Telecoms Key Test of China’s Accessibility

It should have been Qualcomm Inc.’s time for celebration. One of China’s leading telecom firms recently signed $1.5 billion in contracts for equipment using the San Diego firm’s wireless standard.

That move by China Unicom is the most positive sign yet that Qualcomm’s code division multiple access technology--known as CDMA--has a profitable future in China, which has an exploding mobile phone market now dominated by Europe’s competing GSM system.

The current success has been a long time coming. In the years that Qualcomm has been chasing its China dream, it has been foiled numerous times. Contracts were supposed to be signed months earlier, but reportedly got caught up in domestic political squabbles and U.S.-China tensions.

Which might explain why Qualcomm’s response to the long-awaited news was a cautious statement that it “looks forward to seeing the roll-out of CDMA in China this year.” Qualcomm’s protective stance reflects the scars of doing battle in one of this country’s riskiest and potentially most lucrative industries. The fast-moving telecommunications industry is where some of the world’s biggest names have been burned by China’s unique way of doing business. It also is where the potential rewards, in the hundreds of millions of dollars, eclipse those of other markets.

The telecommunications industry is like the canary in the mine shaft, an early-warning system to detect whether China can carry out the changes the international community demands as the price of admission to the World Trade Organization.

The challenges are huge. China will have to alter the rules of competition without jeopardizing the power of the Communist Party, open lucrative government monopolies to foreign competition while protecting domestic franchises, and create channels for new information that could prove to be destabilizing.

As part of these complex reforms, the government is deregulating the telecom sector, moving from a single, state-owned provider--China Telecom Corp.--to a marketplace with half a dozen carriers, dozens of foreign and domestic hardware providers and a profusion of companies offering Internet services and related products.

The potential for a dramatically different post-WTO world--coupled with the fact that China’s is one of the few economies still expected to grow at healthy rate in the coming year--has triggered a flurry of activity as foreign firms snare partners and cut deals designed to give them first-mover advantage.

But China experts warn against unrealistic expectations of exactly what the Chinese government has agreed to and how quickly this huge, complex economy can be restructured.

“The Chinese still believe in the Chinese economy for Chinese companies,” said Peter Lovelock, an analyst with Madeforchina.com, a Beijing-based consulting firm. “So they will continue to provide enough support to maintain national champions and keep enough barriers in place to slow the foreigners down.”

Getting in on the early days of China’s telecom boom could be extremely profitable. In 1997, under pressure from U.S. trade officials, China reluctantly agreed to allow Qualcomm’s CDMA standard to be tried on a limited basis. But today CDMA, which primarily is used in the U.S., Japan and South Korea, has only a fraction of the country’s 110 million mobile phone users.

Patrick Horgan, a telecom expert in the Beijing office of APCO Associates, a Washington consulting firm, said heavy U.S. lobbying and the “unequivocal and public support” of Chinese Premier Zhu Rongji kept the CDMA battle alive.

With the contract announcement, government-backed China Unicom appears finally to be launching a national CDMA network that is expected to charge much lower rates than its GSM competitors. Qualcomm is expected to earn royalties on all equipment and handset sales. In addition, five foreign firms are sharing in the $1.5 billion in contracts for CDMA network equipment. They are Lucent Technologies Inc. and Motorola Inc., Sweden’s Ericcson, Nortel Networks Corp. of Canada and Samsung Electronics Co. of South Korea.

But companies such as Qualcomm, Sprint Corp. and AT&T; Corp. also can attest to the dangers that can befall a foreigner wading into China’s highly politicized and chaotic telecommunications arena.

China’s government-backed firms--like their competitors in other countries undergoing telecom privatization--are struggling to keep their protected status for as long as possible. Government officials also are torn between a desire to exploit the information revolution and a fear of foreign domination of an industry that is not only extremely lucrative but also is a powerful tool for exerting political control.

Huge Potential Payoff

Telecom deals are particularly vulnerable to government policy shifts because they often take place through “back-door” arrangements that may not be legal under present laws but are expected to be exempted after China joins the WTO. Similar deals crop up in other parts of the economy but are more likely to surface in telecom because the potential payoff is so huge.

Take the February announcement that Rupert Murdoch’s News Corp., Goldman, Sachs & Co. and two Chinese companies invested $325 million in China Netcom, one of China’s newer government-backed telecom firms. Foreigners still are banned from investing in basic telecom services, though China has agreed to allow up to 49% foreign ownership in that sector post-WTO.

James Murdoch, a senior News Corp. executive and son of founder Rupert Murdoch, said the deal is legal but would not elaborate on how his firm was able to circumvent the foreign investment ban. China Netcom also refused to comment on that issue.

But Murdoch said he was willing to “push the envelope” of regulatory controls to best his competitors in China. “Once you have WTO accession, everybody and their brother is going to rush in.”

China’s commercial history is littered with foreign firms that have ventured into special business deals with local, or sometimes even central, government approval and then been burned when the policy winds shifted. The most infamous case involves China Unicom, which was launched by the Chinese government in 1994 to provide competition for the state-owned giant, China Telecom.

To build its mobile network quickly, Unicom sought partnerships with multinational giants such as Sprint, Motorola, France Telecom and Siemens and created a special legal structure known as China-China-Foreign (CCF) designed to circumvent restrictions on foreign investment. More than $1.4 billion poured into about 40 joint ventures around the country.

