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China Mobile Poised To Benefit From Surging Data Demand

As can be seen from the Chinese telecom data released each month, the carriers are now adding more number of 3G subscribers than 2G. China Mobile, which is more than six times the size of Verizon with over 665 million mobile subscribers currently, stands to gain heavily from this transition. Increasing 3G adoption will serve to boost its already increasing data ARPU levels further, more than compensating for the fall in voice ARPUs as a result.

But the Chinese behemoth hasn't been able to capitalize on its huge 2G subscriber base as well as it should have. As of May, China Mobile's 3G subscriber base stood at around 64 million which translates to a 3G penetration of just under 10%. This compares poorly to the industry-wide average of more than 16% in China.

A major reason for that has been its homegrown TD-SCDMA 3G network which is incompatible with most smartphones currently available, including the iPhone. This requires handset vendors to come out with specially crafted phones for the carrier's proprietary network which has proved to be a huge deterrent.

We believe that Qualcomm's (QCOM) recent announcement of a baseband chip that supports China Mobile's networks will finally make it easier for Apple as well as other vendors to release compatible smartphones on the world's largest carrier. (See "Qualcomm Paves the Way for an Apple-China Mobile iPhone Deal." ) A possible launch of the iPhone 5 on China Mobile later this year could be the much anticipated tipping point for the carrier in its bid to drive 3G adoption rates.

Near-Term Margin Pressures

However, the carrier will have to bear a huge subsidy burden to drive the demand for 3G smartphones. Having a huge subscriber base to promote 3G to is no doubt a good opportunity, but the subsequent near-term subsidy pressures could be huge if 3G demand inflates suddenly.

So far, China Mobile hasn't had to subsidize much due to the dearth of smartphones that run on its 3G network; but, looking at how much China Unicom's margins have taken a hit over the last few years due to the subsidy burden, the margin pressures could be huge. China Unicom's mobile Ebitda margins have nearly halved in the last three years as subsidies for smartphones such as the iPhone ate into profits.
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