china mobile ltd. (nyse: chl)€¦ · important disclosures appear on the last page of this report....

Important disclosures appear on the last page of this report.

Krause Fund Research | Spring 2015 Telecommunications & Utilities

Recommendation: BUY

Analysts

Emily Brannon [email protected] Emily Miller [email protected] Katie Stych [email protected]

Company Overview China Mobile was incorporated in Hong Kong, China in 1997. China Mobile Communications Corporation, as a holding company with their respective subsidiaries of China Mobile Communication (BVI) Limited, China Mobile Communication Co., Ltd. (CMC) Guangdong Mobile, and China Mobile Pakistan, operates in the mobile telecommunications industry within 31 provinces in China and Hong Kong. The state-owned China Mobile Communications Corporation has a 73.7% stake in China Mobile’s operations. China Mobile has nearly 800 million customers, and offer services including voice, data, SMS, MMS, and varying applications and information services. In the global telecommunications market, China Mobile has approximately 7.1% market share, second to only Verizon.ii In the last few years, China Mobile has helped to secure their market share by undertaking large investments in the 4G and LTE capabilities in addition to offering more desirable products such as the Apple iPhone.i

Stock Performance Highlights 52 week High $69.74 52 week Low $44.49 Beta Value 0.73 Share Highlights Market Capitalization 270.24 b Shares Outstanding 4.02 b Book Value per share $31.88 EPS $4.92 P/E Ratio 14.03 Dividend Yield 2.41% Dividend Payout Ratio 40.94% Company Performance Highlights ROA 10.97% ROE 16.05% Sales $630.18 b Financial Ratios Current Ratio 1.29 Debt to Equity 0.48%

China Mobile Ltd. (NYSE: CHL) April 15, 2015

Current Price $69.02

Target Price $72.34-$78.82

China Mobile Market Dominance Strong Market presence in mobile telecommunications services China Mobile is the leading mobile telecom provider in China and is the largest provider by number of customers in the world. In most recent complete year numbers, China Mobile had 62.1% market share in China (for 2013).iii China Mobile has provided guidance that they plan to invest heavily in marketing and purchases of products demanded by consumers.

Expansive network infrastructure China Mobile’s network capabilities include 2G-4G and is able to support both new and old networks. Data traffic of China Mobile’s WLAN reached 1,485 billion megabytes in 2013, far above competitors.iv China Mobile has invested heavily in their infrastructure and increased their property, plant, and equipment by 22% in the past three years during the smart phone boom; we are forecasting going forward China Mobile will be able to enjoy these investments by growing PPE at a more reasonable rate around 8% now that they have the infrastructure in place. Strategic expansion in new geographies As the Chinese market continues to become more saturated, it is vital for China Mobile to diversify their operations to mitigate risk and increase market capabilities. They have been expanding geographically in instances such as investing a 18% stake in Thai True Corp in 2014 and the acquisition of Pakistan’ Paktel in 2007.ii We believe this gives them more growth potential and diversification. We forecast this will boost their growth in phone and data sales in the next three years, and will stabilize their earnings after that with revenues from multiple countries.

One Year Stock Performance


Overall, we see China Mobile continuing with their market dominance. They are currently near a 5-year high, trading at 69.02 on the NYSE, with most of that growth in the past year. The telecommunication industry has benefited greatly with increase in GDP and healthy economic expansion. The Chinese government has set direction for continued economic growth, and consumers will be quick to spend their money to increase their connectivity. China Mobile has been unique in their ability to successfully adapt and capitalize on the rapid development of 4G. China Mobile has established themselves as a leader in the telecommunication providers industry.

While there are risks about pressure to adapt in the wake of government policy changes, China Mobile is very aware of them and therefore we are issuing a BUY recommendation. Our research on markets that will benefit most in the telecommunications sector point to countries like China with large growth potential. We believe China Mobile is positioned better than US companies which are having problems passing inflation increases to consumers and retaining customers who have small amounts of loyalty to companies when competition for the cheapest plan is fierce.

We believe there are five macroeconomic indicators that impact China Mobile’s stock performance along with the telecommunications industry as a whole. The indicators include: gross domestic product, interest rates, inflation, the regulatory environment, and the currency exchange risk. Gross Domestic Product (GDP) Gross Domestic Product, commonly referred to as GDP is one of the primary indicators to gauge the overall health of the economy. GDP represents the total economic dollar value of goods and services and change in GDP typically results in a significant effect on the stock market. Both increases and decreases in real GDP can be linked to personal consumption in areas such as telecommunication (increasing data usage, buying larger phone package, or switching to a different phone company).v In all of our following discussions, when we refer to GDP growth, we are referring to real GDP growth, which removes the effects of inflation.

In 2014, China’s economic growth slowed slightly below target to 7.4%, the lowest increase in nearly 25 years. In 2013, the growth had been 7.7%. This decrease in momentum for the economy could impact capacity and debt, among other areas. The International Monetary Fund has predicted 6.8% GDP growth for 2015. The first quarter yielded results similar to expectations, ringing in growth of 7% for 2015.vii

While we also forecast a slowing GDP growth rate, we don’t believe their GDP growth will be as severe as International Monetary Fund’s predictions. Our outlooks for the following six years are 7.20%, 7.20%, 7.00%, 6.80%, 6.50%, 6.00% and 5.80%. We used this to help forecast how fast revenues for multiple segments would grow. We do see China’s health as higher than the United States. The numbers above and in our

model are still much higher than our outlook the United States’ GDP growth.

Interest Rates The rates of return that investors seek from investments (including an industry such as telecommunications) are directly tied to the risk-free rate that they can earn from government securities. If government interest rates fall as we speculate they will continue to do in China, the price of other investments are pushed upwards.vi

In February of 2015 China’s central bank, the People’s Bank of China, announced that the benchmark one year interest rates would decrease by 25 basis points to 5.35%. This became effective on March 1st and shows a potential weakening of the Chinese economy going forward.viii

The above chart reveals that one year interest rates have had a decreasing trend since 1998, with some variation to reach the current level of 5.35%. We foresee a slight decrease for the foreseeable future. We believe this is realistic for our model since the longest periods have been below 6.00%. Inflation Inflation determines how much of an investment’s value is being lost. If deflation is happening consumers are likely to hold onto their money in hopes prices will drop lower so spending is severely reduced. If telecommunication companies are able to raise prices and pass along inflation, they can keep costs down and profits increasing.viii

The most recent inflation numbers released for 2015 was 1.40%. As depicted in the graph above, the inflation rate from 1986 to 2015 averaged 5.63% with a minimum of -2.2% in April 1999 and a maximum of 28.40% in February 1989. In the short term, we anticipate inflation decreasing but then increasing. We predict that the inflation for 2015 as a whole will be 1.60%, and

Economic Analysis

Executive Summary


will become more stable in the next six years respectively resulting in 2.00%, 2.40%, 2.60%, 2.60%, 3.00%, and 3.00%.

Governmental Regulation The telecommunications industry in China is governmentally regulated and controlled by the Chinese Ministry of Industry and Information Technology (MIT) due to state reform in 2008. In that same year, the MIT awarded 3G licensing to the largest three telecom institutions in China: China Telecom, China Mobile, and China Unicom which are all partially state-owned enterprises. To keep up with technological change, in 2014 the MIT granted 4G licensing to the largest three telecom institutions in China. In addition, there has been recent discussion about these three institutions teaming up to establish a nationalized facilities company that would allow telecom infrastructure sharing. In addition, as China entered the World Trade Organization in 2001, foreign operators are slowly being allowed to enter the Chinese telecom market. ix

Although the strict regulation poses some uncertainty, we anticipate these three companies to continue to dominate the Chinese market and receive benefits from the government due to the government’s financial interest within their operations. Exchange Rate Risk As China Mobile is traded in the United States in the dollar currency (USD) and China Mobile’s operations occur in the Chinese Yuan Renminbi (CNY), there is additional economic risk in the form off currency exchange rates on the stock price. The Yuan began to be pegged to the US Dollar in 1994 to benefit exports as opposed to being a floating exchange rate that changes along with the market. Throughout the last two decades, the currency was allowed to appreciate several times, and then in July 2005 was moved to a managed float system with a basket of international currencies that includes the US Dollar. Currently, China maintains the policy of gradually moving the value of the Yuan currency up as they see fit.vii

Source: OANDA Historical Currency Exchange Rates

As demonstrated in the chart above, currently, the exchange rate rests at 0.1625 USD to 1 CNY. The value of the currency has increased substantially since 2002 from 0.1200 to the current 0.1625. We believe that the Yuan will continue to be pegged to the same basket of currencies, and maintain that the USD and CNY exchange rate will be more stable in the foreseeable future and staying at the current level of 0.1625.

