On 8 July, 2016, the world’s largest towerco, China Tower Corporation (CTC) finalised its leasing and pricing agreements with China Mobile, China Telecom, and China Unicom. The agreement outlined a pricing formula that offers deep discounts for co-locations. We dive into the details of the agreement plus offer a look at what the pricing formula means to the operators and the other independent towercos. (Yes, there are independent towercos in China!)
Lease agreement details
The terms of the lease agreement are for a five-year term covering:
1) Acquired towers
2) Newly constructed towers
3) Indoor distribution systems
4) Transmission products
5) Service products
Pricing formula
The pricing formula takes into account factors such as standardised construction costs, depreciation, maintenance expense, cost markup, and co-sharing discounts. The formula to be used for “newly-added telecommunications towers” is:
Product price = base price × (1 – co-sharing discount rate 1) + (site cost + electricity input cost) × (1 – co-sharing discount rate 2)
Base price = (standardised construction cost × (1 + impairment rate) + maintenance expense) × (1 + cost markup rate) useful lives of depreciation
Due to the variance in construction costs across different geographical areas in China, the 31 provinces are divided into four categories with a different adjustment rate for each. The impairment rate and cost mark up rate are fixed at 2% and 15% respectively. The maintenance expense is to be adjusted based on the final actual price. The site cost and electricity input cost are either priced on a lump sum or itemised basis.
Co-sharing discount rates
On new towers, a 20% discount will be applied for sites shared by two lessees and a 30% discount for those shared among three lessees, with the first sole occupier (“anchor tenant”) benefitting from a further 5% discount. When it comes to site cost and electricity, a co-sharing discount of 40% will be applied for two lessees and 50% for three lessees. Again, the anchor tenant would enjoy an additional 5% discount.
What does this mean for the operators?
On the one hand operators benefit by paying less rental fees as CTC takes in less revenue, but at the end of the day China Mobile, China Unicom, and China Telecom all have stakes in CTC, at 38%, 28.1%, and 27.9% respectively.
Back in March 2016, the Chairman of China Mobile, Shang Bing disclosed that during November to December 2015, China Mobile paid rental fees of CNY 5.6 bn to CTC. He also indicated then that early estimates of 2016 fees would be approximately CNY 35 bn. Local news media Sina also quoted Xue Taohai, the company’s Vice President and Chief Financial Officer as saying that while initial rental fees are similar to opex, as tower ratios increase, the costs are expected to decrease.
Compared to the last iteration, this new, finalised agreement allows all three operators to enjoy reduced rental costs when the newly engendered culture of infrastructure sharing encourages widespread co-location, with an estimated 10% cut in costs for China Telecom and 5-10% for China Unicom, according to a report by Nomura International.
With lower rental fees from the operators, this agreement means CTC would need to improve operational efficiency and drive down opex as it aims for an IPO in 2017.
“We expect China Mobile, China Unicom, and China Telecom will enjoy CNY 2.4 bn, 1.9 bn, and 1.8 bn leasing cost savings, which will boost their FY16F EBITDA by 1%, 2%, and 2% respectively,” said Leping Huang, Executive Director of China Telecom and Technology Research at Nomura. Also, as this agreement is retroactive, the leasing fees and losses from last year would need to be adjusted, though this is not expected to have much impact on the three operators’ 2015 earnings, said Huang.
What can we deduce from pricing figures?
Previously, none of the operators nor CTC have disclosed the actual number of towers in existence in China, possibly because they didn’t yet know as huge asset registers are still being reconciled and networks integrated. However, on 22 July, to celebrate its two-year anniversary, CTC released figures stating that up to the end of April 2016, it was responsible for operating 1.55mn sites, which we believe includes macro towers, rooftops, and IBS.
Nomura estimates there were just under 2mn towers leased at the end of 2015 by all three operators. Though note this is just a proxy for total tenancies, not for the actual number of towers.
CTC also revealed that it delivered on 485,000 out of 584,000 tower-related requests from the three operators in 2015. As of June 2016, CTC fulfilled 885,000 of 1mn requests overall.
Our sources suggest average tenancy ratio for CTC by year-end 2016 could be in the range of 1.15 to 1.35, given a lot of the old infrastructure was overlapping thus reducing the need for co-location, plus not all new build has been completed.
In the independent sector, average tenancy ratios are around 1.4 to 1.5. Prior to CTC pricing being released, average lease rates were roughly CNY ¥4166 pcm (US$625) per lessee, based on two MNOs co-locating.
CTC lease rates are significantly lower than anywhere else in the world, with estimates around CNY ¥26,000 per tower on an annual basis or CNY ¥2166 pcm (US$325). This figure is surprisingly low and suggests a business model calibrated in favour of the MNOs, leading one to question the impact on its future valuation as CTC gears up for an IPO.
Speculation continues as to whether CTC will list domestically as an A-share or open up to international investment through a Hong Kong listing. This latest pricing announcement suggests a leaning towards the A-share option, but no final decision has yet been reached.
No doubt international investors are keeping an eye on the space, but the latest pricing formula and lease rate estimates are raising eyebrows: will CTC be a profit centre or a cost centre? Is this simply a balance sheet re-engineering exercise, to take the costs off the MNOs? Or can CTC generate value through efficiencies?
While it’s too early to reach any conclusions, the government seems keen to expand the scope of CTC in the future. The latest news mentioned potentially having sensors on the towers to help provide traffic and environmental data; adding and monetising LED billboards through advertising sales; and playing a role in electric vehicle charging stations.
What does this mean for the other independent towercos?
The word on the street is that the three operators are still keen to engage with other independent towercos, especially as CTC cannot currently keep up with demand for new build in all provinces. The formation of CTC means the operators are not allowed to build their own towers anymore.
China being such a large country, it has a lot of local tower builders serving various regional areas. Their existing contracts with the operators largely remain intact. However, there is a sense of pricing pressure moving forward now the biggest player has set a downwardly revised marketplace benchmark, apparently after a review of what the other independent towercos were charging. But China’s myriad of ~200 independent towercos can still play a role – as long as their pricing is kept just below what CTC is offering.
