Expanded Resume and Examples of My Work Product Since 2010


Hi, my name is James Huddleston, but people call me Jack. Thank you for visiting my website. If you would like to contact me, my email is jackhudd1@gmail.com, or feel free to call me at 615-525-7592.

Please Note that Links to Examples of My Work Are on the Right Side of this Page: Click any of the links on the right side to go to that specific article.

Purpose of this Website. This website is an expanded resume where you can see examples of my analytical and financial modeling abilities. There are links on the right side of the page to examples of my work product from 2010-2013. I was employed in the first part of 2014, but that work product is confidential, so I can’t post any of it.

Summary of Qualifications (Details are Below the Summary)

– Links to examples of my work product from 2010-2013 and to articles I have written are on the right side of this page under “My Analyses & Financial Models” and “Published Articles”.

– Advanced skills in Financial Analysis, Accounting, Investment Analysis, complex financial modeling, analyzing assets and companies, Excel and PowerPoint (longer list below)

– Passing the 3 Chartered Financial Analyst (CFA) Exams is proof of my knowledge and work ethic

– 4 years of experience as a Financial Analyst

– Completed the Chartered Financial Analyst (CFA) Program (passed all 3 exams – 2011, 2012 and 2013)

– Master of Accounting degree (3.46 GPA) and B.S. in Finance (3.92 GPA)

– Software – Certified Expert in Excel with Master-level skills. Advanced PowerPoint and Word. Proficient in Access. Familiar with SAP, SQL, Hyperion Planning, Essbase. I can quickly learn the software used.

– Expert at Financial Statements and SEC Filings. I have analyzed hundreds of companies and hundreds of financial statements, 10-K’s, 10-Q’s and 8-K’s.

– Team player, courteous, reliable, fast learner, self-disciplined, no bad habits, 25, single, and no dependents.

Advanced Skills. I have advanced proficiency in: accounting and financial statements; financial analysis, corporate finance, financial modeling (over 1,000 hours in Excel), budgeting, forecasting, costs, revenues, and variance analysis; Excel, PowerPoint and Word; valuation, DCF, NPV, IRR, ROI, ROE, accretion/dilution analysis, peer comparison, industry analysis, scenario analysis, operational analysis, and risk evaluation; analyzing depreciation, working capital requirements, investment opportunities and investment performance. Expert skills in Financial Statement Analysis – I have analyzed hundreds of companies and read hundreds of financial statements, annual reports, 10-K’s, 10-Q’s and 8-K’s. If you want to see a detailed explanation of how I analyze and value companies, click the fourth link on the right side of this page titled “How I Analyze and Value Companies“. Expert in Excel – I have spent over 1,000 hours doing financial modeling in Excel. Examples are in the Analyses on the right side of this page.

4 Years of Work Experience.

   Punch Card Capital L.P. Financial Analyst for an Orlando investment fund. Reviewed over 100 companies and detailed analyses of two. Reviewed public filings, peer comparison, industry analysis, valuation and scenario analysis in Excel, forecasted future cash flows to assess default risk. Oct. 2013 to March 2014.

   Self-Employed Financial Analyst. Examples of my work product from this job can be found at links on the right side of this page. Between 2010 and 2013, I analyzed hundreds of companies and their financial statements, 10-K’s, 10-Q’s and 8-K’s, and spent over 1,000 hours preparing complex financial models in Excel. I used a fundamental analysis approach to analyze companies’ financials, operations, strengths, weaknesses, opportunities, threats (including competition, Porter’s Five Forces, and macro trends), and did a risk assessment. For the companies I liked, I did a DCF analysis to determine a valuation range. You can see the checklist I developed to analyze and value companies at the fourth link on the right side of this page. I worked for my parents, who paid me – we would discuss my progress every day, but the analysis was left up to me. This was great experience and I learned a lot because every company is different. Based on my analyses they bought 11 stocks, including China Mobile, Devon Energy, National Oilwell Varco, Berkshire Hathaway B, Apple, Wal-Mart, Johnson & Johnson, and Kraft. Examples of my analyses, financial models, articles I have written, and complex projects that I completed in 2010, 2011, 2012 and 2013 are at links on the right side of this page under the Categories “My Analyses & Financial Models” and “Six Published Articles”. March 2010 to Sept. 2013.

Education – Master of Accounting and B.S. in Finance. I graduated from the University of West Florida (UWF) in December 2011 as a Finance major (3.92 GPA on a 4.0 scale) and received a Master of Accounting (MAcc) degree in 2014 (3.46 GPA). From March 2010 to March 2014 I was also working and until June 2013 I was also studying for the CFA exams. I pursued a Master of Accounting degree for two reasons. First, as Warren Buffett said “Accounting is the language of business”. Second, UWF has a strong accounting program. In 2013, UWF ranked number 5 in the U.S. out of 266 small accounting programs for first-time pass rates on the CPA exam (source: the NASBA, which is the national accounting regulatory organization).

At the Berkshire Hathaway (BRK.A) annual shareholders meeting for the year 2013

At the Berkshire Hathaway (BRK.A) annual shareholders meeting for 2013

Chartered Financial Analyst (CFA) Program – 5 Years of Training in Financial Analysis. I have passed all 3 CFA exams – 2011, 2012 and 2013. To complete the CFA Program requires passing 3 very difficult exams, two of which are only offered once a year. I started studying for the CFA exams in 2008 and passed the Level 1 CFA exam in June 2011, passed the Level 2 exam in June 2012, and in June 2013 I passed the Level 3 exam. According to the CFA Institute, the worldwide pass rate was 39% for the Level 1 exam in June 2011, 42% for the Level 2 exam in June 2012, and 49% for the Level 3 exam in June 2013. The CFA Program has been referred to as a “gold standard” by The Economist and Financial Times. It has been described as “grueling” and “the equivalent of a master’s degree in finance with accompanying minors in accounting, economics and statistical analysis”. It is said that completing the CFA Program requires “ability, dedication, ethical grounding and hard, transferable analytical skills”. The CFA Program Curriculum consists of 8,000 pages in 18 volumes and covers topics such as Financial Reporting and Analysis, Corporate Finance, Quantitative Methods, Equity and Fixed Income, Economics, Alternative Investments, Portfolio Management, and Ethical and Professional Standards. I spent over 2,000 hours studying for the CFA exams and have spent an additional 1,000 hours doing financial modeling in Excel.

Software. I am a Certified Expert in Excel and have Master-level skills. I use Excel every day. I also have advanced skills in PowerPoint and Word, am proficient with Access, and familiar with SAP, SQL, Hyperion Planning, and Essbase. I am a fast learner and can quickly learn the software used.

Thank you for visiting my website.

James “Jack” Huddleston
Updated  March 24, 2015

Richfield Analysis and Valuation (2015)


Analysis and Valuation of Richfield International Limited

By James “Jack” Huddleston, January 19, 2015

Table of Contents

A. Introductory Notes

B. Investment Result

C. Analytical Procedures and Due Diligence Performed in the Course of Analyzing and Valuing this Company

D. Analytical Procedures and Due Diligence Not Performed

E. Description of the Company

F. Richfield Marine Agencies (“RMA”)

G. Speeda Shipping Co. (“Speeda”)

H. The Main Reasons Why I Think Richfield International is Undervalued by the Market

I. The Main Arguments for Buying Stock in this Company at Current Prices

I.8. Currency Risk

I.9. Analysis of Financial Statements and Notes for Normalcy and Material Misstatements, and Comments About the Auditor

J. The Main Arguments Against Buying Stock in this Company at Current Prices

J.4. Accounting Concerns

K. Valuation of this Company – Liquidation Value and Intrinsic Value (using Probabilistic Scenario Analysis)

L. After Weighing the Pros and Cons, Should Stock Be Purchased in this Company? Analysis of 4 Scenarios.

M. Since the RMA Business Appears to be Good, Why Not Buy this Stock as a Long-Term Holding?

A. Introductory Notes – This research was conducted in early December 2014. I found this stock using a screening program. This article is a compilation of my notes – it is not a polished article. I only post it here as a recent example of my work. From it, you can judge my skills in research, due diligence, financial analysis, valuation, scenario analysis, Segment Analysis, risk evaluation, and analysis of Financial Statements and notes for normalcy, misstatements, and accounting concerns (see I.9 and J.4 – my accounting knowledge is very helpful in this regard), and also my ability to undertake and complete a complex financial analysis in a fairly short period of time. I spent about 15 hours on this analysis.

B. Investment Result – I bought this stock for my own account on 12-15-14 at AUD 0.088 and sold it on 1-19-15 for AUD 0.165, an 87% return in 5 weeks. I do not recommend this stock at current prices.

