CHU Reports, Seals iPhone Deal

China Unicom (CHU - Analyst Report) has announced interim 2009 results with reported net income of RMB6.6 billion (US$970 billion) or RMB0.28 per share, down 42.1% compared to RMB12.1 billion (US$1.8 billion) or RMB0.51 per share reported in the corresponding period a year-ago.

This significant year-over-year decline in profitability is due to erosion in fixed-line revenue, higher marketing and capital expenditures associated with deployment and expansion of 3G wireless services, and intense domestic competition. Capital spending for expansion of its 3G network grew 17.1% year over year to RMB10.1 billion (US$1.5 billion) during the first-half of 2009 while associated marketing expenses increased 6.6% to RMB9.7 billion (US$1.4 billion).

China Unicom contends with an increasingly competitive domestic wireless market. The second-largest Chinese wireless carrier remains significantly challenged by the aggressive nationwide 3G service roll-out plans of its peers China Mobile (CHL - Snapshot Report) and China Telecom (CHA - Snapshot Report).

Consolidated revenue for the period was RMB76.3 billion (US$11.2 billion), down 6.3% year over year due to weak contribution from the fixed-line business. The reported consolidated service revenue decreased 4.3% year over year to RMB74.5 billion (US$10.9 billion).

Service revenue from the GSM mobile business increased 5.7% year over year to RMB34.2 billion (US$5 billion). However, this was more than offset by 11.3% annualized decline in fixed-line service revenue that reached RMB40.2 billion (US$5.9 billion). On a positive note, revenue from the fixed-line broadband service grew 10.3% year over year to RMB11.7 billion (US$1.7 billion).

At the end of the first-half of 2009, China Unicom had approximately 140.38 million GSM subscribers with a net addition of 7.01 million for the period. The company’s broadband subscriber base increased by 4.83 million to 34.91 million while erosion in legacy fixed-line subscriber base continued with a loss of approximately 1.12 million customers, taking the total customer base to 108.45 million.

The company is progressing with diversification beyond traditional voice services through the expansion of its value-added services, which are offering important revenue streams. Its GSM mobile value-added business, including SMS, GPRS and ring-tone services, posted respectable growth in first-half 2009. Total GSM SMS volume grew 0.9% year over year to 38.4 billion while ringtone subscriber base increased by 5.2 million to 49.4 million. GPRS business achieved 8.8 million net subscriber additions during the reporting period.

In June 2009, the company paid a final dividend of RMB0.20 per ordinary share for fiscal year ended December 31, 2008, totaling approximately RMB4,754 million (US$697 million).

China Unicom announced a major milestone as it officially clinched an exclusive three-year agreement on August 28, 2009, to launch Apple Inc’s (AAPL - Analyst Report) iPhone 3G in China in fourth-quarter 2009. The deal, however, does not include any revenue-sharing terms.

The iPhone deal represents a major opportunity in wireless for China Unicom as the company continues to face downward pressure on wireless ARPU (average revenue per user) due to stiff competition. The company reported a 4.3% year-over-year decline in ARPU in the first-half of 2009. China Unicom will leverage its 3G WCDMA network to roll out iPhones in mainland China, which will offer a significant competitive edge over its larger rival China Mobile while providing a major opportunity to boost ARPU and subscriber growth.

China Unicom’s 3G venture remains on track as the company launched commercial trials of its 3G services across 56 Chinese cities (including Beijing and Shanghai) in May 2009, and subsequently extended that to 44 more cities. The company plans to spend RMB38.7 billion (US$5.7 billion) to deploy its 3G network, covering 335 cities by the end of the current year with 74% penetration of China’s population. The company targets capturing one-third of the Chinese 3G market by 2010.

While we remain bullish on China Unicom’s future growth prospects in the 3G wireless market given the iPhone opportunity, we remain concerned about the precipitous declines in the landline business. Additionally, a high level of associated marketing and capital expenditure is expected to erode profitability and constrict free cash flow and margins for the remainder of 2009.

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