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CHL AT A GLANCE

P/E ► 12.2 AVG EV/EBITDA ► 6.69 AVG ROA ► 19.3% HIGH ROE ► 28.5% AVG Debt to Equity ► 0.487 AVG Current Ratio ► 1.33 AVG Interest Coverage Ratio ► 97.5 HIGH

 

 

 

 

 

 

China Mobile Ltd. (NYSE:CHL, SEHK:0941) is China's dominant mobile service provider, with 60% national market share. It is the world's largest telecom (telecommunications company) by subscriber count, serving more than 384 million people as of March 27th, 2008. Its size gives it an efficiency and resource advantage over its competitors, but brings a burden as well. As the shining star of the Chinese telecom industry, China Mobile is expected to be a main financial supporter of any home-grown telecom technologies--a literally draining honor.

China Mobile is currently focusing its domestic expansion and development resources on rural market capture. Rural markets are much more sparsely penetrated than urban ones, and China Mobile's extensive existing network gives it a significant boost in the race to grab as many of the rural market mobile users as possible. China Mobile's future success will depend in large part on its rural expansion.

The Chinese government plays a large role in regulating the telecom industry, and China Mobile is very much subject to any disturbances that may come from that direction. In May 2008, China Mobile lost $26B in market value when the Chinese government said it would start to merge smaller rivals to increase competition.^[1] With the 2008 Olympics looming, China is anxious to release its new third-generation homegrown mobile technology. In an effort to build this network, China Mobile signed a $1B deal with Alcatel to provide the infrastructure for the network. The ensuing distribution of licenses will have a huge impact on China Mobile's course for the next few years.

History, Company Profile, and Products

In 2000, China Mobile split off from then-monopoly China Telecom (NYSE:CHA), and has since leaped to the forefront of China's telecom industry. Known in China for its high quality of service and extensive network, it is the mobile operator of choice for most of China's nearly 400+ million mobile phone users.

China Mobile's vast size gives it an important economic scale advantage in telecom, an industry which rewards carriers for being large (i.e., many subscribers and an extensive network). The bigger a telecom company, the more free capital it has to spend on growth areas, and thus the better its network coverage, research, distribution, and marketing. This higher-quality service and better public image attracts more subscribers, which leads to yet more growth. In addition, incremental costs (including marketing, advertising, and distribution costs) tend to plateau after a certain point of expenditure: so when a large telecom company grows, the proportion of income spent on incremental costs declines, too.

As a wireless carrier, China Mobile sells services instead of products. These phone services can be divided into three main categories:

• Standard voice services let users make and receive calls, including local, long distance, and roaming calls, with domestic and international options.
• Value-added services include voice mail, caller ID, caller restrictions, call waiting/holding/forwarding, and conference calls. These services are usually added to a calling plan individually at extra charge, or bundled together in certain high-demand groups.
• Data services also tend to be individual options that are added on to a basic calling plan. These include SMS (Short message services, or text messages), MMS (multimedia messaging services), WAP (wireless application protocol, which allows internet access from the phone), Color Ring (replaces the standard dialing/connecting ring that a caller hears with a song or voice recording), internet telephony, and Java application platforms.

Different combination packages of these services distinguish China Mobile's three primary brands from each other. Each brand is geared towards a different audience. GoTone targets the middle-to-high end market with wide and reliable network coverage, a strong selection of value-added and data services, and a high-quality support team. Shenzhouxing targets the mass market with lower prices and cheaper phone plans. Finally, M-Zone uses its poppy image and emphasis on multimedia selection with "cool" features to rope in the youth/student group.

Business Drivers

Rural Market Expansion

China's rural regions remain largely untouched by cellular companies: total market penetration is just 12% (compared to 32% overall nationally). In addition, the Chinese government's recent focus on addressing the urban-rural divide by increasing rural income and development means that the rural population may experience an increase in demand for cellular services. China Mobile's already extensive physical network of cellular signal centers means that it is in prime position to take advantage of this developing rural market.

The table below provides a comparison of rural ownership of some common, reasonably expensive household appliances. Mobile phones are clearly gaining in importance, and may soon overtake fixed-line phones as the primary means of communication.

