China Telecom launched the iPhone 4S on its network last Friday, becoming only the second carrier in the country to officially offer the iPhone for sale. China’s second largest carrier, China Unicom, has been selling the iPhone since 2009 and launched the 4S in January.
China Telecom also announced that it would launch Nokia’s Lumia line of smartphones on its network by the end of this month.
Although China Telecom is well behind Unicom in terms of the overall subscriber base, it has about 39 million 3G subscribers on its network, which is just a shade under Unicom’s 43 million. By launching these popular 3G smartphones and transitioning its 2G base to 3G, China Telecom is hoping to close that gap quickly. Our price estimate for China Telecom stands at $68.45, about 20% ahead of market price.
3G market in China is an equitable mix
At less than 14%, 3G penetration in China is very low. This gives smaller wireless carriers such as China Telecom more opportunity to compete with China Unicom and the behemoth, China Mobile.
With more than 650 million subscribers, China Mobile is the largest wireless carrier in the world and has more than five times as many overall subscribers as China Telecom. China Unicom has almost twice as many total subscribers as China Telecom. But when it comes to 3G, the advantage is much less clear.
As of January, China Mobile had around 54 million 3G subscribers compared to China Unicom’s 43 million and China Telecom’s 39 million.
China Mobile may have the most number of 3G subscribers, but China Unicom has been adding more number of 3G subscribers on a monthly basis. China Telecom is not far behind, and the launch of the iPhone 4S last week may give it the added impetus to bridge the gap with Unicom. The iPhone 4S received more than 200,000 pre-orders in the week before launch, exceeding China Telecom’s expectations.
Increasing 3G adoption to help drive up ARPUs
Adding 3G subscribers will help China Telecom increase its ARPU levels as 3G smartphone users are huge data users as well. But the subsidies associated with selling an expensive smartphone such as the iPhone to drive sales will cause its margins to contract in the near term.
China Telecom announced that it is offering the iPhone 4S for free with a two- or three-year contract. That, along with increased marketing spend on promoting the phone, will take a toll on earnings in the coming quarters.
But signing the contract means that subscribers will be locked to its network for two or three years, ensuring a long-term patronage for its higher-margin postpaid plans, reduce churn and bring steady cash flows. The basic 16 GB model is being sold with a 3G postpaid plan of 389 yuan ($62) per month for a two-year contract or 289 yuan ($46) per month for a three-year contract. Even the cheapest $46 plan exceeds China Telecom’s current ARPU levels of around $7.40 by more than 6 times, implying that ARPU levels are likely to increase quickly with the iPhone in tow.
We have seen early iPhone adopter China Unicom’s EBITDA margin for its mobile division decline sharply since the end of 2009, when it first started selling the iPhone, but recover sharply since, pointing at the long-term benefits of subsidizing 3G smartphones. Moreover, the strategy of selling low-cost smartphones alongside the iPhone will provide some relief to the margin pressures.