The onset of the 3G revolution in China has unleashed the demand for data consumption providing telecommunication service providers with golden opportunities. However, China's three telecom operators -- China Mobile (NYSE:CHL), China Unicom (NYSE:CHU), and China Telecom (NYSE:CHA) – have had varied success as far as 3G is concerned. China Mobile, despite having the highest number of wireless subscribers, has largely been a laggard (3G adds have started picking up only recently), whereas comparatively smaller operators China Telecom and China Unicom have been quick to capitalize on 3G.
China Telecom's 3G foray has particularly been quite beneficial and it has the potential to significantly contribute to the company's growth in the coming years. China Telecom's broadband division has also shown decent growth in the past, and is likely to perform even better as fiber to the home gains momentum. We have a price estimate of $61 for China Telecom's stock, which is about 30% ahead of the current market price.
Strong Focus on 3G Has Paid Off
Despite being the smallest of the three Chinese carriers, China Telecom has managed to convert almost 50% of its wireless subscribers to 3G. China Telecom's 85 million 3G subscribers have brought in a lucrative and rapidly growing stream of data revenues. Mobile service revenues for the year 2012 were RMB 92 billion, recording a 36% jump over the previous year, bolstered by 50% growth in its data revenues. At present, wireless data contributes almost 50% of the mobile service revenues and is only going to assume greater significance in the coming years.
3G Subscriber Additions Could Stagnate
China Telecom has added 3G subscribers at a rapid pace in the last few years. In 2012 alone, it added close to 33 million 3G subscribers, thereby almost doubling its 3G subscriber base from 2011 and ending 2012 with 69 million 3G subscribers. However, the latest data shows that China Telecom's 3G subscriber additions seem to have stagnated at 3 million per month, whereas China Mobile and China Unicom continue to grow by leaps and bounds, adding 8 million and 4 million 3G subscribers per month, respectively.
EBITDA Margins Improve on Acquisition of CDMA Network Assets
In 2012, China Telecom acquired CDMA network assets from its parent company China Telecom Group to avoid paying network leasing fees, which was a heavy burden on its EBIDTA margins. As a result of this, in Q1 2013, network operation and support expenses declined by 27%, thereby improving EBIDTA margins by 7 percentage points as compared to the same period last year. Exclusive of mobile terminal sales, EBITDA margins for the first quarter of 2013 stood at 36.3% as compared to 29.5% in Q1 2012.
With strong growth in data revenues, China Telecom would have continued to pay higher network leasing fees, had it not acquired CDMA network assets from its parent. Hence, we feel that the company has taken a wise decision of taking control over its network assets, even though it had to take an additional debt burden of $7 billion.
Banking On Fiber Broadband
China Telecom, being the world's largest wireline broadband service provider, has a lot to gain as high-speed broadband gains momentum. With strong backing from the Chinese government, fiber to the home (high speed broadband) has the potential to significantly improve the fortunes of its broadband division. Before going into the specifics, it is important to highlight certain inherent advantages that China Telecom enjoys with respect to its broadband division.
China Telecom has more than 90 million broadband subscribers. It added 13.5 million broadband subscribers in the year 2012, and has a long way to go as household broadband penetration in China has only reached about 40%. More than 70% of China Telecom's broadband subscribers enjoy broadband speeds in excess of 4Mbps. It is these subscribers that the company would eventually target, as it offers numerous complimentary services like IPTV and video on demand, with the help of FTTH.
China Telecom is aggressively investing in expanding its FTTH network. As at the end of 2012, it successfully provided FTTH access to 55 million households, with 15 million subscribers switching to the high speed FTTH network. Considering China Telecom's steadily growing broadband subscriber base, the potential for growth of FTTH is huge. FTTH is important for China Telecom as it can increase the broadband ARPU, which has marginally decreased over the years. However, much of this potential increase in broadband ARPU is likely to be offset as China Telecom also expands in rural areas, where broadband services are sold at lower price points.
Disclosure: No positions.