china telecoms sectorpg.jrj.com.cn/acc/res/cn_res/indus/2016/7/21/88caa22a-0d... · 2016. 7....

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CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION®

Client-Driven Solutions, Insights, and Access

21 July 2016

Asia Pacific/China

Equity Research

Telecommunication Services (Telecommunication Services ID

(Asia)/Telecommunication Services TH (Asia)/Telecommunication Services CN

(Asia))

China Telecoms Sector SECTOR REVIEW

Data growth driving earnings growth

Figure 1: Asian cellular YoY growth—China is emerging from a double-dip

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16

Malaysia India Singapore Philippines Taiwan

China Indonesia Thailand Korea

Source: Company data, Credit Suisse estimates

■ Our latest series of network tests in China show that 4G coverage is close to

ubiquitous in tier 1 cities, and that China Telecom and even Unicom's 4G

coverage in tier 2 cities is improving rapidly. An improved YoY 4G net

addition run-rate for all three operators therefore looks sustainable.

■ Crucially, while we discovered some aggressive-looking promotions in

specific areas and of specific duration, the absence of unlimited data plans

(and the fact that there are no new government policies) is allowing

operators to enjoy material ARPU uplifts (of circa 25.8-69.5%) as 4G

customers sign up to 1GB/month plans. This gives us confidence over

cellular revenue growth of 5.4% YoY in 2Q16, as revenue emerges from a

policy-driven 'double-dip'. The fixed broadband market is still expanding from

57.4% penetration and single digit growth looks achievable for Unicom and

China Telecom in spite of SARFT and China Mobile's 'entry' to fixed line.

■ Our DCF-based target prices of HK$123.5 for China Mobile, HK$16.0 for

Unicom and HK$6.85 for China Telecom, which suggest significant potential

upside for all three stocks, are unchanged. We expect a rerating as cash

flows expand further into FY17, and investors takes note of lower P/E ratios.

Research Analysts

Colin McCallum, CA

852 2101 6514

[email protected]

Ricky Chui

852 2101 6529

[email protected]

21 July 2016

China Telecoms Sector 2

Focus charts and tables Figure 2: 4G* net addition numbers/month (mn)—clearly more of a three-player market

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16

China Mobile Unicom China Telecom

* Note: 3G/4G net addition numbers for Unicom and China Telecom throughout 2015, but 4G-only figures

throughout the time series for China Mobile. Source: Company data, Credit Suisse estimates

Figure 3: Data is being monetised—monthly fee (US$/MB) Figure 4: Monthly fee—developing markets (US$/MB)

11.014.2 14.5

23.8

28.7

7.79.0

12.9

20.6

24.5

8.98.9

11.2

22.4

25.8

0

5

10

15

20

25

30

35

250 MB 700 MB 1GB 2.5 GB 4 GB

China Mobile 4G July 2016 Unicom 4G July 2016

Telecom 4G July 2016

0

5

10

15

20

25

30

~250MB ~700MB ~1GB ~2.5GB ~4GB

China India Indonesia Malaysia Philippines Thailand

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Figure 5: China’s cellular market—revenue growth FY10A-20E driven by data (and absence of government policies)

% YoY FY10A FY11A FY12A FY13A FY14A FY15A FY16E FY17E FY18E FY19E FY20E

China Mobile 7.3 8.8 6.1 5.4 (1.5) 0.4 12.1 6.3 4.3 1.8 0.6

China Unicom 17.6 25.4 22.0 19.9 3.0 (8.4) 11.3 9.3 8.4 7.7 5.3

China Telecom 59.1 43.0 36.0 22.6 5.7 3.5 14.6 9.8 7.6 5.9 4.1

Market 11.4 13.7 11.4 9.8 0.2 (0.8) 12.3 7.3 5.5 3.4 2.0


Figure 6: Comparative multiples—the China telcos look cheap on EV/EBITDA, and in FY17 look attractive on P/E

Close Target Upside Normalised P/E (x) EV/EBITDA (x) FCF yield (%) Div yield (%)

price price (%) 16E 17E 16E 17E 16E 17E 16E 17E

China Telecom 3.56 6.85 92.4% 12.7 10.4 3.6 3.3 -3.7% 7.2% 3.2% 4.8%

China Unicom 7.86 16.00 103.6% 23.1 14.5 3.2 2.6 3.8% 8.2% 1.9% 3.0%

China Mobile 94.40 123.50 30.8% 14.2 13.2 4.6 4.2 3.5% 5.8% 3.0% 3.8%

Unicom A 4.29 5.00 16.6% 37.3 24.2 4.4 4.0 2.4% 5.1% 0.9% 1.4%

NJA *–Integrated 17.7 15.5 7.2 6.7 4.0% 6.9% 4.2% 4.7%

NJA *–Mobile 16.3 15.4 6.2 5.7 3.4% 5.7% 3.2% 3.8%

* Non-Japan Asia sector averages. Source: Company data, Credit Suisse estimates

21 July 2016


Data growth driving earnings growth Three's company: Getting on with business

Our latest series of on-the-ground network tests in China refreshed our datapoints for

network performance in two tier 1 cities, namely Beijing and Shenzhen. We also wanted to

gain an understanding of how well Unicom and China Telecom's 4G rollouts were

proceeding in tier 2 cities, and we chose Tianjin in eastern China to assess their progress.

We found that China Mobile's 4G network is now ubiquitous, with 100% coverage. However,

China Telecom and Unicom are progressing quite well, with 80% and 70% 4G coverage

respectively in Tianjin, and overall network performance feels comparable across all the

cities tested. We therefore believe that the improved YoY 4G net addition run-rate for all

three operators is sustainable. Crucially, while we discovered some aggressive-looking

promotions in specific areas and of specific duration, the absence of unlimited data plans

(and the fact that there are no new government policies) is allowing the operators to enjoy

material ARPU uplifts (of circa 25.8-69.5%) as 4G customers sign up for 1GB/month plans.

This time investors should see top line growth

Given the increase in data use that accompanies the upgrade to 4G (and results in ARPU

uplifts), the rising number of 4G subscribers is driving revenue growth for all three Chinese

telcos in FY16. Indeed, we project that the cellular revenue growth rate will accelerate from

the 5.1% YoY growth achieved in 1Q16 to 5.4% YoY in 2Q16. This dynamic of data

monetisation was not cleanly observable in 2014 and 2015 given the imposition of VAT,

which cosmetically affected stated revenue in 2Q14, 3Q14, 4Q14, 1Q15 and 2Q15, and

then the imposition of data rollover, which affected stated revenue in 4Q15. Given that no

new policies have been introduced since data rollover in October 2015, 2Q16 will represent

a second consecutive quarter of clean YoY service revenue growth—the first time we have

seen two clean quarters in a row since China Mobile launched 4G!

Fixed line competitive disruption limited

While the outperformance of China Mobile versus the Hang Seng index might suggest that

investor confidence in cellular monetisation is indeed increasing, we note that China

Telecom has only performed in line with the index. We suspect this may be due to investor

fears over China Mobile's aggressive 'entry' into the fixed line segment. However, the

overall broadband market in China is still expanding from a penetration level of just 57.4%,

and China Mobile has in fact been offering broadband services since 2008. We show that,

as in previous years, both Unicom and China Telecom's fixed line division are likely to

deliver single digit revenue growth in 2016 and beyond, and we conclude that the existence

of fixed line operations is not a reason to avoid exposure to China Telecom or Unicom.

Revenue growth leads to cash flow & earnings growth

Expectation of slightly higher (non-cash) depreciation charges as a hangover to the 4G

investment phase lead us to trim our FY16 earnings forecast for China Mobile and China

Telecom by 1.9% and 3.6% respectively. Unicom, with its very low net margin, is affected to

the tune of 10.2%. However, our DCF-based target prices, which suggest significant

potential upside for all three stocks, are unchanged. We believe that the cash flow yield and

net profit margins (affecting P/E) of the China telcos are partially suppressed by the fact that

they are only just emerging from significant nationwide 4G network rollouts. Our thesis is

that rising revenues (as 4G penetration rises and resulting data use is monetised), together

with declining capex requirements, will drive higher cash flows and higher earnings going

forward. We expect a rerating towards our DCF-based target prices as cash flows expand

further into FY17, and the market takes note of the lower P/E ratios and tower company

IPO. We maintain OUTPERFORM ratings on China Mobile, Unicom and China Telecom.

4G coverage, and overall

network performance, are

converging

At current price points, 4G

data growth is set to drive

mid-single digit cellular

revenue growth

With broadband penetration

at just 57.4%, competition

fears are overplayed

We expect a rerating as

cash flows expand and

investors take note of low

FY17 P/E ratios

21 July 2016


Sector valuation Figure 7: Regional telco comparative multiples

Close Target Mkt cap Normalised

P/E (x)

EV/EBITDA

(x)

FCF yield

(%)

Div yield

(%)

