"I purchased a large block of shares in China Mobile before Apple's most recent Worldwide Developers Conference (WWDC) anticipating that the iPhone would finally be released on the world's largest telecommunications network. After this did not happen, UBS downgraded the stock to a sell citing the Chinese government's redistribution of company profits to other carriers and poor management. If you had a significant play in the stock, would you hold the stock and look for a bump, or dump it and cut your losses?"
Redistributing profits from one company’s income statement to another company’s income statement – an idea that could only be Made in China. The weird way you have to think about China is that of one massive company which operates many subsidiaries. All they are doing is shifting profits from one of their subsidiaries to another to create equality (or what they perceive as equality) – a core belief of socialist/communist principles. That’s how I think of it, anyways, but I’m sure it is much more complicated. Since you mentioned that your intent was to profit from an iPhone adoption on the network, I will focus my analysis on the short-term view of the company.
Cell Phone Carriers – US versus China
The major difference between cell phone buyers in the United States and those in the rest of the world is how the phone is purchased and/or financed. In the United States, we buy a 16GB iPhone 5s for $199, then spend the next 2 years paying a hiked-up monthly service fee that helps to cover the remaining cost of the iPhone’s actual $649 price tag. In the rest of the world, including China, buyers have to shell out the $649 ($549 in the case of the “cheap” iPhone 5c) at initial purchase. That is no small investment, especially for a country with an average monthly income of less than $1,000 in its capital city (much lower for the whole country).
iPhone/3G Smartphone Adoption on China Mobile Network
I’m curious as to why you would choose to invest in China Mobile to profit from an iPhone announcement as opposed to investing in Apple. I would think that Apple has more to benefit from selling new iPhones to China’s largest carrier than China Mobile has from more monthly subscription payments. Nevertheless, the issue with China as a whole is that only 13% of mobile subscribers use 3G service – most likely due to the aforementioned price premium of purchasing a 3G enabled phone (smartphone). China Mobile has been adding approximately 3 million 3G users per month over the last year, with 22% of total users utilizing 3G (169.5 million out of 755.2 million total users). While that certainly presents a growth opportunity, the country’s standards of living and supply of low-cost smartphones will dictate how much users are willing to spend on these higher-priced services going forward.
Directly addressing the iPhone/China Mobile adoption, I personally think that the iPhone will be released on the network sometime this year or early next year. There is a rumored November 11th release of the iPhone on China Mobile (keyword: rumored). It is only a matter of time before the iPhone is released on China Mobile’s network, and I would be surprised if (at the very latest) it is released more than a month after rolling out its new 4G service.
Summary
One of the main reasons China Mobile reported a significant drop in profit for Q3 was higher costs associated with building the 4G network and expanding the 3G network. If I trusted the Chinese government and China Mobile’s leadership, I would not be concerned as an investor in the company. Despite lower profit for Q3 due to higher costs associated with network investment, the company continues to report higher subscriber growth, higher revenues, and higher percentages of customers utilizing 3G. However, the fact that this company operates out of a communist regime seems to weigh heavily on the stock price. If a company of similar size, growth rate, and dividend yield were offered in the United States, I estimate it would trade in the $127 to $153 range (based on industry average P/E ratios and considering the same number of shares outstanding).
Recommendation
Hold until rumored release date and reassess position on November 11th. You have fundamentals in your favor, but technical indicators working against you. Look for price support around the low $51 mark. I don’t think you will recoup all of your losses in the short-term, but there is opportunity for some price appreciation. Definitely more upside than downside at this price.
Other things to keep in mind:
China Mobile is an American Depositary Receipt (ADR) meaning a U.S. bank purchases shares in a foreign company (in the company’s domestic currency) and then gives you a fixed number of shares in the company. There is nothing inherently wrong with this, but it adds, among other things, certain macroeconomic variables including currency risk. Because of this currency risk, ADRs will be disproportionately negatively affected should the Federal Reserve decide to taper their QE program in the coming months. This is because QE (since they are essentially “printing” money) causes inflation. This means the price of China’s currency is appreciating (versus the US dollar) since the US has a higher inflation rate than that of China. Based on current conditions, if the stock price of China Mobile were to remain the same in China’s currency, the value of China Mobile (an ADR) would increase due to the increasing value of the Chinese Yuan versus the US Dollar. The opposite would take effect should the fed decide to taper. Investors generally retreat from stocks at the end of the QE programs (which would cause the stock to go down), and the US inflation rate would most likely fall below the inflation rate of the Chinese Yuan, causing a disproportional drop in the China Mobile ADR versus a company that trades directly in US Dollars.
