Deep-dive 2021-6: China Unicom (Hong Kong) Limited

At 0.33x EV/Sales, China Unicom (762 HK) is possibly the most inexpensive of any telecom operator globally. It's the third largest telecom operator in China, with exposure towards both wireless and fixed-line services.

The wireless telecom industry is competitive and we don't necessarily think that China Unicom possess real pricing power to speak of. But carriers enjoy subscription revenue that is recurring and high earnings visibility. Also, in China the industry is an oligopoly with only three major companies. The regulator has so far been kind to the incumbents.

In 2020, China Unicom achieved an operating margin of 3.7%. We think that this operating margin is likely to go up in the next few years:

  • China Unicom's 5G capex was front-loaded, with capex and depreciation occurring far ahead of the actual revenue 5G was likely to bring

  • Smartphones that support 5G are becoming more ubiquitous and the company is now marketing its 5G plans heavily

  • As China Unicom's 5G penetration rate goes from current 23% to a much higher level, blended ARPUs are likely to increase and revenue growth is likely to accelerate

  • China Unicom's new partnership with China Telecom means that capex and maintenance expenses are going to be shared with another company, thus enabling the company to go head-to-head with industry leader China Mobile in terms of network quality while maintaining the capex / sales ratio at a reasonable level

The company's share price suffered from 2019 onwards due to the capex needed to launch a 5G network. It also suffered somewhat during the depths of COVID-19 as roaming revenue and mobile data usage dropped temporarily as individuals stayed at home. Further, US Executive Order 13959 prohibited American investors from investing in China Unicom, putting selling pressure on the stock from the second half of 2020 onwards.

We think there is a good chance that President Biden will scrap the executive order altogether. Even if he doesn't, the selling pressure is likely to abate by November 2021, which is the last date at which American investors will be able to sell their shares by. Judging from our own discussions with other investors, we think it's highly unlikely that any major American shareholder still owns large positions in the Chinese telcos. The selling pressure has already abated.

With a share price very close to its 2003 lows, a net cash position and an EV/Sales of 0.33x, we think the downside is limited. Assuming an uptick in China Unicom's operating margin to 5.4% by 2023e, we foresee an EV/EBIT of 6.1x, implying an upside of +64%.

The major risk is that the government pushes telecom operators to lower their prices. A mitigating factor is that the government is reliant on dividends from its SOEs and therefore does not want to see profitability deteriorate.

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The above article and PowerPoint presentation constitute the author’s personal views only and is for entertainment purposes only. It is not to be construed as financial advice in any shape or form. Please do your own research and seek your own advice from a qualified financial advisor. The author may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this article. Disclosure – we do not hold a position in China Unicom (Hong Kong) Limited at the time of publishing this article (this is a disclosure and NOT A RECOMMENDATION).

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