China Mobile Ltd (CHL), the largest telecom operator of the world in terms of number of subscribers, beat analysts' estimates by improving its net profits by 1.3% for the third quarter of the current year while its revenue for the first nine months of 2012 increased by 1.4% compared with last year. The company now has more than 698 million subscribers while it continues to add at least 5.4 million customers each month. The business dominates in the Chinese market where it continues to gain traction due to its cheap phone and call packages through hefty handset subsidies, which now stand at $4.1 billion.
China Mobile did not release any specific quarterly data but said that it earned $14.92 billion in the first nine months of 2012, up from $14.73 billion in the corresponding period last year. Based on that data, the company's net profit for the third quarter was $4.98 billion, rising from $4.91 billion in 2011 and beating the estimated $4.89 billion. Despite the continuous increase in subscriber base, the company's profits have not increased as it has not been able to upsell subscribers to 3G data plans even though China's 3G market touched 200 million users in the last week of October.
On the other hand, China Mobile's closest rival, China Unicom (CHU) reported that it now has more than 63 million 3G subscribers. As a result, the company's profit jumped by 30% and revenues rose by 19% from January to September as compared with last year. Unicom reported a net profit of $865 million for the first nine months of 2012, rising from $674 million in the same period last year. China Unicom's superior performance has highlighted the importance of data downloads compared with conventional voice calls.
Total Subscribers (Millions)
YoY Subscriber Growth
*Q2 2012 Data
Where China Mobile's margins are reflective of its business model with lost barriers-to-entry and heavy subsidization, China Unicom has the advantage over peers since it was the first Chinese operator to support Apple's (AAPL) iPhone and remains the market leader in that respect. China Mobile's own 3G network could not support the previous versions of iPhone while China Telecom (CHA) has started support for the smartphone this year.
China Mobile has been a hole in Apple's penetration strategy for a long time due to its refusal to adapt its supply chain to accommodate the unique transmission system. However, the new iPhone 5 is equipped with Qualcomm's (QCOM) modem that communicates using China Mobile's TD-SCDMA technology, which means that with minor tweaking, the iPhone can finally run on China Mobile's network. Perhaps Apple is clearing the way toward a possible partnership with China Mobile. It needs it if it wants to staunch the market share bleeding that is happening.
China Mobile has itself been hinting at discussions with Apple but so far nothing has happened. China is a huge smartphone market, which is growing rapidly and is dominated by Samsung. Lenovo recently secured the second spot and is becoming notorious for displacing former U.S./European leaders in technology device sales. It has surpassed Hewlett-Packard (HPQ) as the largest PC seller and now leap-frogged over Nokia (NOK) and Research In Motion (RIMM) in China. It has an impressive strategy to attack up and down the market simultaneously while up-selling the brand image as a local producer.
China Mobile's relatively lower P/E, higher yield and ROE offer a good option for the value investor. Its peers have been struggling due to the tough competition on price. And it is hard to imagine a future where China Mobile will not dominate the Chinese market due to the sheer size of its lead in subscribers. The challenge will now be its ability to generate greater revenue per user by attracting 3G and 4G customers. Currently, China Mobile leads with 75.6 million 3G users, which is closely followed by China Unicom with 66.9 million users and China Telecom with 56.4 million users. Although China Mobile has the lead but that's a very small number compared with its huge subscriber base and China Unicom and China Telecom are not that far behind China Mobile in terms of 3G users. Looking at those numbers more closely, just 10% of China Mobile's total subscribers are 3G as opposed to China Unicom's 30% and China Telecom's 40%. China Mobile is now investing heavily to develop its 3G network while it is planning to start 4G trials next year in the key areas of Hangzhou, Shenzhen and Guangzhou in anticipation of The Chinese Ministry of Industrial and Information Technology awarding 4G licenses, which is very likely.
As smartphone ASPs drop and the devices rise in functionality, a great number of those 2G subscribers will upgrade to 3G and eventually 4G and at that point China Mobile's thin margin, high CAC (Customer Acquisition Cost) business model will begin to pay off handsomely. But, like Amazon's approach, everything has to go right for that to happen. One misstep can put it in a serious cash crunch. Investing in China Mobile on this thesis will require watching its 3G roll-out carefully and we should expect to see margin expansion over time.