CHINA MOBILE LTD 941
June 13, 2017 - 7:45pm EST by
agape1095
2017 2018
Price: 83.90 EPS 0 0
Shares Out. (in M): 20,476 P/E 0 0
Market Cap (in $M): 1,718K P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0 0

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Description

Pair Trade

Long China Mobile (941 HK) and short China Unicom (762 HK) – all numbers in RMB unless stated otherwise

Thesis Summary

Both companies operate in an oligopolistic market that is also highly regulated.  Due to the need for continuous capex deployment (5G rollout only 2 – 3 years away), China Mobile’s superior scale and stronger balance sheet to Unicom should warrant a valuation premium.  The current valuation discount to China Unicom provides an attractive trade for hedged investors.

Background

The telecom industry is considered “strategic” in China and as such the government maintains a tight grip on the industry.  The 3 telcos – China Mobile, China Telecom and China Unicom – serve the entire market and are in effect State-owned Enterprises (SOE).  All major decisions (e.g., strategic, personnel, M&A) require government blessing.  Recently a 4th telecom license was issued to another SOE – China Broadcasting Network – but the impact is expected to be negligible as the big 3 incumbents are well-entrenched.

Weighted by 2016 revenue, China Mobile is the leader with 53% market share and Unicom has 20% market share.

Mobile Market

In mobile, subscriber growth is limited as the market is saturated.  Penetration rate is over 100% with the number of subscribers slightly over total population.  Growth, if any, will have to be driven by ARPU.

As in elsewhere in the world, two trends are apparent.  First, fixed-line is in secular decline as consumers substitute with mobile.  Second, voice is losing market share to data.  Mobile data is the sweet spot and the vital battleground.

In order to capitalize on these 2 trends, the telcos are heavily investing in LTE networks in order to drive customers into higher ARPU products.  China Mobile is the dominant player in mobile.

Broadband Market

The broadband market is also dominated by the big 3.  They have been aggressively investing in fibre to keep pace with demand.  The independent operators that lease infrastructure from the big 3 are not real competition because their broadband speed significantly lags the big 3.  The difference in speed is especially striking when one visit a non-mainland Chinese website.

Geographically China Unicom dominates the Northern provinces and China Telecom dominates the South.  China Mobile, through its Tietong acquisition, mainly competes in urban cities.

There are 4 reasons why China Mobile is a better quality business and thus should trade at a premium to China Unicom

  1. China Mobile has far better economies of scale

China Mobile generated 2.6 times revenue and 3.2 times EBITDA of China Unicom in FY 2016.  Telecommunication is a capital intensive business with high fixed cost.  This is crucial as huge investments (4G, 5G, fibre, etc.) are required in the foreseeable future.  As the leader in scale, China Mobile is better positioned to invest and monetize its investment than China Unicom.

  1. China Mobile is far more profitable than China Unicom

Economic profit is defined as EBITDA minus net capex.  By this measure, and because of its scale, China Mobile is consistently profitable in the last 7 years and Unicom is only profitable in 3 out of the last 7 years.

China Mobile

EBITDA

net capex

Op FCF

FY 2010

236,984

-114,326

122,658

FY 2011

248,412

-124,291

124,121

FY 2012

253,578

-125,018

128,560

FY 2013

240,348

-139,997

100,351

FY 2014

240,125

-175,699

64,426

FY 2015

239,754

-173,686

66,068

FY 2016

256,178

-188,802

67,376

 

China Unicom

EBITDA

net capex

Op FCF

FY 2010

59,623

-75,182

-15,559

FY 2011

63,412

-76,430

-13,018

FY 2012

72,659

-85,697

-13,038

FY 2013

83,963

-71,214

12,749

FY 2014

92,771

-68,789

23,982

FY 2015

87,502

-86,129

1,373

FY 2016

79,498

-91,903

-12,405

 

  1. The return on invested capital track record between the two companies are very different despite both are operating in the same industry and are backed and regulated by the same central government.

Invested capital is defined as equity plus interest bearing debt minus cash and short term investment.  Op FCF is the numerator and is before tax.  ROIC declined significantly for both companies in recent years as both have to invest heavily in 4G LTE which debuted in 2014.  

The main point is China Mobile was able to absorb this capex and stay profitable whereas China Unicom was unprofitable in 3G (2010 – 13) and in hindsight was under-invested in 4G and now has to play catch-up in the crucial mobile segment.

ROIC

China Mobile

China Unicom

Difference

FY 2010

41.2%

-5.7%

46.9%

FY 2011

37.3%

-4.5%

41.9%

FY 2012

36.9%

-4.1%

41.0%

FY 2013

27.6%

3.8%

23.8%

FY 2014

15.2%

7.1%

8.2%

FY 2015

13.5%

0.4%

13.1%

FY 2016

13.0%

-3.4%

16.3%

 

  1. The capex/investment burden will continue to heavily weigh on the telcos.  China Mobile has the balance sheet to fund investments.  China Unicom is less capitalized.