C. Analytical Procedures and Due Diligence Performed in the Course of Analyzing and Valuing this Company

Approximate time: 15 hours

  • Read full annual report for 2013
  • Read Chairman’s letters for 2005, 2007, 2009, 2011, and 2013
  • Segment Analysis
  • Ratio analysis: profitability, credit, liquidity
  • Assessment of investment thesis via my net-net checklist
  • Assessment of corporate governance via checklist
  • Director compensation
  • Director backgrounds
  • Director independence and conflicts of interest
  • Assessment of accounting fraud via checklist
  • Income statement, balance sheet, and cash flow statement vertical and horizontal analyses
  • Balance sheet and cash flow accruals
  • Comparison of cash flow to accrual income
  • Auditor reputability
    • Contacted audit partner with a few questions regarding audit procedures performed (no response yet)
  • Auditor fee relative to assets and revenue
  • Regulatory requirements the company is under
  • Normalcy of accounting policies to IFRS and U.S. GAAP
  • Check for various things: presence of speculative derivatives, level 3 fair value assets, pensions, off-balance sheet items, related-party transactions, etc
  • Assessment of risk factors via my checklist
  • Various readings to gain basic understanding of business model
  • Browsed for all online articles relating to the company and its founder
  • Browsed company websites for any interesting information
  • Valuation, including both liquidation and capitalization of operating businesses
  • Historical multiple analysis
  • Probabilistic Scenario Analysis

D. Analytical Procedures and Due Diligence Not Performed

  • Comps comparison
  • Management assessment
  • Competitive advantage assessment
  • Industry economics assessment
  • Future growth assessment
  • Catalyst identification

E. Description of the Company

Richfield International Limited is a port service and shipping company. Its stock sells below net current asset value (current assets minus all liabilities) and net cash (cash minus all liabilities). In addition, the business is profitable and has no debt. The company is listed on the Australian Stock Exchange under the symbol RIS. This stock can be purchased via Interactive Brokers. Trading volume tends to be low and sporadic.

Richfield has two operating businesses: Richfield Marine Services (“RMA”) and Speeda Shipping Co (“Speeda”). The two businesses are described below.

F. Richfield Marine Agencies (“RMA”)

RMA offers a comprehensive range of port services to incoming and outgoing ships. Essentially, RMA’s business focuses on handling local complexities that would be difficult for a foreign ship to handle by itself, given how many ports and countries that such ships must visit. Its services include: shipbrokering (bringing together those who need cargo shipped with those who provide shipping services), crew handling services (hotel booking, transportation services, travel arrangements, medical needs, etc), supply services (spare parts, bunker fuel, fresh water, etc), storage services, assistance in obtaining port permits and licenses, customs clearance and forwarding (communicating with port authorities, completing paperwork and documents, etc), arrangement of marine and cargo surveying services, providing port and market information (such as freight rates), repair and maintenance services, and so on.

In many cases – perhaps most cases – RMA does not provide these services itself, but arranges for local contractors to do the work.

RMA focuses on ports in Singapore and Shanghai (the Shanghai office opened in 2007). RMA has a particular focus on ships owned by American companies, which explains why such a large portion of revenues, costs, receivables, payables, and cash is in U.S. dollars.

G. Speeda Shipping Co. (“Speeda”)

Speeda provides containerized shipping services to exporters and importers. The company operates a fleet of containers and fills container slots on ships. Speeda does not own any ships. This business was largely wound-down by the end of 2013.

Speeda used to be the focus of Richfield. The 2005 chairman’s letter states that, at the time, company’s strategy to grow was by (1) developing a fleet of ships, (2) expanding operations geographically, including Australia, and (3) creating a shipping service to Western Australian ports linking Southeast Asian ports.

It appears that the company originally listed on the ASX in anticipation of developing a significant business in Australia. However, the shipping industry subsequently entered a period of depression. Management changed its plans, and has almost eliminated the Speeda business line.

H. The Main Reasons Why I Think Richfield International is Undervalued by the Market

  1. No perceived catalyst.
  2. Declining revenues and a dismal reported financial performance since its IPO in 2005.
  3. Investors do not believe that the minority shareholder has, or will ever have, any control over this company.
  4. Over the past few years it has habitually traded below net current asset value (current assets minus all liabilities) and net cash (cash minus all liabilities). Even “net-net” (a company trading below net current asset value) bargain hunters avoid perceived “perennial net-nets.”

I. The Main Arguments for Buying Stock in this Company at Current Prices

  1. With a market capitalization of AUD 5.5 million at December 15, 2014, Richfield is selling for less than two-thirds of net current asset value (current assets minus all liabilities) and net cash (cash minus all liabilities). Current assets are almost entirely cash and cash equivalents. Therefore, you get $100 of value for about $66, plus the two operating businesses for free.
  2. The company was profitable in the last 8 out of 9 years and had positive free cash flow in 7 out of 9 years, in spite of the negative impact of the Speeda business.
  3. Both net current asset value and book value have increased since 2005 with some year-to-year consistency. Given the company’s historic profitability and positive free cash flow, it is probable that both net current asset value and book value will increase in the future.
  4. No debt. This fact, along with management’s stated attitudes and actions, seems to indicate a very financially conservative mindset. Liabilities are primarily composed of trade payables and tax liabilities. There is a small off-balance sheet operating lease obligation.
  5. The company should benefit near-term and possibly over the next 5 years from low oil prices, which will increase global trading activity as a result of lower bunker fuel prices, depending on OPEC’s actions.
  6. RMA is highly profitable and capital light, while Speeda is highly unprofitable and capital intensive. The company has been winding-down Speeda over the past few years, and by the end of 2013, Speeda had been largely wound-down. This fact may not be fully accounted for by the market. RIS has focused on RMA, which it has successfully grown over the years and which has achieved consistent year-to-year profitability. RMA has high returns on capital ex cash. It was profitable during both the financial crisis and the recent lean years in the shipping industry. The RMA business almost certainly has a positive net present value and will provide some assurance against NCAV declining.RIS 0 -- Segment results
  1. Given that Speeda has been largely wound-down, future results should predominantly reflect RMA’s results. Therefore, so long as RMA’s business continues as it has in the past, it should show stronger results over the next few years. This improvement in financial results could be a catalyst to gain greater market attention and spur optimism for the stock.
  2. Currency Risk – There is limited currency risk for a U.S. investor. Cash, receivables, and revenue are primarily in USD. Payables and costs are split about 50-50 between the USD and the Singapore Dollar.
  3. Analysis of Financial Statements and Notes for Normalcy and Material Misstatements, and Comments About the Auditor – It appears unlikely that the financial statements are materially misstated or fraudulent. The company is listed on the Australian Stock Exchange. It must adhere to Australian Accounting Standards and its financial statements are compliant with IFRS, according to the auditor (that is my opinion as well). The reported results do not look “too good to be true.” Cash flow and net income do not diverge significantly over a period of years. There are not significant net balance sheet or cash flow accruals over time. Cash and accrual taxes align over a period of years. Transparency and disclosures seems adequate. Overall, the accounts and accounting for the company are simplistic – there are no level 3 assets or speculative derivatives, for example, and there are not multiple corporate layers in the organization. The auditor, Stephen Moore, seems to be reputable. The auditor’s fee and total assets have shown a normal relationship over time. Assumptions used in goodwill impairment testing seem conservative. Depreciation policies seem conservative.

J. The Main Arguments Against Buying Stock in this Company at Current Prices

  1. Historically, RIS has sold at a discount to both NCAV and net-cash on average. The company has historically sold for much, much lower prices than the current price – as low at 20% of net cash (AUD 0.02 per share in 2012 versus AUD 0.09 per share today). The current price is relatively high when compared to average prices in the past.
  2. Corporate governance at the company is probably a farce. The non-executive directors appear to just be a rubber stamp body. 2 out of the 5 directors are executives. The board is probably dominated by the founder of the company, Chak Chew Tan, who owns 37.18% of outstanding shares and sits on the board. The non-executive directors have multiple other obligations and work activities, so it would be very difficult for them give much serious thought to matters at Richfield. It is questionable whether two of the directors (Steven Pynt and Andrew Phillips) even visit Singapore and the RIS’s operations during the year. The non-executive directors do not seem to be subject-matter-experts when it comes to the port services or shipping industries. In short, it seems unlikely that minority shareholders could ever have any influence on management or company policy, much less ever have the ability to replace management if it behaves poorly. Management is compensated with a fixed salary, regardless of the progress of the company or financial results.
    1. There are a few offsetting factors. First, the company is listed on the Australian Stock Exchange and must adhere to ASX corporate governance standards. Second, management has not done anything seriously contrary to minority shareholder interests so far. Winding down Speeda’s operations was a great idea, in my opinion, and prevented potentially massive value destruction for the shareholders. Third, senior management is not paid extravagant salaries. Fourth, the founder and CEO has a significant portion of his personal wealth in the company’s stock, which helps to align his interests more closely with the other shareholders. And fifth, the non-executive directors are not paid much for their services, relative to what the average director makes.
  1. Dividends and Shares Repurchased – The company has not paid any dividends since its IPO in 2005. No shares have been repurchased.
  2. Accounting Concerns – There are a few yellow flags and one red flag in regards to the company’s accounting:
    1. The company is far too small to support any significant system of internal control. There are just 28 full-time employees, including senior management. This risk is increased by the fact that the company has offices in multiple countries.
    2. The company had its IPO in a foreign country rather than its host country.
    3. It is unclear whether the auditor actually visited the company’s operations in Singapore (I have contacted the audit partner about this, but have not gotten a response yet as of December 28, 2014).
    4. The red flag is that there was a significant related-party loan at the time of the company’s IPO. The transaction is listed in the financial statements, but there is no mention of it in the notes to the financial statements, despite the loan being large. In any case, the loan was repaid and at a very high interest rate (Loan proceeds: 378,274 in 2005. Loan repayments: 456,795 in 2005 and 37,290 in 2006). Unusual related-party activities close to an IPO are one sign occasionally seen with fraudulent Chinese reverse merger companies.
  1. RIS has held a large cash balance since listing on the ASX. It is unlikely this will change in future. The company may, however, make an acquisition with the cash. While there is a risk of overpaying, RIS has so far exercised patience and discipline in waiting for the right candidate. The company has been actively looking for an acquisition since at least 2007 (that has been mentioned in the chairman’s letter in every annual report since then). An acquisition has not been made in 6 years, in spite of them actively looking. So they have demonstrated patience so far, especially considering that they were losing revenue and not highly profitable for much of that time.
  2. Management has indicated that it may expand its containerized business when conditions improve. The containerized shipping business, in my opinion, is not a good business, and management has shown poor judgment in the past when it comes to projecting market conditions for that business. RIS began investing in its shipping fleet right when the commodity boom was at its peak. Apparently, management thought this trend would continue. So they invested and a few years later it began crashing (starting in 2009). The investment has been a complete failure. It is possible, therefore, that management could make a hugely value-destroying mistake in the future with regards to their business decisions.
  3. Management has issued shares over time via secondary offerings to investors. I did not see an explanation as for why. This action is puzzling, because the company already had an enormous amount of cash, and the cash from the secondary offering has not been used since then.
  4. Given how small the company is, it could “go dark” and stop sending annual reports to shareholders, or it could delist from the ASX. Such an action would make it very difficult to sell RIS shares.
  5. Chak Chew Tan is clearly a key employee. Without him, it is unclear what value there is to the company or whether it could survive. He is age 57 now.

