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Chinese Telecoms Sector Summary

Core Content

The report discusses the valuation and strategic implications of the Chinese telecoms sector, particularly focusing on the impact of tower-sharing arrangements and the potential for value creation through asset monetization. It outlines the analyst's upgrade of the sector from Neutral to Overweight and the respective upgrades of China Mobile (CM) and China Unicom (CU) to Buy, while retaining the Hold rating on China Telecom (CT). The analysis highlights the benefits of tower-sharing for the sector and the differing impacts on each operator.

Main Points

• Sector Upgrade: The sector is upgraded from Neutral to Overweight due to the potential upside from tower valuation and increased industry efficiency from tower sharing.
• Tower Valuation: The enterprise value of the tower company is projected to be CNY284 billion, implying a 22% upside for CU, 17% for CT, and 4% for CM.
• Barbell Strategy: The analyst recommends a barbell strategy, buying CM for its 4G upside and CU for its tower-asset monetization potential.
• Tower Leasing Impact: Tower leasing fees will affect operating profits, with CM experiencing relatively less impact compared to CU and CT.
• Price Targets: The price targets for CM, CU, and CT have been raised by 12%, 17%, and 2%, respectively, based on the tower valuation analysis.
• Valuation Drivers: The key factors influencing tower valuation include the lease payment, number of towers, co-location ratio, and margins.

Key Information

• Tower Asset Monetization:

  • China Mobile: CM is the best 4G play in China. It will receive CNY65 billion in cash from the tower spin-off, with the majority paid in 2017. Its value is not heavily dependent on the tower company's IPO.
  • China Unicom: CU is the biggest beneficiary of the tower spin-off due to its smaller market cap. It stands to gain significantly from the monetization of its tower assets.
  • China Telecom: CT is also a beneficiary but its upside is less significant due to its lack of immediate cash proceeds and higher exposure to future tower lease costs.

• Valuation Assumptions:

  • A 20% margin on operating costs and 7% return on capex are used as benchmarks.
  • The co-location ratio is projected to increase from 1.24 in 2016 to 1.5 by 2018, with potential for further growth.
  • The tower company's equity value is estimated at CNY202 billion based on DCF analysis.

• Operating Profit Impact:

  • Operating profits for CU and CT are expected to decline significantly from 2016 onwards due to increased tower lease costs.
  • CM's operating profit is expected to remain more stable as it has a lower incremental tower requirement compared to its competitors.

• Investor Recommendations:

  • China Mobile is recommended for investors with a short to medium-term focus due to its stable profitability and strong 4G position.
  • China Unicom is recommended for investors with a long-term view due to the potential for higher upside from tower valuation in 2017.
  • China Telecom remains a Hold due to its higher sensitivity to future tower lease costs and lower immediate cash benefits.

Summary Table

Additional Notes

• The analyst notes that tower consolidation may lead to a decrease in the number of towers over time, which could impact the value of tower support service providers.
• The co-location ratio is a key factor in determining the value of the tower company, with the base case projecting an increase to 1.5 by 2018.
• The sensitivity analysis shows that the equity value of the tower company ranges from CNY141 billion to CNY292 billion depending on the return on invested capital and margin assumptions.
• The DCF-based equity value of the tower company is estimated at CNY202 billion, with the respective shareholding percentages for CM, CU, and CT as follows:
  • CM: 38% (equity value: CNY77 billion, 4% of market cap)
  • CU: 28% (equity value: CNY57 billion, 22% of market cap)
  • CT: 28% (equity value: CNY56 billion, 17% of market cap)

Figures and Assumptions

• Figure 1-3: Show the target price changes for CM, CU, and CT.
• Figure 4-7: Present operating profit and net profit estimates for the three operators.
• Figure 8-18: Include the assumptions and sensitivity analysis for co-location ratios, tower numbers, and operating costs.

The report concludes that while all three operators benefit from the tower spin-off, China Unicom offers the highest upside potential due to its smaller market cap and greater exposure to tower valuation.