Bottom line: China's VNO program appears to be gaining momentum heading into its third year, and could reach the 200 million subscriber mark by the end of 2017.

It's been more than a year since I last wrote about China's fledgling attempt to breathe new life into its telecoms services sector by creating virtual network operators (VNO), mostly because the program seemed to be sputtering in its first couple of years. But new data from the telecoms regulator seems to suggest the industry may finally be finding its legs, and could be starting to take some meaningful market share from the nation's monopoly of 3 big state-run telcos.

The headline figure underpinning my assertion is 43 million, which appears to be the number of VNO subscribers in China at the end of last year. (Chinese article) I need to give a quick disclaimer here, as nowhere in the article is the term VNO or variant MVNO used to describe this sector, which is called the "mobile resale business". But that term, combined with a description of the program, does seem to indicate that these are VNO subscribers.

To give the year-end figure some context, China had just 8.2 million VNO subscribers in August 2015, a little more than a year after the program was launched by the Ministry of Industry and Information Technology (MIIT). So it's probably fair to say that after a bumpy first year, the sector consisting of 42 VNO licensees has managed to increase its subscriber base by a factor of 4 or 5 in its second year. The MIIT proudly points out that at the current levels, VNO subscribers now account for about 3 percent of China's total of about 1.3 billion mobile users.

Here we should quickly recap the VNO program, which has gone through a long and arduous process to get to its current state. The idea behind the program has been tried in the west with mixed results, and basically sees traditional telcos lease out capacity on their networks to third-party companies that simply sell air time to consumers under their own brands. Many of China's biggest Internet names have launched VNO services, including Alibaba (NYSE; BABA), JD.com (Nasdaq: JD) and Suning (Shenzhen: 002024).

The big problem is that the traditional telcos, China Mobile (HKEx: 941; NYSE; CHL), Unicom (HKEx: 762; NYSE: CHU) and China Telecom (HKEx: 728; NYSE: CHA), were unlikely to cooperate in the effort, since doing so would just create new competition for themselves. But as with everything in China's telecoms space, the regulator has strong-armed the telcos to accept the program and probably set prices for leasing network capacity that are somewhat reasonable.

We haven't heard too much from the VNOs themselves, so it's hard to say whether any are operating profitably. In the early stages, many said they were willing to operate at a loss indefinitely and were using the service to draw consumers to their core businesses, often e-commerce. But I do suspect that many will want to operate profitably eventually, since telecoms services can be quite lucrative.

Shifting Field

All that brings us back to the present, and what's likely happening behind the scenes. I would guess that among the field of 42 licensees, probably around two-thirds aren't really actively promoting their services or gaining any traction. That would leave around 15 VNOs now promoting the business, equating to about 3 million subscribers for each. The MIIT says the 42 licensees have invested 3.1 billion yuan ($456 million) to date, and I suspect the lion's share of that has come from the most active 12-15 players.

Companies like Alibaba and JD.com probably have quite a bit more than just 3 million users, as they have quite a lot of money and have shown they are willing to heavily subsidize new businesses with future potential. What's more, these particular businesses probably aren't that large in the big scheme of things, meaning those companies will be likely to continue their subsidies for at least the next 4 or 5 years.

At the end of the day, it does seem like this new group should be able to keep up its recent momentum, and perhaps could double or even triple its subscriber base in the year ahead. The biggest danger is that the telcos might start to react by creating new obstacles if and when they realize that these companies could actually pose a serious threat to their monopoly. But that's probably more than a year away, and in the meantime I would expect the VNOs could collectively pass the 200 million subscriber mark this year.