CHU revenue increased by 10.1% in 2005; lower than the 20.7% growth seen in 2004, with 2005 net profit rising by 9.6%. Facing a mature market, GSM revenue grew by 9.7%, while the CDMA loss before income tax decreased from RMB-563 mn in 2004 to RMB-200 mn in 2005. MOUs of GSM and CDMA are approaching the same level, which means CDMA began to compete with GSM in the low-end market.
Based on new phone orders, we are skeptical that the subsidy will abate and we believe the company will keep its handset subsidy policy in 2006 but reimburse less for each new subscriber and for more subscribers. The fact that CHU was not invited into the TD-SMACD massive test presents a negative signal for future competition. CHU will invest RMB 12.7 bn in upgrading GPS to provide value added service.
Based on conservative inputs, we calculate a target price of $9.00 by cash flow model. Furthermore, 1.14X P/B is really low for a telecom company. Since the market price has been fairly impacted, we keep our HOLD rating.
Sales Grew at a Lower Rate:
Full-year 2005 revenues for CHU amounted to $10.85 bn, up 10.1% from 2004, EBITDA increased by 5.4% to $2.54 bn, and net profit increased by 9.6% to $614.9 mn. The sales growth rate significantly fell to 10.1% yoy in 2005, compared to 20.7% in 2004.
Both the GSM and the CDMA mobile businesses suffered from a maturing industry. Revenue from the GSM mobile business, which is CHU’s main profit source, grew by 9.7% to $6.50 bn, compared to 21.7% in 2004. CDMA mobile revenue grew by 13.2%, significantly dropping from last year’s 51.4%, but CDMA loss before income tax decreased from RMB-563 mn in 2004 to RMB-200 mn in 2005. In fact, the CDMA business was profitable in 2H2005. Shang Bing, Executive Director and President of China Unicom, predicts that the CDMA business could be breakeven in 2006.
ARPU Declining Rates Down:
Competition from China Mobile (NYSE:CHL) and PHS (Personal Handy-phone System) caused ARPUs to continue to drop, but the rate of decline slowed. The GSM ARPU decreased by 1.8% compared to 12.3% in 2004, while the CDMA ARPU decreased by 12.0% compared to 32.2% last year. We believe the slowdown in decline of ARPU reflects the fact that all telecommunication operators including CHU have little room left for price wars and that the mobile voice business has become mature.
Buy More Mobile Handsets for Subsidy:
CHU has been selling handsets under cost in order to promote CDMA service for a long time and has promised to reduce its CDMA business loss by decreasing the mobile handset subsidy. However at the end of March, CHU decided to double its mobile handset purchase from 3 mn units to 6 mn units, which suggests CHU will not give up or reduce its subsidy. In 2005, the cost of telecom products is RMB 3.48 bn, an increase of 44.95%, while the subsidy ratio (as measured by the phone set subsidy divided by the cost of telecom products sold) declined from 30.46% in 2004 to 21.12% in 2005. Furthermore, prices of most of the phone sets that CHU bought for CDMA in January were under RMB 1,000. We believe that CHU’s strategy will be to offer a lower reimbursement for each new subscriber but offer a reduced reimbursement to more subscribers.
Out of TD-SCDMA Massive Test:
We note that Ministry of Information Industry (MII) invited all telecom operators (China Mobile, China Telecom, and China Netcom) to the TD-SCDMA massive test except China Unicom. Chang Xiaobing, the Chairman of China Unicom, said there was not necessarily a causal relationship between the test and the license and other 3G standards would be developed in China.