Commentary

Put China Unicom On Hold

Tech Market WatchBy Perry Wu
Last week we looked at China Mobile, China's largest mobile phone operator. Now we dial up China Unicom, which is a distant second. Let's take a brief look at how China Unicom connects with investors.

Some history here: before 1994, China Telecom was the only provider of telecommunications service in mainland China. Virtually every living Chinese adult surely has memories of the interminable wait for home phone installation before 1994. Needless to say, China Telecom was not a model of efficiency.

Then, beginning in the mid-1990s, the Chinese government began liberalizing the telecom system. By 1999, the Chinese State Council decided that China Telecom should be split up. Essentially, China Telecom retained the land-line part of the business, and a new company, China Mobile, was established to take over the cellular business

Along with this liberalization, the Unicom Group was established in 1990s to start building cellular networks along with China Mobile.

In June of 2000, China Unicom did its IPO and became listed on both the Hong Kong and New York Stock Exchanges.

Overall, as duopolists, both China Mobile and China Unicom have some good economics. For example, both companies have low levels of bad debt. At China Unicom, the delinquency rate for its GSM services in 2003 was only 2.8%. The company has figured out how to establish an effective credit control system: it basically doesn't provide credit. The company normally requires deposits up-front to activate services, and in some cases, requires subscribers to maintain certain account balances at banks.

But the mobile phone business is an area where size matters. Customers want cellular coverage to be broad and that means a large cellular network. That requires cash. And in this, China Mobile is the clear winner. China Mobile now competes with China Unicom in many areas of China and this competition will only increase as the mobile phone market becomes saturated. Even Unicom's CDMA project seems like a failure compared to how well China Mobile has made GSM a part of everyday Chinese people's lives.

And unlike China Mobile, which has two to three dollars of cash for each dollar of long-term liability, China Unicom is not as conservatively financed. At December 31, 2003 the company only had cash of slightly over US$1 billion versus long-term liabilities of US$3.7 billion, although the liabilities have decreased by about US$700 million since the end of 2003.

So not only is China Unicom more risky from a business standpoint (China Mobile has a larger share of the mobile phone market), its leverage gives it considerably more financial risk.

Something about Unicom's activity reminds me of a comedy. Remember the reception problems that plagued CDMA in China during the early stages? Coverage was so sparse that during the first China BREW Conference held in Beijing's Grand Hyatt two years ago, there was no coverage for CDMA phones! What an embarassment. And Unicom is currently playing a silly game by working Java and Brew against each other with their joint-ventures UniJa and UniBrew. They should instead find ways to deliver the functionality of both to the widest possible audience, as they have with CDMA and GSM. This shows a good negotiation strategy, but lousy service to customers. Unicom should be doing everything possible to make fully functional color handsets available to everyone, just like Vodaphone does in UK and Verizon does in the U.S.–this would be a huge blow to China Mobile.

Add to this, there is the increasingly popular "Xiaolingtong" or "Little Smart" services offered by China Telecom and China Netcom, China's land line providers. "Little Smart" is basically a glorified portable phone that only works within a given region of China. The price advantage of "Little Smart" compared to real mobile phone service has already made it popular with tens of millions of Chinese.

Now, you might think: if China Unicom is experiencing competition from "Little Smart" then China Mobile must be facing similar problems. China Mobile is, but not to the same extent.

The "Little Smart" phenomenon has basically split up the mobile phone market into two segments: 1) those customers that want a cheap mobile phone but are less concerned about coverage and 2) those customers that are willing to pay more for expanded coverage. "Little Smart" has taken many of the first group of customers. But for the second group, China Mobile's sheer size and coverage area (it is now in every part of China) give it a clear advantage. China Unicom will be increasingly squeezed somewhere in the middle.

And China Unicom's recent numbers show that "Little Smart" has indeed created some ominous problems. For the year 2003, the churn rate (roughly the rate of subscriber disconnections divided by total subscribers) for its GSM services increased from 15.5% in 2002 to 29.1%. Much of this increase was surely due to "Little Smart".

So China Unicom is still better then most Chinese stocks, but China Mobile is still the better call to dialup.

About the author:
Perry Wu is a writer and correspondent for ChinaTechNews.com and can be reached here at the site. Perry Wu does not hold any positions, long or short, on any of the Chinese or American company securities mentioned in this article.

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