Source: PRC National Bureau of Statistics

High Rural Profitability

Mobile companies' standard profitability indicators include ARPU, average revenue per user. Most rural subscribers tend to favor the most inexpensive and basic plans, depriving mobile carriers of the more profitable added-value voice and data services. Thus, rural ARPUs are usually expected to be lower than urban ARPUs, making each rural subscriber less profitable to the company on average than each urban subscriber. However, China Mobile's current rural ARPU of RMB40-50/month is significantly higher than is needed for rural break-even (RMB30/month; US$1 is apprx. 7.9RMB). Rural areas can be much more profitable than expected, for a number of reasons:

• Rural ARPUs are lower than urban ARPUs by about RMB30/month, but rural building and maintainance costs are also lower.
• A significant minority of rural subscribers (small-business owners, migrant seasonal workers, or students) have relatively liberal spending habits. Many small farmers are also growing dependent on value-added data services, including SMS reporting of weather conditions and crop price fluctuations.
• Cellular substitution in rural areas has been a more prevalent than expected. Many rural Chinese are replacing fixed-line phones with mobile phones as China Mobile begins to undercut fixed-line prices. New models of cellular phones that mimic the look and feel of traditional fixed-line phones further encourage the cellular substitution trend.

The Challenge of Rural Markets

As rural market penetration increases, China Mobile may have difficulty maintaining its rural profitability for two main reasons:

• The family-based nature of most current rural subscriptions make it difficult for China Mobile's rural expansion to remain so lucrative. Most subscribed rural families have only one mobile phone and thus can afford to spend a relatively large amount on it. But if the subscriber count goes up, more phones per family will mean less expenditure per phone, resulting in an ARPU drop. If China Mobile tries to get around this by signing up more families, it will have to expand into poorer segments of the population, who again won't be able to spend as much per new subscription.
• The Chinese government has been experimenting recently with "New Socialism" in an effort to revitalize certain ailing rural communities. Uncertainty about the effect of these experiments on rural spending capacity and their possible widespread adoption could raise problems for China Mobile's rural expansion plan.

Governmental Regulation

China Mobile Limited's parent company is China Mobile Communications Corporation, a state-owned enterprise that holds 75% of CHL's shares. These close ties to the Chinese government means that China Mobile Ltd. can be pressured into actions not in the best interests of its minority stockholders. Governmental intervention is one of China Mobile's biggest risks.

3G Licensing and Development

The impending introduction of 3G or third-generation mobile technology could potentially damage China Mobile's financial position. 3G's advent means that the Chinese government will have to distribute new operating licenses for competing "standards" (mobile information transmission protocols): internationally-accepted WCDMA, and home-grown TD-SCDMA. The government strongly favors TD-SCDMA for political and nationalist reasons--the coming 2008 Olympics are a particularly big deadline for the standard's launch--but a swich to TD-SCDMA will be expensive, since it requires extensive new infrastructure and testing that the already-established WCDMA doesn't.

Although disputed half a year ago, today it is generally understood that China Mobile's parent company will be required to "lead" TD-SCDMA's network development with support from China Netcom (CN) and China Telecom (CHA). It will take the lion's share of a RMB27 billion (apprx. US$3.4 bn) bill as a way of "fulfilling its social responsibility" as China's leading mobile carrier. China Mobile may only be licensed to operate TD-SCDMA, a blow to its profitability. On the other hand, if the Chinese government throws its full weight behind TD-SCDMA, the home-grown protocol may dominate the Chinese market and make WCDMA irrelevent.

Enforced Restructuring

China Mobile's near-monopoly on the Chinese wireless market may lead government officials either to reorganize and split up China Mobile, or to demand the implementation of policies that would help smaller telecom companies compete. For instance, China Mobile might be forced to introduce one-way number mobility (this lets people leaving the service keep their old numbers, while people switching to China Mobile for the first time still deal with the hassle of getting new numbers), or to allow the use of its extensive cellular network by other companies for roaming.

Pro-Consumer Legislation

With the advent of the 2008 Olympics near at hand, the Chinese government is eager to promote "harmony and goodwill" throughout the country. As part of this effort, a slew of pro-consumer legislation is in the works. If passed, the legislation would probably call for changes that either benefit consumers at the expense of companies' competitive edges (e.g. number mobility) or that eliminate misleading but lucrative practices. The government may also demand expensive investigations of embezzlement and corruption in China Mobile, which would damage its public image no matter what the investigation's results are.

