Madden: Watch out, China is getting squirrelly

Madden

Here in California, the term "squirrelly" means that your surfboard is unstable and makes quick and unpredictable turns at any time. We're seeing this in the Chinese mobile market now.

Last year, China Inc. bought 41 percent of the macro base stations sold worldwide, with huge numbers devoted to LTE deployment. All three Chinese mobile operators (China Mobile, China Unicom and China Telecom) have big plans for LTE deployment, and the competition is fierce this year, with about 20 million customers signing up for LTE service every month.

It's important for the industry to understand that Chinese mobile operators do not compete as commercial companies in the same way as Western companies. All three operators are state-owned companies. Sure, there are a few shares traded publicly, and there are a few private shareholders. But in all three cases, the government owns a controlling majority of shares, and the central government makes surprise decisions without the usual Western process of shareholder meetings and public transparency.

For example, the Chairman of China Unicom and the Chairman of China Telecom swapped jobs this year. These two guys were theoretically in charge of their mega-companies, but they were abruptly reassigned. Imagine that for Verizon and AT&T! Also, a senior bureaucrat from the Ministry of Industry and Information Technology (MIIT) recently replaced the chairman of China Mobile. All three companies have new leadership this year.

As another example, in May 2015, MIIT ordered the three Chinese carriers to lower their prices by 30 percent to spark faster adoption of LTE. Evidently the government doesn't want a repeat of 3G, where the home-grown technology was a big flop.

The MIIT gave TD-LTE commercial licenses to all three operators in December 2013 in adjacent bands between 2555 and 2655 MHz. All three deployed small trial networks, but only China Mobile moved forward to deploy a network, partly because of a fundamental technical issue: You can't operate two unsynchronized TD-LTE networks in adjacent spectrum without major interference issues. This kind of issue illustrates how major decisions come from top-down political decisions, not bottom-up business plans.

This year, the industry's dependence on China has become very clear, with a corruption investigation that has essentially shut down TD-LTE deployment at China Mobile for the past five months. This has hurt the semiconductor industry more than everyone else (except the executives that wound up in jail). The radio semiconductor companies have been hurt deeply, because TD-LTE uses eight radio transceivers where FDD-LTE uses two. In 2014, China was responsible for 62 percent of macro radio transceivers sold worldwide. This year, half of the market has been closed, for half of the year. Ouch.

This painful state of affairs creates big questions about the future of deployment in China.

• Will China Inc. continue with its plans for a million FDD-LTE base stations by 2020? 
• Will China Telecom and China Unicom deploy TD-LTE in the bands they were given, despite the interference issues with the China Mobile system?   
• Will China Mobile take the next step toward its vision of 2 million 4G base stations nationwide?
• How do recent macroeconomic issues impact Chinese government policy with regard to billion-dollar investments in "extra" capacity?

The answers to these questions essentially come down to government policy and politics. Economics cannot explain the overcapacity that is already built in China, with ARPU at $9.70 and tremendous capital investments in fiber and base station hardware. The government may choose to continue investing in more capacity, but we should be clear that this will be an economic stimulus program, not true competition between rival carriers.

Mobile Experts has recently published a study in which we investigated one "most likely" scenario for restructuring in China's telecom sector. The central government has already decided to reduce the number of state-owned companies from 112 to 50. We believe that a restructuring is likely in the next year or two, but of course the timing is totally unpredictable.

Overall, our conclusion is that the OEM community should be cautious about ongoing production. Don't think of these three companies as typical mobile operators. It's better to think of them as three government agencies that compete for attention from Uncle Xi Jinping. If Uncle Xi decides that they need to be profitable, we could see the macro base station market drop in half instantly.