An insider’s view: how the tower market works in China

China is about to make international headlines in the telecom press when a million towers, rooftops and DAS are transferred from China Mobile, China Unicom and China Telecom to the recently created China Tower Company (CTC), representing the clearest indication to date that China has embraced infrastructure sharing. What readers may be less aware of is the fact that there are around 15,000 independently owned towers in China. With abundant organic growth opportunities, the Chinese independent tower sector could represent an interesting opportunity for international investors, if those investors can comfort themselves that the market offers sufficient transparency. TowerXchange and Q Towers’ CEO Ted Zhong are on a mission to create that transparency!

TowerXchange: Ted, Please introduce yourself and Q Towers.

I’m a telco veteran with 15 years of executive experience. Before I founded Q Towers I was with China Netcom, a nationwide telco later merged into China Unicom, and Wasu Media Network, a listed carrier similar to COMCAST.

Q Towers was founded in 2007 and has been the pioneer of introducing tower business to China.  So far we have 100 ground based towers (GBTs) and 20 rooftops with an extraordinary tenancy ratio of 2.8.

TowerXchange: Please introduce us to the Chinese tower market; we’ve heard reports that there are 1-1.3mn towers, of which China Mobile currently own around half, with Unicom on 30% and Telecom on 20% – before the assets are transferred to China Tower Company (CTC). Are we about right?

If we say 1-1.3mn BTSs rather than towers, then the numbers are correct. Unfortunately Chinese carriers did not distinguish their BTSs as towers, DAS or rooftops historically. We can only estimate that half of them are towers.

Most new build towers in China are monopoles – they consume less land and look prettier!

TowerXchange: How complete is coverage and the progress from 2G and 3G to 4G, and the associated network densification? At what rate are new towers being built?

Unlike anywhere else in the world, the Chinese carriers do not allow subscribers to roam between each other’s networks. That’s why all three wireless carriers here need complete coverage, and they have achieved that.

For instance a Provincial capital city in China would require one to two thousand new builds of BTSs and at least half of them would be GBTs. There 30+ cities like this and hundreds of cities with lower numbers.

Coverage in China is at 98%+ percent, which is rare in the rest of the world, and densification builds are seemingly endless.

Since all three carriers in China were SOEs (State-Owned Enterprises), they have a mandate to provide 100% geographical coverage. Even for remote areas with few subscribers.

TowerXchange: I understand that Q Towers were pioneers in the creation of an independent tower market. What is the structure of the Chinese tower market before and after CTC? How many independent towers are there and who owns them?

Before CTC was established there were only a few private tower operators in the market with small portfolios. The total number would have been around 2,000 nationwide.

After CTC made its grand entrance, hundreds of small towercos popped up throughout the country. My assumption would be that they own around 15,000 towers in total. Usually these owners come from a telecommunication contractor background. It makes sense for a pipeline company move into the tower business.

TowerXchange: What are the implications of the creation of CTC for China’s independent towercos?

The creation of CTC has removed couple crucial obstacles for independent towercos.

1. It validated the market.

2. It forced the carriers to change their budgeting system at a corporate level: no more capex and lots and lots of opex. This broke the glass ceiling we once had with all carriers when their total expenditure on leasing sites exceeded their opex capacity.

3. CTC will soon settle a valuation and risk control benchmark for all financial institutions in China. This will allow us all to access more affordable debt, and will ensure the recognition of towers as pledge-able assets.

4. CTC is offering US$80,000 to acquire towers from the market, so there is one more exit for us.

TowerXchange: Is that a standing offer of US$80,000 per tower regardless of the tower cash flow generated per site? It sounds like an attractive offer for some towers, but not a great offer if you have a tenancy ratio of 2.8!

Right now CTC don’t seem to care how many tenants are on a tower – they’re offering to buy existing sites because they are struggling to meet the targets set by the carriers’ search rings.

CTC was contracted to build 120,000 new towers, but I would estimate they only have capacity to build around a third of those sites. 120,000 is a huge number for a new company to build, so the industry is turning back to independent developers to supplement their capacity because they realise they can’t put all their eggs in one basket. CTC is looking for every possible opportunity to fulfill the search rings, for example, if they can use one operator’s tower to fulfill another operator’s site requirement, they will co-locate even though the existing towers haven’t been transferred to them yet.

TowerXchange: When do you think the transfer of China Mobile, China Unicom and China Telecom’s existing towers to CTC will actually take place?

