China Unicom (NYSE:CHU), China’s second largest wireless operator, announced its annual results for 2011 last week. The company said that it added close to 32 million subscribers in the year to take its year-end tally close to 200 million. 3G adoption rates grew strongly as the company added more than four times as many 3G subscribers as 2G ones and almost tripled its 3G base to more than 40 million. Despite increasing competition from China Telecom (NYSE:CHA) and China Mobile (NYSE:CHA), China Unicom’s revenues grew 13.4% and net profit 14% over the previous year as subscribers grew steadily and data revenues increased due to growing 3G as well as wireline broadband penetration.
Service revenue from 3G nearly tripled over the previous year to RMB32.74 billion and contributed almost 32% of the overall mobile service revenues, up from 14% last year. Meanwhile, revenues from its 2G/GSM business remained steady; so overall mobile service revenues were up more than 25% over 2010. Growing data ARPUs from both its GSM and 3G businesses bolstered the overall mobile ARPU by more than 8% to RMB47.30. 3G ARPUs remained at a high level of RMB110 for the year.
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China Unicom’s solid 3G performance
While 3G penetration in China has been growing, it is still very low at less than 14%. This gives smaller wireless carriers such as China Unicom ample opportunity to compete with the behemoth that is China Mobile. China Mobile has more than three times as many overall mobile subscribers as China Unicom and is the world’s largest wireless carrier by subscriber base. But when it comes to 3G, the difference is not nearly as high. As of February, China Unicom had around 46 million 3G subscribers to about 57 million on China Mobile’s 3G network.
Moreover, China Unicom has been closing the gap with China Mobile by adding a growing number of 3G subscribers every month. February saw China Mobile add less than 2.7 million 3G subscribers to more than 2.8 million that China Unicom added. The story was the same in January as well, when China Mobile added close to 2.7 million 3G subscribers to China Unicom’s more than 3 million.
A big reason for China Unicom’s 3G outperformance has been the iPhone, which it has been selling since late-2009. However, China Unicom lost its exclusive hold on the iPhone this year as China Telecom launched the iPhone 4S on March 9. A China Mobile-Apple deal is also on the cards following Qualcomm’s launch of a baseband chip that will allow the next-generation iPhone to access China Mobile’s so far incompatible 3G as well as the under trial 4G network. With competition increasing, it will become increasingly tough for China Unicom to maintain its 3G lead.
Margins will however remain pressured as a result
While healthy demand for 3G helped China Unicom increase its ARPU levels but the subsidies associated with selling expensive 3G smartphones has had a telling effect on its margins. EBITDA margins dropped 4.4% over last year as the cost of subsidies as well as the SG&A expenses from promoting 3G services mounted. The mobile operator said that the cost of subsidizing 3G handsets in 2011 totaled CNY5.79 billion. It expects these subsidies to rise this year as competition intensifies and 3G demand increases.
But signing up for the subsidies also means that customers are locked to the carrier’s network for two or three years, ensuring a long-term patronage for its higher-margin postpaid plans, reduced churn and steady cash flows. So, while there may be margin pressures in the near-term, the data ARPU rise should offset those losses in the long run.
We are in the process of revising our $24 price estimate for China Unicom, in light of the recent earnings.
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