China Mobile: Tea Leaves Give Mixed Reading

There has been a lot of confusion around China Mobile’s (CHL) future prospects in the wireless market. China Mobile is currently building out a 3G network standard known as TD-SCDMA, created in China and rife with protectionist tones and technical snafus. The Chinese Ministry of Industry and Information Technology has mandated that China Mobile build out the standard, but by sourcing all the development work domestically, the standard has lost any global relevance and inter-operability.

Still, the rollout continues unabated as 38 cities are to be up and running by mid-2009. Meanwhile, China Mobile’s two main competitors are likely to get 3G licenses from the government in the globally compatible CDMA2000 and W-CDMA standards. The confusing setup is all part of a broader, concerted effort by the Chinese government to create three globally competitive operators, where before China Mobile was the lone 800lb gorilla. (This earlier post discusses the forced M&A that went on earlier in the year)

Tea Leaves Give Mixed Reading

So the bad news is that billions are being spent on a system that closes off many handset options, including the iPhone. However, compared to its competitors, China Mobile’s billions in capex needed to get rollout moving have been quite modest. The company has only spent $2.2 billion (U.S.) to get the first 10 cities implemented, whereas China Unicom (CHU) and China Telecom (CHA) will need to pony up a combined $36 billion to get their networks set up, as basically, they are starting from scratch.

China Mobile, meanwhile, has received increasing handset offerings for its 3G standard, getting Nokia on board recently to join LG Electronics (LGERF.PK) and Samsung (SSDIF.PK). CHL has also re-opened talks with Apple (AAPL) to work out a deal, one that would likely include Apple designing a dual-band handset capable of running on GSM and TD-SCDMA while shutting off its W-CDMA chipset. We could see something inked early in 2009, but (as with all business plans right now) that is subject to change.

The good news is that we’re fairly close to the time when serious 4G rollout plans will begin. The global recession may throw a massive wrench into the current timetables, but 4G figureheads Verizon (VZ), Vodaphone (VOD) and China Mobile have discussed getting a rollout going as early as the first half of 2010. While Verizon and other Western telecoms will likely adopt a slightly different multiplexing standard than China Mobile, the global equipment makers will dually support the standards.

For its part, management at CHL has pretty much acknowledged the current problems with its 3G license, but note that about 60% of the investment in TD-SCDMA terminals can be put towards integration into 4G LGE. For the next year, China Mobile will continue to expand the 3G rollout, mainly to get the infrastructure footprint built for 4G, which should include all the necessary backwards compatibility for 3G and GSM (EDGE 2.5G), the latter being the “fallback” network currently used by nearly all CHL customers.

Stock Price Stabilizing

CHL shares are forming what appears to be a stable bottom just above the $40 level. Down over 50% from their peak, China Mobile shares reflect the certainty of slowing growth and the ongoing concerns of government intervention. The margins are absolutely to die for, with a 27.9% net margin in the last quarter to go with operating margins above 35%. Go compare this with Verizon or AT&T (T) to find out just how rare this is in the industry.

China Mobile’s dividend (which is quasi-pegged to the USD) should see continued growth as management has expressed its desire to keep the payout ratio constant. For investors willing and able to take a 3-5 year view of this company, the secular trends in play should stand out like a neon light. Rural exposure is still below 50% in most provinces, and China Mobile is years ahead of the competition in terms of customers and footprint.

The company is adding over seven million new customers per month, and also continues to drive operating leverage from higher use of SMS and other data services. China Mobile currently trades for about 11x run-rate earnings and boasts a minute .08 debt/equity ratio, providing valuable measures of safety to market and sector averages.

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Disclosure: Author does not hold a position in the companies mentioned.

Comments

[Pipo:]

its time to invest in chinese stocks, says Jim Rogers

www.jimrogers-investme...

2008 Nov 27 11:12 AM

[Urbane Gori...:]

Pipo..... Rogers has been saying this for a long time. In fact, he has been saying this as the FXI has fallen from its peak to its present 65% loss. Rogers has said many times that he is not a market timer, so if you have his cash, then you'll probably do pretty well. If, like most investors, you do not have his collateral, then you might want to buy China when it shows signs of life,

There are signs of panic in China right now. Just look at their 30% rate cut last week, their unemployment figures, the drop in their exports and production, their pollution problems, their real estate deflation, collapsed car sales, their fraudulent banking issues, etc... etc.. If you want to buy China, I'd seriously study it, rather than just listening to the latest 5 minute blurb on CNBC, or pronouncements from one Guru or the other. If you are serious, then, I'd buy James Trippon's book.. "Become Your Own China Guru", then I'd read 'Oracle Bones' and subscribe to Michael Pettis' excellent RSS feed at mpettis.com. Unfortunately, we Americans tend to measure the rest of the world by our own yardstick. Other countries have a different perspective. If you do not understand their perspective and where they are coming from and how they fit into this global jigsaw puzzle, you don;t know what you are buying. That's a recipe for disaster. And, speaking for myself, I don't need any more pain this year.

