CHINA TELECOM SERVICES
Spend now, profits later?
We turn more cautious on the Chinese telecom services subsector as we believe the
recent switch to higher subsidies associated with more aggressive subscriber
acquisition strategies will raise the competitive ante and derail profit margins in
2012. Indeed, paying today for higher profits in 2013 and beyond has too many
question marks, in our view. We cut our estimates for the group and downgrade
China Unicom to 3-Underweight from 1-Overweight as we lower our 12-month price
target to HK$15. We retain our 1-Overweight rating on China Telecom with a
modestly lower price target of HK$5.10, and we keep our 2-Equal Weight rating on
China Mobile with a higher price target of HK$85.
What has changed – spend today and hope for profits tomorrow. Our expectations
had been for balanced market shares and profit focuses for the three operators in 2012;
this now looks unlikely. Instead, focuses on bigger market shares and revenue increases
will likely lowers margins and drive higher investments. The hope that revenue gains
will produce higher profits in 2013 and beyond is problematic, in our view, given the
lack of clarity for 4G licensing due by then.
Why 3-UW on CU now? CU’s revamped growth strategy tests whether investors are
willing to pay for higher revenue growth at the cost of short-term profits in the hope
that higher profits come later. We are sceptical as 4G licensing concerns and CM’s
renewed competitiveness are issues outside CU’s control, both in terms of profitability
prospects into 2013 and beyond, and the valuations placed on those profits. Given this,
we believe the premium valuations based on growth into 2013 and beyond become less
likely – our lower price target of HK$15 is based on an EV/EBITDA multiple of 5.3x.
We prefer CT to CM. For CT, the iPhone 4S launch should be positive to sentiment
although the subsidy hit to profits will come before revenue driven gains later. The
stock’s book value of HK$3.70/share should provide good support as well. For CM, we
continue to see limited downside risk but no immediate catalyst either; clarity on 4G
timing is critical to monetise the mobile data opportunity but is as yet unclear.
Where could we be wrong? 1) Profit growth could be stronger than we expect if the
competitive ante does not increase; 2) 4G licensing could come later than 2013, which
would likely be positive for CU; and 3) mobile number portability (MNP) could be
introduced, which should be positive for CU.