The telecommunications sector is a mature value sector closely following the S&P 500. The mobile telecom sector has continued to offer unprecedented opportunities for economic growth in both developing and developed markets, and mobile communication services have become an essential part of how economies work and function.x

We see mobile technology as integral to communication and will continue to grow with the economy. Firms that will benefit from this will be ones heavy in wireless and less reliant on their wired segments.

Sector: Telecommunications Services Industry: Wireless Telecommunications Life cycle position: Growth Business cycle: Non-Cyclical

The telecommunications sector is a competitive and federally regulated sector. In the United States, it is centered upon three key players: AT&T, Verizon, and CenturyLink. Other players are much smaller and much less profitable. In Chinese telecommunications markets, we are exploring China Mobile for the Krause Fund, a Chinese telecommunications company that is traded in the United States. Although China Mobile trades in the United States, their performance depends on Chinese factors. In the graph above, the three largest competitors quarterly EBITDA is averaged for the past five year. Percentages are extremely similar, showing that the Chinese telecommunications industry is non-cyclical.

Telecommunications Life Cycle As a whole, the global wireless telecommunications industry is in the growth stage of its industry lifecycle. The industry value-added is anticipated to grow annually along with GDP at a rate of 3.6% until 2019. The global wireless industry is integral to today’s societal importance of connectivity. The major sources of growth in this industry lie within emerging markets, as the market saturation is still relatively low compared to that of more developed areas. This is a very complex, and rapidly changing technological industry and the lifecycle is cyclical and evolving. the initiation of new technology, such as that of 4G, requires massive infrastructure alterations and capital.

Industry Analysis

Capital Markets Outlook


According to IBIS World, the lifecycle is in the growth stage as the “Industry value added is growing at a faster rate than global GDP, industry firms continue to introduce new products and services, and the number of mobile subscribers and average revenue per user (ARPU) continue to increase.”xvii

Product Lines Companies in the telecommunications sector offer either wired and wireless services or only wireless services. The industry differentiates these companies by classifying them as wireless, those who provide cellular and wireless telecommunication services like paging, cell phone and other satellite, or integrated. Integrated companies provide services other than wireless, including fixed-line and wireless services. Companies that have been profitable in the past year are almost all wireless companies, as consumers move away from land lines.

Competitors China Mobile competes with China Unicom and China Telecom. However, they are far behind China Mobile’s ability to provide 4G. Between 3G and 4G, China Mobile added 94 million customers, while rivals China Unicom and China Telecom combined added less than 33 million. Our group has pinpointed this as one of the key catalysts for growth in China’s telecommunications market. China Mobile enjoys a dominant share of 62.4% of the country’s wireless market. In the telecommunications industry it is critical to success to be large as it capital-intensive investing in equipment and advertising for new customers.xi The three main players, China Telecom, China Unicom, and China Mobile are the only companies licensed by the Chinese government to supply 3G to customers. Because of this, the competition between the three players is fierce and market share is extremely important for financial success.

The Chinese wireless phone market has had double digit growth since 2009. The volume is projected to increase to 515.6 million units and have a market value of $59.5 billion by the end of 2016, which would lead to the compound annual growth rate of 8.3% from 2011-2016.xii Each of the three competitors have provided guidance to maintain their current market shares with the upcoming expected growth.

Regulation Because of the government control and ownership in China Mobile and its competitors, they have both stability from the government supporting them as well as pressure to follow their recommendations. However, we do not think this is much different than the United States; United States companies

eventually have to follow the laws the government passes. Whether it is heard first from government ownership or waiting until laws pass, companies eventually all have to comply with the government laws. For this reason, we do not see the government stake in Chinese telecommunications companies as any more risky than United States telecommunications companies.

4G LTE and Coverage The development of 4G is relatively new within the United States, and even more so in China. Customers are extremely hungry for the fastest connection, and the new 4G service is what provides this. Companies who are able to supply this to consumers will be quick to profit. The government has only recently awarded 4G LTE licenses to carriers which allowed them to expand with greater ease. xi

Technological capabilities are a differentiating factor among the highly competitive telecom market. Innovation in LTE wireless data is what sets companies apart from one another. The development of 4G wireless platforms should continue to gain speed although telecom companies will still rely on 3G wireless to handle most of their traffic. Compete integration of 4G would provide a telecom company with a significant competitive advantage but no company has been able to optimize their network capacity to that level yet.

Smartphone Demand Consumers also desire the newest phones. Telecommunications companies luckily do not have to advertise these new phones to the level the phone suppliers do, but it is important that they advertise they are providers of phones like the Apple iPhone and the Samsung Galaxy. It is also critical to maintain relationships with these suppliers as consumers will move phone providers to have the phone they desire. Their purchasing power is strong for smartphone and fiber optic cables alike.

Business Description China Mobile operates exclusively in the telecommunications realm, consisting of voice, SMS/MMS, and data capabilities. Voice includes domestic, international, roaming, and long distance calling. Voice value added include caller ID, call restrictions, forwarding, holding, voicemail, and conference calling. Mobile data services include SMS, MMS, and applications all operating through 2G-4G networks. The apps under China Mobile include Migu Music, Mobile Market, and others. Also, China Mobile has varying interconnection services with other mobile networks. As of FY2013, China Mobile had 4.29 million access points throughout China.xiv

Corporate Strategy China Mobile is vying to grow through investment opportunities such as acquiring and investing in other telecom companies, most likely within the content and Internet offerings.xv

Due to intense competition, China Mobile is focusing on improving 4G connection and mobile internet. China Mobile also focuses on improving and growing existing business, data traffic, and corporate customers. They see further opportunities lying in boosting current customers’ data and voice/SMS usage,

Company-Specific Analysis


and have been seeing consistent increases in this area such as customer growth which was up 8% in 2013 as compared to 2012.xvi

China Mobile has invested heavily in their 4G infrastructure to keep up with this competition and increased their property, plant, and equipment (PPE) by 22% in the past three years during the smart phone boom. We believe going forward China Mobile will be have a more conservative PPE growth rate around 8% now that they have the infrastructure in place that drove the large increase in PPE in years past. Financial Summary China Mobile is fortunate to operate in the largest market with the most subscribers in the world. China Mobile is expectedly focusing on the 4G integration, which may pressure profit growth in the short term.xviii

As a whole, the sales for China Mobile have increased over the last 12 months and are expected to stay relatively the same or increase for the next two fiscal years. The margins are expected to increase in conjunction with the EBIT decreasing. The financial summary in addition to several key ratios are also highlighted.xviii While China Mobile has not released their 20-F (the foreign equivalent to a 10-K), Thomsen One provided numbers from quarterly earnings as what they believe are accurate numbers and ratios for 2014, many of which are very similar to our model.

Source: Thomsen One

Our sales revenue and net income projections for 2014 are slightly higher than Thomsen One’s as we see a spike in revenue from sales of phones. With the recent release of the iPhone 6 and 6 Plus, we are projecting a 36.01% growth in sales of phones and other accessories over 2013. We believe their efforts to market themselves as a carrier of the iPhone and 4G LTE infrastucture in place will drive revenue and income up. Additionally, they have been able to maintain above-industry averages for margins on sales of phones.xxi

Products Offered China Mobile breaks up their products into voice services (local calls, domestic long distance calls, international long distance calls, and roaming) and value-added services. Value-added services are where most of the growth in the market has happened. Value-added is further broken down into sub-segments that include voice value-added services (caller display, call holding, call waiting, voicemail, conference calls), short

message services (SMS), mobile internet access services, and other data services (wireless music, multimedia messaging service, mobile video, mobile reading).xix

Revenue The revenue of China Mobile is almost entirely from mainland China. China Mobile earned revenues in 2013 of ¥630,177 million, which was up from 2012 levels 8.30%.

The revenues are reported in four separate streams: voice services (2013 56.44%), data services (32.83%), other services (4.48%), and sale of products (6.25%). Revenues for voice services has been steadily decreasing as customers rely on messaging services and social media to communicate with less of an emphasis on the need for large amounts of minutes on their plans. Data services on the other hand has increased dramatically; we are projecting this growth to continue with a 17.86% growth rate in 2014. The other services category which encapsulates miscellaneous fees increased in 2013 in comparison to 2012. As discussed earlier, sales of products also increased thanks to strategic management decisions to invest in relationships that allow them to have high volume of sales and margins.iv

New Product (4G) and Competitors China Mobile has been quick and powerful in bringing 4G to market. Two months ahead of their 2014 schedule, they hit 50 million 4G subscribers in October. China Mobile is easily the country’s largest 4G market; they added 41 million 4G and 53 million 3G subscribers before October in 2014.xx

China Mobile’s competitors, China Unicom and China Telecom have had more difficult bringing new products to market quickly. An extremely important differentiator in the telecommunications industry is size. The competitor’s smaller size has handicapped their ability to achieve a higher profit with simply not enough customers to make margins on. China Mobile has a market cap very similar to Verizon in the United States. Both have had very stable earnings in past years.

