Mobile and Data Fuel Sales Growth at China Telecom


China Telecom increased revenue 15.5% to CNY 283 billion ($46 billion) in 2012, or 11.8% to CNY 258 billion excluding handset sales, driven by strong growth in mobile, Internet data, and broadband access businesses. EBITDA margins (post capacity leasing fees paid to the parent) narrowed more than 120 basis points because of heavy investments in advertising and handset subsidies to drive smartphone conversion and data usage.

The higher leasing fees paid for the CDMA capacity owned by the parent also contributed to the margin contraction, although we expect China Telecom to see modest efficiency gains after it recently completed the acquisition of CDMA assets from its parent at the end of December. We are maintaining our narrow economic moat rating on the stock and plan to maintain our $61 fair value estimate. The stock looks undervalued, trading at about 3.3 times forward enterprise value/EBITDA, although we see few near-term catalysts to move the stock.

Mobile voice, data, and broadband access were the key drivers of revenue over the past year, posting year-over-year increases of 27%, 22%, and 17%, respectively. The carrier added 34 million new mobile subscribers over the past 12 months, of which 90% were higher-margin 3G subscribers, and also added 13 million new broadband access users. The carrier increased its 3G market share to about 30%, from 28.5% at the end of 2011, mainly at the expense of larger rival China Mobile CHL . We attribute its share gain to aggressive bundling strategies, the promotion of entry-level 3G handsets to lower the adoption hurdle, and most recently, a boost from the iPhone introduction.

However, EBITDA fell 6% year over year, under pressure from hefty handset subsidies and from accelerating network capacity leasing fees due to strong 3G mobile voice and data traffic. Handset subsidies and capacity leasing fees outpaced revenue growth in 2012, up 39% and 34% year over year. In addition, the carrier also invested heavily in marketing and promotional activities to boost its brand image and build better connections with consumers, spending CNY 35 billion in 2012, or about 27% higher compared with 2011. We expect the carrier to increase revenue 12% in 2013 and maintain EBITDA margins in the high 20s.


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