China Mobile’s Thailand Investment Likely A Long-Term Investment

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China Mobile (NYSE:CHL), the world’s largest carrier by subscribers, has bought an 18% stake in one of Thailand’s leading telecom companies, True Corp., for over $880 million. [1] The Chinese carrier has been battling declining profitability in the country’s saturating wireless market for the past few quarters, and the company’s Chairman informed investors of their intention to invest overseas last year. This is China Mobile’s second major foreign deal, following its acquisition of Pakistan carrier Paktel (now known as Zong) in 2007. [2]

The deal fits well with China Mobile’s plans to expand its business in new markets by utilizing its huge cash pile of over $70 billion. The investment is also likely to help the company diversify into fixed-line broadband, WiFi and pay TV services in the future, as True Corp. already holds a leading position in these markets in Thailand. However, the deal seems unlikely to bring significant strategic and financial benefits to the carrier in the short term.

We currently have a price estimate of $53 for China Mobile, implying a premium of less than 10% to the market price.

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Concerns With The Deal

We believe that there are a number of issues which could prevent China Mobile from gaining substantially in terms of technology and profits from this investment in the short term. Firstly, the political situation in Thailand is highly unstable, and there are also concerns whether the scheduled spectrum auctions can take place in the later half of this year. Therefore, it is somewhat surprising that China Mobile chose to invest at such a time.

Secondly, China Mobile’s investment is part of a cash-raising exercise by True Corp. to boost its financial position. Although this helped China Mobile get a 13% discount to True’s share price (prior to the deal announcement), there could be complications if True decides to involve other foreign carriers as part of its broader $2 billion fund raising.

Thirdly, the True group has a total subscriber base of about 29 million, which includes users on its 3G/4G mobile, fixed-line broadband, WiFi and pay TV service. This is insignificant compared to China Mobile’s combined subscriber base of about 785 million. Therefore, even if True can help the carrier in improving its 3G and 4G LTE networks, we expect it to be of little consequence in the short term.

Lingering Profitability Concerns

China Mobile’s profit declined 9.4% in the first quarter this year primarily on account of higher subsidy expenses incurred by the carrier, in addition to higher marketing costs and discount offerings. In contrast, China’s second largest wireless carrier, China Unicom(NYSE:CHU), increased its first quarter profits by 74% on a growing subscriber base and focus on low-cost smartphones, which reduced its subsidy expenses (see China Unicom’s Profit Rises 74% On Revenue Growth In 3G/4G & Broadband).

Subsidy and marketing expenses were necessary for China Mobile to improve the acceptability of its homegrown 3G network. The company faced intense competition in gaining 3G subscribers earlier because rivals China Unicom and China Telecom (NYSE:CHA) used the internationally accepted WCDMA 3G standard, which is compatible with a majority of the popular smartphones available in the Chinese telecom market, unlike China Mobile’s homegrown SCDMA standard. Therefore, because of the limited handset options available for use on its 3G network, China Mobile had to offer much more competitive handset pricing and discounts to attract subscribers, which put pressure on its margins.

Government Directive To Help Improve Margins

China Mobile announced at the start of the year that with growing 4G adoption and competition from rivals China Unicom and China Telecom, its subsidy and marketing costs were likely to rise by about 30% over 2013 levels. However, with the Chinese government’s recent directive to the carriers to reduce their marketing expenses by 50% over the next three years, China Mobile’s expenses are likely to decline by about RMB 3.5 billion ($530 million) per year. ((Chinese carriers to lower subsidies on smartphone purchases, WantChinaTimes, May 23 2014))

Since competition in the Chinese wireless market is expected to get more intense in the coming months with the introduction of Mobile Virtual Network Operators (MVNOs) and the possibility of FDD-LTE 4G licenses being issued, a reduction in handset subsidies could immensely help the carriers, especially China Mobile, in improving their bottom line. We also expect such a move to partially offset the impact of the Value Added Tax (VAT), scheduled to be implemented from June 1 this year.

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Notes:
  1. Press release, China Mobile, June 9 2014 []
  2. China Mobile to buy Paktel in first overseas deal, Reuters, January 22 2007 []