Riding China's telecom networks expansion
By A J Leow
The China-based but Singapore-listed telecom wireless network solutions provider, Sinotel Technologies, as one broking house noted recently, is in a sweet spot as it stands to become one of the main beneficiaries of China's massive efforts to upgrade its national telecommunications infrastructure.
Beijing had announced on 7 January this year that it intends to roll out an extensive 3G network in key cities and commercial locations by the end of 2009. The Ministry of Industry and Information Technology said that China is expected to spend close to RMB280 billion on 3G upgrading works – primarily through the three telecom majors, China Mobile, China Unicom and China Telecom – of which more than half or RMB150 billion would allotted for 2009 alone.
Founded in 2002, Sinotel had started off as a distributor of LG handset phones but its management was quick to realise the potential of moving into the wireless network space by providing the coverage for mobile phone users either by laying cables and installing antennas for buildings and other indoor facilities, or building base stations along highways or other outdoor locations. Compounded annual growth in both revenue and profits have since seen an average rate of more than 50%.
As the group's vice-president of corporate communications and investor relations, Ben Ng explained, "The margins for distribution may be high initially for new handsets, about 15%, but they tend to drop off to 7% or less as newer models come into the market."
In contrast, the margins for providing wireless network solutions tend to be more consistent and much higher, between 40% and 50%, depending on the size and scope of the contract, which can range in size from RMB 300,000 for a single building to more than RMB 20 million for larger scale jobs, noted the company's chief financial officer, Lo Fui Chu.
 Some of Sinotel's landmark projects include the China Congress Building, China World Hotel, Beijing Railways and the China Unicom headquarters. It had in the first quarter of 2009 also clinched six orders worth RMB 32.9m from China Unicom to provide network optimisation solutions for its branches in Beijing, Guangxi, Chongqing, Hebei, Shanxi and Jiangsu.
Ms Lo also noted that while the number of handsets distributors has increased over the years, there has been a high degree of consolidation among wireless network providers with the numbers dwindling from more than 200 a few years ago to currently about 30 to 40 players, of which Sinotel is ranked among the top 10, and one of the seven listed – the others being listed on the China and Hong Kong stock exchanges as well as Nasdaq in the US.
Opportunities Galore
Sinotel, which was listed on the main board of the Singapore Exchange on November 12, 2007, has now expanded its operations from Shanxi in 2002 to currently eight provinces in northern China, as well as major metropolitan areas such as Beijing and Shanghai, serving a reputable clientele that includes domestic mobile telecom majors such as China Unicom and China Mobile.
China Telecom, which was formerly restricted to fixed lines and the latest to be granted a mobile licence by the central authorities following a shake-up of the national telecom sector is likely to be joining its list of domestic clients which also include municipalities as well as property and township developers.
What these means is that the will be opportunities galore for wireless solutions providers like Sinotel and its closest rival, Hong Kong-listed Comba Telecom which has an estimated 14% to 15% of the market share based on its topline revenue of RMB 2.5 billion last year compared to Sinotel's RMB 362 million.
As Ms Lo explained, "With the three telecom majors using different 3G platforms, all new buildings in China be required to have at least three different sets of cables and network equipment in order to ensure that there will be adequate mobile coverage for all users. It may mean more complications for the building owners but that's where opportunities arise for us."
Added Mr Ng, "With 200 cities targeted to be 3G ready, it will take at least two to three years to build up the national network before it's get extended to the suburban and more remote areas in China. By then, we may be looking at the next generation of mobile technology, which will be 4G like what's starting to happen now in Japan and the US. Let's not also forget that the current GSM network too will still be needed as not everybody will be on the 3G network, just like the case in Singapore now."
Mr Ng also pointed out to the demand for higher-capacity wireless networks in China and hence the need for more base stations, especially in outdoor areas, due to the needs for more functionality among Chinese users.
"Unlike in Singapore where we tend to use the mobile phone for conversations, SMSes or email, users in China like those in Japan and South Korea tend to use mobile phones for a greater variety of purposes such as the downloading of video, music or even movies due to the longer daily commutes or long distance travel. Eventually, 4G systems will be able to offer transfer speeds of up to 1 gigabit/sec compared to only 100 megabits/sec in Singapore." (I gigabit = 1,000 megabits)
Then, there is also the matter of mobile penetration which is currently only at 47.3 % on the mainland compared to 105% in Singapore, 83% in Korea and 75% in US as well as the rapid rate of urbanization now in China which will lead to greater demand for wireless systems – both indoors and outdoors – with the erection of new buildings and expansion of transportation networks.
