China Telecom’s Q1 Profit Soars 18% On 3G, Broadband, Cost Savings

China Telecom (NYSE:CHA) reported robust first quarter 2014 earnings with net profit soaring 18% year-over-year (y-o-y) to RMB 5.57 billion (~$900 million) driven by growing 3G and Broadband revenues and significant cost savings. These cost savings were largely on account of the network assets acquired from its parent company as well as a favorable revision of interconnection fees by the government last year. The carrier’s operating revenues grew 6.9% y-o-y to RMB 83.2 billion ($13.42 billion) on account of increasing 3G service revenues and consistent growth in fixed broadband. 3G service revenues increased as the carrier added over 26 million new 3G users in the preceding one year period, taking its total 3G subscriber base to 104 million by the end of March 2014. However, the company’s lackluster performance in terms of subscriber adds in the first quarter this year was reflected in its mobile terminal sales, which declined 2.1% y-o-y to RMB 9 billion ($1.45 billion). ^[1]

On the cost side, expenses incurred on the maintenance of network operations increased by 30% over the same period last year on account of the company’s efforts in improving its wireless network quality. Depreciation & amortization (D&A) was down 5.9% y-o-y owing to completion of the acquisition of CDMA assets by the carrier from its parent company- China Telecom Corp. The customer relationships acquired by China Telecom as part of the deal were fully amortized by December 2013 which led to amortization savings in the first quarter this year. The company also gained from the favorable revision in network interconnection fees by the government last year (effective from January 1, 2014) which helped reduce the other operating expenses by about 5.4%. Overall, operating expenses increased 5.9% y-o-y to RMB 74.5 billion ($12 billion) in Q1 2014. ^[2]

China Telecom launched its 4G service (TD-LTE) in February this year and unsurprisingly, it did not significantly impact its first quarter financial results. We expect the company to effectively gain from 4G only when the Chinese government awards FDD-LTE 4G licences to the carrier, which according to rumors in the Chinese media, could be as soon as next month. We currently have a price estimate of $52 for China Telecom, implying a premium of about 10% to the market price.

See our complete analysis of China Telecom here

Growing 3G Subscriber Base Drives Revenues

China Telecom has been quick to capitalize on 3G demand and boasts an industry-leading 3G penetration of about 57%. In comparison, market leader China Mobile (NYSE:CHL) and second-placed China Unicom (NYSE:CHU) have 3G mixes of 29% and 46%, respectively. Despite its already high 3G penetration compared to rivals, China Telecom was able to add around 26 million 3G subscribers in the one year period prior to March 31, 2014 . However, its net 3G additions in the first quarter this year were only 1 million, about 88% lower than its quarterly average last year. This was likely a result of China Mobile’s aggressive expansion in 3G and 4G and China Unicom making steady progress with its 3G HSPA+ and high speed 42M (“3.5G”) networks.

Growth in 3G subscribers propelled China Telecom’s mobile data revenues, which now contribute almost 50% of China Telecom’s mobile service revenues. Another positive development for the carrier was that its mobile ARPU (average revenue per user) marginally improved over its full year 2013 value of RMB 54.8 ($8.93) in the quarter, aided by robust growth in mobile data revenues. Going forward, the company plans to actively apply for the FDD-LTE 4G licenses and build a seamless high-speed wireless network, effectively integrating its 3G, 4G TD-LTE and 4G FDD-LTE networks. This should help in expanding the share of Internet data in the carrier’s mobile service revenues, thus driving up its mobile ARPU further.

Fixed Line Broadband Subscribers Growing Consistently

China Telecom’s fixed line broadband subscriber adds offset most of the decline in local access line subscribers (land-line telephones). The company added 2.23 million fixed line broadband subscribers in Q1 as the carrier continued to bolster its Fiber-To-The-Home (FTTH) penetration. The carrier’s strategy was consistent with the government’s ‘Broadband China’ plan to universalize broadband Internet in the country. With a market share of over 50%, China Telecom has over 102 million fixed line broadband subscribers, of which more than 20 million are on the faster FTTH network.

China Telecom’s broadband business holds a lot of potential, as China’s broadband penetration presently is only around 40%. Moreover, the carrier might offer higher value services such as IPTV and Video-On-Demand to a majority of its customers going forward, which could potentially increase its broadband ARPU. The only concern for China Telecom in this business could be the growing competition from new players such as China Mobile and stricter government regulations.

The “Three New Roles” Strategy

China Telecom aims to rapidly grow in the Chinese telecom market and effectively tackle competition and regulatory challenges to create a ‘New China Telecom’ going forward. Its strategy to achieve this objective is by leveraging its ‘dual-technology strengths’ of 3G/4G and fixed-line broadband. The company essentially plans to evolve into an Internet-business type model with primary focus on reform and innovation. “Three new roles” is a strategy being implemented by the company to achieve these aforementioned goals. The three new roles refer to (1) Leader of Intelligent Pipeline, (2) Provider of Integrated Platforms and (3) Participant of Content & Application Development. ^[3]

The new strategy essentially relates to targeting customers better, innovating new products to match customer expectations, improving network management and integrating various service platforms for a refined user experience. The dynamic innovation-based concept provided positive results for the company last year, helping both revenue and net income grow in double-digits. However, China Telecom will need to better implement its ‘three new roles’ plan going forward considering that the carrier has lagged behind rivals in attracting wireless subscribers in the last several months.

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1. Press Release, China Telecom, April 28 2014 [↩]
2. Key Performance Indicators, China Telecom, April 28 2014 [↩]
3. Fact Sheet, China Telecom, August 2013 [↩]