Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Over the past several years, China Mobile (CHL) has become the largest cellular carrier in the world with nearly 700 million customers. The company has been able to tap into the Chinese market and secure such a customer base that today the company holds nearly 70% of the cellular market. This customer count, though, does not equal penetration in the market. This is 70% of the cellular market that currently exists, but there is a Chinese middle class that is growing significantly and thus growth is not topping out. In May I wrote an article ("More Room To Grow Than AT&T and Verizon Combined"), where I outlined the fundamental strength CHL had and the room for growth that existed in both 2G and 3G markets. The situation has not changed and the stock's valuation is still a buy compared to American counterparts AT&T (T) and Verizon (VZ). The release of Apple's (AAPL) iPhone 5 represents an incredible opportunity for both AAPL along with CHL. The compatibility with CHL's TD-SCDMA-3G network is thought to be "imminent" by industry professionals and this will ultimately augment CHL's network dramatically, increase AAPL iPhone sales significantly, and prop up CHL's stock price to a reasonable level. This being said, the deal is by no means done and though the partnership is likely to commence, it will not come without bumps in the road.
(Click to enlarge)
CHL data by YCharts
iPhone 5:
For months, it has been rumored as to whether or not the iPhone 5 would be compatible for CHL's 3G platform that from a technical standpoint is different than other carriers. This all changes with the iPhone 5 because AAPL built it to be compatible with the frequency that CHL operates on. The 3G penetration within China is currently only 18%. When the iPhone becomes available through CHL, this will give CHL a new platform to drive 3G penetration and ultimately do so by dramatically increasing AAPL iPhone sales. Tucker Grinnan, HSBC Hong Kong analyst, states:
They're talking about reaching 100 carriers in 240 countries by the end of this year. That's a much, much broader push. And countries like Hong Kong which in the past have not been in the first line of launch, are in this time around. So it does appear that Apple is significantly expanding the addressable base and China Mobile should be one of the top customers globally in the next year or two.
This represents an opportunity for both AAPL and CHL and ultimately could double the amount of iPhones within China relatively quickly. Analysts estimate that there are roughly 22 million iPhones within China currently. If hypothetically CHL gets 4% of its customer base to switch to iPhone use, this will represent over 27 million AAPL devices being sold. Scott Sutherland of Wedbush Securities explains:
What you get with the iPhone 5 are all these new features: Chinese language integration, social networking websites, Siri is going to be in Chinese, so again, they're making a big focus on the software functionalities of this phone.
This represents much of the brilliance within the new AAPL device. AAPL decision to give the iPhone 5 the capabilities to work on CHL network will drive sales more than any new feature incorporated into the device.
What Needs to Happen For a Deal to Commence:
The iPhone 5 coming to CHL network is not a sure thing as of now. There have been supplies troubles within the manufacturing of the MDM-9615 chip that is necessary for the iPhone to operate on CHL's TD-SCDMA network. Ultimately, Qualcomm (QCOM) will have to come through with this chip and be able to support the demand that would come through CHL's network. This only represents the hardware concerns. The other aspect of the deal is that of the contract that would occur between AAPL and CHL along with CHL and customers. There is more upfront cost in selling a smartphone than a 2G phone due to the need to subsidize the cost of the phone for consumers. This means taking less profit up front in the face of securing data plans in the future. The short-term ramifications of this could be marked in lower profit margins for CHL. For AAPL, this deal would mark a dramatic increase in unit sales and in the long term would offset nearly all expense attributed to its launch. The landscape is as follows:
- Qualcomm may not be able to deliver the chip within the short-term and thus will delay the launch of the phone on the CHL platform. This being said, many believe a launch will occur.
- In the beginning stages of CHL carrying the phone, profit may lag due to the need to subsidize the cost of the phone to consumers.
- AAPL's unit output and demand will increase dramatically and give the company further exposure within China: the largest market in the world.
(More Information on Qualcomm's Delay)
CHL Fundamental Strength:
From an investment perspective, CHL is priced extremely well and has achieved success in nearly all metrics. Her are the company's financials and valuation statistics, as compared to T and VZ:
Forward Price/Earnings: 10.82
EV/EBIDA: 3.90
Profit Margin: 23.29%
Return on Equity: 19.56%
Dividend: 3.60%
These numbers illustrate the success CHL has had in controlling costs and driving earnings, while the stock has simultaneously stayed undervalued compared to its American counterparts. CHL profit margin on 23.29% is simply incredible and speaks to the fundamental strength within the company's operating platform. Another positive for investors is the company's sheer size. With a market cap of $215 billion, investors have security within the empire that has become CHL.
Conclusion:
In the wake of the newly released iPhone 5 being compatible with CHL's network, CHL technical and fundamental strength, and the growing middle class within China, CHL is positioned well. Even with the company's past growth and incredible size, there is enormous opportunity to drive penetration within both the 2G and 3G market within China. Whether AAPL and CHL reach a deal next week or in a year, there is incredible upside for CHL and AAPL in the long run no matter the short term hurdles. Both CHL and AAPL are going to aid dramatically from this "imminent" union and investors will follow suit in reaping the rewards.
A(All financial metrics referenced above are obtained from Yahoo Finance, CNBC Analytics, S&P Capital IQ and Thomas Reuters.)
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