China Mobile (CHL) recently announced its annual results for 2012. The largest wireless carrier in the world added close to 61 million subscribers during the year to take its total subscriber base past 700 million, and grew revenues by more than 6% over 2011. More than 60% of the total subscribers added during 2012 were 3G, which suggests that traction for the carrier’s homegrown TD-SCDMA network is gradually picking up after lagging rivals initially. As expected, voice revenues grew sluggishly by about 1% while surging demand for smartphones and data helped China Mobile more than make up for the slack with close to 20% growth in data revenues. While a big chunk of China Mobile's revenues still comes from voice (over 70%), data is growing fast. We expect this to sustain going forward as the carrier rolls out 4G TD-LTE in the coming months and looks to transition its huge subscriber base away from 2G quickly.
However, in order to sustain the huge data demand and roll out a LTE network, the carrier guided for almost a 50% hike in capital expenditures in 2013. Compared to RMB 127 billion spent on network upgrades last year, China Mobile expects to incur more than RMB 190 billion in capex spend this year. More than 50% of its mobile network spending, or about $7 billion, will be driven by TD-LTE, which the company is looking to build out in the coming months. Going forward, we expect the high network investment to continue as the company looks to expand its LTE network to new regions and uses it as the primary network for data traffic in the future. However, considering the surging data demand and the monetization potential left untapped in the carrier’s huge 2G subscriber base, we maintain a $60 price estimate for China Mobile, about 15% ahead of the current market price.
Growing 3G Adoption Drives China Mobile's Value
3G services have driven the ARPU levels of many carriers in the developed world. Carriers such as Verizon, AT&T and Sprint in the U.S. have seen rapid growth in mobile data revenues over the past few years driven by growing demand for 3G-capable smartphones. This has come even as voice ARPUs have declined, a trend that can be seen in the Chinese telecom market as well. China Mobile's voice ARPU levels have declined from around $7.40 in 2007 to about $6 in 2012, by our estimates.
With voice ARPU on the wane, Chinese telecom operators have started pushing 3G-capable smartphones to drive data ARPU levels. 3G penetration is at a low 22% currently so the opportunity to push 3G is immense. As can be seen from the Chinese telecom data released each month, the carriers are now adding more 3G subscribers than 2G. China Mobile, which is more than six times the size of Verizon with over 700 million mobile subscribers currently, stands to gain heavily from this transition. Increasing 3G adoption will serve to boost its already increasing data ARPU levels further, more than compensating for the fall in voice ARPUs as a result.
But the Chinese behemoth hasn’t been able to capitalize on its huge 2G subscriber base as well as it should have. As of January, China Mobile's 3G subscriber base stood at around 95 million which translates to a 3G penetration of just over 13%. This compares poorly to the industry-wide average of more than 22% in China. A major reason for the lag has been its homegrown TD-SCDMA 3G network, which is incompatible with most smartphones currently available, including the iPhone. This requires handset vendors to come out with specially crafted phones for the carrier's proprietary network which has proved to be a huge deterrent.
LTE Will Help Overcome 3G Shortcomings
In order to overcome this problem, China Mobile will be rolling out a TD-LTE network this year. Considering that the technology is being used by multiple carriers around the world to build out their 4G networks, TD-LTE is expected to be widely supported by handsets. What should also give China Mobile hope is that it has recently started adding 3G subscribers at a rate that is far exceeding expectations. The carrier added 7.05 million and 5.5 million net 3G subscribers in December and January, much higher than the average of about 3 million in the previous months. So, while China Mobile has some way to go before it catches up with the competition in terms of 3G penetration, most signs indicate that the transition away from 2G has picked up and will gather more pace in the coming years. The high initial investment in LTE should therefore not be a worry in the long run as 4G drives demand for data and helps the carrier attract more of the high-end mobile subscribers.
Moreover, the recent strong showing means that China Mobile will not be hard-pressed to sign an iPhone deal with Apple. Considering that Apple will be looking to penetrate the emerging markets where its presence is very low, China Mobile may be able to negotiate lower subsides or gain access to a cheaper iPhone -- both of which should limit the margin impact as smartphones start forming a bigger chunk of its handset sales.
Disclosure: No positions.