EQUITIES ● TELECOMMUNICATIONS
11 September 2018Investment thesis
In this report, we take a detailed look at the potential costs of 5G rollout in China. We think that
the expectation that China telcos will massively over-invest in 5G is too simplistic. We believe
that high levels of past investment should lower the 5G cost, and that management teams will
‘go slow’ as the business case for 5G is unclear, and telcos are facing regulatory controls that
pressure the top-line. We believe that the overhang risk of 5G will start to ease as this becomes
clear, with capex guidance in March 2019 a key focus point.
Most customers have moved to 4G, and competition is intensifying. The impact of the ban on
regional data plans has been to accelerate growth of unlimited or high capacity data plans.
This blunts the main weapon of Unicom, which was willing to offer more than its peers on 4G to
catch up. We expect this growth to slow as competition between the three heats up now that 4G
penetration has risen.
We resume coverage with Buy ratings on all three companies. We expect growth of high
capacity plans on all three companies to offset regulatory pressure on the top-line. We believe
China Telecom offers an attractive mix of growth and stability. Unicom should continue to
benefit from Mixed Ownership Reform (MOR) initiatives, while we look for continued
improvements in the dividend payout ratio from China Mobile.
Key risks to our view are a much higher investment in 5G than we forecast; increased
competition between the three now that 4G penetration is high; erosion of value in the wireline
business at China Telecom and Unicom; investment in overseas where visibility is poor; further
regulatory measures that curtail top-line growth; and unexpected management change.
A 5G joint venture makes sense – a full merger doesn’t
Bloomberg (4 September 2018) reported that China’s top officials are reviewing a proposal to
combine China Unicom and China Telecom. The rationale would be to create a more effective
competitor to China Mobile, and speed up the development and deployment of 5G.
We believe a full merger would be detrimental to telco sector shareholders, employees, and
investors in the China SOE sector more broadly, as well as resulting in less competition and a less
efficient sector. The integration challenge would be enormous – and would be further complicated if
Investment summary
Expect data roaming curbs to be offset by launch of higher capacity
data plans
Market continues to worry about 5G – we expect guidance on
investment and timing to be assuring
Resume coverage with Buy ratings on China Mobile, China Telecom
and China UnicomEQUITIES ● TELECOMMUNICATIONS
11 September 2018
employee layoffs were politically difficult. A full merger would undermine China Tower’s earnings
very soon after listing, and likely impair appetite for future SOE listings. The corporate governance
implications would be compounded for investors in China Unicom, which would see its Mixed
Ownership Reform – a flagship initiative for the government – derailed. Finally, the move to a
mobile duopoly would result in less competition – something the government has moved against in
wireline by bringing in China Mobile as a competitor to Unicom and Telecom.
For these reasons, we believe a full merger is highly unlikely. Much more possible (and
beneficial, in our view) would be a formal 5G network joint venture (JV). In this scenario, Unicom
and Telecom would pool all 5G network investment, but maintain separate services and retail
brands. This type of collaboration is common in the telco sector, and we expect it to become
more so in the 5G era, given the potentially high investment requirements and uncertain
business model.
5G: the billion dollar question
How much China telcos will spend on 5G is the biggest uncertainty facing the sector. In June 2017,
an MIIT (Ministry of Industry and Information Technology) research report sent shockwaves through
the sector. It estimated 2017 China telcos’ 5G spending at RMB1.65trn (USD240bn) between 2017
and 2025 – this compares to total capex (including wireline and all additional functions) of RMB439bn
/ USD63bn in 2015 – the peak year of 4G rollout. Since then, operators have stressed their desire to
maintain a balance between shareholder returns and investment. However, visibility is an issue: the
China telcos aim to deploy ‘Release 16’, rather than the version (‘Release 15’) that the South Korea
telcos will launch in March 2019. Release 16 isn’t expected to be finalized until late 2019 – this
means that we may not get a clear guidance on total capex – including 5G – until early 2020.
This presents a major overhang risk for the China telcos. However, we argue that the risk can
be quantified to a degree, and that there are several offsetting factors:
High levels of prior investment, including at high frequencies. Chinese mobile
networks are already dense. This particularly applies to China Mobile, which has deployed
much of its 4G infrastructure at 1.9GHz and 2.5GHz (at a considerable cost).
Large amount of fibre (backhaul) deployment. Following a big investment in fibre
backhaul, operators in markets such as Korea and Japan have been able to limit capex –
and are guiding that 5G rollout can be managed within existing capex parameters.