Ticker Ccy price Rating price (US$ bn) 16E 17E 16E 17E 16E 17E 16E 17E

Asia

Integrated operators

China Telecom 728 HK HK$ 3.56 O 6.85 37.2 12.7 10.4 3.6 3.3 -3.7% 7.2% 3.2% 4.8%

China Unicom 762 HK HK$ 7.86 O 16 24.3 23.1 14.5 3.2 2.6 3.8% 8.2% 1.9% 3.0%

Chunghwa 2412 TT NT$ 123 N 115 29.8 22.2 21.8 10.8 10.5 4.9% 5.1% 4.6% 4.7%

HTHK 215 HK HK$ 2.86 O 3.10 1.8 15.9 15.9 7.2 6.8 8.0% 8.5% 4.5% 4.9%

KT 030200 KS W 30450 O 37000 7.0 10.9 9.8 2.8 2.5 23.6% 25.7% 2.6% 3.9%

PCCW 8 HK HK$ 5.67 N 4.9 5.6 19.6 19.6 10.7 10.3 5.5% 5.7% 4.8% 5.3%

HKT Trust 6823 HK HK$ 12 O 11.8 11.7 19.0 18.8 11.9 11.7 5.5% 6.0% 5.0% 5.7%

PLDT TEL PM P 2098 N 1950 9.6 16.8 17.6 8.4 8.4 1.8% 1.8% 4.9% 4.3%

SingTel ST SP S$ 4.3 O 4.45 50.5 18.1 17.3 8.1 7.7 3.5% 4.8% 4.1% 4.3%

SPK SPK NZ NZ$ 3.795 U 2.88 4.8 20.0 18.1 7.9 7.8 6.0% 6.6% 6.6% 6.6%

CNU CNU NZ NZ$ 4.33 N 4.22 1.2 16.2 15.3 5.9 5.8 -10.9% -5.4% 3.7% 4.6%

TM T MK RM 6.84 N 6.75 6.1 23.6 22.1 7.0 6.8 6.9% 7.0% 3.8% 4.2%

Telstra TLS AU A$ 5.83 U 5.25 53.1 16.2 13.2 7.5 6.7 6.8% 8.2% 5.4% 5.5%

Jasmine JAS TB Bt 5.5 O 5.5 1.7 29.4 20.7 8.6 6.0 -3.5% -0.8% 2.0% 2.9%

True Corp TRUE TB Bt 9.1 U 2 10.3 -91.8 -155.5 17.5 16.0 -0.7% -0.2% 0.0% 0.0%

Link Net LINK IJ Rp 4350 O 8300 1.0 15.7 11.1 7.2 5.5 3.7% 6.4% 1.6% 2.7%

HKBN 1310 HK HK$ 8.95 O 11.5 1.2 26.3 21.3 11.1 10.4 5.3% 6.3% 4.6% 5.3%

Asia avg–integrated 13.2 10.5 6.4 6.0 8.9% 11.3% 2.9% 3.2%

NJA–integrated 17.6 15.5 7.2 6.7 4.0% 6.9% 4.2% 4.7%

Mobile operators

AIS ADVANC TB Bt 175.5 O 202 14.9 21.2 19.2 9.8 8.9 2.0% 3.2% 4.7% 5.2%

Bakrie BTEL IJ Rp 50 U 16 0.1 n.m. n.m. 11.3 10.9 -30.1% -29.2% 0.0% 0.0%

Bharti BHARTI IN Rs 363.4 U 275 21.6 24.6 20.8 6.7 6.3 0.6% 0.8% 0.9% 1.0%

China Mobile 941 HK HK$ 94.4 O 123.5 249.1 14.2 13.2 4.6 4.2 3.5% 5.8% 3.0% 3.8%

DiGi DiGi MK RM 4.91 U 4.15 9.5 20.5 20.5 12.8 12.2 -0.2% 5.0% 4.9% 4.9%

XL EXCL IJ Rp 3820 O 4850 3.1 16.0 20.2 5.9 5.5 1.8% 5.8% 3.4% 3.2%

FarEasTone 4904 TT NT$ 74.9 O 83 7.6 19.6 18.6 9.9 9.3 6.6% 6.3% 5.2% 5.5%

Globe GLO PM P 2300 O 2675 6.5 18.8 16.6 8.1 7.6 1.4% 1.7% 3.8% 4.1%

IDEA IDEA IN INR 105.35 U 90 5.6 12.3 28.3 5.9 5.2 -9.3% 4.0% 0.7% 0.3%

Indosat ISAT IJ Rp 6900 O 7250 2.9 21.5 18.1 4.6 4.2 6.6% 8.3% 1.9% 2.8%

LG Uplus 032640 KS W 10700 O 12800 4.1 11.2 10.4 3.6 3.3 13.6% 16.5% 2.7% 2.9%

Maxis MAXIS MK RM 6.12 U 5.3 11.4 27.8 27.8 13.2 12.8 0.1% 4.5% 3.3% 3.3%

M1 M1 SP S$ 2.73 U 2.05 1.9 15.2 17.1 8.7 9.3 6.1% 5.5% 5.5% 4.8%

PT Telkom TLKM IJ Rp 4190 O 4150 32.0 21.3 19.1 10.2 9.6 3.2% 4.0% 2.8% 3.7%

Reliance RCOM IN INR 50.35 U 40 1.9 13.0 10.8 5.6 5.1 28.3% 30.0% 0.4% 0.5%

SmarTone 315 HK HK$ 13.66 O 17.5 1.9 14.5 14.2 7.2 6.4 7.6% 9.1% 5.2% 6.0%

StarHub STH SP S$ 3.96 U 3 5.0 18.9 20.8 10.2 11.0 5.0% 4.6% 5.1% 5.1%

TAC DTAC TB Bt 32.5 O 66 2.2 15.6 14.4 4.0 3.6 4.6% 7.0% 3.2% 3.5%

Taiwan Mobile 3045 TT NT$ 113 O 125 12.1 19.1 18.2 10.1 9.6 5.2% 4.9% 5.2% 5.3%

Asia average–mobile 15.7 15.1 5.7 5.6 3.9% 5.8% 3.1% 3.7%

NJA–mobile 16.3 15.4 6.2 5.8 3.4% 5.7% 3.2% 3.8%

Note: (1) Rating: O = Outperform; N = Neutral; U = Underperform; (2) The averages are based on market capitalisation; (3) The P/E for non-Asian

stocks are based on Credit Suisse adjusted EPS; (4) PCCW's earnings exclude contribution from Cyber Port; (5) FCF yield = (EBITDA - interest

exp. - tax - capex) / mkt cap. Priced as of 20 July 2016


21 July 2016


Three's company: Getting on with business Latest tests show a convergence of coverage…

Our latest series of on-the-ground network tests in China refreshed our datapoints for

network performance in two tier 1 cities, namely Beijing and Shenzhen. We also wanted to

gain an understanding of how well Unicom and China Telecom's 4G rollouts were

proceeding in tier 2 cities, and we chose Tianjin in eastern China to assess their progress.

Perhaps not surprisingly, given that China Mobile commenced its 4G rollout one year earlier

than competitors, has no strong underlying blanket of 3G network in place, and has

invested by far the largest amount in absolute capex terms, China Mobile's 4G network

coverage in both tier 1 and 2 cities is now ubiquitous; China Mobile's network was present

in every location we tested in all three cities.

Figure 8: 4G coverage by city—July 2015 Figure 9: 4G coverage by city—July 2016

100% 100%90%

100%

80%

90%100%

90% 90%

0%

20%

40%

60%

80%

100%

Shenzhen Beijing Shanghai

China Mobile China Unicom China Telecom

100% 100% 100%100%

80%70%

100%90%

80%

0%

20%

40%

60%

80%

100%

Shenzhen Beijing Tianjin

China Mobile China Unicom China Telecom

Source: Credit Suisse network tests Source: Credit Suisse network tests

While in Shenzhen Unicom and China Telecom also had 4G network presence in 100% of

locations tested, the 4G coverage in Beijing dropped to 80% and 90% respectively (in line

with last year's network tests), while in the tier 2 city of Tianjin coverage dropped a further

notch to 70% and 80% respectively.

…and network performance….

While China Mobile therefore retains a (relatively small) 4G coverage advantage at present,

the overall network experience of Unicom and China Telecom, which have stronger

underlying 3G networks, already feels very competitive. We observe that average download

speeds improved to 34.6Mbps for Unicom and 34.5Mbps for China Telecom, very close to

the 38.0Mbps demonstrated by China Mobile's network. Upload speeds for Unicom and

China Telecom are, however, significantly faster than that delivered by China Mobile's

network, at 19.8Mbps and 17.4Mbps respectively, given their use of FDD-LTE technology.

The net result is that across all three competitors speeds are high enough for seamless

enjoyment of most common smartphone uses (e.g. viewing social media, launching Youku

Videos and uploading photos to Weibo).

China Mobile's 4G network

is now ubiquitous…

…but network performance

is quite comparable across

all three players

21 July 2016


Figure 10: Average 4G speed (Mbps)—July 2015 Figure 11: Average 4G speed (Mbps)—July 2016

35.9

25.2

28.7

5.46.8 6.3

0

5

10

15

20

25

30

35

40

CM 4G CU 4G CT 4G

Download (Mbps) Upload (Mbps)

38.0

34.6 34.5

5.2

19.8 17.4

0

5

10

15

20

25

30

35

40

CM 4G CU 4G CT 4G

Download (Mbps) Upload (Mbps)

Source: Credit Suisse network tests Source: Credit Suisse network tests

We show the average performance for these tasks in the figure below—the experiences

were quite comparable. Of course the greatest change in the last two years has been in

China Mobile's network. Under TD-SCDMA 3G technology in 2014, our tests showed that

the network had really struggled with even basic smartphone functions. With its aggressive

4G network build, China Mobile has largely solved that problem, though uploading photos

was slightly slower than on Unicom or China Telecom's 3G and 4G networks.

Figure 12: Average time (actual time in seconds) for regular smartphone usage

Average time in seconds Sina.com m.JD.com espn.go.com amazon.com Upload a photo

to social website

Launch Youku

video

China Mobile average 1.60 1.53 4.87 7.93 4.03 1.83

CM worst performance 3.00 3.00 10.00 20.00 10.00 15.00

CM 3G May 2014 10.33 8.33 14.67 20.00 22.33 30.00

Unicom average 2.31 2.03 6.07 10.00 2.66 2.34

CU worst performance 4.00 5.00 20.00 20.00 6.00 20.00

China Telecom average 1.83 1.77 5.33 6.13 2.60 2.20

CT worst performance 5.00 5.00 20.00 20.00 6.00 20.00


…suggesting Unicom/Telecom's capex had an impact

Our network test results suggest that the capex invested in by China Mobile across FY13-

FY15, while very high in absolute and relative terms, has had a clear impact on the data

experience enjoyed by customers.

Similarly, China Telecom's relatively heavy expenditure on 4G in 2H14 and 2015, supported

by access to the tower assets of the China Tower Company (Not listed) has yielded

coverage results not only in tier 1 cities but also in tier 2 cities. On the basis of the base

transceiver system (BTS) figures disclosed by China Telecom, we estimate that 75% of

China's population was covered by 4G by December 2015, and with this year's investment

of circa Rmb46.0 bn, we expect that coverage to reach circa 85.0% of the population.

Unicom, which constructed a large and dense 3G network at 2100MHz, has been most

reticent about investing in 4G. The 3G phase in China was, unfortunately for Unicom,

severely truncated. 3G licences were issued relatively late (January 2009) but 4G rollout

was relatively early, with China Mobile commencing network construction in 2013 (due to

the aforementioned problems with its TD-SCDMA technology for 3G). Thus, just as Unicom

emerged from the 3G investment phase in FY13, China Mobile was already pressing on

with 4G. Unicom's attempt to 'harvest' cash flows generated by the 3G investment phase

lasted less than two years, in contrast to 5-10 years in other markets. Indeed, Unicom's

attempt to extend the 'harvest' of the 3G network into a second year (2015) caused a loss

of operational momentum, as both China Mobile and China Telecom were already

aggressively marketing 4G as 'the technology of the future'.

China Mobile's 4G capex

has clearly had an impact

Unicom constructed 4G

relatively late

21 July 2016


On arrival at Unicom in August 2015, Chairman Wang, formerly the Chairman of China

Telecom, immediately recognised this problem, and invested aggressively in 4G network

upgrades. Thus, FY15 capex was raised from 'less than Rmb100 bn' to Rmb133.9 bn in a

matter of months, and the 4G-specific capex was revised up to Rmb33.5 bn.

Figure 13: Network rollout to-data and stated target coverage

000s 4Q15 Frequency Pop

coverage

FY15 4G

capex

FY16 4G

capex

End 2016

BTS

Target areas Pop coverage

(MHz) (%) (Rmb bn) (Rmb bn)

BTS count - 2G

China Mobile 900 900MHz GSM 100% 900 Nationwide 100%

China Unicom 424 900MHz GSM 90% 424 All cities 90%

China Telecom 290 850MHz CDMA 90% 290 All cities 90%

BTS count - 3G

China Mobile 500 2100MHz TD-SCDMA 90% 500 All cities 90%

China Unicom 472 2100MHz W-CDMA 90% 472 All cities 90%

China Telecom 290 850MHz EVDO 90% 290 All cities 90%

BTS count - 4G

China Mobile 1100 2600MHz TD-LTE 92% 79.1 75.7 1400 Nationwide 95%

China Unicom 400 2100MHz FDD-LTE 70% 33.5 29.9 680 Nationwide 80%

China Telecom 510 1800MHz FDD-LTE 75% 49.3 46.0 800 Nationwide 85%


We estimate that this change in strategy resulted in Unicom's 4G coverage reaching circa

70% of the population as at 2015, so circa 5 pp less than that of China Telecom and circa

22 pp less than that of China Mobile. Our network testing results seem to bear this out. We

expect Unicom's population coverage to reach 85% by end-2016.

We note that, although Unicom has been unfortunate in the short nature of the 3G phase in

China, the 3G network constructed has given a solid foundation on which the 4G networks

can be constructed—in many cases with a 'software-only' upgrade of the 2100MHz 3G BTS

to enable FDD-LTE functionality; Unicom is using the same 2100MHz spectrum band for

both 3G and 4G rollout. This has enabled a relatively rapid 4G catch-up, with lower 4G

capex in FY15 and FY16 in absolute terms than China Telecom.

