On the eve of 5G’s arrival: the game between operators’ capital expenditure and investment returns?

In recent years, while operators' revenues have been rising, their capital expenditures have been declining year by year, and their financial reports have become more and more impressive. For example, China Mobile's revenue in 2014 was 651.509 billion yuan, and its capital expenditure was 215.1 billion yuan. In 2015, its revenue reached 668.335 billion yuan, but its capital expenditure dropped to 195.6 billion yuan. In 2016, its revenue exceeded 700 billion yuan, reaching 708.421 billion yuan, and its capital expenditure further dropped to 187.3 billion yuan. Its share of communication business revenue dropped from 36.36% to 33.49% and 30.04%, and even dropped to 24.5% in the first half of this year.

But this is more like the silence before a big war. The arrival of 5G is about to trigger a global "arms race".

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Last month, the National Development and Reform Commission issued the "Notice on Organizing the Implementation of the 2018 New Generation Information Infrastructure Construction Project", requiring that 5G large-scale networking pilot projects will be carried out in no less than five cities in 2018, with no less than 50 5G base stations in each city and no less than 500 5G terminals in the entire network.

In fact, since China Mobile opened the first 5G base station in Guangzhou in June 2017, the three major operators have successively launched 5G field experiments, deploying 5G base stations in more than a dozen cities including Beijing, Shanghai, Guangzhou, Shenzhen, Xiongan, Suzhou, Chengdu and Chongqing.

According to China Mobile's previous plan, large-scale networking will be carried out in 20 cities in 2018, and 5G will be pre-commercialized in 100 cities in 2019, far exceeding the goals set by the National Development and Reform Commission. Moreover, this plan is likely to be further accelerated due to the policy guidance of the National Development and Reform Commission.

The clock for 5G, which was originally planned to be commercialized in 2020, has been constantly accelerated, and the standards, pilot projects, and industries are all accelerating.

One thing wins, the other loses

The huge change in experience from 3G to 4G has caused consumers to consume more data than ever before, but at the same time, the improvement of industry maturity, competition among operators, and national policy requirements are also forcing operators to continuously reduce data prices. At present, the growth rate of data demand is slightly higher than the decline in data prices, which is also the main reason why operators can currently maintain revenue growth.

Since the launch of the Broadband China Strategy in 2013, the National Development and Reform Commission, the State Council, and the Ministry of Industry and Information Technology have repeatedly promoted "speeding up and reducing fees" in the broadband, mobile communications, and enterprise communications markets.

Take the mobile communications market as an example. In 2010, China Mobile's mobile Internet traffic was about 100 million GB, with revenue of 30.453 billion yuan. In 2011, the figures were 157 million GB and revenue of 43.689 billion yuan. Throughout the 3G era, the price of domestic traffic remained at 0.3 yuan/M, or 300 yuan/G.

In 2016, the industry's overall traffic price dropped to about 60 yuan/GB. In the first half of 2017, traffic prices continued to decline, with China Unicom's traffic price dropping to 16.93 yuan/GB, while China Mobile's average traffic price was 38 yuan/G. During the same period, the average traffic usage of consumers also increased from about 100M in the 3G era to 2G per capita.

At present, whether it is the regulatory trend or the competitive situation among operators, "reducing the unit price of traffic while maintaining personal tariffs" is basically an industry consensus.

The "Economic Operation of the Communications Industry in October 2017" released by the Ministry of Industry and Information Technology last month showed that from January to October 2017, the national mobile phone outgoing call duration reached 2.24 trillion minutes, a year-on-year decrease of 4.5%; the national fixed local phone call duration reached 128.3 billion minutes, a year-on-year decrease of 18.6%. At the same time, from January to October, the three basic telecommunications companies achieved fixed data and Internet business revenue of 165.8 billion yuan, a year-on-year increase of 9.9%.

The "footprints" of the pursuers

In 2009, Chinese operators started to catch up with their foreign counterparts. Their capital expenditures were higher than those of international operators, but they only took half the time to recover their investments.

China's three largest operators have been listed in the Fortune Global 500 for many years, along with more than 10 operators from Europe, the United States, Japan and other countries. However, according to the financial reports of Verizon, AT&T, NTT and other American and Japanese operators for many years, their capital expenditures accounted for 14%-18% of their revenues. In contrast, the capital expenditures of the three largest domestic operators accounted for more than 30% of their revenues for many years.

