SPIN DOCTORS
In China, telecom CFOs don't even try to keep state-level meddling at bay. They just try to make it all sound fair.
By Enid Tsui

You won't become a social leper if you don't know the spectrum your mobile phone runs on. You can even get away with being totally clueless when it comes to 3G - so are most analysts these days. But if you know nothing about the most talked-about deal in the telecommunications sector in China this year, then for goodness' sake, keep it to yourself. Here's the reason. At a stroke, Chinese officials put an end to China Telecom's monopoly in the world's fastest growing telecom market and opened the door to real competition. We're not talking Adam Smith-style capitalism here, but major steps in that direction. At least that's how the CFOs of three of China's biggest telecom companies see it. How they are coping with the rapid change in terrain offers a bird's eye view of today's China. But first, a little history.

In May, China Telecom gave away all its businesses in ten northern provinces, including Beijing, to new rival China Netcom. This "gift" made the latter China's third-largest operator overnight, and yet it doesn't have to pay China Telecom a cent. The State Council and the Ministry of Information Industry (MII) have hailed the deal as an epoch-making episode. They claim it ends China Telecom's monopoly over basic telecommunication services and brings a new spirit of competition to the industry. Indeed, the grandness of scale and swiftness of execution have left most industry analysts flabbergasted.

At the same time, Chinese authorities announced that the country will soon have four full-service providers - China Telecom, China Netcom Communications, China Mobile Communications and Unicom Group - competing head-to-head on both fixed and mobile services. And as if this wasn't enough, the sector now faces international competition as China gradually lifts the cap on foreign investment under China's World Trade Organization agreement.

The Heart's Willing

Certainly, there's a great deal to play for. Last year, China's fast-growing telecom industry managed to notch up a whopping US$43.6 billion of total revenue, three times the size of India's market in the same period. The new China Telecom now controls 21 of the southern provinces, and the new China Netcom Communications is the combination of China Telecom's businesses in the ten northern provinces, Jitong Communications and existing China Netcom businesses. Rather than drawing the perforated lines around separate business groups, the latest split was geographical.
The MII clearly has a strong agenda: to increase the telecom penetration rate and geographical coverage, and to promote competition. The latter has become a priority because of public outcry against high telecom tariffs and poor service.

Currently, operators have to gain the MII's approval when they set their rates. It appears the ministry would rather leave future price adjustments to the market.

Amidst this fast-changing environment, CFOs of the listed arms of China Mobile Communications, Unicom Group and China Netcom Communications have to maneuver deftly, spinning many plates in the air to ensure their regulatory overlords, their customers and their shareholders are happy. Here's how they do it.

China Netcom: Fan Xingcha

Fan Xingcha finally makes it home at ten in the evening after a long day at work. He winds down, changes into designer jeans and a black T-shirt, and lights up his favorite cigar. Home may not look like a home - it's a hotel in Beijing's thriving central business district, the Chaoyang area. And Fan does not look like the CFO of a major Chinese company - he's only 37 years old. But he is clear about his ambitions. "I want to prove to the world that there is a new generation of CFOs in China now; CFOs who are involved in strategic decisions and with liaising with the outside world; CFOs who know how to create value for shareholders," he declares.

On May 16, Fan got his chance. That was the day his world turned upside down as the MII announced that China Telecom's ten northern provincial divisions and Jitong Communications would be merged into the new China Netcom Communications (CNC). Overnight, Fan's payroll went from 3,000 to over 210,000. Instead of running a lean, increasingly profitable internet protocol network, most of the group revenue will now come from operating low-margin, basic copper line telephone service. Worse, CNC has been given the poorer, less developed northern provinces. The new CNC not only missed out on the most lucrative markets, bar Beijing, it will also have to implement MII's universal service obligation. That is, it has to invest in network expansion to cover the poorer provinces.

