Price (27 Dec 13 , HK$) 11.70
TP (prev. TP HK$) 19.10 (18.20)
Interconnect savings to outweigh higher handset subsidies and broadband price cuts
● The introduction of an asymmetrical interconnect regime, under which Unicom will pay Rmb0.04/min to China Mobile but still receive Rmb0.06/min will raise FY14 EBITDA by circa Rmb4.9 bn.
● Against this, while we would not over-exaggerate the impact of China Mobile’s launch of the iPhone in itself, the expectation of a higher total handset subsidy budget from China Mobile leads us to raise our gross Unicom subsidy forecast by Rmb2.1 bn and our cellular capex forecast by Rmb7.9 bn as competition intensifies.
● We have also factored in sharper broadband price point declines due to China Mobile's (listco) receipt of a fixed line licence.
● Fortunately, this division is not Unicom’s primary value driver and the interconnect cost savings outweigh both higher handset subsidies and sharper expected fixed line broadband ARPU declines. Our FY14 earnings forecast has been revised up by 8.4% and we note that our forecast is a very material 24.7% more than the current consensus. Our DCF-based target price rises 4.9% to HK$19.10 and we maintain our OUTPERFORM rating. China Unicom Hong Kong Ltd is a NJA Focus List stock.
Interconnect changes positive for Unicom…
While the potential for a change in interconnect rates was first mentioned in press articles in October, the Ministry of Industry and Information Technology (MIIT) on 23 December 2013 confirmed that interconnection rates in China will be amended as of 1 January 2014.
Until now, the mobile-to-mobile (M-M) interconnect rate in China was set at Rmb0.06/min for all cellular-to-cellular calls made by China Mobile, China Telecom and China Unicom. The announcement states that as of 1 January 2014, the interconnect rate paid by Unicom and China Telecom to China Mobile will decline to only Rmb0.04/min, but the rate paid by China Mobile to its two competitors will be maintained at Rmb0.06/min. In FY12, Unicom paid Rmb17.2 bn in interconnection, and we estimate that around Rmb14.6 bn of this amount was paid to China Mobile. Thus, the proforma FY12 impact of the interconnect rate change would be a cost saving of circa Rmb4.8 bn. Unicom has grown revenue and traffic since FY12, but its flow of traffic to China Telecom has also increased. Thus, we have lowered our FY14 interconnect cost forecast—and raised our EBITDA forecast by Rmb4.9 bn to reflect the upcoming change in interconnect rate to China Mobile.
..but factoring in higher handset subsidies and capex...
It has also now been confirmed that China Mobile and Apple will launch the TD-LTE enabled iPhone 5S and 5C on 17 January 2014— in time for the Chinese New Year sales. While we would not wish to over-exaggerate the impact of an official Apple-China Mobile deal; China Mobile already has circa 35 mn iPhone users on its network (though not using 3G wireless data services), China Mobile is simply launching a product that both China Telecom and Unicom have already had in the market since September 2013, and Apple has been losing market share in the China market due to rapidly rising volumes of lower-cost smartphones.
However, given the high cost (and high subsidy level) per unit, and the fact that Apple will no doubt have required a volumes commitment from China Mobile, we believe that the deal will result in China Mobile spending circa Rmb5.3 bn more on handsets subsidies in FY14 than would otherwise have been the case. We expect a knock-on impact on the broader competitive environment and we have therefore increased our gross Unicom subsidy forecast by Rmb2.1 bn and our Unicom cellular capex forecast by Rmb7.9 bn.
..and more intense fixed line competition
On 4 December 2013, the MIIT granted 4G TD-LTE licences to all three China operators, and also awarded China Mobile (listco) a fixed line operating licence. This will allow China Mobile to use its fibre backbone and backhaul (constructed to support the cellular and Wi-Fi businesses) to offer fixed broadband services in competition to Unicom and China Telecom. Indeed, we believe that the change in interconnect rates can be thought of as ‘compensation’ for this negative structural change for Unicom’s fixed line division. We have factored in sharper broadband price point declines due to this additional competitive pressure, and projected earnings of the fixed line division have been cut 7.7% in FY14, 11.7% in FY15 and 27.6% in FY16; fortunately this division is not Unicom’s primary value driver.
Nevertheless, the Rmb4.9 bn (per annum) saving in cellular interconnect costs outweighs the negative impact of higher handset subsidies and depreciation, and sharper expected broadband price and ARPU declines. Our FY14 earnings forecast has been revised up by 8.4% and we note that our forecast is a very material 24.7% more than the current consensus. Our DCF-based target price rises 4.9% to HK$19.10 and we maintain our OUTPERFORM rating.