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C O V E RS T O R Y
Access denied
Western telecomms manufacturers and suppliers, already
suffering as a result of the severe economic downturn in the Far
East, now face potentially devastating new restrictions. For, as
Martyn Warwick reports, it seems likely that the joint venture
system through which foreign companies have been able to
gain access to China¹s highly protected telecomms industry is
about to be banned
For the authorities in the People's
Republic of China (PRC), it has long
been an article of faith, often aired in the
state media, that foreigners should be
excluded from involvement in the
telecomms sector. Nevertheless, being
supreme pragmatists, and working on the
principle that the right hand does not
necessarily have to know what the left
hand is doing, those selfsame authorities
devised a system whereby foreign
(primarily Western) companies could be allowed to contribute to the
development of the telecomms infrastructure and services in the world's largest
market - without actually appearing to do so.
This system goes (or perhaps that should now more properly read 'went') by the
name of the Chinese-Chinese-Foreign (CCF) joint ventures (jv) system. CCFs
are created when a foreign company forms a jv with a Chinese company, which
in turn forms another jv with a Chinese telecomms operator. The result is that on
paper the final joint venture is between two distinct Chinese organisations, when
in fact it is heavily backed by the foreign company that took place in the initial jv.
The CCF system has worked well, and to the benefit of all parties, for some
time. Therefore it has come as a great shock to those companies now used to
doing good business in China to find that things are about to change.
What has happened is that China's State Council has drafted a decree that will
terminate all CCF joint ventures by the year 2000. At first sight, the decree might
seem to be the result of nothing more than the usual infighting within the upper
echelons of the PRC's body politic, but if enacted it will have serious effects -
and on more than just Western companies.
China Unicom (the PRC's state-owned second telecomms operator) will suffer
so badly that it might even go to the wall; global carriers (such as Bell Canada,
Deutsche Telekom, France Telecom, NTT International and Sprint Corp, and
other investors) that have either succeeded in gaining access to the lucrative
network services market on the Chinese mainland, or are manoeuvring to do so,
stand to lose millions of dollars. Up to today, some 40 foreign companies have
invested about US$1.4 billion in the telecomms sector in the People's Republic.
There are two schools of thought on how the decree came to be written. One is
that Zhu Rongji, the Prime Minister, leads a group of influential Communist Party
members who are concerned that control of the strategic telecomms sector will
go to foreign investors. The second is that last year's very successful listing of
China Telecom on the Hong Kong Stock Exchange has shown Beijing that it is
possible to finance telecomms growth without allowing foreign companies into
the market.
Sudden changes
As far as telecomms are concerned, China has come a long way fast, but it still
has an even greater distance to go. Last year, in a country of 1.3 billion people
and rising, the telecomms penetration rate stood at just over 7% (of which 24%
are in the cities); the target penetration is 10% by the year 2000 (with about
40% in the cities).
In the mobile telecomms environment, the number of cellular subscribers topped
12 million at the end of last year (the latest period for which official figures are
available) and is expected to reach 35 million by the turn of the century,
CCF financing is a complex
process, but it has been an
effective methodology
whereby investors have got
around the prohibition on
foreign ownership,
operation or management
of telecomms in China. In
reality, although CCFs
have been carried through
in what has been effectively a legal vacuum, they have nevertheless won open
endorsement from senior Chinese officials - and were generally regarded as the
basis for long-term co-operation between foreign telcos and Chinese operators.
What is more, CCFs allowed China Unicom and many of the companies
controlled by the People's Liberation Army (PLA) to gain access to global
sources of capital. That in turn allowed them to compete with the powerful
incumbent China Telecom, which still has a virtual monopoly in fixed-line
services.
In fact, it was only last year that the US telco Sprint Corp went into a US$30
million CCF venture with China Unicom to set up a fixed-line telecomms
network in Tianjin, China's fourth-largest city. This project was the first to
challenge the state monopoly on fixed-line networks, and was regarded as a
prime example of how the telecomms sector in the PRC was slowly but surely
opening-up to foreign participation.
The policy change has been as unexpected as it was sudden. Unicom had taken
a chunk of China Telecom's market share and the PLA had intended to raise $5
billion to build a new backbone network - and it seemed that the central
government had quietly decided to approve of Western-style project finance and
private equity schemes. Indeed, the Minister for Information Industry, Wu Ji
Chuan, made hugely publicised speeches in which investors were promised that
they would be able to realise "equity-like returns" through the CCF system.