For competitive reason, telcos have to invest in their network because aside from price, consumers also value speed and reliability.  China Mobile has invested over 1 trillion RMB in capex while China Unicom invested around 555 billion RMB in the last 7 years.  The former has better coverage and speed and thus is able to charge more than the latter.

Going forward, both firms have to continue to invest in 4G and 5G is expected to rollout in 2019-20, which would spur another cycle of capex.

Additionally, in China SOE investment decisions are often driven by the central government, not rationality or market forces.  The most notorious example is the TD-SCDMA (3G) standard that is only usable in China.  The State Council issued a “Broadband China Strategy and Implementation Plan”.  Phase II of the plan was completed in 2015.  Phase III is scheduled to be completed in 2020.  One thing is certain, whether it makes economic sense or not, capex will be ramped up.

China Mobile has a pristine balance sheet with ¥452.6B of net cash.  Its EBITDA is enough to pay for capex.  In contrast, China Unicom net debt is ¥149B (net debt/EBITDA = 1.9x), but most importantly, its capex is consistently greater than EBITDA, which means it is bleeding cash flow.  The dollar-weighted net capex/EBITDA from 2010 – 16 is 60% for China Mobile and 103% for China Unicom.

Valuation

The stock price in HKD has been translated into RMB using an exchange rate of 1 HKD = 0.87 RMB.  If Unicom trades down to Mobile EV/EBITDA multiple, the pair trade would return 25%.  If Mobile trades up to Unicom multiple, total return would be 12.7%.  If the relationship mean-revert and Mobile trade at 0.5X EBITDA higher than Unicom, the pair trade could return 23 – 43%, depending on if Mobile’s multiple expand or Unicom’s multiple contract.

EV

China Mobile

China Unicom

HKD / RMB

0.87

0.87

stock price in HKD

83.9

11.2

stock price in RMB

73.0

9.7

Shares outstanding

20,475.5

23,947.0

 

 

 

Market cap

1,494,568

233,340

cash

-457,607

-25,366

Debt

4,998

174,960

Minority Interest

3,117

275

EV

1,045,076

383,209

EV/EBITDA

4.08

4.82

 

 

 

 

 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

When investors realize that China Unicom is hardly breaking even after capex, which should be apparent as management telegraph its capex needs for LTE and 5G rollout

    sort by    

    Description

    Pair Trade

    Long China Mobile (941 HK) and short China Unicom (762 HK) – all numbers in RMB unless stated otherwise

    Thesis Summary

    Both companies operate in an oligopolistic market that is also highly regulated.  Due to the need for continuous capex deployment (5G rollout only 2 – 3 years away), China Mobile’s superior scale and stronger balance sheet to Unicom should warrant a valuation premium.  The current valuation discount to China Unicom provides an attractive trade for hedged investors.

    Background

    The telecom industry is considered “strategic” in China and as such the government maintains a tight grip on the industry.  The 3 telcos – China Mobile, China Telecom and China Unicom – serve the entire market and are in effect State-owned Enterprises (SOE).  All major decisions (e.g., strategic, personnel, M&A) require government blessing.  Recently a 4th telecom license was issued to another SOE – China Broadcasting Network – but the impact is expected to be negligible as the big 3 incumbents are well-entrenched.

    Weighted by 2016 revenue, China Mobile is the leader with 53% market share and Unicom has 20% market share.

    Mobile Market

    In mobile, subscriber growth is limited as the market is saturated.  Penetration rate is over 100% with the number of subscribers slightly over total population.  Growth, if any, will have to be driven by ARPU.

    As in elsewhere in the world, two trends are apparent.  First, fixed-line is in secular decline as consumers substitute with mobile.  Second, voice is losing market share to data.  Mobile data is the sweet spot and the vital battleground.

    In order to capitalize on these 2 trends, the telcos are heavily investing in LTE networks in order to drive customers into higher ARPU products.  China Mobile is the dominant player in mobile.

    Broadband Market

    The broadband market is also dominated by the big 3.  They have been aggressively investing in fibre to keep pace with demand.  The independent operators that lease infrastructure from the big 3 are not real competition because their broadband speed significantly lags the big 3.  The difference in speed is especially striking when one visit a non-mainland Chinese website.

    Geographically China Unicom dominates the Northern provinces and China Telecom dominates the South.  China Mobile, through its Tietong acquisition, mainly competes in urban cities.

    There are 4 reasons why China Mobile is a better quality business and thus should trade at a premium to China Unicom

    1. China Mobile has far better economies of scale

    China Mobile generated 2.6 times revenue and 3.2 times EBITDA of China Unicom in FY 2016.  Telecommunication is a capital intensive business with high fixed cost.  This is crucial as huge investments (4G, 5G, fibre, etc.) are required in the foreseeable future.  As the leader in scale, China Mobile is better positioned to invest and monetize its investment than China Unicom.

    1. China Mobile is far more profitable than China Unicom

    Economic profit is defined as EBITDA minus net capex.  By this measure, and because of its scale, China Mobile is consistently profitable in the last 7 years and Unicom is only profitable in 3 out of the last 7 years.

    China Mobile

    EBITDA

    net capex

    Op FCF

    FY 2010

    236,984

    -114,326

    122,658

    FY 2011

    248,412

    -124,291

    124,121

    FY 2012

    253,578

    -125,018

    128,560

    FY 2013

    240,348

    -139,997

    100,351

    FY 2014

    240,125

    -175,699

    64,426

    FY 2015

    239,754

    -173,686

    66,068

    FY 2016

    256,178

    -188,802

    67,376

     

    China Unicom

    EBITDA

    net capex

    Op FCF

    FY 2010

    59,623

    -75,182

    -15,559

    FY 2011

    63,412

    -76,430

    -13,018

    FY 2012

    72,659

    -85,697

    -13,038

    FY 2013

    83,963

    -71,214

    12,749

    FY 2014

    92,771

    -68,789

    23,982

    FY 2015

    87,502

    -86,129

    1,373

    FY 2016

    79,498

    -91,903

    -12,405

     

    1. The return on invested capital track record between the two companies are very different despite both are operating in the same industry and are backed and regulated by the same central government.

    Invested capital is defined as equity plus interest bearing debt minus cash and short term investment.  Op FCF is the numerator and is before tax.  ROIC declined significantly for both companies in recent years as both have to invest heavily in 4G LTE which debuted in 2014.  

    The main point is China Mobile was able to absorb this capex and stay profitable whereas China Unicom was unprofitable in 3G (2010 – 13) and in hindsight was under-invested in 4G and now has to play catch-up in the crucial mobile segment.

    ROIC

    China Mobile

    China Unicom

    Difference

    FY 2010

    41.2%

    -5.7%

    46.9%

    FY 2011

    37.3%

    -4.5%

    41.9%

    FY 2012

    36.9%

    -4.1%

    41.0%

    FY 2013

    27.6%

    3.8%

    23.8%

    FY 2014

    15.2%

    7.1%

    8.2%

    FY 2015

    13.5%

    0.4%

    13.1%

    FY 2016

    13.0%

    -3.4%

    16.3%

     

    1. The capex/investment burden will continue to heavily weigh on the telcos.  China Mobile has the balance sheet to fund investments.  China Unicom is less capitalized.

    For competitive reason, telcos have to invest in their network because aside from price, consumers also value speed and reliability.  China Mobile has invested over 1 trillion RMB in capex while China Unicom invested around 555 billion RMB in the last 7 years.  The former has better coverage and speed and thus is able to charge more than the latter.

    Going forward, both firms have to continue to invest in 4G and 5G is expected to rollout in 2019-20, which would spur another cycle of capex.

    Additionally, in China SOE investment decisions are often driven by the central government, not rationality or market forces.  The most notorious example is the TD-SCDMA (3G) standard that is only usable in China.  The State Council issued a “Broadband China Strategy and Implementation Plan”.  Phase II of the plan was completed in 2015.  Phase III is scheduled to be completed in 2020.  One thing is certain, whether it makes economic sense or not, capex will be ramped up.

    China Mobile has a pristine balance sheet with ¥452.6B of net cash.  Its EBITDA is enough to pay for capex.  In contrast, China Unicom net debt is ¥149B (net debt/EBITDA = 1.9x), but most importantly, its capex is consistently greater than EBITDA, which means it is bleeding cash flow.  The dollar-weighted net capex/EBITDA from 2010 – 16 is 60% for China Mobile and 103% for China Unicom.

    Valuation

    The stock price in HKD has been translated into RMB using an exchange rate of 1 HKD = 0.87 RMB.  If Unicom trades down to Mobile EV/EBITDA multiple, the pair trade would return 25%.  If Mobile trades up to Unicom multiple, total return would be 12.7%.  If the relationship mean-revert and Mobile trade at 0.5X EBITDA higher than Unicom, the pair trade could return 23 – 43%, depending on if Mobile’s multiple expand or Unicom’s multiple contract.

    EV

    China Mobile

    China Unicom

    HKD / RMB

    0.87

    0.87

    stock price in HKD

    83.9

    11.2

    stock price in RMB

    73.0

    9.7

    Shares outstanding

    20,475.5

    23,947.0

     

     

     

    Market cap

    1,494,568

    233,340

    cash

    -457,607

    -25,366

    Debt

    4,998

    174,960

    Minority Interest

    3,117

    275

    EV

    1,045,076

    383,209

    EV/EBITDA

    4.08

    4.82

     

     

     

     

     

     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise do not hold a material investment in the issuer's securities.

    Catalyst

    When investors realize that China Unicom is hardly breaking even after capex, which should be apparent as management telegraph its capex needs for LTE and 5G rollout

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