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Fitch: China's Telco Rate Changes Will Not Reduce China Mobile's Dominance

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Fitch Ratings says that China's latest cut in mobile interconnection rates will be insufficient to achieve its goal of creating a level playing field by redistributing profits from China Mobile to smaller operators.

Fitch believes that China Mobile will retain its strong market leadership position as we estimate that the proposed changes will reduce EBITDA by just 3%. The EBITDA of the second-largest operator, China Telecom, will likely rise by 3%. The ratings agency believes these changes in themselves will not be material to the companies' market positions and credit ratings, although China Mobile's ratings headroom will be reduced.

With effect from 1 January 2014, the mobile interconnection rate that China Telecom and third-largest operator China Unicom pay to China Mobile for most calls will be reduced to CNY0.04/minute. However, the rate that China Mobile pays to China Telecom and China Unicom will be maintained at CNY0.06/minute. In addition, the settlement rates for SMS and MMS would also be reduce to CNY0.01/message and CNY0.05/message respectively.

Fitch expects competition to partially offset the potential benefits to China Telecom and China Unicom, and put further pressure on China Mobile's profitability. The cut in the mobile interconnection rate payable by China Telecom and China Unicom will lower their average cost for voice traffic and may lure them to reduce tariffs to gain market share. In 1H13, the average mobile voice revenue per minute for China Telecom was CNY0.10, and CNY0.08 for China Mobile. However, Fitch does not expect a price war, as China Telecom and China Unicom focus more on mobile data than the traditional voice business.

Competition from over-the-top (OTT) operators, which provide voice, messaging and other content and services over the internet, is another rating driver. Fitch forecasts that China Mobile's revenue growth will slow, and profitability will remain under pressure due to intensifying OTT substitution. In 1H13, China Mobile still received 69% of its revenue from traditional voice and SMS services, which tend to command higher margins but have higher substitution risk. Fitch expects EBITDA, at best, to remain stable, as margins will continue to decline.

For China Telecom, Fitch expects its operating EBITDA margin to remain steady over the next two years, driven by steadily rising mobile market share and improvement in subscriber quality. However, stiffer broadband competition may constrain margin improvement. The agemcy said that it believes that China Telecom will also pass on benefits from the cut in interconnection rate to customers. They do not expect China Telecom to deleverage in the next two years and its higher 4G capex will keep its funds flow from operations-adjusted net leverage at around 1.4x in 2014.

China Mobile dominates China's telecoms industry, accounting for 53% and 57% of the industry's service revenue and EBITDA, respectively, in 1H13. China Mobile had a 62% share of China's mobile subscribers in October 2013, though the company has been put at a disadvantage in 3G technology as it was tasked to roll out the locally developed 3G technology, which is less mature and less competitive.

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