TELECOMS: Mega Merger Coming for China Telcos?

Bottom line: The MIIT is quite possibly weighing a merger between China Telecom and Unicom, but any final decision might take at least a year due to the regulator’s cautious and slow-moving nature.

Marriage on tap for China Telecom, Unicom?

A new research note is raising the intriguing possibility that a merger could be coming for the smaller of China’s 3 big telcos, saying China Unicom (HKEx: 763; NYSE: CHU) and China Telecom (HKEx: 728; NYSE: CHA) may soon be forced into marriage. The reasons for such a marriage are certainly compelling, and a recent leadership shuffle among the nation’s 3 big telcos could point to such a move.

Some might argue that such a marriage would be anti-competitive, reducing China’s mobile space from 3 carriers to just 2. But the fact of the matter is that China’s telecoms regulator has become quite frustrated with this trio, who constantly fight among each other for market share but do very little to innovate despite controlling the world’s largest mobile market. Rather than focus its efforts on reforming this laggard bunch of state-run behemoths, the regulator has taken a number of other recent steps to bring more innovative, private investment into the sector.

Speculation about a merger between China Telecom and Unicom came in a research note from Deutsche Bank (Chinese article), which cited the recent swapping of leaders between the 2 companies in August as a sign that a marriage might be coming. (previous post) The carriers saw a similar leadership swap about a decade ago, though nothing happened immediately after that. But a few years later the regulator did end up merging the nation’s 4 major telcos into the current field of 3.

The Deutsche Bank note cites a similar instance of leader swapping between 2 major shipping companies as a reason behind its thinking, but it doesn’t appear to have any inside sources confirming such a move for the telecoms carriers. But as I’ve said above, such a move would certainly seem logical based on recent signals coming from the telecoms regulator, the Ministry of Industry and Information Technology (MIIT).

For starters, China Telecom and Unicom combined would only control a modest one-third of China’s mobile market, a substantial but hardly monopolistic share. The MIIT had much bigger hopes when it conducted its last industry overhaul 6 years ago. At that time it aimed to create a more competitive landscape and equal distribution of market share between the 2 smaller companies and dominant player China Mobile (HKEx: 941; New York: CHL), which controlled two-thirds of the market.

Lack of Progress

Fast forward to the present, when the 3 companies’ market shares remain about the same as they did at the time of the reorganization, and none has done much to innovate. Instead, the most innovate players in China’s telecoms space have been app developers like Tencent (HKEx: 700), whose WeChat sparked a high-profile spat after China Mobile complained the hugely popular mobile messaging service was stealing its traditional SMS business and thus was the equivalent of a stealth telco.

In the absence of innovation from the big 3 telcos, the MIIT has embarked on a number of programs to bring private money into the sector. The most advanced of those led to last year’s creation of several dozen virtual network operators (VNOs), which sell mobile service under their own brands while leasing networking capacity from the big 3 telcos. More recently the MIIT has also indicated it will let private companies build their own network infrastructure to directly offer broadband and other telecoms services.

All that brings us back to the original question of whether or not a merger of China Telecom and Unicom is in the offing. Shares of both companies have lost about a third of their value since recent peaks in late April, indicating investors aren’t too excited about such a possibility or don’t believe it’s coming. The recent signals from the regulator, including the August leadership changes, lead me to believe that such a move could quite possibly be under consideration. But the MIIT never moves quickly on anything, and if such a move is indeed in the works it could be another year or longer before the MIIT takes any definitive action.

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