A press release suggested the legacy tower assets would be injected into CTC by the end of August 2015,

The asset registers probably need to be audited and cleaned (which is why it’s impossible to provide an accurate tower count for China), so I think full integration will be at least one year from now.

TowerXchange: Can you still build towers independently? Can you acquire other towercos?

The truth is everyone is building towers and leasing to all three carriers as we speak.

It is natural for carriers not to put all their eggs in one basket. Besides, records show that CTC can barely deliver a third of the required new builds. That leaves us a huge gap in the market for independent towercos to grow.

Yes we can acquire other towercos. In fact if I wasn’t capital constrained, I would have acquired decent assets with a tower count of several hundred already.

TowerXchange: Are we right that China Mobile has not shared much infrastructure, but Unicom and Telecom have shared on a case by case basis, meaning few towers have multiple tenants on them in China?

Yes.

TowerXchange: What kind of tenancy ratio growth has been achieved in China?

Q Towers has 2.8, but it is not realistic to expect to sustain such high tenancy ratios at a large scale. We believe a tenancy ratio of 1.8 – 2 is a realistic near term goal for independent Chinese towers.

TowerXchange: What lease rates are typical in China?

Lease rates are consistent in China. In well-developed areas, lease rates are around US$800-1,000 per carrier per platform per month. In remote areas it’s US$650-700 per carrier per platform per month. Once CTC settles pricing guidelines, the rent may rise higher than historical numbers.

Each carrier does not need just one platform because each carrier runs multiple networks and needs multiple tenancies. So whereas in the U.S. each carrier might need only one RAD centre, China Mobile alone own three different networks which require three different platforms. Admittedly towercos don’t usually charge 3x, providing a discount for purchasing in bulk.

TowerXchange: What business model is operated by Chinese towercos; steel and grass or full service inclusive of power?

Our position is analogous to that of a landlord. There are three components to the service we prove: tower, shelter and connections to the electricity grid, and we sometimes use them as bargain chips – if you want lower rental rates, maybe we exclude one of the services. We have limited responsibility for security: we provide the shelter, but anything outside the shelter remains the tenant’s responsibility, not the tower operator’s.

We don’t provide backup batteries, diesel generators (DGs) or air conditioning; these remain the responsibility of the carrier. Although I’ve never seen an onsite DG – the Chinese operators all have portable backups, and almost all sites are on grid. Frankly I’ve not seen a country that enjoys such reliable power supply in Asia.

TowerXchange: Is it quick and easy to get a permit to build a tower in China?

Compared to a tower market like the U.S., there are less specific  permitting requirements in China. Permitting a tower in the U.S. is subject to a zoning system which my American friends describe as a “long and painful road!” In comparison, the process of securing permission to build a tower in China has never been as strict as in the U.S.; there is no specific permitting process for towers in China. This is because historically telecom companies were SOEs, so there was no such thing as permitting, they would just build. There are still urban planning regulations of course, but the government still treats Chinese MNOs like insiders.

There is no registration system that says a tower operator owns land, or that title can be exchanged, indeed lots of people build telecom towers in China without following any procedure, and the reality is that many of the existing towers to be rolled into CTC have not followed a procedure, but they will still be fine.

However, Q Towers and members of our consortium of the country’s leading independent towercos all follow a code: we all secure urban planning permission and certificates of rights of way, which we feel represents best practice in China. We’re hoping the creation of CTC will raise the bar for independent tower operators by instigating a more formal, specific process for permitting telecom towers as CTC’s assets need to be run through the risk management processes of banks.

TowerXchange: What do out international readers need to know about land ownership and urban planning in China?

Legally the Chinese government owns all the land, but usually they will rent or sell certain usage rights to all kinds of entities, including SOEs and private companies. So it’s not the land owner but the usage rights owner who has to be negotiated with and paid if you want to build a tower.

Even if the usage rights owner signs a contract, legally you still need the permission of the government, so you must apply to the local Urban Planning Bureau (similar to the Zoning Board in the U.S.). As in many tower markets, if you have right connections you are more likely to get the answer you are hoping for! It remains more challenging to secure approval to build towers in urban than in sub-urban and rural areas.

TowerXchange: How is the area around a tower protected to ensure that, for example, another towerco cannot build a tower across the road from yours?

I feel the protection of tower assets in China is greater than in India, for example, where it seems you can build almost anywhere. Chinese towers are protected by local and central government.

Local government has the capability to protect against the building of parallel infrastructure. A department which you might translate as ‘City Administration’ can issue a notice to tear down an unpermitted site over the road from an existing tower, or they can intervene directly to prevent the build.

