Balanced View on Chunghwa

We reaffirm our Neutral recommendation on Chunghwa Telecom Co. Ltd. (CHT - Analyst Report) as we believe Chunghwa’s mobile and Internet/Data operations will drive overall growth in the years to come. However, a highly competitive Taiwanese telecom market remains the major concern for the company.

Aggressive roll-out of fiber-to-the-home and 3G mobile services have placed the company ahead of its competitors. The company has also expanded into IPTV and cloud-computing services.

Chunghwa holds 80% of broadband market share, 96% of local fixed-line and 77% of long-distance fixed-line market share in Taiwan. The company also commands 34% of the Taiwanese wireless market share.

A recent ruling of the Taiwanese government has changed the pricing right of a landline-to-mobile call in favor of the fixed-line operator from mobile operator. This shift in government policy boosted Chunghwa’s revenue. Management sets a yearly revenue target of approximately $7.6 billion by 2015, which will be an improvement of 16% from 2010.

Chunghwa is trying hard to enter into the Chinese telecom market. The company is also eyeing the lucrative $33.3 billion Chinese cloud-computing market. It has agreements with China Telecom Corp. Ltd. (CHA - Snapshot Report) and China Unicom Ltd. (CHU - Analyst Report) to access software from their application stores to provide value added services to subscribers.

Chunghwa is gradually expanding its subscriber base for high-speed next-generation FTTx (fiber to the home/building/curb) offerings. The company is investing heavily to build a formidable FTTx (fiber-to-the-home/premises) network in Taiwan. At the end of the third quarter of 2012, FTTx subscriber base stood at 2.67 million, which accounted for 58.5% of total broadband subscriber base.

Nevertheless, Taiwanese telecom market is oversaturated with 115% wireless penetration and has become extremely competitive following the telecom regulatory changes. Chunghwa competes in a tough environment with two other major service providers – Taiwan Mobile Company and Far EasTone Telecommunications Co. Ltd. Going forward, the company expects to face severe challenges from China Mobile Ltd. (CHL - Snapshot Report) and Far EasTone Telecommunications, as they are cooperating for the 4G LTE-TDD network technology.

Chunghwa Telecom’s 3G customer base is much less as compared to Taiwan Mobile’s 71% and Far EasTone’s 63%. If the company’s wireless segments fail to bring and retain new customers, Chunghwa’s overall top line may be severely affected. Moreover, management has provided a weak financial guidance, lowering the revenue and income expectations for full year 2012.

Chunghwa Telecom retains a Zacks #3 Rank, implying a short-term Hold rating.