K. Valuation of this Company

I valued RIS using two approaches. The first is by estimating liquidation value.

RIS 1 -- Liquidation Value Table

The company is clearly selling for less than its liquidation value. However, the calculation of liquidation value is heavily dependent on the value of the company’s cash and cash equivalents. There is a possibility that management could destroy some of the cash value via poor investments or acquisitions.

Therefore, I also valued the company’s excess cash separately and add that cash value to the estimated earnings power value of the RMA business, subtracting for residual losses from Speeda and parent-level costs.

Total cash on the balance sheet as of September 30, 2014, was AUD 10,789,929. Assuming the company needs current assets to cover current liabilities 1.50 times, AUD 2,535,911 cash is required for working capital purposes. Therefore, excess cash is AUD 8,254,019. This is probably a conservative estimate.

Below is how I estimated earnings power for RMA:

RIS 2 -- Earning power calculation table

I estimated intrinsic value as the weighted average of four scenarios: worst case, pessimistic case, normal case, and optimistic case.

RIS 3 -- Intrinsic value estimation table

Clearly the market price cannot be justified based on the value of the RMA business alone. Therefore, the market is attributing some value to the excess cash and assets on the balance sheet. But the implied value for that cash given by the market price is at a tremendous discount from its book value.

The “normal” scenario capitalizes earnings at 8 times because that is the average multiple shown in market prices since 2005. My valuation for RMA is far below what management paid for it and what they estimate it is worth in the footnotes for goodwill impairment testing. Therefore, my valuation for the RMA business is probably conservative.

L. After Weighing the Pros and Cons, Should Stock Be Purchased in this Company? Analysis of 4 Scenarios.

I analyzed potential returns on investment based on 4 scenarios:

RIS 4 -- ROI estimation table

In the weighted average, normal, and even pessimistic case, the stock offers a strong possibility for market-beating returns. This is in spite of using, in my opinion, a conservative valuation and with a critical eye for risk and downside possibilities.

The fact that the company has on average sold at a large discount to net current asset value and net cash is probably a deal-breaker for most people, even bargain hunters. Some investors demand a specific “catalyst” for any investment of this type.

I think the risk-reward justifies investing a small amount of money in this company as part of a diversified portfolio. I think that the downside is largely protected by (1) the amount of cash on the balance sheet, (2) a profitable and cash-positive underlying business, and (3) reasonably intelligent and seemingly conservative management. If Richfield Marine Agencies continues to grow, then this investment could provide a reasonable return even if the price continues to stay at a discount to net current asset value. And if the market temporarily gets optimistic about the company, because the RMA business shows strong results or for some other reason, then there is a good probability of being able to sell this company’s stock near or above net current asset value.

M. Since the RMA Business Appears to be Good, Why Not Buy this Company as a Long-Term Holding? 

There is very little information available from English sources about the RMA business. Really, the only detail is from the company’s reports and its website, and the details available are vague.

Unless I can attain a better degree of understanding about what makes the business tick, I’m only comfortable paying a price that is based on the value of the assets of the Company. There is no way of knowing, for example, to what degree the success of the RMA business depends on Chak Chew Tan’s knowledge, connections, and reputation. If he left in the next 10 years, would the business lose half of its customers? I don’t know. Such an event would cause a huge impairment of the value of that business.

The earning power value of the RMA business provides a good cushion for the asset value and downside protection, but I’m basing my decision to buy stock on the asset value of the company rather than on the future of RMA.

In addition, the company’s stock presents a risk inherent in all of the Chinese reverse merger companies: no matter how much one studies the financial statements and notes, it is still possible that this company could be a complete fraud and the analyst could miss it.


Debt Servicing Ability of 15 Oil & Gas E&P Companies (2012)


Debt Servicing Ability of 15 Oil & Gas Exploration and Production Companies

 By James “Jack” Huddleston

Data as of July 2012 and earlier – Posted 8-22-12, Revised 9-2-12

Table of Contents

A. Format of this Report

B. Overview

C. The Effects of Oil and Gas Price Volatility on Debt-Servicing Ability

C.1. Average Monthly Oil & Gas Prices for 2011 to 2006

D. Comparison of Financial Condition

D.1. Financial Condition Ratios for 2011

D.2. Financial Condition Ratios 2006 through 2011 (6 year averages)

D.3. Financial Condition Ratios for the Year 2009

D.4. Debt Servicing Ability by Cash and Liquid Assets

E. Break-even Oil & Gas Prices and Break-even Costs

F. Relative Valuation

F.1. Valuation Multiples

G. Concluding Thoughts

H. Notes

I. Raw Data Tables

I.1.   Revenue, 2006 to 2o11

I.2.   Earnings Before Interest, Income Taxes, Depreciation, Depletion & Amortization, 2006 to 2o11

I.3.   Depreciation plus Depletion plus Amortization, 2006 to 2o11

I.4.   Interest Expense (excluding capitalized interest), 2006 to 2o11

I.5.   Interest Capitalized to PPE, 2006 to 2o11

I.6.   Impairments from Full-Cost-Ceiling Test, 2006 to 2o11

I.7.   Earnings Before Income Taxes, 2006 to 2o11

I.8.   Net Income (continuing Income where applicable), 2006 to 2o11

I.9.   CFO (continuing CFO where applicable), 2006 to 2o11

I.10. Cash & Cash Equivalents plus Short-term Investments plus Restricted Cash, 2008 to 2o11

I.11. Receivables, 2008 to 2o11

I.12. Total Debt, 2006 to 2o11

I.13. Shareholders’ Equity, 2006 to 2o11

A. Format of this Report

For the convenience of the reader, the sections of this report are numbered and I have tried to use a text size that is easy to read on computers and mobile devices.  Notes to tables can be found at the bottom of the table and general notes are at the end of the report.

B. Overview

This article compares the debt servicing ability of 15 U.S. oil and gas exploration and production companies (the “Peer Group”). These companies primarily derive their operating income from North America, from exploration and production, and from onshore activities.

Note: If for any reason the tables in this article are obstructed, right click the table and then select “view image.”

C. The Effects of Oil and Gas Price Volatility on Debt-Servicing Ability

In the U.S., the historical chance of a recession in any year is roughly 1 in 5, so it is important for a company to be prepared for that possibility. While oil and gas generally have inelastic demand, recessions are often accompanied by a decline in oil and gas prices and sometimes the prices collapse, as occurred during the last recession. This can be seen in the recent history of West Texas Intermediate (WTI) crude oil spot prices and Henry Hub (HH) natural gas spot prices.

Average Monthly Oil & Gas Prices for 2011 to 2006 (1)

debt 1

(1) The spot prices here generally correspond to the average price realized by each company before netting the effect of derivatives hedging. Some companies seem to continually receive higher prices than others, but the relative movement year-after-year is similar.

The preferred way to pay debt service is from operating cash flow but prolonged low sale prices can cause operating cash flow to decline after hedges expire. Marginal operating cash flow is not an immediate issue if a company carries an adequate amount of cash to service debt or maintain basic operations if oil and gas prices drop below the break-even point. (See ”Break-even Oil & Gas Prices and Break-even Costs” below). Some oil and gas companies, however, carry little of their total assets in cash and have little cushion to protect against adverse events (See table below: “Debt Servicing Ability by Cash and Liquid Assets.”).

A cash reserve deficiency can be countered by very stable operating cash flow. That is why utility companies, for example, can safely carry very large amounts of debt that would not be safe for the typical company. In the event of a major price decline, O&G companies that have inadequate cash reserves could be forced to service debt rather than replenishing reserves lost through depletion, which could result in an impairment of value. A more severe consequence would be a near-term funding shortfall. If debt service can’t be paid from operating cash flow or cash reserves, it may become necessary to sell long-term assets, but a decline of oil and gas prices would decrease the amount a company could liquidate those assets for. The result could be very problematic.

D. Comparison of Financial Condition

The tables below compare the ability of the 15 oil and gas companies (the “Peer Group”) to service debt interest and principal from cash flow, cash reserves, and liquid assets. The formulas used to calculate these ratios can be found below the first table, “Financial Condition Ratios for 2011”. The data seems to indicate that there are significant differences in the ability of the companies to service debt in the event of a protracted period of low oil and/or gas prices.


