Mr. Ted Dean

1. China Telecom Market Overview
2. PHS Market Value Chain
3. Competitive Landscape
4. Prospects for the Future



1. China Telecom Market Overview

     There are four major telecom carriers in China. China Telecom and China Netcom are the fixed-line carriers that were created by the break-up of the former China Telecomfs nationwide monopoly and the merger into the northern provinces of the former Netcom and Jitong Corporations. China Netcom is the primary fixed-line provider in Chinafs northern 10 provinces, and China Telecom operates in Chinafs 21 southern provinces. These two operators offer PHS service in China. China Mobile and China Unicom are both nationwide mobile carriers. China Mobile offers GSM/GPRS service, and China Unicom operates both a CDMA and GSM network.
     At the end of August 2003, there were 244.12 million mobile subscribers in China and 244.93 fixed-line subscribers including PHS. China is adding between 4 and 6 million new mobile subscribers each month and somewhat fewer fixed-line subscribers. In September, mobile subscribers overtook fixed-line subscribers for the first time.
     Total service revenues of Chinafs six largest telecom operators including China Railcom and China Satcom reached USD 26.5 billion in H1 2003 up 12.1% YoY. H1 2003 CAPEX totaled USD 9.5 billion.

2. PHS Market Value Chain

     The PHS market value chain in China includes infrastructure vendors, operators, service providers, handset makers, and consumers. UT Starcom is the largest vendor followed by ZTE and Lucent.
     For operators, PHS has become a major growth driver. 41% of subscriber additions in the first half of 2003 were PHS subs at China Telecom. As of June 2003, the total PHS market size reached 22.5 million subscribers, up by 71% from 13.14 million at year-end 2002. PHS subscribers are growing at an average of 1.5 million per month and will break 30 million subs this year. The growth in PHS has been driven by service launches in Guangzhou and Beijing, in April and May, respectively, as well as new promotions and handset subsidies. China Telecom reports plans to increase investment in network capacity.
     Operators are adding value added services to PHS in order to boost the ARPU of PHS users and shorten the return on investment period. There are over 3 million PHS SMS users. The value added data platform C-mode (Chinafs i-Mode) has been launched in 21 Chinese provinces with over 1 million users. A number of Service Providers are now feeding content to C-mode, many of which are local content portals including Tianfu Online, Wuhan Hotline and Shanxi Information Harbor. China Telecom and Netcom charge SPs a commission of 10% compared to China Mobilefs 15% for GSM/GPRS.

     In 2003, a large number of new players moved into the handset business. BDA believes there are currently 10 PHS handset manufacturers in the market lured by strong subscriber growth. There is no licensing requirement by the government (i.e. MII does not require a gRu Wang Zhengh (Network Certificates) for PHS handsets.), so there are lower barriers to entry relative to traditional GSM and CDMA handset manufacturing.
     As more players move into the market, the PHS handset business model is changing in China. Where vendors once sold handsets primarily to operators who controlled distribution to customers, vendors are now also selling through third-party distributors in a model much more similar to traditional GSM or CDMA handset distribution in China. In the past, operators were also more involved in handset maintenance. Today vendors are setting up their own networks to manage maintenance in an increasingly competitive market. Perhaps the most significant change in the market has been the growth in importance of PHS handset consumer brands. In the past when operators managed distribution and the market was less competitive, vendors did not have to invest as heavily in marketing. As competition has intensified, the importance of building a consumer brand has grown as well.

     PHS subscribers can generally be divided into two groups. Those who carry only a PHS phone are generally low-end subscribers. However, there is a large group of subscribers who carry both a PHS phone and a mobile phone. Surprisingly, these subs are actually higher end than typical mobile subscribers in terms of their income and average revenue per user.

