China Unicom Got Its "Mixed-Ownership Reform" Money. Its Financing History Mirrors the Advances and Retreats of China's State-Owned Enterprise Reform | 2017 Big Business Stories ⑤

As the year runs out, we're using 10 articles to sum up its most important business news — stories that often signaled a shift in an industry's balance of power, or were the result of one.

After 13 straight quarters of falling core revenue, China Unicom got the money it needed through "mixed-ownership reform."

On the afternoon of August 16, 2017, China Unicom announced it was taking 78 billion yuan from 14 investors, launching its mixed-ownership reform as a state-owned enterprise.

That is a lot of money — more than three times the cash China Unicom had left on hand at the end of 2016, or roughly Alibaba's profit for an entire year.

To raise it, China Unicom privately placed new shares equal to 40% of its share capital, double the ceiling the China Securities Regulatory Commission (CSRC) had set earlier that year. On August 20, the CSRC published a short statement saying it "deeply recognizes and understands the major significance of China Unicom's mixed-ownership reform as a pioneering test case for deepening state-owned enterprise reform," and that it would treat Unicom's case "as an individual case."

China's four largest internet companies — Tencent, Alibaba, Baidu, and JD.com — got special handling too. Together they put 27.35 billion yuan into a company that could not stop sliding.

JD.com earned just 1 billion yuan in net profit in the third quarter, yet spent nearly 5 billion yuan on China Unicom. The money came from Jingdong Sanhong, a company wholly owned by Richard Liu personally. Baidu, Tencent, and Alibaba likewise kept their listed entities out of it. Tencent and Baidu invested through industry funds, while Alibaba's money came through Alibaba Venture Capital, which Jack Ma controls personally. That kept the deal from weighing on the listed companies.

Mixed-ownership reform, discussed for more than two years, began with China Unicom, but it will not end there. Too many state-owned enterprises need new sources of capital. The return on assets at China's state-owned enterprises is now lower than it was during the 2008 financial crisis — a little more than a third of what private companies earn. On the same pile of assets, a state firm makes a third of the annual profit a private one does.

In October 2015, the State Council issued the Guiding Opinions on Developing a Mixed-Ownership Economy in State-Owned Enterprises, proposing mixed-ownership reform as a way to bring new capital into state firms. By 2017 the reform plans were coming out one after another, and state-owned enterprise reform entered a new stage.

At the end of 2017, after China Unicom's plan was made public, a spokesperson for the State-owned Assets Supervision and Administration Commission (SASAC) said at a routine State Council policy briefing that the third batch of mixed-ownership reform pilots had been settled: 31 companies, 10 of them subsidiaries of central state-owned enterprises and 21 local state-owned enterprises. The three batches together come to 50 companies.

This is the fifth piece in our 2017 Big Business Stories series.

This is not the first time China Unicom has been first in line to test an institutional change.

Every rise and fall in its 23 years has been tied directly to policy. Since work on setting it up began in 1993, China Unicom has ridden the separation of government and business in China's telecom industry and the breaking of monopolies, and has lived through the lurches of administrative intervention in 3G and 4G networks. Today, like the other carriers, it has become a "pipe" supplying basic service to internet companies.

In a business that takes enormous capital just to start, China Unicom has absorbed several different telecom operations, tried the "Sino-Sino-foreign" investment model that was later shut down, and become one of the dozens of companies that rushed to list in Hong Kong and on the NYSE before China joined the WTO. Now it is the earliest pilot in the mixed-ownership reform of central state-owned enterprises.

Its history has caught China's market growth, state-owned enterprise reform, overseas listings, policy swings, and internet disruption over the past 23 years.

China Unicom Took Shape in 1993, and So Did Telecom Regulation and the Split Between Government and Business

In 1993, two years after the Soviet Union collapsed, the American carrier AT&T obtained a set of figures from China's Ministry of Posts and Telecommunications for a global communications report: "As of the end of 1991, China, with a population of 1.1 billion, had 8.5 million telephone lines in total. That works out to one telephone for every 33 Chinese households."

That was news at the time — not because China had so few phones, but because the Ministry of Posts and Telecommunications had released data to the outside world at all. The New York Times wrote a story about it.