Financial Condition Ratios for 2011 (2) (3) (4)

debt 2

debt 3

(2) Chesapeake has the unusual practice of capitalizing nearly all (around 92%) of its interest charges from debt, making it appear much financially stronger than it really is. On average the other companies capitalize 25% of their interest charges.

(3) Newfield recently issued $1 billion of debt at a yield of 5.625%. This increases its 2011 debt to equity ratio to 102.2% (97% based on Q1 2012 data) and lowers its 2011 EBIT TIE ratio to 4.63 and its 2011 EBITDA TIE ratio to 7.95.

(4) The “overall Peer Group average” calculates the same ratio for its column except it uses the sum figures of the group (rather than taking the arithmetical average of the ratio calculated for each company, which can be distorted by outliers). The “median of ratios” is just the median of the calculated ratios. The downside of the average is that it gives greater weight to larger companies; the median is calculated and presented as an alternative.



Financial Condition Ratios 2006 through 2011 (6 year averages)

debt 4

The worst year for these companies was 2009, when they felt the impact of the rapid decline in oil and gas prices. In addition, the cost structure of several companies was higher as they pursued unconventional projects. The ratios for 2009 are below:



Financial Condition Ratios for the Year 2009

debt 5



Debt Servicing Ability by Cash and Liquid Assets

debt 6


E. Break-even Oil & Gas Prices and Break-even Costs

The gas predominant companies seem to have adequate debt servicing abilities when gas prices are in the $3.50 to $4.00 range, but at $3.00 or less they are tight. The oil predominant companies seem to experience pressure when oil prices fall to the $75 range. This gives evidence to the notion, I think, that if prices fall below these marks at the current cost structure, then the independent E&P companies will be incentivized to cut new exploration and development expenditures, thereby reducing supply.

The cost structure from 2008 to 2011 reflects industry adjustments to new operational requirements associated with unconventional production. Costs will probably decline in the future, and thus so will the breakeven price. The breakeven cost will also vary from basin to basin: the Marcellus Shale is known for having low costs – in part because of better economies of scale and a close proximity to its end-use markets – whereas oil sands production has relatively higher costs.


F. Relative Valuation

Valuation Multiples (5)

debt 7

debt 8

(5) Price data from Yahoo! Finance, using closing price data on July 13, 2012.

It seems that the market’s valuations of the Peer Group are based primarily on expectations of growth. Not much weight seems to be given to the risks undertaken to achieve that growth. In some cases growth is being achieved by utilizing a high percentage of debt financing. Normally, companies with a speculative capital structure are given a discount in the multiple as compared to equivalent companies that do not have a speculative capital structure. Among the 15 companies compared in this article, however, there seems not to be a noticeable association that can be attributed to the capitalization factor.

G. Concluding Thoughts

This article is not a complete analysis of the companies discussed. I cannot offer any definite conclusions as to which companies are speculatively capitalized, as simple statistical ratios cannot alone answer such questions. I think it is generally true, however, that companies with low liquid assets and a high level of debt are riskier. It is possible that some companies will be able to grow their way out of debt, but that level of analysis is beyond this article’s scope.

I am not an expert on each company mentioned in this article. If you have detailed knowledge of any of these companies, I would be grateful if you shared it in the comments section below for the benefit of everyone, or feel free to e-mail me. I have completed a 30 page analysis of Devon Energy Corporation that is available on my website.


Disclosure: Long position in Devon Energy (DVN)

H. Notes

Note 1:

The ratios are adjusted for impairments of proven oil and gas properties that are the result of “full cost ceiling” accounting, which practically means – although this is a gross oversimplification – that oil and gas companies must write off a portion of their assets when oil and gas prices fall by a large percentage.

Except for the affect on the cash flows of 2008-2010, companies were largely unaffected by the price volatility that caused the impairment. Although a significant portion of the impairment was warranted, especially for natural gas properties, the impairments have been added back to improve comparability among the companies.

In addition, the timing of the impairments among companies is different (most made the necessary impairments in 2008 and/or 2009, but some waited until 2010 or 2011, and some made several smaller write-offs over the whole period), so it is necessary to add the impairments back so the companies can be compared fairly.

Note 2:

The term “gross interest” is used to differentiate it from “net interest,” which subtracts interest income. Some oil and gas companies have little in cash and cash equivalents, and in those cases interest income is typically immaterial. In addition, the specific interest income is not even reported by some companies, which would reduce comparability if included.

Note 3:

The source of all data is the 10-k and 10-q statements of each company from the SEC database.

I. Raw Data Tables

debt 9 debt 10 debt 11 debt 12 debt 13 debt 14 debt 15 debt 16 debt 17 debt 18 debt 19 debt 20 debt 21

Copyright Jack Huddleston, 2012

You are allowed to copy all or part of this article as long as you credit:

James “Jack” Huddleston, www.jamesjackhuddleston.com

China Mobile Analysis (2011)


Note: The Devon Energy Analysis which was written in 2012 is a better example of my skills. Based on this analysis my client bought China Mobile stock.

Analysis of China Mobile (CHL)

By James “Jack” Huddleston, research in May 2011, posted on August 1, 2011

Note: If you have trouble reading the tables, contact me and I will email them to you.

Assumptions and Limitations:

This analysis is based on limited knowledge of China Mobile and the analysis was mostly undertaken in May 2011. The main purpose of the analysis was not to determine how China Mobile will perform relative to other telecommunications companies, but if China Mobile appeared to be a good long term investment. Based on the analysis we bought China Mobile on 5-31-11 for $45.60 per share and as of 7-29-11 the price was $49.83. Please note that the analysis was written in May 2011 and the language is as of that time frame. Much of the report is from my notes.

Summary of Conclusions

China Mobile Limited (CHL), at a price of $45 per share, is selling at a price below what I believe it would sell for to a private buyer, which I believe would be between $65-100 per share. This means that the stock is undervalued by at least 44.44% and at most 122.22%. In other words, based on earnings of $4.55 for 2010, CHL should sell appropriately between a TTM P/E of about 14.29 and 21.98. This “private buyer” value is what I will refer to here as the “target price” or “intrinsic value.”

The low price, I believe, has three main causes: (1) a decline in earnings growth for 2009 and 2010, (2) a fear among investors of Chinese stocks which began late 2010, and (3) the perception of CHL as being too large to grow and operating in a “boring” industry. There are many other factors affecting the price – such as the trading price for its shares on the Hong Kong Stock Exchange (HKSE), the RMB (China’s currency) to USD exchange relationship, and so on – but these three are likely the most prominent.

Admittedly, CHL has not been given the same valuation as have reverse merger and small cap Chinese companies. What I have observed indicates that many people are altogether avoiding anything from China. I believe that the depressed price of CHL since the market crash of 2008 is heavily influenced by emotional factors.

It is well known that stock prices can move sometimes dramatically in response to recent earnings reports – it isn’t uncommon for a company to be revalued downward as much as 10% by the market because of a poor quarterly earnings report (often followed by a 10% upward valuation when the next quarterly report is favorable). This is may the case for CHL. The following table illustrates the story.

Table I: China Mobile Price Data1

This table requires some interpretation. In the past, the company has released its annual report between March and June. The exchange rate and share price data presented here are from July 15, or the closest day available, of each year. By July 15, the markets have had ample time to digest the annual report and adjust the stock price accordingly. “% change in market price” should be compared to the fundamental data for the previous year. Therefore, the change in market price by July 15, 2011 should be in response to a change in earnings per share – or any other fundamental measure – from 2010, which would have been reported just weeks before July 15, 2011.

The price of CHL has generally moved in motion with the market even in spite of strong fundamental changes. The share price declined about 25% in by the middle of 2009 from the same date the previous year despite of a recently reported increase in earnings of 44.28%. This was clearly the result of the stock market crash of late 2007 and 2008. Yet, while the general market has since increased to its previous level, CHL has frustratingly stagnated.

The reason is likely the result of very low earnings growth from 2008 to 2009 and from 2009 to 2010. Although China was relatively immune to the last recession, China Mobile’s earnings growth slowed for two main reasons: (1) slowing customer growth and (2) a decrease in revenue per customer. This slowdown and the reason as to why the past two years is likely temporary will be discussed in more detail below.

The other two causes of CHL’s undervaluation, although important, will not be given much consideration here as they are based on my limited observations and are not provable except in retrospect. The main refutation to both of these points is the valuations given to both of CHL’s main competitors, China Unicom (CHU) and China Telecom (CHA). Both of these companies, despite having no history of earnings growth, are being given extreme valuations by the market at the moment.

CHU, for example, is selling for 56 times the average of its EPS for the past 5 years and yet there has been no noticeable trend of growth in intrinsic value upwards or downwards since the year 2001. This is most likely the result of CHU’s exclusive rights to selling Apple (AAPL) products in China, but the current valuation is even more curious in that it is highly likely that this monopoly will be broken in the coming year.2 The future may show very high growth for CHU, but without a history of proof or any overwhelming reason to suppose it should happen, the current price is evidently speculative.

1 IFRS is the reporting method from 2010 to 2006 and U.S. GAAP is used from 2005 to 1999.

Competitive Position of CHL

CHL’s stock sells on both the NYSE and the HKSE. The actual shares are listed in Hong Kong and ADS’s (American Depository Shares) are listed on the NYSE. Each ADS represents 5 actual shares. CHL is one of the largest companies in the world, the largest telecommunications company in the world, and is listed in several indexes. The company is apart of the Hang Seng Index (HSI), one of the earliest indexes in Hong Kong.

