China Telecom Misses, But Is Well Positioned to Benefit From Growing Market

| About: China Telecom (CHA)
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China Telecom (NYSE:CHA) announced 2009 results with adjusted earnings per ADS of US$2.40 missing the Zacks Consensus Estimate of US$2.57. Adjusted earnings exclude amortization of upfront connection fees and impairment losses. The incumbent Chinese fixed-line operator reported an adjusted net income of RMB13.27 billion (US$1.95 billion), down 33.9% year-over-year.

The drop in profit is primarily attributable to higher marketing expenses associated with the deployment of the company’s 3G wireless services and aggressive handset roll-outs. China Telecom reported a 47% year-over-year increase in SG&A costs (including mobile handset subsidies).

Reported net income of RMB14.42 billion (US$2.14 billion) or RMB0.18 per share (US$2.65 per ADS) represents an increase from RMB884 million (US$130 million) a year ago, which was hit by one-time impairment charges on Personal Handyphone System (PHS) assets and losses related to natural disasters.

Revenue & EBITDA

The Chinese operator reported revenues of RMB209.37 billion (US$30.7 billion) for 2009, up 12% year-over-year, driven by healthy contribution from its wireless and broadband Internet segment which offset the decline in fixed-line voice business. Adjusted revenues of RMB208.2 billion (US$30.5 billion) represent a 12.9% year-over-year growth.

Adjusted EBITDA shrank 4.4% year-over-year to RMB82.13 billion (US$12 billion) with an EBITDA margin of 39.4% compared to 46.5% a year ago.

Wireless & Broadband Offset Wireline Voice

Revenues from the wireline segment dipped 3.2% year-over-year to RMB172.6 billion (US$25.3 billion). Voice and non-voice revenues accounted for 45.4% and 54.6% of total sales, respectively.

Wireline voice revenues declined 18.5% year-over-year to RMB78.4 billion (US$11.5 billion) due to a weak economy and accelerated fixed-to-mobile substitution. To revive its wireline business, China Telecom has initiated several steps including cost control and bundled wireline voice, non-voice and mobile services.

Broadband access revenues came in at RMB51.6 billion (US$7.6 billion), growing 26.6% year-over-year. China’s broadband market is expected to grow at a compound annual rate of 25% over the next three years, offering significant opportunity for China Telecom which targets 65 million customers by 2011.

China Telecom added mobile operation to its services in October 2008 after the acquisition of China Unicom’s (CHU - Analyst Report) CDMA wireless business for roughly RMB43.8 billion (US$6.39 billion). Total revenues from the wireless segment were approximately RMB35.6 billion (US$5.2 billion) including wireless voice revenues of RMB20 billion (US$2.9 billion).

Revenues from the company’s value-added information applications grew 32.5% year-over-year to RMB21.5 billion (US$3.2 billion), representing about 10% of total sales. ‘Best Tone’ information service revenues rose 14.7% year-over-year to RMB5.46 billion (US$800 million).

Subscriber Results

China Telecom lost 19.8 million voice access lines during 2009 bringing the total access line base to 189 million (down 9.5% year-over-year). On a positive note, the company added 9.19 million broadband subscribers in 2009 bringing the total broadband customer base to 53.46 million (up 20.8%).

Total mobile subscriber base reached 56.1 million (up 101%) with a net addition of 28.2 million customers. China Telecom’s wireless market share grew to 7.7% from 4.5% in 2008. The company hopes to increase its total mobile subscriber base to over 100 million by 2011, driven by the continued success of its ‘e-Surfing’ 3G network brand. This will represent over 15% of the total Chinese wireless market.


China Telecom plans to lift capital spending in 2010 to boost its broadband and value-added services businesses. The company plans to spend RMB39 billion (US$5.7 billion) in the current year compared to RMB38 billion (US$5.6 billion) in 2009.

China Telecom is the market leader in fixed-line phone services in one of the world’s fastest growing telecom markets. However, the company is currently the smallest of the big three wireless carriers in China.

China Telecom remains committed to its 3G wireless venture and its 3G network covered 342 Chinese cities (addressing 95% of urban population) at the end of 2009, amassing 4.07 million users. Its CDMA 2000-based 3G network is 50% faster than China Mobile’s (NYSE:CHL) home-grown 3G TD-SCDMA network.

In addition to upgrading its 3G network, China Telecom continues to broaden its handset range. The carrier currently has roughly 600 handset models in supply including 100 3G models.

China Telecom is reportedly launching Research in Motion’s (RIMM) BlackBerry and Palm’s (PALM) Pre smartphones in May and July 2010, respectively. The opportunity to market two of the world’s most sought-after cell phone brands may lift the company’s fortunes in wireless.

We believe China Telecom is well positioned to benefit from the rapidly growing Chinese wireless market driven by the 3G prospect, enhanced distribution capabilities and expanding handset portfolio. However, expenses associated with the ubiquitous deployment of high-speed wireless services may continue to drag profit and margins.

Moreover, the carrier is exposed to intense competition, which is set to intensify in 2010 following the completion of 3G network deployments by the incumbent Chinese carriers.