China Calling

Did you ever meet a four-year old who would rather eat broccoli than ice cream? Or an investor who would rather buy a value stock than a “growth stock”? Value stocks are the green vegetables of the investment world, and who wants to eat those? Almost nobody wants to eat the stuff that’s “good for you”…the stuff that’s bad for you is so much more delectable.

The recent rally on Wall Street is a perfect case-in-point. The shares of companies that are losing money are racking up triple-digit gains, far outdistancing the blue chips. But the short-term success of highly speculative stocks is just that…short term. In the longer term, the tortoise- like gains that companies of substance tend to produce are much more rewarding for investors than the hare-like starts and stops of speculative stocks.

Unfortunately, companies of substance are rare…and they do not necessarily operate in the United States. China Mobile (Hong Kong) Ltd., the world’s largest mobile phone operator (as measured by number of subscribers), is a company that has captivated our attention lately. It is, we believe, a company of substance with both a low valuation and a promising growth profile.

China Mobile Limited: Why We Like It

During the company’s latest quarter, it increased its revenues, earnings and subscriber base. That’s not too shabby. The company also produced expanding EBITDA margins, despite intensified competition in the Chinese telecommunications market. Meanwhile, Moody’s Investors Service, citing CHL’s improved business fundamentals, has put the company’s debt on review for a credit rating upgrade.

We like China as an investment destination. Sure, the massive Asian juggernaut struggles with various growing pains. But at least the pains derive from a growing economy, rather than a growing bureaucracy. China Mobile is well-placed to benefit from the country’s exciting long- term growth profile. China Mobile’s first-quarter revenues rose 10% from a year before, reaching $4.55 billion, while net earnings increased 9.7% to $1.08 billion. Subscriber growth also continued its upward march. CHL has a whopping 127 million subscribers.

Over the past year, CHL’s share price has been under pressure, a trend we are at a loss to explain in light of the company’s continuing growth in earnings and free cash flow. Furthermore, a few months ago, CHL began paying a dividend that represents a 20% payout of earnings and a 2.2% dividend yield. The company also appears committed to increasing the dividend payment in concert with growing earnings. Yet, despite all the positive news, CHL shares have not been a standout performer. At the current market price, CHL trades for about 11 times trailing 12-month earnings, 10 times 2003 estimated earnings and about 5 times enterprise value to EBITDA.

At least some of the recent weakness in China Mobile shares can be attributed to worry about the economic effects of the SARS epidemic in Asia. But what impact SARS will eventually have on CHL’s prospects is anybody’s guess. Certainly, if it turns out that SARS has substantially reduced economic growth in China, CHL’s subscriber growth will also slow. But it is also possible that phone usage will increase somewhat, as people seek to minimize face-to- face meetings. Assuming the possibility of SARS becoming an apocalyptic plague has been quelled, any near-term setbacks will eventually be eclipsed by CHL’s substantial long-term growth prospects.

China Mobile Limited: Telecom Competition

Another drag on CHL’s share price, we think, may be anecdotal reports of intensified competition in the Chinese telecommunications market. It has long been anticipated that competition would increase among China’s main telecom operators – China Mobile, China Unicom and China Telecom – thereby putting the squeeze on prices. And, indeed, price pressures have intensified over the past couple of years.

However, we think the market has overreacted to these sporadic reports, and the apparent bottoming-out of CHL’s average-revenue-per-user (ARPU) numbers in the first quarter confirms our suspicion that pricing pressure will not be as brutal as some have forecast.

The slowing decline in ARPU is even more noteworthy considering that most of CHL’s subscriber growth continues to come from low-usage/lower-revenue prepaid subscribers rather than from higher-revenue-generating contract subscribers. Contract subscribers, of course, pay a minimum monthly fee while prepaid subscribers pay only for actual usage. Because prepaid users generally use the prepaid plan only so long as it’s cheaper than a contract plan, they tend to generate lower ARPU than contract customers do. And since more of CHL’s subscribers are choosing the prepaid plan, a continuing decline in ARPU has been expected. As of March 31, prepaid subscribers represented 60% of CHL’s total subscriber base, compared to 54% in March 2002 and 37% in March 2001.

China Mobile also said that average usage has increased to 209 minutes per user per month from 207 minutes in the September 2002 quarter. Two minutes may not seem like a substantial increase, until one realizes that CHL has over 120 million subscribers!

China Mobile Limited: A Possible Ratings Upgrade

On April 16, Moody’s Investors Service announced that it was considering an upgrade in CHL’s Baa2 senior unsecured debt rating. Moody’s pointed to CHL’s proven business model and strong performance as reasons for the review: “The review reflects the strong progress that [China Mobile] has achieved since the rating was assigned in 1999, both in terms of building a strong business and maintaining a healthy financial profile. It also reflects diminishing forced acquisition risk.”

In considering China Mobile for a ratings upgrade, Moody’s recently mentioned that China Mobile “has been able to generate strong cash flows that have allowed it to fund its expansion without a heavy reliance on debt funding. In addition, the company is strategically important to the economic development of [the People’s Republic of China], and is a significant source of tax revenue.”

