China's OTT/cloud providers pick up steam as telcos stumble

Matt Walker/Ovum
24 May 2016

China’s telecoms sector has come down to earth. Operator revenues have declined year-on-year (YoY) for two straight quarters. However, China’s cloud/over-the-top (OTT) providers are surging: Annual revenue growth for China’s Internet content providers (ICPs) is above 30% and capex growth is strong. China’s tech vendors will benefit initially, but as China’s ICPs expand globally, they are likely to diversify their corporate relationships.

Annualized China ICP capex grew 39% in 1Q16 to $4.7b

Over the last four quarters (2Q15–1Q16), capex spend by China’s ICPs was around $4.7 billion, up 39% from 2Q14–1Q15. That is impressive growth, but the absolute level remains small relative to the telco market. China’s total telecoms service provider revenue for the same period was $60 billion, nearly 13 times that in the ICP market. This makes China’s ICP sector small in relative terms: The global telecoms service provider market was only four times that of ICPs for the same period. China’s restrictive regulatory climate is a likely factor behind this disparity.

Even with friendly regulators, Chinese operators are now struggling to find growth. Service revenues are flat to down, and device revenues are not quite making up the difference. The big three, China Mobile, China Unicom, and China Telecom, may benefit on the cost side from their recent tower spin-off, China Communications Facilities. However, they also now face a new entrant in the shape of cable TV player China Broadcasting Network. Local telcos face a range of homegrown ICPs, each with a slightly different business model, many impacting the telco business competitively. The homegrown ICPs Ovum tracks include Alibaba, Baidu, Qihoo 360, Sina, Sohu, Xunlei, Youku (now part of Alibaba), and YY.

China’s ICPs are globalizing and growing

Over the last year, China’s ICPs have grown much larger, entering new markets domestically (e.g. Alibaba’s Netflix-like service Tmall Box Office), investing abroad (e.g. Tencent’s data center collocation deals with Equinix and Cogeco), and working more closely with the global tech supply chain (e.g. both Tencent and Alibaba joining the SDN/NFV-focused Open Daylight Project earlier this year). There also has been some consolidation, as companies realign business models and search for scale in their key markets. Alibaba closed its $4.1 billion acquisition of Youku in April 2016, while Baidu is spinning off its video division (iQiyi) for $2.8 billion. These types of shifts are natural as a new market evolves.

Chinese ICPs’ biggest investments are large data centers and related infrastructure (e.g. data center interconnect, cloud software), along with real estate. Some of China’s ICPs have their own network backbone, typically built off leased fiber procured from one of the main CSPs, and optical/packet gear from a local supplier. Overseas, Alibaba has been most aggressive, with two data centers in Silicon Valley, and a $1 billion cloud expansion underway, which was announced in late 2015. However, its revenue streams and network assets are almost entirely in China.

Growth prospects for China’s ICPs remain good, absent a regulatory shock. Even with the country’s recent financial market turmoil and moderation in GDP growth, this is still China. Perspective may help. Ten years ago, China’s telco sector (in capex terms) was roughly one-third the size of North America and now they are roughly equal. China’s ICPs may not catch up to local telcos as quickly, but they are worth watching.

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