China Unicom (CHU) has announced first-quarter 2010 results with net income plunging 68% year-over-year to RMB1.13 billion (US$165.7 million). This significant year-over-year decline in profitability is attributable to the high costs associated with 3G service deployments and network expansion, intense domestic competition and sustained erosion in fixed-line voice business.

China Unicom contends with a highly competitive domestic wireless market. The company remains significantly challenged by the aggressive nationwide 3G service roll outs of its peers China Mobile (CHL) and China Telecom (CHA).

Revenue Break-Down

The second largest Chinese wireless carrier posted consolidated revenues of RMB40.4 billion (US$5.9 billion), up 6.6% year-over-year. Service revenues increased 4.6% year-over-year to RMB38.62 billion (US$5.7 billion), accounting for roughly 96% of total sales.

Service revenue from the GSM mobile business increased 11.9% year-over-year to RMB18.63 billion (US$2.7 billion). Service revenue from the carrier’s 3G business was RMB1.59 billion (US$233 million). Wireless ARPU (average revenue per user) came in at RMB41.5 (US$6), up from RMB41.3 a year ago.

Growth in wireless was partly offset by a 1.6% annualized decline in fixed-line service revenue that reached RMB19.90 billion (US$2.9 billion). China Unicom’s local fixed telephony business continues to decelerate as a result of frozen tariffs and ongoing fixed-to-mobile substitution. The company is offering converged services to stem the losses in the fixed voice segment.

On a positive note, revenue from broadband service grew 23.8% year-over-year to RMB7.13 billion (US$1.05 billion), boosted by expansion of application content and increased network speeds.

Expenses Hit Bottom-line

Total expenses for the quarter leapt 16.9% year-over-year to RMB38.94 billion (US$5.7 billion) on account of higher marketing/promotional expenses, network deployment costs and depreciation charges. Selling and marketing expenses rose 22% year-over-year, mostly due to higher promotional spending on 3G services.  

Subscriber Statistics

At the end of the quarter, China Unicom had approximately 147 million 2G GSM subscribers while its 3G subscriber base reached 4.82 million. Growth in broadband was positive with roughly 2.9 million customers added in the quarter to reach 41.5 million connections in service. Erosion in legacy fixed-line voice subscriber base continues with a loss of approximately 1 million customers, bringing the total customer base to 101.8 million.

Opportunities & Challenges

China Unicom is making significant progress in expanding its WCDMA technology based 3G services which the carrier launched across 285 Chinese cities in October 2009. The carrier targets spending RMB23 billion (US$3.4 billion) on 3G in 2010 and capture one-third of the Chinese 3G market by year-end. 3G remains a compelling opportunity and represents the single biggest driver of the company’s long-term growth.

China Unicom introduced its customized Android handsets (“Uphone”) in January 2010 that uses Google’s (GOOG) Android platform. The government-backed Uphone project represents China Unicom’s second biggest opportunity in 3G handsets besides the iPhone, which it exclusively markets in China.

Moreover, China Unicom is planning to add Wi-Fi (wireless broadband) function to the iPhone. Lack of Wi-Fi support has hindered the device’s wider market adoption, resulting in lower sales.

While we remain bullish on China Unicom’s future growth prospects in 3G wireless, the associated expenditures for nationwide network deployments are likely to impact short-term profitability, tighten free cash flow and impact margins. Moreover, the carrier’s 3G business has challenges ahead as its rivals promote 3G services at lower tariffs and higher subsidies.
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