Regulatory Uncertainties And Mixed 4G Strategy Overshadow China Unicom’s Otherwise Strong Fundamentals

Despite sustained 3G subscriber growth and arobust 47% year-over-year (y-o-y) rise in net profit in 2013, China Unicom‘s (NYSE:CHU) shares have fallen almost 30% in the last five months. This can be attributed to negative market sentiment on account of ambiguity in the company’s initial 4G strategy and a host of regulatory uncertainties. Initially, the company was unable to decide between TD-LTE and FDD-LTE technology for its 4G launch, which gave a competitive advantage to its peers, who had already launched their services. Moreover, the delay in the issuance of FDD licences and the introduction of a VAT in the telecom sector by the government has increased uncertainty in the industry.

However, we believe that China Unicom can regain its lost value going forward, as certain aspects of its business still remain promising. The carrier reported sustained growth in its 3G subscriber base last year, even as China Mobile (NYSE:CHL) upped the ante with its aggressive 3G/4G network expansion. The carrier’s overall revenues increased more than 18% y-o-y in 2013, backed by an improving 3G mix and growing average revenue per user (ARPU). China Unicom also boasts a faster 3G network than rivals because of its HSPA+ upgrades and 42M network launch.

Our current price estimate for China Unicom is $17, implying a premium of about 40% to the market price. We will update our estimates in accordance with future regulatory developments in China.

See our full analysis for China Unicom’s stock here

Regulatory Uncertainties Keeping Market Sentiment Low

The Chinese government issued 4G TD-LTE licenses to carriers in December, but has yet to award FDD-LTE licenses. Initially, China Unicom was unsure on whether to use the home-grown TD-LTE standard or wait for the FDD-LTE license to launch 4G services. Even now, the carrier has chosen to selectively launch 4G services on the TD-LTE standard by building the required network itself and it will wait for FDD-LTE licenses to expand further. On the other hand, market leader China Mobile is focusing completely on TD-LTE for its 4G network expansion, and smaller rival China Telecom (NYSE:CHA) categorically informed investors that it will lease TD-LTE infrastructure from rivals in the near term to launch 4G and focus on FDD-LTE to expand its service to smartphones going forward. ^[1]

China Unicom’s market sentiment has equally been impacted by regulatory uncertainty in the Chinese telecom sector. The government’s decision to hold back 4G FDD licences and its reluctance to even provide a tentative issue date has discouraged investors in telecom companies such as China Unicom. The government’s recent decision to introduce a value added tax (VAT) in the telecom sector has also raised concerns over an increase in tax liabilities for carriers and its impact on profitability. If a VAT rate similar to that in other sectors such as transportation (11%) is implemented in the telecom sector, China Unicom’s profits could be impacted by as much as 25% in the near term (see VAT On Telecom Services Could Hurt Carrier Profits In China).

Strong Fundamentals Have Enabled China Unicom To Improve Profitability

China Unicom has been able to maintain its 3G subscriber growth rate in the wake of aggressive network expansion by China Mobile partially because of its strong 3G network. China Unicom offers the fastest 3G network speed in the country with its HSPA+ upgrades. It also launched a 42M network last year, referred to as 3.75G by the Chinese media, which offers Internet speeds of up to 42Mbps to its subscribers. Such improvements in its 3G service enabled the carrier to provide a near-4G experience to its existing users and encouraged 2G subscribers of rival networks to transition to its 3G network.

In addition to this, China Unicom’s focus on low cost smartphones for 3G subscriber additions also helped the carrier to reduce subsidies and improving its 3G penetration in the country. Adding 3G subscribers has helped China Unicom improve its average revenue per user (ARPU) as smartphone users tend to consume huge amounts of data. Its HSPA+ upgrades and 42M network launch have further helped increase use of data-intensive applications, thus providing a further boost to its overall ARPU. China Unicom’s ARPU grew from RMB 47.90 ($7.79) in 2012 to RMB 48.20 ($7.84) at the end of 2013.

We believe that China Unicom is well-positioned to maintain long-term growth on the back of these factors. However, its success is still subject to the government’s regulatory policies and its 4G strategy in the near term.

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1. Unicom last to launch 4G services on March 18, ShanghaiDaily, March 4 2014 [↩]