Shares in China Telecom (Hong Kong), China's flagship listed telecoms company, fell to their lowest closing level this week as fears grew over a possible yuan devaluation and the unlocking of a potential 580 million shares in October. CTHK shares hit $9.85 by the close on Wednesday, well below its $11.68 a share issue price last October. This came, ironically, as the company released news that it had just experienced a bumper two months for subscriber growth. Chief operating officer Li Ping disclosed that it had added another 800,000 customers during June and July, giving CTHK a subscriber base of about six million and well above forecasts. China's total mobile market is just over 18 million - a nationwide penetration rate of about 1.5 per cent. CTHK has about a third of the mainland market. In June CTHK completed the acquisition of its parent's mobile assets in Jiangsu province, paying US$2.9 billion. Mr Li appeared to indicate that, because of market conditions, that might be the only asset injection for the time being, although the company is thought to have been looking at Shanghai as a possible target. 'Organic growth has become more important when market conditions are not that good,' Mr Li was quoted as saying. This organic growth has been impressive. After adding 300,000 new subscribers in the first quarter, CTHK added 400,000 in April and May, before doubling that figure in the next two months. ABN Amro Asia, for example, had a year-end closing forecast for CTHK of 6.2 million subscribers. If the company goes on growing at the rate of the past two months, it will hit eight million by the end of the year. But these are not the figures being focused on by the market. Apart from the fear of a yuan devaluation (CTHK's revenues are all in yuan), growing in the minds of investors is the possible effect of a 580-million-share stock overhang held by strategic investors which could be released on the market in October. This amounts to just under 5 per cent of the company's total stock and equal to about a third of the current free float. 'If that number of shares hit the market, it could be very significant for the price,' Paribas Asia Equity analyst Neil Juggins said. Twelve 'Beijing friendly' companies bought 9.9 per cent of CTHK's stock at the initial public offer (IPO) price, each promising to hold half the stock for a year and another half for two years. That means, in theory, that on or after October 23 (the anniversary of the IPO) this stock is free to be sold into the market or placed out. Of the 12, five are thought to be probable sellers with the need to generate cash to help liquidity in other parts of their business. For example, Hysan Development told an analyst meeting recently it would certainly sell but a Cheung Kong director said it saw the stock as a long-term investment, implying it would not sell. With the stock trading well below the level these corporates initially paid, those who might want to sell may still chose to wait until the stock recovers. A problem may be that it will not recover until this overhang is gone. Bear Stearns Asia analyst Daniel Widdicombe reckons CTHK at the current levels offers fundamental value, but he warns that the overhang issue will set a cap in the short term. In the meantime, the short sellers of CTHK have been out in force, using concerns about the overhang and a yuan devaluation to push down the price. Mr Widdicombe said that in the longer term the market would welcome the extra liquidity offered by the release of stock. 'It doesn't have a huge free float relative to its weighting in the Hang Seng,' he said. 'It is already liquid but it could be much more so, and in doing so attract new investors from funds that previously may not have been able to touch the stock.' His view was that the hangover could be absorbed because CTHK was 'under held' in the first place. That appears true, as some hedge funds have had trouble borrowing the stock needed to short the share. In the longer term, analysts are split over the organic growth story for CTHK. It is an accepted principal that the first customers on any network are the most valuable and return the highest revenues. To encourage more customers, prices have to be cut, in the process reducing revenue per subscriber. In theory each additional customer earns you less than the rest 'As penetration [of services] rises, average monthly revenue per subscriber continues to fall,' Mr Juggins said. The way round this is to do what Hong Kong's established cellular networks have done and try to promote greater use and revenues from added-value services, such as voice mail and caller-number display. The challenge for CTHK may be not to build out huge networks but ones capable of delivering these added-value services. Despite this, ING Barings reckons CTHK is the 'best and only proxy' to the mainland's cellular growth story. Some estimate that in 2001 China will hit 50 million subscribers. In a recent report Salomon Smith Barney concluded the shares would provide 'near-term shelter' in turbulent markets and would receive substantial near-term support from Beijing at IPO levels due to the desire to raise further funds for CTHK and other red chips. CTHK will report interim profits either at the end of this month or early next. The figures themselves are likely to be confusing. Before its formation as a public company, it paid tax at a rate of 9 per cent. Now it will be taxed at 33 per cent. This means while notional year-on-year revenues will show a big jump, net profits could actually fall.