In 2009, Verizon, a giant US mobile operator, began testing commercial 4G services. That year, Verizon's capital expenditure was $17.05 billion, accounting for 15.8% of its revenue. Since then, Verizon has never exceeded this ratio. In the same year, AT&T's capital expenditure was $17.3 billion, accounting for 14.1% of its revenue. Although AT&T has increased its capital expenditure since then, the highest was only $21.23 billion in 2013, accounting for 16.5% of its revenue. The highest capital expenditure of Japanese operator NTT in recent years was 753.7 billion yen in 2012, accounting for 16.8% of its revenue.

However, in 2009, the Ministry of Industry and Information Technology issued 3G licenses and China entered the 3G era. China Unicom, which had always been weak, hoped to surpass WCDMA, which had a leading advantage, and spent 112.5 billion yuan to build a network, of which 36.4 billion yuan was used for 3G construction. In that year, China Unicom, which had just deployed 3G, had a revenue of only 153.4 billion yuan, and capital expenditure accounted for 73% of its revenue. During the same period, China Mobile's capital expenditure was 129.4 billion yuan, accounting for 29% of its revenue. China Telecom spent 38 billion yuan, accounting for 18% of its revenue.

During the entire 3G period from 2009 to 2013, the three major operators had a cumulative capital expenditure of 1.4 trillion yuan. During the same period, the three major operators had a cumulative revenue of 5 trillion yuan, and capital expenditure accounted for 28.2% of revenue.

In 2014, 4G came. China Mobile spent 215.1 billion yuan a year, accounting for 36% of its revenue. China Unicom, which entered the peak construction period in 2015, spent 133.9 billion yuan, accounting for 56.9% of its revenue. China Telecom spent 33% of its revenue, 109.1 billion yuan.

If we take into account the capital expenditure budget of the three major operators in 2017, in the four years from 2014 to 2017, the capital expenditure of the three major operators totaled 1.48 trillion yuan. The expenditure in four years has exceeded the total expenditure in the five years of the 3G era.

Nearly a year of first-mover advantage has enabled China Mobile to lead the way, with a total of 622 million 4G users to date. The total number of 4G users of China Telecom and China Unicom is only 328 million, and China Mobile mainly relies on low-price competition to seize the market share of new mobile users.

According to the 2017 semi-annual report, China Mobile had a cash flow of 406 billion yuan and earned 7.685 billion yuan in interest income in the first half of the year. China Mobile has ample funds to deploy 5G.

In contrast, in the first half of 2017, China Unicom's cash flow was 33.8 billion yuan, which was mainly due to its reduction of capital expenditure by nearly 30 billion yuan. In the first half of the year, financial expenses due to loans were 23.89 billion yuan, and the debt-to-asset ratio reached 61.4%; China Telecom's free cash flow was 7.2 billion yuan, the debt-to-asset ratio was 52%, and interest expenses were 1.855 billion yuan.

In a research report published in August this year, Huachuang Securities Co., Ltd. researchers Shu Haifeng and Zhang Yi analyzed that “Since China Mobile launched 4G services one year earlier than China Unicom and China Telecom, China Mobile’s number of users far exceeds that of China Telecom and China Unicom…China Mobile will recover its 4G investment costs in the next 3-5 years. As for China Telecom and China Unicom, since they launched services one year later than China Mobile, it is expected that they will also recover their investment costs in 3-4 years.” The research report also predicted that “4G will still be the dominant position in the next three years.” (2)

The “bonus” of leadership

It is an indisputable fact that China is leading the 5G era in many aspects. According to the forecast of the China Academy of Information and Communications Technology, the number of 5G connections in China will reach 428 million in 2025, which is equivalent to the penetration rate of 4G in 2015. With the development of the new era of 5G, it is expected to drive the domestic direct economic output to 6.3 trillion by 2030 and create 8 million jobs.

There is no consensus in the industry on the future investment costs of 5G.

Wei Ming, vice president of Ericsson China and general manager of the Shanghai branch, predicted in a public speech in August this year (3) that the three major operators' 4G investment was US$117 billion, and 5G investment will reach US$180 billion, with construction costs 48% higher than the 4G era.

