China Telecom Services:Gauging new regulatory impact:from tariff cut to depressed multiple

Premier Li called for elimination of long distance roamingOn Mar 5, China Premier Li Keqiang announced key guidance for thetelecommunication industry in the Government Work Report: (1) toeliminate domestic long-distance roaming charges before YE2017, (2) toreduce international roaming charges, and (3) to cut the tariff of Internetdedicated line access for small- and mid-size enterprise (SMB). Mr. Li alsoencouraged telco carriers to accelerate their data tariff reduction for bothwireline and wireless services. According to Caixin, three Chinesetelco carriers, CM, CT, and CU plan to eliminate domestic roamingcharges on October 1, 2017. Mr. Xi Guohua, the former CM chairman,commented that the elimination of roaming charges would have a neartermnegative impact on earnings, but is long-term positive to the industrythrough price elasticity.

Moderate earnings impact, but meaningful depression on multipleWe estimate that CM currently has more revenue exposure to roamingthan CT and CU because CM has a dominant market share in high-endusers and both CT and CU have already eliminated roaming charges in alltheir 4G packages. Moreover, we estimate that roaming represents only3%-4% of total revenues at CM because CM has proactively reduced itsexposure to roaming charges throughout 2016 and already targeted toeliminate roaming by late 2018. For example, CM has approximately 64%of its total subscribers on packages without roaming charges.

Consequently, we expect roaming elimination to impact only moderatelyon CM and minimally on CU and CT. The tariff cut on dedicatedInternet access to SMB may be more significant to CT and CU as theyare two traditional wireline service providers. For example, IT services &Applications represented 4% of total revenues at CT in 2015. Given verylimited information currently, we believe the new regulatory changes couldlower 2017-2018 earnings by c. 4%-8% at CM, CT, and CU based onexisting revenue breakdown although we do not incorporate into ourestimates yet. We note that the strong regulatory control over tariffs mayreinforce investor concerns of regulator interference that we believe hasbeen the main reason for the deep valuation discount of Chinese telcostocks that trade at 3.7X 2017E EV/EBITDA, well below that of their Asiapeers at 7.3X.