Handset supply good, and promotions more flexible…

Our store visits confirmed that, regardless of the fact that China Mobile’s rollout represents

the first mass-scale rollout of TD-LTE worldwide, equipment vendors have been extremely

supportive of China Mobile. Thus, while China Mobile focuses on '5-mode' handsets,

namely GSM, W-CDMA, TD-SCDMA, FDD-LTE and TD-LTE, we found that there are now

over 1,000 handset models available. Price points in this deeply commoditised space

continue to decline. The cheapest 4G handsets that we found—the TCL P308M—costs just

Rmb200 (US$30).

Unicom focuses on '4-mode' handsets, namely GSM, W-CDMA, FDD-LTE and TD-LTE.

China Telecom focuses on '5-mode' handsets, namely GSM, W-CDMA, TD-SCDMA, FDD-

LTE and TD-LTE, as well as '6-mode' handsets, namely GSM, W-CDMA, EVDO, TD-

SCDMA, FDD-LTE and TD-LTE. We found that for both Unicom and particularly China

Telecom the handset range has improved dramatically over the last year. From circa 100

models in July 2015, the number of 4G handset models available for use on Unicom and

China Telecom's networks had expanded to 578 and 385 models respectively.

Supply of 4G handsets, at

relatively low price points, is

plentiful

21 July 2016


Figure 14: Handset availability by operator

No. of models Price range Cheapest model

currently

Most expensive model

currently

Expected no. of

models end-2016

China Mobile 4G (TD) 1047 US$30-835 TCL P308M (Rmb200) iPhone 6S Plus (Rmb5,500) 1150

Unicom 4G (FDD) 578 US$39-835 TCL P502U (Rmb260) iPhone 6S Plus (Rmb5,500) 750

Unicom 3G (WCDMA) 826 US$29-835 Coolpad 7060S (Rmb190) iPhone 6S Plus (Rmb5,500) 820

China Telecom 4G (FDD) 385 US$48-835 Coolpad 5263 (Rmb319) iPhone 6S Plus (Rmb5,500) 500

Source: Credit Suisse Network Testing, ZOL.com.cn

Therefore, we found that in terms of network performance and 4G handset availability,

Unicom and China Telecom are 'catching up' with China Mobile's head-start on 4G.

It was also clear that the marketing efforts of all three companies are more firmly focused on

4G offerings—the key change here is that Unicom is more actively promoting 4G, and its

local marketing efforts seem more flexible and market responsive as compared with the

centralised approach under the tenure of Chairman Chang.

We also found that marketing efforts are often focused on bundled promotions. For

example, one bundled plan on offer in Shenzhen included 1,000 mins of voice, 2GB data,

20Mbps Topway broadband, a free 42’ Skyworth HDTV and VR glasses! This bundled plan

was priced at Rmb194.9/month, compared with the standard nationwide tariff of

Rmb228.5/month if we had purchased a 2GB 4G data plan from Unicom, and a further

Rmb82.5/month (Rmb 990/12 months) for a 20Mbps Topway broadband plan separately

(and of course there are no Free TVs or VR glasses under the standard plans).

Figure 15: Unicom bundled promotion—more dynamic Figure 16: Telecom 50% promo—limited area & duration

Source: Credit Suisse on due diligence trip Source: Company website

China Telecom has also consistently used short-term promotions of limited geographical

scope and duration to keep the marketing message fresh and achieve sales targets. For

example, in Shanghai there was a China Telecom promotion offering a 50% discount to the

standard nationwide plans, but this promotion was only available between 1 July and 30

September, and only in Shanghai.

Nevertheless, the net result of comparable network performance, handset availability and

marketing messages has been a much more even split of net additions so far in 2016

versus 2015.

Thus we find that while China Mobile has added 116.3 mn 4G subscribers in 1H16, up from

99.6 mn in 1H15, China Telecom has added 31.6mn 4G subscribers in 1H16, up from 12.4

mn 3G/4G net additions in 1H15. The improvement in Unicom's operating figures is even

more stark, with 28.3 mn 4G net additions in 1H16, up from just 8.7 mn 3G/4G net additions

in 1H15.

21 July 2016


Figure 17: 4G* net addition numbers per month (mn)

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16

China Mobile Unicom China Telecom

* Note: 3G/4G net addition numbers for Unicom and China Telecom throughout 2015, but 4G-only figures

throughout the time series for China Mobile.


Crucially, the fact that the overall 4G market in China is expanding, and that subscriber

numbers are exceeding the stated targets of the operators (China Mobile reached 312.5 mn

4G customers as at December 2015, well ahead of its target of 250.0 mn) in our view

reduces the need for regulatory interference in tariffs, or, indeed, the likelihood of a more

radical industry shake-up, such as the introduction of a new cellular player.

With an expanding market also being more evenly shared amongst the three operators, we

believe that the chances of further regulatory remedies to help Unicom and China Telecom

at the expense of China Mobile are also diminishing. Previous policies include the

introduction of an asymmetrical interconnect rate in January 2014 (with Unicom and

Telecom paying a lower voice interconnect fee to China Mobile than they receive), and the

aforementioned imposition of mandatory tower sharing in April 2015.

..but the Chinese telcos are monetising data growth

We mention policies because one of the great frustrations of investing in China telecoms is

the perceived, and actual, level of government interference. Over the last year the key area

of perceived risk has been over data pricing, following a call from premier Li Keqiang, made

on 14 April 2015, that the telecoms operators should provide faster and cheaper internet

access to help foster economic growth and bolster the economy. Data pricing is also of

course critical to the operators' attempts to monetise the rapid growth of their 4G subscriber

bases, and drive revenue over the heavy recent 4G capex investment that we have set out.

Prima facie, there was a case to answer by the Chinese operators on data pricing, since

China has the highest data revenue per MB in Asia ex-Japan, followed by Singapore. While

data pricing is relatively complex, and disclosure across the region is neither complete nor

consistent, we set out the data published yield per market below for those markets in which

at least one operator discloses data volume and data revenue (thereby allowing a

calculation of data revenue per MB).

21 July 2016


Figure 18: 4Q15 data revenue per MB (US$/MB) Figure 19: Data revenue per MB versus data volume

0.011

0.007

0.004

0.0030.002

0.0020.001

0.003

0.000

0.002

0.004

0.006

0.008

0.010

0.012

China Singapore India Indonesia Philippines Malaysia Taiwan Thailand

Dat

a re

ven

ue

per

MB

(U

S$/

MB

)

Country

China

Indonesia Thailand

Singapore

Taiwan

Philippines

India

Malaysia

0.000

0.002

0.004

0.006

0.008

0.010

0.012

0 2,000 4,000 6,000 8,000 10,000 12,000

Dat

a re

ven

ue

per

MB

(U

S$/

MB

)

Data use per smartphone sub (MB/subs/month)


However, this 'snapshot' approach of data use versus data price points is too simplistic. In

all markets data is priced along a volume curve, such that as data volume increases, the

data price per MB tends to decline. Thus, data does not have a 'single' price point but

instead is offered to consumers as a range of packages with different prices for different

volumes. The high price points per MB in China in 2015 are therefore in part due to the

relatively low data volumes consumed.

In order to better demonstrate this point, and put current data pricing in China into proper

context, we have developed a standard price curve for each market in our coverage

universe. We have defined data access consumers into five different ‘standard’ categories:

Low data users (250 MB/month), Low-medium data users (700 MB/month), Medium data

users (1 GB/month), Medium-high data users (2.5 GB/month) and High-volume data users,

(4 GB/month). The key variable here, of course, is the quantity of data consumed. In reality,

most consumers also purchase voice services. In order to capture the voice variable, but

reduce the amount of distortion it might cause in the pricing packages, we assumed that all

of our customers wish to consume 200 minutes of outgoing voice calls per month.

We then looked into which data package each of our five standard consumers groups would

choose under each operator in our coverage universe; of course we assume that in each

case the standard subscriber would be rational and would take up the cheapest package

that contains the required amount of voice and data. The figures below show the total

amount which rational customers would pay to access the standard data volumes (together

with 200 minutes of voice) across emerging markets in Asia.

We note that we have used the 'standard' data plans of the three China telcos to develop

the pricing curves for China; short term or limited duration promotions such as those found

on the streets of Shenzhen or Shanghai will not have an overly material impact on overall

average nationwide price points achieved.

Very importantly, none of the three China telco operators have been tempted to offer

unlimited data plans. Thus, the standard data pricing curves slope upward to the right and

subscribers must pay more in order to use more. ARPU levels therefore rise as subscribers

begin to consume data. In fact, this is the case for all emerging Asian markets.

In all markets data is priced

along a volume curve

21 July 2016


Figure 20: Monthly fee—China operators (US$/MB) Figure 21: Monthly fee—developing markets (US$/MB)

11.014.2 14.5

23.8

28.7

7.79.0

12.9

20.6

24.5

8.98.9

11.2

22.4

25.8

0

5

10

15

20

25

30

35

250 MB 700 MB 1GB 2.5 GB 4 GB

China Mobile 4G July 2016 Unicom 4G July 2016

Telecom 4G July 2016

0

5

10

15

20

25

30

~250MB ~700MB ~1GB ~2.5GB ~4GB

China India Indonesia Malaysia Philippines Thailand


We fully expect the price per MB in China to fall as customers move along the data curve

(which, after all, does not slope upwards at 45 degrees). This is already happening, and we

find that Chinese data revenue per MB fell by 29.2% HoH in FY15, from US$0.016/MB in

1H15 to US$0.011/MB in 2H15, as the average data use per subscriber expanded by

27.8% HoH.

While Chinese operators do not disclose the details of data traffic and revenue on a

quarterly basis, we expect a similar magnitude of decline in price per MB HoH into 1H16.

Importantly, this is being achieved simply by customers signing up to 4G data plans and

therefore moving along the data curve, rather than any material changes in the standard

data pricing. For this reason, we believe that the response of the Chinese operators to Li

Keqiang's call for 'higher speed, lower tariff' was a sensible one; namely, the operators

focused government attention to price per MB, and committed to circa 30% declines in

price per MB which were happening naturally anyway given the existing data pricing curve.

Figure 22: Data revenue per MB

China 2H

China 1H

Indonesia 4Q

Indonesia 3QThailand 4QThailand 3Q

Singapore 4Q

Singapore 3Q

Philippines 3Q

Philippines 4Q

India 4QIndia 3Q

Malaysia 4QMalaysia 3Q

0.000

0.002

0.004

0.006

0.008

0.010

0.012

0.014

0.016

0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000

Dat

a re

ven

ue

per

MB

(U

S$/

MB

)

Data use per smartphone sub (MB/subs/month)


Is declining price per MB a problem for revenue generation? We don't think so, since usage

levels also increase as customers move along the curve. As a result, the overall ARPU level

per subscriber is still set to increase. As set out in Figure xx below, there is a clear ARPU

uplift of circa 47.8%, 69.5% and 25.8% versus the average 1Q16 ARPU levels of China

Mobile, Unicom and China Telecom if subscribers shift to a 'medium' 4G data plan

comprising 1GB of data and 200 minutes of voice.

.

A focus on declining price

per MB was sensible

21 July 2016


Figure 23: Announced data packages as a multiple of 1Q16 blended average ARPU

standard user definition Low Low-Medium Medium Medium-high High volume

Assumed data per month ~250MB ~700MB ~1GB ~2.5GB ~4GB

Assumed "outgoing" voice/month 200 200 200 200 200

China Mobile

Implied ARPU post VAT 68.0 88.0 90.0 148.0 178.0

1Q16A blended ARPU post VAT 60.9 60.9 60.9 60.9 60.9

Uplift multiple 11.7% 44.5% 47.8% 143.0% 192.3%

China Unicom



Uplift 1.7% 61.0% 69.5% 171.2% 222.0%

China Telecom



Uplift multiple 0.4% 0.4% 25.8% 152.8% 190.9%


Again, this theory is, so far, being borne out in practice. As mentioned, the data price per

MB declined by 29.2% in 2H15 versus 1H15, but given that the average data use per

subscriber grew by 27.8% HoH, and given that the number of smartphone subscribers also

expanded, total data revenue grew in double digits (11.0%) over the period.