Marketing Strategy Since China Mobile dominates consumer usage in those that want 4G, they rely on word of mouth from their customers. They have invested in improving user options and aggressively expanded their network to give consumers what they want. Additionally, in China’s largest cities they have bought ad space on billboards to reach additional customers.


We are forecasting that China Mobile will be able to rely on word of mouth advertising with their large customer base and not have to increase their SG&A expense more than 2.00% in the future.

Significant Customers Total customers for China Mobile totaled 806,634,000 as of December 31, 2014. Additional customers added in December 2014 totaled 2,778,000. Cumulative net additional customers for the year was 39,428,000. As of December 31, 2014 3G customers were 245,753,000 and 4G customers were 90,064,000.xxi China mobile has a stable retention of middle to high-end customers and has seen growth in the corporate customers division and communication and informational services.xx

Additionally, China has invested heavily in 4G base stations and used an aggressive network expansion strategy. By the end of October, they had installed 570,000 4G base stations in 2014 in 300 cities. This covers about 75% of their 1.4 billion population.xi

Analysis of recent earnings releases While full year figures have not been released yet because of their foreign filing status (will be released late April 2015), figures for the first half of 2014 have been released by China Mobile executives. The first half of the year is looking extremely promising; in particular, data revenue is up 27.8% from the same period last year and wireless revenue is up 51.8%. Additionally management increased investments in areas of “explosive growth in data traffic, in particular to accelerate expansion of 4G business and build up core competitiveness” xx

Production and distribution China Mobile has worked to build the world’s largest 4G network, putting in 410,000 base stations to provide access to more than 300 cities. Manufacturing costs have not taken a hit relative to revenue increases. This hasn’t affected their profits however, with most lines leased totaling around 3% of their total revenues from telecommunication services. We forecast this trend to continue as in years past. xx

Other than towers, telecommunication companies like China Mobile sell products from suppliers like Apple; they make relatively small margins on phones, especially after promotions offering $200 off a phone when renewing a contract.

4G Coverage The ability to provide customers with 4G, even in rural areas is going to set apart telecommunication companies going forward. Companies who are able to do this will see a large increase in revenues. Consumers are hungry for connectivity and the fastest version of this, and are willing to pay for it.

We believe China Mobile is positioned best to continue to provide the most expansive 4G network. As discussed earlier, they have heavily invested in developing their infrastructure, and are now in a place to continue with this growth while not having to invest large amounts of cash.

Ability to Pass Price Increases to Customers Telecommunication companies have long struggled with the ability to pass along price increases to their customers. Unlike a normal good where a price can be increased gradually, after 2 years in a contract, prices have to be increased drastically to adjust for price changes. China Mobile is continuing to work to find different plans that work for both customers and the company. They have provided guidance that they are confident through “Pay As You Go” plans, they can pass along these changes month-to-month and be able to realize higher revenue and lower churn rates.xx

Offering New Phones Large corporations (like China Mobile with 62.1% of the Chinese market) are likely to be the ones to gain most from phone launches because of their capacity to offer deals. This is very hard to match for small providers. It’s imperative for the success of these large corporations to maintain relationships with phone providers.

Consumers will switch from China Mobile, Chine Telecom, or China Unicom if either provider doesn’t have the phone they desire. Because of China Mobile’s size they have an easier time maintaining relationships with the phone provider than their competitors; Samsung and Apple also don’t want to lose their large sales from China Mobile’s market share.

Key Assumptions

We believe China Mobile will see continued growth over the next seven years. Below are the specific assumptions we used to get our target price of $72.34-$78.82.

Revenue Decomposition and Growth Rates We realized the most effective way to forecast China Mobile’s sales growth is to break down their segments. To forecast our revenue decomposition, we combined historical performance, managerial guidance, and our projections for macroeconomic variables.

Some of these segments, like data services and sales of products we see consistent growth in. With the increased expansion of 4G LTE and China Mobile’s leadership in supplying this, we see consistent growth in the data services resulting in between 4.00% and 6.00% growth in the next five years. Beyond that, we

Valuation Summary

Catalysts for Growth/Change


see a slowly declining growth rate, slowly moving towards 2.76% growth in data services. We also see continued high growth in revenues from sales of products. In past years, China Mobile as enjoyed growth around 30% from their ability to bring new phones to their customers quickly and in mass quantities.

However, we do forecast a negative growth rate for voice services. More customers are decreasing their usage of minutes on the phone, so decreasing the amount of voice services in their plans. China Mobile has had 1.05% growth in 2012 and -3.35% growth in 2013; they have also had a -3.32% growth in the first 6 months of 2014. We forecast a continued negative growth rates for the next 8 years, staying close to -3.00% and -4.00%.

Market Share and Population Growth A large driver of the telecommunications industry is market share. As mentioned before, China Mobile has been fortunate to enjoy a large market share. However, in the future it is imperative they maintain this market share. We are forecasting that China Mobile will lose around 2.00% of their share of the population going forward. Currently the Chinese government supports the three large players, but has discussed the possibility of introducing one additional small competitor. Airing on the side of caution, we forecasted this could cause China Mobile to lose a small percent of their customers. They devote a large amount of resources to maintaining their customer’s satisfaction. They realize the importance of customer base in the telecommunications sector.

In recent years, population growth in China has been around 0.50%. We are forecasting a 0.60% population growth in the next two years, then back to the historic 0.50% growth rate. We are forecasting China Mobile to maintain their market share of 62.1% with the population growth as well.

Profit Margins We are forecasting that China Mobile will have a slight decline in profit margins. In the past three years, China Mobile has went from a 24% profit margin to 19%. We believe this slight decline is China Mobile realizing their realistic future margins. In the future, we are forecasting their profit margins to stay very close to this healthy 20%. There are small fluctuations in the first few forecasted years as China Mobile works to stabilize their customer base and supply of new phones.

Weighted Average Cost of Capital

Cost of Equity We used the Capital Asset Pricing Model (CAPM) to estimate the cost of equity. We chose the yield for the 30 year US Treasury Bond as the risk free rate because of the extremely low risk of default. We consulted Damodaran’s estimate of the market risk premium to determine ours as 5.67%. His reputation and experience modeling to accurately predict the market risk premium drew us to use his estimate. In reviewing the historical betas for China Mobile as calculated on Bloomberg, the most consistent measures over time were the daily betas. The five year timeframe seemed to be a fair representation, so beta was calculated as a historical average of daily betas. The result was a beta of 0.73, which corresponds with the guidance that large tier telecommunications companies’ betas should be less than 1.00, and will be lower with a lesser exposure to emerging markets.

Additionally, we added country risk premium since China Mobile does not operate in the United States and is only traded here. Damodaran’s webpage on country risk premiums provided us with an estimate for China’s country risk premium of 2.21%.xxii

Weight of Equity The market value weight of equity is majorly impacted by the shares outstanding. We did not forecast shares outstanding to increase because there are no employee stock option plans diluting the shares outstanding. We see no other reason to increase the shares outstanding and therefore kept it constant at the 2013 shares outstanding levels. Additionally there have small or no increases in shares outstanding in years past. Cost of Debt Estimating the cost of debt proved to be difficult as China Mobile does not have any long-term bonds issued and their competitors do not as well. However, they are rated as a whole even though they do not have any current long-term bonds outstanding. China Mobile currently has a AA- rating. We found the default premium that corresponds to the firm’s rating and measurement period on Damodaran’s webpage on the topic of estimating a cost of debt.xxiii

Weight of Debt Because of the government ownership, China Mobile has very small amounts of debt. They had large amounts of capital from the government’s initial equity investment in them. The government provided them with enough capital in their equity purchase to still not need debt to finance their operations today or in the future. The only debt China Mobile has is short-term debt accounting for 0.16% of their capital structure. We predict in the future this percentage will remain constant, with no need for a variable WACC.

Final WACC Value Through our analysis of cost of equity, cost of debt, as well as the weights for each of these, we reached a final WACC value of 8.26% which we think fairly represents the risk to invest in a Chinese company.

Valuation Models

Discounted Cash Flow and Economic Profit Models Both the discounted cash flow (DCF) model and economic profit (EP) models discount future income streams at the weighted average cost of capital. The discounted cash flow model is very popular because of its close link to economic theory. The economic profit model highlights whether a company is earning its cost of capital and how its financial performance is expected to change over time. xxiv

After partial year adjustments and conversion to US dollars, we arrived at a value of $76.78, 11.24% above its current share price of $69.02. Both valuation methods suggested this same intrinsic value for China Mobile. According the DCF and EP models, the stock price for China Mobile is currently undervalued. We believe this is reflective of our views on China Mobile. We believe China Mobile is positioned in the Chinese market very well with great ability to grow with their population growth and maintain their market share; the United States


market has a different perception of this however and does not see China Mobile as a continued dominant player in the future.

