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China Tower pursues 5G ambition with $6.9bn Hong Kong IPO

Investors wary of low profitability and fallout from US-China trade friction

China Tower Chairman Tong Jilu speaks at a news conference on the company's initial public offering in Hong Kong on July 24.   © Reuters

HONG KONG -- Despite the shock waves from a full-blown trade war with the U.S., China continues to harbor a dream of being a global leader in fifth-generation wireless communications.

It has sent China Tower, the world's largest telecom tower operator and spearhead of Beijing's ambitions, to Hong Kong with the task of holding the largest global initial public offering in two years. The state-owned company raised $6.9 billion, and its shares will begin trading on Hong Kong Stock Exchange on Wednesday at an offer price of 1.26 Hong Kong dollars a share, the lower end of its proposed range.

Investors may be wary of China Tower. It is far from a profit generator and the communications sector is one of the industries targeted by the Trump administration, which is ratcheting up tariffs on Chinese products. Moreover, its business, construction of communications towers, is not exactly at the cutting edge of next-generation wireless communications.

About 60% of the IPO proceeds, roughly $4 billion, will go to building smaller but more accurate base stations.

China Tower was created in 2014 by China's three state-backed telecoms providers, China Mobile, China Telecom and China Unicom, which pooled their transmission facilities to cut costs and avoid duplicating investments.

The company is strategically important to China's drive to become a "cyber power." Among Beijing's goals are to have commercially available 5G service by 2020. The next generation of wireless technology will not only increase mobile internet speeds by up to 100 times compared with 4G, it is also essential for new internet services such as driverless cars and telesurgery.

But a large-scale deployment of 5G in China requires a major upgrade of China Tower's base stations. The company owns and operates 1.9 million of these across the country, and has a market share of 97%. However, it will also have to build many more cells, packed more closely together. This is because 5G signals do not travel as far as those used in 4G.

Creating more cells will require heavy investment. China is expected to spend 1.2 trillion yuan ($180 billion) within the next five to 10 years to get its 5G network up and running, and set up 2.4 million 5G transmitters by 2022, according to a report by consultancy Frost & Sullivan. Senior managers at China Tower must find a way to pay for that investment despite already carrying a high level of debt due to the company's rapid expansion.

As of the end of March, China Tower's total debt stood at 160.4 billion yuan, of which 70% will fall due within a year, according to its prospectus. That was up from 156.3 billion yuan in 2017 and 140.0 billion yuan in 2016. Its gearing ratio also rose to 53.8% in 2017, up from 49.4% in 2016.

In fact, about 30% of the IPO proceeds, or about $2 billion, will be used to repay bank loans with annual interest rates between 4.35% and 4.75%.

Despite a market valuation of $28 billion, China Tower's profits are thin compared with its global peers. It earned 1.9 billion yuan on sales of 68.67 billion yuan in 2017, while New York-listed American Tower Corp. made a profit of $1.23 billion on sales of $6.66 billion during the same period.

The poor profitability is partly due to the company's "sandwich" relationship with its shareholders, who are also its clients. China's three telecoms companies together own more than 90% of China Tower. They also accounted for more than 99% of its total revenue last year. This makes it hard for the state-owned tower builder to negotiate higher prices despite its monopoly position in China.

"China Tower's profit margin will be kept low by the state, even with it rolling out 5G-related services," said Harry Yuen, associate director at Oceanwide Securities, as the authorities want to make high-speed wireless communications affordable for ordinary people.

According to a 2015 report by New Street Research, toweroperators in China charge an average $750 per tower in monthly rent, while their American counterparts charge $2,000. Rental fees are also lower in China than in developing countries such as Indonesia, Thailand, Chile and Colombia.

The company's low profitability makes China Tower less attractive to international investors, particularly at a time when the broader stock market is weak. Hong Kong's benchmark Hang Seng Index is down 16% from its January peak, closing at 27,819 on Monday, with the escalating trade war between the U.S. and China weighting on market sentiment.

Nevertheless, Edison Lee, an analyst at Jefferies, said in a report that China's 5G timetable is not likely to be affected by the U.S.-China trade tensions despite Washington's recent ban on high-tech exports to 44 Chinese companies, including those operating in the in nuclear, chemical, electronics and telecommunication sectors.

"The 44 Chinese companies newly placed under the export ban are defense- or Belt and Road-related," Lee said. He believes the U.S. government will keep trade with China open for "civilian" technologies such as telecoms, as there is a "significant U.S. commercial interest" that would be at risk if U.S. tech companies cannot sell to China, he said.

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