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China Mobile（941.HK）- Mature stage with a slow growth!

Monday, August 31, 2009

5417

China Mobile(941)

Recommendation on 31 August 2009
Recommendation	Hold
Price on Recommendation Date	$77.650
Target Price	$81.510

Weekly Special - 000157.SZ Zoomlion

Summary

China Mobile Limited (CM or Company) continues the trend of growth slowing dragged by the increase of outside competition and cost, and will lag behind China Unicom (CU) and China Telecom (CT) for a long time in 3G progress with obvious disadvantage in TD-SCDMA.

Though it is losing its operating advantages, as the NO.1 in customers of this sector in the world, CM still has its strength: first, its rich capital gives support to network construction under great increasing operation cost, and also ensures its survival in price competition.

Second, the participation of Taiwan peers will promote the TD-SCDMA progress and made it possible for CM to obtain comparable 3G technology earlier. Last and the most important one, its overwhelming competitiveness in rural area, which makes CM evade the direct struggle with the other 3G operators in a degree, backs strongly for its revenue and profit stability.

In general, CM is stepping into mature stage with a slow growth. And we recommend a conservative but reasonable investment to hold for the stable dividend. Based on our DCF model, we think its embedded value is HK$72.45, lower than the current price, rating Hold, and 12-month target price is HK$81.51.

Profit growth continuing down in 2H09

CM recorded revenue, EBITDA and net profit of RMB 212.9billion, 109.9billion and 55.3billion in 1H09, 8.9%, 5.8% and 1.4% y/y growth respectively. At the meantime, EBITDA margin dropped to 51.6% from 53.12% in 1H08 due to the large rise of depreciation, 16.75% y/y. Its operating expense rise 15.65% y/y is another factor of dragging net profit growth.

In 1H09, CM finished with MOU of 490 minutes and ARPU of RMB 75yuan, dropping 1.21% and 10.71% respectively y/y. Its new added customers are 40.43million and total customers amount to 498million by the end of July in 2009, with TD-SCDMA users are 1.088million. Its new market share obtained is 65.27%, much lower than the 88% in 2008, slightly cutting its total share to 73.14% from 73.93%.

Looking forward to 2H09, we expected there is an intense price war among these three operators after 3G commercial application. CU is already reported to have a plan of canceling roaming and call-receiving charges. Weakness of TD-SCDMA in the short and middle term will transfer some customers to choose other 3G service. So we expected a further decline in market share for its new added customer and an exacerbation trend should not be excluded.

Apart from the elements of competitor, growth on operating and depreciation expense will also maintain the high level in China Mobile, because it will be dragged by the full 3G commercial application and conservative accounting method of depreciation (5 years vs 8-10 years in peers). In general, we expect the downside modify trend of company's performance will continue, the bottom depends on the timing of market share's recovery.

Defensive position results from weakness of TD

TD-SCDMA still exist some defects as the worst network standard of 3G licenses in mainland, including extreme scarce terminal, very immature network technology and strong resistance from mature standard setter, which we believe will be resolved over time supported by the government. Besides huge capital expense, CM is still limited by time cost that it needs to resolve the problems above and therefore falls behind the other two in a long time.

Dragged by the TD weakness, CM is doomed to be in a defensive position faced with the other two. CT takes the leading role of 3G progress in 1H09, completing the full coverage of CDMA2000 in July and being the first to promote 3G business on campus. With the full commercial application of WCDMA in October, CM will certainly advocate its 3G business to wiping out its weakness of 2G. The fierce competition in 2H09 may be more than expected.

With the concerns mentioned above, we cautiously expect a fast shrinking of CM's new added customer share. Before the mature of TD-SCDMA, its extending model of increase will gradually give to embedded value increase, like attracting exits customers to consume more value-added service and tightly cost controlling, instead of improving market share with new customers development.

Speed cooperation with Taiwan peers to offset the TD terminal shortcoming

CM invested NT$17.8billion（RMB3.6billion） on 12% share of Taiwan Far Eastone Telecom on Apr. 29, 2009. After that, Wang Jianzhou, Chairman and CEO of CM arrived in Taiwan on Aug.21 to visit the major peers and industry parks. Recently, the smart mobile phone producer, HTC has signed a cooperation memorandum of TD-SCDMA with CM who will supply HK$47million to HTC for their deep cooperation. Furthermore, the Father of Cottage Mobile Phone Media Tek also announced to support the TD-SCDMA in full.

We look these events as a signal for CM to speed cooperation with the industry chain in Taiwan to offset TD terminal shortcoming. And, this is a very positive movement, for the electronic industry is strong in Taiwan with mature R&D and manufacturing strength which is lacking in the Mainland counterpart.

Risks

Downside risk

1. Fierce price war broke out among domestic carriers.

2. High-end customers outflow faster than expected after 3G formal commercial application.

Upside risk

1. Red chips returning to A stock market brings trade opportunity.

2. Customers show less sentiment of transferring to 3G business.

3. TD progresses faster than expected.

Holding for stable dividend in its mature stage

Domestic carriers still faced a challenge of increasing revenue with less profit in the near future as customer addition will be offset by fee cut and cost increase. Under these circumstances, CM will step into its mature stage with a slow growth, featuring stable cash flow and dividend. So we choose to use the DCF model, and assume the situation under.

1. Free cash flow in 2009 is lower than 15% of 2008 for sharp TD expenses increase.

2. Free cash flow will recover from 2010 to 2011 and reach the level of 2008 in 2011.

3. The sale value of CM is 20X free cash flow in 2011, higher than current 17.8X in line with FY2008's, implying the permanent growth of free cash flow is 7.5%.

4. Required rate of return is 15%, equivalent to average growth of Chinese nominal GDP in recent 10 years.

Based on above assumptions, we calculated China Mobile's embedded value is HK$X72.45, lower than the current price, rating Hold, and 12-month target price is HK$81.51.

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