Relative Valuation: P/E In order to perform relative valuation for China Mobile, we identified companies that operate in similar environments to them. The companies we chose to compare them to were China Telecom (CHA), China Unicom (CHU), Nippon Telegraph (NTT), AT&T (T), Telefonica Brasil (VIV), and Verizon (VZ). We attempted to find more foreign operating companies in countries other than the US and China that we could include, however many of their direct competitors are too small to have analysts predict their P/E value or earnings per share. We were able to find estimates for direct competitors China Unicom and China Telecom.

The companies we chose to compare were not based on market capitalization, but under similar environment conditions. Although China Unicom and China Telecom had significantly smaller market capitalizations, we chose to include them since they are their most direct competitors operating in China. We included Nippon Telegraph and Telefonica Brasil because they are foreign operating telecommunication companies traded in the United States. Lastly, we included Verizon and AT&T because they are major players in the United States and have similar size and growth rates in data usage.

China Mobile’s relative P/E valuation resulted in an implied intrinsic value of $72.34-$78.82. We did not choose to use the PEG ratio analysis given the number of outliers. Very similarly to the DCF and DP models, the relative valuation shows that China Mobile is currently undervalued. We believe this is very reflective of China Mobile’s current state.

Dividend Discount Model The final model we used was the dividend discount model (DDM). This valuation method looks at all forecasted future dividends and discounts them using the cost of equity.zz Our DDM model produced an intrinsic value of $48.16, a drastically different value that what the DCP, EP, and relative models had given us. The dividend discount model showed that China Mobile is currently overvalued. However, we deemed that the DDM produces an overvalued rating for China Mobile because their earnings have grown so rapidly in the past few years in line with the boom in smart phones. We project these earnings will not be as high per share in the future and that has brought down the value of the DDM model. We deemed this is a less accurate intrinsic value. If we would have increased our payout, the intrinsic value would increase, however we believe that China Mobile will retain most of their earnings in order to invest in expanding operations geographically and in their current network infrastructure.

The impact of the change in two variables is demonstrated through a sensitivity analysis in regard to the intrinsic value of an equity. Within our examination, we conducted four sensitivity analyses to measure the impact on China Mobile in response to a change in CV growth and COGS, CV growth and WACC, the

risk free rate and the equity risk premium, and the beta versus country risk premium. COGS vs. CV Growth We first looked at the COGS values (COGS/Sales) in comparison to the CV growth assumptions. This pair is very influential in determining the intrinsic stock value for China Mobile. By purely holding the CV Growth constant and raising the COGS by 0.10%, the intrinsic value of the stock decreased $0.18. In holding the COGS constant, an increase of 0.10% in CV growth resulted in an increase of $0.37. This demonstrates the importance in minimizing the COGS and maximizing the CV growth. CV Growth vs. WACC The WACC is used to discount both the FCF and the Economic Profit to obtain a present value amount. WACC has an inverse relationship with stock price, as when WACC raises the intrinsic value of the stock lowers. The model’s assumptions rest on a projected WACC for China Mobile is 8.26% and the anticipated CV growth in NOPLAT is 1.00%. A 10 basis point movement of the WACC holding the CV growth constant results in a movement of $0.08 either direction. A 10 basis point movement of the CV growth holding the WACC constant results in a movement of $0.37 respectively. Risk-Free Rate vs. Equity Risk Premium The WACC is comprised of the market value of equity multiplied by the cost of equity added to the market value of debt multiplied by cost of debt. As China mobile has 99.84% equity capitalization, we decided to manipulate two major components of the cost of equity for a sensitivity analysis: the risk free rate and the equity risk premium. The cost of equity was determined through the CAPM, which is changed with an alteration of the risk free rate and the equity risk premium. In our analysis, we compared our projected risk free rate of 2.51% with the equity risk premium of 5.67%. Holding the risk free rate constant at 2.51%, an increase of 10 basis points in the MRP results in an increase of WACC of 0.07%, conversely a decrease of 10 basis points in the MRP results in a decrease of .08% WACC. Holding the MRP constant at 5.67% and increasing the risk free rate 10 basis points results in an increase of .1% WACC, and conversely a decrease in the risk free rate 10 basis points results in a decrease of 0.10% WACC.

Beta vs. Country Risk Premium This sensitivity analysis explored the impact of the additional country risk premium added for China in comparison to beta on the intrinsic value of China Mobile. China poses additional risk because the stock may have a greater variation in the correlation and beta with the US stock market. In our model, we decided in conjunction with Damodaran’s analysis to add an additional China risk premium on top of the general market risk premium to reflect the added risks with conducting business purely outside of the US. The risk premium is essential in completing the DCF and EP valuation models, and the beta is a crucial part of the CAPM, which flows into the WACC through cost of equity calculation. The country risk premium was decided to be 2.21% and the beta was 0.73. In holding beta constant, a change in the country risk premium positively and negatively of .10% respectively decreases and increases the intrinsic value by $0.64.

Sensitivity Analysis


In holding the country risk premium constant and altering beta in either direction by 0.10, the share price decreases with a beta increase by $6.23 and the share price increases with a beta decrease by $7.76 showing that the price is highly sensitive to the beta.

i IBIS World, “Global Telecommunications Carries: Major Companies”

ii MBASkool, “Top 10 Telecom Companies of the World 2014” http://www.mbaskool.com/fun-corner/top-brand-lists/9841-top-10-telecom-companies-of-the-world-2014.html?start=8

iii Marketline Advantage, “China Mobile Limited: SWOT Analysis”. 22 Aug. 2014

iv Marketline Advantage, “China Mobile Limited: Revenue Analysis”. 22 Aug. 2014

v The Wall Street Journal, “China Economic Growth is Slowest in Decades”. Mark Magnier, 19 Jan. 2015.

vi Pragmatic Capitalism, “Interest Rate Scenarios and Stock Market Performance”. http://www.pragcap.com/interest-rate-scenarios-stock-market-performance

vii CNBC, “China cuts benchmark interest rates by 25 basis points”, 28 Feb. 2015. http://www.cnbc.com/id/102465368

viii Trading Economics, “China Interest Rates”. http://www.tradingeconomics.com/china/interest-rate

ix International Comparative Legal Guides, “China – Telecoms, Media and Internet Laws and Regulations 2015”, Wan Rui. http://www.iclg.co.uk/practice-areas/telecoms-media-and-internet-laws/telecoms,-media-and-internet-laws-and-regulations/china

x Deloitte, “The impact of mobile on economic growth”, Chris Williams. http://www2.deloitte.com/uk/en/pages/technology-media-and-telecommunications/articles/impact-of-mobile-telephony-on-economic-growth.html

xi Forbes, “China Mobile Continues to Dominate as 4G Subscribers Cross 50 Million” Trevix Team. 19 Nov. 2014 http://www.forbes.com/sites/greatspeculations/2014/11/19/china-mobile-continues-to-dominate-as-4g-subscribers-cross-50-million/

xii Marketline Advantage, “China - Mobile Phones”. 21 Sept. 2012

xiv Marketline Advantage, “China Mobile Limited”. 22 Aug. 2014

xv Reisinger, Don, “China Mobile’s next growth strategy: Acquisitions” CNET. 14 Aug. 2014 http://www.cnet.com/news/china-mobiles-next-growth-strategy-acquisitions/

xvi China Mobile, “Business Review” http://www.chinamobileltd.com/en/business/business.php

xvii IBIS World, “Global Telecommunications Carriers: Industry Outlook”

xviii Thomson One, “China Mobile Summary”

xix Marketline Advantage, “China Mobile Limited”. 22 Aug. 2014

xx China Mobile, “Interim Report 2014” http://www.chinamobileltd.com/en/ir/reports/ir2014.pdf

xxi China Mobile, “Investor Relations: Operation Data” http://www.chinamobileltd.com/en/ir/operation.php

xxii Damodaran, Aswath. “Country Default Spreads and Risk Premiums”.1 Jan. 2015. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html

xxiii Damodaran, Aswath. “Estimating a synthetic rating and cost of debt”. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/valquestions/syntrating.htm

xxiv McKinsey and Company, “Valuation: University 5th Edition”, Tim Koller, et al.

Source Citations


Important Disclaimer This report was created by students enrolled in the Applied Equity Valuation (FIN:4250) class at the University of Iowa. The report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students’ skills, knowledge and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report.

