China / Hong Kong Industry Focus Hong Kong Telecom Sector Refer to important disclosures at the end of this report DBS Group Research . Equity 25 Apr 2017 Spectrum re-assignment putting mobile operation at risk HSI: 24,139 • Re-assigning 60% of 900 MHz and 1800 MHz spectrum through auction ANALYST • Expect the related spectrum utilisation fee to Tsz Wang TAM CFA, +852 2971 1772 [email protected] increase by more than 100%, impacting mobile Chris KO CFA, +852 2971 1707 operators’ earnings by 3-14% [email protected] • Potential new entrants such as China Unicom will intensify market competition • Maintain cautious view on HK mobile market Expect new entrants into a crowded mobile market. Between November 2020 and September 2021, mobile operators’ 15- Recommendation & valuation year licences for 49.8 MHz of spectrum in the 900 MHz band and 148.8 MHz of spectrum in the 1800 MHz band Company Price T arget Rec Mkt FY18F (collectively 2G spectrum) will expire. 40% of the expiring Price Cap Yield HK$ HK$ US$m % spectrum will be kept by the incumbent operators while 60% of the spectrum will be re-assigned through auction. The Hong Kong Telecom operators auction may introduce new entrants from China such as China HKBN 8.15 12.2 Buy 1,054 7.3 Unicom Hong Kong which has indicated its interest to (1310 HK) participate in the auction. HKT Trust 9.94 13.5 Buy 9,675 6.9 (6823 HK) Higher spectrum utilisation fee puts earnings at risk. Based on Hutchison Telecom 2.29 2.4 Hold 1,419 5.4 the current proposals to determine the new spectrum (215 HK) utilisation fee (SUF) for the 2G spectrum, we expect the SUF to Smartone Telecom 10.2 10.4 Hold 1,454 5.1 increase from an average of HK$1.45m to HK$3.95m per MHz (315 HK) per year, representing an 100%+ increase. As a percentage of earnings, we expect Hutchison Telecom (HT, 215.HK, HOLD) to Source: Thomson Reuters, DBS Vickers be impacted the most by higher SUF followed by SmarTone (SMT, 315.HK, HOLD). We expect the increase in SUF to represent 14% and 9% of HT’s FY17F and SMT’s FY6/17F earnings respectively. HKT (6823.HK, BUY) will be least impacted as the increase in SUF will only represent 3% of its FY17F earnings. Maintain cautious view on HK mobile market. We do not favour telecom operators with large exposure to mobile operation such as SMT and HT in the sector as the 2G spectrum re-assignment may introduce new Chinese entrants into the mobile market and incur higher SUF in the medium- term. The market has yet to price in the potential earnings risk, in our view. Moreover, industry wide mobile tariff hike is challenging in the near-term as competition remains intense. Maintain HOLD on SMT and HT. We prefer HKT and HKBN (1310.HK, BUY) as they have less exposure to mobile business in terms of percentage of earnings. We also expect them to enjoy ARPU and profitability upside in the duopoly-like residential broadband market in the medium term. Maintain BUY on HKT and HKBN. ASIAN INSIGHTS VICKERS SECURITIES ed-TH/ sa- DL Industry Focus Hong Kong Telecom Sector Background of 900 MHz and 1800 MHz spectrum re- the 1800 MHz band which are currently vacant, a total of 200 assignment MHz of spectrum will be re-assigned. The re-assignment is a major reshuffle of spectrum resources as 2G spectrum, Mobile operators’ 15-year licences for 49.8 MHz of spectrum in totalling 198.6 MHz of spectrum, accounts for 36% of a total the 900 MHz band and 148.8 MHz of spectrum in the 1800 of 552 MHz of spectrum in Hong Kong and 45% of spectrum MHz band (collectively 2G spectrum) will expire between deployed for 4G network service. November 2020 and September 2021. Together with 0.2 MHz of spectrum in the 900 MHz band and 1.2 MHz of spectrum in Mobile spectrum allocation 2500/ Frequency band 850/900 MHz 900 MHz 1800 MHz 2100 MHz 2300 MHz 2600 MHz Total Unit: MHz CM HK - - 26.4 19.6 30.0 40.0 116.0 HKT 15.0 16.6 72.8 29.6 - 60.0 194.0 HT 10.0 16.6 23.2 29.6 30.0 20.0 129.4 SMT 10.0 16.6 26.4 39.6 - 20.0 112.6 Total 35.0 49.8 148.8 118.4 60.0 140.0 552.0 Source: Office of the Communications Authority, DBS Vickers 2G spectrum was firstly assigned in the 1990s for the provision to provide 3G services. We expect the demand for the of 2G services and was re-assigned in the period of 2005/2006. spectrum to be high as 4G services will be the major mobile Now, 145.6 