Cell Phone Carriers – US versus China
The major difference between cell phone buyers in the United States and those in the rest of the world is how the phone is purchased and/or financed. In the United States, we buy a 16GB iPhone 5s for $199, then spend the next 2 years paying a hiked-up monthly service fee that helps to cover the remaining cost of the iPhone’s actual $649 price tag. In the rest of the world, including China, buyers have to shell out the $649 ($549 in the case of the “cheap” iPhone 5c) at initial purchase. That is no small investment, especially for a country with an average monthly income of less than $1,000 in its capital city (much lower for the whole country).
iPhone/3G Smartphone Adoption on China Mobile Network
I’m curious as to why you would choose to invest in China Mobile to profit from an iPhone announcement as opposed to investing in Apple. I would think that Apple has more to benefit from selling new iPhones to China’s largest carrier than China Mobile has from more monthly subscription payments. Nevertheless, the issue with China as a whole is that only 13% of mobile subscribers use 3G service – most likely due to the aforementioned price premium of purchasing a 3G enabled phone (smartphone). China Mobile has been adding approximately 3 million 3G users per month over the last year, with 22% of total users utilizing 3G (169.5 million out of 755.2 million total users). While that certainly presents a growth opportunity, the country’s standards of living and supply of low-cost smartphones will dictate how much users are willing to spend on these higher-priced services going forward.
Directly addressing the iPhone/China Mobile adoption, I personally think that the iPhone will be released on the network sometime this year or early next year. There is a rumored November 11th release of the iPhone on China Mobile (keyword: rumored). It is only a matter of time before the iPhone is released on China Mobile’s network, and I would be surprised if (at the very latest) it is released more than a month after rolling out its new 4G service.
Summary
One of the main reasons China Mobile reported a significant drop in profit for Q3 was higher costs associated with building the 4G network and expanding the 3G network. If I trusted the Chinese government and China Mobile’s leadership, I would not be concerned as an investor in the company. Despite lower profit for Q3 due to higher costs associated with network investment, the company continues to report higher subscriber growth, higher revenues, and higher percentages of customers utilizing 3G. However, the fact that this company operates out of a communist regime seems to weigh heavily on the stock price. If a company of similar size, growth rate, and dividend yield were offered in the United States, I estimate it would trade in the $127 to $153 range (based on industry average P/E ratios and considering the same number of shares outstanding).
Recommendation
Hold until rumored release date and reassess position on November 11th. You have fundamentals in your favor, but technical indicators working against you. Look for price support around the low $51 mark. I don’t think you will recoup all of your losses in the short-term, but there is opportunity for some price appreciation. Definitely more upside than downside at this price.
Other things to keep in mind:
China Mobile is an American Depositary Receipt (ADR) meaning a U.S. bank purchases shares in a foreign company (in the company’s domestic currency) and then gives you a fixed number of shares in the company. There is nothing inherently wrong with this, but it adds, among other things, certain macroeconomic variables including currency risk. Because of this currency risk, ADRs will be disproportionately negatively affected should the Federal Reserve decide to taper their QE program in the coming months. This is because QE (since they are essentially “printing” money) causes inflation. This means the price of China’s currency is appreciating (versus the US dollar) since the US has a higher inflation rate than that of China. Based on current conditions, if the stock price of China Mobile were to remain the same in China’s currency, the value of China Mobile (an ADR) would increase due to the increasing value of the Chinese Yuan versus the US Dollar. The opposite would take effect should the fed decide to taper. Investors generally retreat from stocks at the end of the QE programs (which would cause the stock to go down), and the US inflation rate would most likely fall below the inflation rate of the Chinese Yuan, causing a disproportional drop in the China Mobile ADR versus a company that trades directly in US Dollars.
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