The Benefits of Open Trade with China - Written 5/28/00:
By Matt Tomkins
Now that the US House of Representatives has voted in favour of establishing
'permanent normal trade relations' (PNTR) with Communist China, it is only a matter of
time before China is also granted acceptance into the World Trade Organization
(WTO). American businesses have long salivated over the potential of this massive and
yet virtually untapped market. Comprising 1/5th of the world's population, there is no
doubt that China offers an incredible opportunity for US exporters. With America's
support, China's formal entrance into the WTO is expected to occur later this summer
and bring with it greater foreign access to the world's most populace nation.
With this event essentially a foregone conclusion, investor focus should now shift to
which sectors and companies are best positioned to capitalize on this new market
opportunity. A sector that is set to become one of the earliest beneficiaries is
telecommunications. China's two largest phone companies, China Telecom and China
Unicom, are together expected to invest upwards of $25 billion on infrastructure
build-out by 2002. When looking for where to invest within the telecom industry, we can
narrow our focus to a single domain, wireless. With a population of over 1.2 billion and
very little infrastructure in place, the undertaking of connecting all these people to a
communications network is daunting to say the least. The creation of such a nation-wide
wireline network would be astronomically expensive, not to mention a logistical
nightmare. The only feasible option for the Chinese government is the development of a
high-speed wireless infrastructure. Costing a mere 1/10th of an equivalent wireline
system, going mobile would allow China to eliminate the lengthy and expensive
infrastructure build-out which burdened North American society during the mid 20th
century and would permit them to move directly towards a much less expensive wireless
network.
Today, the dominant technology used by China's 45 million wireless subscribers is
GSM. This may sound like a large number (and it would be in most countries) but when
you have over a billion citizens, this works out to less than a 4% penetration rate, making
it far from an entrenched standard like in Europe. Compare these numbers to the 70%
penetration in Finland and you begin to see the compelling growth opportunity offered by
this market. Although part of the low adoption rate is a function of demographics (i.e.
low income, low education, etc.), usage is still expected to rise 63% in 2000, bringing
the total users from 45 million to 70 million and should break 170 million by 2005. It is
my opinion that much of this growth will shift to CDMA, providing companies involved
in this technology some of the most explosive growth opportunities. When it comes to
CDMA no company will benefit more than Qualcomm, making it perhaps the biggest
winner from China's acceptance into the WTO.
So what incentives does CDMA offer Chinese carriers that will compel them to drop
GSM in favour of this new technology? Well, basically the same incentives that it offers
the rest of the developing world, something that I call the 2Cs: capacity and cost.
CDMA offers greater capacity at a lower cost, and this combination is practically the
holy grail of any communications network. There are many benefits that make CDMA
the superior technology but these two are the most important and are only magnified by
the massivity (I couldn't find an existing word that accurately described the situation) of
the Chinese population. The greater efficiencies of CDMA will be the only way that the
increased traffic can be supported in such a densely populated nation. As an illustration
of the strain on North America's current system, in order to substitute wireless for
current wireline voice traffic, network capacity would have to increase by 22 times. It is
not financially possible for carriers to simply increase their current infrastructure
deployment by a factor of 22. They must instead find a more cost-efficient technology in
order to make wireless a viable alternative to present wireline services. Only CDMA
offers the efficiency to make widespread wireless adoption economically feasible,
allowing data to be transferred at much higher rates and using as little as 1/9 the
frequency spectrum. Now imagine the capacity to support a country only slightly larger
than the US in land mass but with four times the population. As for cost savings, while it
is true that individual CDMA base stations are more expensive than their GSM
counterparts, they also have a much greater range. Therefore, fewer sites are required to
cover the same area, resulting in a reduction of cells by as much as 50%. Fewer cell sites
translates into reduced operating expenses and thus savings for both the operator and
the end user. This more than compensates for the increased cost of an individual station.
Earlier this year, Qualcomm scored a strategic victory when it landed a deal with China
United Telecommunications (China Unicom). The agreement called for Qualcomm to
license its CDMA technology to Unicom in exchange for royalty payments and potential
future chipset sales. Over the next couple of years, Unicom had hoped to deploy a
CDMA based wireless network that could support up to 10 million users. Unfortunately,
soon after this announcement, the Chinese government announced that the CDMA
deployment had been postponed. This decision had nothing to do with the technological
situation; it was purely a political power play. Qualcomm had unfortunately become a
pawn in a high stakes political game between the Chinese and US governments. The
move was perceived as a bid for support from the U.S. lawmakers for China's entry into
the World Trade Organization. Now that this has occurred, China's acceptance into the
WTO will soon be finalized and there should be no reason to continue blocking CDMA
deployment. As I stated earlier, despite Qualcomm's recent setbacks, the greater
capacity and cost savings offered by the technology will force them to eventually choose
CDMA. In an enormous market like China, the system that can support the greatest
number of users will have a nearly insurmountable advantage over other technologies,
thus providing Qualcomm and CDMA with an incredible strategic edge.
Despite all of the technological advantages of CDMA, there remains a factor that can
never be accurately predicted, the political factor. Anticipating government decisions,
especially non-democratic ones, has always been difficult, since, often they are not made
in the best interest of the people. For instance, barring CDMA development could be
related to Beijing's long standing efforts to retain control over their fastest growing
markets. China already possesses the capacity to produce networks and handsets using
GSM but development of a CDMA based system, using an American company's
proprietary technology would likely require cooperation with many foreign businesses.
This type of reliance on outside sources could result in the Chinese government loosing
the upper hand. In the end, however, the one constant throughout all of this is that all 3G
migration paths eventually lead to CDMA. Regardless of a carriers 2G decision, the
eventual adoption of third generation technology, whether it be W-CDMA or cdma2000
will result in Qualcomm receiving a significant revenue stream through both royalties and
ASICs.
China's political system is one for which I don't particularly have a complete
understanding. Any country whose two largest telecom competitors (China Telecom and
China Unicom) are both owned and run by the state and yet are encouraged to
compete, has some problems. I can't imagine China's Commutalist (hybrid
Communist/Capitalist) system lasting much longer. It just isn't possible to run successful
capitalist businesses while maintaining communism's iron fist and big brother-like control.
The country can only straddle the fence for so long before they'll have to make a
decision on which side they want to fall. It is my belief that they will migrate towards a
free open market economy, this decision will not be driven by a violent revolution but
rather one based on information and communication. The most powerful weapon against
oppression has always been information and the ability to communicate. Once the
revolution occurs, it will be those companies, such as Qualcomm, that have already
established significant beachheads in the country that will be best positioned to reap the
rewards of a free and open market China.
- Matt Tomkins
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