China Mobile did not exist yet. Everything in China having to do with communication — letters written by hand, telephones, mobile phones, the internet, pagers — sat in the hands of the Ministry of Posts and Telecommunications. That ended the day before Christmas in 1993.

The State Council issued Document No. 178, approving the Ministry of Electronics Industry, the Ministry of Electric Power, and the Ministry of Railways to jointly set up China United Telecommunications Corporation.

The names of those three ministries alone show how much China has changed: not one of them still exists. The Ministry of Electronics Industry merged with the Ministry of Posts and Telecommunications in 1998 to form the Ministry of Information Industry, which merged with several other ministries a decade later into today's Ministry of Industry and Information Technology. The Ministry of Electric Power and the Ministry of Railways were both abolished over the following two decades.

Under the State Council's approval, China Unicom was a state-owned enterprise responsible for its own profits and losses, with three businesses to run: fixed-line telephones, mobile phones, and value-added telecom services — mainly the internet. That year the whole world had only 34 million mobile phone subscribers, a number that would grow twentyfold by 2000.

The document settled one more thing: market access. Local governments could no longer set up new companies of their own to run telecom businesses.

China's mobile communications business had in fact started locally. In 1987, Guangdong's postal and telecommunications system completed the mobile communications design plan for the Guangzhou area. That November, Guangzhou switched on the country's first mobile phone.

That business would eventually be spun out, listed in Hong Kong, and renamed China Mobile, becoming the world's largest mobile carrier and China Unicom's chief rival.

On July 19, 1994, China Unicom was formally established. Fierce competition arrived in less than three months: the postal and telecommunications system led the building of China's first province-wide GSM digital mobile network, in Guangdong.

GSM is the technology underneath mobile phones and, later, the mobile internet and smartphones, but it had only just gotten going. Nokia did not launch its first GSM handset until the end of 1992, at £700 — about 11,000 yuan, more than three times the average annual wage of a Chinese city resident in 1993.

Before a carrier can make money, it has to build a network people can use. China Unicom had a stack of licenses, but the registered capital the ministries put in came to only 1.34 billion yuan, and it had no revenue yet.

Foreign capital wanted into this new market, but the telecom industry was closed to foreign investment. So China Unicom used the "Sino-Sino-foreign" model: an affiliate of China Unicom set up a joint venture with an overseas company, the overseas company invested through that joint venture to build telecom networks around the country, and China Unicom signed project cooperation contracts with the joint venture to operate the finished networks.

Through this arrangement, China Unicom signed cooperation contracts covering 46 projects with telecom companies from 11 countries and regions. By Caijing magazine's count at the time, foreign investment in China Unicom's telecom networks reached 61.8 billion yuan over a little more than two years.

But the model's legality was murky, and the Ministry of Posts and Telecommunications several times called it "irregular." In 1998, then-Premier Zhu Rongji issued an instruction requiring China Unicom to "stop the Sino-Sino-foreign projects, return the principal to its partners, and compensate them appropriately."

At the same time, because the telecom industry had no clear policy on network interconnection, China Unicom's phones could not connect to the existing telecom network run by the postal and telecommunications system, and its earnings fell far short of plan. The money the Sino-Sino-foreign model brought in never got put to good use either.

The Three-Carrier Landscape Appears in 1999: China Unicom Joins the State Firms Listing Overseas for Cash, Then Picks CDMA for Policy Reasons

In August 1999, the Ministry of Information Industry shut the Sino-Sino-foreign projects down for good, ordering every one of them wound up by mid-September.

That meant handing investors back their principal, plus a sizable compensation payment.

By Caijing's count at the time, terminating the Sino-Sino-foreign projects cost China Unicom more than 10 billion yuan in returned principal and roughly 4 billion yuan in compensation.

With foreign capital gone, China Unicom still had to keep raising money to build out its network.

In July 1993, Tsingtao Brewery became the first Chinese company to list on the A-share market and in Hong Kong at the same time. A few months later Sinopec Shanghai Petrochemical listed simultaneously on the A-share market, in Hong Kong, and on the NYSE, giving state-owned enterprises a new way to raise money and drawing in foreign capital to open up new markets.

