China Mobile Earnings Preview: Growing 3G Adoption Likely To Drive Revenues, Subsidy Costs Could Hurt Profits

Chinese wireless major China Mobile (NYSE:CHL) is expected to announce its fourth quarter and full-year 2013 results later this month. The carrier reported mixed results for the first nine months ending September 2013, with profits falling by about 1% year-over-year (y-o-y) even as revenues increased by over 9% to RMB 463 billion ($74 billion). China Mobile’s earnings were weighed down by growing competition from rivals China Unicom (NYSE:CHU) and China Telecom (NYSE:CHA), as well as the chipset incompatibility issues of its 3G network (TD-SCDMA) with many popular smartphones. The carrier’s results were also negatively impacted by the growing popularity of Over-The-Top (OTT) instant messaging alternatives such as WeChat, which resulted in a massive drop in revenues from traditional messaging services. Overall, China Mobile’s net average revenue per user (ARPU) per month declined marginally, from RMB 68 ($10.79) in 2012 to RMB 66 ($10.47) at the end of September 2013.

The fourth quarter was an exciting one for China Mobile, as it finally completed its much anticipated deal with Apple (NYSE:AAPL) to offer iPhones on its network and also became the first carrier to launch 4G services in the country. However, these events are unlikely to have had a significant impact on the company’s finances for 2013 as they occurred towards the end of the fourth quarter. The period saw China Mobile’s net 3G subscriber additions decline by 30% over the previous quarter, likely because users delayed their migration to 3G in anticipation of the company’s 4G launch. However, owing to the consistent increase in new 3G subscribers over the full year, the carrier’s 3G penetration more than doubled from 12.4% in 2012 to 25% at the end of 2013.

For the full year 2013, we expect revenues to have grown in high single digits over the prior year on account of increasing 3G penetration and a growing subscriber base. However, China Mobile’s profitability could be hit due to increase in handset subsidies and discount offerings.

We currently have a price estimate of $55 for China Mobile, implying a premium of over 20% to the market price.

See our complete analysis of China Mobile here

Growing 3G Adoption Likely To Drive Revenues

China Mobile added about 38 million new 3G subscribers in 2012 and its Internet ARPU grew almost 43% y-o-y. Adding 3G subscribers helps the carrier increase its ARPU levels as 3G smartphone users consume more Internet data compared to 2G subscribers. The carrier added over 100 million new 3G subscribers in 2013, taking its total 3G subscriber count to more than 191 million. China Mobile should continue to benefit from the growing adoption of 3G services since most of the growth is coming from data rather than voice, which has reached near-saturation. A higher ARPU directly impacts the company’s top line, and we believe that the carrier can grow its mobile Internet service revenues at double-digit rates in the near term and mid-single-digit rates in the long run.

Competition And Higher Subsidy Costs Could Hurt Profits

China Mobile witnessed an unexpected decline in net profits of about 9% in the quarter ending September 2013. This resulted in the company’s net profits for the first nine months of 2013 declining by about 1% over the same period in 2012. This was attributed to growing competition from rival carriers which resulted in increased handset subsidy costs as well as higher marketing expenses.

The company faced intense competition in gaining 3G subscribers because rivals China Unicom and China Telecom used the internationally accepted WCDMA 3G standard, which was compatible with majority of the popular smartphones available in the Chinese telecom market, unlike China Mobile’s homegrown SCDMA standard. Therefore, because of the limited handset options available for use on its 3G network, China Mobile had to offer much more competitive handset pricing and discounts to attract subscribers, which put pressure on the company’s profit margins.

China Mobile offered a massive RMB 27 billion ($4.4 billion) in subsidy costs last year, even as the smaller carriers shifted their focus to low cost smartphones to maintain profitability. Going forward, this strategy might help China Mobile in racing ahead of its rivals in terms of 3G/4G subscriber growth, but its profits are likely to remain subdued in the near term. ^[1]

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1. China Mobile Boosts Subsidies as Carrier Awaits IPhone Deal, Bloomberg, Dec 18, 2013 [↩]