China Mobile (NYSE:CHL) doesn’t seem to be adding as many high-quality 3G subscribers as it would like. The largest wireless carrier in the world saw its profits stagnate in the first quarter of 2013 despite adding more than twice as many subscribers at it used to in previous quarters. Net profit for the quarter grew only 0.3% over the same period last year even as revenues grew 5.7% due to a larger subscriber base. The carrier added as many as 26 million 3G subscribers in Q1 2013, as compared to the 8 million it had added during the same period last year. However, wireless data traffic dropped 7.4% sequentially and average revenue per user (ARPU) declined from 71 to 63 RMB, suggesting that many of the 3G additions may not have been of the highest quality. The lack of the iPhone has hurt China Mobile’s 3G subscriber growth in the recent past, and now that the carrier seems to be finally adding more 3G subscribers, the effect isn’t being felt at the ARPU level.
The carrier is therefore investing in building out a next-generation 4G TD-LTE network that would help it move on from its home-grown TD-SCDMA network and increase its chances at landing lucrative smartphone contracts. As a result, the carrier has guided for an almost 50% hike in capital expenditures in 2013. Compared to RMB 127 billion spent on network upgrades in 2011, China Mobile expects to incur more than RMB 190 billion in CapEx spend this year, of which, more than 50%, or about $7 billion, will be driven by the TD-LTE network. Going forward, we expect the high network investment to continue as the company looks to expand its LTE network to new regions and uses it as the primary network for data traffic in the future.
Considering therefore the surging data demand and the monetization potential left untapped in the carrier’s huge 2G subscriber base, we maintain a $60 price estimate for China Mobile, about 10% ahead of the current market price.
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 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 around $7.40 in 2007 to about $6 in 2012, by our estimates.
With voice ARPU on the wane, Chinese telecom operators have been pushing 3G-capable smartphones to drive data ARPU levels. 3G penetration is at a low 25% 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 3G subscribers than 2G. China Mobile, which is more than six times the size of Verizon with over 700 million mobile subscribers currently, stands to gain heavily from this transition. Currently, the low 3G penetration means that the impact of the higher 3G ARPUs is more than offset by the decline in voice ARPUs. Over time, we expect a steadily growing 3G adoption to boost the already increasing data ARPU levels further, more than compensating for the fall in voice ARPUs as a result.
For this to happen, China Mobile needs to step up its efforts in the 3G arena. As of March, China Mobile’s 3G subscriber base stood at around 114 million, which translates to a 3G penetration of less than 16%. This compares poorly to the industry-wide average of almost 25% in China. A big shortcoming of China Mobile’s home-grown 3G network has been that handset makers have had to make phones specially for the otherwise incompatible network, making it harder for the carrier to secure supplies of enough 3G handsets to promote the network. The lack of the iPhone can partially be attested to this fact.
LTE will help overcome 3G shortcomings
In order to overcome this problem, China Mobile will be rolling out a TD-LTE network this year. Considering that the technology is being used by multiple carriers around the world to build out their 4G networks, TD-LTE is expected to be widely supported by handsets. What should also give China Mobile hope is that it has recently started adding 3G subscribers at a rate that is far exceeding expectations. The carrier added, on an average, more than 8 million 3G subscribers per month in Q1, much higher than the average of about 3 million in the previous months. So, while China Mobile has some way to go before it catches up with the competition in terms of 3G penetration, most signs indicate that the transition away from 2G has picked up and will gather more pace in the coming years. The high initial investment in LTE should therefore not be a worry in the long run as 4G drives demand for data and helps the carrier attract more of the high-end mobile subscribers.
Moreover, the recent strong showing in 3G additions and growing competition in the smartphone market means that China Mobile will not be very hard-pressed to sign an iPhone deal. Considering that Apple will be looking to penetrate the emerging markets where its presence is very low, China Mobile may be able to negotiate lower subsides or gain access to a cheaper iPhone – both of which should limit the margin impact as smartphones start forming a bigger chunk of its handset sales. However, it is tough to say if Apple will be ready to make such a compromise. Even if it doesn’t, we don’t see China Mobile having a tough time promoting its LTE network considering how competitive the smartphone landscape is with players such as Samsung, Nokia, HTC and several other Asian manufacturers ever ready to pick up the mantle.