China Telecom Reaps Efficiency Gains in 1Q After 3G Assets Acquisition

Carrier China Telecom CHA increased first-quarter revenue 15% year over year to CNY 78 billion ($12.6 billion) thanks to strong mobile service revenue and handset sales. EBITDA grew at a much faster pace of 36%, as the firm benefited from scale efficiencies on its 3G network after it acquired the assets from its parent at the end of December. We are maintaining our narrow economic moat rating and $61 fair value estimate, and we think the stock is undervalued.

Mobile and broadband businesses were key growth drivers for China Telecom, thanks to strong subscriber growth and a fairly stable average spending trend. The carrier added 9 million 3G users in the quarter (to a total of 78 million) and 3.1 million broadband customers (to a total of 93 million), bringing in solid incremental revenues from mobile voice, data, and other value-added services. Similar to what we heard from rival China Unicom CHU on Thursday, the legacy fixed-line business service remained a laggard for China Telecom because of the loss of customers to mobile services.

For the quarter, the firm’s EBITDA margin expanded by close to 700 basis points to 36.3% of service revenue, which we attribute to favorable leverage of the 3G network. Network operations and support expenses fell 27% year over year as the firm no longer had to pay leasing fees for the 3G network capacity, although this was partially offset by higher depreciation expenses due to a larger asset base. We expect China Telecom to reap more benefits from scale efficiency as it ramps up 3G subscriber growth in the coming quarters.

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