Sorry about the sop-box rhetoric, but aside from the issues I've indicated above, there are particular issues that affect CHL. To become completely familiar with them, I'd Google 'China Mobile' and 'TD-SCDMA'.. I'd also read up on the Chinese governments manipulation of these three players in the Chinese phone market. There have been some excellent articles here on SeekingAlpha. Briefly, the government has forced the merger of the two smaller players, and has forced CHL to accept their proprietary TD-SCDMA format. They have forced CHL to fund the smaller players, and have allowed the other two companies access to the globally compatible formats as stated above.

This is not to knock China. China clearly is more inwardly looking than the rest of the world. Further, they have stated they are not interested in playing nice with anyone else if it compromises their future. Nothing wrong with that. Don;t you wish our government had done the same?

Anyway... Nice article.... jegan ;-)

2008 Nov 27 12:32 PM

[Dan Butterf...:]

Nice article Ryan.

I thought it was interesting to read recent comments from China Mobile's CEO re Apple's App Store ... Wang Jianzhou gave Apple and Steve Jobs kudos for the tremendous success with the iPhone and App Store. Yet it is apparent that China Mobile wants to control the entire wireless value added services platform. Wang Jianzhou has even hinted about building their own App Store and even a wireless handset operating system that supports China Mobile's Monternet VAS.

Few handsets today are delivering a superior net browsing experience and China Mobile is none too pleased with the initial crop of TD-SCDMA ready handsets (when people don't like your network, blame the phone). They have high hopes for the forthcoming crop of TD-SCDMA models from Nokia, HTC/Android and the rumored but yet to be confirmed TD iPhone 3G from Apple.

My hope is that Apple will have two iPhone deals in China ... One with China Mobile ... the aforementioned "customized" TD iPhone 3G, and a second deal with China Unicom to deliver a more standard iPhone 3G.

China MIIT has dropped several recent hints over issuance of all three 3G licenses within the next 90 days. I wouldn't hold my breath ... but it is looking like this just might happen. China Unicom has also hinted that they will be ready to launch their W-CDMA network by mid-2009. This will bring some legitimate competition to China's mobile market.

It's my belief that China Unicom would be more willing to give free reign to handset makers' services and innovations - such as Apple's (e.g. App Store, Mobile Me, Wifi, iTunes [someday] and in the future "wave-pay")

In my view China Mobile attempting to control the entire VAS ecosystem is not going to work for many hundreds of millions of wireless customers and China Mobile stands to lose customers to China Unicom and China Telecom if they insist on over-customization and total control of handsets.

~ Dan Butterfield, iPhonAsia

2008 Nov 27 12:39 PM

[bbowen7:]

For those of us who like to pick their own stocks, this is good evidence that there are limits to our ability. Experts in China's markets and in telecom add real value for those who want to benefit from the rise of China. I owned CHL for awhile as a play on China (and have some Turkcell for similar reasons), but realized that I didn't understand either the technology or the governmental strategy - just that the government would control what happened, and it would probably not be with my interests at heart. My advice would be to pay a fund manager.

2008 Nov 27 01:08 PM

[Ryan Barnes:]

Thanks jegan & Dan...and kudos on your blog Dan, I read through some of your great posts to help me understand the landscape. I agree that CHL has gotten itself into a pickle, and will likely begin to lose customers as soon as CHU gets their 3G up in the first 10 cities. I'm hoping that the 4G upgrade will then happen within a year, or shortly enough to keep the customer losses to a minimum.

Long term I do think CHL's inherent costs advantages and outlays will keep them the best-positioned of the three operators. But MIIT is a real wildcard; I think the desire to keep citizens happy will ramp up the freedoms given to all three companies. I see AAPL doing two different deals; they are much too protective of their brand to let it get away from them in China. But they also won't spurn CHL; 400m customers is too many to ignore.

Regards, RB

2008 Nov 27 01:19 PM

[Dan Butterf...:]

@Ryan you said "I see AAPL doing two different deals; they are much too protective of their brand to let it get away from them in China. But they also won't spurn CHL; 400m customers is too many to ignore."

I agree ... Apple's first deal in PRC may have to be with China Mobile ... Building a special (still just guesswork) "TD iPhone 3G for China Mobile" presents a real dilemma for Apple ... This type of crippling customization is an almost unthinkable divergence in strategy for Apple and I can already hear the “no ways!” … However, China (MIIT and other ministries) may have pushed hard for just such a compromise as a way to promote their nascent TD-SCDMA network. Think of this compromise as Apple’s entrance fee into China’s highly controlled handset market. The good news is that a large share of Apple’s risks/costs in developing this customized TD iPhone 3G may be born by China Mobile’s parent CMCC (i.e. China). More >
idannyb.wordpress.com/.../

2008 Nov 27 01:53 PM