CHL’s competitive strengths are threefold: (1) the oligopolistic nature of the telecommunications industry in China, (2) its pricing power as GDP-per-capita and inflation increases, (3) and the several million people right now in China who are without a mobile phone plan.

The telecommunications oligopoly in the PRC has been orchestrated by the government under the philosophy of “rational competition”. The Chinese government wants all the efficiencies that come about with economies of scale, yet want to avoid the creation of a complacent and sluggish monopoly. The current industry situation was created only a few years ago and there are no indications that the underlying philosophy will change in the near future. The PRC government has even gone in the past as far as to give assistance to CHL’s competitors by way of temporarily regulation that gives those competitors a shield from CHL, which was stealing market share from them.

CHL has a 70% market share at the moment and it is likely that this will decrease over time, as the company does not indicate to me that it has the managerial ability and industry economics to protect its moat perfectly from the two other firms in the industry and changing government policy. The degree that its moat or market share will decrease, if at all, is unknown, but the companies, like countries, need not last forever and it can be reasonably expected that its position will weaken over time.

The company’s current competitive position is advantageous in that it provides a great deal of stability and predictability of future earnings than in allowing for high growth rates. The infancy of the telecommunications industry, however, has allowed and will allow for strong growth into the future for some time. The mobile penetration rate in China was 64.40% in 2010. There is much more room for growth as a result of customer additions. Further, the average time spent talking on the phone per CHL customer per month was 8.70 hours. If China ever reaches the amount of wealth of the most advanced countries in the world, that amount of time should increase several-fold. Average revenue per user (ARPU), as well, will likely increase as Chinese GDP-per-capita increases.

2 See “Catalysts for a Valuation Reserval” below for further discussion.

Telecommunications Industry in China

China Unicom (CHU) and China Telecom (CHA), the two competitors of CHL, are valued at 50x and 20x historically demonstrated earnings power, respectively. Both companies have a history of increasing assets and sales several folds yet being unable to increase net income and earnings per share over the same time period. Being that one can increase earnings at the same rate as principal simply by depositing more money into a savings account, that is not entirely impressive.

Currently I am not very familiar with both companies in qualitative terms, but it appears that CHU’s valuation is based on it having exclusive rights to sell AAPL products in China. CHA’s high valuation is unclear, but it is presumably also related to 3G smart phones. It could also be because both companies are smaller and perceived as having greater growth opportunities (similar to the high valuations given to independent oil drillers, currently valued at about a 20 P/E, versus the major integrated oil companies, with P/E’s of about 10 on average). Where CHU and CHA have been awarded rights by the government to use internationally accepted standards of 3G technology, China Mobile has been required to use a homebrewed version of 3G referred to as “TD-SCDMA,” which is generally considered inferior and prevents the company from selling iPhones, as AAPL believes that standard may affect the quality of the phone and thus its reputation.

An expert of the industry may know better, but CHU and CHA, are without a doubt speculative. Without a proof of income growth in the entire history of the two companies, the analysis of future growth must qualitatively stated. The current prices could only be justified by an extraordinary earnings growth that can only be sustained by stealing customers from CHL. Presumably it is assumed these people will eventually flock to those companies to have access to western smart phones. This logic seems to ignore that the vast majority of Chinese customers are buying cell phones for practical purposes, rather than discretionary purposes (see section below “Calculation of Intrinsic Value”). This will change sometime in the future, but by then it would seem too late as CHL has long been in talks with AAPL to release AAPL devices utilizing either the TD-SCDMA or TD-LTE (4G) standard. AAPL obviously wants access to the rest of the Chinese population, of which CHL stands as a toll bridge (see “Catalysts for a Valuation Reversal” for further discussion).

Operational Statistics

The table below shows all the relevant operational statics relating to CHL.3

Table II: China Mobile Operating Statistics4


CHL’s return on equity (ROE) is very high in comparison to its industry and all businesses in general. A look at return on invested capital (ROIC) shows an even more favorable picture – CHL achieves its returns using little debt. The ROE is driven primarily by a high profit margin. This high profit margin, in turn, is mainly the result of a very strong industry position – the major firm in a triumvirate of general telecom providers – in a very strong economy. This profit margin has been maintained in spite of government-mandated decreases in the prices charged to customers.5

Operating ratios:

Interconnection appears to be an unprofitable business whereas SIM cards and handsets is enormously profitable. These statistics are of limited value, however, because it is unclear how the costs are distributed. For example, the costs relating to “interconnection” (see Appendix I for CHL’s income statement) could include overhead or other costs that benefit another part of the company. Similarly, the costs relating to “SIM cards and handsets” may not be including some expenses.

Efficiency ratios:

Asset turnover and other “asset efficiency” measures are not as important for CHL as it has little in inventory and receivables. In any case, the company beats its industry in the two figures shown.

Liquidity ratios:

The company has a sufficient amount of working capital to prevent any serious loss of business in the event of a liquidity crunch arising from a recession in China or such. CHL exceeds its industry average in both measures of liquidity shown here. Liquidity is not an issue overall and thus only two ratios are presented.

Credit ratios:

CHL’s capitalization is about 90% equity and is not at all pressured by debt or interest. The 20-F notes that the company’s credit rating by Standard and Poor’s is “AA-/Outlook Stable,” the same rating as the PRC’s sovereign debt.


As explained later in this report, CHL’s future growth rate will most likely fall below the historic growth rate as the company faces diminishing returns. There are multiple reasons as to why the historical growth rate may continue for some period, but a core tenet of “value investing” is that the merit of an investment should not be based on the expectations of good future results. In value investing, the chief purpose is to guard against the future rather than bet on it.

It is noteworthy that the “total voice usage” growth rate is almost double that of net income. The reason for this is explained in more detail later and relates primarily to a regulatory-mandated decrease in prices charged by telecommunication operators in the PRC.

Payout ratios:

The company’s expected payout ratio for 2010 was 43%. The 20-F notes that the expected payout ratio for 2011 is also 43%.

Market-price ratios:

Table II shows that the company is being given a lower valuation by the market overall to its peers. It is hard to comment as to why this might be the case, as I have not investigated the prospects and competitive position of each and company in the industry. It seems to me that CHL would have better opportunities than most other companies, however, given its special position in China’s flourishing economy, which CHL will partake in at least as much as the average company. As stated above, I believe this relative undervaluation is attributed to recent slow growth, temporary distrust of Chinese companies, and it being just a large and boring sort of company.

The large price to sales and price to book ratios are the result of the company’s high profit margin and return on equity. Market capitalization to net income and net income to sales multiplied by one another results in the price to sales ratio. It follows that a higher profit margin will necessarily result in a high price to sales ratio. Similarly, price to book a function of price to earnings and return on equity. A higher ROE always results in a higher P/B because of the mathematical relationship.

Other ratios:

Net income has stayed slightly above free cash flow as a large portion of the company’s capital expenditures were for expansionary purposes and therefore were higher that year’s depreciation charge. This is not unusual for expanding companies.

3 See “Appendix I” for a balance sheet, income statement, and cash flow statement for CHL from 2010 to 2006; all the aforementioned statements stated as the percentage growth from the previous year; and all the aforementioned statements stated as a percentage of assets (balance sheet), revenues (income statement), and pre-tax cash flows from operations (cash flow statement).


4 Calculated from data stated in RMB terms, which accounts for the differences in earnings growth shown in Table I. With the exception of “Dividend yield” and “Operating margin,” industry average information is from MSN Finance and is current as of July 11, 2011. Industry average data is shown only where available and 5-year average industry data is used where available or can be by calculated using other available data (such as with the tax rate). See “Appendix II” for the exact formulas used in these calculations.


5 See “Estimation of Earnings for 2011” for further discussion.

Method of Calculating the Target Price Explained

The intrinsic value of an asset, in general, is the present value of its future cash flows. The intrinsic value of an asset, then, can be found by (1) taking the average of historical earnings, (2) projecting these earnings into the future at a conservative growth rate, and (3) discounting these earnings on the basis of the risk of those earnings not being realized. It is assumed in this calculation that the company will be a going concern at least 100 years from now, as earnings from that time forward have no worth in present value terms. History has shown that very few companies are capable of lasting that long as most either go bankrupt, get acquired, merge, and so on.

It is very easy to plug in numbers into such a model and deceive oneself into believing a stock is undervalued based on the output (“garbage-in, garbage-out”). For that reason, a high level of conservatism is used in this calculation and the final calculation of intrinsic value is discounted further about 25% to reflect the model’s weaknesses. Some may say that this level of “conservatism” is going overboard, but I believe it is necessary to achieve good results. If the company is selling at a strong discount to this number, in spite of my all efforts to make the company look bad, then it has a strong chance of being undervalued with an adequate “margin of safety.”

Some may also argue that this kind of calculation isn’t necessary and that CHL can be proven as an investment operation on the basis of its operations, its strong position in its industry and economy, and so on. I have, however, two reasons for making this calculation: (1) I have limited knowledge of the telecom industry and the Chinese economy and (2) there is no way to judge those factors relative to the price of the stock short of having the an intuitive feel gained from long experience and knowledge of studying companies in the industry. Qualititative aspects of CHL are more like the icing and cherry on top, rather than the substance of the reason for its stock purchase. Benjamin Graham, the father of “value investing,” once said that while it is a requirement that a security be justified on quantitative grounds, it is by no means sufficient – it must be justified on both quantitative and qualitative grounds.

