China, the world’s largest mobile phone market, recently crossed the one billion mobile connections mark in March. To put this number in perspective, the U.S. currently has just over 330 million active connections in all. While the Chinese figure may not be reflective of the actual number of mobile users in country as some of these connections are currently inactive, it is still a compelling statistic that shows the huge growth opportunity that China presents for many smartphone manufacturers. At the same time, it is also a huge opportunity for the incumbent Chinese telecom providers such as China Unicom (NYSE:CHU), China Telecom and, especially, China Mobile (NYSE:CHL) to tap their huge 2G subscriber base and drive the demand for the more lucrative 3G data services.
China Mobile is not only China’s largest wireless services provider but also the world’s largest. It has a subscriber base of over 665 million, more than three times as many as its nearest competitor, China Unicom. We believe that this huge subscriber base is what puts China Mobile in a better position than rivals to tap the huge surge in demand for 3G in the coming years.
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Growing 3G adoption drives China Mobile’s value
3G services have driven the ARPU levels of many carriers in the developed world. Carriers such as Verizon, AT&T and Sprint in the U.S. have seen rapid growth in mobile data revenues over the past few years, driven by growing demand for 3G-capable smartphones. This has come even as their voice ARPUs declined, a trend that can be seen in the Chinese telecom market as well. China Mobile’s voice ARPU levels have declined from above $7.30 levels in 2007 to about $6.60 in 2011, by our estimates.
With voice ARPU on the wane, Chinese telecom operators have started pushing 3G-capable smartphones in order to drive data ARPU levels. 3G penetration is at a low 15% currently, so the opportunity to push 3G is immense. As can be seen from the Chinese telecom data released each month, the carriers are now adding more number of 3G subscribers than 2G. China Mobile, which is more than six times the size of Verizon with over 665 million mobile subscribers currently, stands to gain heavily from this transition. Increasing 3G adoption will serve to boost its already increasing data ARPU levels further, more than compensating for the fall in voice ARPUs as a result.
But the Chinese behemoth hasn’t been able to capitalize on its huge 2G subscriber base as well as it should have yet. As of March, China Mobile’s 3G subscriber base stood at about 60 million, or a 3G penetration of just under 9%. This compares poorly to the industry-wide average of 15% in China.
A big reason for that has been its homegrown TD-SCDMA 3G network that is incompatible with most smartphones currently available in the market such as the iPhone. This requires handset vendors to come out with specially crafted phones for the carrier’s proprietary network which has proved to be a huge deterrent.
We believe that Qualcomm’s recent announcement of a baseband chip that supports China Mobile’s networks will finally make it easier for Apple as well as other vendors to release compatible smartphones on the world’s largest carrier. (see Qualcomm Paves the Way for an Apple-China Mobile iPhone Deal) A possible launch of the iPhone 5 on China Mobile later this year could be the much anticipated tipping point for the carrier in its bid to drive 3G adoption rates.
Near-term margin pressures
However, the carrier will have to bear a huge subsidy burden in order to drive the demand for 3G smartphones. Having a huge subscriber base to promote 3G to is no doubt a very good opportunity, but the subsequent near-term subsidy pressures could be huge if 3G demand balloons up suddenly. Since China Mobile’s mobile voice and internet services division accounts for a huge chunk of our $59 price estimate, the margin pressures could weigh heavily on the stock in the near-term. It will therefore be very important for China Mobile to manage the near-term margin pressures well so that it can reap the huge benefits of an increase in data consumption later.