China Unicom Earnings Grow As Cost Improvements Offset 4G Weakness

China Unicom (NYSE:CHU) registered 4.5% year-over-year growth in its first half 2015 net income, making it the only large Chinese carrier to post earnings growth for the first half of the year. ^[1] Earnings were driven primarily by lower selling and marketing expenses – as the carrier pushed for the transformation of its sales and marketing model – and slightly lower interconnection fees. That said, things were challenging on the revenue front, amid subscriber losses (about 10 million net losses in H1) and shrinking market share, brought about by a slow start to the carrier’s 4G campaign. This is concerning, given that data subscriber and traffic growth is becoming the primary lever of earnings growth in a saturating Chinese wireless industry. In this note, we review the carrier’s key metrics for the reported period and look at how the carrier can build momentum on the 4G front.

We have a $16 price estimate for China Unicom, which represents a 15% premium to the current market price.

See our complete analysis of China Mobile | China Unicom | China Telecom

Tepid 4G Growth Fails To Offset 2G Attrition

China Unicom’s total service revenues declined by 5.3% to about RMB 120.267 ($18.80 billion) for the first half of the year, while mobile service revenues plummeted by 9.7%. While the impact of the VAT reforms introduced in June last year continued to put pressure on the top line, much of the decline appears to have come from the carrier’s steady loss of market share. China Unicom and China Telecom (NYSE:CHA) received their full FDD-LTE licenses in February, allowing them to operate 4G services across the country. However, even with the licences in place, China Unicom has apparently been slow to bolster its 4G network and marketing, and may have also underestimated the strength of China Telecom’s high-speed campaign.

Although the carrier remained tight-lipped about its exact 4G numbers, it revealed that its mobile broadband subscribers (3G/4G) increased by just 8.68 million to 157.8 million during H1. The carrier has lost a total of about 10 million subscribers since December, with its subscriber base standing at 289.3 million at the end of June, indicating the modest gains in high-speed users could not compensate for the loss of 2G customers. Its market share has declined by about 85 basis points to around 22.3%. In comparison, China Telecom noted that it had added about 12.37 million high-speed customers, with its 4G adds standing at 22 million in H1.

As expected, customer level metrics are improving, driven by rapid growth in data consumption, a growing share of non-voice services and a greater mix of 3G/4G users (54.5% vs 47.7%) compared to a year ago. Data usage by mobile broadband handset users grew by 54% year-over-year, while ARPU has been steadily improving over the last two quarters, rising from about RMB 40.3 ($6.29) in Q4 2014 to about RMB 42.1 ($6.57) in Q2 2015.

Why The Carrier Should Be Able To Turn The 4G Tide

Despite the lackluster performance thus far, the company has not yet missed the bus on 4G. Overall 4G penetration in China stood at under 18% as of June 2015, by our estimates, leaving plenty of room for growth. Moreover, China Unicom has a decent track record of building high-speed networks – it still holds roughly 23% of overall high-speed customers in China on account of its strong 3G user base. It’s possible that it could turn the tide with 4G as well, since the FDD-LTE standard that it is using is more commonly used throughout the world, giving it access to a larger number of handsets and possibly more economical equipment. The carrier also intends to ramp up its mobile broadband base stations from 837,000 to 1.2 million by the end of this year, with plans to officially launch dual-carrier aggregation for LTE, taking downlink speeds to as high as 330 Mbps by 2016. ^[2] China Unicom could also benefit from the tower sharing joint venture that it is setting up along with rivals China Telecom and China Mobile (NYSE:CHL). The move is expected to be particularly beneficial to China Unicom and China Telecom, being the smaller carriers,  since it could help to alleviate any shortage of prime sites, for their 4G services roll-out, while also potentially leading to a reduction in capital expenditures and operating expenses.

H1 Earnings Review

• Total revenues fell by 3.3% y-o-y to RMB 144.69 billion ($22.59 billion)
• Net income grew 4.5% y-o-y to RMB 6.99 billion ($1.1 billion)
• Selling and marketing expenses fell 38.6% y-o-y to RMB 14.63 billion ($2.29 billion)
• Cash and cash equivalents grew to RMB 16.31 ($2.55 billion)
• Fixed line broadband customers grew to 70.59 million from 67.42 million a year ago.
• The company will not pay an interim dividend this year.

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1. China Unicom H1 2015 Earnings Press Release [↩]
2. China Unicom Earnings Presentation [↩]