What’s The Downside Risk If China Unicom Fails To Shore Up Its 4G Woes?

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China Unicom

China Unicom (NYSE:CHU), China’s second largest wireless carrier in terms of subscribers, has had a difficult 2015 amid slower-than-expected uptake of its 4G LTE wireless services and a consequent decline in its subscriber base (related: The State of The Chinese Wireless Market In October). Below we take a brief look at how the carrier got into this situation and examine the potential downside risks to its stock price if it fails to address these woes.

Our $15 price estimate for China Unicom is about 25% ahead of the current market price.

See our complete analysis of China MobileChina UnicomChina Telecom

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Carriers Have Differed In Their 4G Approaches 

The Chinese government awarded its TD-LTE 4G licenses in December 2013, which only benefited China Mobile, as China Unicom and Telecom intended to build out their 4G networks using the FDD-LTE standard. The first mover advantage helped China Mobile grow its 4G subscriber base exponentially from just over 1.3 million users in February 2014, to 90 million in December 2014 to over 265 million users at the end of October 2015. The government only awarded the full FDD-LTE 4G licenses to the smaller two carriers earlier this year. China Telecom – the smallest of the three carriers – focused its initial build-out on densely populated urban areas where most early adopters are likely to be located, allowing for reasonably strong subscriber growth. On the other hand, China Unicom adopted a much more ambitious strategy of building out its 4G coverage all across the mainland. However, it ended up spreading itself too thin, since it could not afford the sort of density that its larger and much better-capitalized rival China Mobile achieved. Not only did this result in a relatively slow adoption of 4G services (27 million 3G/4G adds through October, slightly below smaller rival Telecom), it also resulted in customers defecting to key rivals due to a desire for better data services. The carrier has lost about 12 million subscribers year-to-date (down 4% from the of end of 2014) and its share of the Chinese wireless market has also fallen to below 22%, from over 23% last year.

What Our $15 Price Estimate Factors In

However, we believe that the carrier could see a turnaround going forward and we are factoring this into our $15 price estimate. The three Chinese carriers have formed a joint venture to share their tower and infrastructure assets and there have been reports that Unicom and Telecom could share their 4G base stations as well. This could help Unicom improve its coverage in a cost efficient manner, bolstering its 4G campaign. China is still in its early stages of 4G data adoption (we estimate penetration at under 30%) and Unicom has a large base of 3G subscribers (61% high-speed mix) who could migrate to 4G services. Per our current valuation model, we estimate that China Unicom’s market share will stand at 21.5% by the end of this year.  We believe that the carrier will reverse some of its market share losses over the next two years, with the number stabilizing at a little above 22% by the end of 2022, which is the terminal year of our discounted cash flow model. We estimate that ARPU will improve from about $7/month to over $8/month by 2022 on account of higher data usage.

15% Downside If Subscriber Losses Continue 

However, if the carrier is unable to take full advantage of the recently awarded FDD-LTE 4G licenses amid continued aggressive promotions by rivals China Mobile and China Telecom, its market share could witness further declines. Additionally, the Chinese government has been promoting competition among state-backed companies (including wireless operators) over the last several years, and there is a chance that it could leave the carrier to fend for itself, without taking additional regulatory measures to stem the decline. If the carrier is unable to shore up its high-speed campaign in a timely manner, leading its market share to decline to about 20.5% by 2022 (versus 22% per our base model), with ARPU also growing at a slower than expected rate to about $7.50/month by 2022 (versus $8+ per month in our base model), owing to slower data usage growth, this could result in a 15% downside to our current price estimate.

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