Even if localised promotional activity becomes more widespread, and even if the standard

data pricing curve, particularly for higher volume usage, shifts down to the right, there looks

to be a lot of room for ARPU accretion. Thus, rising 4G subscriber numbers, with higher

ARPU, should continue to drive revenue growth.

21 July 2016


This time investors should see top line growth Rising 4G subscriber numbers to drive revenue

Given the ARPU uplift driven by 4G, and the accompanying increase in data use, the rising

number of 4G subscribers is the primary driver behind our forecast of increasing revenue.

China Mobile's 4G subscriber base hit 312.2 mn as at December 2015, ahead of its

unofficial 'target' of 250 mn subscribers. With ARPU in FY15 at Rmb85.0 (Rmb88.0 in 2H15

if we adjust for data rollover impacts), and average 4G data use of 780MB per month, there

is a clear uplift versus blended average ARPU levels, that looks set to result in revenue

growth from FY16 onwards.

Figure 24: China Mobile—service revenue growth assumptions

2014 2015 2016E 2017E 2018E 2019E 2020E

4G subscribers ('000s) 90,064 312,282 462,282 612,282 732,282 822,282 882,282

4G penetration of subscribers (%) 11.2% 37.8% 55.2% 72.7% 86.5% 96.6% 100.0%

Average 4G subscribers ('000s) 90,064 201,173 387,282 537,282 672,282 777,282 852,282

4G ARPU (Rmb) 98.4 85.0 84.5 79.4 75.2 71.4 68.4

Blended average ARPU (Rmb) 58.1 57.1 61.7 64.8 67.0 67.4 67.1

Post VAT service revenue (Rmb mn) 581,817 584,089 654,657 695,747 725,952 738,713 742,888

Service revenue growth (%) -1.5% 0.4% 12.1% 6.3% 4.3% 1.8% 0.6%


Importantly, given their accelerated 4G rollouts, both China Telecom and Unicom are also

now enjoying the same dynamic. After a slow start expect Unicom's service revenue to rise

in FY16 as the 4G subscriber base reaches 35.1% of subscribers.

Figure 25: Unicom—cellular service revenue growth assumptions

2014 2015 2016E 2017E 2018E 2019E 2020E

4G subscribers ('000s) 5,000 44,160 92,160 142,160 192,160 232,160 272,160



4G ARPU (Rmb) 72.6 75.5 71.6 67.3 64.2 61.5



Service revenue growth (%) 3.0% -8.4% 11.3% 9.3% 8.4% 7.7% 5.3%


China Telecom's cellular service revenue growth rate has consistently exceeded those of

China Mobile and Unicom and we expect that to be repeated in FY16.

Figure 26: China Telecom—cellular service revenue growth assumptions

China Telecom 2014 2015E 2016E 2017E 2018E 2019E 2020E

4G subscribers ('000s) 6,000 58,460 116,460 156,460 196,460 231,460 246,460



4G ARPU (Rmb) 76.9 65.3 62.4 61.1 58.7 57.0



Service revenue growth (%) 5.7% 3.5% 14.6% 9.8% 7.6% 5.9% 4.1%


21 July 2016


Disruption due to VAT and data rollover is now over

Why was this dynamic of data monetisation not observable in 2014 and 2015? After all,

China Mobile launched 4G, and began to report 4G subscriber numbers, in February 2014.

The reason lies in two government policies:

(1) Effective 1 June 2014, basic telecoms services, including voice, became subject to an

11.0% VAT rate, while value-added telecoms services, including data, internet access

and SMS, became subject to a 6.0% rate. This superseded the business tax, which was

charged at 3.0%. Since China Mobile and the other operators state revenue net of

business tax and VAT, and since the operators did not pass on VAT to their customers,

the cosmetic impact was a like-for-like decline in stated revenue starting in June 2014.

We call this the 'first order implication' of VAT. The imposition of VAT also encouraged a

shift from 'handset subsidies' towards 'tariff discounts', and this 'second order

implication' of VAT, as we call it, also had the impact of reducing revenue from June

2014 (but also reducing handset subsidy costs, resulting in an EBITDA-neutral

outcome).

(2) Effective 1 October 2015, one month data rollover was imposed on the industry by the

Ministry of Industry and Information Technology (MIIT). This allowed customers to enjoy

the unused portion of data allowances the following month. Since the operators

accounted for data use on a first-in-first-out basis, and only booked as revenue the data

actually used by subscribers, the cosmetic impact was that one month of cellular data

revenue "went missing" from the telco P&L accounts in 4Q15.

With VAT having been introduced part-way through a quarter, these VAT impacts led to a

like-for-like YoY decline in published service revenue in 2Q14, 3Q14, 4Q14, 1Q15 and

2Q15. As the VAT impacts finally washed through in 3Q15, China's cellular industry

revenue growth recovered to 4.3% YoY, only to relapse into a 4.7% YoY decline in revenue

in 4Q15 with the introduction of data rollover. China's policy-induced double-dip in revenue

is shown clearly in Figure 27 below.

Figure 27: Asian cellular markets' YoY growth rates over time—China's double dip

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16

Malaysia India Singapore Philippines Taiwan

China Indonesia Thailand Korea


21 July 2016


China is one of the faster-growing Asian markets

However, with no new policies having been introduced since October 2015, China reported

a sharp recovery in revenue growth to 5.1% YoY, versus the data rollover-driven decline of

4.7% YoY in 4Q15. The recovery shows that the China operators are monetising data

relatively well, and, as shown in the figure above and the table below, China's cellular

revenue growth rate into 1Q16 was third fastest in our Asia ex-Japan telecoms universe.

The ability of Chinese operators to drive higher ARPU from subscribers shifting to 4G data

plans, despite ongoing cannibalisation of voice, roaming, and SMS revenues, is due to the

construction of the sensible looking tiered data plans explained earlier. This does stand in

contrast to markets such as Singapore and Malaysia, which are currently facing revenue

declines. (It is no coincidence, in our view, that Malaysia currently faces two new entrants,

while in Singapore a new player is likely to enter the market in 3Q16, leading to some pre-

emptive price pressure.) China, of course, suffers no such new entrant threat and the

fastest growing/most successful data monetisation story in Asia, namely Indonesia, is

actually enjoying market consolidation from ten players to currently seven (and in terms of

trajectory, heading towards just three players).

Figure 28: Fastest growing markets (most profitable)

1Q16A Cellular service

revenue

Voice revenue Data revenue 1Q16A

data

Consolidated

EBITDA

Consolidated net

profit

% QoQ % YoY % QoQ % YoY % QoQ % YoY as % of

total

revenue

% QoQ % YoY % QoQ % YoY

Indonesia -2.4 14.2 -5.5 8.7 0.0 18.6 57.5 1.2 17.6 17.3 91.3

India 6.3 9.8 5.5 2.6 8.2 32.5 29.2 9.9 11.8 -0.4 -15.7

China 12.4 5.1 -10.0 -12.1 0.0 11.0 58.0 26.8 -0.2 1.1 -7.9

Thailand 1.6 3.5 -3.0 -12.9 5.3 20.0 57.9 -9.4 -12.2 -7.3 -18.2

Korea -1.4 1.9 n.m n.m n.m n.m n.m 8.8 3.6 n.m -14.7

Taiwan -1.1 1.1 n.m n.m n.m n.m n.m 11.3 7.8 19.8 6.8

Philippines -2.8 0.8 -6.5 -11.3 -0.3 9.8 62.1 8.6 -2.2 9.4 -14.2

Singapore -3.5 -1.7 -5.9 -10.9 -1.4 7.6 54.5 4.3 0.6 3.4 4.4

Malaysia -3.7 -4.8 -3.0 -4.3 -4.7 -5.5 44.8 -0.9 6.4 -1.5 -11.2


Looking further forward, our analysis of the competitive and regulatory structures of the

markets in Asia, together with the exposure of the operators to rising smartphone and 4G

penetration, drives our expectations for revenue growth as set out below. Our analysis

suggests that, with a benign competitive and regulatory backdrop, Indonesia should be

expected to deliver the highest growth in the region, given relatively low smartphone

penetration and sensible (albeit low) data pricing. In fact the 1Q16 trends look very

supportive of this conclusion; Telkomsel's overall revenue growth rate accelerated to 17.8%

YoY in 1Q16 from 14.5% YoY in 4Q15.

We believe that the China market can produce the second highest growth rate at 6.9%,

equal to the expected growth rate of the Indian market (where, in spite of very low

smartphone penetration, there is the prospect of much more aggressive pricing, and

perhaps even unlimited data pricing, from Rjio on its launch as it attempts to fill its network).

Again, with no new entrants, and what looks to be sensible data pricing (i.e., avoidance of

unlimited data plans), we expect mid-to-high single digit revenue growth to resume. The key

risk is regulatory, but the pricing curve suggests a very strongly elastic response to any cuts

in tariffs.

21 July 2016


Figure 29: Service revenue projections by market

ccy mn (Indonesia, Korea: bn) FY15 FY16 FY17 FY18 3Y revenue CAGR

China 885,261 956,013 1,025,888 1,082,492 6.9%

Hong Kong 22,920 23,424 24,022 24,582 2.4%

India 1,972,656 2,151,296 2,298,424 2,445,188 7.4%

Indonesia 127,956 142,027 154,648 163,493 8.5%

Korea 24,355 24,259 24,437 24,499 0.2%

Malaysia 21,505 21,829 22,164 22,675 1.8%

Philippines 199,972 203,255 211,429 221,689 3.5%

Singapore 4,369 4,312 4,225 4,168 -1.6%

Taiwan 222,414 228,474 236,551 244,146 3.2%

Thailand 234,703 240,435 251,811 263,078 3.9%


Unicom and China Telecom to grow in revenue market share

With Unicom and China Telecom catching up on 4G network coverage, and coming from a

much lower market share base, we think it likely that both operators will be able to grow

slightly faster than China Mobile across FY17-20. Thus, we expect their market share by

revenue to rise. However, we do not expect the same pace of market share gains as

experienced in the FY09-13 '3G' era, in which both Unicom and China Telecom held

technology-driven advantages over China Mobile's home-grown TD-SCDMA network. With

a relatively level playing field in place for 4G, we expect market share gains to be much

more gradual going forward.

Is it reasonable to expect Unicom to grow market share? We note that China Telecom has

consistently outgrown China Mobile, through both the 3G era and also through the

disruption caused by VAT and data rollover accounting. Unicom also outgrew China Mobile

across FY10-14 (inclusive), and only really lost momentum in FY15. The 'hangover' from

the loss of momentum in FY15 is continuing to drag the YoY growth rate in FY16, but with

new management in place, together with improving network coverage, that is soon to

reverse. With Unicom's 4G subscriber penetration reaching just 27.8% as at June 2016,

versus China Telecom at 43.3% and China Mobile at 51.2%, some catch-up growth looks

warranted.

