Unicom(0762.HK):Poor mobile business

Weakening fundamentals

China Unicom’s 1H results were weak, with earnings slightly aboveexpectations, while mobile revenue disappointed. Net earnings were up4.5%YoY to Rmb7bn, 9% above expectations due to big marketing costcut. But, mobile revenue declined 9.7%YoY due to loss of users,especially high-end. Unicom lost 10m users in 1H and another 0.9m inJuly. 3G/4G users rose by 5m in July, but most are low-end users. 3GARPU declined 16.7%YoY in 1H and could continue to decline at doubledigits. The company raised capex to stay competitive. Shares havedeclined 12% last month. Our HK$11.50 target implies 6% upside plus2% yield. We retain our TP, but upgrade the stock from SELL to U-PF.

Mobile revenue disappointed

Mobile business disappointed. Mobile service revenue was down 9.7%YoY toRmb73.5bn, 2.6% below expectations. The disappointment was likely to lossof subscribers, especially high-end and big data pricing decline. Unicom lost9.8m users in 1H. Total users declined 1.9% to 289m. Unicom is struggling togrow 4G users given a lack of investment. It is also losing high data usersback to China Mobile. CU lost another 0.9m users in July. 3G/4G usersincreased by 5.1m in July, but most are from its 2G users with low ARPU.

Big drop in mobile ARPU

Blended ARPU fell 11.6%YoY to Rmb41.6 in 1H, near historical low. Unlike CTand CM, CU ARPU was flat HoH even without VAT impact. Both 2G and 3GARPU continued a big downward trend. 2G ARPU was down 14.7%YoY toRmb24.5 while 3G ARPU declined at bigger 16.7%YoY to Rmb57.3. 3G ARPUcould continue to decline at double digits with new low-end 3G/4G users.

Big marketing cost cut boosted EBITDA, but not sustainable

EBITDA grew 5.8%YoY to Rmb50.5bn and EBITDA margin was 42%. EBITDAwas better than expected due to big marketing cost cut, which was down38%YoY. The lower marketing cost also resulted from weak user growth. But,the big marketing cost cut could hurt future growth as a small operator.

Raising capex

CU increased 2015 capex budget from Rmb100bn to Rmb110-120bn tostrengthen competitiveness. Capex should peak this year, but could stay highin 2016, depending on competition. FCF just turned positive in 2013 and willlikely be negative again this year. Management change will unlikely changethe competitive landscape materially. Turning around CU is not easy given thehigh debt and government pressure to cut cost and lower data pricing.