After that, every large state-owned enterprise that needed capital chose to list overseas. State firms in power, property, steel, petrochemicals, and aviation rang the bell at the Hong Kong Stock Exchange one after another. In 1997 the mobile phone businesses of the Guangdong and Zhejiang postal systems were combined and listed in Hong Kong as well. This was the forerunner of China Mobile, then still called China Telecom (Hong Kong) Limited.

China Unicom, which still had no real business to speak of, got the assets to go public out of the separation of government and business inside the postal and telecom system. In 1998 the Ministry of Posts and Telecommunications — which ran both postal and telecom services while also regulating the telecom industry — disappeared. Its enterprises were split into postal and telecom operations run independently, and its regulatory half became part of the new Ministry of Information Industry.

The next year the State Council approved the China Telecom Restructuring Plan. China Telecom's mobile phone business, including the Hong Kong-listed China Telecom entity, was carved out to become China Mobile. The then-booming pager business was folded into China Unicom, giving it a division with steady, sizable revenue. In June 2000, China Unicom listed on the Hong Kong Stock Exchange and the NYSE, raising 6 billion US dollars.

But the direction was already obvious: mobile phones would wipe out pagers. Flush with cash, China Unicom started planning a new mobile network. It had two options — GSM, led by Europe, and CDMA, led by the United States.

By 2000, Nokia had passed Motorola as the world's largest handset maker, and the GSM standard it pushed had become the mainstream. Phones still could not open full websites, but they could already pull data over second-generation GSM networks (GPRS). China Mobile built MMS and ringback tones on top of that, and was preparing a game-download business.

China Unicom held a series of talks with Qualcomm, which led CDMA, but in June it said it would turn Qualcomm down and go with GSM like China Mobile — building a 2G network first, then moving to the WCDMA 3G network people were only starting to discuss. A China Unicom executive said "the bandwidth of CDMA networks is too narrow; China Unicom plans to build a WCDMA network."

Then the US government lobbied hard. Brent Scowcroft, a Qualcomm board member and national security adviser under George H.W. Bush, and Qualcomm chairman Irwin Jacobs met then-Premier Zhu Rongji and China Unicom chairman Yang Xianzu in early October 2000. A week later China Unicom announced it would develop CDMA.

Eight years on, that choice would turn into a very big deal.

The 3G Era Arrives, China Unicom's Leadership Is Swapped Out, and It Loses Its CDMA Network

Once each had raised capital through its own listing, the three carriers, run independently day to day, began competing hard. "Top up your phone bill, get a free handset" and 20-yuan monthly data packages both date from this period.

It was also the best stretch the carriers' business ever had. A phone's main purpose then was still calling and texting, a business the carriers held tight. The new extras — ringback tones, MMS, reading the news, playing games — all had to run through the carriers too. The profit in the mobile phone industry sat with them.

But in May 2004, faced with overheated investment, Beijing began tightening investment and lending. Regulators also started noticing what competition in telecom was doing to profits: profit growth at all three carriers was far below the average for state-owned enterprises. The conversation about telecom shifted from "breaking the monopoly" to "excessive competition."

On November 2, 2004, the Organization Department of the CPC Central Committee and the State-owned Assets Supervision and Administration Commission announced a rotation of the top job at China Telecom, China Mobile, and China Unicom.

Wang Xiaochu moved from China Mobile to become chairman and CEO of China Telecom. Chang Xiaobing replaced Wang Jianzhou as chairman of China Unicom. Wang Jianzhou went from the China Unicom chairmanship to China Mobile. According to what The Financial Times learned at the time, neither Wang Jianzhou nor China Unicom's board got much warning.

In the United States this would be like the government abruptly swapping the CEOs of AT&T and Verizon. The three carriers' bosses were executives of Hong Kong-listed companies, but they also held vice-ministerial rank. After the carriers, the same kind of swap among rivals in one industry happened in oil, aviation, and other sectors.

A string of transfers followed, between carriers and between their provincial subsidiaries. Once the reassignments were done, competition eased and China Unicom's cash position started to recover.

The second big shake-up came in 2008. This time the point was, naturally, mobile: mobile and broadband carriers were merged. China Unicom was caught off guard again.

According to the Notice on Deepening Telecom System Reform, issued jointly by the Ministry of Industry and Information Technology, the National Development and Reform Commission, and the Ministry of Finance, the restructuring was meant to "issue three 3G licenses and support the formation of three market players with nationwide network resources, comparable strength and scale, full-service operating capability, and strong competitiveness."

