China’s second largest mobile operator, China Unicom’s ([stock]CHU[/stock]) prime source of revenue is wireless service. China Unicom focuses on strengthening its position in the domestic 3G wireless market, launching innovative services, and bundling fixed-line and mobile offerings to subscribers that will likely improve its overall revenue and profitability.
3G remains a compelling opportunity and represents the sole driver of the company’s long-term growth. China Unicom had made several endeavors to enhance its WCDMA network with respect to its 3G business. The company launched star handset terminals, innovative tariff plans and advanced mobile Internet services.
China Unicom spent RMB70.19 billion in 2010 to develop its mobile and broadband business and expects 2011 capital spending to be RMB 73.80 billion. The cost related to continuous deployment of 3G services and network expansions led to the 60% decline in the company’s fiscal 2010 earnings. Notably, 2010 was the second consecutive year when China Unicom's net income dropped more than 50%.
We expect these expenditures for nationwide network deployment to impact short-term profitability, tighten free cash flow and impact margins. In addition, high levels of marketing and promotional expenditures related to the company’s 3G services will also negatively impact its profitability.
Further, China Unicom operates in a highly competitive domestic wireless market. The company remains significantly challenged by aggressive nationwide 3G service rollouts by its peers China Mobile ([stock]CHA[/stock]).
Thus, after considering the pros and cons, we remain cautious on China Unicom with our long-term Neutral recommendation on the stock. However, for the short term (1–3 months), the stock retains a Sell rating with the Zacks #4 Rank.
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