovation into state companies through outside investment and private capita; and the biggest recent deal under Beijing’s ‘mixed ownership’ reforms, which mark a significant departure from the Communist managed economy of the past, but stop short of full private ownership and accountability.

In a statement, Unicom said the funds from its new investors will be used to upgrade 4G capabilities, develop 5G technologies and trials, and “develop innovative businesses” to enhance its “core competiveness … and speed up its strategic transformation”.

It said the investors, which also include industrial groups like Didi Chuxing and Suning Commerce Group, have very complementary businesses to Unicom’s own, and “strong fundamentals”.

It is right to say this. If the new ownership structure is well managed, Unicom could benefit not just from its backers’ money, but their understanding of the web and industrial worlds. That could help accelerate the process of getting new applications and user experiences out to Chinese consumers, giving Unicom the differentiation to make economic sense of its network expansion programs and reverse some of its capex cuts.

More importantly, it could help it make a reality of the idea that 5G networks must support a wide range of vertical market, industrial and IoT services, in order to deliver ROI. That is a nice idea, but in many markets, industries like transport, manufacturing and energy complain that the MNOs do not understand their requirements, or do not build networks which are optimal for enterprise use. In future, network slicing should help provide optimal network connectivity for each sector, but in the near term, it is important that MNOs forge close, cooperative links with industry partners.

That could lead to a situation where there is shared investment in 5G networks. Rather than shouldering the entire burden of each new upgrade, the MNO could be the anchor partner. By investing themselves, industry partners would have a better ability to drive the way networks are planned and ensure their needs are met. Then all players could monetize the network in their particular sectors, whether for external services like MNOs, in-sector B2B services (as GE is doing for other manufacturers with its cloud platform), or purely for internal efficiencies.

Unicom could use its new structure to do just that, and start to win back ground lost to its rivals. It said key areas of cooperation will include big data analytics; payment and internet finance; IoT; content aggregation; and cloud computing. It has already been establishing ecommerce operating centers with Tencent and Alibaba, independently of the change of ownership.

These Internet players have increasingly been extending their search, advertising, ecommerce and social media services to mobile platforms and seeking to drive the mobile experience in the same way that Google does in the west. Baidu and Alibaba have even experimented with their own devices and mobile operating systems, but having a close relationship with a carrier can help them to increase their collective influence over smartphone platforms and services.

Consolidation is also all the rage in India, set to overtake the USA as the world’s second largest mobile market in the next few years. The entry of disruptive force Reliance Jio – on top of a long history of ultra-low ARPUs, excessive competition and limited or expensive spectrum allocations – has driven several operators to merge or exit the market.

The biggest of these transactions – between Vodafone India and Idea Cellular – has now been approved and creates a new market leader in India. Now called Vodafone Idea, the company overtakes Bharti Airtel and has 408m subscribers and combined revenues of around $8.26bn. It expects to make about $1.2bn in cost savings and capex reductions in the first year alone.

Balesh Sharma will be the CEO of the new entity, moving up from his previous role as COO of Vodafone India. Vodafone Group will own 45.2% of the company, with Aditya Birla Group owning 26%.

As of the end of June, Vodafone and Idea Cellular had almost the same market shares –  19.4% and 19.2% respectively, and now have almost 39% of active mobile connections and 32% share of revenues, plus the largest spectrum portfolio of any player, at 1850 MHz. Bharti Airtel’s share is almost 30% and Reliance Jio’s is almost 19% after less than two years of commercial services. The merged company will continue to use both brands.

“India telecoms has witnessed a whirlwind past 2-3 years,” Prashant Singhal, leader of EY’s TMT emerging markets practice, told LightReading. But with three large operators now commanding about 87% of the market (with state-owned BSNL having a further 10%), “stability is likely to set in within 6-12 months”.

The Indian government has not, unlike its counterpart in China, persisted with plans to force a merger between the two state-owned operators, BSNL and MTNL. This has often been suggested in the past, as a way to strengthen the finances and scale of both ailing firms and make them credible alternatives to the major private carriers. With BSNL on 10% share and MTNL (which only operates in Delhi and Mumbai) on less than 2%, the time may have passed to build these two companies into a significant force in the market.

The deliberations, in these countries and elsewhere, do highlight the broader issue of whether consolidation is essential to the 5G case. Rather than focusing on maintaining competition among network deployers, the argument goes, regulators should ensure there is plenty of consumer choice supported by an open ecosystem of MVNOs and other service providers. But these should be supported by increasingly few physical networks, giving their deployers the scale to afford to invest in high capacity and quality, in short timescales.

It seems China will take this view, and South Korea, another 5G frontrunner, already has. While the GSMA has been criticizing the European Union for its hostility to MNO consolidation, in South Korea, the three mobile operators are to conduct a joint 5G launch to “avoid excessive competition”. This will be based on a significant degree of infrastructure sharing, as mandated earlier this year by the government.

They will cooperate to launch their 5G service simultaneously next year, and so ensure that their country is ahead of the game in commercial 5G services. SK Telecom, KT and LG Uplus will all introduce the services on ‘Korea 5G Day’, which will be in March, according to local reports. In the wake of 5G demonstrations at the recent Winter Olympics in South Korea, the MNOs plan to launch commercial services for enterprise customers in March 2019, followed by consumer services in the second quarter of the same year. The network will initially be built in Seoul and then expanded to the rest of the country.