In practice, six companies in the industry were merged into the three carriers we know today.

China Unicom merged with China Netcom, which had a dominant fixed-line business across ten northern provinces. China Tietong was folded into China Mobile. China Telecom paid 60 billion yuan in cash, plus 50 billion yuan transferred to it from China Mobile, to buy China Unicom's CDMA business. China Satcom, split off in the first telecom restructuring, had its basic telecom operations merged back into China Telecom.

China Unicom got the WCDMA license, a 3G network built on GSM that was already fairly mature in Europe. China Telecom, having taken over CDMA, brought in the CDMA2000 network built on top of it. China Mobile got the TD license, a homegrown Chinese standard and the least mature network standard of the three. Even so, China Mobile was still the carrier with the most users: 390 million GSM subscribers.

The restructuring blew up China Unicom's plans for mobile internet infrastructure. It had been preparing the next generation of its CDMA network; its GSM network was still being built and offered only basic calling. In 2007 the iPhone launched and the mobile internet became a phone's most important function. Yet China Unicom's GSM network had only just begun offering the 2G data service China Mobile had been running for more than a decade — and it still could not roam across provinces.

In the end, though, the shake-up worked out for China Unicom, and bought it several good years once smartphones took off.

Thanks to Its 3G License, China Unicom Had a Few Good Years

At China Unicom's 2017 shareholders' meeting, chairman Wang Xiaochu said: "We had it relatively easy in the 3G era. On the network, we had a big advantage over the other two."

China Unicom got the best of the three 3G licenses, WCDMA — the very network China Mobile had planned to upgrade to, before the reorganization handed it the TD license instead.

At a New Year staff rally in 2009, the general manager of China Unicom's Shanghai branch said: "Whether Unicom can turn itself around, and how the next round of growth goes, rides on 3G."

As smartphones spread, the handset mattered more than the carrier. Most overseas phone brands ran directly on WCDMA networks: the same hardware would do, and once the Ministry of Industry and Information Technology approved it, the phone worked on China Unicom's network.

China Mobile was another matter. TD then required different chips from the models sold abroad, a big engineering job for manufacturers. Neither Nokia nor Apple was willing at the time to put its new phones on China Mobile's TD network.

China Telecom was not mainstream in the 3G era either. CDMA was the dominant mobile network in the United States, but China Telecom required a SIM card, while American phones were mostly sold in carrier stores with the number written straight into the handset. So overseas brands needed hardware changes to work on China Telecom's network too.

China's largest carrier then was China Mobile, and China Mobile failed to land Apple.

At first China Mobile played it tough. In October 2008, in an interview with China Business News, Wang Jianzhou called the iPhone a "fashion product," saying: "As a fashional product, the iPhone is not China Mobile's only choice."

Apple and China Mobile had been negotiating for more than a year by then, with nothing to show for it. Wang Jianzhou, then president of China Mobile, said he had spoken with Apple CEO Steve Jobs by conference call several times, and that China Mobile's negotiating team had met Apple COO Tim Cook face to face several times. The two sides never agreed.

A China Mobile insider summarized Apple's position this way: "Everyone who likes the iPhone is my user — Apple's — not yours, the carrier's. Because even though they're on the carrier's network, all the content is downloaded from my store, and all the money goes to Apple."

For what was then the world's most valuable carrier, that was unacceptable.

In 2009, China Mobile's market value was $199.5 billion, higher than Apple's $180 billion, Samsung's $101 billion, and Nokia's $47.2 billion.

It was not only the iPhone. China Mobile built its own OMS system on top of Android, and phones sold through it had to carry China Mobile's OMS, its own app store (Mobile Market), and its own interface elements.

For a few years, popular Android phones other than Samsung's could barely support China Mobile numbers. Xiaomi, hugely popular at the time, started selling phones in 2011 but did not release a version that worked on China Mobile's TD 3G network until 2013.

Of the three carriers, only China Unicom's network could handle newly released phones right away. China Telecom had to wait months; China Mobile often never got them.

While users chased the newest handsets rather than any particular carrier, China Unicom ended up with the best handsets.