Figure 30: China’s cellular market—revenue growth FY10A-20E

Rmb mn FY10A FY11A FY12A FY13A FY14A FY15A FY16E FY17E FY18E FY19E FY20E

China Mobile 33,128 42,768 32,414 30,398 (8,994) 2,272 70,568 41,091 30,205 12,761 4,175

China Unicom 12,356 20,930 22,729 25,097 4,499 (13,012) 16,102 14,778 14,558 14,427 10,828

China Telecom 17,719 20,526 24,555 20,948 6,517 4,235 18,131 14,007 11,841 9,899 7,340

Market 63,203 84,224 79,698 76,443 2,022 (6,505) 104,801 69,875 56,604 37,086 22,343

Growth (% YoY)

China Mobile 7.3 8.8 6.1 5.4 (1.5) 0.4 12.1 6.3 4.3 1.8 0.6

China Unicom 17.6 25.4 22.0 19.9 3.0 (8.4) 11.3 9.3 8.4 7.7 5.3

China Telecom 59.1 43.0 36.0 22.6 5.7 3.5 14.6 9.8 7.6 5.9 4.1

Market 11.4 13.7 11.4 9.8 0.2 (0.8) 12.3 7.3 5.5 3.4 2.0


Figure 31: China’s cellular market—revenue and revenue market share FY10A-20E

Rmb mn FY10A FY11A FY12A FY13A FY14A FY15A FY16E FY17E FY18E FY19E FY20E

China Mobile 485,231 527,999 560,413 590,811 581,817 584,089 654,657 695,747 725,952 738,713 742,888

China Unicom 82,377 103,307 126,036 151,133 155,632 142,620 158,722 173,499 188,057 202,484 213,311

China Telecom 47,722 68,248 92,803 113,751 120,268 124,503 142,635 156,642 168,483 178,382 185,722

% market share

China Mobile 78.9 75.5 71.9 69.0 67.8 68.6 68.5 67.8 67.1 66.0 65.1

China Unicom 13.4 14.8 16.2 17.7 18.1 16.8 16.6 16.9 17.4 18.1 18.7

China Telecom 7.8 9.8 11.9 13.3 14.0 14.6 14.9 15.3 15.6 15.9 16.3


21 July 2016


We have also 'sanity checked' our longer-term forecasts for the China market as a whole,

by factoring in the following assumptions to build 'blue sky' revenue forecasts for FY18:

■ Voice revenue to decline by 35% (i.e., a 13.4% p.a. compound decline in voice revenue

across FY15-18).

■ SMS revenue to decline by 90% (i.e., a 53.6% compound decline in voice revenue

across FY15-18).

■ Data volumes per smartphone subscriber to reach 3.7GB/month; the average (ex-

Taiwan) developed market usage per smartphone subscriber. We strip out Taiwan as

an outlier given that, at present, unlimited data plans have been avoided in emerging

Asian markets.

■ Data price points for 3.7GB/month usage country-by-country to be cut by 55-70%

depending on competitive intensity.

Figure 32: Base case FY18 revenue assumptions versus our 'blue sky' forecasts

US$ mn FY18

base

case

FY18

smartphone

penetration

Voice

revenue

SMS

revenue

Data

volume

per sub

Data price

US$

Discount to

current

price point

Discount to

current data

yield

Data

revenue

Blue sky'

revenue

Upside/d

ownside

risk

China 168,350 88.5% 60,103 6,076 3,729 0.003 -55.0% -75.6% 145,526 185,608 10.3%

India 37,331 43.1% 20,562 696 3,729 0.001 -70.0% -60.8% 31,176 45,493 21.9%

Indonesia 11,852 83.5% 4,682 1,383 3,729 0.001 -55.0% -68.3% 11,202 14,431 21.8%

Malaysia 5,585 76.3% 2,997 435 3,729 0.002 -55.0% -5.7% 2,370 4,377 -21.6%

Philippines 4,819 70.6% 1,796 1,399 3,729 0.001 -70.0% -63.1% 3,498 4,837 0.4%

Thailand 7,603 99.8% 3,255 157 3,729 0.001 -55.0% -48.6% 5,546 7,677 1.0%


This analysis looks bullish for China. As mentioned, there has been great concern over

fears of regulatory interference, though the operators have broadly been able to achieve

declining price points per MB simply through customers moving along the current data

curve, rather than through a material downward shift of the pricing curve being required.

However, our analysis suggests that even though the curve does shift downwards by 55.0%

(and the effective data yield per MB actually declines by 75.6% from 4Q15 levels), there

could be upside risk to our revenue forecast. Under this scenario compound revenue growth

would touch double digits (10.4%), versus our current forecast of 6.9%.

21 July 2016


Fixed line competitive disruption limited China is still a (low) growth market for fixed line

Among 'emerging' markets in Asia, China is something of an exception, with relatively high

fixed line and broadband penetration, when compared with ASEAN markets such as

Indonesia and the Philippines. On the one hand, China was less affected by the Asian

financial crisis given its closed exchange rate regime, and on the other hand its government

and regulator specifically encouraged the rollout of fixed line infrastructure.

Specifically, aggressive copper line rollout by the two well-capitalised fixed line operators

(China Telecom and Unicom) was encouraged by the Chinese government, which owns

majority stakes in both businesses. This rollout was largely financed by connection fees,

and as a result 49.8% of households in China as at December 2009 had a fixed line phone.

Second, as traditional voice and long distance revenues were cannibalised by rising cellular

penetration, the operators upgraded their networks to broadband to drive up overall

revenues received from fixed line customers and reduce churn. Arguably, both fixed line

operators were particularly aggressive in pursuing this opportunity since they were not

awarded cellular licences until industry restructuring in May 2008. This in itself was a

deliberate government decision; by not allowing China Telecom and Netcom (which was

subsequently merged with Unicom) to invest in the cellular space, the companies were

discouraged from the technology 'leapfrogging' to cellular that was occurring in other

markets, particularly in the ASEAN region.

Given this, China demonstrates by far the highest broadband penetration rates in emerging

Asia, with circa 263.0 mn broadband subscribers recorded as at December 2015 (57.4%

household penetration).

Figure 33: 2015 fixed line penetration (of households) Figure 34: 2015 broadband penetration (of households)

10.5% 14.2%21.3%

32.5%42.0%

60.4%

144.3%

109.8%

147.4%158.8%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

160.0%

180.0%

6.3% 7.2% 9.8%

32.0% 34.7%

57.4%

105.8%99.6%

75.6%

108.9%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%


However, it is clear that a confluence of factors—including content development and e-

commerce, fixed line/Pay TV convergence, fixed line/cellular convergence and declining

equipment price points—is resulting in ongoing demand for fixed line broadband services,

as evidenced by broadband penetration in markets such as Hong Kong, Singapore, Taiwan

and Korea reaching 75.6-108.9% of households. This suggests that there is still room for

growth in the fixed broadband space in China.

The Chinese government also continues to be supportive of fixed broadband growth, with

the China State Council having recently issued the "Broadband China" strategy setting out

aggressive development targets for the next eight years (and targeting 400 mn broadband

subscribers, or 86.0% household penetration, by 2020). On the basis of current broadband

net addition rates, this looks achievable. Four policies have been put in place to support this

trajectory.

(1) Firstly, Unicom and China Telecom are likely to continue to upgrade their networks to

facilitate broadband, in order to continue to drive revenue (and compensate for

Fixed line broadband

penetration in China is

higher than in other

emerging markets…

…but still has room to

expand

21 July 2016


declining traditional voice and long distance revenues), but also to reduce churn and

through converged fixed and cellular offerings. The MIIT's 'higher speed, lower tariff'

policies also apply to fixed broadband services as well as cellular.

(2) As part of the government's broader State Owned Enterprise (SOE) reform programme,

the Chinese government is pushing for an opening up of the broadband market to

private capital. This is being done through the issuance of CPN (customer premises

network) broadband licence to private players (such as Dr Peng and the Aipu (Not

listed) internet service provider purchased by 21 Vianet).

(3) Pay TV cable operators are now allowed to enter the broadband space. Moves towards

what has become known as “three network convergence”, i.e., the convergence of

broadcasting with telecoms and internet access, were first mooted by the Information

Industry Department, a predecessor of the MIIT, in August 2006. Official targets were

then finally introduced by the General Office of the State Council in January 2010,

whereby trials of broadcasters and telcos entering each other’s fields would be

conducted from 2010 to 2012, initially across ten cities, followed by a nationwide rollout

from 2013 to 2015. This policy was recently given further endorsement with the official

issuance of a fixed broadband licence to China Broadcasting Network Limited in May

2016.

(4) China Mobile received a fixed line licence in December 2013, arguably becoming an

extremely well-capitalised new entrant. This allowed it to use its fibre backbone and

backhaul (constructed to support the cellular and Wi-Fi businesses) to offer fixed

broadband services, and to launch ‘bundled’ cellular and fixed broadband packages as

offered by Unicom and China Telecom.

Among these policies, the issuance of a fixed broadband licence to China Broadcasting

Network Limited, and the entry of China Mobile into the provision of fixed broadband

services has, not surprisingly, gained most attention. We further analyse the impact of both

of these events below.

SARFT impact limited to date, likely to continue to be

On 5 May 2016 China's Ministry of Industry and Information Technology (MIIT) approved

the issuance of a basic telecom service operating licence to China Broadcasting Network

Limited, established by the State Administration of Radio Film and Television (SARFT).

Importantly, China Broadcasting Network Limited was not given a cellular licence.

Instead, the company was given a fixed broadband service provider licence. However, the

cable operators, in which SARFT has direct and indirect stakes, can already offer

broadband access services under the 'Three network convergence' policy that we explained

was implemented in 2010. So in our view there is no change to the competitive dynamics in

the fixed line space, and no 'new' entrant threat arising from this licensing 'formality'.

Indeed, thus far, as set out in our 17 May 2011 report "Broadcasting and telecoms - slow to

converge" the telecoms operators have made far deeper in-roads into broadcasting, through

their IPTV services, than the cable operators have made into broadband access. In the

report we identified three key reasons for this, and all are still valid five years later:

■ First, the cable TV industry remains highly fragmented into small regional and municipal

operations.

■ Second, shareholding structures are complex, preventing effective consolidation and

the creation of a nationwide cable 'champion'.

■ Third, profitability amongst pay TV operators was (and still is) low, and capital is

constrained in the (very large) unlisted part of the sector.

We do not believe that the issuance of a broadband licence to the China Broadcasting

Network Limited will quickly resolve any of these key structural issues..

21 July 2016


Receipt of a cellular licence would have been more damaging—but it did not occur

We would be far more concerned over industry profitability had SARFT been awarded a

cellular licence. The introduction of a well-capitalised new entrant is, in our view, the single

most damaging structural change that can happen in a cellular market, given that it triggers:

(1) higher spectrum costs, (2) higher capex (as a new entrant is forced to build nationwide

coverage), (3) tariff competition; and (4) increased marketing expenditure. The tariff

competition (for example, the introduction of unlimited data plans) and increased marketing

expenditure are the natural result of the new entrant attempting to fill its empty network and

attract revenue over its fixed cost base.

However, a pre-requisite to launching cellular services is a licence and the receipt of cellular

spectrum. SARFT currently has control of 700MHz spectrum for TV broadcasting, but a

decision to re-allocate this to cellular has not yet been made and would likely be highly

controversial. Even if it were awarded for telecoms use, the aforementioned issues which

have made the cable TV companies relatively ineffective in the broadband space over the

last six years (regional fragmentation, poor capitalisation, lack of scale) would be all the

more constraining in cellular, particularly given how large the three cellular operators have

become. China Mobile has 2.5 mn BTS (and 1.1 mn 4G BTS) in place after an extremely

aggressive 4G rollout, while Unicom has 1.4 mn BTS in place and China Telecom has 1.1

mn. This would be time consuming, and extremely expensive, for any new entrant to

attempt to replicate. We are not, therefore, surprised that no cellular licence was awarded to

China Broadcasting Network Limited, and, again, in the cellular space our forecasts for what

remains a stable, three-player market, are unchanged

China Mobile a more potent force (but not a new one)

On 30 November 2015 China Mobile announced the acquisition of Tietong (Railcom) (Not

listed) from its unlisted parent company. With China Mobile's very strong balance sheet,

large scale and dominant position in the cellular industry, it does not suffer from any of the

disadvantages we see in the fragmented Pay TV industry. Thus, at least in theory, it

appears that China Mobile represents a more powerful potential threat to China Telecom

and Unicom's fixed line business units.

