China Mobile (NYSE:CHL) continued its recent streak of 3G dominance in August, adding a record 11.6 million net subscribers in a month that saw nearest competitor China Unicom (NYSE:CHU) add only about a third as many. This is a huge improvement from last year when the carrier was adding only about 3 million 3G subscribers every month and having a tough time competing against smaller rivals China Unicom and China Telecom (NYSE:CHA), who were adding almost as many. As a result, China Mobile has more than doubled its 3G subscriber base over the past year.
The much improved 3G performance is testament to the huge untapped potential in its wireless subscriber base which is the largest in the world. The carrier has over 750 million subscribers on its network, miles ahead of China Unicom and China Telecom which account for a combined subscriber base of less than 450 million. However, years of 3G under-performance due to the homegrown TD-SCDMA network that wasn’t widely supported by handsets made it impossible for the carrier to transition away from 2G meaningfully. Its 3G penetration is therefore still very low at about 20%, but has been growing rapidly in recent months. The carrier has increased its focus on smartphones with a higher subsidy budget this year and is looking to invest in a high-speed 4G TD-LTE network which should mitigate incompatibility concerns and increase its chances at landing lucrative smartphone contracts down the road.
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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 2012, China Mobile expects to incur more than RMB 190 billion in CapEx spend this year, more than 50% of which, or about $7 billion, will be driven by 4G investment. 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 surge in 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 7% 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 shown rapid growth in mobile data revenues over the past few years by driving the 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 30% 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 has the lowest 3G penetration of the three, 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.
LTE will help overcome 3G shortcomings
In order to overcome the 3G problem, China Mobile is planning to roll out a TD-LTE network in the coming months. 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. Although China Mobile still has some catching up to do 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 may decrease cash flow in the near term but should not be a worry going forward as 4G drives demand for data and helps the carrier attract more of the high-end mobile subscribers.
Additionally, the recent strong showing in 3G additions and growing competition in the smartphone market means that China Mobile is not 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.