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CT’s edge in
differentiation. CT was the first to launch 3G services in Mar09, and it is still leading the market in terms of 3G coverage. CT’s strategy in mobile business is integral in part of its overall business strategy – differentiation. Compared with CM and CU whose 2G and 3G networks are separate, CT’s existing 2G network can be upgraded to become 3G network through software upgrade. As a result, the only difference between a 2G sub and 3G sub is if he uses data services. Currently, we estimate that CT has 165,000 – 175,000 base stations, including 100,000 – 110,000 already upgraded to 3G. This convergence in 2G and 3G network, together with its bundling services with fixed-line and broadband, gives CT an edge in differentiation.
CM is still a heavyweight. CM has lagged behind in 3G coverage and may continue to suffer from the drawback of the new TD-SCDMA 3G standard. Despite difficulties in the near term, CM remains competitive in the 3G market in the long run:
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CM has 527.4m mobile subs (as of Jan10), which is the most valuable asset. CM has completed integration of its 2G and 3G core network and services. Existing 2G users can migrate to 3G services without re-registration, changing SIM card and changing number;
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CM is a pure mobile telecom operator. Hence it has the advantage to centralize resources on mobile business. Though CM has no fixed-line and broadband business, the LTE (4G) would help CM enter these market in the future;
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Meanwhile, CM has financial strength and support from government to develop the TD-SCDMA business. It is reported that CM has built 2m lines of FTTH network, targeting the high-end broadband market in China;
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Furthermore, we don’t expect sharp increase in churn ratio before the implementation of MNP in China;
Financial position and capex
As 3G capex is borne by parent companies, we do not see much capex burden with CM and CT going forward. But CU will suffer growing capex burden in the coming few years. Though CM and CT would have to save money for buying back 3G assets in the future, they have great flexibility to invest in key growth markets (like FTTx) in the next few years.
Investment cycle has not ended. 2009 might have seen the peak in the telcos’ total capex but the investment cycle has not come to an end. Though the telcos’ total capex will be on the downtrend going forward, it will stay at high levels in the coming three years.
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2009 is the first year of large scale 3G investment. We believe it will take three years for comprehensive network coverage;
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In addition, upgrade to LTE would require extra capex on top of ongoing 3G capex budgets. This might happen in the next two to three years depending on telcos’ speed in network upgrade;
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Meanwhile, the telcos are in another investment spree in all-IP network and fibre-optic network (FTTx), which would persist over the next three to five years in our view.
The persistent capex requirement would be a challenge to the telcos’ financial status over the next few years.
CM: cash abundant. As of Jun09, CM has over RMb250bn cash and bank deposits, no borrowings. As the investment in 3G network is borne by parent company, CM’s capex will be declining going forward. As such, we do not see any financial burden for CM in the near term. However, the cash might be used for two purposes: 1) expansion to overseas market through acquisitions, and 2) acquisition of the TDSCDMA assets from its parent company. Hence, CM may not give, if any, substantial special dividend despite its abundant cash on hand.
CT: good enough. CT will be better off as well in the coming few years, as the 3G investments are borne by parent company. Though CT might suffer losses in the CDMA business in the next two years, rising free cash flow from the wireline business should help CT remain in a healthy financial position going forward.
CU: capex burden is getting
heavier. CU received c.RMB30bn cash inflow from distributing the CDMA business in 2008. But the cash will soon be depleted, given its huge capex requirement in the coming few years. CU may suffer negative free cash flow in the coming few years, resulting in an annual capital shortage of RMB20bn – RMB25bn in our view. This would raise its gearing ratio and interest expenses going forward.
Growth outlook
We do not expect growth surprises for CM in the next two years. CT might deliver earnings surprises benefiting from regaining growth in wireline and a low base in mobile business. CU has the biggest downside risk in earnings, battered by huge capex and soaring opex.
CM: growth rests on ARPU
expansion. Driven by continued subs growth (especially from rural market) and stabilizing ARPU, CM would continue to record revenue growth in the coming few years. However, CM is unlikely to return to double-digit revenue growth in the next two years. In the long run, CM’s revenue growth will rest on ARPU expansion, which in turn depends on its non-voice business. Since 2Q09, ARPU has stabilized at RMB75. In 1H09, non-voice revenue accounted for 23.7% of total revenue. This small percentage of non-voice revenue is mainly due to the bottleneck in application services in China. With rapid growth in residential and household income in China, we see users’ willingness to spend 20%-30% more for suitable application services such as mobile payment, mobile reading etc. This will be particularly important for CM, given that it has a huge subs base. In fact, CM has also noted the importance of developing application services and has since several years ago been the most pro-active operator in application development in China.
EBITDA margin would be on a downtrend in the next two years, on mounting marketing expenses (mainly handset subsides to retain high-end subs) and R&D expenses to develop platforms for application services. However, we also expect rising economies of scale, which would mitigate margin pressure. In this regard, we do not see substantial downside in earnings, with a worst case scenario of 5-%- 10% earnings decline in the next two years in our view.
CT: strong growth
achievable. 2010 should see a turnaround in the wireline business, driven by strong growth in broadband business, which would more than offset declines in the fixed-line business. Meanwhile, we expect a surge in revenue from mobile business, in view of the company’s aggressive target to double the number of mobile users to 100m by end-10. Since Sep09, CT has sustained a monthly mobile subs growth of above 3m since Oct09, which suggests that its 100m-subs target by end-10 is achievable. In 1H09, revenue from mobile services accounted for 12.4% of total revenue and it should contribute a majority of our expected double-digit revenue growth in 2010.
EBITDA margin would be under pressure this year, as huge handset subsidies will be required for CT to achieve its mobile subs target. In 2009, handsets subsidies accounted for c.37% of mobile services revenue. We expect the ratio to be slightly lower this year. Since acquiring the mobile business in mid-08, CT has made a lot of efforts to cultivate the CDMA terminals value chain. As a result, CT has effectively lowered the CDMA terminal prices substantially.
For example, the average purchase price was only RMB1,000 in a CDMA 5m-handset procurement in 2009. In addition, by leveraging on its less than 50% network utilization, CT is able to offer more traffic subsidies. In this regard, we expect the handset subsidies to be around 35% in 2010. As the capex on mobile business is borne by parent company, CT faces the least capex pressure as compared with CM and CU. Though CT would continue to invest in broadband and fibre network upgrade, total capex should be decreasing going forward. And as a result, depreciation would be decreasing from this year as well.
CU: soaring expenses. With a shifting focus from 2G to 3G, CU’s 2G business is losing strength. CU not only remains at substantial disadvantage in 2G network coverage compared with CM, it’s 2G business is also facing increasing threat from CT. Though CU has had a strong start in 3G, significant revenue contribution is not expected in the next two years. As with CT, we expect a turnaround in wireline business this year. However, without the drive from mobile revenue, CU would continue to suffer from stagnant revenue growth in the next two years.
CU might face the greatest pressure in both EBITDA margin and net margin given that it has to provide handset subsidies to acquire 3G subs and its self-borne 3G capex would put enormous pressure on profit margin in the next few years. In this regard, we see the biggest downside risk with CU’s profit in the next few years.
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