Some investors have indeed taken the view that China Mobile's acquisition of Tietong

marks a significant strategic departure from its focus on cellular, and therefore heralds a

significant intensification of competition in the fixed line space—with an impact much like a

well-capitalised 'new entrant' threat in the cellular space.

However, we would note that:

■ China Mobile is not in fact a new entrant in the fixed line space. China Mobile's parent

China Mobile Group (Not listed) actually acquired Tietong during the 2008 industry

restructuring (which created three cellular players and three 'fixed line' players). The

listed company (i.e., 941 HK) resold Tietong's broadband services as part of an early

'bundling' strategy.

■ Furthermore, China Mobile (i.e., 941 HK) requested and was granted a fixed line licence

of its own in December 2013. This allowed it to use its own fibre backbone and

backhaul (constructed to support the cellular and Wi-Fi___33 businesses) to offer fixed

broadband services, and extend the geographies in which it was offering 'bundled'

cellular and fixed line services in areas not covered by Tietong.

China Mobile has therefore been active in the fixed line space for around eight years, with a

pick-up in intensity occurring from December 2013. The business model of fixed line is quite

different from that of cellular. In cellular, given the requirement for each operator to roll out a

nationwide network, the primary determinant of return on capital is each operator's revenue

market share (and therefore the 'asset turn' over the nationwide network assets

constructed). In fixed line, there is no requirement to roll out a full nationwide network before

service launch, allowing a 'cherry picking' approach. Furthermore, given the heavier cost

China Mobile acquired

Tietong (Railcom) from its

parent in December 2015

21 July 2016


'per line' of fixed line rollout, returns on capital are primarily determined by the proportion of

homes passed that are converted into customers.

China Mobile's management does seem to have an awareness of this dynamic, and has

adopted a relatively gradual approach to fixed line rollout over the years. Thus, service

rollout and launch have been targeted in areas where China Mobile already has strong

backhaul network resources in place. For example, fixed broadband services have been

offered in buildings in which China Mobile already had fibre coverage in support of existing

cellular base transceiver systems (BTS).

In this context, we see the December 2015 Tietong acquisition more as tidying up of

disparate fixed line assets. In an increasingly converged/data-centric world, the presence of

some supporting fibre assets at the unlisted parent company, together with some at the 941

HK level, probably made less and less sense. The December 2015 transaction cleared this

up and simplified management and operating structures. The assets included 99,000 fibre

km of backbone cable, 1,822,000 fibre km of metro fibre, 24.71mn ipv4 addresses, 11.98

mn fixed broadband customers, 18.29 mn fixed lines and various real estate assets. The

financial implication was that China Mobile used a small proportion of its net cash balance

to pay its parent Rmb31.88 bn in cash, representing a price to book of 1.1x, and acquired

an annual revenue and EBITDA stream of circa Rmb22.4 bn and Rmb7.5 bn respectively

having brought the assets on-balance-sheet.

Has competitive intensity in fixed line ratcheted up in 2016? The level of disclosure

regarding fixed line has certainly increased since the Tietong acquisition, with China Mobile

now disclosing fixed line broadband subscriber numbers, and having given investors a

'target' fixed line net addition rate of circa 10 mn net adds in 2016 (which China Mobile

looks set to exceed, given that it has achieved 10.8 mn broadband net adds in the year to

June!). The fact that run-rate is higher than that achieved by either China Telecom or

Unicom (4.9 mn and 1.6 mn respectively) and that China Mobile's fixed broadband ARPU

level in 2H16 was sharply lower than its fixed line peers, at just Rmb32/month, has raised

fears of a structural change for the worse in competitive intensity.

Figure 35: Fixed broadband subscriber bases (mn) Figure 36: Fixed broadband ARPU levels (Rmb/month)

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

Dec 2015 Jan Feb March April May June

China Unicom China Telecom China Mobile

0

10

20

30

40

50

60

70

China Unicom China Telecom China Mobile

Broadbad ARPU (Rmb/Month)


However, even the addition of 15 mn broadband customers, taking the Y/E 2016 broadband

subscriber base to circa 70.0 mn, does not in our view look overly 'aggressive' in the context

of China Mobile's overall business (837 mn subscribers) or even the fixed broadband

marketplace, which currently comprises 257.8 mn subscribers and is still expanding. We

currently project that China Mobile's fixed line market share will reach 10.6% in 2016, up

from circa 9.6% in 2015, and that it will continue to add a further 1.0 pp of market share per

year through 2020.

21 July 2016


Figure 37: China’s fixed line market—revenue and revenue market share FY15-20

Rmb mn 2015 2016E 2017E 2018E 2019E 2020E

China Mobile 28,289 32,011 36,003 40,035 43,875 47,715

China Unicom 92,658 93,741 94,725 96,705 98,558 99,515

China Telecom 174,672 176,203 177,358 177,931 178,509 178,852

% market share

China Mobile 9.6% 10.6% 11.7% 12.7% 13.7% 14.6%

China Unicom 31.3% 31.0% 30.7% 30.7% 30.7% 30.5%

China Telecom 59.1% 58.4% 57.6% 56.5% 55.6% 54.8%


Other things being equal, China Mobile's presence in the fixed broadband space is of

course negative for China Telecom and Unicom and will result in lower growth rates for both

incumbents than would be the case if China Mobile did not offer broadband services.

However, we note that:

■ The impact of China Mobile's fixed line operations on China Telecom and Unicom's

growth rates is not new, and has been evident since 2008.

■ Given that China Mobile's fixed broadband targets are not overly aggressive, and

continue to represent a 'cherry-picking' strategy rather than the sort of sudden 'shock'

triggered by launch by a cellular entrant with an empty, nationwide network, we still

expect China Telecom and Unicom's fixed line businesses to achieve revenue growth,

(as they have done over recent years).

■ Unicom and China Telecom do enjoy some structural growth in the fixed line space due

to their data centre divisions, which are enjoying circa 20% YoY growth rates. This

further offsets the impact of loss of fixed line revenue, and any attrition to fixed

broadband ARPU levels.

China Mobile's piecemeal entry into the fixed line market has therefore lowered China

Telecom and Unicom's growth rates, but not resulted in their businesses actually shrinking.

We conclude that neither the existence of the Pay TV operators, nor the existence of China

Mobile, in the fixed line space is a reason to avoid exposure to China Telecom or Unicom.

Figure 38: China’s fixed line market—revenue growth FY15-20

Rmb mn 2015 2016E 2017E 2018E 2019E 2020E

China Mobile n.a 3,722 3,992 4,032 3,840 3,840

China Unicom 2,868 1,083 984 1,979 1,854 957

China Telecom 1,889 1,530 1,155 574 578 343

Growth (% YoY)

China Mobile 13.2% 12.5% 11.2% 9.6% 8.8%

China Unicom 3.2% 1.2% 1.0% 2.1% 1.9% 1.0%

China Telecom 1.1% 0.9% 0.7% 0.3% 0.3% 0.2%


21 July 2016


Revenue growth leads to cash flow & earnings growth Factoring in slightly higher depreciation charges…

Expectation of slightly higher (non-cash) depreciation charges as a hangover to the 4G

investment phase leads us to trim our FY16 earnings forecast for China Mobile and China

Telecom by 1.9% and 3.6% respectively. Unicom, with its very low net margin, is affected to

the tune of 10.2%. However, our DCF-based target prices, which suggest significant

potential upside for all three stocks, are unchanged, as set out below.

Figure 39: Model amendments

China Mobile China Telecom China Unicom

Rmb mn Previous Revised % Previous Revised % Previous Revised %

Service revenue 654,657 654,657 0.0% 319,258 319,258 0.0% 252,463 252,463 0.0%

EBITDA 267,233 267,233 0.0% 97,661 97,661 0.0% 89,009 89,009 0.0%

Depreciation (142,440) (145,289) 2.0% (69,774) (70,508) 1.1% (77,204) (78,264) 1.4%

Net profit 116,711 114,480 -1.9% 20,171 19,442 -3.6% 7,812 7,017 -10.2%

Target price 123.5 123.5 0.0% 6.85 6.85 0.0% 16.0 16.0 0.0%


..but reference to comps suggests valuations cheap

We note that all three Hong-Kong listed China telcos look very cheap on EV/EBITDA

relative to regional peers. China Mobile and China Telecom also look somewhat cheap on

FY16 P/E even on our revised forecasts, though the valuation gap with regional peers is

narrower than when EV/EBITDA is considered. On free cash flow yield the Chinese

operators trade more in line with regional peers.

The cheap EV/EBITDA multiples are therefore partly a reflection of the high capex and

heavy depreciation burdens of the China telcos. In our view part of this burden in turn is due

to structural inefficiencies suffered by State-Owned-Enterprises in China. China Mobile's 4G

technology allocation (2600MHz TD-LTE) also contributes structurally to a particularly

heavy capex burden.

However, we believe that the cash flow yield and net profit margins (affecting P/E) are

partially suppressed by the fact that the China telcos are only just emerging from a very

significant nationwide 4G network rollout phase.

Figure 40: Comparative multiples—the China telcos look cheap on EV/EBITDA, and in FY17 look attractive on P/E

Close Target Upside Normalised P/E (x) EV/EBITDA (x) FCF yield (%) Div yield (%)

price price (%) 16E 17E 16E 17E 16E 17E 16E 17E

China Telecom 3.56 6.85 92.4% 12.7 10.4 3.6 3.3 -3.7% 7.2% 3.2% 4.8%

China Unicom 7.86 16.00 103.6% 23.1 14.5 3.2 2.6 3.8% 8.2% 1.9% 3.0%

China Mobile 94.40 123.50 30.8% 14.2 13.2 4.6 4.2 3.5% 5.8% 3.0% 3.8%

Unicom A 4.29 5.00 16.6% 37.3 24.2 4.4 4.0 2.4% 5.1% 0.9% 1.4%

NJA *- Integrated 17.7 15.5 7.2 6.7 4.0% 6.9% 4.2% 4.7%

NJA * - Mobile 16.3 15.4 6.2 5.7 3.4% 5.7% 3.2% 3.8%

* Non-Japan Asia sector averages. Source: Company data, Credit Suisse estimates

Our thesis is that rising revenues, as 4G penetration rises and resulting data use is

monetised, together with declining capex requirements, will result in higher cash flows and

higher earnings going forward. We capture the upside from this growth using our DCF

valuation methodology set out below.

We suspect that, as previously explained, investors are nervous about further policy

interventions which might affect this trajectory.

21 July 2016


With no new policies having been introduced since October 2015, and with the 4G market

expanding ahead of expectations, we see no need for further regulatory interference at

present (though of course it cannot be guaranteed).

The other key risk to our thesis would be the commencement of a 5G investment phase,

which would cut short the ability of China Mobile, Unicom and China Telecom to properly

'harvest' the heavy investments which are being made in 4G. Fortunately, China's 4G

investment phase commenced relatively early (2013) and progress towards 5G

formalisation and standardisation has been relatively slow. Our global equipment team

suggests that, at best, preliminary 5G investment in developed markets such as Japan

might commence in 2020. Crucially, this suggests that the China telcos have several more

years to monetise 4G before the 5G investment phase begins.

We value China Mobile at HK$123.5/share

Our thesis for China Mobile is that, given the absence of unlimited data plans, rising data

use will drive cellular revenue growth. Furthermore, with China Mobile's 4G network having

already covered 92% of the population by the end of 2015, with 1.1mn 4G BTS in place, we

fully expect capex to decline further in FY16, to Rmb186.0bn. Rising revenue and EBITDA,

together with declining capex, are leading to free cash flows (FCF) expanding.

