China Mobile’s Q1 Profit Drops Even As 4G Subscribers Soar

China Mobile (NYSE:CHL), the world’s largest wireless carrier, reported mixed Q1 2015 results with net profit declining 5.6% year-over-year (y-o-y) to RMB 23.83 billion ($3.84 billion) even as operating revenues grew by 3.9% to about RMB 161 billion ($26 billion) on the back of robust growth in product sales. The decline in net profits can be 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. OTT applications such as WeChat allow users to share text/picture/video messages over their phone’s Internet connection, and their increased usage resulted in a massive drop in revenues from traditional SMS and MMS messaging services for the carrier. Overall SMS usage on the carrier’s network declined over 6% over the previous quarter to 146.2 billion in Q1 2015, in addition to a decline of 5% in total voice usage in the same period. ^{[1] [2]}

While growing costs put a dent in earnings, the carrier was able to grow its 3G-4G subscriber base by over 150 million to about 378 million by the end of March 2015. Considering that data traffic is quickly becoming the primary avenue for future revenue growth, the carrier vigorously expanded and promoted its high speed 4G network, gaining over 53 million 4G subscribers in the last quarter. Going forward, we expect China Mobile to continue gaining 3G-4G subscribers faster than its rivals, owing to its larger 4G network and its ability to offer higher discounts. This robust growth in 4G subscribers is likely to help the carrier further improve its top line performance going forward as well, since 4G subscribers generally use more data than 2G and 3G users, which helps increase ARPU (Average Revenue Per User). However, higher costs and increasing competition from rival wireless carriers China Unicom (NYSE:CHU) and China Telecom (NYSE:CHA), as well as OTT applications such as WeChat, might continue to weigh on profitability in the near term.

We expect 2015 to be an exciting year for the Chinese wireless market considering that all major players now have full 4G licenses and have set ambitious goals for high speed user adds. Competition should increase as the year progresses, but China Mobile should be able to sustain its growth momentum owing to its massive size and network presence. We currently have a price estimate of $60 for China Mobile, implying a significant discount to the current market price.

See our complete analysis of China Mobile here

Decline In Handset Subsidies Could Help Improve Profitability

China Mobile’s net profit declined primarily on account of higher discount offerings due to rising competition and also likely due to higher network maintenance costs. Marketing was necessary for China Mobile to improve the acceptance 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.

In August last year, China Mobile revised its pricing strategy for high-end smartphones such as the iPhone, and also stated that it intended to focus on low-cost handsets to cater to the country’s mass markets. Owing to such 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)) ^[3] ((Chinese carriers to lower subsidies on smartphone purchases, WantChinaTimes, May 23 2014))

Solid Growth In 4G Data Usage

Leveraging its first mover advantage in 4G, China Mobile rapidly expanded its TD-LTE network coverage across the country last year, setting up 720,000 base stations and covering a population of over one billion people. The company offered discounted plan rates and easy upgrade services to encourage customers to adopt 4G. This resulted in the carrier recording 90 million 4G subscribers in 2014 and another 53 million in the first three months of this year. Its 3G-4G mix also improved from 25% in 2013 to over 46% by the end of March 2015. The rapid rise of 4G customers along with discounted data rates resulted in solid increase in data traffic demand, which increased 158% in Q1 2015 over the same period last year.

Impact Of 4G On ARPU

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, they used 44% of the total data on the carrier’s network last year. The company’s monthly ARPU declined year over year in Q1 2015 to RMB 59 ($9.53), but reported a slight improvement over the previous quarter’s RMB 58. Going forward, we expect China Mobile’s ARPU to improve as rising data traffic more than compensates for the decline in voice and SMS usage.

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1. Operating data, China Mobile, April 21 2015 [↩]
2. Press Release, China Mobile, April 21 2015 [↩]
3. China Mobile Surges on Planned $2 Billion Cut in Subsidy, Bloomberg, Aug 15 2014 [↩]