The Chinese Telecom Growth Story: Part 2
In my last article, I discussed some of the general industry-level factors that make the three state-owned Chinese telecom operators, China Mobile (CHL), China Unicom (CHU) and China Telecom (CHA), potentially good investments. In this article, I’ll elaborate on the specifics of each company, as well as some concluding remarks on which of them may be the most attractive. I’ll focus on China Mobile and China Unicom, but also briefly touch upon China Telecom.
China Mobile is the leading wireless telecom in China and the largest wireless company in the world by subscribers. The company went public in 1997, with operations initially concentrated in Guangdong and Zhejiang provinces. Between 1998 and 2004, the company acquired numerous mobile operations from the government, ultimately expanding its reach to all of China’s 31 provinces. The company has 522 million subscribers, $210 billion in revenue and $215 billion market cap.
Below are summary financials for China Mobile. I’ve converted all figures to US dollars.
Over the past decade, the company has been the principal beneficiary of China’s rapidly increasing wireless usage. Wireless penetration has steadily risen from approximately 10% in 2000 to approximately 60% today. With market share of about 80% and ARPU that is nearly double China Unicom’s, CHL has enjoyed strong growth.
The question, however, is how CHL will fare going forward. As part of the industry-wide restructuring in 2008, China Unicom was granted WCDMA technology, which is the most mature 3G wireless technology out of the Chinese telecoms. WCDMA capability has played a part, for instance, in allowing China Unicom to win exclusive rights to the IPhone. China Telecom’s CDMA platform is also a more advanced technology than China Mobile’s.
Both China Telecom and China Unicom have been making heavy investments in their wireless business following the industry restructuring, and are certain to become a more viable competitive threat to China Mobile in the future. Government initiatives aimed at leveling the playing field, such as number portability, will also eat into CHL’s competitive position.
Nevertheless, China Mobile will continue to have a bright future given the general growth of the mobile sector in China, and the three-operator competitive landscape. In 2011, many telecoms in the world will be transitioning to the next generation of wireless networks, and CHL will likely be a frontrunner in upgrading to “Long Term Evolution”, or LTE technology, as it transitions its network to 4G infrastructure.
Furthermore, CHL’s management, operational infrastructure and brand identity are several notches above that of China Unicom and China Telecom. Even though its technology may be lagging when compared to CHU or CHA, at least until CHL upgrades to 4G, the company can compensate for that through strong operational execution. Indeed, the slowdown in China Mobile’s metrics have not been dramatic so far. In the most recent quarter, CHL’s revenue still grew 8% year-over-year, and its subscriber count rose 3% compared to the prior quarter.
China Mobile trades at a relatively low valuation, at about 12x 2010 P/E and 4.7x 2010 EV/EBITDA.
China Unicom is the second largest wireless operator and second largest fixed wireline operator in China. The mobile operations were begun in 2000, and steadily grew through acquisitions in subsequent years. The fixed wireline operations operated in the form of China Netcom prior to 2008, when the industry-wide restructuring pushed China Unicom and China Netcom to merge. As of 12/31/09, China Unicom had 148 million mobile subscribers, $11 billion in mobile revenue and $12 billion in fixed-line revenue. Its market cap is approximately $35b.
Below are summary financials for China Unicom. I’ve converted all figures to US dollars.
China Unicom’s historical financials are not very meaningful, because the company changed materially as part of the 2008 industry restructuring. The company was granted a WCDMA license by the government, which is a more advanced technology than the TD-CDMA or CDMA2000 licenses operated by China Mobile and China Telecom, respectively.
The company is currently undertaking high expenditures in both capex and marketing in order to build out its WCDMA network and strengthen its brand identity. The company’s former GSM technology was viewed as low-quality by consumers, and the company is in the process of re-branding itself as a higher-end operator.
The most attractive part of the China Unicom story is that it has underperformed so much historically that its future is bound to be brighter than its past. Its ARPU and minutes of use per subscriber has historically been nearly half of China Mobile’s. It controlled only 13% of the Chinese mobile market in 2009, compared to 79% for China Mobile. With its new WCDMA license, its exclusive rights to the IPhone, its high capex spend, and government policies designed to help CHU at the expense of CHL, China Unicom is poised to improve its profitability and competitive position.
That said, it’s unclear just how much CHU’s operating metrics will improve. Part of the problem with China Unicom is poor management. Not only is the company tackling a difficult acquisition, given that its 2008 merger with China Netcom was a merger of equals amongst two poorly-run state-owned enterprises, but the company has a more centralized, bureaucratic management structure when compared with China Mobile. As well, the company’s WCDMA technology represents a small portion of the firm’s overall revenue, and is projected to remain small in 2011. As of June 2010, WCDMA represented 5% of CHU’s total mobile subscribers and is likely going to remain at 10% to 20% of CHU’s wireless subscribers in 2011. Given that global wireless operators are likely going to transition to 4G technology in 2011-2013, CHU’s WCDMA advantage is unlikely to transform the Chinese mobile landscape over the long-term.
The company currently trades at a high valuation. At 13x 2011 EV/EBITDA, much of the company’s turnaround appears to be already priced in. The stock’s valuation is inflated partly because the company has A shares traded in Shanghai, where valuations are artificially propped due to the fact that China restricts domestic investors from investing outside of China.
Last, we have China Telecom. China Telecom is predominantly a fixed wireline telecom, but is looking to transition to its new wireless operations, given the secular decline of the wireline sector. The company entered the wireless business via the 2008 industry restructuring, when it acquired the CDMA assets of China Unicom. CHA went public in 2002 and proceeded to acquire numerous wireline telecom assets from the government throughout 2002 to 2008. As of 12/31/09, China Telecom had 57m mobile subscribers, $31b in revenue and its market cap is approximately $43b.
Like China Unicom, the company’s historical financials are not a reliable predictor of its future performance, given its lack of wireless operations prior to 2008. CHA is suffering a predictable decline in its wireline business, and its future performance will depend on its ability to offset that decline with growth in its mobile segment. Also like China Unicom, it’s attempting to brand itself as a high-end wireless provider, given that its CDMA technology is in certain ways stronger than China Mobile’s. The company is hoping to begin selling a CDMA-based iPhone in 2011. Finally, the company is growing from a small base, and favorable government policies and rising customer acceptance of its brand and technology should help China Telecom steal market share from China Mobile.
In terms of its fixed line business, the company is attempting to use broadband growth to offset the decline in voice customers.
Financials for China Telecom are below:
From a valuation perspective, China Telecom trades at a discount to China Unicom, at a 2011 EV/EBITDA multiple of 4.2x and 2011 P/E of 16x.
In my prior article, I argued that the secular growth in wireless / broadband usage in China and the 3-operator dynamics of the Chinese telecom sector provides a favorable backdrop for CHL, CHU and CHA. In this article, I’ve provided more details on each of the major telecoms. From a valuation perspective, CHL and CHA appear reasonably priced, while CHU’s valuation remains somewhat optimistic about its ability to grow rapidly in the coming years.
From a long-term perspective, a basket approach to the telecom sector would allow investors to benefit from the overall growth and reasonable valuations of the industry, without having to determine which of the three telecoms will emerge strongest over the coming years. Alternatively, an investor could bypass CHU due to its lofty valuation, and just invest in both CHA and CHL, or simply choose one. None of these three companies are going away, and all are likely to grow steadily over the long-term. I’ve chosen CHL as my vehicle to benefit from the China telecom story, but the underyling thesis has more to do with secular tailwinds than a belief that one of the three players will prove triumphant over the others.
Disclosure: Long CHL