China Telecom’s Q1 Profit Drops 9% On Sluggish Subscriber Adds, VAT Reform

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China Telecom

China Telecom‘s (NYSE:CHA) net profit declined over 9% year-over-year (y-o-y) to RMB 5.05 billion ($810 million) in the first quarter. This was largely attributable to the impact of the value-added tax (VAT), discounted service offerings and a net addition of just 20.7 million high speed subscribers (3G and 4G) and 5.6 million total subscribers in the prior one year period. Management stated that the low wireless subscriber additions and VAT reforms also impacted its overall revenue, which declined 2.1% y-0-y to RMB 81.45 billion ($13.13 billion) driven by a 15% decline in mobile terminal sales. Wireline revenues reported a slight increase on the back of a steady increase in broadband subscribers. ((Press Release, China Telecom, April 28 2015)) [1]

As part of its tax and fiscal reforms for the country, the Chinese government imposed a value added tax (VAT) on telecom services last year, coming into effect across the country on June 1 2014. The VAT rate applicable to basic telecom services and value-added services are 11% and 6%, respectively. While the earlier Business Tax (3%) was calculated based on net sales, the VAT is calculated on the difference between net sales and cost of goods sold (COGS).

On the cost side, expenses incurred on the maintenance of network operations increased by 28.3% over the same period last year on account of the company’s efforts in improving its wireless network quality and creating effective synergies between its wireless (3G and 4G) and wireline broadband networks. 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. Personnel expenses, contributing 20% of total expenses, increased 16.7% y-o-y in the first quarter on a rise in performance-linked remuneration to the company’s front line employees. This increase also indicates that the company’s performance was not as bad as the numbers indicate and that the VAT may have had a significant impact on the top and bottom line, much like it impacted China Unicom‘s (NYSE:CHU) and China Mobile‘s (NYSE:CHL) results, reported earlier this month. (China Unicom’s Q1 Earnings Decline On Increasing Competition, VAT ReformsChina Mobile’s Q1 Profit Drops Even As 4G Subscribers Soar)

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China Telecom lagged behind the bigger players, especially China Mobile, owing to limitations in expanding its 4G network coverage because the government hadn’t granted the required licenses (for FDD-LTE) last year. Now, with the full FDD-LTE 4G licenses in place, we expect the carrier to aggressively expand its 4G network coverage and boost its monthly high speed user adds. Its 4G subscriber base at the end of March 2015 was 16.75 million, of which 9.67 million were added in the first three months this year. Although it is a good start considering that it received its full 4G license only in February 2015, it is still a far cry from its full year target of 100 million 4G customers. In comparison, market leader China Mobile added over 53 million 4G customers in the first quarter.

We have a price estimate of $57 for China Telecom, which is significantly below the current market price.

See our complete analysis of China Telecom here

Competition Impacts Wireless Subscriber Adds; 4G Mix at 8.9%

China Telecom has historically done well in expanding its subscriber base in the Chinese wireless market. It increased its market share from just over 4% in 2008 to 15% by the end of December 2013. However, the carrier struggled to keep up with China Mobile’s aggressive user additions last year and its market share actually declined by 65 basis points y-o-y by the end of December 2014. It showed a marked improvement in its performance after the government granted trial FDD-LTE licenses last June, and this momentum helped the carrier improve its market share by 16 basis points in the first quarter this year. The carrier also leads the Chinese wireless market in 3G penetration, with over 66% of its total subscribers using 3G/4G services, followed by China Unicom (51.4%).

The carrier added just 15.5 million new 3G/4G subscribers last year, compared to an average monthly increase of about 3 million in 2013. This is attributed to increased competition in the Chinese wireless market, especially with China Mobile upping the ante with its rapid 3G and 4G expansion. Now with the full 4G license in place, it is starting to report a steady increase in high speed user additions. The carrier added 9.67 million 4G users in Q1 2015, taking its total 4G subscriber count to 16.75 million. However, this increase was partially offset by the decline in the carrier’s 3G user base. With a market share of 14.5% in the Chinese wireless subscriber market, China Telecom currently has an overall subscriber base of about 189 million users, including 125 million 3G/4G users and a 4G mix of 8.9% (March 2015).

Steady Fixed-Line Broadband Top Line Gains

China Telecom is the largest broadband service provider in China, with a share of more than 53% in a 200 million subscriber market. [2] 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. Broadband penetration in the country is currently around 40%. The carrier’s 108 million subscribers are mainly concentrated in southern China, where it enjoys a near-monopoly. The other major player in fixed broadband, China Unicom, has a share of 34% and mainly provides broadband services in the northern part of the country. ((Operating Data, China Unicom, Feb 2015)) ((Key Performance Indicators, China Telecom, Feb 2015))

The carrier reported that its overall wireline revenues in Q1 2015 were slightly higher than that reported for full year 2014 on the back of consistent increase in broadband subscribers. In 2014, overall wireline revenues reached RMB 73.5 billion ($11.80 billion), representing an increase of 4% over 2013. As part of its total wireline broadband business, China Telecom had earlier stated that it initiated comprehensive bandwidth upgrades for all subscribers with its mainstream products having speeds of 50 Mbps and 100 Mbps. It also enhanced its service capabilities with products such as “Joy me”, “Smart Family”, prepaid cards as well as “Speedy Connect” cards.

In addition to its efforts in transforming its core fiber broadband business, the carrier also made progress in scaling up its emerging businesses — value added services (VAS) and integrated information application services – which include Internet Data Center (IDC) services, IPTV services as well as cloud computing services. With growing adoption of higher value services such as IPTV and Video-On-Demand going forward, the company should be able to gradually increase its broadband ARPU which declined from RMB 62.1 ($9.97) in 2013 to RMB 59.1 ($9.49) in 2014.

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Notes:
  1. Key Performance Indicators, China Telecom, April 2015 []
  2. Mainland China Telecoms Statistics, Marbridge Consulting, 2014 []