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China Mobile – Big on Upside

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By: Sam Quest
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China Mobile Ltd. (CHL) is the largest mobile services provider in the most populous country in the world. A state-owned enterprise, it is headquartered in Hong Kong, but services customers residing on mainland China as well. The company boasts the largest wireless services subscriber base in the world, and the largest wireless network in China.

China’s dynamic economy has taken on a new shape over the last three decades owing to massive urbanization. Rural to urban migration is at the highest levels in the country’s history, and China Mobile has already gained much from the trends. However, we expect more growth going forward, as a large portion of the Chinese wireless services market is still untapped.

China Mobile’s sales, as reported at the end of the first half of 2013 (1H13), totaled $48.9 billion – up 16% year-over-year (YoY). The compounded annual growth rate (CAGR) of sales over the preceding three years had been 13%. Its subscribers at the end of the period totaled 740 million – an increase of 8.5% YoY. As of 1H13, China Mobile’s subscriber base had been growing by an average 11.3% each year over the three preceding years.

Business Model

China Mobile operates a communications network and controls related infrastructure. The company, unlike its competitors, does not provide wireline services; instead, it focuses on wireless solutions, including wireless voice and data services. A majority of the company’s revenues are generated from mobile voice communication services, but recent trends point to a gradual increase in the share of revenues from mobile data services in the overall mix.

The company releases its performance reports on a semi-annual basis. All values quoted in the report are represented in US dollars.

Segments

China Mobile generates most of its revenues from two of its three operating segments. The company’s Voice Services segment contributes 61% of its topline, followed by the Data Services segment, which contributes 34%. Interconnection Services is the smallest segment, accounting for only 5% of the company’s total revenues.

Voice Services

The Voice Services segment generates revenues from calls made over the China Mobile network. This has historically been the largest segment for the company in terms of revenues, as China Mobile’s network infrastructure was initially only able to support wireless telephony services. Voice Services generated $28.3 billion through 1H13, an increase of 0.9% YoY. The segment had been growing at a three-year CAGR of 5.7%.

Even though Voice Services remains the largest business segment for China Mobile, its share in total revenues has been declining over recent years. It contributed 71.5% of the company’s revenues at the beginning of 2010, but only 61% of the total as of 1H13 as most of its revenue share was steadily taken over by the Data Services segment.

Data Services

The Data Services segment generates revenues from subscribers’ usage of data services. The Chinese government has recently issued licenses for the rollout of next generation Long Term Evolution (LTE) technology. The introduction of the technology is likely to catalyze growth in demand for data services, as it will allow faster data transfer rates and enable mobile users to watch data-heavy content, like videos, on the go. Revenues from the segment over 1H13 totaled $15.4 billion, up 28% YoY. The segment posted a three-year CAGR of 23.5%.

Within its Data Services segment, China Mobile records revenues under three distinct heads, namely: Mobile Data Traffic Service; Applications and Information Services; and SMS and MMS Revenue. Among these three categories, Data Traffic accounts for the largest chunk of Data Services revenues. Data traffic jumped 129% YoY in 1H13, increasing from 389 billion megabytes (MB) to 891 billion MB; while revenues from data traffic increased from $4.6 billion in the comparable year-ago period to $7.6 billion – an increase of 65.6% YoY. Data traffic revenues had been increasing at a three-year CAGR of 59.4% since 2010.

Applications and Information Services is the second-largest revenue stream within the Data Services segment. It generates revenues from sales and usage of mobile apps. It reported revenues of $4.4 billion for 1H13, which was an increase of 12.3% over the year-ago period. The segment had a three-year CAGR of 14.3%.

SMS & MMS Revenues are generated from text and video messages sent over the carrier’s network. Revenues under this head totaled $3.3 billion for 1H13; down 3.6% YoY, even though the segment had recorded a CAGR of 5.5% over the three preceding years.

Interconnection Services

Interconnection Services, China Mobile’s smallest business segment, generates revenues by charging connection fees to other carriers when a call is placed by them through China Mobile’s network. Revenues in the six months through June 2013 totaled $2.3 billion, up 8.1% YoY. The segment had a three-year CAGR of 18%.

Industry

The Chinese telecom industry – the largest in the world in terms of subscribers and connections – provides wireless, fixed line, internet and TV services to an ever-expanding market. Like other industries in the Chinese economy, it is dominated by a few state-owned enterprises.

