CHU China Unicom Ltd

China Unicom (CHU), China's second largest mobile operator, announced first half 2011 results with earnings per share of RMB 0.113 ($0.17 per share) dropping 8.9% year over year.

Adjusted net income fell 5.5% year over year to RMB 2.637 billion ($0.403 billion). The significant decline in profitability can be traced to high costs associated with 3G service deployments and network expansion.

Revenue & Subscriber

Excluding deferred fixed-line upfront connection fees, total revenues climbed 22.9% year over year to RMB 101.385 billion ($15.5 billion). Telecommunication service revenues, comprising roughly 89% of total revenue, were RMB 90.350 billion ($13.8 billion), up 13% from the year-ago period.

Healthy revenue growth was attributed to strong sales of Apple Inc.'s (AAPL) iPhones as the company enjoys the exclusive right to distribute the device in China since October 2009. 

Total revenue from the mobile business shot up 44% year over year to RMB 60 billion ($9.1 billion). A large contributor was telecommunication service with revenues of RMB 48.998 billion ($7.49 billion), up 25.3% from the prior year-period. China Unicom’s subscriber base expanded 15.7% year over year to 181.61 million at the end of the first half.

China Unicom’s 3G business is growing at a faster pace since its introduction in October 2009. 3G business telecommunication service revenues were RMB 13.180 billion ($2.01 billion) in the first half, skyrocketing 134% year over year. The company’s total 3G subscriber base reached 23.945 million, with 9.885 million new customers added in the first half.

Telecommunication service revenue from the GSM business inched up 1.9% year over year to RMB 35.818 billion ($5.48 billion). Net additions were 4.229 million subscribers, reaching 157.665 million at first half end.

Excluding deferred fixed-line upfront connection fees, revenue from the fixed-line business was RMB 40.936 billion ($6.26 billion). Telecommunications services revenue from the fixed-line business rose 2.5% year over year to RMB 40.903 billion ($6.25 billion) backed by the rapid growth in fixed-line broadband business.

Telecommunications service revenues from the broadband business was RMB 17.172 billion ($2.6 billion), up 18.7% from the year-ago period. In the first half, China Unicom added 5.098 million customers bringing the total number to 52.322 million.

The fixed-line voice business recorded revenue of RMB 17.663 billion ($2.7 billion), down 15% from the year-ago period. Erosion in fixed-line voice subscriber base continues with the loss of approximately 1.177 million customers over the first half, bringing the total customer base to 95.458 million.

Expenses

Total expenses increased 24.2% year over year to RMB 97.891 billion ($14.96 billion) due to higher selling expenses, network deployment costs and depreciation charges. Selling and marketing expenses rose 19.9% year over year to RMB 2.256 billion ($0.34 billion), mostly due to higher promotional spending on 3G and broadband services. 

Liquidity

China Unicom’s debt-to-capitalization ratio remained healthy. At the end of June 2011, the debt-to-capitalization ratio was 31.7% while the net debt-to-capitalization ratio was 25.7%.

China Unicom generated operating cash flow of RMB 34.352 billion ($5.25 billion), up 10.5% year over year. The company spent RMB 25.968 billion ($3.97 billion) in 3G, GSM, broadband and data, and infrastructure and transmission network in the first half 2011. This represents a decline of 22.1% from the first half 2010.

Our Analysis

China Unicom expects to generate revenue at a faster clip by accelerating large-scale developments of 3G and fixed-line broadband. The company is working to improve the 3G penetration rate in the rural sectors and hopes to exceed its 3G user expectation of 25 million for the year. Besides, China Unicom focuses on optical fiber access network construction to facilitate broadband upgrade and speed enhancement.

However, China Unicom is significantly challenged by aggressive nationwide 3G service rollouts by its peers, China Mobile (CHL) and China Telecom Corp. (CHA). Additionally, high levels of marketing and promotional expenditures related to 3G service deployments could hurt profitability. Further, increased operating expenses coupled with higher depreciation and amortization will have an adverse effect on the company’s profitability, free cash flow and margins.

We are currently maintaining our long-term Underperform rating on China Unicom. The stock retains a Zacks #3 (Hold) Rank for the short term (1–3 months).

 
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