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The Best Deal of the Year is the Apple of China's Eye

|Includes: AAPL, China Mobile Limited (CHL)
We've all heard the advice, "Buy on the rumor. Sell on the news." Usually that works out well in practice. But last week's biggest most enticing rumor was completely overwhelmed by global stock market convulsions.

The rumor, spread by several credible sources, including AppleInsider, goes like this: "Apple is said to have landed the biggest prize in the mobile industry, partnering with China Mobile, the largest wireless carrier in the world, according to alleged company filings."

With 611 million subscribers, China Mobile (NYSE:CHL) dominates a whopping two thirds of the Chinese wireless phone market. Apple (NASDAQ:AAPL) was largely shut out of that immense customer pool several years ago after China Mobile refused to accept Apple's tough terms for partnership. Apple instead partnered with the smallest of China's telecom companies, China Unicom, in 2009 and sales of the iPhone got off to a sluggish start on the mainland.

A deal with China Mobile now would be a huge breakthrough both for Apple and for the world's biggest phone company.

But so far neither stock has reacted to the widespread reports.

Apple One-Week Performance

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The nosedive taken by U.S. and European markets last week also took Apple stock down about 5 percent, despite the many news reports of the company's potential for revenue gains in China.

It's tough to explain China's appetite for the iPhone. Even though China Mobile has been negotiating unsuccessfully with Apple since 2007, the wireless company says it actually gained an amazing 700,000 grey market iPhone 4 users in May alone. China Mobile reportedly has 6.2 million iPhone 4 users in total, even though the devices are not normally compatible with its network and they are technically illegal.

That's why the potential for revenue growth with fully compatible iPhone units, with Beijing's blessing, and with a carrier-subsidized subscription plan is huge.

How China Mobile Wins

China Mobile has been losing subscribers to China Unicom since the smaller carrier got access to the iPhone in 2009. Then several million subscribers jumped to China Unicom in order to get their hands on the iPhone as soon as possible. That trend continued over the following years as haggling dragged on between Apple and China Mobile.

Among the signs that a deal has finally been reached was a visit by Apple CEO Tim Cook to China Mobile headquarters last month. AppleInsider has published photo of the new iPhone, designed for China Mobile. But the mounting evidence didn't help China Mobile stock last week either.

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China Mobile shares and ADRs were off almost five percent as global financial turbulence pummeled markets on both sides of the Pacific.

We can safely say that the news has not been priced into either stock. So how big is the potential? Brian White of Ticonderoga Securities tells Benzinga that the market for smartphones in China is 100-125 million subscribers. That would translate to potentially $70 billion in revenues.

In a note to investors, White adds, "Apple generated $5 billion in revenue from Greater China during the first half of fiscal 201." That's a huge jump from just $3 billion in sales for all of 2010.

Undevalued?

The speculation among telecom sources is that China Mobile will release its own version of the iPhone as early as October. It might take several more months, but every indication appears to support the rumors of an imminent Apple-China Mobile deal.

An early launch could mean two or three million more iPhones sold in China this year. That would add to an already soaring Apple revenue base. Cash flow from China ballooned sixfold in the most recent quarter compared to a year ago.

With the latest market decline, Apple shares do not reflect the company's most recent blowout quarterly report. Revenues were up 82 percent and profits shot up by 125 percent.

Sales of the iPhone were up 142 percent and iPad sales were up 183 percent for the quarter year over year. The company also reported record quarterly revenue of $28.6 billion and record quarterly net profit of $7.31 billion. Apple's P/E multiple of 14.97 and forward P/E of 11.69 with a PEG ratio of 0.71 does not seem to reflect the company's potential valuation or growth rate.

Even without the China Mobile deal added to the balance sheet, Apple's profit margin is 23.53 percent. It's ROE is 41.99 percent.

China Mobile also has a relatively low valuation with a forward P/E of 11.17 and a profit margin of 24.74 percent. The company pays out a dividend of 4.10 percent at current share prices. The world's biggest wireless firm has a debt/equity ratio of 0.02.

In times of severe global volatility, the share prices of good companies are dragged down along with all the rest. The question is which will bounce back the fastest?

The answer is fairly obvious. The biggest, most stable and most undervalued firms should make the biggest gains when worldwide financial chaos subsides.

In my opinion these are two strong contenders and their potential deal makes them both even stronger.


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