China Mobile Limited

Revenue Decomposition

Fiscal Years Ending Dec. 31 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021CV

Operating Revenue (in RMB millions)

Revenue from telecommunications services (not

including sales of products): 528.00 560.41 590.81 595.82 604.35 606.56 611.82 617.69 622.65 626.64 628.74

YoY Growth 8.81% 6.14% 5.42% 0.85% 1.43% 0.36% 0.87% 0.96% 0.80% 0.64% 0.34%

Voice services 364.19 368.03 355.69 331.56 322.75 310.19 297.36 287.67 277.71 268.49 260.29

YoY Growth 5.87% 1.05% -3.35% -6.78% -2.66% -3.89% -4.14% -3.26% -3.46% -3.32% -3.05%

Data services 139.33 166.35 206.89 243.83 259.12 271.98 288.30 302.26 315.72 327.64 336.79

YoY Growth 15.37% 19.39% 24.37% 17.86% 6.27% 4.96% 6.00% 4.84% 4.45% 3.78% 2.79%

Others 24.48 26.04 28.24 20.44 22.48 24.39 26.16 27.76 29.21 30.51 31.66

YoY Growth 19.54% 6.37% 8.44% -27.62% 10.00% 8.50% 7.23% 6.14% 5.22% 4.44% 3.77%

Revenue from sales of products and others 21.42 39.37 53.54 64.10 74.15 81.29 89.45 97.06 103.75 111.24

YoY Growth 83.76% 36.01% 19.72% 15.67% 9.63% 10.04% 8.51% 6.89% 7.22%

Operating Revenue Total 528.00 581.84 630.18 649.36 668.45 680.70 693.10 707.14 719.71 730.38 739.97

YoY Growth 8.81% 10.20% 8.31% 3.04% 2.94% 1.83% 1.82% 2.03% 1.78% 1.48% 1.31%

Customer Base and Customer Usage

Customers (In Millions) 649.6 710.3 767.2 820.9 865.2 909.3 952.8 995.6 1037.3 1077.8 1116.6

YoY Growth 11.23% 9.34% 8.01% 7.00% 5.40% 5.09% 4.79% 4.49% 4.19% 3.90% 3.60%

Voice Usage (in billions of minutes) 3887.2 4192.3 4316 4295.3 4317.6 4286.6 4298.7 4348.7 4390.4 4438.5 4499.2

YoY Growth 12.29% 7.85% 2.95% -0.48% 0.52% -0.72% 0.28% 1.16% 0.96% 1.10% 1.37%

Wireless Data Traffic 361.4 1039.2 2011.8 3612.2 5206.2 6485.7 7382.1 8271.6 9143.1 9989.0 10803.9

YoY Growth 152.20% 187.55% 93.59% 79.55% 44.13% 24.58% 13.82% 12.05% 10.54% 9.25% 8.16%

Mobile Data Traffic 161 289.8 526.8 849.91 1139.79 1357.10 1503.55 1645.98 1783.37 1915.15 2041.10

YoY Growth 56.16% 80.00% 81.78% 61.34% 34.11% 19.07% 10.79% 9.47% 8.35% 7.39% 6.58%

Average Monthly Churn Rate 3.21 3.25 3.15 3.09 3.03 2.96 2.91 2.85 2.79 2.73 2.68

YoY Growth -0.31% 1.25% -3.08% -2.00% -2.00% -2.00% -2.00% -2.00% -2.00% -2.00% -2.00%

Key Assumptions

Chinese population growth 0.50% 0.50% 0.50% 0.60% 0.60% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%

Real GDP growth 9.30% 7.70% 7.70% 7.40% 7.20% 7.20% 7.00% 6.80% 6.50% 6.00% 5.80%

Market Share 62.71% 62.00% 62.00% 61.50% 61.00% 60.00% 59.00% 59.00% 59.00%

Inflation 4.06% 2.41% 2.51% 1.60% 1.60% 2.00% 2.40% 2.60% 2.60% 3.00% 3.00%


Income Statement (in RMB millions)


Sales 528.00 560.41 630.18 649.36 668.45 680.70 693.10 707.14 719.71 730.38 739.97

Cost of Goods Sold 57.01 65.96 140.08 153.25 162.39 168.40 174.59 181.73 188.25 193.88 199.00

Depreciation 97.11 100.85 104.70 122.09 122.49 123.11 124.41 125.96 127.92 130.26 132.96

Amortization of Intangibles 0.05 0.07 0.08 0.09 0.11 0.13 0.14 0.16 0.18 0.21 0.24

Amortization of Deferred Charges 0.32 0.35 0.38 0.45 0.54 0.67 0.85 1.08 1.35 1.67 2.08

Gross Income 373.44 393.19 384.94 373.48 382.92 388.40 393.10 398.20 402.00 404.37 405.69

SG&A Expense 216.20 239.54 247.01 252.69 255.82 250.87 250.30 249.09 246.58 244.24 241.18

Other Operating Expense 0.09 0.31 0.20 0.19 0.23 0.26 0.24 0.25 0.26 0.27 0.27

EBIT (Operating Income) 157.15 153.34 137.72 120.59 126.86 137.27 142.57 148.86 155.16 159.86 164.25

Nonoperating Income - Net 11.54 15.48 16.20 39.68 20.73 23.02 24.91 27.09 23.94 24.74 25.17

Interest Expense 0.56 0.39 0.33 0.18 0.12 0.13 0.15 0.13 0.14 0.14 0.14

Unusual Expense - Net 5.85 2.82 2.07 3.38 3.53 2.95 2.98 3.21 3.17 3.08 3.11

Pretax Income 162.28 165.62 151.52 156.71 143.94 157.21 164.35 172.60 175.79 181.38 186.17

Income Taxes 40.60 41.92 36.78 38.04 34.94 38.16 39.89 41.89 42.67 44.03 45.19

Equity in Earnings of Affiliates 4.30 5.68 7.06 7.28 7.49 7.63 7.77 7.92 8.07 8.18 8.29

Consolidated Net Income 125.98 129.38 121.80 125.95 116.49 126.68 132.22 138.63 141.19 145.54 149.27

Minority Interest 0.11 0.11 0.11 0.11 0.11 0.11 0.11 0.11 0.11 0.11 0.11

Net Income 125.87 129.27 121.69 125.84 116.38 126.57 132.11 138.52 141.08 145.43 149.16

EPS (recurring) 31.99 32.26 30.27 31.30 28.95 31.48 32.86 34.45 35.09 36.17 37.10

Total Shares Outstanding 4.01 4.02 4.02 4.02 4.02 4.02 4.02 4.02 4.02 4.02 4.02

Dividends per Share 11.87 12.37 12.39 13.29 14.25 15.29 16.39 17.58 18.86 20.22 21.69

EBITDA 254.65 254.60 242.88 243.22 250.01 261.17 267.98 276.07 284.62 292.00 299.52

EBIT 157.15 153.34 137.72 120.59 126.86 137.27 142.57 148.86 155.16 159.86 164.25

Depreciation & Amortization Expense 97.49 101.26 105.16 122.63 123.14 123.90 125.41 127.20 129.45 132.14 135.28


Balance Sheet


Assets

Cash Only 62.67 56.45 44.93 42.57 63.29 113.49 137.53 171.13 205.23 234.64 263.43

Short Term Investments 270.30 346.45 374.98 384.79 414.20 417.58 429.47 445.56 454.92 464.94 474.49

Accounts Receivables 28.91 20.58 26.30 27.92 29.59 30.68 31.81 33.11 34.30 35.33 36.26

Inventories 7.94 7.19 9.15 9.72 10.30 10.68 11.07 11.52 11.94 12.29 12.62

Other Current Assets 12.85 15.91 24.78 29.08 33.59 36.06 37.67 38.91 39.85 40.57 41.16

Total Current Assets 382.68 446.59 480.14 494.08 550.96 608.50 647.55 700.24 746.24 787.77 827.97

Net Property, Plant & Equipment 464.40 486.01 564.23 566.24 569.84 575.34 582.62 591.77 602.49 615.02 629.13

LT Investment - Affiliate Companies 43.80 48.35 53.94 56.48 58.80 60.10 61.54 63.49 64.98 66.18 67.38

Other Long-Term Investments 0.25 5.54 6.94 3.66 4.65 5.81 5.67 5.28 5.70 5.95 5.95

Net Goodwill 36.89 36.89 36.89 36.89 36.89 36.89 36.89 36.89 36.89 36.89 36.89

Net Other Intangibles 0.82 0.92 1.06 1.10 1.13 1.16 1.20 1.23 1.26 1.28 1.31

Deferred Tax Assets 10.91 13.54 4.45 3.50 1.95 1.31 0.80 0.51 0.32 0.21 0.13

Other Assets 23.71 14.24 19.74 21.15 23.09 21.46 22.93 23.76 24.31 24.46 25.10

Total Assets 963.47 1,052.11 1,167.40 1,183.10 1,247.31 1,310.57 1,359.20 1,423.19 1,482.20 1,537.76 1,593.86

