China Mobile Eyes Long-Term Growth, But It Comes With A Cost

| About: China Mobile (CHL)


China Mobile has recently reported its half-yearly results.

China Mobile’s revenues climbed but income dropped on higher costs.

China Mobile’s profits could continue to remain under pressure this year.

It’s long term outlook, however, is what investors should focus on.

China Mobile (NYSE:CHL), the biggest player in China's enormous telecom market, with the largest subscriber base in the world, could continue to struggle with profits this year. But the company is eyeing a brighter future in the long term.

The recent earnings release has shown a drop in profits, but the company is growing where it matters most, data services.

Earlier this month China Mobile released its half-yearly results in which operating revenues increased by 7.1% in H1-2014 from a year ago to $52.8 billion, driven by a 4.7% increase in revenues from telecommunication services, to $48.5 billion. The improvement was due to a 27.81% increase in data services revenues which offset the 53% drop in voice services revenues. The data services unit was buoyed by 52% higher wireless data traffic revenues, which now represent a little less than a quarter of China Mobile's core telecommunication services.

Clearly, the relatively newer data services business has been driving China Mobile's growth. On the flip side, with a shift toward wireless data traffic, the company's traditional business has come under pressure. During the first half of this year, the voice service revenues dropped by 5.3% to $26.9 billion and the high-margin SMS/MMS revenues fell by 13.2% to $2.9 billion from the corresponding period last year.

A surge in operating costs by 13.2% caused a drop in net profits by 8.5% to $9.38 billion. China Mobile has been making heavy 4G investments and has been giving iPhone subsidies following the deal with Apple (NASDAQ:AAPL) which caused a surge in expenditures.

On the other hand, China Unicom (NYSE:CHU), the second biggest player in the industry, which recently made headlines following a deal with electric car maker Tesla (NASDAQ:TSLA), reported 3.6% and 25.8% growth in operating revenues and profits for the first half of this year on the back of lower operating expenses and strong adoption of 3G.

Meanwhile, the relatively smaller China Telecom (NYSE:CHA) has also released its second quarter results in which it managed to increase its revenues and profits 5.7% and 4% from a year ago, respectively. China Telecom's results showed slowest top and bottom-line growth in the last six quarters.

Higher 4G Investments

During the first half of this year, China Mobile added 46.9 million 3G and 13.94 million 4G subscribers, taking the aggregate customer base to 790.61 million users. Due to the strong growth of 3G/4G customers, they now represent 32% of China Mobile's total subscriber base, up from 25% in 2013.

The growth, particularly in terms of 4G subscribers, is significant considering China started offering 4G services at the end of last year.

The company has already doubled its annual capital expenditures to $12 billion. By the end of the year, China Mobile expects to have 50 million 4G subscribers. China Mobile has made significant investments to ramp up its 4G offerings. The company has already built more than 410,000 4G base stations in the country, more than twice as much as in Europe, and will have more than 500,000 base stations by the end of this year.

Other Chinese telcos also are eyeing strong growth in the 3G and 4G space. The three leading players, China Mobile, China Unicom and China Telecom, have established China Communication Facilities Services Corporation to develop infrastructure for provision of 4G services across the country with an initial investment of $1.63 billion. The new entity will undertake construction and operation of telecom towers, base stations and other essential transmission network.

Lower Smartphone Subsidies

The increase in China Mobile's 3G and 4G customer base was partly fueled by subsidy costs. A significant portion of the growth of its 4G customer base was driven by its deal with Apple. The company offers its own SCDMA 3G standard, as opposed to the WCDMA 3G standard, which is offered all over the world as well as by its other two competitors. To lure customers, China Mobile offered deep discounts, which albeit led to the explosive growth of its 3G/4G subscribers, had an adverse impact on the company's bottom line.

Initially, China Mobile planned to spend $5.7 billion, 30% up from last year, to tap into the rising demand of 4G handsets. However, due to the government's call on reducing marketing expenses, the company is cutting its expenditures by $2 billion. China Mobile has already spent $2.49 billion in the first half and has just $930 million for the remainder of the year. Lower subsidy costs will likely have a positive impact on H2-2014 results.

Lower subsidies will substantially increase the prices of 3G and 4G compatible phones, particularly Samsung's Galaxy phones and Apple's iPhones. This can have an adverse impact on the 3G and 4G adoption in the country. China Mobile could witness a drop in the robust growth of its 3G and 4G subscribers.

On the other hand, the much anticipated launch of iPhone 6 in the near future can give a boost to China Mobile's 4G subscriber growth. Analysts have said that the launch of the phone could be a major catalyst for China Mobile.

The chairman of the Chinese company Xi Guohua has repeatedly stressed that his company "must" be the first Chinese carrier to offer iPhone 6. Guohua will likely get what he requests, given that Apple's fate in China is closely tied with its relationship with the country's biggest carrier.

Inorganic Growth

Additionally, China Mobile also has said that it will pursue investment avenues overseas. The company has acquired 18% of True Corp., a Thailand-based telecommunications company, for $880 million. This was China Mobile's second big step outside of its home after its bought most of a Pakistani telco Paktel, rebranded as Zong, about seven years ago for $284 million.

During the earnings conference call, China Mobile said that it is still looking for additional acquisition opportunities, particularly those companies that can complement its core business. The telecom giant has also clarified that it is not only looking at other companies in emerging markets, but also hunting for companies with growth opportunities in developed countries.

The company has net cash (cash and bank deposits minus total debt) of more than $74.3 billion.

Bottom Line

China Mobile is eyeing long-term growth, but it comes at the expense of lower short-term profits.

China Mobile's bottom line will remain under pressure due to the $12 billion capital expenditure program, but the company will likely witness improvements in revenue growth in the coming years. The company could continue growing its 3G and 4G subscribers and with better coverage, China Mobile also could lure customers from other subscribers. The company will likely continue growing its data services revenues at a robust pace, which will offset the declines coming from the traditional voice and SMS/MMS revenues.

The company is also targeting inorganic growth through acquisitions which is a positive development. Historically, China Mobile hasn't used its massive cash reserves to invest in other companies either at home or abroad. However, it appears that the company is now getting serious about using its cash to fuel its growth.

China Mobile's American depository receipts have risen by 19% this year. In terms of trailing price-to-earnings ratio, the shares are cheaper than China Unicom and China Telecom. China Mobile also offers an attractive yield of 3.27%, significantly higher than its two peers. I expect the shares to continue going higher as it builds its 4G infrastructure and grows its data revenues.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Sumaiya Amin, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Sumaiya Amin have any positions in the stock(s) mentioned in this article.