Spectrum is distributed, not auctioned. This is a substantial advantage, and is unusual in
global telecom markets (Japan is the only other Asian market that doesn’t auction spectrum).
For China Unicom and Telecom, a further positive is that continued network sharing is likely. We do
not expect a full merger of these two companies (which could lead to thousands of SOE job losses).
We revise our capex forecasts for the next five years to make explicit forecasts for 5G BTS
(base transceiver station) unit cost and deployment. We assume investment in other businesses
continues on the recent trend, with some exceptions such as our forecast that Unicom will
increase its investment in the fixed line network. We forecast RMB560bn on 5G BTS, excluding
investment in other areas (such as transmission) that could be deemed 5G-related.
As a global team we take a relatively cautious view of 5G (see our thematic reports 5G – what’s
the use, 29 March 2018 and 5G in Asia: Generation gap, 30 May 2018, for more details).
Commentary by telco management suggests that they share this cautious view – the respective
chairmen have reiterated that the business model for 5G is unproven, while holding out cautious
hope that 5G will help them address new customers and service areas – in enterprise services
and IoT in particular.
EQUITIES ● TELECOMMUNICATIONS
11 September 2018Changes we make
Our forecasts compared to consensus and changes to our estimates are outlined in the table below.
Key changes are as follows. These changes also include the impact of 1H18 results.
Revenues. We reflect lower handset revenues at the telcos, which are now lower than we
previously forecast at China Mobile and China Telecom. The China telcos have now
implemented IFRS-15, which has resulted in revenue previously allocated to handset sales
being booked over the life of a contract.
EBITDA. We cut our EBITDA estimates for China Unicom in particular due to higher
employee costs than previously forecast. We expect Unicom to pay more in employee
expenses due to its increased freedom following Mixed Ownership Reform, and we now
believe our prior forecasts were too low.
Net income. We cut our net income forecasts for China Unicom and Telecom due to lower
net income forecasts for China Tower. This affects Unicom particularly due to the low net
income margins at this business as it recovers.
Valuation
We continue to use a sum-of-the-parts based valuation for each of the telcos, with DCF used to
value the core telecom businesses and China Tower. Our methodology is unchanged in this
report – however, we do reflect a new cost of equity of 8% (from 8.5% previously) following the
recommendation of our strategy team. All three telcos are currently trading roughly one-third
below their five-year average EV/EBITDA multiples. This reflects current regulatory pressure as
well as uncertainty over 5G investment, in our view. China telcos continue to trade at attractive
valuations relative to peers – as we show in the regional comparison table on page 6.
China telcos: HSBCe vs Consensus, HSBC estimates vs prior estimates
____ HSBCe vs Consensus _________ Changes to last estimates ___
2018e 2019e 2020e2018e 2019e 2020e
China MobileChina Mobile
Sales -0.1% -1.7% -2.3% Sales -1.2% -1.5% -1.1%
EBITDA 1.2% -2.1% -3.5% EBITDA 0.0% -0.6% 1.9%
OP 2.7% 2.2% 2.3% OP 1.6% -1.1% 5.9%
Net Income 5.3% 7.7% 13.2% Net Income 0.2% -1.9% 3.3%
EPS 5.3% 7.3% 12.5% EPS 0.2% -1.9% 3.3%
China UnicomChina Unicom
Sales -0.7% -2.4% -5.5% Sales -2.3% -1.7% -1.5%
EBITDA 0.6% -3.2% -8.8% EBITDA -5.4% -5.5% -9.0%
OP 4.9% -5.7% -13.1% OP -27.9% -18.8% -26.3%
Net Income -5.4% -20.7% -25.2% Net Income -27.7% -36.4% -39.8%
EPS -9.5% -17.0% -24.0% EPS -27.7% -36.4% -39.8%
China TelecomChina Telecom
Sales -1.8% -4.1% -5.2% Sales -3.0% -7.1% -8.0%
EBITDA -0.4% 0.3% -2.7% EBITDA 2.5% 4.0% -1.0%
OP 2.2% -1.0% 0.1% OP 1.7% 2.7% -8.1%
Net Income 4.7% 8.8% 9.5% Net Income -7.1% -5.8% -14.3%
EPS 2.2% 5.9% 8.5% EPS -7.1% -5.8% -14.3%
Source:HSBC estimates, Bloomberg。