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The leading provider of wireless communication services in South Korea, SK Telecom Corp. (SKM - Analyst Report) has reported second quarter 2012 results. Quarterly consolidated net income plunged a massive 74% year over year to KRW 121 billion (approximately $109 million). Increased investments in advanced wireless networks, marketing expenses and tariff cuts were largely responsible for the decline in the quarter.

Revenues

Despite higher smartphone penetration and rising LTE subscriber base, consolidated operating revenue fell 0.6% to KRW 4,015 billion ($3.6 billion).

Mobile service revenue dropped 2.1% year over year to KRW 2,666 billion (approximately $2.4 billion). Interconnection revenue declined 11.7% to KRW 264 billion ($229 million) while new business and other revenue was down 18.6% at KRW 140 billion ($126 million) from the year-ago quarter.

Operating Income & Expenses

Operating income fell 42.8% to KRW 385 billion (approximately $347 million) in the second quarter, resulting in operating margin of 9.6%, down 710 basis points. The decline was mainly due to the reduction in mobile tariffs.

Operating expenses rose 7.9% year over year to KRW 3,631 billion (approximately $3.3 billion). Marketing expenses rose 17.2% year over year to KRW 960 billion ($864 million). Marketing to sales ratio increased to 31.3% from 25.6% in the year-ago quarter.

Subscriber, ARPU & Churn

During the second quarter, subscribers increased 1.5% year over year to 26.66 million with a net addition of 103 customers.

Average revenue per user (ARPU) fell 2.5% year over year to KRW 39,729 (approximately $35.21) owing to cuts in monthly mobile service rates while the churn rate improved to 2.4% from 2.7% in the year-ago quarter.

Liquidity

SK Telecom exited the second quarter with KRW 1,699 billion of cash and marketable securities on its balance sheet compared with KRW 1,785 billion in the year-ago quarter. Debt-to-equity ratio was 61.5% compared with 41.4% a year ago. Capital expenditure increased to KRW 616 billion from KRW 559 billion in the prior-year quarter.

Our Analysis

SK Telecom continues to lead the domestic wireless market through successful smartphone offerings as well as the expansion of its 4G LTE service. Moreover, 3G network expansion, Apple Inc. (AAPL - Analyst Report) iPhone offerings, cloud computing and mobile software businesses should boost the company’s long-term prospects. However, increased promotional expenses and heavy handset subsidies may hurt the company’s earnings in the near future. SK Telecom is continuously investing to improve its network visibility that would also restrict its future earnings. Further, we remain cautious on tariff reductions, intense competition from its biggest rival KT Corporation (KT - Snapshot Report) and heavy regulation by the Korean ministry.

We are currently maintaining our long-term Neutral recommendation on SK Telecom. For the short term (1–3 months), the stock retains a Zacks #4 Rank (Sell).

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