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China Unicom (CHU - Analyst Report), China's second largest mobile operator, announced first half of 2012 results with earnings per share of RMB 0.14 (or 2 cents), up 27.3% from the year-ago period.

Adjusted net income increased 31.5% to RMB 3.5 billion ($0.56 billion) from RMB 2.6 billion in the year-ago period on the back of strong revenue growth.

Revenue & Subscriber

Total revenue (excluding deferred fixed-line upfront connection fee) climbed 20% year over year to RMB 121.69 billion ($19.28 billion). Telecommunication service revenues, comprising roughly 84% of the total revenue, were RMB 102.39 billion ($16.2 billion), up 13.3% from the year-ago period.

Healthy revenue growth was credited to rapid growth of the 3G and fixed-line broadband businesses as well as strong sales of Apple Inc.'s (AAPL - Analyst Report) iPhones in spite of losing the exclusive right to distribute iPhones to China Telecom Corp. (CHA - Snapshot Report) last year.

Total revenue from the mobile business increased 32.9% year over year to RMB 79.75 billion ($12.6 billion). A large contributor was the telecommunication service with revenues of RMB 60.48 billion ($9.6 billion), up 23.4% year over year. China Unicom’s subscriber base expanded 20.7% year over year to 219.249 million at the end of the first half.

China Unicom’s 3G business is growing at a faster pace since its introduction in October 2009 and has become the major driver of revenue growth. 3G business telecommunication service revenues were RMB 26.90 billion ($4.26 billion) in the first half, which doubled from the year-ago period and accounted for 44.5% of service revenue from the mobile business. The company’s total 3G subscriber base reached 57.530 million, with 17.511 million new customers added during the first half.

Telecommunication service revenue from the GSM business fell 6.3% year over year to RMB 33.58 billion ($5.32 billion) driven by growing data substitution and stiff competition. Subscriber additions increased 2.6% to 161.719 million at the end of the first half.

Revenue from the fixed-line business inched up 1.5% year over year to RMB 41.53 billion ($6.6 billion). Telecommunications services revenue from the fixed-line business also rose 1.5% year over year to RMB 41.50 billion ($6.6 billion) backed by consistent growth in fixed-line broadband business.

Telecommunications service revenues from the broadband business was RMB 19.40 billion ($3.1 billion), up 13.0% from the year-ago period. China Unicom added 4.876 million customers during the reported period bringing the total number to 60.527 million.

The local telephone business recorded service revenue of RMB 15.07 billion ($2.39 billion), down 14.7% year over year. Erosion in fixed-line voice subscriber base continued with 3.0% decline from the year-ago period, bringing the total customer base to 92.569 million.

Expenses

Total expenses crept up 19.6% year over year to RMB 117.12 billion ($18.55 billion) due to higher selling expenses, network deployment costs, interconnection charges and depreciation charges. Selling and marketing expenses increased 20.4% year over year to RMB 16.38 billion ($2.59 billion) in the first half, mostly due to higher promotional spending on handsets and applications.   

Liquidity

China Unicom exited the first half with cash and cash equivalents of RMB 18.625 billion compared with RMB 18.177 billion in the year-ago period. Debt-to-capitalization ratio increased to 35.4% as of June 2012 from 34.2% as of December 2011.

Operating cash flow grew 3.3% year over year to RMB 35.54 billion in the reported period.

Our Take

China Unicom will continue to benefit from the ongoing development strategy aimed at enhancing its growth and profitability. The company expects to generate higher revenues by accelerating large-scale developments of 3G and fixed-line broadband services.

Nevertheless, high levels of marketing and promotional expenditures would continue to hurt future profitability. Further, we remain concerned about the precipitous decline in the landline business as well as intense competition in the domestic wireless market, in particular from China Mobile (CHL - Snapshot Report) and China Telecom.

We are maintaining our long-term Neutral recommendation on China Unicom. The stock retains a Zacks #3 (Hold) Rank for the short term (1–3 months)

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