I do believe, however, that the purchase of CHL is justified by the merit of its competitive position, which I summarized above. 7 out of every 10 people with a mobile phone in China use CHL as its service and this ratio has not changed significantly over the past decade.6 In addition, the mobile penetration rate was about 64% in 2010 whereas it was 7.79% in 2001.7 This means that CHL, up until today over several years, has attracted and retained about 7 out of 10 people in the past decade who were looking for a mobile phone service. The company must be doing something right, they will probably continue to do that, and there are still hundreds of millions of people in China without a mobile phone plan. CHL’s ability to attract as many customers as it has is probably related to its low price, which is one reason the company’s ARPU has declined as much as it has over the decade. In other words, most of its new customers are relatively poor.

In addition, the quantitative data presented in Table II, Appendix I, and Appendix III says a lot about the qualitative aspects of the company (its competitive strengths, managerial ability, and so on). That these ratios and figures have remained substantially unchanged over time speaks volumes.

6 Market share, according to the CHL’s 20-F statements:

2010: 69.30%

2005: 65.60%

2001: 69.60%


7 The mobile penetration figure is implied by other data available. Dividing the number of customers in 2001 by CHL’s published market share and then dividing that figure by China’s population in 2001 yields 7.79%. 2010’s figure is the official data of the Ministry of Industry and Information Technology (MIIT).

Estimation of the Growth Rate for 2011

As discussed above, a rate of earnings growth must be determine for the calculation of the target price. The primary determinant of long-term intrinsic value growth is return on equity (ROE) multiplied by the percentage of earnings that are to be reinvested into the company. Historic ROE provides a starting point, but it is marginal ROE that will ultimately determine future growth rates. It should not be expected that the fantastic growth rates so far experienced by CHL should continue indefinitely into the future as it (1) faces increased competition and (2) experiences diminishing returns.

The calculation of marginal ROE is somewhat complex, so the explanation will be as brief as possible. Below is the historical exhibit of ROE and marginal ROE in comparison to EPS (note that the earnings shown in Table I are the ADS figures stated in USD’s, while this table shows the earnings per Honk Kong share stated in yuan):

Table III: China Mobile Returns8

Marginal ROE for 2011 is expected, by my calculations, to be 15.45%. This adds to the evidence that CHL faces diminishing future returns and that the growth showing during 2009 and 2008 is probably temporary. This means that the overall ROE for 2011 is likely to decline slightly, probably somewhere from 19.00% to 20.50%. Discounting that ROE by the percentage of earnings that is expected to be reinvested (43% is expected to be paid in dividends), the expected growth rate for earnings – before accounting for changes in currency translation – for 2011 is between 10.83% and 11.69%.

8 Marginal ROE is calculated as follows:


Marginal ROE = (NIt – NIt-1) / (BVt-1 – BVt-2)


NI = Net Income

BV = Shareholders’ Equity



This formula takes into account that a reinvestment generally takes a year before the full effect is shown on the income statement.

Estimation of Earnings for 2011

The calculation of marginal ROE for 2011 requires estimating 2011’s earnings. The first step in this process is estimating revenues, which are a function – in CHL’s case – of the number of subscribers and the overall ARPU per month. This section will show the process taken in calculating earnings for 2011.

As of May 31, 2011, CHL has 611.17MM customers according to its investor relations website. Assuming that CHL’s customer base increases at about the same at as it has so far for 2011, it should add up to 650MM customers by the end of that year, which is about the same number added during 2009 and 2010. This method of estimation cannot be used forever, as the company will eventually reach a wall as there are a limited number of people in China, but it doesn’t seem unlikely that it will be reached in a big way within the next 7 months to December 31. The table below shows ARPU for the past decade:

Table IV: CHL ARPU 2010-20009

The downward trend of ARPU is obviously unsustainable, but it has some worried that it will lower future revenue growth. It has not thus far because the company’s increase in the number of subscribers has outpaced the decreases in ARPU. The decrease in ARPU is mainly the result of regulatory mandates implemented so that a greater percentage of the population may afford mobile service. The specific cause of the decrease for 2010 is attributed by the company to regulated price ceilings set by the PRC’s Ministry of Industry and Information Technology (MIIT) and increased competition. It is anyone’s guess as to where ARPU will be in the next year or two, but it probably will increase over the long-term as GDP per capita in China grows and “data” services (mobile internet, etc) – not facing as many government pricing regulations – becomes more popular.

The “prepaid” subscribers are apparently mostly rural citizens and that appears to be the cause of the decrease of ARPU. The company’s 20-F for 2010 states that it expects ARPU to decline further as its customer base expands. In addition, it notes that about half of new customers for 2010 were from such rural areas. It seems proper to assume 2011’s ARPU will be 73 yuan.

Thus far it is calculated that that total customers by the end of 2011 is expected to be 650MM and the ARPU on average for the year will be RMB 73. Using this data, total revenue for 2011 is expected to be RMB 540.49B.10 Multiplying this revenue number by the average of the profit margin over the past 5 years, 24.36%, results in expected net income of RMB 131.66B, or RMB 6.48 per share assuming no change in shares outstanding.

This estimation of earnings is a 10.05% change over 2010’s EPS of RMB 5.89. This is about in line with the expected earnings growth rate calculated above. The actual rate may vary considerably from this depending on changes in the exchange rate between the RMB and USD. If ARPU declines again for 2011 (meaning it will increase further in the future), growth for the next year will around 4-5%. This report, however, makes no attempt to predict near term prices, earnings, and so on. Any decrease in a year’s earnings because of a regulated price ceiling could just as easily result in a great increase in earnings as the ceiling in lifted and ARPU rises or as more customers begin buying data services.

The strengthening of the RMB in the past few years has allowed U.S. stockholders to receive more in value than created by the company intrinsically. I will not, however, make any attempt to predict exchange rates. If the U.S. government decides to clear away some of its debt by inflating the dollar, it does seem possible that U.S. inflation will outpace Chinese inflation, which is high because of demand, and thus result in the yuan strengthening further, resulting in an increase the growth rate of earnings beyond that aforementioned.

Additional data of a miscellaneous character regarding CHL customers, along with a brief commentary, is in Appendix III.

9 The company stopped including ARPU data for contract and prepaid customers as of 2007.

10 (584MM + 650MM) / 2 = 617; 617 x RMB 73 x 12 = 540,492. This method of calculation – taking the average of customers at the beginning of the year and the end of the year and multiplying by ARPU for the year – has proved a fairly accurate predictor of revenue for 2010 and 2009.

Calculation of the Target Price:

The growth of earnings is projected in the following way:

  • 10% for 3 years
  • 6% for 27 years
  • 2% to infinity

The previous two sections dealt with the calculation of 10% growth. The 2% to infinity after 30 years is meant to reflect basic increases in inflation whereas earnings generally stagnate. The medium term growth rate, 6%, is simply a rough estimate of earnings growth that can be expected over the long-term based on:

  • Mobile penetration rate increasing from 60% to about 90%.
  • Higher ARPU as GDP per capita in China increases (presumes that there will be less “prepaid” users and more contract users paying more for data services such as mobile internet and so on).
  • Inflation over the long-term of about 2%. Note that this is number is based on the average Chinese CPI from 2009 to 1996. 1994 had an usual spike of inflation and including 1994 into the calculation would have brought the average rate to about 4%.
  • Moderate Chinese population growth of about 0.50%.
  • CHL’s market share declining over time.

Long-term earnings projections defy calculation, but I think it can be reasonably assumed that the company’s volume of business and the ARPU of its customers will generally increase at a slow rate over time and thus that period deserves a higher rate than inflation. The following table shows the discounted cash flow table:

Table V: Calculation of Intrinsic Value11

The cash flows are distributed between retained earnings (which are expected to result in capital gains) and dividends. The dividends are assumed to be taxed at 35% (the qualified dividend rate will probably decrease in the future as the Bush-era tax cuts expire). This is not everyone’s tax rate, but it is probably a median figure.

The discount rate used in this calculation differs from some analysts in that I do not calculate them using the cost of equity capital or a function based on stock price volatility. The inherent stability of CHL’s mobile subscription revenues in the PRC and the company’s dominant position in its industry means there is less risk as the company is not as vulnerable to the vicissitudes of the economy. The discount rates used are instead calculated based on the 10-year T-bond plus a spread subjectively determined to reflect the risk of those cash flows not arriving by at least that amount.

It is important to remember that many of CHL’s subscription revenue are not a part of their customer’s discretionary spending – the business is not seasonal. Many Chinese today have mobile phone subscription plans because it is logically perceived as either a necessity or such a great convenience as to be too good to live without. This is evidenced by the fact that the ARPU annually for mobile services as a percentage of GDP per capita is 3% in China whereas it is 1.5% in the U.S.12 In addition, the average amount of time spent talking on the phone per CHL customer per month in 2010 was about 8.70 hours – or 17 minutes and 24 seconds a day on average. The average Chinese customer clearly isn’t subscribing to CHL for frivolous matters.

The intrinsic value using the discounted cash flow method – and hopefully conservative estimated inputs – is about $82. At a price of $45, this means that CHL is potentially undervalued by about 80%. Interestingly, the price of CHL’s common reached above this calculated value before the market crash in 2008. The importance of this calculation of intrinsic value is that it assumes no special performance by the company in the future. The company can perform quite poorly, even, and still be yield a good result. There is obviously quite a bit of speculative value well above this calculated figure if the company has exceptional performance.

