China Unicom (CHU), China’s second largest mobile operator, announced its fiscal 2010 results with earnings per share of RMB 0.16 ($0.024 per share) plunging 60% year over year.

Adjusted net income fell 59.7% year over year to RMB 3.85 billion ($0.569 billion). This significant year-over-year decline in profitability can be traced to high costs associated with 3G service deployments and network expansion.

2010 represents the second consecutive year when China Unicom’s net income has dropped more than 50%.

Revenue & Subscriber

Total revenues climbed 11.3% year over year to RMB 171.3 billion ($25.3 billion). Telecommunication service revenues were RMB 161.8 billion ($23.9 billion), representing approximately 94% of total revenue. Excluding deferred fixed-line upfront connection fees, total revenue and telecommunication service revenues, respectively, increased 11.5% and 8.5% year over year.

Total revenue from the mobile business increased 24.4% year over year to RMB 89.55 billion ($13.23 billion). A large contributor to this was telecommunication service with revenues of RMB 82.36 billion ($12.16 billion), up 18% from the prior year. China Unicom added 19.839 million subscribers bringing the total number to 167.426 million at the end of 2010.

China Unicom’s 3G business is growing at a faster pace since its introduction in October 2009. 3G business telecommunication service revenues were RMB 11.59 billion ($1.71 billion) in 2010 compared with RMB 769 million in 2009. The company’s total 3G subscriber base reached 14.060 million, with 11.318 million new customers in 2010.

Telecommunication service revenue from the GSM business rose 2.6% year over year to RMB 70.77 billion ($10.45 billion). Net additions were 8.521 million subscribers, reaching 153.366 million at the end of 2010.

Excluding deferred fixed-line upfront connection fees, revenue from the fixed-line business was RMB 79.86 billion ($11.79 billion) and telecommunications service revenue was RMB 78.70 billion ($11.62 billion). Telecommunications services revenue from the fixed-line business dipped 0.4% year over year.

Telecommunications service revenues from the broadband business was RMB 29.82 billion ($4.4 billion), up 24.8% from the previous year. China Unicom added 8.674 million customers bringing the total number to 47.224 million at the end of 2010.

The fixed-line voice business recorded revenue of RMB 40.12 billion ($5.92 billion), down 13.3% from the prior year. Erosion in fixed-line voice subscriber base continues with the loss of approximately 6.187 million customers over the year, bringing the total customer base to 96.635 million.

Expenses

Total expenses in fiscal 2010 increased 17.5% year over year to RMB 166.52 billion ($24.59 billion) due to higher selling expenses, network deployment costs and depreciation charges. Selling and marketing expenses rose 13% year over year, mostly due to higher promotional spending on 3G services. 

Liquidity

China Unicom’s debt-to-capitalization ratio remained healthy. At the end of December 2010, debt-to-capitalization ratio was 32% and net debt-to-capitalization ratio was 24.6%.

The company spent RMB 70.19 billion ($10.37 billion) in 3G, GSM, broadband and data, and infrastructure and transmission network in 2010. This represents a decline of 37.6% from 2009.

Our Analysis

3G remains a compelling opportunity and represents the single biggest driver of the company’s long-term growth. We believe China Unicom will continue to make significant progress in expanding economies of scale in 3G, broadband and other businesses that will likely improve the company’s overall revenue and profitability.

However, the company contends in a highly competitive domestic wireless market. China Unicom remains significantly challenged by aggressive nationwide 3G service rollouts by its peers China Mobile (CHL) and China Telecom Corp. (CHA).

Further, despite the 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.

We are currently maintaining our long-term Neutral rating on China Unicom supported by the Zacks #3 (Hold) Rank.

 
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