ST Debt & Curr. Portion LT Debt 1.68 1.23 2.82 1.91 1.99 2.24 2.05 2.09 2.12 2.09 2.10

Accounts Payable 116.27 123.90 174.52 150.73 157.90 166.00 161.55 164.70 167.27 167.51 169.10

Income Tax Payable 10.86 10.86 8.72 12.00 11.85 11.56 12.51 12.69 12.94 13.34 13.54

Accrued Payroll 5.38 5.56 5.65 6.48 6.62 6.67 6.98 7.16 7.32 7.51 7.64

Miscellaneous Current Liabilities 139.06 156.26 184.21 148.27 146.05 135.97 121.68 114.24 104.87 95.43 87.55

Total Current Liabilities 273.24 297.80 370.93 319.39 324.41 322.44 304.77 300.88 294.52 285.87 279.93

Deferred Tax Liabilities 0.02 0.05 0.09 0.08 0.07 0.08 0.08 0.08 0.09 0.09 0.09

Other Liabilities 10.91 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Deferred Income 0.26 0.33 0.66 0.44 0.49 0.53 0.57 0.55 0.57 0.59 0.60

Total Liabilities 313.05 326.80 376.67 319.91 324.97 323.05 305.42 301.51 295.18 286.55 280.62

Common Stock Par and Additional Paid-In Capital 388.77 389.32 389.38 389.38 389.38 389.38 389.38 389.38 389.38 389.38 389.38

Retained Earnings 374.70 416.20 457.22 529.64 588.72 653.83 720.03 787.87 853.14 917.26 979.22

Accumulated Other Comprehensive Income (114.40) (82.08) (57.83) (57.83) (57.83) (57.83) (57.83) (57.83) (57.83) (57.83) (57.83)

Total Shareholders' Equity 649.06 723.45 788.78 861.19 920.27 985.38 1,051.59 1,119.42 1,184.69 1,248.81 1,310.77

Accumulated Minority Interest 1.35 1.86 1.95 2.01 2.07 2.13 2.20 2.26 2.33 2.40 2.47

Total Equity 650.42 725.31 790.73 863.20 922.34 987.51 1,053.78 1,121.68 1,187.02 1,251.21 1,313.24

Total Liabilities & Shareholders' Equity 963.47 1,052.11 1,167.40 1,183.10 1,247.31 1,310.57 1,359.20 1,423.19 1,482.19 1,537.76 1,593.86

Book Value per Share (in RMB) 161.68 179.96 196.19 214.20 228.89 245.09 261.56 278.43 294.66 310.61 326.02

Book Value per Share (in USD) 26.27 29.24 31.88 34.81 37.20 39.83 42.50 45.24 47.88 50.47 52.98

Liabilities & Shareholders' Equity


Historical Cash Flow Statement

Fiscal Years Ending Dec. 31 2011 2012 2013

Net Income / Starting Line 166.58 171.30 158.58

Depreciation, Depletion & Amortization 97.49 101.26 105.16

Other Funds (35.33) (44.74) (43.80)

Changes in Working Capital 4.81 13.06 19.20

Receivables (5.00) (6.91) (7.41)

Inventories (3.49) 0.44 (2.16)

Accounts Payable 0.65 5.44 5.37

Other Assets/Liabilities 12.65 14.09 1.36

Net Operating Cash Flow 233.55 240.88 239.14

Capital Expenditures (124.50) (125.20) (140.40)

Net Assets from Acquisitions 0.00 0.00 0.00

Sale of Fixed Assets & Businesses 0.26 0.01 0.05

Purchase/Sale of Investments 0.00 0.00 (44.22)

Other Funds (53.18) (76.57) (1.40)

Other Sources 2.70 14.00 0.00

Net Investing Cash Flow (177.42) (201.77) (185.96)

Cash Dividends Paid (52.57) (55.43) (55.49)

Change in Capital Stock 0.14 0.53 0.04

Issuance/Reduction of Debt, Net (4.72) 0.02 (23.63)

Other Funds 0.00 0.40 (0.02)

Net Financing Cash Flow (57.15) (54.47) (79.10)

Exchange Rate Effect (0.26) 0.01 (0.05)

Miscellaneous Funds 0.00 0.00 0.00

Net Change in Cash (1.28) (15.35) (25.97)

Beginning Cash 81.50 62.67 56.45

Ending Cash 62.67 56.45 44.93

Operating Activities

Investing Activities

Financing Activities


Cash Flow Statement

Fiscal Years Ending Dec. 31 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021CV

Operating Activities

Net Income / Starting Line 125.84 116.38 126.57 132.11 138.52 141.08 145.43 149.16

Depreciation, Depletion & Amortization 122.18 122.60 123.23 124.56 126.12 128.10 130.47 133.20

Changes in Working Capital -62.81 -2.15 -3.86 -21.52 -7.50 -9.26 -10.72 -8.37

Receivables -1.63 -1.67 -1.09 -1.13 -1.30 -1.19 -1.03 -0.93

Inventories -0.57 -0.58 -0.38 -0.39 -0.45 -0.41 -0.36 -0.33

Accounts Payable -23.79 7.18 8.10 -4.46 3.15 2.57 0.24 1.58

Other Assets/Liabilities -36.83 -7.08 -10.48 -15.55 -8.90 -10.23 -9.58 -8.70

Net Operating Cash Flow 185.21 236.83 245.94 235.15 257.15 259.92 265.18 273.99

Investing Activities

Capital Expenditures -124.10 -126.09 -128.61 -131.69 -135.12 -138.63 -142.79 -147.07

Net Assets from Acquisitions 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Investment in Affiliate Companies -2.54 -2.32 -1.30 -1.44 -1.95 -1.49 -1.20 -1.19

Purchase/Sale of Investments -6.53 -30.39 -4.54 -11.75 -15.70 -9.78 -10.27 -9.55

Change in Intangible Assets -0.13 -0.14 -0.16 -0.17 -0.19 -0.21 -0.24 -0.26

Net Investing Cash Flow (133.30) (158.94) (134.61) (145.07) (152.96) (150.11) (154.50) (158.08)

Financing Activities

Cash Dividends Paid -53.43 -57.30 -61.45 -65.91 -70.69 -75.81 -81.31 -87.20

Change in Capital Stock 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Issuance/Reduction of Debt, Net -0.91 0.08 0.25 -0.19 0.04 0.03 -0.04 0.01

Change in Minority Interest 0.06 0.06 0.06 0.06 0.07 0.07 0.07 0.07

Net Financing Cash Flow -54.28 -57.16 -61.14 -66.04 -70.58 -75.71 -81.28 -87.12

Net Change in Cash -2.37 20.72 50.20 24.04 33.60 34.10 29.41 28.80

Beginning Cash 44.93 42.57 63.29 113.49 137.53 171.13 205.23 234.64

Ending Cash 42.57 63.29 113.49 137.53 171.13 205.23 234.64 263.43


Common Size Income Statement


Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cost of Goods Sold (COGS) 10.80% 11.77% 22.23% 23.60% 24.29% 24.74% 25.19% 25.70% 26.16% 26.54% 26.89%

Depreciation 18.39% 18.00% 16.61% 18.80% 18.32% 18.09% 17.95% 17.81% 17.77% 17.83% 17.97%

Amortization of Intangibles 0.01% 0.01% 0.01% 0.01% 0.02% 0.02% 0.02% 0.02% 0.03% 0.03% 0.03%

Amortization of Deferred Charges 0.06% 0.06% 0.06% 0.07% 0.08% 0.10% 0.12% 0.15% 0.19% 0.23% 0.28%

Gross Income 70.73% 70.16% 61.08% 57.51% 57.28% 57.06% 56.72% 56.31% 55.86% 55.36% 54.83%

SG&A Expense 40.95% 42.74% 39.20% 42.01% 42.44% 42.36% 42.26% 43.12% 43.30% 43.39% 43.58%

Other Operating Expense 0.02% 0.06% 0.03% 0.03% 0.03% 0.04% 0.03% 0.04% 0.04% 0.04% 0.04%

EBIT (Operating Income) 29.76% 27.36% 21.85% 15.47% 14.81% 14.66% 14.42% 13.15% 12.52% 11.93% 11.21%

Nonoperating Income - Net 2.19% 2.76% 2.57% 6.11% 3.10% 3.38% 3.59% 3.83% 3.33% 3.39% 3.40%

Interest Expense 0.11% 0.07% 0.05% 0.03% 0.02% 0.02% 0.02% 0.02% 0.02% 0.02% 0.02%

Unusual Expense - Net 1.11% 0.50% 0.33% 0.52% 0.53% 0.43% 0.43% 0.45% 0.44% 0.42% 0.42%

