China Telecom Performs Well Where It Counts, With Solid Data Growth

China Telecom (NYSE:CHA), the smallest of the three major Chinese carriers, published a relatively strong set of interim results for the first half of 2015. ^[1] Although revenues and earnings saw a slight decline on a year-over-year basis, on account of the VAT reforms, lower voice usage and the government’s move to reduce data tariffs, the company performed well in two crucial areas – driving data revenue growth through its aggressive 4G rollout and higher wireline broadband speeds, while also managing its operating cost base. Data consumption and cost management are likely to be the primary levers of earnings growth in a saturating Chinese telecom industry, which is contending with a slowdown in macroeconomic growth and mounting competition for subscriber adds. In this note, we provide a brief overview of China Telecom’s performance and summarize the key takeaways from the earnings.

We have a price estimate of $63 for China Telecom, which is about 15% ahead of the current market price. We will be revisiting our valuation model and price estimate to update for the earnings release.

See our complete analysis of China Mobile | China Unicom | China Telecom

Wireless Services Revenues See A Rebound

China Telecom’s mobile service revenues, which saw a 6% sequential dip in the second half of 2014, recovered by about 7% this quarter, rising to $9.76 billion, driven by a strong start to its 4G campaign and a lower sequential impact of the new VAT as the carrier optimized its development and sales model. Although voice revenues fell by about 17.4% compared to the first half of 2014, this was more than offset by the growth in data revenues (17.5% y-o-y), allowing total mobile service revenues to rise by about 0.4% year-over-year.

China Telecom and its larger rival China Unicom (NYSE:CHU) received their full FDD-LTE licenses in February, allowing them to operate their 4G services across the country. The company said that it had 29 million 4G users as of June 2015, up from 17 million users in March. Although the size of the company’s 4G user base is dwarfed by industry leader China Mobile (NYSE:CHL) , which reported 190 million 4G LTE users at the end of June, it appears to be faring better than rival China Unicom in terms of overall high-speed adds (12.37 million vs. 8.68 million over H1). 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. While this is certainly a good start, the carrier has some way to go before it achieves its full year target of 100 million 4G customers.

The shift to 4G should bode well for the carrier in the long run, since its ARPU for 4G is about 55% higher compared to 3G/2G ARPUs at about $13.40.  Monthly average data traffic per terminal user is also much higher at 700 MB, versus about  311 MB for 3G/4G services. However, 4G pricing is likely to trend lower as the Chinese government has ordered carriers to reduce per-unit pricing for data services. China Telecom had indicated in May that its prices for data would fall by an average 30% per MB by the end of this year. While this discounting could cap 4G ARPUs in the near term, it should bring more users into the 4G fold, while helping to increase data consumption. 4G deployment should 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 reduce maintenance and handling costs. The carrier also began deploying its 4G+ (LTE-A) service that will offer peak speeds of up to 300 Mbps on the downlink and 50 Mbps on the uplink, making it the fastest network in mainland China. ^[2] Although the service will only be available in select cities, it should help to improve the carrier’s branding and reputation in a relatively premium and rapidly expanding market.

Updates On Tower Sharing Agreement

Last year, the three major Chinese carriers – China Mobile, China Unicom and China Telecom – formed a joint venture to handle the construction, maintenance and operation of telecommunications network towers and auxiliary infrastructure across the country. Now, per China Telecom’s CEO, the infrastructure-sharing has started, and roughly 70% of the initial pool of 60,000 towers provided by the joint venture were put to use in the first half. The joint venture is expected to come fully under way during the second half of this year, with nearly a million network towers expected to be transferred into this entity. The move will allow carriers to avoid overlapping investments and duplication of work related to building network infrastructure in the country, ultimately leading to a reduction in capital expenditures as well as operating expenses.

Earnings Review

• Revenues for the six-month period ended June 30 declined by about 0.6% y-o-y to RMB 164.95 billion ($25.8 billion), while net income fell by 4% to $1.72 billion.
• The company says that y-o-y earnings growth would have stood at 11.3% adjusted for VAT impacts.
• Operating expenses fell by about 0.3% y-o-y, while SG&A expenses fell by 32%.
• Mobile subscriber base stood at 191 million (up by 5.82 million y-o-y), with a 68% 3G/4G mix as of June 30.
• Wire line broadband base grew by 2.61 million to 109.56 million users.
• FY’2015 Capex budget of RMB 107.8 billion ($16.9 billion)
• The company will not pay an interim dividend this year.

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1. China Telecom Press Release [↩]
2. China Telecom Interim Results Presentation [↩]