Description

China Mobile (CHL, 941.HK) was recently written up by Enright in October. Since then, what was already an exceptionally cheap and stable asset has gotten 12% cheaper on essentially technical selling. Another unexpected event will drive this stock even lower next week (perhaps significantly), on what may be unprecedented forced selling – possibly 4% of total outstanding shares and close to 20% of float have to be sold into a market with no natural/”legal” buyers in TWO days. It is quite rare to see a $100B+ market cap company going through a micro-cap spin-off set-up, but this may present a proverbial “fat pitch”, so I want to get the idea out before the fireworks, and possibly get some dialog going.

Background: China Mobile is the dominant telco in a three-player market, with nearly twice the market share of the other two players combined and best of class margins. The company is primarily listed in HK with the parent co owning 73% and has a US ADR. On any fundamental measure, the stock is extraordinarily cheap. It trades at 7x PE, under 1.5x EV/EBITDA. Dividend yield is 7.5% at slightly over 50% pay-out ratio. Market cap is $900B HKD, or $750B RMB, while the company carries $400B RMB of cash & equivalents, $73B RMB of safe short-term investments, and $155B RMB of equity investments (mostly China Tower and Pudong Development Bank), for an effective EV of $150B RMB vs. TTM EBIT of 122B, or $300B EBITDA. (note that RMB has appreciated 8% against USD/HKD since June 30, the last interim report of financials).

Setup: In early November, President Trump signed an executive order against a list of so-called state-controlled “communist Chinese military companies”, including the parent company of China Mobile. There was much confusion as to how/whether the executive order will be enforced, especially in light of Trump’s defeat in the election. The consensus seems to be US entities can not buy China Mobile (ADR and HK shares) after Jan 8 2021, and may not own China Mobile after Nov 2021. There has been some selling since November on elevated volume, and the stock is down 14% from the peak in November already and down 40% for the year (rev/earnings are largely flat YoY). Note that right before the ban, the company/industry reported a decent Q3 with ARPU/industry pricing seemingly turning the corner and stock reactedly positively.

Now comes a rather unexpected and unprecedented move by NYSE after the market close on Dec 31 – NYSE decides to delist the ADR on 1/5/2021, effectively giving ADR shareholders only two days to liquidate. https://ir.theice.com/press/news-details/2020/NYSE-to-Commence-Delisting-Proceeding[…]hree-Issuers-to-Comply-with-Executive-Order-13959/default.aspx. I cannot locate the exact number of ADRs outstanding, but judging by the Bloomberg holder list, it is reasonable to estimate that ADR holders account for less than 4% of total outstanding shares (with top five holders accounting for 1%). I have spoken to a top shareholder, and they are exploring ways to convert the ADR into HK shares, and I would imagine other shareholders who want to hold on to the shares will do the same. On the other hand, it is quite possible that some holders have decided it is not worth the trouble and will choose to dump the ADR next week. Most retail shareholders will also likely dump as their brokers will choose the easiest way out.

On the other side, the only buyers are arbitragers/market makers who will buy the ADR and convert/short out the HK shares. The magnitude of the price drop will depend on how many ADR shareholder want to remain shareholders and how eager the HK shareholders want to step in front of this falling knife. Given the compressed time frame, it is anyone’s guess, and personally I am bracing for a 10% (perhaps 20% intra-day) drop. On the other hand, I would argue the bigger the drop, the more attractive the stock is, given the balance sheet. This is about as safe as 8% yield for a safe corporate issuer, and in due time should attract non-US investors, many of whom undoubtably are waiting for a clearing event, which may culminate after Wednesday.   

Fundamental Backdrop: For much of last five years, CM is the quintessential value trap, as multiples continue to get compressed. Much of the bear case boils down to 2 parts. 1) The company is an SOE and is not run for minority shareholders but public good. Shareholders will never see the cash on the balance sheet, and indeed the China Tower/Pudong Bank investments remind shareholders of poor capital allocation policies. 2) The 5G cycle will lead to elevated capex and opex, depressing margins and returns with very little to show for on topline or profit.

I’d concede both points are quite valid, but offer the following counter-arguments (some of which was discussed in the previous write-up). First, on 5G capex, 2020 capex has actually come in lower than feared, and China Mobile has built more base stations and added more 5G subs than planned. 2020-2022 will be the peak years for China Mobile and the industry, and the company should gush FCF after then. Secondly, the government mandated tariff cuts are largely behind the industry, as ARPU has stabilized and grown sequentially/YOY for CM and the industry starting in Q3. It should continue as the company/industry adds more 5G subs and churns 2G/3G subs. The absolute ARPU at 45 RMB is already quite low given the quality of the service, and I doubt many customers really think there is much price gouging as it is just 2 cups of SBUX coffee or 1 pound of pork. Industry competitive dynamics also seem to have improved. Thirdly, while CM is often criticized for the no-growth mobile market (flat subs and flat/declining ARPU), often overlooked is the home broadband market, where CM has consistently taken market share from 30% three years ago to 43% today. It is maybe even more sticky than mobile subs, and ARPU has more room for price increase as it is lower than mobile ARPU. CM also has an enterprise business and cloud/IDC business which are much faster growing, both of which carry much higher multiples in public markets. Fourth, on regulatory issues, the industry has gone through their fair share of punishment, and after a tough 2020 in which the company has been a model corporate citizen through Covid, and suffered many hits in the US-China trade war due to no fault of their own, I think it is quite reasonable/possible that the Chinese government will throw them a bone, whether that’s future pricing increase and/or better shareholder return policies. The recent Ant fiasco vs. the Big Four banks could also offer a preview of Telcos vs. internet companies. It is arguable that the dumb pipes have not earned their “fair share” vs. the privately owned internet companies despite shouldering the capex on infrastructure. On corporate governance, it should be noted that in early 2020, the company instituted the first major employee equity incentive plan where its top 5500 employees received equity incentives at strike prices much higher than current prices.

Summary: China Mobile is ridiculously cheap and may get significantly cheaper next week on purely technical selling. I doubt (naively hope) that 8% safe dividend yield lasts too long for a triple A credit with no fundamental issue. Much of the bad news is discounted in the current price and more, and many (potential) positives could drive a sentiment shift and partial re-rating. Risk reward seems disproportionally tilted to the upside, as the stock was $70 HKD in early 2019 before Covid, with arguably no change or slight improvement in company/industry fundamentals. More venturesome investors may also find call options interesting and more juicy.

Catalyst

selling climax after next week

safe 7.5% dividend