A “significant source” of revenue is something the Chinese government would hate to lose, we suspect.

Accordingly, intensified competition and pricing pressure that poses a threat to China Mobile’s financial health would probably be highly unpopular in government circles. As such, we think investor fears that China will replay the price wars that decimated the American and European telecom experience are unfounded. To the contrary, China Mobile looks well positioned to continue growing within the rapidly growing Chinese economy.

Maybe it’s time to eat your vegetables!


Robert Tracy,
for The Daily Reckoning
July 16, 2003


We are in the 32nd year of the Dollar Standard period, in which dollars have replaced gold in the coffers of central banks and the hearts of investors.

We are late in the period, we think.

“U.S. budget deficit put at $455 billion,” says the headline in today’s Herald Tribune. Seems expenses – notably the occupation of Iraq – have been running ahead of income; the deficit is now 50% higher than February’s estimate, very near to our guess of $500 billion.

The cost of maintaining U.S. troops in Iraq has risen to $4.6 billion a month, not to mention the soldiers who are killed every day. The poor grunts have been left in a hot and hostile place, where their only role seems to be to help desert malcontents to improve their aim.

But that is not our subject for today. Today, we follow the money and wonder how late in the Dollar Standard period we really are.

When a study was made of how much the federal government is likely to need to pay for all its promises, reduced by what it is likely to collect in taxes, the calculation must have sent sparks flying from the economists’ computers. As it turns out, the shortfall comes to $44 trillion…or about half a million dollars per family.

That doesn’t count the private debt in America – estimated to be another quarter of a million per family.

There is also the trade deficit, which – at about $500 billion annually – deserves at least a dishonorable mention. It is another animal altogether, of course, but one which drinks from the same watering hole.

Now, imagine that you are the chief financial officer of this enterprise…one that already has net debts and liabilities far beyond its ability to pay. Even if the entire world pitched in to help, debts of this magnitude could never be honestly settled. And yet, the enterprise is still living way above its means; every day, the federal government spends about $1.5 billion more than it takes in…and so do consumers!

Yet, Alan Greenspan is shown in today’s paper with a smile on his face, like a foolish poker player with a winning hand. Mr. Greenspan knows he has an ace up his sleeve…or rather, a printing press in the basement. He is prepared, he told Congress, to keep rates low “as long as necessary”…or even to cut them…in order to get the economy moving. What else can he do? That is the only game he knows…providing the world with trillions in dollar credits. It is what made the players think Mr. Greenspan wise…and themselves rich.

But it is a game that cannot go on forever. There is an endgame to the Dollar Standard period. Bond investors seemed to see it coming yesterday; they dumped bonds even while Mr. Greenspan was talking. But gold investors saw something different. They sold off gold, bringing the price down $5.60. What did they see? Japan before Argentina? A long period of falling prices and economic slump, before the printing press money finally destroys itself?

Which of the players will be right? Those dumping bonds…or those dumping gold? We can hardly wait to find out…



Mr. Fry, checking in from the street of dreams…

– Stocks fell a little. Bonds fell a lot. The Dow dropped 48 points yesterday to 9,129 and the Nasdaq Composite dipped 2 points to 1,753. Meanwhile, the bond market crumbled. The 10-year Treasury note took a nosedive of 1 24/32 to yield 3.94 percent, while the 30-year government bond cratered 2 25/32 to yield 4.95 percent.

– Bond investors rushed for the exits after Chairman Greenspan remarked, “The FOMC stands ready to maintain a highly accommodative stance of policy for as long as it takes to achieve a return to satisfactory economic performance.” This Greenspan-speak, translated into everyday English, means that the Fed will cut short-term interest rates to the bone and print a limitless number of dollars to insure that deflation does not take root in the U.S. economy.

– Yesterday, bond investors rightfully imagined that the Fed – while trying to combat deflation – might print one or two dollars bills too many, thereby sowing the seeds of inflation. And if a new inflationary trend were to sprout from the U.S. economic soil, a 10-year bond yielding less than 4% might not be the best asset to own.

– For the last several months, Chairman Greenspan has been trudging through the undulating fields of interest rates, swinging his monetary scythe back and forth across the yield curve. He has felled interest rates of all varieties like so many sheaves of wheat.

– In the process, investors learned to trust that low interest rates would be a permanent feature of the monetary landscape. They borrowed aggressively at low, short-term rates and invested at higher, long-term rates (even when the higher long-term rates weren’t that high) because they believed this yield-curve arbitrage to be a risk-free, Fed- sanctioned trade.

– Default risk was the last thing on their minds. So they conducted every form of interest-rate speculation known to man – and to computer. But the problem with a permanent license to print money is that it is never permanent.

– Interest rates sometimes rise and yield curves sometimes “flatten out,” such that short rates and long rates are nearly equal. In fact, rates are rising now, which is very bad news for the housing market, and for the stock market.

– Chairman Greenspan can crop the Fed funds rate to very low levels, but he cannot prevent Treasury yields from sprouting higher once again. Try as he might, interest rates will go wherever they wish to go and, at the moment, they wish to go higher…much, much higher. The yield on the 10-year Treasury note has jumped nearly one full percentage point since early June.