Many operators’ experts have also publicly predicted that 5G investment will double that of 4G. Because 5G has a higher frequency, to achieve the same coverage as 4G, the number of base stations must increase by 1.5-2 times, and 5G equipment will be much more expensive than 4G. At the same time, the network speed will be greatly improved, and the investment in transmission, computer room, etc. will also increase.

However, experts who hold the former view say that since China is leading in 5G, Chinese companies have mastered many key 5G technologies and can avoid paying high patent licensing fees to foreign companies, thereby saving construction costs.

At the same time, the development of technology is also greatly reducing equipment costs. The development of 5G will be lower than the equipment cost of 3G/4G. For example, more than 10 years ago, China Mobile spent 80 billion to build 15,000 base stations, while China Unicom spent 440 billion to build 430,000 WCDMA base stations. The construction cost of the latter is less than 20% of the former.

In specific operations, operators will also look for multiple ways to reduce investment costs. Ma Hongbing, deputy general manager of China Unicom's Network Construction Department, introduced at the China Unicom Network Technology Conference on November 7 that in the face of 5G knocking on the door, it is necessary to make good use of the huge 4G assets and smoothly evolve to meet the challenges. He said: "The existing 4G resources are strategic resources for low-cost construction of 5G. The key technical requirement is to use the existing spectrum to build good 5G coverage and extend C-band uplink coverage." At the same time, "in the 5G network construction model, China Unicom may launch a 'small mixed reform' to innovate." Like Yunnan Unicom, by introducing a third party to build a bridge, the equipment sold by the equipment vendor to Unicom is purchased by the third party, and Unicom is responsible for building the network and giving the third party a share of the business. He said: "This model may not become the mainstream of China Unicom's network construction, but the internal atmosphere that encourages business model innovation may open up another way for China Unicom's 5G network construction."

5G Outlook

In fact, due to the overall trend of increasing speed and reducing fees, the three major operators have long turned their attention beyond the consumer market. The Internet of Things and the Internet of Vehicles are good examples.

In 2017, operators have invested hundreds of billions of yuan in building NB-IoT networks, with China Mobile's entire NB-IoT network project budget reaching 39.5 billion yuan. As of the first half of 2017, China Mobile already had 150 million IoT devices, becoming the world's largest IoT operator. During the same period, China Telecom and China Unicom developed 30 million and 40 million users respectively.

It is worth mentioning that the Internet of Vehicles has begun to take shape. According to data from the China Academy of Information and Communications Technology under the Ministry of Industry and Information Technology, as of August 2017, China Unicom's Internet of Vehicles users exceeded 20 million, China Telecom's Internet of Vehicles users reached 11.06 million, and China Mobile's Internet of Vehicles users reached 27 million, totaling 58 million. Currently, China has 290 million cars, and 20% of them are connected to the Internet.

However, at present, most of the Internet of Vehicles use 2G and 3G terminals, which only have the function of networking. The LTE-V2X standard technology, which is committed to providing interconnection between vehicles, vehicles and people, and vehicles and roads, just completed the standardization work in March 2017 and has not yet been officially commercialized. As for the 5G-V2X standard for 5G Internet of Vehicles, the standardization work has not yet started, and it is expected to start the standardization work as early as March 2018.

However, at the previous International Seminar on Future 5G Information and Communication Technologies, Bi Qi, chief engineer of China Telecom Beijing Research Institute, pointed out that 5G vehicle networking still faces very great challenges. In mobile scenarios with large-scale coverage, 5G cannot yet provide a continuous, reliable, low-latency network, but this is a necessary condition for autonomous driving in the 5G era.

In addition to the Internet of Vehicles, the Internet of Everything also faces challenges. Almost all IoT devices are pursuing the limit in terms of long life, low cost, and low power consumption, but operators that provide services for the IoT have always been following the business model curve of "high investment, fast return". Take China Mobile as an example. It has proposed the goal of achieving 5 billion connections and 100 billion yuan in revenue by 2020, which requires each device to pay 20 yuan per year. However, this "extremely low" IoT fee in the eyes of operators is still not enough to attract IoT companies, which are more committed to pursuing free services.

The technology tree of operators has extended to the field of Internet of Things. During the 5G pilot phase from 2018 to 2020, whether operators are able to resolve the increasingly urgent bottleneck of investment returns and the contradiction between the Internet of Things industry and build a viable business model is a proposition that they urgently need to consider, especially for China Telecom and China Unicom.