China Unicom’s (NYSE:CHU) 3G subscriber additions seem to be falling behind China Mobile’s in recent months. Recently announced wireless data for October shows that China Unicom added about 3.2 million 3G subscribers as compared to China Mobile’s 3.7 million during the same month. This is the third month in a row that China Unicom has added fewer 3G subscribers than China Mobile, a sharp contrast from the first half of the year when China Unicom led the 3G charts with about 17.5 million 3G net adds compared to China Mobile’s less than 16 million for the same period. While a part of the reason could be China Mobile finally getting serious about its 3G business and driving smartphone penetration, we feel that the under-performance is more due to pent-up demand building up ahead of the iPhone 5 launch in the coming months.
China Mobile’s huge market share advantage over rivals means that Apple will look to sign an iPhone deal with the carrier soon, and this could cut into China Unicom’s near-term advantage. However, with 2G subscriber growth slowing and 3G still in early stages of penetration, there is significant growth potential for China Unicom as well. We have a $23 price estimate for China Unicom stock, almost 35% ahead of the current market price.
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Unicom Profits From An Equitable 3G Mix
With over 700 million subscribers, China Mobile has more than twice as many subscribers as China Unicom. But when it comes to 3G, the difference is not nearly as wide. As of October 2012, China Mobile had 79 million 3G subscribers, only about 13% ahead of China Unicom’s 70 million 3G subscribers. Low 3G penetration of around 20% in China is giving smaller wireless carriers such as China Unicom ample opportunity to compete on an even ground with the otherwise dominant China Mobile.
Moreover, the fact that China Mobile runs its 3G network on a proprietary homegrown TD-SCDMA standard has proved to be a big deterrent for the carrier in securing smartphones compatible with its network. Even the iPhone, which is already launched on the other two carriers in China, hasn’t made its way to China Mobile yet. Moreover, due to the heavy subsidies associated with the iPhone, it seems the Chinese government is less keen on a China Mobile deal with Apple despite the fact that the iPhone 5 was launched with a TD-SCDMA compatible chipset. (see Apple Faces China Mobile-Sized Stumbling Block Limiting China Upside Potential)
Taking advantage of this, China Unicom has been closing the 3G gap with China Mobile this year. For the first ten months of 2012, China Unicom has led the 3G charts with about 30 million 3G net adds as compared to the much larger China Mobile’s 27 million during the same period. The standoff between China Mobile and Apple gives China Unicom some more breathing space to grow initial 3G market share and use that base to build on as 3G catches on further in the coming years.
ARPU rises as 3G penetration grows
Growing its 3G base is proving beneficial for China Unicom because most of the growth is coming from data rather than voice, which has reached near-saturation. Adding 3G subscribers helps China Unicom increase its ARPU levels as 3G smartphone users consume huge amounts of data. For the first half of 2012, China Unicom’s 3G ARPU was RMB 92, almost two and a half times as much as its 2G ARPU of RMB 35. The higher speed HSPA+ network, which the carrier has recently started rolling out, will help it increase ARPU levels further as subscribers use more data-intensive applications on their phones. (see China Unicom Speeds Ahead In Smartphone Race With HPSA+ Rollout)
However, margins will continue to be impacted by the sale of subsidized 3G phones such as the iPhone, but China Unicom is betting on making its money back by locking in customers for the term of the contractual period. The carrier is also pushing down the prices in the Android market, and was the first to launch a foreign brand RMB 1000 smartphone. Low smartphone prices decreases the subsidy China Unicom has to pay per phone and increases the demand for 3G handsets as well. With China poised to become the largest smartphone market by the year-end, China Unicom stands to benefit from the proliferation of affordable low-end smartphones in the country. Growing smartphone penetration will increase the usage of 3G services, and a broad product portfolio will help China Unciom tap the growing demand effectively.
In order to support the rising data demand, China Unicom will also have to aggressively spend on network upgrades and maintenance to improve coverage and increase quality of service. This will have a negative impact on cash flow but the growing market for 3G as well as the carrier’s focus on driving 3G penetration gives us reason to believe that the carrier will be able to recoup more than its upfront investment in due time.