China Mobile Earnings Preview: 4G User Adds, Profitability In Focus

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China Mobile (NYSE:CHL), the world’s largest wireless carrier by subscribers, is expected to release its first quarter 2015 earnings on April 21. The carrier’s financials have been under pressure for the last six quarters on account of 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. OTT applications such as WeChat allow users to share text/picture/video messages over their phone’s Internet connection, and their increased usage has resulted in a massive drop in revenues from traditional SMS and MMS messaging services for the carrier.

Owing to the aforementioned factors, the carrier’s net profit declined over 12% year-over-year (y-o-y) to about RMB 27 billion ($4.3 billion) in the previous quarter and over 10% to RMB 109.3 billion ($17.64 billion) in full year 2014. Overall SMS usage on the carrier’s network declined about 17% from 734 billion messages in 2013 to about 611 billion in 2014, in addition to a decline of 0.5% y-o-y in total voice usage. Correspondingly, revenues from SMS/MMS and voice services fell by 16% and 13% in full year 2014, respectively. However, overall operating revenues grew by 1.8% to RMB 641.45 billion ($103.53 billion) on the back of robust growth in product sales. ((Operating data, China Mobile, March 19 2015)) [1]

In the upcoming earnings release, we expect the company to report robust y-o-y revenue growth backed by aggressive expansion in the 3G and 4G market and a favorable comparable period. The carrier added over 113 million 3G and 4G users in the eleven month period from April 2014-February 2015, of which over 67% users were on the 4G network. This surge in high speed subscribers is also expected to positively impact the company’s monthly Average Revenue Per User (ARPU), which declined by 10% y-o-y to $9.85 last year. However, the rapid user growth would not have been possible without a comparable increase in the company’s handset subsidy costs, discount offerings and marketing expenses. This rise in operating expenses, in addition to the recent introduction of a Value Added Tax (VAT) in the telecom industry, is likely to weigh on China Mobile’s net profit in the first quarter as well.

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We currently have a price estimate of about $60 for China Mobile, implying a discount of about 15% to the market price.

See our complete analysis of China Mobile here

4G User Adds To Help Improve ARPU, Mix

China Mobile added about 30 million 3G and 4G subscribers in the first two months of the year, taking its total 3G-4G subscriber count to about 366 million, and 3G-4G penetration to 45%. In comparison, the carrier’s 3G penetration was about 25% at the end of 2013 and 41.7% at the end of 2014. Higher 3G-4G penetration is good for the company’s top line, as high speed subscribers generally use more data than 2G users due to the network’s higher Internet speed, which helps in increasing ARPU.

Despite the growing high speed user base, China Mobile’s overall ARPU declined 10% y-o-y to $9.85 in 2014. This was likely because the decline suffered by voice and SMS/MMS revenues offset the increase in its Internet ARPU. Going forward, growth in 4G users is likely to drive ARPU levels 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. This can also be gauged from the fact that even though 4G subscribers contributed only around 11% of China Mobile’s total user base last year, they used 44% of the total data on the carrier’s network. Notwithstanding the 10% decline in monthly ARPU in 2014, we expect China Mobile’s ARPU to improve going forward as rising data traffic more than compensates for the decline in voice and SMS usage.

Declining Subsidies To Help Improve Profitability

China Mobile witnessed an unprecedented decline in earnings in 2013 owing to higher handset subsidy costs, discount offerings and higher marketing expenses, which continued last year as well. In 2014, the company’s net profit declined over 10% primarily on account of higher discount offerings due to rising competition and higher network maintenance costs. Marketing was necessary for China Mobile to improve the acceptability of its homegrown 3G network. The company faced intense competition in gaining 3G subscribers in 2012-13 because rivals China Unicom and China Telecom used the internationally accepted WCDMA 3G standard, which was compatible with a majority of the popular smartphones available in the Chinese telecom market, unlike China Mobile’s homegrown SCDMA standard. However, the carrier successfully dealt with this limitation by making available diverse multi-mode TD-LTE compatible handset models in the market for customers in 2014 including its self-branded models as well as mainstream brands.

The company took its first steps towards reducing handset subsidies to improve profitability in September last year. Owing to these efforts and its first mover advantage,the company was able to cut down its handset subsidy costs by over 28% in 2014. This is a significant achievement and bodes well for the company’s plans to improve bottom line performance going forward. ((China Mobile Taking Steps to Cut Smartphone Subsidies, Bloomberg, Sept 26 2014)) [2] ((Chinese carriers to lower subsidies on smartphone purchases, WantChinaTimes, May 23 2014))

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Notes:
  1. Press Release, China Mobile, March 19 2015 []
  2. China Mobile Surges on Planned $2 Billion Cut in Subsidy, Bloomberg, Aug 15 2014 []