Consolidation with an eye on the China prize

When Australia’s Telstra last week unveiled a plan to create Hong Kong’s largest mobile phone company through a merger with a local rival, it was an announcement the territory’s wireless market had been awaiting for years.

Although analysts do not expect the elimination of one operator to end cut-throat competition in Hong Kong’s crowded mobile market, the move is being hailed as a step towards further consolidation.

“The scene won’t change dramatically from six to five [operators] because there are still too many. But if we can go down to four, and I can see it coming, that will be a totally different picture,” said Bertrand Chui, analyst at ICEA Securities in Hong Kong.

Consolidation has long been the holy grail of the Hong Kong mobile phone sector which, with 121 per cent market penetration, is among the most competitive in the world.

The city’s mobile companies have some of the world’s lowest margins because of high handset subsidies and other discounts to lure customers, along with high churn and heavy sales and marketing costs.

A mobile user in Hong Kong can talk for 550 minutes for as little as HK$50 (US$6.45) each month. This is compared with the cheapest monthly plan offered by Singapore Telecom, which at S$19.95 (US$11.80) includes free incoming calls and only 80 minutes of outgoing voice time, according to SingTel.

Companies and industry experts have been predicting consolidation since 2001, when the Hong Kong government awarded 3G mobile phone licences to only four of the six operators.

But the proposal from Telstra’s CSL, Hong Kong’s third-largest operator, with 1.3m subscribers, to acquire New World Mobility, the territory’s second-largest with 1.35m users, is the first concrete move in this direction.

According to Merrill Lynch, Hong Kong operators had an average margin of 24 per cent on earnings before interest, tax, depreciation and amortisation basis in the second quarter of this year. This was at the bottom end compared with other markets with six operators, where margins on average ranged from the low 20s to the high 30s in percentage terms, Merrill Lynch said.

By comparison, markets with five operators on average had ebitda margins of between 25 per cent and 47 per cent, rising to 30 per cent to 50 per cent for those markets with only four companies.

ICEA’s Mr Chui blames subsidies for the low margins, which he estimates are enjoyed by up to two-fifths of users in Hong Kong.

Mr Chui also says Smar-Tone, controlled by developer Sun Hung Kai Properties, could have doubled its net profit last year if it were not for subsidies.

“With less competition, one of the most direct and positive impacts would be fewer subsidies,” he says.

But analysts say competition is likely to intensify before further consolidation because of the entry of two new, strong operators into the market in the past five months.

PCCW, the territory’s biggest fixed-line operator, in June bought a controlling stake in Sunday, Hong Kong’s smallest mobile player in terms of users, touting the importance of convergence between fixed and mobile telecoms services. China Mobile, the country’s largest wireless company, in October bought a controlling stake in China Resources Peoples, one of the two operators in the market that do not have 3G licences.

“Competition could get worse before it gets better as the new entrants are better financed than their predecessors,” says Wendy Liu, analyst at Merrill Lynch, in a research report.

Although only 6 per cent of Hong Kong’s mobile users currently subscribe to 3G, operators without the capacity to provide broadband services are likely to be eliminated sooner or later, analysts say.

They see SmarTone as a likely target for China Mobile as it is seen as a non-core asset for Sun Hung Kai.

But even without consolidation, international telecoms companies may still see a presence in Hong Kong’s mobile market as valuable.

Explaining the rationale behind the proposed CSL/New World merger, Telstra said the territory offered the company a platform for eventual entry to China. CSL was a “highly leverageable asset”, said Sol Trujillo, Telstra’s chief executive. China is expected eventually to grant greater freedom to foreign mobile operators as part of its WTO commitments.

Analysts are more cautious. “The China story is a always a good one to tell. But who knows to what extent there will be any truth in it?” asks one.