Earnings: China Telecom Buzzes, Sohu Fizzles

Includes: CHA, SOHU
by: Doug Young

As the current earnings season gets into full swing, let’s turn our attention to the latest results that show encouraging signals from both wireless carrier China Telecom (HKEx: 728; NYSE: CHA) and Internet company Sohu (Nasdaq: SOHU). Yet despite the upbeat reports, shareholders have reacted quite negatively to the Sohu results by dumping its stock. That sell-off is probably mostly technical, for reasons I’ll explain soon. In the meantime, China Telecom’s shares have languished over the last year, even though in my view it’s rapidly emerging as the shrewdest of China’s 3 major state-run telcos.

Let’s start off with China Telecom, as I think investors have overlooked this company over the past few years. As the smallest of China’s 3 mobile carriers, China Telecom has spent heavily over the last 2 years to build up its subscriber base to gain ground on rivals China Unicom (HKEx: 762; NYSE: CHU) and China Mobile (HKEx: 941; NYSE: CHL). That aggressive build-up hurt the company’s profit growth, and this year it made a conscious effort to pare back spending in a bid to become more profitable. Those efforts are now bearing fruit, with China Telecom reporting its third-quarter profit rose a healthy 20 percent (company announcement). That rate represents a steady acceleration from a 16 percent profit gain in the first half of the year, and a 9.5 percent decline in 2012 when it was aggressively courting new customers.

I’m quite encouraged by the company’s accelerating profit growth, but I also quite like its broader strategy that has it focusing on high-end users for its 3G network. The company reported that 3G users now account for about half of its total, up from 43 percent at the end of last year. By comparison, the vast majority of China Mobile’s subscribers still use its older 2G service, and even Unicom’s 3G users only account for 41 percent of its total.

I also like China Telecom’s decision to focus on a globally-tested technology for its 4G network, unlike its rivals that are betting partly or completely on a homegrown technology for political reasons. Yet despite all those positives, China Telecom stock has languished over the last year, down about 10 percent over the past 52 weeks. So perhaps this could represent a good buying opportunity as profit growth accelerates and Beijing gets ready to issue 4G licenses.

From there let’s look at Sohu, whose results look relatively solid with 1 noticeable exception (company announcement). Despite the positive report, the company’s stock tanked by 16 percent after the results came out. I suspect the big drop represents investors locking in some of their gains, since the stock had doubled over the last 52 weeks before the sell-off.

I won’t get too detailed with my look at Sohu’s results, except to point out that growth was very solid for its search and online video advertising businesses, which have both seen strong momentum lately. Its older gaming business grew, though the rate was less impressive at 7 percent. But perhaps what spooked investors was Sohu’s prediction for a relatively large fourth-quarter loss.

The company didn’t provide much explanation about the forecast, but at least some of the loss looks related to the recent sale of a stake in its Sogou search business to Internet leader Tencent (HKEx: 700). While a loss is never good, I do expect the company will return to profitability next year; it should also show some good growth through the Tencent tie-up, and could soon form another alliance with strong growth potential for its online video service (previous post). For those reasons, I do expect the stock will bounce back in the next few weeks, and that Sohu could also represent a good buying opportunity.

Bottom line: China Telecom and Sohu could both represent good buying opportunities, as each gains momentum by focusing on its strongest growth areas.