Fitch Ratings cautions that China’s forthcoming licensing for 4G technology will result in inefficient capex. That’s because some telecoms operators will be tasked to roll out two parallel 4G networks. Also, high handset subsidies will likely persist and competitive pressures are likely to increase over the medium term.

However, the 4G capex cycle will represent an opportunity for equipment vendors to repair their credit profile.

In this Q&A, Kelvin Ho, Fitch’s telecoms-media-technology (TMT) sector analyst based in Hong Kong, explains the key features of China’s forthcoming 4G licensing, and its likely impact on Chinese telecoms operators and equipment vendors’ credit profiles. In a previous commentary “China telcos may face higher regulatory risks” published on 15 January 2013, Kelvin explained China’s telecoms industry may face growing regulatory risks, including an accelerated 4G licensing timetable.

Q1. Fitch has been expecting China’s 4G licensing to take place in late 2013 or early 2014. Is there any update on the timetable?

Although the 4G licensing timetable has yet to be announced, Fitch believes that it is highly likely that China will grant time-division long-term evolution (TD-LTE) licences to the three Chinese large telecoms operators by the end of 2013. On 8 August 2013, China’s State Council issued guidelines to fast-track information technology-related consumption, including targeting 4G in 2013 and the promotion of TD-LTE technology. In addition, Chinese telecoms operators have announced that they have allocated additional capex budgets for possible 4G network construction.

Q2: What is Fitch’s expectation on the technology side of 4G licensing and how might it differ from 3G?

In the case of China’s 3G licensing in 2009, China Mobile Limited (CML, A+/Stable) was put in a significant technology disadvantage position relative to its rivals since CML was tasked to roll out the home-grown 3G technology, which was less mature and less competitive.

For 4G licensing we think that all the three operators – CML, China Telecom Corporation Limited (CTCL, A/Stable) and China Unicom (Hong Kong) Limited (CUHKL) – will be granted 4G licenses based on China’s home-grown TD-LTE technology first. We believe that there will be a delay of twelve months or less in licensing the global frequency duplexing long-term evolution (FDD LTE) technology to CTCL and CUHKL, but not to CML which will remain solely focused on TD-LTE technology.

Q3: Who will be the winners and losers of China’s forthcoming 4G licensing?

Early licensing of TD-LTE operation to all three telecoms operators will promote the development of TD-LTE networks. Wider TD-LTE technology deployment will encourage handset vendors to invest more to improve handset quality and lower handset costs, which will help reduce CML’s disadvantages in mobile data. CML’s 3G business continues to be hindered by the inferiority of its technology compared to competitors’ global 3G technologies. Consequently, the company has been losing some high- to middle-end mobile subscribers.

Fitch does not expect major improvement in CML’s competitive position in mobile data in the short term as it will still take time for TD-LTE handsets to become more widely available. However, the agency expects CML’s profit margins to weaken under pressure in the short to medium term due to higher handset subsidies and competition from other telecoms companies and over-the-top operators.

Although Fitch expects FDD LTE to be the main technology for CTCL and CUHKL and that they will continue to benefit from the international scale of FDD LTE, CTCL and CUHK will need to incur higher 4G capex to roll out both FDD LTE and TD-LTE networks. Running two parallel 4G networks concurrently will prove to be inefficient and lead to higher operating expenses and capex over the longer term.

Q4: Do Chinese telecoms operators have the financial strength to fund the 4G network construction?

CML’s liquidity is strong; at end-June 2013 its unrestricted cash balance of CNY452bn significantly exceeded total debt of CNY29bn. The company also has strong cash generation ability. CML has already increased its capex budget for 2013 by 49% to CNY190bn, partly due to TD-LTE capex. We expect higher capex to pare pre-dividend free cash flow margin to below 10% in the next two years. However, Fitch expects CML to maintain its strong net cash position, even after significant 4G capex investment in the next two years.

For CTCL, Fitch expects CTCL to spend some CNY40bn on 4G capex in 2014. However, Fitch expects that CTCL will cut broadband capex starting from 2014, following completion of the three-year fibre network upgrade project started in 2011. 3G capex is also likely to be trimmed to accommodate 4G investment. In addition, steadily improvement in profitability will help cash generation.

Q5: Apart from telecoms operators, what other companies will be affected?

Fitch also expects the 4G capex cycle will be an opportunity for equipment vendors, including ZTE Corporation (ZTE, B+/Stable) and Huawei Technologies Co. Ltd. Fitch expects ZTE’s operating EBIT to rebound in 2013 from a substantial loss in 2012 but its funds flow from operations (FFO)-adjusted leverage to remain above 5x. Sourece:  http://www.cellular-news.com, Published on: 15th Nov 2013