Triple Play Makes Optical Communication the Biggest Winner
Broadband enhancement is an inevitable requirement of Triple Play, which demands services such as HD video-on-demand and thus requires high bandwidth. However, China's current broadband level is between 2M-4M, far below the 10M-20M required for converged services. Therefore, optical communication technology and equipment companies will become the primary beneficiaries of Triple Play.
High prosperity to last 3-5 years
On April 8, the Ministry of Industry and Information Technology (MIIT), together with seven other ministries, issued the "Opinions on Promoting the Construction of Optical Fiber Broadband Networks," stating that "the importance of optical fiber broadband network construction must be fully recognized, and network construction must be accelerated." The plan targets over 80 million optical fiber broadband ports by 2011, with investment in optical fiber broadband network construction exceeding RMB 150 billion within three years and over 50 million new broadband users.
In terms of FTTx penetration, China still lags far behind developed countries, leaving enormous room for future growth. Against the backdrop of MIIT's vigorous promotion of Triple Play, operators are accelerating the deployment of optical fiber broadband access. For example, China Telecom stated at its interim results press conference that it would add RMB 5 billion and RMB 10 billion in investment for broadband access in 2010 and 2011, respectively. China Unicom invested RMB 11.86 billion in broadband access in the first half of 2010, a 200% year-on-year increase, and stated that it would further increase fixed-line broadband investment in the second half of the year to maintain rapid growth in this business.
Of the RMB 150 billion investment planned by MIIT, approximately RMB 100 billion is expected to be used for broadband access network construction. According to the latest data from China Telecom, the comprehensive construction cost of FTTH in 2010 was approximately RMB 1,450 per subscriber, while FTTB was RMB 680 per subscriber. Currently, the FTTB model dominates FTTx deployment, but looking at future development trends, the proportion of FTTH access will gradually increase, with FTTH expected to reach 10% next year.
An FTTx system consists of three parts: central office equipment (OLT), user terminal equipment (ONT), and the optical distribution network (ODN). As a critical component of the FTTx system, the ODN is the optical transmission physical channel between the OLT and ONU, typically composed of optical fiber cables, optical connectors, optical splitters, and supporting equipment for installing and connecting these components. The ODN includes five sections: the feeder segment, optical cable distribution point, distribution segment, optical cable access point, and drop segment. The feeder segment from the ODF frame in the central office to the optical cable distribution point serves as the backbone optical cable for long-distance coverage; the distribution segment from the optical cable distribution point to the user access point performs localized fiber distribution for user areas along the feeder cable; and the drop segment from the user access point to the terminal enables fiber-to-the-home. In construction expenditure, active equipment OLT and ONU account for approximately 45%, while passive equipment ODN and construction account for approximately 55%.
Driven by the accelerated deployment of Triple Play and 3G data services, operators' increasing demand for bandwidth is expected to sustain high prosperity in this industry for 3-5 years, with the main drivers being operator transport network expansion, FTTx access network projects, bidirectional upgrading of radio and television cable networks, and nationwide cable network construction.
Rapid growth of related equipment
Driven by service providers' need to develop new revenue-generating services such as broadband TV and upgrade their networks, PON (Passive Optical Network) equipment has begun large-scale deployment worldwide, strongly driving rapid growth in the PON equipment market. In 2009, the global PON equipment market totaled USD 2.18 billion, a 35% increase over 2008, and is expected to double again from the 2009 level by 2014.
In the domestic market, products from ZTE, Huawei, and FiberHome hold a monopolistic position with a combined market share of over 85%, of which ZTE and Huawei each hold approximately 35% and FiberHome holds 15%. In the international market, the market share of domestic manufacturers is also steadily increasing.
Optical supporting equipment outdoor cabinets have enormous potential. Currently, China's broadband access methods are mainly ADSL (using copper cable as the signal transmission medium) and FTTx (using optical fiber as the signal transmission medium). For a long time, ADSL has dominated China's broadband access market. As of the end of 2009, the user ratio of the two technologies was approximately 8:2. However, due to ADSL's low copper cable transmission rate and weak electromagnetic interference resistance, the significant impact of copper price fluctuations on network construction costs, and the risk of cable theft, ADSL can no longer meet emerging broadband service demands. In contrast, optical fiber offers advantages such as high bandwidth and electromagnetic interference resistance. Nevertheless, since operators have laid large amounts of copper cable during ADSL broadband access network construction, operators mainly adopt the fiber-to-the-building + ADSL networking approach during FTTx construction to fully utilize these resources, greatly driving demand for outdoor cabinets. In addition to FTTx demand, integrated outdoor cabinets can effectively reduce operators' site construction costs and operational energy consumption in base station construction, and are applicable in urban and rural locations where site selection is difficult.
According to industry expert analysis, over the next 3-5 years, the application of outdoor cabinets in the domestic communications sector will reach 500,000 units, with sales reaching a scale of over RMB 10 billion. Currently, products from Sunsea Telecommunications and New Sea Union are in a state of supply shortage, and Yongding Co., Ltd. will also share in the high-growth opportunities of this industry after its share issuance project is implemented.
Supply and demand basically balanced
According to the latest 2010 CRU data, global total optical fiber demand reached 168.5 million fiber-km in 2009, a 24% year-on-year increase, of which China's demand was 78.8 million fiber-km, an 89% year-on-year increase, accounting for 46.8% of the global total, while demand in other regions worldwide declined by 4% in 2009. In 2009, global optical cable production totaled 172 million fiber-km, with China alone producing 80.42 million fiber-km, accounting for 46.8% of world production.
Driven by 3G construction, domestic demand surged in 2009, but the number of base station constructions dropped significantly in 2010, from 350,000 to 200,000. It is estimated that optical fiber consumption for base stations will decline from 22 million fiber-km to 13 million fiber-km. In 2010, the main incremental market for optical fiber consumption came from access network upgrades brought by FTTx. Considering the accelerated deployment by operators, total optical fiber demand for 2010 has been revised upward from 85 million fiber-km to 90 million fiber-km.
On the supply side, in 2009, China's optical cable production reached 80.42 million fiber-km, with exports of 20 million fiber-km and imports of 25 million fiber-km. China's 12 optical fiber drawing enterprises produced 60.4 million fiber-km of optical fiber in 2009, of which YOFC, FiberHome, and Futong each produced over 10 million fiber-km. After capacity expansion in 2009, China's optical fiber market supply and demand remained basically balanced in 2010 (with estimated production capacity of 91 million and 100 million fiber-km for 2010-2011, respectively).
Regarding optical fiber price trends, prices remained at RMB 75-78/fiber-km from 2005 to 2008. In 2009, surging demand from 3G construction drove fiber prices up. As optical fiber manufacturers completed capacity expansion in 2010, the supply shortage was alleviated. Fiber prices are expected to fall back to RMB 75/fiber-km from the second half of 2010, and China's optical fiber market will maintain steady growth over the next 2-3 years.
Considering that China's optical fiber cable market already accounts for over 40% of the global total, and domestic demand will face a decline after the peak of 3G and FTTx construction, the possibility of long-term sustained high growth is unlikely. However, as major optical fiber manufacturers successively succeed in developing preform rod projects and gradually achieve import substitution, product costs can be effectively reduced, and industry profitability will be significantly enhanced.
Based on the above analysis, listed companies related to the optical communication industry will face favorable investment opportunities, and leading companies in segmented sectors are expected to achieve rapid earnings growth. Key stocks to watch include New Sea Union, Sunsea Telecommunications, Hengtong Optic-Electric, FiberHome Telecommunication Technologies, and ZTT.