China Telecom Earnings Preview: Rising 3G Demand And Broadband Expansion To Drive 2013 Results

China Telecom (NYSE:CHA) is China’s leader in 3G penetration, with more than 55% of its subscribers using 3G services compared to 25% for wireless market leader China Mobile (NYSE:CHL). In the first three quarters ending September 2013, China Telecom saw its operating profits grow by over 27% year-over-year (y-o-y), with profit margins improving by more than 5 percentage points from the year-ago period. This was attributed to growing demand for the carrier’s 3G services and consistent broadband subscribers adds. The acquisition of CDMA network assets from its parent company last year also helped China Telecom improve margins as it saved on network leasing expenses.

China Telecom is the third largest wireless telecom carrier in China, with about 185 million subscribers. The carrier has done well since it entered the wireless market, increasing its market share from just 4% in 2008 to about 15% by the end of 2013. With mobile phones becoming increasingly popular, the company’s landline subscriber count declined by over 4% to 156 million in 2013. However, this was more than offset by growth in broadband subscribers, which increased by over 10% to cross 100 million by the end of 2013.

We expect growing 3G demand, broadband expansion and acquisition of its CDMA network assets to drive China Telecom’s full year 2013 earnings, which are expected to be released later this month. We currently have a price estimate of $53 for China Telecom, implying a premium of about 30% to the market price.

See our complete analysis of China Telecom here

Growing 3G Subscribers Likely To Drive ARPU

Increasing 3G users help carriers improve their ARPU, as the faster 3G network encourages subscribers to use more data-intensive applications which boost overall data usage. Considering that China Telecom’s 3G penetration is more than 50%, the increase in 3G ARPU more than compensates for declining voice revenues. This is evident from the fact that the company added about 18 million 3G subscribers in the first six months of 2013 and its overall ARPU grew by 3.6% to RMB 54.3 ($8.69). According to data released by the carrier, China Telecom added more than 16 million 3G subscribers in the second half of 2013, which should further help improve the company’s overall ARPU. A higher ARPU directly impacts the company’s top line, and we expect China Telecom’s mobile revenues to grow in high single digits in the near term and mid single digits in the long run.

CDMA Network Acquisition Could Offset Rising Subsidy Costs

Mobile handset subsidies offered by China Telecom increased more than 20% y-o-y to RMB 14 billion ($2.24 billion) during the first six months of 2013, which subsequently impacted the company’s bottom-line growth. The carrier’s subsidy costs increased due to higher iPhone subsidies and increasing competition from rivals such as China Mobile. However, this was offset by China Telecom’s acquisition of CDMA network assets from its parent company. As a result of the network acquisition, network leasing expenses declined by 25% and profit margins improved by almost five percentage points in the first half of 2013. ^[1]

Going forward, we expect the decline in network lease expenses to partially offset rising subsidy costs. However, increasing competition and price sensitivity in the Chinese telecom market could result in subsidies growing faster than the decline in leasing costs, which could put pressure on the company’s margins.

Steady Broadband Subscriber Growth To Boost Revenues

China Telecom is the largest broadband service provider in China with more than 52% share in a 200 million subscriber market. ((Mainland China Telecoms Statistics, Marbridge Consulting, 2013)) This market has grown at a rapid pace historically and is likely to continue in the future as the government implements its “Broadband China” strategy to universalize broadband usage in the country. The carrier’s 100 million subscribers are mainly concentrated in southern China, where it enjoys a near monopoly. The other major player, China Unicom (NYSE:CHU), has a share of 35% and mainly provides broadband services in the northern part of the country.

In the first half of 2013, China Telecom’s broadband revenues increased 5.5% y-o-y to RMB 35.2 billion ($5.6 billion) owing to a 15% growth in the number of subscribers. Considering that the company consistently gained subscribers in the latter half of the year as well, we expect broadband revenues to continue their single digit growth for full year 2013.

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1. Interim 2013 Results Announcement, China Telecom [↩]