Limited exemptions
A study by the US Commerce Department discloses that China Unicom has
raised almost 12 billion Renminbi (RMB) - about $1.5 billion - from foreign
investors for 23 GSM projects. This actually accounts for an astonishing 72% of
total Unicom mobile venture financing.
Given the prevailing mood, it should perhaps be
regarded as something of a bonus that the Chinese
authorities will exempt certain projects from the
prohibitions. So China Unicom's local network
undertakings in Chongqing and Sichuan, as well as the
Sprint jv in Tianjin, will go ahead.
Elsewhere, a so-called 'grandfather' clause will
protect existing investors - but not for long: in fact, only until the year 2000.
Extant CCF funding contracts will be allowed to continue, provided that
scheduled capital commitments were paid by the end of June this year. However,
projects that have not met investment requirements will at best be revised and at
worst be scrapped.
Furthermore, CCF projects will be capped - none will be permitted to last
longer than 15 years - and 90% of the assets funded will be 'transferred' to
China Unicom within five years of project completion. The remaining 10%
interest will revert to the local Chinese partner. Precise regulations have not yet
been made public, but other - and potentially more onerous - terms may yet be
specified.
These 'safeguards' notwithstanding, Sprint still stands to lose money on the deals
it has made in the PRC, because its jv with China Unicom presently permits it to
connect only 50,000 customers. This is less than 10% of the numbers Sprint
needs to connect to break even on its investment in China, let alone make any
profit.
Meanwhile, France Telecom has two GSM projects in train in the booming
southern Chinese province of Guangdong, which borders Hong Kong. To date,
the French telco has spent some $60 million of a planned investment of $350
million in the area.
The termination of the CCF arrangements actually means that foreign companies
stand to lose more in prospective profits than in current revenues. That is
because almost all CCF jvs have been designed to maximise returns for foreign
investors at the time that the projects will be close to final completion.
Frailty, thy name is Unicom
The president of the PRC, Jiang Zemin, recently ordered the PLA and other
military organisations to withdraw from commercial enterprises. A number of
PLA-controlled companies were involved in network services and infrastructure
projects funded via the CCF system, one of the most important being the Great
Wall Mobile Communications Company, a 50/50 CDMA-based jv with China
Telecom.
The PLA and China Telecom have been waging a war of attrition over control of
the radio spectrum, and it could be that the incumbent telco will now try to take
control of Great Wall rather than split ownership and revenues with the PLA.
As usual, political jealousies and differences lie at the heart of events. What has
happened is that the MPT, whose apparatchiks were renowned for their spirited
defence of the monopoly position of China Telecom, has seen off its upstart
rivals at the MEI, who are sympathetic to the notion of competition within
Chinese telecomms. Ex-MPT officials now inhabit all the important strategic
posts at the Ministry of Information Industry (MII), including the directorships of
Policy, Planning, Regulation, Economic, Wireless Administration, Personnel, and
Foreign Affairs.
This new MII management has wasted no time in circulating its own draft order,
Regulation 405, which is an interpretation of the State Council's decree banning
the CCF system. There can be little doubt that the tiny crack in China's
regulatory environment through which creative
financing schemes for alternative carriers had been
squeezed will soon be completely filled.
On the face of it, things look particularly bad for
China Unicom - so bad that the Chinese authorities
are believed to be making contingency plans to ensure
its survival. For example, a government commission is
recommending that Chinese domestic banks should extend and enhance
Unicom's loans and has even gone so far as to suggest that Unicom be allowed
to issue bonds and seek a stock market listing.
However, it must surely be true that if Unicom is prevented from having access
to the overseas technologies and expertise that would have come as part of a
completed CCF deal, it is bound to be less effective in its plan to compete
head-to-head with the massive monolith of China Telecom.
A Great Wall by any other name
On a recent visit to Beijing, David L Aaron, US under-secretary of international
trade, expressed concern at the lengthening list of trade barriers that are
adversely affecting international commerce with China.