– We suspect, therefore, that the housing market will soon feel the ill effects of rising interest rates. The housing market will soon share the bond market’s pain.

– “The housing bubble is drifting toward a sharp pin,” says Robert Tracy, lead analyst at Apogee Research. “And that pin is rising interest rates.

– “As for specific companies that will feel the pain of a bursting housing bubble,” Tracy continues, “the best candidates are those who have ridden the housing bubble for the past few years. Any company who underwrites, services, holds or insures mortgages is vulnerable. Vulnerable mortgage originators and those who service mortgage include: Countrywide (CFC), Washington Mutual (WM), Greenpoint (GPT). Mortgage insurers who will be hit hard from a housing bust include Radian (RDN) and PMI Group (PMI). Homebuilders like D.R. Horton Inc. (DHI), Lennar Corp. Cl A (LEN) and Centex Corp. (CTX) will also feel the pain of a housing bust.

– “But the carnage of a collapse will extend beyond the obvious to companies like General Motors, which has seen its own sizable mortgage operations. Other victims will include all of the major investment banks, who have generated hundreds of millions if not billions in fees associated with securitizing mortgages. Even the giant GSE’s Fannie Mae and Freddie Mac could find themselves in trouble as their flimsy equity balances (i.e. $17.9 billion for FNM and $24.6 billion for FRE) may prove inadequate to fully absorb a tidal wave of defaulted mortgages.”

– Tracy could be wrong, of course. The housing market might continue to flourish despite rising interest rates…But it shouldn’t. (More from Tracy in today’s Daily Reckoning guest essay below…)


Bill Bonner, back in Paris…

*** Colleague Dan Denning told us what happened to him on Bastille Day: “Well, you know it was terribly hot. I was in my apartment, dressed in a t-shirt and a pair of boxer shorts. Then, I heard the planes flying overhead, for the celebration…so I just stepped out of my door for a second to catch a glimpse of them. And, oh no…a gust of wind slammed my door shut and I realized I had walked into the kind of thing you have bad dreams about:

“I was locked out of my apartment in just a t-shirt and undershorts…without a dime or a credit card…or anything…

“What could I do? I knocked on some neighbors’ doors…but I don’t know them…and they weren’t home, anyway. I was just hoping to borrow a pair of pants so I could walk over to a friend’s house. Then, I finally found someone home…it was a young woman, also dressed in little more than underwear…

“You know, my French is not very good, and there I was standing at her door in my underwear trying to explain what happened…But fortunately she didn’t shut the door in my face…and I eventually got my idea across. Naturally, she didn’t have any men’s clothes…but she lent me a green sarong and a pair of terry-cloth bath slippers. So I put them on and walked across town to the office.

“You can imagine how people might giggle and stare at a man walking down the street in a green sarong and bath slippers…but here’s the crazy thing; no one seemed to notice. This is Paris, after all. I had to pass through the gay section of town…and some guys even whistled.

“I didn’t have a penny, but I persuaded a guy at an internet café to let me send out a distress call…and finally a friend of mine got the message and rescued me.

“The whole experience wasn’t so bad. It was a little like that flower-pot falling on your head: I met a very nice neighbor…and I don’t know…maybe that green sarong look will catch on…”

*** While Europeans eagerly prepare to take vacation for the whole month of August, Americans feel they must apologize for every day they take off. Eric managed only a few days at the beach. Other Americans take their holidays furtively…sneaking off for a few days as if they were playing hooky from school.

Now comes this email from our friends at Early to Rise, explaining how work-obsessed Americans can still enjoy a break:

How to Have the Best Summer Vacation Ever!

“You can get away from the office. You can travel. You can even leave your laptop and cell phone behind. But you can’t make the work go away. It stays behind like a wretched beast, waiting for your return, angry at your absence, growling and whining and getting bigger and meaner and harder to deal with each passing hour. By the time you get back to the office, it will rip you to pieces and gobble you up.

“Unless…you take precautions.”

Here is a short list of the precautions they recommend for enjoying a great vacation without getting behind in work:

“First and most important – treat your vacation like a project…

“…Provide at least three weeks’ advance notice to everyone you are normally in contact with…

“…Two weeks before you leave, meet with all your key subordinates and hand them a memo listing all their ‘on- vacation’ responsibilities and important ’emergency’ data. Let them know that this is an opportunity to advance their careers…

“…About a week before you leave, send a note to your boss ‘reminding’ him of your vacation and letting him know that everything is under control, that you’ll be checking in (if you can check in), that you’ve left an emergency number with someone (not with him), etc. Define ’emergency’ in, say, three degrees…

“…Between now and the day you leave, catch up on as much important work as possible. Pay special attention to projects with deadlines that are due while you are away…

“While you are on vacation, have your e-mail automatically bounce back messages to senders with instructions on what to do for ’emergencies’… And keep a notepad with you… to write down the great ideas that will be flooding your way while your brain gets a chance to relax…”

The editors of Early To Rise have prepared a 10-point guide for the work-weary. If you accomplish each task on a schedule (today if possible), they say, you will have a stress-free summer holiday.