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China Telecom Sector
Investment summary
A laggard sector in 2009. The China telecom sector was a laggard in 2009, mainly due to continued market concern over huge capex on 3G, intensifying competition, rising penetration and low earnings visibility. However, downside should be limited in view of the undemanding sector valuation compared with both historical valuation and major global peers’ valuation. Furthermore, we believe the worst is over for the sector, as the telcos’ capex should have peaked in 2009 while telecom tariffs have begun to stabilize since 3Q09.
2010 a year for re-entry. The three telcos have made bold targets in the number of 3G subs for 2010, with a range between 20m to over 30m by end-10. Should the telcos fulfill their targets, the number of 3G subs in China will reach 60m with a monthly add of over 5m, which would provide strong support for share prices in our view. Meanwhile, we expect more catalysts to kick in, which might be China Mobile (CM) returning to the A-share listing and potential earnings surprises for CT from 1H10 onwards.
Wireline to regain growth. 2010 would see a turnaround in China wireline market. By segments, the telcos’ revenue from PHS (personal handy system) should have fallen below 5% of total revenue since 1H09. As a result, strong growth in broadband revenue would more than offset decline in fixedline reenue from 2010 onwards. Meanwhile, we do not expect deteriorating competition in the wireline market. On hand one, 3G is not a big threat to broadband due to its bottleneck in bandwidth. On the other hand, the convergence of the internet, phone and TV would benefit incumbent wireline operators more than potential threats from TV providers in our view.
China to take a shortcut in 3G and 4G. The global telecom sector has seen accelerating development in the past few years with falling equipment and handset prices, enriching terminals selection, contents and applications. Though a laggard in 3G licensing, China is taking a shortcut in 3G deployments and 4G commitments. With intensive investments in 2009, the telcos in China have built large scale 3G coverage in 240-340 cities and have come to the forefront in network technologies in the world. Though CM has lagged behind in 3G network coverage due to the new TD-SCDMA technology, it plans to upgrade its 3G network to 4G directly in the next few years.
Accelerating technological evolution and convergence. The global telecom market has seen accelerating network upgrade and mobile subs migration from 2G to 3G. Meanwhile, LTE (Long Term Evolution) has been considered as the 4G standard by a majority of the telecom operators in the world, with 51LTE commitments according to GSA. In the wireline market, we are seeing accelerating migration from copper wire (DSL – Digital subscriber line) broadband to fibre-optic broadband (FTTH – Fibre to the home). The rapid evolution in new technologies has speeded up convergence of internet, phone and TV, as well as penetration of telecom services in various industries.
CT remains our top pick for the service sector. CT has a bold mobile subs target of 100m by end-10, doubling the number of its mobile subs in 2009. We believe this would provide strong support for CT’s share prices, should this target materialize. Meanwhile, we expect CT to regain double digit growth from 2010, underpinned by regaining growth in wireline business as well as high growth off a low base in mobile business. Though handsets subsidies remain a big drag to CT’s profit for 2010, the risk is mitigated substantially as CT will focus on handsets with prices ranging from RMB1,000 to RMB2,000. As a result, we see more downside than upside in its expenses on handset subsidies
China’s rise in global telecom equipment market. Led by Huawei and ZTE in the core telecom equipments market and Comba in wireless coverage market, China’s telecom vendors have risen to top equipment vendors in the world. While global vendors have been hit hard by the global financial crisis since 2008, intensive 3G investments in China have given the Chinese vendors a boost to their competitiveness. Looking ahead, we believe they would benefit the most from network upgrade in emerging markets and the evolution toward LTE and FTTH in the developed market as well. By market, domestic sales might have peaked in 2009, but we expect accelerating overseas sales from gaining overseas market share going forward.
Comba remains our top pick for the telecom equipment sector. Though the China telcos’ capex on core equipments might have peaked in 2009, they would continue to increase capex on wireless enhancement and opex on post-sales services. Furthermore, Comba has made a substantial foray in the core equipment market, as some of its products (like antennas, microwave and RRU etc.) have become key parts of the telecom infrastructure. In this regard, we believe Comba can sustain decent double digit growth over the next three to five years.
2010 a year for re-entry - The worst is over
2009 was the toughest year for China telco’s, battered by domestic economic slowdown and side effects from industry restructuring. However, we believe 2010 will be a turning point. Looking ahead, we expect re-rating on the sector.
The worst is over. The three telecom companies (the telcos) in China have been laggards in 2009, which should be mainly due to persistent market concern over capex, competition and slowing mobile subs growth. However, we expect some catch-up this year, as we see the worst should have been seen in 2009. Though the telcos would have to keep capex at high levels in the coming few years, we believe capex should have peaked in 2009 as the telcos have built or upgraded 3G network in 240-340 major cities in China.
We have seen intensifying competition in 3G market (including handsets subsidies and lowering tariffs) since 4Q09, which might become even fiercer this year. But competition remains mild in the fixed-line and broadband market. Since 3Q09, 2G mobile subs ARPU has stabilized, as the telcos launched a series promotional packages with traffic subsidies, which mitigated the declining tariffs and helped to keep ARPU stable. Looking ahead, 2010 might remain a tough year for the telcos, but they have laid a foundation in the 3G business, while economies of scale should be growing in 2G, fixed-line and broadband business.
Telecom Capex has peaked. According to the MIIT (Ministry of Industry and Information Technology), the telcos had spent a total of c.RMB161bn capex on 3G in 2009. Although the telcos’ overall capex should have peaked in 2009, it would remain high in coming few years given need to expand 3G network to more cities and also need to increase network capacity in covered areas to meet growing number of 3G subs.
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Capex on fixed-line has been decreasing since several years ago, and will continue to be on the downtrend going forward;
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Capex on broadband would increase driven by strong subs growth and network upgrade (from DSL to FTTH etc.);
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With slowing subs growth, CM has reduced capex budget on 2G while China Unicom (CU) has shifted to focus more on 3G and reduced capex on 2G. CT has upgraded 2G to 3G in most covered cities, hence capex on 3G should be declining before LTE buildout; By end-09, the telcos had built 3G networks in most prefecture cities, including 238 cities by CM, 335 cities by CU and 342 cities and over 2,000 counties by CT. CM plans to expand its 3G coverage from cities to rural areas with a target to build 80,000 more TD-SCDMA base stations to a total of 180,000 by end-10.;
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CM intends to build trial 4G TD-LTE network at the Shanghai Expo, which might mark a start in 4G upgrade for CM. Following the launch of 4G LTE in Norway and Sweden by TeliaSonera in late 2009, CM might be among the first batch of telcos in the world to deploy 4G in
2010
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