Scenarios That Could Significantly Impact China Telecom’s Valuation

China Telecom (NYSE:CHA) is China’s largest wireline operator and third largest wireless carrier with about 109 million and 190 million subscribers, respectively. Having a dominant share of over 53% in the wireline broadband subscriber market, its customers are mainly concentrated in southern China, where it enjoys a near-monopoly. The other major player in fixed broadband, China Unicom (NYSE:CHU), has a share of 34% and mainly provides broadband services in the northern part of the country. In the country’s wireless market, China Telecom has a share of about 14.6% and trails both China Unicom and China Mobile (NYSE:CHL). China Unicom and China Mobile have market shares of 22.5% and 62.8%, respectively.

In the Chinese wireless market, there is currently fierce competition for high speed (3G and 4G) subscribers with 4G networks (FDD-LTE and TD-LTE) being promoted and expanded in a big way in the country. By the end of April, over 170 million subscribers were using 4G services in China with about 85% of them on market leader China Mobile’s network. China Telecom reported about 16.8 million 4G subscribers by the end of March 2015, constituting about 10% of the overall 4G market in China. China Mobile has raced past the others in adding 4G subscribers in the last year because of its first mover advantage.

The Chinese government awarded TD-LTE 4G licenses in December 2013 which only benefited China Mobile since China Telecom and China Unicom intended to build and expand their 4G networks using the FDD-LTE standard. The lack of FDD-LTE licenses for China Telecom and China Unicom helped China Mobile grow its 4G subscriber base exponentially from just over 1.3 million users in February 2014 to 90 million in December 2014 to over 153 million users at the end of April 2015. The government only recently awarded FDD-LTE 4G licenses to carriers, and China Telecom, unlike China Unicom, has made a good start to its 4G campaign.

In this article, we discuss various scenarios in the wireline as well as wireless industry which could significantly impact the company’s valuation. We have a price estimate of $63 for China Telecom, which is slightly below the current market price.

See our complete analysis of China Telecom here

Increase In Wireline Broadband ARPU (-5% Impact)

China Telecom is the largest broadband service provider in China, with a share of more than 53% in a 204 million subscriber market. ^[1] 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 company 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 could stabilize its broadband ARPU (Average Revenue Per User) which declined from RMB 62.1 ($9.67) in 2013 to RMB 59.1 ($9.44) in 2014. However, it is plausible that growing competition limits the company’s pricing power going forward and its ARPU further declines. China Mobile entered the fixed line broadband market in January 2014 and has been making great strides by offering competitively priced products and services. If China Telecom’s broadband ARPU continues to decline at the current rate to below $8 levels on the back of rising competition, our price estimate for the company’s valuation could decrease by about 5%.

Wireless Market Share Decline (-10%)

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 25 basis points in the first five months this year.

However, the company may not be able to sustain this increase considering that China Unicom has yet to fully launch its 4G services. If China Mobile continues to improve share and China Unicom reverses its declining trend, China Telecom may not be able to achieve the growth that we expect for the company in our current forecasts. Furthermore, if Unicom outpaces China Telecom in gaining subscribers and the latter’s market share declines to its historical average of 12.5%, we could witness a decline of about 10% to our price estimate for the company.

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1. Mainland China Telecoms Statistics, Marbridge Consulting, 2015 [↩]