Description

CHU (NYSE)/ 762HK summary: China Unicom is the world’s fourth-largest telecom company by subscriber base. Although there are plenty of reasons to be concerned about it in the short-term, the stock is now cheap enough to offer a large margin of safety. A recovering Chinese economy, a partnership with China Telecom, and continued 5G rollout provide upside, while the solid dividend, share repurchase program, and overall depressed valuation provide strong support and a good margin of safety.

It can be traded in Hong Kong, or as an ADR here in the US. 

I believe that CHU can realistically double within a year.

Background: I’ll spare you the company history, except to say that CHU started as a state-owned enterprise (SOE). There was an attempt at SOE reform in 2016-2017, as these companies were seen as uncompetitive. This effort (somewhat) decreased state control, added strategic partners such as Tencent, and improved profitability on the bottom line, but could not overcome the issue of mobile saturation. This is one factor in the current depressed share price, although I argue that COVID-19 and rising US-China tensions contribute as well.

Thesis: The core to the thesis that the current depressed share price has more than priced in these concerns, and that the extremely strong financials, the balance sheet, and the dividend limit any further downside risk. This is further buttressed by the share repurchase program approved 5/25/20, for up to 10% of the existing shares. I do not think there is any company in the US with equivalent cheapness and quality. While the dividend isn’t quite as attractive as at rival China Mobile (CHL), I think that CHU offers a far better chance at additional upside via equity appreciation and is therefore a better investment target. Deutsche Bank estimates the stock will be at a 6% FCF yield in 2020

https://www.sec.gov/Archives/edgar/data/1113866/000119312520114410/d823309d20f.htm

Potential upside drivers:  The rollout of 5G should be a significant driver for CHU. Statistics from the China Academy of Information say that 5G devices were ~39% of Chinese phone production in April, up from 28.6% in March. This trend should continue according to IDC, with 5G smartphone shipments +184% sequentially in 2H20.

This is significant as 5G ARPU is higher. Mobile average revenue decline per user dropped to 3% in Q1, thanks to higher uptake of 5G plans, and upgrades from 4G could raise ARPU by 10%+ over the course of the year.

To give a better idea of how broad this roll-out should be, it is expected that all of China’s prefectural-level cities will have 5G access by YE20, vs. only 50 in 2019. CHU expects to have 250K 5G base stations, up from 20K at YE19, in partnership with China Telecom.

The China Telecom partnership is also interesting. The two firms are not just collaborating on 5G, but other spectrums as well. This is a welcome change after a long period of battering competition with China Mobile. Even with the 5G rollout, capex for CHU is guided to be only CNY70bn, up from CNY60bn Y/Y thanks to this partnership. I don't want to speculate further on how this partnership could develop, but it's certain possible that CHU and China Telecom work even more closely in the future as their older competing 3G networks go obsolete.

Risks: There are plenty of risks, although as mentioned, I believe shareholders are being compensated to take them. Risks include: a sustained second outbreak of covid19, a broader US crackdown on CHU and other Chinese telecoms operating in the US, further US limitations on 5G technology, weakness or recession in the Chinese economy, increased competition from China Mobile/CBN partnership, large Chinese government stake, ADR/currency risk.

Catalyst

Overall, I believe that CHU offers an excellent risk/reward, with protection to the downside, and a very good chance at upside.