CHU China Unicom Ltd

We have upgraded our long-term recommendation from Underperform to Neutral on China Unicom (CHU) based on strong 3G subscriber additions.

China's second largest mobile operator’s 3G business is performing well and reached 27 million subscribers at August end. The growth was primarily driven by Apple Inc.’s (AAPL) iPhone sales. With this, China Unicom has achieved its target of expanding its user base beyond 25 million by this year-end.

Further additions would indicate growth prospects in China Unicom’s mobile 3G business, and will subsequently result in higher average revenue per user. We believe China Unicom continues to make significant progress in expanding economies of scale in 3G, broadband and other businesses that will likely improve its overall revenue and profitability.

The company is also poised to benefit from the stabilization in the fixed-line business and expansion of fiber optic service in the fixed-line broadband business. China Unicom expects to cover 40 million families with more than 20Mbps broadband access capabilities by the end of the year.

Coming to the second quarter results, net income declined due to higher network expansion costs but revenues improved on the back of strong iPhone sales and increased 3G subscribers.

Although we are encouraged by China Unicom’s future growth prospects in its 3G wireless market, high levels of marketing and promotional expenditures and precipitous decline in the landline business might hurt profitability going forward. Additionally, China Unicom remains significantly challenged by aggressive nationwide 3G service rollouts by its peers, China Mobile (CHL) and China Telecom Corp. (CHA).

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.

The stock has a Zacks #3 (Hold) Rank for the short term.

 
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