Telcos Get a Message from Beijing


By Frederik Balfour (Editor's note: Corrected on Aug. 27)

The chill winds of autumn started early this year for China's mobile-phone data-service providers. First hit was Sohu.com (SOHU), which on Aug. 13 announced that China Mobile (CHL), the telecom that is 75%-owned by the state, would suspend Sohu's multimedia messaging services for a year. That prompted Sohu to slash its third-quarter earnings estimates by as much as $1.8 million, to $26.3 million.

The reason for the suspension? Sohu had sent 1,374 unauthorized messages to mobile-phone users soliciting them to subscribe to its photo service. A few days later, Sohu got slapped with a $500,000 fine for improperly unsubscribing 85,000 users.

Sohu isn't the only service provider feeling China Mobile's wrath. Sina.com (SINA) saw its interactive voice-response services, mostly chat lines, suspended because of content that the state deemed "inappropriate." Read: Adult. Several service providers, including Shanghai Mtone Wireless, have recently seen their multimedia services suspended for illegally spamming subscribers or offering dubious content. Nasdaq-listed KongZhong (KONG) has been barred from approval of new applications for new products and services on all platforms until June 30, 2005. In all, a total of 22 service providers were either fined or sanctioned for other violations.

IDEOLOGY OR ECONOMICS? What's behind the crackdown? For starters, the government is getting more aggressive in going after pornography. Since July 16, the police have shut down some 700 pornographic Web sites and arrested hundreds involved in their operation. Beijing has also issued strict guidelines barring minors from frequenting Internet cafés. And the decision to include wireless-service providers in the cleanup campaign makes sense when you look at the numbers. China has some 87 million Internet users, vs. 305 million mobile-phone users.

That may not be the full story, however. China's mobile-phone users send one another an average of 1 billion messages per day, paying an average cost of 1.2 cents to send a simple text message and 4.8 cents for a multimedia message. According to Beijing-based telecom consultancy BDA, wireless-content providers will see the market more than double this years, from $361 million in 2003, to $783 million this year.

Duncan Clark, managing director of BDA, says it's unclear whether ideology or economics lie behind Beijing's new aggressiveness. All of the sanctions thus far have been applied by China Mobile at the behest of the Information Industry Ministry, one of eight government ministries involved in scouring content. Clark says China Mobile could be using the cultural cleanup as a pretext to strengthen its hand against the hundreds of content providers with whom it is partnered.

BOTTOM-LINE PAIN. Clark reckons that China Mobile, which has 70% of China's cell-phone subscribers has its eye on the lucrative value-added services. Under current revenue-sharing agreements, it gets only 15% of billings from text and data messaging, while data service providers like Sohu keep 85%. By playing bad cop, China Mobile might gain leverage when it comes time to negotiate the next round of revenue-sharing agreements.

China Mobile did not comment on the revenue-sharing agreements, but in an e-mail reply to BusinessWeek Online's questions it said: "We hope to work together with the [service providers] and achieve a win-win situation,rotectconsumer rights, andwork for ahealthy, sustainable developmentof wireless data servicesbusiness.Wehave only stopped thecontent or services that have violated the regulation. We willmaintain theco-operative business model with the [service providers]."

With growth in revenues from pure text messages tapering off and prices falling as hundreds of providers compete for the market, companies are relying more and more on value-added services to build profits. So the suspensions slapped on Sohu, Kongzhong, and Sina could hurt their bottom lines. What's more, Sohu and Kongzhong have been barred from applying to offer any new products or services until June 30, 2005.

POLITICAL HOSTAGE. Although Sohu and Sina make the majority of their money from advertising revenues and paid listings on their Internet portals and search engines, being shut out of the mobile-phone arena is a blow. Safa Rashtchy, a senior research analyst at Piper Jaffray, warned in an Aug. 19 industry note that "we have not yet seen the end of activities by China Mobile against the service providers."

It's unclear what this means for shareholders of Sina and Sohu. Even before the announcement of sanctions, each had seen its shares fall about 30% from their 2004 highs. The Aug. 13 news sent Sohu's stock skidding some 12%. Sina's stock dropped around 10% on the news of its suspensions.

Although analysts reckon that the loss of revenues from suspended messaging services has been priced into these companies' stock prices, the latest raft of actions illustrates that China's regulatory environment can still be held hostage to political whims. In that light, these stocks may actually be overpriced.

SCHIZO APPROACH. What's clear is how reliant all the wireless-service providers are on the awesome power of China Mobile. Maintaining good relations, or guanxi, with China Mobile and the country's other mobile operator, China Unicom (CHU), is of paramount importance to their future growth. If the price of guanxi is giving up more revenue, then the likes of Sohu would be well-advised to make such concessions. In fact, many have wondered why China Mobile and China Unicom have allowed the carriers to keep so much of the booty this long.

Finally, this whole affair illustrates China's schizophrenic approach to telecoms. By licensing only two operators, China Mobile and China Unicom, Beijing is perpetuating a state-owned duopoly model. In contrast, the nearly 800 wireless-service providers are all privately owned and represent some of China's best entrepreneurial talent. As long as this dichotomy continues, China can expect more friction between its mobile giants and the scrappy upstarts.

Correction: The original version of this story incorrectly stated that KongZhong had its multimedia services suspended. Balfour is the Asia correspondent for BusinessWeek based in Hong Kong


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