This model can, at best, just give a ballpark estimate. The calculation here is quite sensitive to changes in the inputs. A difference of 1% in the discount rate for “Years 11-Infinity” can result in a change in the calculation of as much as $15. Moreover, the estimates in the model, while at a very low figure, are still quite speculative and it is almost certain that the actual figures in the future will differ. For those reasons, it is difficult to rely on the model blindly and instead set a range around which intrinsic value should lie reasonably. Therefore, as stated at the beginning of this report, the intrinsic value “range” is between about $65 and $100.

11 CHL, in its own DCF model for the purpose of calculating asset impairment, uses a perpetual growth rate of 0.50% and 10.00% as the discount rate.

12 U.S. ARPU calculated as the average of AT&T, Sprint, and Verizon.

Final Analysis:

The lower limit of $65 has been chosen kind of arbitrarily. The type of discounted cash flow analysis as described above can be misleading. I do not think it is prudent to make actual decisions rigidly based on such a quantitative model, despite the variables being so conservatively calculated, because of the number of estimates involved. Furthermore, many people may never attribute any value to earnings “to infinity” or even a hundred years from now.

Ultimately, a person can only sell an asset for what the other person is willing to pay. No matter how logical and conservative my calculations may be, the other person may never come to agree with them because of either differing opinions or some ideology. It is logical to not rely very heavily on the pure math of the matter.

Therefore, I believe this amount should be discounted to $65 for the following reasons:

  1. A discounted cash flow calculation is very easy to make mistakes in on account of how difficult it is to predict the future. It is easy to deceive oneself as to the surety of the calculated value because it very mathematical. The company’s lifespan may not last for 100 years, for example, or the telecommunications industry in China may be dramatically different from today’s.
  2. Even if the data rigidly states the intrinsic value is $82, the market may never agree with this calculation. CHL may perpetually stay below what a conservative discounted cash flow analysis say it should be.
  3. My own limited experience and knowledge in regard to CHL creates the need to discount for any chance my analysis is mistaken.

Therefore, a lower limit intrinsic value of $65 has been chosen as the absolute minimum value that should be attributed to the value of China Mobile as of today. This is about 25% less than the “true” intrinsic value calculated above. The reason for choosing $65 is a little simplistic.

Figure 1: CHL Price History13

It is a general axiom in value investing that the price of a stock is not always equal to its intrinsic value and that the price generally fluctuates above and below that intrinsic value. Table 1 near the beginning of this report shows that the P/E of China Mobile has been as high as about 30 and as low as about 10.30 – its current P/E. The period during 2007 where the price rose briefly to about $100 in response to a year of high reported earnings growth was probably an overvaluation. The stock price later tumbled in response to the recession (although China was not affected by the recession, its shares are listed on the NYSE) and has stagnated in response to very low growth rates for the years 2009 and 2010. The overvaluation retreated to an undervaluation.

The price of $65, based on this logic of the price fluctuating around a central value, is taken as just the average of the historic prices. The price during late 2007 and early 2008 was about $80 and that price represented probably an overvaluation. The price during 2009 to now has been about $50 and represents a period of undervaluation. The price has recently retreated to as far as $44 in response, probably, to the general dislike and perception of riskiness of Chinese stocks in general. The central value, therefore, is calculated as $65 as the proper lower limit intrinsic value. Keep in mind that this is not a “target price” for next year or any time in the future. I do not know what the price will be in the future. Value investing supposes that over the long-term, stock prices will eventually reach their calculated value and it is hoped for, though not guaranteed, that CHL and any other stock will eventually reach that value.

In any case, it seems odd that a company with stability and future prospects like China Mobile would sell for a P/E of less than the average stock, as shown by the S&P 500 index’s P/E of 14, and even less than the average major Chinese corporation, as shown by the “iShares FTSE China 25 Index Fund” with a P/E of 11, of which China Mobile is a constituent. I believe this degree of discounting is unwarranted.

13 From Yahoo! Finance.

Catalysts for a Valuation Reversal

As stated above, a fundamental principle of value investing is that there is an element of emotion or irrationality in decision making by investors. The necessary corollary is that stock prices deviate from their intrinsic value. There are also many whose investing decisions are logical, but are independent of stock values – technical traders, selling to pay for retirement, and so on. It is known that stocks generally fluctuate above and below a stock’s intrinsic value. These undervaluations and overvaluations may last as long as a few days to a few years. The point is that one major assumption of a “value investor” is that at some point his or her diversified portfolio of undervalued securities will reverse at some point in the future, although the exact time frame for this revaluation is uncertain.

There are many investors and portfolio managers, though, who are not satisfied with this “wait and pray” approach. Many demand a “catalyst” – a reason for a security to be revalued by the market within a specific time frame. As for CHL, there are three catalysts I know of that could cause a reversal of the current valuation. These are: (1) a great bull market, (2) a strong reported growth in earnings or some other fundamental measure, and (3) CHL being given rights to sell AAPL products in China. I won’t discuss the first catalyst, but the latter two have a strong probability of occurring.

Any growth in earnings beyond that shown in 2009 and 2010 can possibly lead to a higher valuation by the market. As discussed above, I believe the growth in 2009 and 2010 is temporary. The second catalyst is AAPL selling products through CHL, which it currently does not because CHL uses the incompatible TD-SCDMA as its 3G technology. This situation, however, may change in the future.

According to the news site M2M, China Mobile is rumored to have reached an agreement with AAPL over iPhone 5, which is supposed to be released sometime in the second half of 2011. This rumor’s basis is founded in Tim Cook, COO of AAPL, having visited the company on June 23rd of 2011. In addition, the site reports that an agreement has been reached on TD-LTE (4G) iPhones. TD-LTE is one of two 4G standards in the world and is gaining some international acceptance.

Further, a state-run paper, People’s Daily, reports that China Mobile had 5.6MM iPhone users with access to its wireless network by the end of May 2011. In addition, 700,000 iPhone 4 users were added to CHL’s network in May. This fact along with competitive pressure from CHA means that CHU’s toll-bridge status for owning an iPhone in China will not last forever. As a result, as People’s Daily reports, CHU has recently been promoting multiple smart phones, rather than promoting primarily the iPhone as before. This could mean that the valuation attributed to CHU is no longer warranted, if it ever was.14 More importantly, some of the enthusiasm for Google, Apple, and others could rub off on CHL.

14 People’s Daily. July 8, 2011. “China Mobile puts more pressure on Unicom.” Accessed July 14, 2011. http://english.people.com.cn/90001/90778/90860/7434076.html

Appendix I: China Mobile Financial Statements

Presentation of financial statement data:

The statements presented are adjusted where possible to represent a truer picture of the company. For example, “deposits with banks” have been consolidated with “cash and equivalents.” The “other current assets” account actually includes amounts that are due after 1 year, but the company does not give enough information to make an adjustment to non-current assets. Certain other immaterial items have just been consolidated under the most relevant account.

The company also uses strange terminology for some accounts that I’ve adjusted to something more typical (e.g. “current taxation” to “taxes payable”). The account “reserves” has been broken down into its component parts. Various esoteric reserves – the reserve required by PRC law, a reserve for unused stock options are consolidated under “other reserves.” A minute accounting standard was adopted during 2009 by the company that changed certain balance sheet accounts. There is inadequate data to adjust 2006 in a similar fashion and that is the reason why there is a sudden increase in certain accounts. Deferred tax assets, deferred revenue, and accrued expenses and other payables were affected by the changed. Operating leases have also been added to both assets and liabilities.

The income statement has been similarly adjusted to be more descriptive and to represent the true situation better. One annoying factor, from an analysis point of view, of IFRS is that it desires financial statements to have “minimum information.” For example, about 50% of all operating expenses were placed in an ambiguous account called “other operating expenses”. The average analyst obviously would want to know what such a significant account includes, so the statements have been readjusted to show the major components.


China Mobile Balance Sheet (December 31)


China Mobile Income Statement (December 31)

China Mobile Statement of Cash Flows (December 31)


China Mobile Balance Sheet (December 31) – Annual Percentage Change

China Mobile Income (December 31) – Annual Percentage Change

China Mobile Statement of Cash Flows (December 31) – Annual Percentage Change

China Mobile Balance Sheet (December 31) – Percentage of Assets

China Mobile Income Statement (December 31) – Percentage of Total Revenues

China Mobile Statement of Cash Flows (December 31) – Percentage of Operating Cash Flows


Appendix II: Table II Formulae


Appendix III: Additional CHL Customer Data

CHL Historic Number of Customers

CHL Historic Customer Usage

Based on information in CHL’s 20-F, prepaid customers seem to be mostly from rural areas. In part for making profits and in part for adhering to PRC philosophy, one of CHL’s and the PRC’s objectives is to minimize the growing “digital divide” between the country’s urban and rural dwellers. Thus, CHL has made great efforts to make mobile phone services available to rural communities. The 20-F for 2010 notes that about half of new customers in 2010 were from rural areas.

It is questionable to me, given my limited data, how profitable these rural customers are at the moment. My knowledge of Chinese civilization is limited to articles and figures showing that men have moved off to cities “in droves,” leaving the women and old men working in the countryside in very poor conditions. At the very least, they may be a decent investment as they will hopefully be wealthier one day and be capable of paying more to CHL for additional and better services.

It is also interesting to note the explosion of billions of minutes usage during the recession years while at the same time the company had less earnings growth. The company’s 20-F for 2010 complains of strain on the network from an increase in communications as an explanation for additional capital expenditures upgrading and expanding the physical network. Increases in ARPU as the country becomes wealthier will almost certainly provide growth for years to come.