Overseas Investing

A good overseas acquisition or partial acquisition results in an important additional source of capital for China Mobile, allowing the company to spend yet more on either further investments or on network maintenance. Interests overseas may also act as buffers against fluctuations of the Chinese market, making China Mobile less susceptible to sudden or unforeseen negative economic trends. However, a bad overseas investment could be a huge drain of resources for China Mobile, and could also expose it to negative publicity.

After a long search for an appropriate venue to invest in, China Mobile recently acquired an 89% share in Pakistani telecom company Paktel. While many are enthusiastic about Paktel's possibilities for expansion, others point out that Paktel is the only of Pakistan's 5 telecom companies that has been losing subscribers annually. China Mobile may have to invest significantly in new equipment and marketing to bring Paktel up to speed.

Comparison to Competitors

Of wireless Chinese telecom companies, China Mobile leads the pack. Its only significant competitor in this sector is China Unicom (CHU), a much smaller company which occasionally tries to undercut China Mobile's prices; however Unicom has difficulty sustaining the price advantage because of its lack of resources. Unicom is not well-positioned for rural expansion. Of the two cellular standards it operates, GSM has cheap handsets but spotty coverage in rural areas, while CDMA has better coverage but pricier handsets--a big minus in the frugal countryside. However, if China Unicom is acquired another major telecom company, it could shift the balance of resources enough to threaten China Mobile's position. Lastly, CHL is eagerly searching for cheap acquistions during the economic downturn, which could better position the company to thrive once the economy goes on an upswing.

China Mobile's biggest threat by far remains wired-line or "fixed-line" companies China Netcom (CN) and China Telecom (CHA). Wired-line companies also provide broadband internet services, which may give them an extra boost. Things to look out for include:

• Personal Handheld System: the PHS device is a limited-range mobile phone that uses land lines for service. A relatively new technology, total PHS subscription has been increasing at more than 30% a year, "stealing" a sizeable chunk of wireless customers from China Mobile and China Unicom. PHS could develop into a serious threat for China Mobile, especially in rural markets.

• Bundling: most industry experts believe that at least one of the two wired-line giants will receive a license that lets them use 3G wireless technology. If so, Netcom or Telecom would be able to bundle broadband internet, 3G wireless service, and fixed-line service in a single package at a competitive rate. China Mobile has no way to offer broadband or fixed-line service and cannot directly compete with this offering.

Over the past few years, wireless companies have been adding subscribers at a faster rate than their fixed-line competitors, as can be seen in the table below.

Note the surge in fixed-line growth towards the middle of the chart--this is due to the introduction and temporary aggressive promotion of PHS by fixed-line companies.

Although most of the data from this chart dates from before broadband internet subscriptions became prominent, it is important to remember that this is no longer the case. The rise of broadband could play an important role in increasing fixed-line subscription rates in these coming years.

Despite impending threats, China Mobile currently leads by a long stretch in revenue. This can be seen clearly in the table below, which compares size (subscribers), subscription growth rates (millions added/month), and ARPU (Millions RMB/month) for China Mobile and each of its three main competitors in 2006. The table also breaks down these elements into service type (GSM mobile, CDMA mobile, fixed line voice including PHS, broadband internet).

But China Mobile's current strong position aside, broadband internet's high ARPUs could help fixed-line providers catch up--especially since the two main providers are relatively close behind in total subscription numbers. China Mobile's gigantic lead is largely due to its extremely high monthly ARPU, a result of its very profitable added-value services. If rural expansion causes the ARPU to go down, China Mobile's margin will be significantly diminished.

All data above is for 2007 Interim Financial reports unless marked by an asterisk. Those catagories marked indicate that the company did not put out figures for the segment to be found within its respective 2007 Interim Report.

References

1. ↑ China Mobile Shares Fall, Losing $26B in Value
2. ↑ China Mobile 2007 Interim Financial Report
3. ↑ China Unicom 2007 Interim Financial Report
4. ↑ China Telecom 2007 Interim Financial Report
5. ↑ China Netcom 2007 Interim Financial Report