Network JV Could Be A Shot In The Arm For China Unicom’s 4G Aspirations

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All three major Chinese wireless carriers- China Unicom (NYSE:CHU), China Mobile (NYSE:CHL) and China Telecom (NYSE:CHA) – released separate statements last week confirming rumors that preliminary discussions were taking place for a network infrastructure joint venture. Unlike countries such as the U.S. and India, China presently does not  have independent network infrastructure companies to buy/lease land, build towers and lease out space for base-stations to network operators. In China, carriers build their towers themselves and install the required base station hardware, acquiring it from network equipment providers such as Ericsson, Nokia (NYSE:NOK), Alcatel-Lucent (NYSE:ALU) and ZTE. ((NEWS REPORT RELATING TO THE ESTABLISHMENT OF A BASE STATION COMPANY, China Mobile, April 30, 2014)) [1] [2] China Unicom, the second largest wireless carrier in China by subscribers, is likely to benefit the most if a joint network infrastructure company is formed in the country.

The Chinese wireless market is currently dominated by China Mobile, which holds a share of 62.3%, and is followed by China Unicom and China Telecom with 23% and 14.6%, respectively. [3] [4] [5] A joint network infrastructure company is likely to benefit all the carriers by reducing their capital expenditures and lowering operating expenses, ultimately driving their bottom line. However, China Mobile could lose its first mover advantage in 4G network rollout. We expect China Unicom to gain the most owing to its hybrid 4G strategy (TD-LTE and FDD-LTE), healthy 3G mix and consistent 3G/4G subscriber adds despite rising competition.

We have a price estimate of $17 for China Unicom, which is roughly in line with the current market price.

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See our full analysis for China Unicom’s stock here

China Unicom’s Hybrid 4G Strategy

After the Chinese government issued TD-LTE 4G licenses to carriers in December last year, China Unicom decided to adopt a hybrid strategy to expand its 4G coverage in smartphones. The carrier planned to lease out TD-LTE network infrastructure from China Mobile in the near term (China Mobile is the only carrier with a significant commercial 4G network) to launch 4G services for smartphones, and expand aggressively when the government launched FDD-LTE 4G licenses.

TD-LTE 4G licences issued by the government favored China Mobile, since TD-LTE technology was compatible only with the market leader’s homegrown 3G standard (SCDMA) unlike China Unicom and China Telecom, whose 3G networks were based on the internationally accepted WCDMA standard. This allowed China Mobile to race past rivals in 3G/4G subscriber adds in the first quarter this year, adding over 36 million new high speed users (3G & 4G) compared to about 10 million and 1 million adds for China Unicom and China Telecom, respectively. However, it is evident from this data that despite China Mobile’s first mover and network compatibility advantage, China Unicom made substantial progress in improving its high speed subscriber base. It should also be noted that its performance in terms of user additions was far better than its smaller rival China Telecom.

Improvement In 3G/4G Mix & ARPU Expected

If a network JV is established, it might enable China Unicom to lease out TD-LTE 4G network infrastructure with relative ease, compared to the present situation where the carrier has to deal with China Mobile individually. The JV is also likely to allow China Unicom to increase its network coverage (2G, 3G and 4G) without the necessary capital costs, which could provide the carrier an edge in terms of maintaining profitability and gaining high speed subscribers. Despite rapid user additions, China Mobile’s net profit declined over 9% year-over-year in Q1 this year. [6]

Since Unicom planned a mixed 4G strategy (TD-LTE & FDD-LTE) from the beginning, it has already rolled out 4G handsets compatible with the TD-LTE standard, thus racing ahead of China Telecom, which has yet to launch 4G for smartphones. This could allow China Unicom to make rapid inroads into the 4G market and further improve its high speed mix. Its 3G/4G mix improved from 43.6% in Q4 2013 to about 46% in the first quarter this year.

In addition to its subscriber adds in TD-LTE, we expect China Unicom’s subscriber base to expand rapidly when the Chinese government awards 4G FDD-LTE licenses to the carriers. Since China Unicom’s 3G network is more compatible with FDD-LTE, its existing 3G users will be able to seamlessly transition to 4G on the FDD standard. This could help the carrier in improving its average revenue per user (ARPU) because 4G networks provide much faster Internet connectivity than 3G and 2G to subscribers, which encourages them to use more data and generate more revenue per month. Although the Chinese government is mum on the matter, the market expects FDD-LTE licenses to be issued sometime later this year.

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Notes:
  1. UNUSUAL PRICE AND TRADING VOLUME MOVEMENTS, China Unicom, April 30, 2014 []
  2. Press Release, MIIT, April 30 2014 []
  3. Operation Data, China Mobile, 25 April 2014 []
  4. Operating Data, China Unicom, April 2014 []
  5. Key Performance Indicators, China Telecom, April 2014 []
  6. More Policy Headwinds for China Mobile, WSJ, May 5 2014 []