China Telcos Set To Tamp Down Competition

Telcos told to rein in spending

Anyone who thought that Chinese telcos behaved like commercial companies is getting a lesson in the country’s unique blend of capitalism, with news that all 3 state-run carriers have been ordered to slash their promotional spending. In any other market, such a move would carry huge anti-competitive overtones and the regulator would quickly step in and stop such coordinated action. But this isn’t any other market, and the order to slash spending is coming from the government organization that is effectively the major shareholder of China Mobile (HKEx: 941; NYSE: CHL), China Unicom (HKEx: 762; NYSE: CHU) and China Telecom. (HKEx: 728; NYS:E CHA)

From a broader market perspective, this kind of move actually makes quite a bit of sense as China’s mobile market shows growing signs of saturation. It also makes sense from the shareholder perspective, since reduced marketing expense should help to boost company margins. Probably the only parties who won’t like the move are consumers, who could see their phone bills rise as the 3 major telcos offer fewer promotions under the latest orders from the State-owned Assets Supervision and Administration Commission, or SASAC.

According to the latest reports, SASAC has ordered China Mobile, Unicom and China Telecom to slash their marketing expenses by a whopping 50 percent over the next 3 years. (English article) China Mobile, the nation’s dominant carrier with two-thirds of the market, will see the biggest reductions with plans to reduce its promotional spending this year by 27 billion yuan ($4.3 billion). Unicom and China Telecom will reduce their spending by a much smaller 4 billion yuan each, the reports say.

Shareholders didn’t seem too excited by the news, with stocks of the 3 companies showing little or no reaction in early Friday trading. But if I were a stock buyer, I would pay a bit more attention to this news that could have big implications for all 3 companies’ bottom lines, despite its highly anti-competitive overtones.

As a longtime China tech reporter, I watched how all 3 telcos regularly added millions of new subscribers each month over the last decade, taking advantage of low mobile penetration rates to sign up new subscribers. But with nearly all Chinese consumers now signed up for service, the market has largely become saturated and new subscriber growth is likely to slow sharply in the next 5 years.

In the absence of new subscribers, the 3 telcos have begun to try to steal users from each other. That’s a costly game with very limited rewards, since each company is likely to spend big money on promotions and post very few net gains in total customers. Thus it’s easy to understand why SASAC would want to protect the government’s position as controlling shareholder of the 3 telcos by limiting costly promotional spending.

If the 3 telcos really do simultaneously lower their marketing expenses by 50 percent, they could see significant improvement to their bottom lines. That’s because none will have to worry too much about losing too many customers, since each will know that its rivals are making similar cuts in their promotional activities. The lower costs should help to improve margins — an important shift that could help China Mobile return to profit growth after several of the weakest quarters in its history.

One other winner in this development could be a newly launched group of virtual network operators (VNOs), which include e-commerce giants like Alibaba, Suning (Shenzhen: 002024) and (Nasdaq: JD). Those companies have recently rolled their own new telecoms service, and could gain traction more quickly if the established 3 telcos cut back their promotions. At the end of the day, SASAC’s new order looks quite controversial on the surface, but could ultimately help to cool the overheated mobile market and help everyone except consumers.

Bottom line: A government order for China’s 3 telcos to sharply reduce promotional spending will help to cool the market, reducing competition and boosting profits for all 3 carriers.

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