The latest round of earnings from China's big telecom firms shows just how much the delay in 3G licenses is punishing fixed-line carriers. For nearly three years, China Telecom ( CHA - Get Report) and China Netcom ( CN - Get Report) have been hoping for licenses that would allow them to start providing mobile service, offsetting weak revenue in their core land-line business. But as they wait, China Mobile ( CHL), the nation's leading wireless carrier, keeps gaining at their expense. Responding to sharp price cuts, customers have been flocking to sign up for its mobile service. China Mobile said on Aug. 18 that its profit in the first half of the year jumped 26% to $3.8 billion. In contrast, the two land-line companies are going backward. China Netcom's earnings fell 8% to $890 million in the first six months of the year, while China Telecom said its profits dropped 4% to $1.8 billion. "The mobile substitution effect has become much stronger since earlier this year, and it's putting great pressure on the fixed-line operators' margins and market share," says Eliza Liu, an analyst for Fitch Ratings in Beijing. 3G, or third-generation, licenses probably won't be issued until mid 2007, which means there may be little relief for fixed-line providers' share prices. "I think 3G licensing is still uncertain right now," says Kelvin Ho, an analyst at Nomura International in Hong Kong. "That's why China Telecom is not really moving anywhere."
China Telecom shares are down roughly 5% from their year-ago levels as of the Aug. 30 close of $34.19. China Netcom has been better, rising 7.4%, but analysts say the two companies face similar challenges. The holdup in 3G licensing has occurred because Beijing wants to iron out problems for a homegrown cell-phone standard called TD-SCDMA. The government plans to put this network into operation alongside the other two international standards, WCDMA and CDMA 2000. Granted, neither of the two fixed-line carriers is a lock to receive 3G licenses, and there are risks for those operators who do get a license. For instance, government authorities might saddle them with the Chinese standard instead of one of the more widely deployed international 3G standards. Also, operators will need to make multibillion-dollar investments to build out the necessary infrastructure -- unless, as is possible, the government hands them one of the mobile carriers' existing wireless networks. "On the one hand, obtaining a 3G license would strengthen a fixed-line carrier's business profile and improve their business prospects over the medium term," says Fitch Ratings' Liu. "But the companies will have to either construct a 3G network or acquire a mobile network from the existing operators. So we expect expanding
capital spending for 3G construction or related acquisitions will put great pressure on cash flows."
China Telecom would be better prepared to handle the expense in terms of its debt load and cash flow, according to Fitch. Some analysts believe the government might offer financial help for the infrastructure buildout, though. Outside investors could also step up their involvement. Last year, Spain's Telefonica ( TEF - Get Report) bought a 9.9% stake in China Netcom. "There's always interest from foreign operators. It won't be difficult if they want to find a partner to fund part of the investment," says Jenny Szeto, a Hong Kong-based analyst at Daiwa. China Telecom chairman Wang Xiaochu said on Thursday that his firm also had received overtures from several foreign telecom firms, though the uncertainties around 3G have made it difficult to strike any deals. Despite the potential downsides, the chance to push into the mobile business offers the best hope for fixed-line carriers struggling with slowing revenue in their core business. China Telecom's performance illustrates the tough choices the carrier has had to make. In the first half of 2006, its revenue from local service fell 2.5% from last year, while long distance slid 1.2%. The operator now expects net additions of 13 million new subscribers this year instead of 18 million. To lift sales, China Telecom has had to push into broadband Internet service and value-added services such as caller ID and ringtones -- two categories that now account for about one-fifth of its revenue. However, a planned marketing push for services is expected to further compress the company's margins later this year.