Copyright Jack Huddleston, 2011

You are allowed to copy all or part of this article as long as you credit:

James “Jack” Huddleston, www.jamesjackhuddleston.com

Article about Facebook (2010)


(Please keep in mind that I did the research for this article about May 2010 and it was written in late July and early August 2010.  It was published on August 6, 2010. It is amazing how things have changed since then. At the time the article was written in 2010, Facebook’s estimated value was in the $11B to $23B range. Facebook went public in May 2012 and raised $16B. As of October 3, 2013 Facebook had a market cap of $120 Billion and by July, 2014, its market cap was over $200B. I think the article has held up well and the things I thought were opportunities for Facebook are still being discussed. Clearly, it would have been a home run for Microsoft or Apple if they had bought Facebook. We never invested in Facebook stock because initially Facebook seemed like a gamble to me as a public company and I thought the IPO valuation was very high – in fact, the stock price dropped almost 50% within 3 months. I am more of a value investor than a growth investor. )

Who Should Buy Facebook? Google, Microsoft, Apple, EBay, Yahoo or Amazon?

This article is on GuruFocus at http://www.gurufocus.com/news/103260/who-should-buy-facebook-google-microsoft-apple-ebay-yahoo-or-amazon

By Jack Huddleston, August 6, 2010

This article will address:

1. The opportunity Facebook presents and how it could be a game-changer.

2. Why I think Facebook is worth more to certain companies than to investors.

3. Some logical prospective buyers for Facebook.

4. The company that could do the most with Facebook.

5. The company that most needs to buy Facebook.

6. Some companies that could be negatively affected if either Microsoft or Apple were to buy Facebook.

The Rise of Facebook:

Facebook has quickly come from nowhere to be the most visited website in the U.S., surpassing Google, and during the twelve month period March to March had a U.S. traffic growth rate 20 times more than Google. That is an amazing statistic. Facebook reached 100 million members in August 2008 and only two years later had over 500 million registered members worldwide and about 150 million in the U.S. Many of Facebook’s members use Facebook to communicate with friends and business associates and visit Facebook daily. An increasing number of people in their 40’s, 50’s and 60’s belong to Facebook and an increasing number of corporate ads say “Visit us on Facebook”.

I think Facebook has become so strong that it has a broad moat and can’t be replaced – it is used by too many people as a way to communicate and stay connected. If you aren’t that familiar with Facebook, ask your friends and co-workers. I don’t write this because I’m a big Facebook fan – I don’t use Facebook on a daily basis

There are 5 facts that got my interest:

1. In March, 2010, according to Experian Hitwise, Facebook became the most visited website in the U.S., overtaking Google. That is startling, but what is even more startling is that for the week ending March 13, 2010, “The market share of visits to Facebook.com increased 185% last week as compared to the same week in 2009, while visits to Google.com increased 9% during the same time frame.” Hitwise says that together Facebook.com and Google.com accounted for 14% of all US Internet visits in that week in March. In the one year period (March 2009 to March 2010), Facebook went from about 2.5% of all internet searches to 7.07%, a staggering increase. (1)

2. About 150 million Americans belong to Facebook.

3. Facebook hit 100 million members in August 2008 and two years later had over 500 million members. It reached a critical mass and has blown away the competition.

4. Major corporations are now simply advertising “Visit us on Facebook” instead of giving a web address. The apparent presumption is that everyone is on Facebook! Going straight to Facebook bypasses search engines, sends traffic directly to Facebook, and increases Facebook’s importance as an internet portal. When I saw this I realized how ubiquitous Facebook has become.

5. Reports indicate that Google sees Facebook as a threat.

Opportunities Facebook Presents:

Facebook’s traffic, traffic growth and position as the entrenched social networking website give it the potential to threaten some major companies. For example:

1. Facebook could become a major search engine and cause a reduction in Google’s market share. According to reports, there were 647 million U.S. searches conducted on Facebook in March, twice as many as the prior March. That is still much lower than the 10.5 billion searches generated on Google during the same month, but it might be the tip of the iceberg.

2. Facebook could become a facilitator of third-party online sales similar to Amazon. It could start as a facilitator who takes a commission and then move into direct sales based on the knowledge it gains as a facilitator and transaction processor. In 2009, it is reported that 30% of Amazon’s sales were third-party sales.

3. Facebook could begin offering an auctioning system like eBay.

The list of online services Facebook could offer is endless. For example, streaming video is one. Facebook reportedly already knows quite a bit about its member’s interests, so product offerings could be targeted based on interests.

The point is that Facebook’s huge membership and traffic create huge opportunities. Think about it – social networking isn’t a commodity like doing a web search where you can choose between Google, Bing, Yahoo or others. There is no viable alternative to Facebook and its massive membership creates a powerful moat. What if you had access to 500 million members and a moat to protect your position? What could you do with that?

Why I Think Facebook is Worth More to Certain Companies than to Investors:

Facebook offers many opportunities, but it will cost a lot of money to achieve them. In spite of the huge traffic, Facebook only achieved positive cash flow in September 2009. 2010 revenues are projected at $1.1B, only a 38% increase from 2009. Facebook has a lot of traffic but investors will be skeptical of its ability to turn that into profits, particularly since its CEO is only 26 years old. On the other hand, what is the potential if Apple or Microsoft owned Facebook? I think the potential synergies make Facebook worth more to Apple or Microsoft.

Some Logical Prospects to Buy Facebook at the Right Price – Who Can Afford It, Who Needs it the Most and Who Could Do the Most With It:

Below is a list of some companies that I think are logical prospects to buy Facebook at the right price. I don’t think all of them can afford Facebook and I doubt that Google would be approved to buy it due to antitrust concerns (antitrust concerns killed the Google -Yahoo search ad deal in 2008):

1. Microsoft – Microsoft needs Facebook more than Apple or Google. Facebook could be a way for Microsoft to seriously compete with Google, Apple, Amazon and eBay and could give Microsoft an advantage in a large number of emerging businesses such as streaming video. Microsoft needs to do something – this could be it. Microsoft is sitting on $36.79B in cash and short-term marketable securities which should be much more than is needed to buy Facebook. I think Facebook might be Microsoft’s best bet for the future. Microsoft already owns 1.6% of Facebook and is Facebook’s exclusive partner for banner advertising, so it probably has less of an antitrust problem than Google. Recently, Microsoft’s Market Cap was $222.66B

2. Google – The main reason Google should buy Facebook is to prevent Microsoft or Apple from buying it, but it seems unlikely that Google could gain approval due to antitrust concerns. You might ask: Why couldn’t Google just develop their own Facebook? The reason that won’t work is because Facebook has become the dominant website of its type and the resulting network effects provide a substantial moat. Google has $30.06B in cash and short-term marketable securities. Recently, Google’s Market Cap was $161.37B.

3. Apple – Apple could probably do more with Facebook than any other potential buyer. Is there anything they can’t do? Facebook would give Apple access to 500 million members. It would be a way for them to compete with Google and would allow them to enter and probably dominate a large number of emerging businesses. Does anyone doubt that Apple could build a great search engine? I would try it… wouldn’t you? I think Facebook members would be thrilled if Facebook was bought by Apple. Could Facebook take on Google or Amazon by itself? That would be tough, but if Apple owned Facebook, it could. Apple has $24.3 billion in cash and short-term marketable securities and an additional $21.55B in long-term marketable securities. Recently, Apple’s Market Cap was $240.25B

4. Amazon – Amazon should be interested in buying Facebook, but I think it would be a stretch. It has cash and short-term marketable securities of $5.11B. Recently, Amazon’s Market Cap was $57.13B.

5. eBay – eBay should be interested in buying Facebook, but I think it would be a stretch. It has cash and short-term marketable securities of $4.9B and an additional $1.83B in long-term marketable securities. Recently, eBay’s Market Cap was $28.15B.

6. Yahoo – Yahoo should be interested in buying Facebook, but I think it would be a stretch. It has cash and short-term marketable securities of $3.24B. Recently, Yahoo’s Market Cap was $19.71B.

In Summary:

Due to antitrust concerns, I do not think Google is a prospect to buy Facebook. I think Apple and Microsoft could do the most with Facebook and therefore should be able to pay the most. Both Apple and Microsoft seem to be able to afford Facebook, which has a current estimated value in the $11B to $23B range, based on various online reports. I don’t know what Facebook is worth, and what it is worth will vary from buyer to buyer based on what they think they could do with it, but it was reported in April 2009 that the Facebook owners thought it was worth $6B, so a price in the $11B to $23B range would be a big increase in a short period of time. I am skeptical about Facebook’s current management being able to achieve the company’s profit potential. I think Microsoft could benefit the most from purchasing Facebook because it could lead to growth opportunities that Microsoft needs. On the other hand, based on their track record, I think Apple could probably make the most of the opportunities Facebook offers. The acquisition of Facebook by either Apple or Microsoft could negatively impact other large companies such as Google, eBay, Amazon and Yahoo, and smaller companies such as Netflix.

(1). From http://weblogs.hitwise.com/heather-dougherty/2010/03/facebook_reaches_top_ranking_i.html, Facebook Reaches Top Ranking in US, March 15, 2010, Heather Dougherty, Director of Research at Hitwise

Disclosure: No positions in referenced companies as of the date of this article.

Copyright Jack Huddleston, 2010

You are allowed to copy all or part of this article as long as you credit:

Jack Huddleston, www.jamesjackhuddleston.com