China’s three largest mobile phone operators are all being investigated for corruption by the Chinese Communist Party’s Central Commission for Discipline Inspection. So far, at least three managers have been forced to turn in their passports and more than 60 people, including some government officials are under investigation. The investigations are another reminder of the pitfalls awaiting the unwary investor in Chinese stocks.

The country’s largest mobile carrier, China Mobile Ltd. (NYSE: CHL) claims more than 606 million subscribers. The second largest carrier, China Unicom (Hong Kong) Ltd. (NYSE: CHU) claims 177 million subscribers and China Telecom Corp. Ltd. (NYSE: CHA) is the third largest with more than 103 million subscribers.

Mobile phone carriers in the US have some problems, but nothing like this. The $39 billion offer from AT&T (NYSE: T) for Deutsche Telecom AG’s (OTC: DTEGY) T-Mobile has stirred a hornet’s nest of oppostion from the US’s third largest carrier, Sprint Nextel Corp. (NYSE: S) and some smaller carriers. The second largest US carrier, Verizon Wireless, a joint venture between Verizon Communications Inc. (NYSE: VZ) and Vodafone Group plc (NASDAQ: VOD), has kept quiet, probably because if the AT&T/T-Mobile deal goes through it will kill off T-Mobile as a low-cost threat to Verizon. The added benefit is that AT&T is going to be distracted for some time with all the hearings and lawsuits surrounding the deal for T-Mobile.

Back in China, the big mobile carriers are getting another lesson in power politics. Earlier this year, a China Mobile executive was formally charged with crimes by the Communist Party’s discipline agency. Other Chinese companies are also getting squeezed by the scandals in the mobile sector.

A company called Myoo Music Entertainment Co. put up about $1.6 million to acquire the right to be China Mobile’s sole provider of music content. China Mobile then changed its mind and selected another company to act as its music provider. Myoo can’t get its money back following an investigation into financial misconduct by a China Mobile manager and the flight of another manager out of China.

Caixin Online notes, “The investment in Myoo was a fraction of the large amount of private money that’s been rushing into the telecom industry in China in recent years.” Here’s the money quote from Caixin:

“By teaming up with a state monopoly and massaging official connections, a private telecom service provider initially may find it easy to overcome technical and policy barriers for doing business. But success often hinges on orders from companies at the mercy of ever-changing government policies and subject to fallout when management troubles, such as a corruption case involving a high-ranking executive, bubble to the surface.”

There have been a succession of irregular accounting stories out of China in the past few months. And there will be more. The corruption story on the mobile operators is not the first of those stories and it won’t be the last.

What makes the corruption story interesting is that the investigations are being conducted by a political body. Either corruption is being viewed as a crime against the political system or its is being seen as a black eye on the free market system as it is developing in China.

Either way, the prosecution of corruption will be uneven, and some companies are likely to escape while others are pummeled. The mobile carriers are not likely to suffer a great deal because they are so large and so central to the country.

Read the quote from Caixin again. It doesn’t apply only to the telecom business. Caveat emptor.

Paul Ausick

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