A Scary Thought for China Investors

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The world's largest mobile communications provider, China Mobile (NYSE: CHL  ) , is investing nearly $6 billion in Shanghai Pudong Development Bank. In return, China Mobile gets a 20% stake in the bank; the deal also helps the mobile carrier push forward its on-the-go e-commerce business.

Seems pretty straightforward, right?

Not so fast...
Reading up on the deal on Reuters, one quote from an analyst at BOC International (Bank of China's investment banking arm) jumped out at me:

"Going into e-commerce is the right direction but the investment in the bank is totally irrelevant," said Allan Ng, a telecom analyst at BOC International. China Mobile could enter the mobile e-commerce segment through partnerships instead, he added.

I scratched my head a bit and did a little digging on some of the U.S. mobile phone giants. Verizon (NYSE: VZ  ) , AT&T (NYSE: T  ) , and Sprint Nextel (NYSE: S  ) all have mobile banking applications that allow their customers to check balances, transfer funds, pay bills, or review their transaction history.

As far as I can tell, none of these carriers has made a significant investment in a major banking institution. Quite the opposite; by going the partnership route, the carriers can allow customers to choose from a menu of banks.

Not only does the partnership route not require a major cash outflow, but it also seems to be a better choice in terms of customer value. So why did China Mobile think that investing in SPDB was the right way to go?

I then recalled the concerns over the capital position of many of the Chinese banking institutions. When you're booming the way China has been, heavy amounts of bank lending are usually involved. As The Economist pointed out late last month:

...the money is needed to offset a massive lending boom last year. To augment stimulus spending by the central government, China's state-controlled banks expanded their balance-sheets by one-third, or almost 10 trillion yuan. An increase in loans inevitably requires an increase in capital in order to maintain prudent buffers. When expansion of credit occurs gradually, this can come from reinvested profits. When lending explodes as it did in China, fresh funds are a necessity.

Nearly three-quarters of China Mobile's shares are owned by China Mobile Communications Corp. (CMCC), one of the many state-owned enterprises in China. Is it just me, or does it seem a little too convenient that a state-controlled telecom carrier with close to $40 billion in cash on its balance sheet is suddenly making an apparently unnecessary investment in a bank in need of regulatory capital?

Sure, when rumors of the investment were swirling, the State-Owned Assets Supervision and Administration Commission (SASAC) supposedly opposed the deal. Or could that have been a bit of misdirection to make the whole "synergy" story more believable? Crazier things have happened.

A tough call
What do we do with this information? For obvious reasons, it's worrisome if the Chinese government is nudging state-controlled assets to do its bidding -- especially if those moves aren't in the best interest of minority shareholders (that's us).

Is it worth hightailing it out of China and missing out on the torrid growth that's going on there? After all, China Mobile isn't the only major company in question here. China Petroleum & Chemical (NYSE: SNP  ) , CNOOC (NYSE: CEO  ) , Huaneng Power (NYSE: HNP  ) , and China Telecom (just to name a few) are all majority-owned by the Chinese government as well.

Considering the size of the opportunity in the Chinese market, abandoning China may be too much to ask. However, investors that dive in need to understand that even if I'm wrong on China Mobile's investment in SPDB, the company doesn't mince words when talking about its relationship with the government. China Mobile's most recent 20-F filing has this to say about the relationship:

[SASAC] promulgates rules, regulations and policies from time to time that govern, among other things, the supervision, reform and management of state-owned enterprises, including CMCC. Actions taken by the SASAC may indirectly have a material adverse effect on our business, financial condition and results of operations, and may conflict with the interests of our minority shareholders.

Does this make you think twice about investing in China? Scroll down to the comments section and share your thoughts.

Global Gains advisor Tim Hanson has some tips for getting the most out of the emerging markets -- including digging into rural markets in China.

Sprint Nextel is a Motley Fool Inside Value recommendation. CNOOC is a Motley Fool Global Gains pick. The Fool owns shares of China Mobile. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Matt Koppenheffer owns shares of AT&T, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool. The Fool's disclosure policy assures you that no Wookiees were harmed in the making of this article.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 11, 2010, at 4:17 PM, CMFStan8331 wrote:

    I think it makes sense to have a small portion of my portfolio invested in Chinese companies, but I'm not touching any of the state-owned enterprises with a ten-foot pole. I am also being very careful to avoid over-allocating to Chinese stocks. Opaque financials, limited oversight and a totalitarian government make for a very high-risk environment...

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