The Chinese telecom industry underwent major reorganization in 2008, which resulted in a great degree of consolidation in the market. Three major carriers emerged from the reorganization, and they currently control the entire Chinese market. These companies – China Mobile Limited, China Unicom Hong Kong Limited (CHU), and China Telecom Corporation Limited (CHA) – together provide wireless services to over 1.17 billion subscribers in mainland China; either directly, or through one of their many regional subsidiaries.

We have covered the Chinese telecom industry in detail in an earlier piece. For further information, read: Chinese Telecoms Look Set to Grow

Upcoming Catalysts

China is the largest consumer market in the world. It has been urbanizing at the rate of 3.7% each year since 2000, and latest data reveals that almost 700 million of its 1.4 billion citizens now reside in the country’s urban areas.

Increasing urbanization and rising urban wages have resulted in an increase in discretionary incomes. Disposable income in urban areas averages about $4,000, which is more than three times the average income of $1,270 in rural areas.

China surpassed the US as the largest market for smartphone buyers in early 2012, and smartphones now account for almost nine of every 10 handheld devices sold in the country. Increasing demand for smartphones in the future, along with growth in discretionary incomes, will lead to higher data usage and, consequently, higher revenues for the company’s Data Services segment.

China Mobile last Friday announced the launch of Apple’s (AAPL) iPhone on its network. The phone is expected to drive sales to high-end users, who typically consume more data and buy more data services products than other users.

The company is also upgrading its network to 4G technology, which will support the iPhone handsets it now offers and result in an increase in data traffic going forward.

Stock Price Drivers

A rising tide lifts all boats, and China Mobile is no exception to that rule. The company’s earnings have replicated growth patterns very similar to China’s employment levels. China Mobile’s per share earnings are positively correlated to the number of employed workers in China by a factor of 0.88.

Device sales and smartphone shipments are also correlated to China Mobile’s earnings by factors of 0.73 and 0.96. Over the years, handheld device and smartphone shipments and sales have grown at incremental rates, and the company’s earnings have moved in tandem: growing from $0.33 per share in 2004 to $1.02 per share as of the end of 2012.

Global smartphone shipments are forecasted to reach around 1.7 billion by 2017, and the Chinese market is still virgin land for the smartphone industry. As of now, smartphone penetration on the Next Generation 3G LTE network stands at a mere 22% in China. Considering China Mobile’s partnership with Apple Inc. (AAPL) and the increase in smartphone penetration worldwide, the company’s large subscriber base offers a big advantage to China Mobile over its peers.

Comparable Valuation Sheet

Industry Metrics

China Mobile generates the highest revenues from wireless services, and also leads the market in terms of its overall subscriber base. This is partly because the company provides wireless services only, compared to its two competitors, which also provide wireline services like landline telephony and broadband internet.

The company also boasts of the lowest churn rate – or the rate at which users discontinue its services – among the three, while recording the highest Average Revenue per User (ARPU).

Financial Metrics

China Mobile is the largest company in the group in terms of current market cap. It also reports the highest wireless revenues, but lags the other two companies in terms of revenue growth rates.

China Mobile also enjoys the highest margins and is able to return more on assets (ROA) compared to the other two companies. It is also significantly deleveraged compared to China Unicom and China Telecom.

*Price-to-earnings multiple.

Valuation

China Mobile stock is currently trading at a P/E multiple of 9.4x, which is a discount of 10.5% to the Hang Seng index, and a 36% discount to the Hang Seng Commerce & Industry Index. China Mobile is also trading at a discount of 51% and 33% to its peers, China Unicom and China Telecom.

Taking P/E multiples based on earnings by year-end 2014, the stock is currently priced at a 5% discount and a 33.5% discount to the Hang Seng and Hang Seng Commerce & Industry indices. It is also trading at a discount of 46% and 25% to China Unicom and China Telecom.

Conclusion

All the numbers seem to be in China Mobile’s favor. For starters, it is the largest mobile carrier in terms of overall subscribers. Secondly, its primary market is the largest population center of the world, which is also becoming increasingly wealthy. Finally, while hundreds of millions of people have migrated to urban areas in the country, about an equal number still remain settled in rural areas, where the company has traditionally enjoyed strong penetration.

From a financial perspective, the company is trading at a discount to its peers, a moderate discount to the Hang Seng index, and large discounts to the Hang Seng Commerce & Industry and the US S&P indices.

We believe the company’s prospects look very strong, as it is continuing expansions and upgrades to its network. These will increase its data transfer speeds and net the company more high-end users, who are more data-hungry and have higher ARPUs.

Given the upside from its increasing market share, larger, faster network, and the introduction of the iPhone, we rate the stock a Buy. Get in on this before it’s too late!

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