China Mobile Ltd. (ADR) (NYSE:CHL) (HKG:0941) will increase the amount it spends on handset subsidies 26% this year, from 27 billion yuan to 34 billion yuan ($5.49 billion) to keep its contract prices competitive in the face of rising competition, Reuters reports, though the company intends to keep its marketing expenses flat this year.

Apple China Mobile Deal

The announcement comes following disappointing 4Q13 earnings from the China Mobile Ltd. (ADR) (NYSE:CHL) (HKG:0941). The company missed consensus EBITDA by 16% and net profits by 13% because of slowing service revenue growth and falling margins. Management has also guided that the dividend payout will remain at 43% of net profits instead of the expected increase to 45%.

“We believe a flat payout ratio could be a disappointment to the market as net profit is expected to decline in 2014 due to rising 4G costs,” writes Morgan Stanley analyst Navin Killa, who rates the company Equal-weight.

Revenue growth, margins both disappoint

Service revenue growth was 2.5% year-on-year (down from 6% growth in the 3Q13) and 3.3% sequentially in the fourth quarter. Voice revenue growth became more negative, falling from -0.7% year-on-year during 1H13 to -4.4% during the second half. This was offset by data revenue growth, but there the overall picture was still problematic as data revenues fell from 25.5% year-on-year in 1H13 to 23.4% in 2H13.

China Mobile Ltd. (ADR) (NYSE:CHL) (HKG:0941) added 12 million new mobile subscriptions, and converted another 10 million subscriptions from 2G to 3G, but average revenue per user (ARPU) declined 5.2%. China Mobile has seen a big spike in its 3G/4G subscription adds since last November when it started offering the iPhone 5, which only covered part of the fourth quarter, so we could see more of an impact on revenue growth when 1Q14 earnings are released.

EBITDA fell 17.5% year-on-year and 11.7% sequentially as margins took a big hit, falling 850 basis points to 35.2%. Net profits fell 16% year-on-year, in line with the EBITDA hit, but also increased 6.5% over the third quarter.

China Mobile needs to improve ARPU

Increasing the amount that it spends on contract subsidies should help China Mobile Ltd. (ADR) (NYSE:CHL) (HKG:0941) drive new subscriptions, but it will also exacerbate the margin pressure that it’s facing. The company needs to find a way to also increase ARPU so that its efforts to bring in new subscriptions can also substantially improve net profits. The boost that China Mobile has gotten from iPhone sales is significant, but it needs to perform in other metrics if it’s going to keep shareholders happy.