At present, China Unicom (NYSE:CHU) is the exclusive official carrier of the iPhone in China. As smartphone penetration is as low as 15% in the country, the company provides heavy subsidies on the mobile handsets it sells, wanting to create a class of mid and low end smartphone users and thereby attempting to increase mobile data usage. Providing both mobile and landline services in China, the company hopes to leverage upon its integrated services offerings and gain competitive advantage. The company faces stiff competition from China Mobile (NYSE:CHL) in the mobile services segment and from China Telecom (NYSE:CHA) in both its mobile and landline segments.
The present structure of the company emerged after the restructuring in the Chinese telecom industry in 2008. The company sold off its CDMA business to China Telecom and the remaining company was merged with China Netcom to form China Unicom, as we know today.
See our complete analysis of China Unicom’s stock here
Large subsidies boost mobile phone sales and impede margins
Revenues from mobile phone sales have increased from $0.1 billion in 2008 to $1.1 billion in 2010 and to $1.7 billion by mid 2011. This has primarily been due to the company’s policy of offering highly subsidized handsets with bundled services.
Such a move by the company has however taken its toll on the margins of the company. The EBITDA margins have steadily declined from 42% in 2008 to 29% in 2010 and we expect them to fall further. In comparison to this, China Mobile reported EBITDA margins of 50.7% in 2010. The company has also increased selling and marketing expenses primarily for the promotion of such subsidized handsets. These expenses grew by 9% in 2009 and 14% in 2010, taking down margins with them even lower.
Further, since the company set up its mobile division only after the restructuring in 2008, it undertook large scale capital expenditure for its network expansion and enhancement. The revenues relating to such expansion are not yet significant enough to meet the additional expenses incurred. Tariff regulations by the government restrict freedom in terms of pricing of mobile services. These have all added up and led to the decline in profitability of the company.
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