China Mobile Cuts Handset Subsidies, Shifts Focus To Low-Cost Smartphones To Boost Profitability

China Mobile (NYSE:CHL) has taken its first steps towards reducing handset subsidies to improve profitability. In line with earlier announcements indicative of such a move, the company has revised its pricing strategy for high-end smartphones such as the iPhone and also stated that it intends to focus on low-cost handsets to cater to the country’s mass markets. ^{[1] [2]} ((Chinese carriers to lower subsidies on smartphone purchases, WantChinaTimes, May 23 2014))

Earlier, the iPhone 5S 16 GB model on China Mobile’s network was available for a down payment of RMB 5,288 ($860) and the carrier subsidized this cost by providing monthly rebates of up to RMB 194 ($31.50) to users for two years. Under this plan, the resultant cost of the handset for the user at the end of two years came out to be RMB 632 ($102.70). With the recent revision in prices, the same phone is expected to cost around RMB 1,224 ($199) to the user at the end of two years. This is an increase of over 93% from the earlier price. However, it is pertinent to note that the initial down payment under the revised plan will be RMB 4,488 ($730), which is about 15% lower than the earlier upfront ask. The revised pricing policy reflects the carrier’s intention to maintain a fine balance between attractiveness of high-end smartphones on its network and improving its profitability.

See our complete analysis of China Mobile here

The news should come as a relief to investors, considering that handset subsidies were increasingly weighing on carrier profits in the wake of rising competition in the Chinese 3G and 4G market. The government issued TD-LTE 4G licenses to all three carriers in December, and China Mobile was the first to launch 4G services for smartphones. In a bid to outshine its rivals in subscriber additions and sale of high-end smartphones such as the iPhone, China Mobile started aggressively marketing its 3G and 4G services, and offered heavy subsidies on handsets to consumers. Although the wireless major managed to race ahead of the smaller carriers in high-speed (3G and 4G) subscriber adds, its net income declined by 6% year-over-year (y-o-y) in 2013 and by 8.5% y-o-y in in the first half of 2014. In comparison, net income for China Unicom (NYSE:CHU) and China Telecom (NYSE:CHA) grew by 26% and 12%, respectively, in the same period.

China Mobile’s total wireless subscriber base at the end of August was 796 million, including about 272 million 3G and 4G users. The wireless major enjoys a dominant share of 62.5% in the country’s wireless market, reporting an improvement of 30 basis points since the start of the year. It is followed by China Unicom and China Telecom with 23.3% and 14.2%, respectively. ^{[3] [4] [5]}

We currently have a price estimate of $56 for China Mobile, implying a discount of about 5% to the market price.

How Handset Subsidies Impact Profits

In its recent interim 2014 earnings release, the company reported an 8.5% drop in profits even as its overall revenues increased by about 7%. This decline in net profit was attributed to increasing competition in the Chinese wireless market, a decline in interconnection fees, the introduction of a Value Added Tax (VAT) and the growing popularity of over-the-top (OTT) applications such as WeChat. In the wake of rising competition, China Mobile had to offer higher handset subsidies on popular smartphones to gain subscribers. Although higher subsidies immensely helped the carrier expand its subscriber base and 3G/4G mix, it also significantly increased its operating expenses, which led to pressure on the bottom line. This trend was visible in 2013 as well, when the carrier spent $4.4 billion in subsidy costs and added almost 104 million 3G subscribers, improving its 3G mix from 12.4% in 2012 to 25% at the end of 2013. ((Press Release, China Mobile, Aug 14 2014)) ^[6]

In a bid to improve profitability, China Mobile announced in its recent earnings call that it intends to reduce its total handset subsidy costs to RMB 21 billion ($3.4 billion) in 2014, from the earlier estimate of RMB 34 billion. Of the total amount, the carrier has already spent RMB 15.3 billion ($2.5 billion) in the first six months of the year, which means that the company intends to spend less than $1 billion dollars in subsidies in the latter half of the year. ^[2]

If the carrier manages to reduce its total subsidies by the intended amount in 2014, its total handset subsidy spend for the year will be 15% lower than last year’s level of around $4 billion. Since 3G and 4G subscriber additions are expected to improve the carrier’s 3G/4G mix and Average Revenue Per User (ARPU) due to higher Internet data usage, we expect the company’s top line to grow rapidly in the near term. Combined with reduced operating expenses in the form of lower subsidies, higher revenues would translate into improved profits. This is likely to help the carrier offset financial concerns related to increasing competition from rival carriers as well as OTT applications, the introduction of the VAT, and the revenue pressure due to an unfavorable revision in carrier interconnection fees.

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1. China Mobile Taking Steps to Cut Smartphone Subsidies, Bloomberg, Sept 26 2014 [↩]
2. China Mobile Surges on Planned $2 Billion Cut in Subsidy, Bloomberg, Aug 15 2014 [↩] [↩]
3. Operation Data, China Mobile, September 2014 [↩]
4. Operating Data, China Unicom, September 2014 [↩]
5. Key Performance Indicators, China Telecom, September 2014 [↩]
6. Presentation, China Mobile, Aug 14 2014 [↩]