But the Chinese government later changed its mind about relinquishing so much control to foreign entities and decided instead to raise money by taking China Unicom public. In spite of a huge outcry, the government declared the CCF deals illegal in 1998.

The foreign investors recovered their initial investments but the returns were far less than they had expected from the explosive growth in China’s wireless industry, which already is the world’s second-largest market.

Chinese Leaders Divided

Most foreign firms quietly accepted the settlement, fearful of burning their bridges with the Chinese. Douglas MacLellan, a Southern California telecom investor, is one of the few who have complained publicly about being cut out of a potentially lucrative deal. But short of taking his case to an international tribunal, he isn’t sure what legal recourse he has, given the weak Chinese legal system.

“Our shareholders are very unhappy,” he said. “But what can you do?”

Battles over telecom regulation are not unique to China. But this arena is particularly sensitive in this one-party state because Chinese leaders remain deeply divided over the best strategy for development, say China telecom experts.

China’s top leaders recognize that they need foreign technology and investment to jump-start their information technology sector and modernize their aging factories quickly enough to keep their giant economy growing.

But they also believe that maintaining control over the country’s basic communications network is crucial to national economic sovereignty and security.

Given those concerns, analysts are doubtful China will allow foreigners to gain control of basic fixed-line telecom companies such as China Telecom or China Unicom.

That is particularly true now that China’s state-owned giants have discovered they can raise billions through the capital markets. China Telecom plans to go public on the Hong Kong and U.S. stock markets this year.

“Will there even be any willing Chinese operators [looking for foreign partners] if they can already access foreign capital through an IPO?” asked Robert Lewis, Asia general counsel for Nortel Networks.

However, Chinese bureaucrats have discovered that relinquishing control to capital markets exerts a different kind of pressure.

When the government unexpectedly disclosed this year that it planned to lower the charges for mobile phone users, the share prices of China Mobile and China Unicom plummeted on fears their profits would be hurt. Telecom officials quickly backtracked.

“That was an interesting example of the increased role capital markets are playing in [government] policy,” said APCO’s Horgan. “In many respects, China is becoming a more normal country.”

China’s path to normalcy has been particularly rocky for foreign telecom firms.

It took AT&T; seven agonizing years to nail down a joint-venture agreement with the Shanghai branch of China Telecom to provide broadband services to foreign firms in Pudong, a fast-growing special economic zone across the Huangpu River from the historic Bund. General Motors Corp., IBM Corp. and Intel Corp. are among the multinationals that call the area home.

Arthur Kobler, a former U.S. diplomat hired to shepherd AT&T; China’s projects through China’s bureaucracy, said the Shanghai deal, which was approved last fall, was delayed by corporate turmoil related to AT&T;’s domestic restructuring and setbacks in China’s telecom deregulation.

But Kobler remains confident the Pudong project--which marks the first time a foreign firm was allowed to provide telecom services in China--will turn a profit within six years and be a strategic beachhead in AT&T;’s effort to wire the commercial centers of the world.

Kobler admitted that the China project has been the subject of “a lot of jokes” within AT&T; because it took so long to complete. But he remains confident that the naysayers will be proved wrong.

“I think we’ve proved the China market has a lot of potential,” he said, pointing to the Shanghai deal, which he believes will open the door for other telecom ventures in that booming financial capital.

For smaller foreign firms, one strategy for staying on the right side of China’s constantly changing laws is to portray themselves as less threatening to China than, say, AT&T.;

Bob Hong, a Taiwan-born entrepreneur who has been doing business in Asia for two decades, said he convinced Chinese officials that his firm, Multacom Corp., would be a more trustworthy partner than the larger multinationals vying for their business.

“AT&T;, they want to dominate the market [in China] so they are a threat,” said Hong, chairman of the board of Multacom. “We are sincere and we really want to be a partner.”

More Opportunities

Multacom, a broadband provider based in Industry, has formed a joint venture with China Railway Telecom, which has 74,000 miles of fixed lines and 26,000 miles of fiber-optic cable previously used for communication within the Ministry of Railways.

Due to limitations on foreign firms, Multacom’s joint venture, known as China Railway Netsol Technologies, can’t directly provide telecom services in China. Instead, the joint venture is importing telecom equipment and providing consulting services to Chinese firms.

But Rolin Liu, the Beijing-based general manager of the joint venture, is confident he will be able to expand into more lucrative telecom services after China joins the WTO.

“In the future, there will be more opportunities,” he said.

Multacom also has signed an agreement with China Unicom to provide broadband connections between the United States, China and Taiwan. The Chinese telecom firm serves the China side and Multacom provides the connection within the U.S.

The company has three data centers in the U.S. and is leasing capacity from the multinational consortium that laid the first fiber-optic cable between the United States and China.

There is another advantage to Multacom’s global partnership that won’t be found in the company’s news releases.

Once China joins the WTO, Taiwan also is expected to become a member. Most China observers say this will force the lifting of the politically imposed trade barriers, which would unleash a huge demand for direct communications between Taiwan firms and their mainland subsidiaries, multinationals operating in the region and families separated by politics.

Multacom officials--who are partners with Taiwan’s giant Chunghwa Telecom--said they hope to be among the first to offer direct telecom services between the two longtime adversaries once the door is opened.

“This is a good opportunity,” said Liu. “We want to do this very quickly or maybe China Telecom or Unicom will get this business.”