The government said it aimed to avoid the MNOs – SK Telecom, KT and LG UPlus – and SK Broadband making making redundant investments. Details of how the investment will be split between the four operators, and any government contribution, are yet to be revealed.

Yoo Young-min, minister of science and ICT, told reporters: “It is important for mobile carriers to avoid heated competition for the title of world’s first 5G service provider.”
He added that operators will also cooperate with small and medium-sized companies in the country to develop relevant 5G use cases for businesses.

In January Yoo asked the MNOs to collaborate on 5G technology to make sure they hit the agreed timeline for launch; and in April, the ministry mandated that the operators – plus one ISP, SK Broadband – should share fiber and other infrastructure to reduce cost and time to market.

This will save them about $938m over a decade, according to local reports, as well as accelerating investment and lowering barriers for the ISP (and, potentially, other operators or partners in future) to offer mobile and multiplay services.

State intervention to manipulate competition and force sharing would be anathema to the EU’s pro-competition stance, but – given the advanced state of South Korea’s mobile services and networks – this approach should not be dismissed too easily. In Europe and other mature mobile markets, MNOs are certainly facing “excessive competition” as price wars rage in saturated countries where consumers will undoubtedly demand 5G services, when those emerge, for the same price as 4G.

This does not encourage MNOs to invest, and consumer mobile broadband is becoming a game of scale, in which operators will increasingly need to reduce the cost of delivering data by sharing active equipment and spectrum, not just passive infrastructure like towers, and possibly relying on third party, neutral host networks too. There should be growth in enterprise and IoT markets, but the business cases are not well-defined yet, as many European telco CEOs have pointed out. And all this would inevitably drive operators towards consolidation, as seen in India.

Ironically, what might be logical in a completely unfettered market is often blocked in the supposedly free western economies, while being encouraged in the state-controlled South Korean industry. Spectrum and active equipment sharing is often frowned on by regulators on the grounds of reducing competition. So are mergers which would reduce the number of providers, even in overcrowded markets where there are new competitors emerging from the MVNO and wireline sectors.

However, attempts by governments to force shared infrastructure have often collapsed amid political differences and arguments over the sharing of investment and revenues – Russia, Kenya and South Africa are among the casualties, although the Mexican national 4G network appears, so far, to be working effectively.

Vodafone merges with smaller rival in Australia:

Australia didn’t have four mobile operators for very long – VHA (Vodafone Hutchison Australia), itself the product of a joint venture consolidation, is to merge with local broadband provider TPG Telecom to create a converged telco. This follows a pattern set by Vodafone in many parts of the developed world, buying or partnering with wireline companies to move beyond its mobile-only roots and offer fixed/mobile and full quad play services.

TPG had recently acquired spectrum and was poised to be a potentially disruptive fourth MNO, a danger which VHA has now averted. This will be a relief to its larger rivals, Telstra and Optus, on the mobile front, but of course, it also creates a stronger competitor for their converged services.

“This transaction accelerates Vodafone’s converged communications strategy in Australia and is consistent with our proactive approach to enhance the value of our portfolio of businesses. The combined listed company will be a more capable challenger to Telstra and Optus and will be much better placed to invest in next generation mobile and fixed line services to benefit Australian consumers and businesses,” said Nick Read, CEO-designate of the merged entity.

The two companies also recently signed a joint venture agreement to buy 5G-targeted spectrum in the 3.6 GHz band. The regulator will auction 125 MHz of this spectrum in November. The partners said that spectrum JV will not terminate if the merger fails to proceed – it needs shareholder and regulatory approval. If those are forthcoming, it should complete next year.

Nokia warns that anti-China tariffs could hurt US 5G progress:

In a filing with the FCC, Nokia has warned that President Trump’s plans to impose new  tariffs on a wide range of Chinese components could hamper deployment of 5G networks in the USA.

Although the bar on Huawei or ZTE selling network equipment to large operators greatly improves Nokia’s chances of success in the US 5G market, the Finnish company is concerned about access to Chinese chips and other components.

“Of particular concern to Nokia are the recent tariffs imposed on trade with China, which specifically target a wide range of components that are critical to 5G,” said its filing. “Unless exemptions are provided for these products, these latest duties threaten to raise the cost of 5G infrastructure in the US by hundreds of millions of dollars. This is an important context that further emphasizes the need for the Commission to lower barriers to deployment where it can.”

Two of Nokia’s top regulatory executives, Brian Hendricks and Jeffrey Marks, voiced the warning in meetings with FCC commissioners Michael O’Rielly and Jessica Rosenworcel.

The vendor, the second largest in the US mobile network space after Ericsson, accepted that the “emerging headwinds … are mostly external to Commission jurisdiction”, but insisted that they “nevertheless threaten to impede 5G roll-out. These headwinds make the Commission’s policy choices in the areas in which it has authority (such as siting reform and spectrum) take on even greater significance.”

Such comments will go down badly with the current administration, which has placed 5G leadership at the heart of the battle with China over trade policies and security.

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