China Unicom (CHU), China’s second largest mobile operator, announced first quarter 2012 results with earnings per share of RMB 0.04 (or 6 cents), which missed the Zacks Consensus Estimate of 19 cents. However, earnings saw a three-fold jump from the year-ago earnings of RMB 0.01 per share.

Adjusted net income showed an enormous increase from RMB 145 million to RMB 1.0 billion ($158.6 million). High costs associated with 3G service deployments and network expansions were compensated by strong revenues.

Revenue & Subscriber

Total revenue (excluding deferred fixed-line upfront connection fee) climbed 24.8% year over year to RMB 61.19 billion ($9.7 billion). Telecommunication service revenues, comprising roughly 82% of the total revenue, were RMB 49.99 billion ($7.92 billion), up 13.9% from the year-ago quarter.

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) iPhones despite losing exclusive right to distribute iPhones to China Telecom Corp. (CHA) last year.

Total revenue from the mobile business shot up 42.3% year over year to RMB 40.45 billion ($6.41 billion). A large contributor was the telecommunication service with revenues of RMB 29.26 billion ($4.64 billion), up 25.6% year over year. China Unicom added 9.827 million subscribers to reach 209.487 million at the end of the first quarter.

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 12.53 billion ($1.99 billion), which accounted for 42.8% of service revenue from the mobile business, up from 24.4% in the year-ago quarter. The company’s total 3G subscriber base reached 48.860 million, with 48.860 million new customers added during the quarter.

Telecommunication service revenue from the GSM business fell 5% year over year to RMB 16.73 billion ($2.65 billion). Net subscriber added were 0.986 million to reach 160.627 million at March 31.

Revenue from the fixed-line business inched up 1.1% year over year to RMB 20.56 billion ($3.26 billion). Telecommunications services revenue from the fixed-line business also rose 1.1% year over year toRMB 20.55 billion ($3.26 billion) backed by the consistent growth in fixed-line broadband business.

Telecommunications service revenues from the broadband business was RMB 9.60 billion ($1.52 billion), up 13.6% from the year-ago quarter. China Unicom added 2.637 million customers in the quarter bringing the total number to 58.288 million.

The local telephone business recorded service revenue of RMB 7.57 billion ($1.2 billion), down 14.7% from the year-ago quarter. Erosion in fixed-line subscriber base continues with the loss of approximately 0.497 million customers, bringing the total customer base to 92.354 million.

Expenses

Total expenses crept up 22.6% year over year to RMB 59.87 billion ($9.49 billion) due to higher selling expenses, network deployment costs, interconnection charges and depreciation charges. Selling and marketing expenses increased 20.1% year over year to RMB 8.15 billion ($1.29 billion), mostly due to higher promotional spending on 3G and broadband services.

Liquidity

China Unicom exited the first quarter with cash and cash equivalents of RMB 17.942 billion compared with RMB 24.757 billion in the year-ago quarter.

Operating cash flow surged 45.4% year over year to RMB 17.032 billion in the reported quarter.

Our Take

China Unicom expects to generate revenues at a faster clip by accelerating large-scale developments of 3G and fixed-line broadband services. Although we are encouraged by China Unicom’s future growth prospects in its 3G wireless market, high levels of marketing and promotional expenditures could hurt profitability going forward.

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) and China Telecom.

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

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