 To get an idea of how big a project can be for a residential development, Sinotel recently invited a number of analysts to visit two of its project sites in Zhengzhou, the capital of Henan province. The smaller of which was an 80-block development while the larger comprised 500 apartment buildings, or as Mr Ng quipped, "We are looking at the equivalent of probably an estate the size of Tampines or bigger in Singapore. Growth will be phenomenal for the next few years with the rapid rate of urban renewal due to the migration of people to the cities."
Most profitable among listed peers
With such projects in hand, Sinotel's orderbook as of end of the first quarter in March 2009 has already hit RMB 390 million, or more than its total of RMB 360 for the last financial year.
What is noteworthy about Sinotel is that it had enjoyed the highest operating margins of 40.5% for FY 2008 compared to its Hong Kong-listed peers Comba (37.5%), Centron (29.1%) and 23.7% for Nasdaq-listed Grentech. When it comes to net profit margin, Sinotel is way ahead at 29.7% compared to Comba's 9.2%.
As Mr Ng explained, this had been possible because of the company's lower overheads as well as its strategy of working within its capital constraints by focusing on selected higher-margin projects in its targeted markets.
"Comba spreads itself over a wider territory to about 20 or more provinces and hence spend more on overheads. It may not necessary be the biggest player in each of these provinces and because of its size, it also tends to bid for bigger sized jobs."
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"Sinotel, on the other hand, tends to figure among the top three players in most of the provinces we operate. The exceptions would probably be in the newer markets such as Jiangsu, Hebei and Liaoning, where we are just gaining a foothold. We also prefer to handle smaller projects that offer healthier profit margins."
"Furthermore, we also do not have a big manufacturing division like Comba which employs more than 4,000 workers compared to about 200 employees for Sinotel. We let third parties take care of most of our manufacturing requirements and we rather deploy our staff as project managers to oversee contract workers for most of our wireless integration work. Hence, we have lower overhead costs due to outsourcing," said Mr Ng.
One of the peculiarities of the telecom sector in China is the extended periods for receivables which for Sinotel was 186 days and for Comba, 171 days in FY2008
This explains why Sinotel only recognises its revenues, only after it's paid for its projects and why it has not been paying out dividends to shareholders since its listing as it prefers to use the funds for its working capital given the upcoming strong pipeline of network upgrading jobs.
As Mr Ng elaborates, "We don't collect deposits for our wireless infrastructure projects which take on average six to twelve months to complete. Rather, we are paid on a 'milestone' basis based on the progressive stages in a project. Upon completion, the client will carry out an inspection and will pay us 50% to 80% of the contract price, which would be sufficient to cover our costs given that our gross profit margin is around 40%.
"Then there is a trial period of another six months to make sure everything runs smoothly and that any defect is rectified. After that, we collect the rest of the payment except for the last 5-10%, which is retained for warranty for a few more months."
Such a protracted payment system however does have one benefit – it deters new players from entering the space.
Other Businesses
 Such stretched-out payment terms however doesn't apply to Sinotel's other businesses, especially its Emergency Mobile Communications Station (EMCS) business, where there is often an upfront down payment.
The EMCS system, which deploys a mobile radio frequency (RF) communications system mounted on top of a vehicle, is often used to restore network coverage to disaster stricken areas, or deployed in remote areas such as coalmines or oil fields. Sinotel is currently the only commercial company in China offering EMCS after setting up the new division in June last year. Margins are also high, about 40% to 45%.
The company is also into the distribution of 3G network cards, which are essentially PC cards that enable mobile users the ability to connect wirelessly to the Internet. Sinotel is one of the pioneers to have developed and distributed the 3G network card in collaboration with its partner China Unicom.
Given the quality of its clients and given that both China Unicom and China Mobile accounts for about 50% of its network jobs, Ms Lo said the company usually does not make provisions for bad debts.
The company's gearing have risen from about 8% for the first quarter to currently about 12%, though Ms Lo reckons that there is scope to raise to 30%-35%, which she said would still be healthy.
"We usually borrow funds for use as working capital and expansion, which often means the banks often loan us up to 80% of a project which we have already secured." said Ms Lo.
In other words, one could actually track how successful Sinotel is performing in terms of new contracts based on its loan profile.
Sinotel's shares have so far been trading at about 2 times price-earnings (PE) compared to its peers in Hong Kong, which are trading at about 9 to 10 times PE.
When asked about the disparity, Mr Ng said unlike in Hong Kong, investors and analysts are less likely to be informed of the telecom sector in China. "Most analysts in Hong Kong would already be familiar with the likes of China Unicom, China Telecom and China Mobile. Then, there is also the fact that there are no comparables on the Singapore Exchange."
Currently, institutional investors account for less than 5% of the shareholding in Sinotel while the public float is about 50%. The company's chairman and founder, Mr Jia Yue Ting holds about 32% with the rest held by the group's top management.
The stock has been recommended as a Buy recently by Phillip Securities Research, Westcomb Financial Group and DMG & Partners.
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