Pretax Income 30.73% 29.55% 24.04% 21.03% 17.37% 17.59% 17.57% 16.51% 15.39% 14.88% 14.17%

Income Taxes 7.69% 7.48% 5.84% 5.86% 5.23% 5.61% 5.76% 5.92% 5.93% 6.03% 6.11%

Equity in Earnings of Affiliates 0.82% 1.01% 1.12% 1.12% 1.12% 1.12% 1.12% 1.12% 1.12% 1.12% 1.12%

Consolidated Net Income 23.86% 23.09% 19.33% 19.40% 17.43% 18.61% 19.08% 19.60% 19.62% 19.93% 20.17%

Minority Interest 0.02% 0.02% 0.02% 0.02% 0.02% 0.02% 0.02% 0.02% 0.02% 0.02% 0.02%

Net Income 23.84% 23.07% 19.31% 19.38% 17.41% 18.59% 19.06% 19.59% 19.60% 19.91% 20.16%


Common Size Balance Sheet


Assets

Cash Only 11.87% 10.07% 7.13% 6.56% 9.47% 16.67% 19.84% 24.20% 28.52% 32.13% 35.60%

Short Term Investments 51.19% 61.82% 59.50% 59.26% 61.96% 61.35% 61.96% 63.01% 63.21% 63.66% 64.12%

Accounts Receivables 5.48% 3.67% 4.17% 4.30% 4.43% 4.51% 4.59% 4.68% 4.77% 4.84% 4.90%

Inventories 1.50% 1.28% 1.45% 1.50% 1.54% 1.57% 1.60% 1.63% 1.66% 1.68% 1.71%

Other Current Assets 2.43% 2.84% 3.93% 4.48% 5.02% 5.30% 5.43% 5.50% 5.54% 5.55% 5.56%

Total Current Assets 72.48% 79.69% 76.19% 76.09% 82.42% 89.39% 93.43% 99.02% 103.69% 107.86% 111.89%

Net Property, Plant & Equipment 87.95% 86.72% 89.54% 88.07% 88.11% 88.57% 88.25% 88.31% 88.38% 88.31% 88.33%

LT Investment - Affiliate Companies 8.30% 8.63% 8.56% 8.70% 8.80% 8.83% 8.88% 8.98% 9.03% 9.06% 9.11%

Other Long-Term Investments 0.05% 0.99% 1.10% 0.56% 0.70% 0.85% 0.82% 0.75% 0.79% 0.81% 0.80%

Net Goodwill 6.99% 6.58% 5.85% 5.68% 5.52% 5.42% 5.32% 5.22% 5.13% 5.05% 4.99%

Net Other Intangibles 0.15% 0.16% 0.17% 0.17% 0.17% 0.17% 0.17% 0.17% 0.17% 0.18% 0.18%

Deferred Tax Assets 2.07% 2.42% 0.71% 1.85% 1.81% 1.73% 1.55% 1.77% 1.75% 1.73% 1.72%

Other Assets 4.49% 2.54% 3.13% 3.26% 3.45% 3.15% 3.31% 3.36% 3.38% 3.35% 3.39%

Total Assets 182.48% 187.74% 185.25% 184.38% 190.98% 198.12% 201.73% 207.59% 212.31% 216.35% 220.41%

Liabilities & Shareholders' Equity

ST Debt & Curr. Portion LT Debt 0.32% 0.22% 0.01% 0.29% 0.30% 0.33% 0.30% 0.30% 0.30% 0.29% 0.28%

Accounts Payable 22.02% 22.11% 27.69% 23.21% 23.62% 24.39% 23.31% 23.29% 23.24% 22.93% 22.85%

Income Tax Payable 2.06% 1.94% 1.38% 1.85% 1.77% 1.70% 1.81% 1.79% 1.80% 1.83% 1.83%

Accrued Payroll 1.02% 0.99% 0.90% 1.00% 0.99% 0.98% 1.01% 1.01% 1.02% 1.03% 1.03%

Miscellaneous Current Liabilities 26.34% 27.88% 28.88% 22.83% 21.85% 19.98% 17.56% 16.16% 14.57% 13.07% 11.83%

Total Current Liabilities 51.75% 53.14% 58.86% 49.18% 48.53% 47.37% 43.97% 42.55% 40.92% 39.14% 37.83%

Deferred Tax Liabilities 0.00% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01%

Other Liabilities 2.07% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Deferred Income 0.05% 0.06% 0.11% 0.07% 0.07% 0.08% 0.08% 0.08% 0.08% 0.08% 0.08%

Total Liabilities 59.29% 58.31% 59.77% 49.26% 48.61% 47.46% 44.07% 42.64% 41.01% 39.23% 37.92%

Common Stock Par and Additional Paid-In Capital 73.63% 69.47% 61.79% 59.96% 58.25% 57.20% 56.18% 55.06% 54.10% 53.31% 52.62%

Retained Earnings 70.97% 74.27% 72.55% 81.56% 88.07% 96.05% 103.89% 111.42% 118.54% 125.59% 132.33%

Accumulated Other Comprehensive Income -21.67% -14.65% -9.18% -8.91% -8.65% -8.50% -8.34% -8.18% -8.04% -7.92% -7.82%

Total Shareholders' Equity 122.93% 129.09% 125.17% 132.62% 137.67% 144.76% 151.72% 158.30% 164.61% 170.98% 177.14%

Accumulated Minority Interest 0.26% 0.33% 0.31% 0.31% 0.31% 0.31% 0.32% 0.32% 0.32% 0.33% 0.33%

Total Equity 123.19% 129.42% 125.48% 132.93% 137.98% 145.07% 152.04% 158.62% 164.93% 171.31% 177.47%

Total Liabilities & Shareholders' Equity 182.48% 187.74% 185.25% 182.19% 186.60% 192.53% 196.10% 201.26% 205.94% 210.54% 215.39%


Weighted Average Cost of Capital (WACC) Estimation

Cost of Equity

Risk Free 2.51%

Risk Premium 5.67%

Country Risk Premium 2.21%

Beta 0.73

Cost of Equity 8.26%

Cost of Debt

Debt Rating AA-

Default Spread 4.01%

Pre-Tax Cost of Debt 6.52%

Tax Rate 24.27%

After-Tax Cost of Debt 4.94%

Capital Structure Weights

Shares Outstanding (millions) 4.02

Current Price 427.64¥

Market Value of Equity 1719.33 99.84%

Market Value of Debt 2.82 0.16%

Total Capitalization 1722.15 100.00%

Weighted Average Cost of Capital 8.26%


Key Inputs:

CV Growth 1.00%

CV ROIC 21.96%

WACC 8.26%



DCF Model

FCF 65.93 96.16 108.19 97.06 107.34 110.96 111.55 114.48

Continuing Value (CV) 1713.15

Discount Periods 1 2 3 4 5 6 7 7

Discount Factor 1.0826 1.1720 1.2687 1.3735 1.4869 1.6097 1.7426 1.7426

PV 60.90 82.05 85.27 70.66 72.19 68.93 64.01 983.12

Value of Operating Assets 1487.14

Excess Cash 32.33

ST Investments 374.98

PV Operating Lease Obligations -34.92

Debt -2.82

Value of Equity 1856.70

Shares Outstanding 4.02

Intrinsic Value Per Share 461.81¥

Intrinsic Value Today (partial year adjustment) 472.48¥

Conversion to USD (1 RMB = 0.1625 USD) 76.78$

EP Model

NOPLAT 96.30 101.86 108.74 112.81 117.73 122.71 126.51 130.25

Beginning Invested Capital 503.58 533.95 539.66 540.21 555.96 566.35 578.10 593.06