Like the good spin doctor he is, however, he's not complaining. "This is the way to create effective competition. Without [this] there's no way of breaking China Telecom's monopoly," he says. Won't the geographical divide simply create two monopolies instead of one? He disagrees, saying CNC is free to bring its business south and vice versa. He says a more effective environment and industry structure has been created. "Organized liberation of the sector is better than unbridled freedom in the market," he says. The 'free and open' telecom sector one finds overseas has taught China an important lesson, he says. What people may call State intervention is actually a short cut to a more competitive landscape, he adds.

But then again, Fan's interest is not in how the State reshuffles its assets, but how to keep the original China Netcom an independent entity answerable to its numerous shareholders. He explains that investors who hold the 12.8 percent stake in it still own the same business as before. It simply becomes a subsidiary under the new CNC. In theory, it may work. In practice, he may not have the freedom as before to implement what he believes to be financial best practices that can maximize value creation. Fan keeps his position in China Netcom and reports to the CEO of the subsidiary, Edward Tien. But the MII has assigned a group-level CFO, Zhang Xiaotie, which raises the question: as the only CFO of a telecom operator without a government background, will he be able to convince the China Telecom influx to honor his commitment to boosting shareholder value?

His background should help. He has a Ph.D. in computer science from Australia and five years of work experience as a consultant for US-based McKinsey in Shanghai. Since joining CNC in 2000, Fan has done well. In the fiscal year ending March 2001, revenues were 200 million renminbi (US$24 million). The next year, that figure shot up to 1.25 billion renminbi (US$155 million). The estimate for 2002 to 2003 is 2.5 billion to 3 billion renminbi and he also expects a positive EBITDA.
Not one to be modest, he's also very proud of a 2000 private placement that raised US$325 million. Even better, Fan says in May the company clinched a 600 million renminbi private placement to develop its household broadband ventures. He might just be able to keep all his various constituents happy. At least he's determined to try.

China Mobile (Hong Kong): Ding Donghua

After five years at the finance helm of US$12 billion-a-year China Mobile (HK), Ding Donghua retired from the Hong Kong- and New York-listed company in July. The announcement came just after Ding completed a US$10.2 billion purchase of eight provincial networks from China Mobile's parent company. The sheer size of the deal made it headline news, even though the transaction was only part of the government's carefully managed privatization of its state-owned enterprises. Indeed, although he was part of a larger government scheme, Ding had to bring many skills to his job. As he made clear in his last interview given as CFO of China Mobile, the job involved more than predicting and producing numbers - he had to defend them too.

For Ding, the toughest moment of his career was in November 2000. That's when rumors reached Hong Kong that the MII planned to slash telecom fees in China by as much as 50 percent by introducing a calling-party-pay (CPP) tariff scheme. The ministry, incidentally, controls China Mobile Communications, the state-owned parent of China Mobile (HK) which owns 76 percent of its shares. As the rumors grew, what could the CFO do? Absolutely nothing. Instead, the head of MII, Wu Jichuan, called a conference at the China Mobile (HK) office at the end of November to smooth fund managers' fears. He promised them there would be no change to mobile fees in the short run. Of course, it's an honor to have a high-ranking government official acting as your investor relations manager. But you can imagine Ding's sense of helplessness as he watched the share price fall by 20 percent within a week.

Previously director general of the Guangdong Post and Telecom Bureau, Ding quickly became more comfortable with the uncertainties all around him. The secret, he says, is to disclose, and disclose quickly. By the end of December 2000, the MII did finalize changes to telecom charges. The bad news for mobile operators was that long-distance fees and various other surcharges were cut. Ding and his sidekick, company secretary Jacky Yung, informed analysts and the media two days after MII's announcement that yes, the cut would reduce pre-tax profit in the first half of 2001 by 5.42 percent, but the longer term effect would be increased airtime, a factor not accounted for in the company's forecast. Investors were pleased to see that the management at China Mobile (HK) wasn't panicking and bought the argument. The company's share price rose slightly after the announcement of the price cuts.

As the CFO discovered, explaining government decisions to shareholders remains very much part of the finance team's job. China Mobile's relationship with Unicom Group, for example, continues to perplex outsiders. Unicom, currently China Mobile's only competition, is allowed to charge 10 percent less for its GSM services in order to help implement the MII's goal to create competition in the mobile sphere. Nobody appears to know how long this will continue.