It was also the first of the three willing to make big concessions to bring in the iPhone.

China Unicom closed the iPhone deal in 2009. A year later it caught the iPhone 4 boom. In 2010 the iPhone 4, with its redesigned body and screen, became a runaway hit in China; scalpers added 2,000 yuan to the price of each one and kept selling them that way for half a year.

China Unicom caught China's first smartphone boom. In the year the iPhone went on sale in China, its cash flow rose 110%.

The years China Unicom spent turning itself around on the iPhone were also the years the carriers were being hollowed out. A large share of carrier revenue had once come from value-added services like ringback tones, reading, and music.

Wang Jianzhou once said in an interview: "However powerful Apple's iTunes App Store is, it has a weak spot: it settles by credit card, and that isn't the habit in mainland China. Most ordinary users won't do it. But China Mobile can take it straight out of the phone bill. That's where our own users and our new strategy come in."

Deducting monthly fees for assorted value-added services straight from the phone bill was how people were used to paying. But once the mobile internet arrived, all the carriers had left to sell was data.

As smartphones became universal, the carriers were reduced to pipes.

The advantage China Unicom held in the 3G era disappeared with 4G.

Carriers Stop Mattering, China Unicom Runs Short of Cash Again, and Mixed-Ownership Reform Begins

In 2013, China Mobile started building 4G. China Unicom's luck and China Mobile's changed places.

From about then on, China Unicom's profit growth was negative every quarter. China Mobile was still the carrier with the most users. There were two 4G licenses, TD-LTE and LTE FDD. FDD was the global mainstream and was what China Unicom had counted on. But with chipmakers behind it, mainstream handset makers could now support the TD network from day one.

Policy tilted toward China Mobile too. At the end of 2013 the Ministry of Industry and Information Technology formally issued 4G licenses, but all three carriers got TD-LTE — not the network China Telecom and China Unicom had prepared for. China Mobile, by contrast, had already built 22,000 base stations nationwide. Samsung, Huawei, and others had set up dedicated 4G teams.

In July 2013, China Mobile's tender for TD-LTE wireless main equipment covered 207,000 base stations and more than 20 billion yuan of investment, outstripping even Japan's SoftBank.

With the handset problem solved, China Mobile launched the iPhone 6 alongside the rest of the world in 2014. After six years of negotiation, it had landed Apple — and this happened to be the best-selling iPhone generation ever. Users flowed back to China Mobile.

Not until February 2015 did the Ministry of Industry and Information Technology formally issue LTE FDD licenses to China Unicom and China Telecom.

Meanwhile, the carriers themselves mattered less and less.

China Mobile's own 2010 figures showed that in Guangdong at least, about 40% of data traffic came from Tencent alone — and China Mobile got no extra cut from Tencent for it.

In 2012, China Mobile president Li Yue said publicly that as the mobile internet grew, carriers' old SMS, voice, and international calling businesses were all under serious pressure. He named Tencent directly, saying QQ ate up an enormous amount of carrier signaling capacity and that some of its mechanisms fit poorly with the way traditional carrier networks were designed.

Today WeChat's users cover nearly every mobile phone user in the country, and Tencent's market value is more than twice China Mobile's.

Tencent now threatens even the most basic business, voice calls. Figures Tencent released at its 2017 Global Partners Conference showed WeChat handling 205 million successful calls a day — an average of 19 calls and 139 minutes of talk time per user per month.

All the carriers had left to sell was data. And China Unicom, whose results already trailed China Mobile's badly, had it worse than the others.

To deal with its losses and its lag in 4G, the three carriers swapped executives again in 2015.

China Unicom's leadership change was announced first: Wang Xiaochu, then chairman of China Telecom, was transferred to China Unicom as chairman. Next came word that the two chairmen had traded places — China Unicom's Chang Xiaobing to China Telecom, China Telecom's Wang Xiaochu to China Unicom. Separately, China Mobile chairman Xi Guohua retired, and Shang Bing, a former vice minister at the Ministry of Industry and Information Technology, took over as China Mobile's chairman.

The three announcements came out one after another, inside an hour.

But swapping leaders again did not stop China Unicom's slide.

In the first half of 2017, China Mobile had 4.3 times as many 4G subscribers as China Unicom, and 1.2 times as many fixed broadband subscribers.

