Financial Journalist

Window, JUNE 28,1996

Hong Kong grapples with telecommunications upheaval

By Gerry O’Kane

HONGKONG Telecom has just had one of its worst years, according to NEW T&T president Leslie Harris, one of those who have helped to make it so. Over the past year, Telecom’s international growth rate has slowed down, three local telephone service competitors have appeared, its much-vaunted video-on demand service has been delayed and the extent of its exclusivity over international services is being reassessed.

Telecom also faced the prospect of dealing with a merger of British Telecom and its own majority shareholder Cable & Wireless. Then it had to weather rumours that Chinese companies were hunting it in a Cathay-style take-over, only to find China International Trust and Investment Corp dumping $3 billion-worth of shares weeks later.

The most significant of these developments is the possible loss of the monopoly on international voice services before Telecom’s exclusivity licence expires in 2006.

These have been confusing times for consumers, too. They have watched the new operators offering cheaper international calls while Telecom retains the international call monopoly. But the key question at the heart of all the hype is what place Hong Kong will have in the world of telecommunications. The next two years could be crucial.

The one thing the industry has managed to do successfully is bamboozle punters, and things may get worse. The complexity of the technology is creating greater competition while making it difficult for users to figure out which solution is best for them. International regulatory issues compound the problem, along with the continuing re-interpretation of Hong Kong’s own telecommunications regulations. Urgency creeps into the equation as the 1997 handover approaches.

Reckon
Hongkong Telecom International and Hongkong Telephone also have to reckon with the man who can determine how fast things change Alex Arena, head of the Office of the Telecommunications Authority. In April, Arena re-examined Telecom’s international licence. Although his ruling came as something of a blow to Telecom, the company did manage a sigh of relief. Arena did not suggest taking away the company’s exclusive right to provide international calls, but he did narrow this exclusivity.

“A number of areas are open to competition without breach of HKTI’s exclusivity,” said Arena in his ruling. “These areas include simple resale of HKTI’s international private leased circuits for tax and data services, virtual private networks for internal communications of companies and organizations, video-conferencing services and customer mobile terminals for mobile-satellite services.”

This opened the way for other companies to compete with Telecom in providing any of these services except basic voice and video-conferencing. Already, it is rumoured, firms like the GlobalOne consortium of Deutsche Telekom, Sprint and France Telecom, with their Asian headquarters in Hong Kong, are looking at getting into these areas.

But then, just a few weeks ago, Arena announced that the government and Hongkong Telecom were to discuss the surrender of exclusive international access before 2006 in return for compensation.

Many people saw the move as a reaction to developments in Singapore, where the government, through the regulatory authority, had said that due to rapid technological advances, it made sense to shorten Singapore Telecom’s hold on international exclusivity. In return for opening international access in 2000, seven years before its franchise was due to run out, the government would compensate the company to the tune of US$1.07 billion.

Despite grumbles from the board of Cable & Wireless, which holds 57.5 per cent of Hongkong Telecom, the company has agreed to talk. However, Arena’s latest statement seems to have less to do with Singapore than with the direction Hong Kong’s telecommunications industry will take over the next few years. The issue is political.

As an aid to understanding present moves, it is necessary to trace the roots of the current situation. In 1981, the government approved a licence giving Hongkong Telecom a 25-year monopoly on international services. Observers say the motivation for this can be traced to domestic British politics. At that stage, Margaret Thatcher’s government was lining up state companies for privatization. Cable & Wireless was near the top of the list, but one of her advisers, Lord Sharp, pointed out that its value was stunted while it held licences for only four or five years in places like Hong Kong, Bermuda and the Maldives. He was backed by then head of the Trade and Industry Department, Lord Young.

Since Hongkong Telecorn was then, and remains, C&W’s cash cow, a longer franchise in the territory would make it an attractive float.

It is not clear whether Britain ultimately influenced the Hong Kong decision to grant a 25-year monopoly. Subsequently, however, Lord Sharp became head of C&W and was later succeeded by Lord Young.

In the years that followed, Hongkong Telecom International, Hongkong Telephone Ltd and Cable & Wireless began to develop one of the most sophisticated local networks in Asia. They also strove to build strong working relationships with China. Telecom was led by Mike Gale and his China strategy was put in the hands of Greg Crewe. Crewe and his team spent years building links with provincial telephone companies and cultivating ties with the power circles of Beijing.

Crewe himself was well liked within the industry. A fluent Mandarin speaker with a love of Chinese calligraphy, he and his colleagues gave China free technology while increasing profits and strengthening relationships. As Hong Kong replaced telephone hardware with the latest digital technology, the company gave its older analogue exchanges away to provincial telephone companies which were underfunded and under pressure to provide services to a population with few telephones.

As CSL, Hongkong Telecorn also wanted to boost its business, so it gave Beijing base stations to serve visiting Hong Kong businessmen with mobile phones. China also collected a hefty 40 per cent of the international call charges.

C&W and Hongkong Telecom set up a little known company called Great Eastern in China to build a fibre-optic link from Hong Kong to Guangdong, Shanghai and Beijing, which has only recently been completed.

But the China strategy began to fall apart when Crewe returned to Britain to join C&W subsidiary, Mercury, which was competing with British Telecom in the UK domestic market. It was believed that C&W was grooming Crewe for a return to Hong Kong, having gained the experience of being the smaller competitor, in time to help Hongkong Telecom face the competition of new local service providers. However, Crewe became a victim of a boardroom battle within C&W, as head of Mercury James Ross, also deputy chairman of C&W, fought for supremacy with chairman Lord Young.

