China Telecom
(CHA) announced interim 2009 results today with net income of RMB8.4 billion ($1.2 billion), or RMB0.10 per share, down 27.5% compared to RMB11.6 billion ($1.7 billion), or RMB0.14 per share, reported in the corresponding period a year ago.

This annualized drop in profit is primarily attributable to higher marketing expenses associated with the deployment of the company’s 3G wireless services and persistent decline in legacy landline business. China Telecom reported a 24% year-over-year rise in operating expenses for the period, largely due to an annualized increase of 60% in SG&A costs (including mobile handset subsidies).

The largest Chinese fixed-line operator reported revenue of RMB102.6 billion ($15 billion) for the period, up 14.8% year over year, driven by healthy contribution from its wireless segment which offset the fall in fixed-line business. EBITDA shrank 2.1% year over year to RMB43.3 billion ($6.3 billion) with EBITDA margin equating to 42.3% compared to 49.5% reported a year ago.

Revenue from the wireline segment dropped 3.1% year over year in the first half of 2009, reaching RMB86.6 billion ($12.7 billion). Voice and non-voice revenue accounted for 47.4% and 52.6% of total sales, respectively. Wireline subscriber base fell by 9 million during the period to approximately 199.4 million.

Wireline voice revenue declined 18.7% year over year due to a weak economy and accelerated fixed-to-mobile substitution. To revive its wireline business, China Telecom has initiated several steps including cost control and bundled wireline voice, non-voice and mobile services.

Broadband access revenue came in at RMB22.7 billion ($3.3 billion), growing 18.2% year over year. At the end of the first half, total broadband connections reached 49.05 million, up 22.8% year over year. China’s broadband market is expected to grow at a compound annual rate of 25% over the next three years, offering significant opportunity for China Telecom which targets to sign up 65 million customers by 2011.

Revenue from the company’s value-added information applications grew 15.6% year over year to RMB13.9 billion ($2 billion), representing about 13.5% of total sales. ‘Best Tone’ service revenue rose 16.6% year over year to RMB2.5 billion ($0.4 billion).

China Telecom added mobile operation to its service offering in October 2008 after the acquisition of China Unicom’s (CHU) code division multiple access (CDMA) wireless business for almost RMB43.8 billion ($6.39 billion). Total revenue from the wireless segment for the first half of 2009 was approximately RMB16 billion ($2.3 billion).

The company hopes to increase its total mobile subscriber base to over 100 million by 2011 from about 39.3 million users at the end of the first half (up 10.8% year over year), driven by continued success of its newly launched ‘e-Surfing’ mobile network brand. This will represent over 15% of the total Chinese wireless market.

China Telecom remains committed to its 3G wireless venture as it plans to sign up 35 million new 3G users in 2009 and address 97% of urban population by the end of 2009. The company’s 3G service covered 342 Chinese cities at the end of first six months. Its CDMA 2000-based 3G network (peak download speed of 3.1 megabit per second) is 50% faster than China Mobile’s (CHL) home-grown TD-SCDMA 3G network, giving it a major competitive advantage.

While we believe China Telecom is well positioned to benefit from the rapidly growing Chinese wireless market boosted by the 3G prospect, expenses associated with the ubiquitous deployment of high-speed wireless services will hurt profit and margins through 2009.

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