China Mobile's Rural Rush

BEIJING -- Having won most of urban China's cell-phone market, powerhouse China Mobile ( CHL) is now ardently wooing customers in the countryside, where a majority of the population still lives.

Over half its new subscribers hail from rural markets, the company says.

The rural push, which has helped boost subscriber rolls, is one of the factors that helped China Mobile deliver an unexpectedly strong third quarter.

On Friday, the telecom outfit reported that its quarterly profits were up nearly 25% from last year's levels to about $2 billion on revenues of $9.58 billion. Sales grew 23%.

Market reaction was muted; the ADRs closed up 8 cents, or 0.2%, to $38 Friday and were recently up 23 cents, or 0.6%, to $38.23 Monday.

But even analysts who've gotten accustomed to upbeat news count themselves surprised.

"China Mobile appears to have landed on that sweet spot where it can do nothing wrong. Its rising scale has led to swelling results that surpassed our high expectations," writes Hong Kong-based Merrill Lynch analyst Wendy Liu in a note.

On the user growth front, China Mobile reached a total of 287 million subscribers as of the end of September -- not far below the 300 million population of the entire U.S.

China Mobile already claims a two-thirds share, based on revenues, dominating the smaller China Unicom ( CHU).

And now it's likely to bolster its standing, as it romances the first generation of rural cell-phone users.

The Chinese countryside looms as big source of growth because cell-phone use lags well behind cities.

For example, in the southwestern province of Sichuan, rural penetration stood at only 9.2% in 2005, according to Sichuan Mobile, a China Mobile subsidiary.

Nationwide, China's cell-phone penetration stood at 33% at the end of the first half of 2006.

Of course, even if China Mobile lands lots of rural subscribers, those customers can't afford to spend as much as their urban counterparts.

So far the telecom outfit has managed to keep average revenue per user (ARPU) steady because its wealthier urban customers are spending more on data, including features such as short message service and ring tones. That has masked any declines in voice revenues.

For the first three quarters of 2006, ARPU stood at 89 yuan ($11.27), slightly above the first six months' average of 88 yuan ($11.14).

But ARPU is bound to see pressure as the company signs up poorer customers who can't afford to spend much on voice, and who scarcely use data services.

Anecdotal evidence suggest rural dwellers in Sichuan typically limit monthly spending to around $2.50, estimates Liu. (Business owners and high school students spend more.)

"At some point, the decline from the voice side will be faster than the increase from the data contribution, simply because China Mobile is getting deeper and deeper into the rural markets," predicts Rohit Sobti, a Hong Kong-based analyst for Citigroup.

Despite lower ARPUs, Merrill's Liu says rural cell-phone service is a moneymaker, and profits will improve as the business gains scale.

"In the long run, new users from rural markets will bring down the ARPU, but it's a very gradual process," says Liu Bin, an analyst for Beijing-based telecom consultancy BDA.

Only in the past year or so has China Mobile made a concerted push outside small cities into the rural heartland, he points out. "New users as a percentage of total users is still small, so the total impact on China Mobile's operations is still minor."

Growth story aside, investors must factor in regulatory risk for China Mobile.

The knock on the shares is that at some point, the government is expected to step in and reshuffle China's telecom industry.

At that time, Beijing will also hand out long-awaited 3G licenses. But it's not yet clear which of the four-leading telecom firms (of which China Mobile is by far the strongest and fastest-growing) will be the lucky recipients.

Some believe these worries are overhyped.

Liu, for example, says a messy industry overhaul isn't likely to take place before the 2008 Olympics in China -- a sort of national coming-out party that Beijing wants to see go smoothly.

But others argue the uncertainty is reason to shy away from the stock, despite its strong short-term fundamentals.

China Mobile "has a window of opportunity to deliver strong earnings," acknowledges Sobti. But he says it's too exposed to regulatory risk for comfort. Also, the stock has already run up enough -- it is up 63% this year -- that it may not have tremendous amount of room for further gains.

Sobti has a hold rating on China Mobile.

Either way, expect China Mobile's rural push to keep yielding big dividends on the subscriber rolls.

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