Of course, while both cash flows and earnings are now on an increasing trend as capital

intensity declines, in absolute terms, the net profit margin (and cash flow generation) are

sharply lower than would have been the case had China Mobile not been rolling out TD-LTE

at 2600MHz, or had enjoyed a working 'blanket' of lower-frequency 3G coverage on which

to add 4G capacity. The extremely dense 4G network required has resulted in the capex-to-

sales ratio reaching very high levels (peaking in 2015 at 36.7%) for an operator that has

68.5% market share by revenue. The heavy capex has led to ROIC dropping from a peak

of 45.4% in 2008 to a trough of 17.8% in 2016 (though this is expected to rise to 18.2% in

2017) and resulting depreciation charges are acting as a drag on the net profit margin

(FY16: 17.5%).

Figure 41: China Mobile—summary P&L and cash flow statement

Rmb mn FY12 FY13 FY14 FY15 FY16E FY17E FY18E FY19E FY20E

Service revenue 560,413 590,811 581,817 584,089 654,657 695,747 725,952 738,713 742,888

% YoY 5.4 (1.5) 0.4 12.1 6.3 4.3 1.8 0.6

EBITDA 253,646 240,426 235,259 247,368 267,233 287,031 304,280 308,569 308,376

% YoY (5.2) (2.1) 5.1 8.0 7.4 6.0 1.4 (0.1)

EBITDA margin (%) 45.3 40.7 40.4 42.4 40.8 41.3 41.9 41.8 41.5

Capex (127,400) (184,900) (213,500) (195,600) (186,043) (165,590) (141,278) (143,878) (144,730)

Capex/sales (%) 22.7 31.3 36.7 33.5 28.4 23.8 19.5 19.5 19.5

FCF 96,598 33,708 4,493 32,086 58,312 96,441 136,456 138,959 139,040

% YoY (65.1) (86.7) 614.1 81.7 65.4 41.5 1.8 0.1

Net profit* 129,274 121,692 109,279 98,443 114,480 123,814 133,596 136,403 136,810

% YoY (5.9) (10.2) (9.9) 16.3 8.2 7.9 2.1 0.3

* Excluding tower gain in FY15. Source: Company data, Credit Suisse estimates

Using a WACC of 9.7% and a terminal growth rate of 1.5%, we derive a DCF-based

valuation of HK$123.5. This figure includes HK$3.49/share of valuation uplift due to the

expected 2017 IPO of the China Tower Company (Not listed), in which China Mobile owns a

38.0% stake. Our overall value for the China Tower Company is Rmb444 bn; we expect

investors to apply a lower WACC (specifically: 8.0%) to the tower company, given what we

expect to be extremely high visibility of contracted cash flows from the three China telcos,

and given the expected absence of risks of populist policies over those cash flows.

We value Unicom at HK$16.0/share

Unicom is also a beneficiary of what we see as structural growth of wireless data, though,

as per our 3 May thematic report, 'Data user per subscriber: Another dimension for growth',

21 July 2016


it is now clear that, given the sharply lower capex and opex costs of 4G versus 3G,

operators such as Unicom which invested heavily in 2100MHz 3G are suffering from

structurally lower profitability compared with operators such as China Telecom, which

minimised 3G investment (and are now focused on 4G).

The inefficiency (in hindsight!) of rolling out a large network of circa 472,000 3G BTS at the

2100MHz frequency is particularly stark in the case of China Unicom since the window to

harvest 3G revenue and cash flows in China proved particularly short. The Chinese

operators commenced 3G rollout relatively late in regional and global terms, since the

industry restructuring which preceded 3G licence issuance was much-debated, and much-

delayed. The restructuring finally took place in May 2008, with 3G licences (three different

technologies to three different players) finally issued in January 2009, several years after

other Asian countries. In contrast, 4G rollout was relatively early, with China Mobile

commencing rollout in 2013, due to problems with its TD-SCDMA technology for 3G.

The net result was that the 3G phase in China was severely truncated. Just as Unicom

emerged from the 3G investment phase in FY13, China Mobile was already pressing on

with 4G. Unicom's attempt to 'harvest' cash flows generated by the 3G investment phase

lasted less than two years, in contrast to 5-10 years in other markets.

Indeed, Unicom attempt to extend the 'harvest' of the 3G network into a third year (2015)

caused a loss of operational momentum, as both China Mobile and China Telecom were

already aggressively marketing 4G as 'the technology of the future'. On arrival at Unicom in

August 2015, Chairman Wang, formerly the Chairman of China Telecom, immediately

recognised this problem, and invested aggressively in 4G network upgrades. Thus, FY15

capex was raised from 'less than Rmb100 bn' to Rmb133.9 bn in a matter of months.

Marketing activity, focusing on 4G also picked up.

As a result of this change in strategy towards 4G, Unicom's operational numbers are

improving: 28.3 mn 4G net adds YTD in 2016, versus 8.7 mn 3G/4G net adds over the

same period in FY15.

However, high depreciation charges due to heavy catch-up investment in 2H15, together

with the marketing expenditure to drive the improved momentum, are dragging profitability.

A second profit warning of the year ahead of the 2Q16 results seems unavoidable;

ironically, Unicom's net profit had looked relatively strong in 1H15 as subsidies and

marketing budgets were slashed on imposition of VAT, and our forecast suggests that 1H16

net profit will be 63.2% lower YoY, at Rmb2,569 mn.

In fact, even this forecast carries relatively high risk; Unicom's net margin is extremely low

(1Q16: 0.8%) that small changes in revenue or cost will have an amplified impact on net

profit. We note that the FY16 consensus earnings forecast for Unicom has been revised

down by 37.3% YTD, and currently sits at Rmb6.1 bn.

21 July 2016


Figure 42: Unicom—summary P&L and cash flow statement


Cellular service 126,036 151,133 155,632 142,620 158,722 173,499 188,057 202,484 213,311

Fixed line service 84,091 87,434 89,790 92,658 93,741 94,725 96,705 98,558 99,515

Service revenue 210,127 238,567 245,422 235,278 252,463 268,225 284,762 301,042 312,827

% YoY 13.5 2.9 (4.1) 7.3 6.2 6.2 5.7 3.9

EBITDA 72,659 83,963 93,315 87,502 89,009 95,482 103,331 111,601 115,562

% YoY 15.6 11.1 (6.2) 1.7 7.3 8.2 8.0 3.5

EBITDA margin (%) 34.6 35.2 38.0 37.2 35.3 35.6 36.3 37.1 36.9

Capex (99,790) (73,459) (84,881) (133,900) (75,584) (73,010) (68,552) (70,874) (70,108)

Capex/sales (%) 47.5 30.8 34.6 56.9 29.9 27.2 24.1 23.5 22.4

FCF (32,980) 4,258 224 (56,367) 6,557 14,091 24,353 28,741 32,464

% YoY (112.9) (94.7) (25,244.2) (111.6) 114.9 72.8 18.0 13.0

Net profit* 7,096 10,408 12,599 3,627 7,017 11,449 18,668 23,946 27,195

% YoY 46.7 21.1 (71.2) 93.5 63.2 63.1 28.3 13.6


However, we also note that the FY16 consensus earnings downgrades have been a

catalyst for Unicom's market cap to contract by a similar quantum (share price down 16.6%

YTD). While understandable, we do not think that near-term earnings—which are clearly the

focus of Hang Seng index investors—are the best measure of value for a company just

emerging from an investment J-curve (both 3G and 4G) and at the cusp of turning cash flow

positive in a growing market.

Instead, we continue to rely on DCF, which we believe more accurately reflects the 'project'

nature of telecoms investment, to value Unicom. Using a WACC of 10.1% and a terminal

growth rate of -2.0% for the fixed line division, and 3.0% for the cellular division, we derive a

DCF-based valuation of HK$16.0.

This figure includes HK$5.26/share of valuation uplift due to the expected 2017 IPO of the

China Tower Company, in which Unicom owns a 28.1% stake. Of course this valuation uplift

constitutes a much larger proportion of our target price than was the case with China

Mobile, given the much smaller value which we ascribe to Unicom's core operations.

As a sanity check on our DCF-based valuation, we note that, if our projections are correct,

Unicom would offer a free cash flow yield of 14.9% in FY18 (by which point the capex to

sales ratio is expected to be 24.1%), and trade at a P/E of 8.7x FY18 earnings.

We value China Telecom at HK$6.85/share

China Telecom clearly benefited from a relatively low-cost 3G upgrade, from CDMA to

CDMA 2000 at the 850MHz frequency. Only 290,000 CDMA BTS were constructed, and the

upgrade to CDMA 2000 3G was primarily a software upgrade, rather than one which

required significant investment or network densification. While CDMA 2000 offered inferior

speeds and service quality versus Unicom's W-CDMA 3G network, China Telecom's service

was still vastly superior to that of China Mobile's TD-SDCMA 3G network, allowing rapid

revenue market share gains (albeit assisted by relatively aggressive marketing and handset

subsidies).

The limited investment in 3G also meant that China Telecom was ready to invest quickly

and heavily in 4G. Again supported by appropriate marketing activities, China Telecom was

able to continue to grow cellular revenue market share even after China Mobile's 4G launch.

While China Telecom's 4G rollout has involved constructing a more dense network (at

1800MHz), the existence of the China Tower Company since October 2015 (and the

introduction of mandatory access to towers since April 2015) has saved both time and cost

on the network build.

21 July 2016


These factors, together with a larger, and more profitable, fixed line division than that of

Unicom, leaves China Telecom with a significantly higher net margin than Unicom (1Q16:

5.9%), less earnings risk, and a materially lower FY16 P/E ratio.

Figure 43: China Telecom summary P&L and cash flow statement


Cellular service 92,803 113,751 120,268 124,503 142,635 156,642 168,483 178,382 185,722

Fixed line service 165,247 170,398 172,783 174,672 176,623 178,627 179,201 179,778 180,122

Service revenue 258,050 284,149 293,051 299,176 319,258 335,269 347,684 358,160 365,844

% YoY 10.1 3.1 2.1 6.7 5.0 3.7 3.0 2.1

Total EBITDA 70,841 96,551 94,853 94,106 97,661 104,704 109,803 112,782 115,024

% YoY 36.3 (1.8) (0.8) 3.8 7.2 4.9 2.7 2.0

EBITDA margin (%) 27.5 34.0 32.4 31.5 30.6 31.2 31.6 31.5 31.4

Capex (53,731) (79,994) (76,892) (109,094) (96,755) (74,331) (67,052) (65,329) (61,222)

Capex/sales (%) 20.8 28.2 26.2 36.5 30.3 22.2 19.3 18.2 16.7

FCF 10,794 5,985 7,117 (25,737) (9,424) 19,110 29,133 33,064 38,713

% YoY (44.6) 18.9 (461.6) (63.4) (302.8) 52.4 13.5 17.1

Net profit* 14,925 17,545 17,680 16,116 19,442 23,920 28,694 31,412 33,799

% YoY 17.6 0.8 -8.8 20.6 23.0 20.0 9.5 7.6


Using a WACC of 9.9% and a terminal growth rate of -1.5% for the fixed line division, and

3.0% for the cellular division, we derive a DCF-based valuation of HK$6.85. This figure

includes HK$1.82/share of valuation uplift due to the expected 2017 IPO of the China Tower

Company, in which China Telecom owns a 27.9% stake. Indeed, we believe that China

Telecom was a key beneficiary of the transfer of tower assets into the China Tower

Company in October 2015; China Telecom received a similarly sized stake in the tower

company to that of Unicom, but contributed fewer towers and fewer tenancies.