Needing a lot of money and a way out of its losses, China Unicom became a pilot for state-owned enterprise reform once more.

After a noisy half-year in 2017, the final mixed-ownership reform plan left China Unicom Group holding 36.67% of the shares. Add China Life's 10.22% and state capital still held more than 50% of the equity, while private capital — Tencent, Baidu, Alibaba, JD.com, Kuang-Chi, Suning, and others — held 35.2% between them.

State capital remains in charge. The internet companies that bought in hold only a minority of board seats, and they compete with each other besides. And as the two leadership swaps showed, all three carriers are listed companies, yet every appointment of a carrier's top executive, every change to pay and incentive schemes, and every exchange of businesses has had little to do with their boards.

Out of all this, China Unicom raised 78 billion yuan, with the CSRC waving it through.

Before the reform money arrived, nearly every Chinese internet company of any size had already teamed up with China Unicom on data SIM cards. To serve the growing number of customized SIM card users, China Unicom set up dedicated Tencent and Alibaba operations centers. Tencent's King Card alone brought China Unicom 50 million new users. Acquiring a user through Tencent cost China Unicom half what traditional channels did.

According to China Unicom's financial reports, investment deposits began arriving in the second quarter of 2017.

By the end of October, the strategic investors' cash subscriptions were complete.

China Unicom never managed to beat the internet companies, but it did get the money.

China Unicom's Part in State-Owned Enterprise Mixed-Ownership Reform: A Timeline

China Unicom Mixed-Ownership Reform Timeline

2015.10.13

The State Council issues the Guiding Opinions on Developing a Mixed-Ownership Economy in State-Owned Enterprises

2016

Mixed-ownership enterprises account for 68.9% at the central state-owned enterprise level

2016.10.9

China Unicom is placed in the first batch of state-owned enterprise mixed-ownership reform pilots, aimed mainly at its domestically listed A-share company, China United Network Communications Limited.

2016.11.1

Reports say China Unicom has settled on its mixed-ownership reform plan

2017.2.17

The CSRC revises its private placement rules, barring listed companies from privately placing more than 20% of total share capital

2017.4.5

China Unicom announces that trading in its A-shares is suspended, effective immediately

2017.5

China Unicom discloses details of the mixed-ownership reform plan, including an employee stock ownership scheme. It says the trading suspension will run two more months.

2017.6.22

Reuters reports that China Unicom plans to raise $10 billion, with Alibaba and Tencent taking part. Both deny it.

2017.7.14

China Unicom announces that the National Development and Reform Commission has approved its mixed-ownership reform pilot plan, and that the trading suspension will run another month.

2017.8.16

China Unicom holds its 2017 interim results briefing and discloses the substance of the mixed-ownership reform. Hours later, it withdraws the related announcement.

2017.8.17

In the early hours, China Unicom announces that the trading suspension continues. CRRC issues a clarification saying it did not subscribe to new shares in China Unicom's A-share company. It is later confirmed that the participant was CRRC Jinzheng Investment Co., a wholly owned subsidiary of CRRC Group, which itself took part indirectly through a fund company.

2017.8.20

Late at night, China Unicom republishes a series of mixed-ownership reform announcements. It plans to privately place no more than about 9.037 billion new shares with strategic investors, raising no more than roughly 61.725 billion yuan.

The CSRC announces that it will treat the private share placement in China Unicom's mixed-ownership reform as an individual case, applying the refinancing rules in force before its February 17, 2017 revision.

2017.8.21

China Unicom's A-shares formally resume trading.

2017.9.6

China Unicom holds a video conference to roll out its organizational streamlining plan. About 42,450 people need to be reassigned, and headquarters headcount is cut by 50%.

2017.10.13

China Unicom receives the CSRC's formal approval documents.

2017.10.27

All the mixed-ownership reform strategic investors complete their cash subscriptions, totaling nearly 75 billion yuan. The remaining 3.213 billion yuan or so is to be raised by granting restricted stock to core employees.

2017.12.15

At a routine State Council policy briefing, a SASAC spokesperson says the list for the third batch of mixed-ownership reform pilots has been settled, though not yet published: 31 companies, 10 of them subsidiaries of central state-owned enterprises and 21 local state-owned enterprises.

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