ROIC 19.12% 19.08% 20.15% 20.88% 21.18% 21.67% 21.88% 21.96%

WACC 8.26% 8.26% 8.26% 8.26% 8.26% 8.26% 8.26% 8.26%

Beginning Invested Capital 503.58 533.95 539.66 540.21 555.96 566.35 578.10 593.06

x ROIC - WACC 10.87% 10.82% 11.89% 12.63% 12.92% 13.41% 13.63% 13.71%

EP 54.72 57.77 64.18 68.20 71.83 75.94 78.78 81.28

CV 1120

Discount Periods 1 2 3 4 5 6 7 7

Discount Factor 1.0826 1.1720 1.2687 1.3735 1.4869 1.6097 1.7426 1.7426

PV CF 50.54 49.30 50.59 49.66 48.31 47.18 45.21 642.78

PV EP 983.56

Beginning Invested Capital 503.58

Value of Operating Assets 1487.14

Excess Cash 32.33

ST Investments 374.98

PV Operating Lease Obligations -34.92

Debt -2.82

Value of Equity 1856.70

Shares Outstanding 4.02




Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models


Dividend Discount Model (DDM) or Fundamental P/E Valuation Model


EPS 31.30¥ 28.95¥ 31.48¥ 32.86¥ 34.45¥ 35.09¥ 36.17¥ 37.10¥

Key Assumptions

CV growth in EPS 2.57%

CV ROE 11.94%


Future Cash Flows

P/E Multiple (CV Year) 13.78

EPS (CV Year) 37.10

Future Stock Price 472.48

Dividends Per Share 13.29 14.25 15.29 16.39 17.58 18.86 20.22 21.69

CV 380.72¥

Periods to Discount 1 2 3 4 5 6 7 7

Discount Rate 1.08 1.17 1.27 1.37 1.49 1.61 1.74 1.74

Discounted Cash Flows 12.27 12.16 12.05 11.93 11.82 11.71 11.60 218.40





Relative Valuation Models

EPS EPS

Ticker Company Price 2015E 2016E P/E 15 P/E 16

CHA China Telecom $73.60 $5.21 $5.10 14.1 12.1

CHU China Unicom $17.95 $0.97 $1.15 17.8 16.2

NTT Nippon Telegraph and Telephone Corp $33.66 $2.05 $2.29 15.0 13.5

T AT&T $32.89 $2.52 $2.59 13.1 12.7

VIV Telefonica Brasil $14.97 $1.19 $1.23 13.0 12.6

VZ Verizon Communications, Inc $49.39 $3.67 $3.88 19.3 25.4

Average 15.4 15.4

CHL-US China Mobile Limited 427.64¥ 28.9 31.5 14.8 13.6

Implied Value:

Relative P/E (EPS15) 445.18¥ 72.34$

Relative P/E (EPS16) 485.07¥ 78.82$

Current Share Price 427.64¥ 69.02$


Key Management Ratios

Fiscal Years Ending Dec. 31 Formulas 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021CV

Liquidity Ratios

Current Ratio Current assets / Current liabilities 1.40 1.50 1.29 1.55 1.70 1.89 2.12 2.33 2.53 2.76 2.96

Quick Ratio

(Cash and cash equivalents+ Accounts

Recievable, net + ST

Investments)/Current Liabilities 1.32 1.42 1.20 1.43 1.56 1.74 1.96 2.16 2.36 2.57 2.77

Cash Ratio

Cash and cash equivalents / Current

liabilities 0.23 0.19 0.12 0.13 0.20 0.35 0.45 0.57 0.70 0.82 0.94

Activity or Asset-Management Ratios

Recievables Turnover

Revenue / Average accounts

receivable 23.98 23.51 26.89 23.95 23.25 22.59 22.18 21.78 21.35 20.98 20.67

Total Asset Turnover Revenue / Total Assets 0.55 0.55 0.54 0.55 0.54 0.52 0.51 0.50 0.49 0.47 0.46

Net Working Capital Turnover Revenue/working Capital 4.82 3.91 6.05 3.72 2.95 2.38 2.02 1.77 1.59 1.46 1.35

Fixed Asset Turnover

Revenue / Property and equipment,

net 1.14 1.20 1.12 1.15 1.17 1.18 1.19 1.19 1.19 1.19 1.18

Financial Leverage Ratios

Debt/Equity Total debt / Total equity 0.48 0.45 0.48 0.37 0.35 0.33 0.29 0.27 0.25 0.23 0.21

Debt/Total Assets Total debt / Total assets 0.32 0.31 0.32 0.27 0.26 0.25 0.22 0.21 0.20 0.19 0.18

Operating CF to Debt Operating cash flows / Total debt 0.75 0.74 0.63 0.58 0.73 0.76 0.77 0.85 0.88 0.93 0.98

Profitability Ratios

ROANet income/ Average total assets

13.79% 12.83% 10.97% 10.71% 9.58% 9.90% 9.90% 9.96% 9.71% 9.63% 9.53%

ROE Net income / Average Total Equity 20.50% 18.79% 16.05% 15.22% 13.04% 13.25% 12.94% 12.73% 12.22% 11.93% 11.63%

Operating Margin Income from operations / Revenue 70.73% 70.16% 61.08% 57.51% 57.28% 57.06% 56.72% 56.31% 55.86% 55.36% 54.83%

Profit Margin Net income / Revenue 23.84% 23.07% 19.31% 19.38% 17.41% 18.59% 19.06% 19.59% 19.60% 19.91% 20.16%

Cash Flow Margin Net operating cash flows/sales 44.23% 42.98% 37.95% 28.52% 35.43% 36.13% 33.93% 36.36% 36.11% 36.31% 37.03%

Payout Policy Ratios

Payout Ratio

Cash dividends declared per common

share /Earnings per common share37.11% 38.35% 40.94% 42.46% 49.24% 48.55% 49.89% 51.03% 53.74% 55.91% 58.46%

Dividend Coverage

Earnings per Share/ Dividends per

Share 2.69 2.61 2.44 2.36 2.03 2.06 2.00 1.96 1.86 1.79 1.71


Sensitvity Analaysis

Share Price COGS/Sales

76.78$ 26.59% 26.69% 26.79% 26.89% 26.99% 27.09% 27.19%

0.70% 76.26$ 76.08$ 75.90$ 75.73$ 75.55$ 75.38$ 75.20$

0.80% 76.61$ 76.43$ 76.25$ 76.07$ 75.89$ 75.71$ 75.53$

0.90% 76.96$ 76.78$ 76.60$ 76.42$ 76.24$ 76.06$ 75.88$

CV Growth 1.00% 77.33$ 77.15$ 76.97$ 76.78$ 76.60$ 76.42$ 76.23$

1.10% 77.71$ 77.53$ 77.34$ 77.15$ 76.97$ 76.78$ 76.60$

1.20% 78.10$ 77.91$ 77.73$ 77.54$ 77.35$ 77.16$ 76.97$

1.30% 78.50$ 78.31$ 78.12$ 77.93$ 77.74$ 77.55$ 77.36$

Share Price WACC

76.78$ 7.96% 8.06% 8.16% 8.26% 8.36% 8.46% 8.56%

0.70% 78.37$ 77.45$ 76.56$ 75.72$ 74.85$ 74.03$ 73.23$

0.80% 78.76$ 77.82$ 76.92$ 76.06$ 75.18$ 74.35$ 73.53$

0.90% 79.15$ 78.21$ 77.28$ 76.42$ 75.52$ 74.67$ 73.84$

CV Growth 1.00% 79.56$ 78.60$ 77.66$ 76.78$ 75.86$ 75.00$ 74.16$

1.10% 79.98$ 79.00$ 78.05$ 77.15$ 76.22$ 75.34$ 74.49$

1.20% 80.42$ 79.42$ 78.45$ 77.53$ 76.59$ 75.69$ 74.83$

1.30% 80.86$ 79.84$ 78.85$ 77.92$ 76.96$ 76.06$ 75.17$

WACC MRP

8.26% 5.37% 5.47% 5.57% 5.67% 5.77% 5.87% 5.97%

2.21% 7.74% 7.81% 7.88% 7.96% 8.03% 8.10% 8.18%

2.31% 7.84% 7.91% 7.98% 8.06% 8.13% 8.20% 8.28%

2.41% 7.94% 8.01% 8.08% 8.16% 8.23% 8.30% 8.38%

RF 2.51% 8.04% 8.11% 8.18% 8.26% 8.33% 8.40% 8.48%

2.61% 8.14% 8.21% 8.28% 8.36% 8.43% 8.50% 8.58%

2.71% 8.24% 8.31% 8.38% 8.46% 8.53% 8.60% 8.68%

2.81% 8.34% 8.41% 8.48% 8.56% 8.63% 8.70% 8.78%

Share Price Country Risk Premium

76.78$ 2.00% 2.01% 2.11% 2.21% 2.31% 2.41% 2.51%

0.43 109.43$ 109.35$ 108.49$ 107.65$ 106.82$ 106.01$ 105.21$

0.53 96.11$ 96.03$ 95.25$ 94.48$ 93.73$ 92.98$ 92.26$

0.63 86.04$ 85.96$ 85.24$ 84.54$ 83.85$ 83.17$ 82.51$

Beta 0.73 78.15$ 78.08$ 77.42$ 76.78$ 76.14$ 75.52$ 74.91$

0.83 71.82$ 71.76$ 71.15$ 70.55$ 69.97$ 69.39$ 68.83$

0.93 66.63$ 66.57$ 66.00$ 65.45$ 64.91$ 64.38$ 63.86$

1.03 62.29$ 62.24$ 61.71$ 61.20$ 60.70$ 60.20$ 59.72$

china mobile ltd. (nyse: chl)€¦ · important disclosures appear on the last page of this report....

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