Central government protection provides even more robust protection of cell site locations. All carriers and their senior executives are appointed and managed by the government; there is a department SASAC who says who goes where and who stays – they’re ultimately the entire Chinese telecom industry’s boss. That department has issued a directive that essentially translates as “anybody who overbuilds towers – the person who is responsible will be removed from their post and will not regain their position for the next three years.” Effectively the Chinese government, your boss, is telling you if you build parallel infrastructure, then kiss goodbye to your career!

I haven’t encountered any overbuild in China since then.

TowerXchange: What is the ownership structure of Q Towers? Can international entities participate in the Chinese tower market?

Q investments owns 90%+ of the company while TZG and a prominent US tower entrepreneur (personally) owns the rest.

We have been active in the tower business for eight years and we have encountered no regulations to prevent us from securing foreign direct investment.

TowerXchange: Why is Q Towers primarily backed by international investors as opposed to by the Chinese capital markets?

The Chinese capital markets lack maturity; they are severed from the rest of the world, more politically dominated.

Consider the two most obvious ways to finance a tower company: debt and equity. Your cheapest option is securing debt direct from a bank, but if the bank does not accept your main assets, telecom towers, as pledge-able assets, then raising debt is not an option.

The other option is through equity. If you want to issue a public offering and get listed in China, the first requirement is that your company has to be profitable. Yet an expanding towerco typically doesn’t achieve profitability for several years. While the tower industry is recognised internationally as a sound platform for debt funded acquisitions, the requirement to be profitable means an IPO is a dead end for many Chinese towercos too.

Venture Capital and Private Equity firms here have no idea what the tower business is – most have same ideas as banks: if the company is not immediately listable in China, it’s not investible. Even when those investment firms call their headquarters in the US, back there they have concerns about a perceived lack of scalability and transparency of Chinese telecom towers.

TowerXchange: What does it cost to build a typical Ground Based Tower in China? And are there any benchmarks for the value of a Chinese telecom tower?

The average cost for tower and its foundation should be US$48,000.

We need a benchmark for the valuation of Chinese tower assets to provide proof and recognition of their value to banks.

CTC has the aforementioned standing offer to acquire towers for US$80,000 each, but that does not take into account tenancy ratios, lease rates and the quality of the assets, so it’s not a good benchmark.

I would expect the spinoff of CTC to be finished by the end of this year, which would suggest an IPO by 2017. Before that they will get huge loan from the Chinese National Development Bank, backed by a pledge of their own tower assets. That will set a benchmark for valuation of towers as pledge-able assets. Until Chinese banks recognise telecom towers as pledge-able assets, they don’t know how to sell them and they don’t know what they’re worth.

TowerXchange: How are Q Towers and your peers in your consortium seeking to create the scale necessary to attract ‘smart money’?

We are currently working on an idea to form an investment vehicle under which we can place 500-800 towers from various high quality, legally sound and robustly constructed independent Chinese tower portfolios, which together expect to grow to over 1,000 towers in the next six months. That investment firm would then have a track record of building and rolling up a substantial portfolios of Chinese towers.

There is the possibility of integrating these portfolios into a single trading entity, indeed all the members had at one point been prospective acquisition targets for Q Towers, but whilst we continue to try to secure the right capital to aggregate towers, the other companies have continued to operate by themselves and have done well.

Ultimately I feel that any of us fighting alone can’t win the war, but together we would represent a very profitable combination for a foreign investor looking for a growth opportunity with a potential future exit strategy either domestically to CTC or perhaps to an international towerco like American Tower, Tower Bersama or Digital Bridge.

TowerXchange: Having spoken to several international investors with a track record of investing in telecom towers, it seems that the number one concern when it comes to evaluating opportunities in China is a lack of transparency.

I’m not surprised. Few Chinese tower companies have English language websites, and there is limited information available on CTC.

We’re hoping to bring a delegation of stakeholders in the Chinese tower industry to the TowerXchange Meetup Asia this year to meet with the international community, to share best practices, and to share our insights into the investibility of Chinese towers.

TowerXchange: Please summarize your vision for the future of Q Towers and of the Chinese telecom tower industry.

The Chinese tower market is facing its first gold rush. However the local capital markets were not completely ready to lead the first round. There is a great window for seasoned international investors to take the lead and support the first wave of consolidation.

Comparing China with India, the regulatory environment, the infrastructure, the scale, and value chain have much in common. I have strong reasons to believe that China will lead the global market both in terms of size and valuation (CTC will be listed in China and the Central Government and MNOs as share holders/customers will be happy to see a really high valuation).