MHz of the 2G spectrum has been refarmed to services in the next few years before the 5G era. provide 4G services and 9 MHz of spectrum has been refarmed Application of radio spectrum in the provision of public mobile telecommunications services Frequency band 2G 3G 4G CDMA 2000 Total unit: MHz 850/900 MHZ 20.0 15.0 35.0 900 MHz 15.2 9.0 25.6 49.8 1800 MHz 28.8 120.0 148.8 2100 MHz 98.6 19.8 118.4 2300 MHz 60.0 60.0 2500/ 2600 MHz 140.0 140.0 Total 44.0 127.6 365.4 15.0 552.0 Source: Office of the Communications Authority The first consultation on the re-assignment has finished on 18 May 2016 and the second consultation has begun and will finish by the end of 24 Apr 2017. Final decision on the arrangement of spectrum re-assignment and the related SUF will be made by the end of 2017. Based on our analysis on the current spectrum re-assignment proposal, we expect mobile operators to suffer from higher spectrum utilisation fee (SUF), more competition from new entrants, and loss of spectrum resources. Page 2 Industry Focus Hong Kong Telecom Sector Approach to re-assign 2G spectrum 1. 2 x 10 [=20] MHz of spectrum in the 1800 MHz band will be re-assigned to each of the four incumbent spectrum After the first consultation, the regulator has proposed that assignees with the right of first refusal (RFR spectrum). 40% of the expiring spectrum will be kept by the incumbent 2. The remaining 70 MHz of spectrum in the 1800 MHz operators and 60% of the spectrum will be re-assigned band and all the 50 MHz of spectrum in the 900 MHz through auction (also refer to the graph below). Under the band, totalling 120 MHz, will be assigned by through proposed re-assignment: auction (auction spectrum). Proposed band plan for the 1800 MHz frequency band Auction HKT Auction SMT CMHK HT Auction Auction Lower band 1710 MHz 10 10 10 10 10 10 10 5 1785 MHz Auction HKT Auction SMT CMHK HT Auction Auction Upper band 1,805 MHz 10 10 10 10 10 10 10 5 1,880 MHz HKT RFR Spectrum to be offered to HKT SMT RFR Spectrum to be offered to SMT Auction Frequency slots to be re-assigned by way of auction CMHK RFR Spectrum to be offered to CMHK HT RFR Spectrum to be offered to HT Source: Office of the Communications Authority Proposed band plan for the 900 MHz frequency band Lower band 890 MHz 55555915 MHz Upper band 935 MHz 55555960 MHz Frequency slots to be assigned by way of auction Source: Office of the Communications Authority Risks: introduction of new entrants and loss of spectrum mobile network to maintain the same network quality with less The proportion of auction spectrum for 2G spectrums is spectrum resources. proposed to increase to 60%, compared with 2100MHz spectrum re-assignment’s 33% back in 2016. It was the regulator’s intention to encourage more competition through the auction to bring in new players. Chinese mobile operators in Hong Kong such as China Unicom Hong Kong (CUHK), China Telecom Hong Kong (CTHK) as well as HKBN (1310.HK, BUY) are the potential bidders. CUHK has indicated its interest to participate in the auction. We reckon that CUHK and CTHK could form a JV to bid and share the spectrum to increase the economies of scale. Existing mobile operators may lose some of their spectrum. They may need to spend more capex on the Page 3 Industry Focus Hong Kong Telecom Sector Approach to set spectrum utilisation fees and SCED’s present inclination is that the final value would be closer to the higher end. In 2005/2006’s re-assignment, the SUF of 2G spectrum was set at HK$145k per MHz per annum in the first 5 years. And from 2. The SUF of the RFR Spectrum should be set at the average the sixth licence year onwards to the expiry (2010/2011- SUF of the auction spectrum in the same frequency band, 2020/2021), SUF was set at 5% royalty over the annual subject to a minimum price and a cap, both to be set by network turnover of the licensee, subject to a minimum fee of the SCED. HK$1.45m per MHz per year. 3. For RFR minimum price, SCED proposed that it may be set In the second consultation paper relating to the SUF, the between HK$38m per MHz (or HK$2.53m per MHz per authority, Secretary for Commerce and Economic Development annum) and HK$67m per MHz (or HK$4.47m per MHz (SCED) proposed: per annum) for 15 years, and SCED’s inclination is that the final value would be closer to the higher end.