3. Competitive Landscape

     Although there are only two licensed mobile operators in China - China Mobile and China Unicom - it is an intensely competitive market. At the end of June 2003, China Mobile had 154.7 million mobile subscribers. China Unicom had 68.5 million GSM subscribers and 11.3 million CDMA subscribers. In addition, China Telecom and China Netcom had 18 million and 4.5 million PHS subscribers respectively.
     China Unicomfs launch of CDMA service has been one of the major drivers of increased competition in the market. In an effort to hit their subscriber targets, China Unicom has made extensive use of handset subsidies, tariff discounts, and low cost pre-paid service.
     In the face of this increased competition from CDMA as well as PHS, China Mobile has responded with price cuts and promotions of its own.

     The intense price competition in the market is evident in the fact that China Telecom and Netcom have in some cases cut PHSfs already low tariffs and used handset subsidies to attract subscribers.
     As PHS operators cut their tariffs, they have an important advantage over China Mobile and Unicom. GSM/CDMA services are charged an interconnection fee of 0.04 cent /minute to terminate calls on fixed-line networks (including PHS), while PHS operators do not have to pay the fee at present. The interconnection advantage helps CT and CNC retain their price advantage and keep the service profitable. According to China Telecomfs CFO, PHS has an average ARPU of only RMB 50 but still pays back its investment in about 3 years. New interconnection rules could level the playing field in the future and limit PHSfs cost advantage, but there is no word yet on when any changes in interconnection might be implemented.

     PHS must also compete with alternative technology standards including SCDMA and CDMA-450. The MII has recently announced its support for SCDMA as a homegrown technology, which can upgrade to 3G TD-SCDMA. SCDMA passed MII appraisal in a meeting on September 21, 2003. The Director General of the Radio Bureau of MII said that it will add another 15 MHz in the 1800 MHz band for SCDMA use. Spectrum may also be allocated in 400 MHz band. The Deputy Director General of the Telecom Administration Bureau of the MII said that it planned to recommend SCDMA system for Universal Service use especially in rural areas.
     Beijing Xin Wei, a subsidiary of Datang, is the sole supplier of SCDMA in China. The company claims a provisional agreement worth RMB 4 billion (USD 480 million) with China Netcom. China Netcom has deployed SCDMA in southern China, in a move to compete with the PHS networks of rival China Telecom in those areas. Shanghai Railcom has also ordered 300,000 lines of SCDMA systems from Xin Wei. SCDMA users in China total approximately 130,000. Given its small scale and lack of widespread equipment and handset vendor support, SCDMA is not yet a significant threat to PHS.
     CDMA-450 is officially banned in China except in Tibet where 20 base stations have been deployed to cover Lhasa and most counties since the service launch in early 2003. However, despite the ban, networks have been deployed in 21 provinces and nationwide subscribers total 100,000. Huawei is the largest supplier, and ZTE is also a player. Recently, there are increasing signs that China is opting to promote PHS rather than CDMA-450. In addition, CDMA-450fs main selling point is that its base stations have a range of as much as 70 km. This makes the technology well-suited for rural deployments, while PHS is more suitable for city use. As a result, CDMA-450 is not viewed as a direct competitor with PHS.

4. Prospects for the Future

     As long as PHS has been in China, there have been concerns about its future, whether it was on the verge of a boom or a bust. Initially, the concern was that the MII might revoke the spectrum used by PHS and completely shut down the service. Following the tremendous growth of PHS over the last two years, this is simply not an option. Yet even now, there are concerns about PHSfs future in China, whether China Telecom and China Netcom will continue to promote the service or turn their focus to 3G.

     BDA believes that 3G licenses have been further delayed. Phase II MTNet trials which are just beginning are to be completed in September 2004. 3G licenses are not likely to be issued until after the tests are completed and, more likely, not until 2005. As a result, PHS still has time to grow.

Without a 3G service to promote, PHS continues to be one of the primary growth engines for both China Telecom and Netcom, so continued investment and promotion is expected. Even when 3G licensees are issued, it is not clear that there is a business case for 3G in lower tier cities in China, so PHS may continue to coexist with 3G serving lower-end subscribers and cities. With the 3G threat reduced, PHSfs real challenge is price competition from China Mobile and Unicom. Yet there are limits to how far the mobile operators will cut their tariffs, so despite this challenge, BDA believes PHS is poised for continued subscriber growth.