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David Riedel of Riedel Research Group recently published a note on China Unicom Limited (CHU) in which they recommended investors HOLD the stock. Excerpts follow:

CHU's revenue in 1Q2006 amounted to RMB22.90 bn, a 9.81% YOY increase and a QOQ increase of 5.19%. Profit rose by 30.55% YOY, and 22.30% QOQ to RMB1.39 bn. High growth rates are not only due to low comparison bases in previous periods, but also due to high profit margin value-added services from upgraded GPS networks in four major Chinese cities.

CHU continues to upgrade GPS in other cities, which will bring in more income in the future. CHU achieved an unusual YOY ARPU increase in 1Q2006 in the competitive market, but its ARPU and MOU still underperformed CHL. CHU’s ‘TIME Strategy’ focuses on seven value-added services, which will drive future revenue and profit growth. Since the profit boom in 1Q2006 has been fairly valued in the market, we rate CHU a HOLD.

We define the financial situation as recovery. Company’s QOQ revenue suffered decreases in 3Q2005 and 4Q2005, while profits experienced drops in 1Q2005 and 4Q2005. Therefore, high growth rates are partly due to low comparison bases. We note that revenue in 1Q2006 is lower than those in 1Q2004 and 3Q2005.

Furthermore, there is a large profit margin for incremental revenue from GSM networks. In four major cities of China (Beijing, Shanghai, Guangzhou, and Shenzhen), CHU upgraded GSM to GPRS, which can provide new value-added services with high profit margin. These services began to be use and contributed to revenue since January of this year.

Although with some achievements, we would like to remind investors that since 2004 ARPU and MOU of CHU underperformed those of China Mobile (CHL).

Focuses on Value-Added Services

During ‘China Unicom Value Added Services Cooperation and Development Conference 2006’ on April 20th, CHU announced a ‘TIME Strategy’, which means ‘based on Telecom, transfer to Information, Media, and Entertainment.’ CHU will focus on seven value-added services — music download, picture download, mobile game, mobile magazine, mobile mail, mobile TV, and mobile Internet. Music download will be the most important among these seven value-added services. Since the voice service market matured and value-added services do contribute to revenue growth as mentioned above, we believe the strategy can generate a positive effect for CHU.

Valuation and Recommendation

We assume GSM QOQ revenue growth rate will decrease 2 percentage points in the next three quarters, and keep at 2% in 2007. We also assume CDMA and Long Distance revenue will grow 1% QOQ in 2006 and 2007. Assumptions of Data and Internet revenue will maintain a downward trend in the next two fiscal years. Revenue growth rates in the next two fiscal years will be 11.3% and 8.08%. Cash flows growth rates in 2008 and 2009 are assumed as 5%, and Cash flows growth rates thereafter are assumed as 3%.

Based on data above, we calculated a target price of $10, close the current market price. Bottom Line: HOLD.

CHU 1-yr chart:

CHU 1-yr chart

Source: Riedel Research: Mixed Feeling About China Unicom (CHU)