Elevated
By this time, Hongkong Telecom had lost its other doyen, Mike Gale, who died suddenly, and Linus Cheung was elevated from the deputy’s position to head the company. To support him, C&W sent out the experienced Peter Howell Davis, but his term of office was short-lived. In November last year C&W’s board of directors had had enough of the struggle between Ross and Young and both resigned. Howell Davis returned to Britain to head Mercury.

All this had severely weakened Hongkong Telecom’s traditionally strong relationship with China. The company had been well-supported by China’s Ministry of Post and Telecommunications. Hongkong Telecom was one of China’s largest foreign exchange providers, through what are known as call termination fees.

Virtually all international calls into China go through Hong Kong. Under international rules, Telecom can charge the company sending the phone call —like BT or AT&T —for delivering the call. China’s fee goes on top of that. Last year these calls and those coming directly from Hong Kong made up 47.8 per cent of the company’s international calls. International services last year constituted more than 56 per cent of Telecom’s turnover, and this is believed to exclude international leased line services to which much of the China traffic has now been transferred.

In 1992, AT&T approached China and offered to set up an international receiving centre in the mainland, cutting out Hong Kong. China refused. Since then, however, the weakening relationship between China and Telecom, the creation of two state telecommunications competitors to the MPT in China, and the recent World Trade Organisation’s preoccupation with communications liberalisation, have completely changed the lay of the land for Telecom.The first sign of trouble has been the year-long delay in China’s approval of personal communications system licences, which potentially will provide a higher-tech, all-purpose service. The Joint Liaison Group is reported to have agreed to award six licences, but Telecom is not said to be among them. Neither is its old ally in Beijing, the MPT, which was in the bidding with Smartone. One of the most obvious signs of deteriorating relationships was the revelation last month by C&W chairman Brian Smith that a cellular project in China was well behind schedule because Beijing did not want Telecom to be involved.

Another has been the WTO’s insistence on liberalising the telecommunications industry. Hong Kong’s position cannot be compared to Singapore’s in terms of competition. SingTel dominates almost every aspect of its domestic market —the first cellular competitor, MobileOne, has yet to launch and there is no local fixed-line competition. Nevertheless, the WTO issue remains important to Hong Kong for political reasons.

Hints of this came at a recent luncheon meeting at which Alex Arena spoke. He noted that 80 per cent of the territory’s GDP came from the service sector and that telecommunications itself was becoming a new trade route.

“But we cannot afford the slightest touch of cornplacency,” he warned. “The premier positions in the information age will be held by those who occupy positions on the intersections of the superhighways. These hubs will be strategic locations and these will be competed for vigorously. Hong Kong’s existing strengths as a hub today can easily be replicated and overtaken: therefore we must be diligent to ensure that we build on these strengths and move ahead lest our position be eroded. That is why we are liberalising the industry rapidly, dismantling monopoly and encouraging new entrants.”

The US has been strongly behind liberalizing these hubs. If HKT sends a call to the US it can negotiate a delivery fee with numerous companies, like MCI, Sprint or AT&T.

The US companies, on the other hand have no choice but to deal with Telecom. As the handover approaches, the issue of WTO membership is a lever for the Americans, either getting access to international traffic delivery in Hong Kong or at least having a choice of players.

Trade
The territory’s trade is dependent on it remaining a member of the WTO, a position it can hold, analysts say, regardless of whether it is a part of China. And China needs Hong Kong to keep its WTO status for two reasons: politically it cannot be seen to be allowing Hong Kong’s trading position to go down the drain after the handover; and China’s own entry to the WTO is still in the air —the issue of telecom liberalization may follow intellectual property rights as the leading criterion in the process.

While Hongkong Telecom’s relations with China might once have given it some protection on these issues, the circumstances have changed, according to John Ure, head of telecommunications at the Centre of Asian Studies. He notes that the MPT faces competition from Jitong, which offers long-distance data services and is run by the Ministry of Electronic Industries and Citic, and Liantong (more commonly known as Unicorn), comprising the MEI, Ministry of Electric Power, Ministry of Railways and other groups, which offers long-distance voice services.

These firms would no doubt like to get some of the termination fee business within China and would be happy to deal with firms like AT&T. They also have the political clout to influence Beijing.

According to Leslie Harris, this is probably why HKT is lamely discussing an early end to its monopoly, “Hongkong Telecom would prefer to have deal with people they know rather than those they don’t,” he says, referring to the coming change of sovereignty.

Though there is no love lost between HKT and Arena, he is seen as being fair, and it is probably best to get a settlement now, for despite the existence of a legal contract, the situation could be overturned by a future administration which deemed such a move to be “in the interests of Hong Kong.”

Recouped
According to Andrew Harrington, telecommunications analyst at Salomon Brothers, the settlement could be worth US$2 billion, to be recouped from the sale of other international licences.

And this is what the new local carriers want. According to Harris,. they do not want what is known as ‘,simple international resale,” in which a company sets up a lowcost gateway to receive international traffic and passes it on to local carriers, either in Guangdong or Hong Kong. “Doing that means the real value would be sucked out of Hong Kong,” he says.

Hongkong Telecom is now trying to adapt to rapidly changing conditions. In this year’s financial report, the company admits it is heavily dependent on international traffic and is looking to shift the balance both with new local services and in overseas investments, like a new Taiwan cellular licence.

C&W, in recognition of the importance of developments in the region, has for the first time appointed a chairman for Asia Pacific, Rod 0lsen, an old Telecom hand who is expected to be based locally.

Hong Kong Telecom