And it must be said that the country's recent actions do not look well in the
context of what is likely to be a generally poor economic outlook for Asia in
forthcoming years. These events are already making foreign companies think
twice about investing in China and making them doubly wary of getting involved
in expensive long-term infrastructure projects. As Aaron says, China is fast
getting a reputation as a country that "changes the rules a little more frequently
than one would like".
Aaron also claims that China's trade surplus with the US, which is estimated to
be in the region of $60 billion this year, is "politically unsustainable", particularly
at a time when Beijing is busily building new trade barriers.
Concern is further compounded by a signal failure on the part of the People's
Republic to promulgate firm rules for build-operate-transfer (BOT) initiatives.
These had been due to be finalised back in 1997, but are still awaiting sanction
from the upper reaches of the Chinese government.
Overseas companies and foreign governments are likely to put pressure on the
Chinese to define their parameters, and their timetable for market access, clearly
and unequivocally. It is even possible that, in the light of Beijing's stated ambition
to join the World Trade Organisation (WTO), the Chinese authorities will
actually make a positive response.
The PRC has not, so far, been badly affected by the massive economic
downturn that has devastated the economies of many of its neighbours in Asia,
but it is in trouble.
The regional recession, together with oversupply difficulties in its domestic
market (which should not be underestimated), has put a brake on China's
economic growth rate. Exports are down and bad debts are up, while
much-needed reforms in the banking sector have been put on hold.
It must also be said, though, that China has made considerable sacrifices in not
devaluing the Renminbi. Other parts of the world have reason to be grateful for
this, because, had China devalued, it is likely that the effects would have
magnified the regional financial turmoil and would also have damaged economies
across Europe and North America.
However, the US, worried by the latest obstructions to trade and investment in
China, has threatened that it will take retaliatory measures. So far these are
unspecified but, unless the situation changes, they are likely to be based on
sanctions applied under various trade laws.
Aaron has said that the US does not want to see protectionism spread as a result
of the events in Asia. "If it does, it will simply deepen the crisis."
Despite all this - and although it has been loath to make far-reaching promises on
market access and deregulation - China continues to pursue its claim to be
admitted as a member of the WTO. Thus, it has, in the course of the latest round
of negotiations over the terms and timing of its proposed membership, agreed to
open the paging market to competition immediately on its accession to the
organisation. Beijing has also promised to add both mobile telephony and
value-added telecomms services (data transmission, for example) within five
years of becoming a member.
If these proposals are accepted and China does
eventually join the WTO, it will usher in an era of
unprecedented competition - and foreign telecomms
operators would be able to take up to a 25% interest
in paging or mobile services and up to a 30% holding
in the value added services market. However, that will
be of little help to CCF investors in the short term.
One possible strategic option for them might be to
approach the Chinese authorities requesting compensation for the altered,
adapted or aborted deals. For example, it has been suggested that China
Unicom or other Chinese companies might buy out overseas investments.
But payments under such an arrangement would cover only the actual amounts
already invested, not the notional profits that should or would have been made
had the projects gone through to their planned ends.
Another compensatory possibility might be for all overseas interests to be pooled
into a single entity, which would continue to supply the Chinese projects and
hence be entitled to a percentage of the revenues generated. However, such an
exercise would be enormously complex and lengthy, not to say fraught with the
potential for acrimonious misunderstandings.
Furthermore, it is probable that, in the immediate future, China's trade policies
will become more overtly protectionist. Many of the state-owned enterprises that
are due to be spun off into the quasi-private sector are certain to put pressure on
the authorities to shelter them from competition from overseas.
Bleak outlook
The most optimistic interpretation of recent events is that the termination of the
CCF jv mechanism is no more than a part of an overall rationalisation that has
been forced onto China by the exigencies of WTO entry requirements. But for
foreign investors in China's telecomms market, there can be little doubt that the
new CCF rules will be very bad news indeed.
It now seems that, unless the PRC's central government makes special provision
for foreign investment in China's telecomms market as collateral evidence of the
seriousness of the country's bid to join the WTO, which is neither likely nor
expected, the opportunities for overseas companies to contribute to the
development and deployment of telecomms in the world's biggest market will
soon cease to exist.
This will have profound and unforeseen consequences for the future fortunes -
and perhaps even the continued existence - of some of those foreign carriers and
operators who have gambled so much in hitching their corporate stars to the five
that fly on the red banner of the People's Republic.
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