How Will The 4G Rollout Impact China Telecom’s Q2 Earnings?

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China Telecom (NYSE:CHA), the third largest Chinese mobile operator by subscribers, is expected to publish its Q2 2015 results shortly. We expect the carrier’s earnings to be driven by its expanding 4G campaign, which has allowed it to improve its market share and should help it shore up its ARPU. The carrier could also benefit from lower interconnection-related fees and potentially better selling, general and administrative expenses. However, this could be partially offset by the impact of the value-added tax (VAT) and discounted service offerings, amid higher competition in the wireless market. 

We have a price estimate of $63 for China Telecom, which is about 15% ahead of the current market price.

See our complete analysis of China Telecom here

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4G Drives Market Share Growth, Could Help ARPU

China Telecom and its larger rival China Unicom received their full FDD-LTE licenses in February, allowing them to operate their 4G services across the country. The company’s 4G subscriber base at the end of March 2015 was 16.75 million, of which 9.67 million users were added in the first three months this year. While the carrier hasn’t broken out its 4G adds for this quarter, it noted that the high-speed base grew by 6.15 million through the quarter to 131 million users, while its overall customer base stood at 191.44 million users (68% high speed mix). This could mean that 4G additions were actually much higher, considering the internal upgrades from 3G to 4G offerings. In comparison, China Unicom added 6.42 million high-speed customers during the quarter, while China Mobile added about 46.6 million 4G subscribers (net of 26.6 high speed adds). [1] The 4G rollout has helped the carrier grow its market share by about 40 basis points through the first half of the year, by our estimates, compared to a contraction of about 65 basis points in 2014.

Although this is a good start, considering that it just received its full 4G license in February, the carrier still has a long way to go before it achieves its full year target of 100 million 4G customers. That said, there is plenty of room for growth since roughly 31.5% of the carrier’s customer mix is still on the slower 2G network, and the carrier is likely to encourage these customers to directly upgrade to 4G by offering discounts and special offers.  The carrier could also encourage its 3G customers migrate to 4G. It is also likely to target 2G/3G customers on rival networks, considering that China’s overall 3G/4G mix stands at a little over 53%, implying that there are still roughly 600 million users on 2G across China.

The impact of 4G on ARPU could be mixed, at least initially, as the carrier resorts to some discounting in order to attract customers. For instance, the carrier noted that it intended to cut pricing by about 30% per megabyte of data by the end of this year, in a move to foster greater 4G adoption. The price cuts should help China Telecom further improve its 3G/4G mix from the current level of 68% (already the best in the industry). This should be beneficial in the long run, since voice and SMS revenues are trending lower, and data usage is likely to be the basis for future revenue growth. 4G deployment could also have a positive impact on margins in the long run, since it is also more efficient than current 3G networks at handling data, helping to reducing maintenance and handling costs.

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Notes:
  1. China Mobile Operation Data []