China Mobile (NYSE:CHL), the world’s largest wireless carrier by subscribers, is expected to release its first quarter 2014 earnings on Wednesday, April 16. The carrier reported a mixed set of results last quarter, when its earnings (reported as EBITDA) suffered a rare decline of about 11% year-over-year (y-o-y) to RMB 54.75 billion ($8.9 billion) even as its operating revenues increased by almost 5% to RMB 167.2 ($27.2 billion). The company attributed this decline to increasing competition in the Chinese wireless market and growing popularity of over-the-top (OTT) messaging applications such as WeChat. OTT applications such as WeChat allow users to share text/picture/video messages through their phone’s Internet connection, and their increased usage resulted in a massive drop in revenues from traditional messaging services (SMS & MMS) for the carrier. 
In the upcoming earnings release, we expect revenues to show an upward trend on the back of aggressive expansion by the carrier in the 3G market, the iPhone deal with Apple (NYSE:AAPL), and the company’s first mover advantage in launching 4G services for smartphones in the country. However, the carrier’s profitability could be hit due to an increase in handset subsidies and discount offerings in the wake of growing competition.
We currently have a price estimate of $53 for China Mobile, implying a premium of over 10% to the market price.
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Growing 3G/4G Adoption Likely to Drive Revenues
China Mobile added about 14 million 3G subscribers and over 1.3 million 4G subscribers in the first two months of this year, taking its total 3G/4G subscriber count to about 217 million, and 3G/4G penetration to almost 28%. In comparison, the carrier’s 3G penetration was about 25% at the end of 2013 and only about 16% at the end of Q1 2013. Higher 3G penetration is good for the company’s top line as 3G subscribers generally use more data than 2G users due to the network’s higher Internet speed. Therefore, they generate more revenue for the carrier per month, represented as the average revenue per user (ARPU) for the carrier.
In 2013, China Mobile’s overall ARPU remained flat at RMB 67 (~$11) compared to prior year levels. The increase in its Internet ARPU helped it offset most of the decline suffered by voice revenues. The number of subscribers increased by over 8% in 2013, and the company’s revenues also increased by similar levels to touch RMB 630 billion ($102.6 billion). Going forward, we expect overall ARPU to improve as 3G penetration increases and sales of high-end smartphones such as the iPhone expand in the Chinese market. Growth in 4G is likely to drive ARPU levels even further, as 4G networks are about ten times faster than their 3G counterparts, thus encouraging subscribers to use even more data intensive applications such as high quality video calling and video streaming.
Subsidy Costs & Discount Offerings To Weigh On Profitability
China Mobile witnessed an unprecedented decline in earnings in 2013 owing to higher handset subsidy costs, discount offerings and higher marketing expenses, as competition in the Chinese wireless market heated up. These expenses were necessary for China Mobile to improve the acceptability of its homegrown 3G network. The company faced intense competition in gaining 3G subscribers because rivals China Unicom (NYSE:CHU) and China Telecom (NYSE:CHA) 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 announced in its earning call last quarter that its subsidy costs are likely to increase by about 30% y-o-y to RMB 35 billion ($5.7 billion) this year. 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.Notes: