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China telecom, as a sector, is cheap. China Telecom, as a stock, is very cheap. I’ll keep this writeup brief. Like many Chinese SOEs, the company is complex, but the value thesis is rather simple.

As you can tell from long run stock returns, or ROEs, there has been a great deal of suffering by investors like us for the past decade or so. Suggesting we should be wary

A decade of disappointment was capstoned by the CCMC sanctions in the waning days of the Trump presidency. The ADR (CHA) delisting, and forced divestment by any remotely US-affiliated investor (in the Hong Kong listing), resulted in both acute and gradual outflows, leaving the shares for dead.

• Most of that selling is far enough in the past that I am not suggesting a technical rebound.

• Nor am I relying on a policy change, where the Biden administration could walk back these sanctions quietly. While not impossible, there’s no movement or clear political incentive to suggest it’s a near-term possibility. It’s worth bearing in mind as a potential upside, especially since the telcos are less optically integrated into the PLA

• However, the effect of those sanctions remains vivid, as CHA remains inaccessible to the majority of offshore investable funds. In simple terms, this asset has artificially restricted demand, which at baseline should result in abnormally high returns

One key story in the stock from the past year has been the catalyst of the A-share listing. I think this is overstated as a catalyst. Per usual, the A-share listed at a significant (> 100%) premium to the H-share, though has traded down to a 50% premium. This setup should drive interest from onshore institutional investors to replace their lower-yielding A-shares with higher-yielding H-shares. And in principle it should motivate management to consider accretive buybacks in the discounted H-shares. Again, for any long-suffering H-share investor, these incentives exist but are muted. Onshore investors are more momentum than value-motivated, and the logic of replacing A- with H- is of limited impact. Similarly, it would be naive to suggest that SOE priorities are fully aligned with offshore shareholders. There is plenty below to suggest that CHA is unusually friendly, especially recently, but optimistic should be balanced against the fact that CHA has not yet conducted any buybacks

As for the business itself, I’d suggest thinking of CHA as 2 businesses: a massive, legacy telco (#2 player behind CHL) at the forefront of the 4G-5G transition; an emerging leader in the IDC space. For the telco structure and history, I’d refer you to earlier China Mobile and China Unicom writeups on this site. There have been ups and downs, with the most notable down the ‘16 cycle, where a combination of costly investment in 4G infrastructure, and a lack of support for pricing power (the telcos are a regulated oligopoly; their product is impressively cheap for their consumer, but they still face political pressure in the spirit of Common Prosperity; for sure, I don’t project significant ARPU growth). The bright side of this debacle was that CHA and CHU have deftly maneuvered themselves into a co-build + co-share 5G (and beyond) infrastructure program. Conceptually, we model this as a massive increase in operative leverage, as visible from the reduced capex (compare depreciation to capex) despite the massive 5G buildout and opex. It’s not quite a full consolidation (into duopoly), but it’s close, especially when accounting for the political constraints on pricing anyway. I believe this leaves CHA able to enjoy benefits of scale comparable to CHL, and thus poised to narrow the gap in margins and valuation. To put some numbers to this, CHA estimates they have saved over 240B CNY in capital expenditures cumulatively (and counting), as well as 20B CNY in annual operating expenditures. To be frank, it’s hard to imagine how CHA and CHU would be handling the 5G cycle without this partnership. But fundamentally, I think the market has underestimated the impact of this co-build + co-share arrangement, which dramatically alters the financial setup and competitive dynamic from earlier mobile cycles. Although I can’t claim the market hasn’t assessed reasonable projections, I think the disconnect arises in the multiple. In short, the market penalizes CHA with a risk of brutal capacity-driven investment for 6G and beyond, where I think the 5G cycle demonstrates a new and proven equilibrium 

I will spare you a misleading SoTP analysis, but the IDC business exhibits characteristics in line with data center-focused listings trading at much headier valuations. The IDC business is on pace for 124B CNY (18B USD) revenue, growing at 20%. Equinix, a 57B USD market cap, sits on < $7B revenue, growing about 10%. GDS (Chinese), a 4B USD market cap, sit on just over 1B USD revenues, growing similarly near 20%. Heavy discounts, for not being pure-play, for being centered in Mainland China, and for sitting in an SOE, all seem warranted. China Telecom and other players have benefited from state support of industrial digitalisation, though of course, there’s risk that after capacity is deployed, there could be government pressure to price aggressively. This risk seems lower than what the telecoms have faced in mobile, given the different political dynamics of the B2B segment. Regardless, the market seems to be handicapping very conservatively the IDC prospects, but I consider this a primary avenue for healthy growth. Unfortunately, I do not see much appetite for a focus-increasing spinoff, which would clearly create a windfall for equity holders. China Telecom seem clearly focused on the potential of IDC, both as a business and politically strategic consideration

To blend all this into a valuation: 8x ‘22 P/E (6x ‘25 P/E), 0.5x P/B, or 2.25x EV/EBITDA

Of course, anything this cheap comes with serious risk of being cheap for good reason. The ROEs remain unimpressive. I’m encouraged here by the progress management has made, not only on the operational front (co-share, co-build), but also on shareholder friendliness. They’ve committed to a >= 60% payout ratio, and >= 70% by 2024, and they’ve thus far over-delivered. Some of this change has incurred across the telcos, though we find it noteworthy and helpful that CHU has under-delivered, pointing to the differentiated inclination and ability of CHA management. One way or another, you’re getting an extremely safe 10% yield. And that yield is poised to grow 15% for the next 2 years. You probably don’t own any Chinese debt, but if you do, I’d suggest making sure you’ve maxed out here first

The primary angle here is value. A low but not insignificant catalyst would be substantial H-share buybacks, which we think are underestimated by the market, with a “this time it’s maybe different”, due to the recent A-share listing. A higher probability, lower impact catalyst is the upcoming Party Congress. There is considerable political incentive for markets to behave well through and after the event. And directionally, I observe caution in China watchers, suggesting a risk appetite that should disproportionately return post-event. Less likely, but possible, would be a relaxation in the CCMC regime that permits US investors to return. These catalysts are individually weak, and in aggregate still not strong, but they offer a variety of potential upsides, accompanying a compelling value in the base case. 

Bottom-line, any cheap asset can languish in the absence of proactive value realization, or catalysts in that direction. And I do not have conviction that China Telecom will aggressively expand on its shareholder friendly steps recently. Still, those steps in themselves are highly supportive of investment: your downside is well-protected by the asset base; you’re being well-compensated with a 10% dividend yield; and crucially, that dividend yield, arising from a ratcheting dividend policy, demonstrates progress on new-found alignment. Some of the worst-case scenarios of owning a cheap-for-a-reason asset are de-risked by virtue of the flow through of earnings

(You may have seen recent news of a China Telecom tower in Changsha burning down. This is tragic, but not relevant for the stock)

Catalyst

• A low but not insignificant catalyst would be substantial H-share buybacks, which we think are underestimated by the market, with a “this time it’s maybe different”, due to the recent A-share listing
• A higher probability, lower impact catalyst is the upcoming Party Congress. There is considerable political incentive for markets to behave well through and after the event. And directionally, I observe caution in China watchers, suggesting a risk appetite that should disproportionately return post-event
• Less likely, but possible, would be a relaxation in the CCMC regime that permits US investors to return.

These catalysts are individually weak, and in aggregate still not strong, but they offer a variety of potential upsides, accompanying a compelling value in the base case.