The MII says this policy will remain in place until the two are comparable in size, but the operators disagree on what's considered "comparable". Ding cheerfully explains that he told investors that this "priority pricing agreement" with Unicom Group is a win-win deal. He says enthusiastically: "The market is like a cake. It's still a small cake at present, but as prices fall, millions, no, billions of customers will join the market and make it into a bigger cake." His benevolence does not extend as far as the definition of "comparable in size", however. He reckons Unicom Group will become a significant competitor that can stand on its own two feet by the time it grabs 35 to 40 percent of market share.

China Unicom: Shi Cuiming

For his part, the CFO of China Unicom, Shi Cuiming, says he thinks that number should be 50 percent. Indeed, parent company Unicom Group got off to a tumultuous start. Launched in 1994 outside the Ministry of Posts and Telecommunications (MPT), which then controlled the majority of telecom activities in China, its founders included three government ministries: the Ministry of Railway, Ministry of Electronic Industries and Ministry of Power. Its 15 shareholders pitched in 1.34 billion renminbi (US$162 million) to launch the startup and it received licenses to operate in fixed-line, paging and mobile services. The money didn't last long in such a capital-intensive industry and the State didn't provide further funding.

Shi Cuiming says: "The company didn't have enough capital for a takeoff and came up with the Zhong-Zhong-Wai (China-China-Foreign) (CCF) structure." This was Unicom's way to bypass restriction on foreign investment in the telecom industry. It set up numerous subsidiaries that formed joint ventures with foreign investors in "value-added services", the one vaguely defined category that did allow foreign financial participation. The likes of US investment bank Goldman Sachs ended up pouring around 8.3 billion renminbi into these joint ventures, and Unicom's subsidiaries would transfer the money to some 43 projects that formed the backbone of the group's core business.

But four years later, the MII, at the request of the State Council, announced that the CCF structure was not allowed. So when Shi joined in 1999, his first task was to get rid of all trace of foreign investment, negotiate with furious investors, and find new sources of funding. A tough call, but Shi's got experience. He was the finance director of the former MPT and the executive director of China Telecom (HK).

The government invested 4.1 billion renminbi in equity to fill the gap the foreign investors left behind. As a bonus, it gave China Telecom's paging division, Guoxin, to Unicom. That was worth 6.9 billion renminbi. It also converted Unicom's 1 billion renminbi bonds, originally sold to the State, into government-held equity. The outcome of the CCF cleanup was that the government held 80 percent of shares before the IPO and made the original founders minority shareholders.

Here, Shi becomes diplomatic. He explains that the "cleanup" was in fact vital for the company's future. "The CCF joint ventures split up our operations into innumerable entities when what we needed most was a centralized management to guide development," he says. For example, the Unicom No. 1 company, a joint venture, had interests in Shenyang, Wuhan and Tianjin, as well as Qingdao in Shandong province. At the same time, Unicom had a subsidiary that controlled the rest of Shandong province. It was, he says, an impossible situation.

Investors were pleased with the changes. In June 2000, Unicom's subsidiary, China Unicom, raised US$5.4 billion through the largest IPO in Hong Kong in history. The listed arm owns Unicom's GSM business in 12 of the wealthiest provinces, its long-distance data business, DDD/IDD and paging service. Its combined assets represent around two-thirds of the group's total. The proceeds are being used to expand its existing services, and to develop its CDMA network which will provide better quality connections and easier upgrades to 3G services.

Although it only occupies a tiny percentage of the company's revenue, China Unicom is the only company in China to offer an alternative to GSM. Currently, the listed arm derives 72.5 percent of its revenue - 21.3 billion renminbi in 2001 - from its GSM service. Yet, its GSM service only occupies roughly 20 percent of the market - the rest belongs to China Mobile. If successful, the CDMA network can be Unicom's ticket into the big league.

Enid Tsui is editor of CFO China, CFO Asia's sister publication.