With the behemoth China Mobile (NYSE:CHL) increasing its focus on 3G, second-placed China Unicom (NYSE:CHU) is facing heightened competition for the more valuable 3G subscribers. The smaller carrier added less than 4 million 3G subscribers in August, about a third of what China Mobile did during the same month. This is in sharp contrast to last year when both the carriers were adding a similar number of 3G subscribers, and the smaller rival was able to compete on an equal footing with its much larger counterpart. China Mobile’s under-performance in 3G was mostly due to a home-grown 3G standard called TD-SCDMA, which was not widely supported by handsets. However, new advancements in chipset technology have helped TD-SCDMA become more mainstream this year, allowing China Mobile to tap into its huge 750 million subscriber base and creating headwinds for Unicom’s 3G ambitions.
As a result, China Unicom’s 3G market share has started to decline. It is already down by about 3% since the start of the year, largely due to China Mobile’s impressive ramp-up in 3G additions. However, China Unicom’s 3G penetration is still below 40%, leaving a lot of room for growth in the coming years. With the carrier’s 3G ARPU almost twice that of 2G, the transition to 3G has been good to Unicom’s top line, which grew y-o-y by nearly 19% in the first half of 2013. At the same time, increasing focus on low-cost smartphones has helped China Unicom control its 3G subsidy costs which caused its first half net income to rise by more than 50% over the same period last year. With profits rising and the 3G transition gaining momentum, we maintain our $18 price estimate for China Unicom – about 15% ahead of the market price.
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The Importance Of China Unicom’s 3G ARPUs
China Unicom has had a lot of success promoting its 3G network so far. Its overall market share has increased and ARPUs have improved due to subscribers transitioning from 2G to 3G. But China Mobile’s 3G resurgence means that Unicom will find it increasingly tough to grow its monthly 3G net adds significantly from here on. While this doesn’t mean that revenues will stagnate since increasing 3G mix will still drive ARPUs up, China Unicom’s 3G growth will become increasingly reliant on ARPUs as time goes by.
The reason this is important is because low cost smartphones have become increasingly popular in the Chinese market, which has impacted China Unicom in two ways. While on one hand, it has helped China Unicom control subsidy costs and arrest the fall in its margins, on the other, it has attracted the less affluent 3G users and lowered 3G ARPU levels. The carrier has seen its 3G ARPU decline from RMB 91 in H1 2012 to less than RMB 78 in H1 2013. The fall did not impact China Unicom much when its 3G subscriber base was expanding rapidly, but any further decline could adversely impact 3G revenue growth. With 3G accounting for over half of Unicom’s mobile revenues currently, the impact could be felt company-wide. It is therefore a good sign that Unicom’s 3G ARPUs seem to be stabilizing at the 77-78 RMB levels as seen in the last two quarters.
4G Shift Increases Competition Concerns
What could help China Unicom in increasing its ARPU levels further is the potential shift to 4G in the coming years. The Chinese government is expected to issue LTE licenses in the coming months. Since LTE is a much faster network than 3G, it will incentivise the use of more data-intensive applications and further drive demand for data. As a precursor to LTE, Unicom has been investing in a HSPA+ network which offers speeds faster than 3G. CapEx investments in LTE will, however, depress Unicom’s cash flow generating ability, which recently returned to the black. The carrier has been conserving cash in preparation for the upcoming 4G LTE rollout.
While the 4G transition will help with the ARPU levels, it will be interesting to see how China Unicom adapts to the increasingly competitive mobile landscape. China Mobile has been the front-runner in 4G, with plans to build more than 200,000 4G base stations in 2013. It will use a TD-LTE technology for its 4G network that should not suffer from the same constraints as its 3G network did because it is more widely supported by carriers worldwide. It will look to use this new network as means to not only improve ARPU levels, but also drive subscriber growth. Given China Mobile’s clout and dominance in the mobile sector, its return to strength remains the most potent threat to Unicom’s 3G/4G growth in the coming years.