21 July 2016


Companies Mentioned (Price as of 21-Jul-2016)

Advanced Info Service PCL (ADVANC.BK, Bt175.0) Apple Inc (AAPL.OQ, $99.96) Axiata Group Berhad (AXIA.KL, RM5.69) Bakrie Telecom PT (BTEL.JK, Rp50) Bharti Airtel Ltd (BRTI.BO, Rs363.85) China Mobile Limited (0941.HK, HK$98.0, OUTPERFORM, TP HK$123.5) China Telecom (0728.HK, HK$3.78, OUTPERFORM, TP HK$6.85) China Unicom Hong Kong Ltd (0762.HK, HK$8.13, OUTPERFORM, TP HK$16.0) China United Network Communications Ltd (600050.SS, Rmb4.21, OUTPERFORM[V], TP Rmb5.0) Chorus (CNU.NZ, NZ$4.37) ChungHwa Telecom (2412.TW, NT$118.5) DiGi.Com (DSOM.KL, RM4.9) Digital Telecom Infrastructure Fund (TRUEIFu.BK, Bt14.9) Digital Telecom Infrastructure Fund (DIFu.BK, Bt14.9) Far EasTone Telecom (4904.TW, NT$75.5) Globe Telecom (GLO.PS, P2292.0) HKBN (1310.HK, HK$8.97) HKT Trust (6823.HK, HK$12.06) Hutchison Telecommunications HK Holdings Ltd. (0215.HK, HK$2.88) Idea Cellular Ltd (IDEA.BO, Rs105.45) Intel Corp. (INTC.OQ, $35.69) Intouch Limited (INTUCH.BK, Bt59.5) JD.com, Inc. (JD.OQ, $22.66) Jasmine International (JAS.BK, Bt5.5) KDDI (9433.T, ¥3,210) KT Corp (030200.KS, W30,750) LG Uplus (032640.KS, W10,700) M1 Limited (MONE.SI, S$2.75) Marvell Technology Group Ltd. (MRVL.OQ, $11.24) Maxis Berhad (MXSC.KL, RM6.06) MediaTek Inc. (2454.TW, NT$235.5) NTT (9432.T, ¥5,016) NTT DoCoMo (9437.T, ¥2,875) PCCW (0008.HK, HK$5.71) PT Indosat Tbk (ISAT.JK, Rp6,900) PT Telkom (Telekomunikasi Indo.) (TLKM.JK, Rp4,120) Philippine Long Distance Telephone Company (TEL.PS, P2094.0) Pt Link Net Tbk (LINK.JK, Rp4,350) QUALCOMM Inc. (QCOM.OQ, $55.82) Reliance Communication Ltd (RLCM.BO, Rs50.3) Reliance Industries Limited (RELI.BO, Rs1022.55) Singapore Telecom (STEL.SI, S$4.23) SmarTone Telecom (0315.HK, HK$13.96) SoftBank Group Corp. (9984.T, ¥5,391) Spark NZ (SPK.NZ, NZ$3.78) StarHub Ltd (STAR.SI, S$3.95) Taiwan Mobile (3045.TW, NT$113.5) Telekom Malaysia (TLMM.KL, RM6.79) Telstra Corporation (TLS.AX, A$5.83) Total Access Communication PCL (DTAC.BK, Bt32.0) Tower Bersama (TBIG.JK, Rp6,600) True Corp PCL (TRUE.BK, Bt9.1) Vodafone Group (VOD.L, 225.65p) Weibo Corporation (WB.OQ, $33.0) XL Axiata Tbk (EXCL.JK, Rp3,670)

Disclosure Appendix

Important Global Disclosures

I, Colin McCallum, CA, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

21 July 2016


3-Year Price and Rating History for China Mobile Limited (0941.HK)

0941.HK Closing Price Target Price

Date (HK$) (HK$) Rating

21-Oct-13 85.05 100.00 O

30-Dec-13 80.50 94.00

20-Mar-14 67.00 86.00

02-May-14 73.10 89.00

31-Jul-14 85.90 94.50

11-Aug-14 85.65 94.50 N

14-Aug-14 88.30 102.00 O

04-Nov-14 96.65 112.00

27-Jan-15 102.70 120.00

17-Apr-15 107.70 133.00

13-Jul-15 95.75 137.00

17-Aug-15 100.90 130.00

20-Aug-15 98.15 133.00

15-Oct-15 93.70 125.17

11-Jul-16 88.70 123.50

* Asterisk signifies initiation or assumption of coverage.

O U T PERFO RM

N EU T RA L

3-Year Price and Rating History for China Telecom (0728.HK)



21-Aug-13 4.06 4.55 N

07-Nov-13 3.97 4.42

30-Dec-13 3.92 4.26

06-Feb-14 3.53 4.26 O

02-May-14 3.98 4.70

31-Jul-14 4.39 5.15

04-Nov-14 4.95 5.80

05-Jan-15 4.54 5.70

17-Apr-15 5.46 6.70

17-Aug-15 4.22 6.38

15-Oct-15 4.08 7.93

13-Apr-16 4.29 7.55

11-Jul-16 3.59 6.85


N EU T RA L

O U T PERFO RM

21 July 2016


3-Year Price and Rating History for China Unicom Hong Kong Ltd (0762.HK)



07-Nov-13 11.94 18.20 O

30-Dec-13 11.68 19.10

28-Feb-14 10.34 18.40

02-May-14 11.68 19.60

31-Jul-14 13.60 20.40

04-Nov-14 11.48 18.85

04-Mar-15 12.20 17.80

17-Apr-15 13.68 25.68

25-Jun-15 12.68 24.00

17-Aug-15 10.40 22.70

15-Oct-15 10.54 22.38

22-Oct-15 9.96 20.35

13-Apr-16 9.98 19.33

05-Jul-16 8.01 18.00

11-Jul-16 7.88 16.00


O U T PERFO RM

3-Year Price and Rating History for China United Network Communications Ltd (600050.SS)

600050.SS Closing Price Target Price

Date (Rmb) (Rmb) Rating

20-Oct-14 3.54 6.05 O *

04-Nov-14 3.72 5.60

02-Jan-15 4.95 5.60 N

04-Mar-15 5.40 5.30

17-Apr-15 7.07 7.69

25-Jun-15 7.80 7.33

17-Aug-15 7.43 7.20

15-Oct-15 6.68 7.10

23-Oct-15 6.96 6.28 U

25-Feb-16 4.07 6.28 O

13-Apr-16 4.44 5.98

05-Jul-16 3.91 5.60

11-Jul-16 3.90 5.00


O U T PERFO RM

N EU T RA L

U N D ERPERFO RM

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21 July 2016


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Target Price and Rating Valuation Methodology and Risks: (12 months) for China Mobile Limited (0941.HK)

Method: Our discounted cash flow (DCF) analysis, based on an estimated 9.7% weighted average cost of capital and a 1.5% terminal growth rate, supports a valuation of HK$123.5/share for China Mobile. At our target price of HK$123.5, China Mobile would trade at an FY16E EV/EBITDA multiple of 6.2x and a P/E of 17.9x. We rate the stock OUTPERFORM, due to the strong data monetisation (tier pricing and high data volume growth).

Risk: The risks that may impede achievement of our HK$123.5 target price and OUTPERFORM rating for China Mobile are: (1) either faster-than-expected, or slower-than-expected growth in the cellular market, from the current penetration level; (2) the prospect that competitors take a larger or smaller proportion of the market share of net additions; (3) that capex forecasts prove higher or lower than expected due to competitive pressures or pressures from the regulator; and (4) that competition leads to higher or lower attrition of revenue per user than expected, for example through a price war.

Target Price and Rating Valuation Methodology and Risks: (12 months) for China Telecom (0728.HK)

Method: Our discounted cash flow (DCF) analysis, based on an estimated 9.9% cost of capital and a 3.0% terminal growth rate for cellular, -0.5% for fixed line, supports our HK$6.85 target price for China Telecom. At HK$6.85, China Telecom would trade at an enterprise value-to-earnings before interest, taxes, depreciation, and amortisation (EV/EBITDA) multiple of 5.8x for FY16. We rate the stock OUTPERFORM, due to the gradual improvement in 4G market share and potential revaluation of the stake in tower company.

21 July 2016


Risk: The risks that may impede achievement of our target price of HK$6.85 and OUTPERFORM rating for China Telecom are: (1) either faster-than-expected, or slower-than-expected growth in the cellular market, from the current level; (2) the prospect that competitors take a larger or smaller proportion of the market share of net additions; (3) that capex forecasts prove higher or lower than expected; and (4) that competition leads to higher or lower attrition of revenue per user than expected. For China Telecom's fixed line division, key risks to our target price include: (1) faster or slower cannibalisation of voice revenue per line by cellular competition; (2) faster or slower rollout of broadband lines than expected; (3) better success in reducing employment-related costs; and (4) better success in lowering capex requirements.

Target Price and Rating Valuation Methodology and Risks: (12 months) for China Unicom Hong Kong Ltd (0762.HK)

Method: Our discounted cash flow (DCF) analysis, based on an estimated 10.1% cost of capital and a 3.0% terminal growth rate for cellular, -2.0% for fixed line, supports our HK$16.0 target price for China Unicom. At HK$16.0, Unicom would trade at an enterprise value-to-earnings before interest, taxes, depreciation, and amortisation (EV/EBITDA) multiple of 5.0x for FY16. We rate the stock OUTPERFORM, due to the gradual improvement in 4G market share and potential revaluation of the stake in the tower company.

Risk: The risks that may impede achievement of our target price of HK$16.0 and OUTPERFORM rating for China Unicom are: (1) either faster-than-expected, or slower-than expected growth in the cellular market, from the current level; (2) the prospect that competitors take a larger or smaller proportion of the market share of net additions; (3) that capex forecasts prove higher or lower than expected; and (4) that competition leads to higher or lower attrition of revenue per user than expected. For Unicom's fixed line division, key risks to our target price include: (1) faster or slower cannibalisation of voice revenue per line by cellular competition; (2) faster or slower rollout of broadband lines than expected; (3) better success in reducing employment-related costs; and (4) better success in lowering capex requirements.

Target Price and Rating Valuation Methodology and Risks: (12 months) for China United Network Communications Ltd (600050.SS)

Method: Our discounted cash flow (DCF) analysis, based on an estimated 10.1% WACC and a 3.0% terminal growth rate for cellular, -2.0% for fixed line, supports our Rmb5.0 target price and OUTPERFORM rating for China Unicom A. We give OUTPERFORMING rating for China Unicom due to valuation, potential value uplift from the listing of tower company, 4G data monetisation.

Risk: The risks that may impede achievement of our target price of Rmb5.0 and OUTPERFORM rating for China Unicom are: (1)either faster-than-expected or slower-than-expected growth in the cellular market, from the current level, (2) the prospect that competitors take a larger or smaller proportion of the market share of net additions, (3) the capex is higher or lower than expected, (4) competition leads to higher or lower attrition of revenue per user than expected.

Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names

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21 July 2016


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Credit Suisse may have interest in (BRTI.BO, IDEA.BO, RLCM.BO, RELI.BO)

As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (0728.HK, 2412.TW, 4904.TW, VOD.L, 2454.TW).

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Credit Suisse (Hong Kong) Limited ........................................................................................................................................... Colin McCallum, CA

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21 July 2016


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Copyright © 2016 CREDIT SUISSE AG and/or its affiliates. All rights reserved.

21 July 2016


Investment principal on bonds can be eroded depending on sale price or market price. In addition, there are bonds on which investment principal can be eroded due to changes in redemption amounts. Care is required when investing in such instruments.

When you purchase non-listed Japanese fixed income securities (Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, Japanese corporate bonds) from CS as a seller, you

will be requested to pay the purchase price only.

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