China Telecom Reaps Big Gains In 3G As 4G Buildout Looms

China Telecom (NYSE:CHA), the third largest wireless carrier in China, posted strong double digit growth of 15.9% in net earnings for H1 2013 as high quality 3G subscribers fostered data revenues. The carrier leads the Chinese telecom industry with a 3G penetration of 50% as compared to 18% and 38% for rivals China Mobile (NYSE:CHL) & China Unicom (NYSE:CHU), respectively. As discussed in our previous analysis (see China Telecom’s Earnings: 3G, CDMA Network Acquisition & Broadband To Provide Strong Growth), China Telecom’s results were buoyed by the CDMA network acquisition which was completed last year. The broadband division also showed steady growth as the company expanded its Fiber-To-The-Home (FTTH) outreach.

However, considering the impending transition to 4G LTE, China Telecom could face challenging times ahead as competition is set to get fiercer. China Telecom did not declare an interim dividend this time in order to conserve cash for its future capital investments in its 4G LTE network. As 4G LTE licenses are expected to be issued by the end of this year, China Telecom has started preparing for deploying a hybrid LTE network in response to China Mobile’s fast paced 4G LTE trials expansion.

We have a price estimate of $60 for China Telecom’s stock.

See our full analysis for China Telecom’s stock here

3G Subscriber Growth & Broadband Boost Earnings

China Telecom has been quick to capitalize on 3G demand. With a much higher 3G penetration compared to rivals, the carrier added around 18 million 3G subscribers in H1 2013, representing growth of 25% compared to the same period last year. Moreover, the pace of 3G subscriber adds has held on as China Telecom continues to add more than 3 million 3G subscribers every month. ^[1]

The growth in 3G subscribers has propelled mobile data revenues which now contribute almost 50% to China Telecom’s mobile service revenues. Another positive development for the carrier has been that its mobile ARPU has risen from $52.4 in H1 2012 to $54.3 in H1 2013, primarily aided by 36% growth in mobile data revenues over the same period. China Telecom’s average monthly data usage for its 3G handset users increased 51% to more than 168 MB, as the carrier increased its marketing efforts by promoting its web applications and products such as 189 Mail & e-Surfing Cloud. Moreover, premium smartphones like the iPhone have also helped China Telecom increase its data traffic and ARPU. ^{[2] [3]}

China Telecom’s wireline broadband revenue growth nullified the fall in wireline voice revenues. The broadband division’s revenues grew by 5.5% in H1 2013 as the carrier continued to bolster its Fiber-To-The-Home (FTTH) penetration. China Telecom has around 95 million broadband subscribers, out of which, more than 20 million are on the faster FTTH network. China Telecom’s broadband division holds a lot of potential as over time the carrier might offer higher value services such as IPTV and Video-On-Demand to a majority of its customers, which could potentially increase broadband ARPU. Moreover, broadband penetration in China has only reached around 40% at present. ^[2]

CDMA Network Acquisition Improves Profitability Despite Subsidy Pressure

China Telecom acquired CDMA network assets from its parent company last year to avoid paying network leasing fees which were denting its profits (as measured by EBITDA margins). As a result, the carrier’s profits have improved from this year even as handset subsidies have grown by 22%. China Telecom’s EBITDA margins increased by around 5 percentage points in H1 2013 compared to the same period last year. ^[2]

The company’s profits have declined over the years as handset subsidies have taken a toll. Moreover, the carrier’s iPhone deal with Apple last year has put additional pressure on margins. However, the CDMA network acquisition bodes well for China Telecom as it will help the carrier improve operational cash flows and profitability.

4G LTE – An Inflection Point

In about four years of offering 3G services, China Telecom has increased its wireless market share from around 4% in 2008 to about 15% at present. Much of this increase has come about at the expense of the largest wireless operator – China Mobile – who has suffered because of its largely incompatible TD-SCDMA 3G network. But the status quo could possibly undergo radical changes as telcos prepare for a 4G LTE rollout.

4G LTE licenses are expected to be issued by the end of this year, and China Telecom has said that it plans to conduct LTE trials in a timely and appropriate manner. The carrier has opted to deploy a hybrid LTE network using both LTE technologies – Time Division Duplex (TDD) & Frequency Division Duplex (FDD). Going forward, we believe that China Telecom’s capex requirement will increase significantly on account of investments in its 4G LTE network. The company also said that it might spend RMB 80 billion on capex as compared to the previous guidance of RMB 75 billion for 2013. Considering China Mobile’s efforts in preparing for a 4G LTE rollout (see China Mobile Readies For A Massive 4G Launch), China Telecom needs to catch up as a fiercely competitive journey lies ahead of it. ^[4]

Understand How a Company’s Products Impact its Stock Price at Trefis

1. 3G Subscribers, China Telecom [↩]
2. H1 2013 Investor Presentation, China Telecom [↩] [↩] [↩]
3. H1 2013 Results Announcement, China Telecom [↩]
4. H1 2013 Earnings Call Transcript, China Telecom [↩]