China Telecom Reports Modest Interim 2014 Results On Slowing 3G Subscriber Growth

China Telecom (NYSE:CHA) reported modest interim 2014 earnings with net profit growing 12% year-over-year (y-o-y) to RMB 11.4 billion ($1.86 billion), driven by growing wireless and fixed line data revenues and significant cost savings. These cost savings were largely on account of a double-digit decline in handset subsidies as well as a favorable revision of interconnection fees by the government last year. The carrier’s operating revenues grew 5.3% y-o-y to about RMB 166 billion ($27 billion) on account of increasing 3G service revenues and consistent growth in fixed broadband. Revenues from 3G service increased as the carrier added about 20 million new 3G users in the preceding one year period, taking its total 3G subscriber base to 107 million by the end of June 2014. However, the company’s lackluster performance in terms of subscriber adds in the first six months this year was reflected in its mobile terminal sales, which declined 9.3% y-o-y to RMB 16.6 billion ($2.7 billion). ^{[1] [2]} ((Key Performance Indicators, China Telecom, Aug 27 2014))

On the cost side, expenses incurred on the maintenance of network operations increased by 26% over the same period last year on account of the company’s efforts in improving its wireless network quality. Depreciation and amortization (D&A) was down 5.5% owing to the completion of the acquisition of CDMA assets by the carrier from its parent company. 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 half of 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 mobile interconnection costs by about 22% and total interconnection costs by about 9% y-o-y.

The carrier received a license towards the end of the second quarter to commence its FDD-LTE and TD-LTE 4G hybrid network trial in 16 cities in the country. We expect this to help improve the carrier’s monthly subscriber additions as well as average revenue per user (ARPU), but only towards the end of the year. We currently have a price estimate of $52 for China Telecom, implying a slight discount to the market price.

See our complete analysis of China Telecom here

3G Subscriber Growth Slowing Down

China Telecom has been quick to capitalize on 3G demand and boasts of industry-leading 3G penetration of about 60%. In comparison, market leader China Mobile (NYSE:CHL) and second-placed China Unicom (NYSE:CHU) have 3G mixes of 32% and 48%, respectively. Despite its already high 3G penetration compared to rivals, China Telecom was able to add around 20 million 3G subscribers in the one year period prior to June 30. However, its net 3G additions in the first six months this year were only 4 million, about 78% lower than figures reported in the same period last year. This was a result of China Mobile’s aggressive expansion in 3G and 4G, and China Unicom making steady progress with its 4G, 3G HSPA+ and high speed 42M (“3.5G”) networks.

The modest 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 improved by 4% over its interim 2013 value of RMB 54.3 ($8.83), aided by robust growth in mobile data revenues. Going forward, the company plans to actively expand its 4G coverage 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, as well as further drive up its mobile ARPU.

Growing FTTH Penetration Boosts Fixed Line Broadband Subscriber Base

China Telecom’s fixed line broadband subscriber adds offset most of the decline in local access line subscribers (land-line telephones). The company added 4 million fixed line broadband subscribers in H1 2014 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 104 million fixed line broadband subscribers, of which about 32% or 33 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.

Capital Expenditures to Rise Rapidly in Near Term

China Telecom reported in its earnings release that it had incurred capital expenditures of about RMB 23 billion ($3.74 billion) in the first six months of 2014, compared to RMB 33.1 ($5.38 billion) in the same period last year. The y-o-y decline can be explained from the fact that the company did not receive a 4G license from the Chinese government in the first six months of the year, and therefore it wouldn’t have been prudent to spend on network development during that period. However, since the company was awarded a trial 4G license last month, it intends to rapidly expand its 4G coverage and presence in the country.

The company estimates that its capital expenditures in 2014 will be around RMB 80 billion ($13 billion), which is close to its spending last year. Considering that it has spent less than 30% of its yearly estimate to date, its capital expenditures will likely rise rapidly in the second half of the year.

Creating a “New China Telecom”

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, which it reiterated in its earnings press release. 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. ^{[1] [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 this 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, Aug 27 2014 [↩] [↩]
2. Presentation H1 2014, China Telecom, Aug 27 2014 [↩]
3. Fact Sheet, China Telecom, August 2013 [↩]