China Mobile Primed for $58 on Burgeoning Smartphone User Base

China has leapfrogged U.S. to be the world’s largest smartphone market by volume, according to latest Q3 figures released by Strategy Analytics. Around 24 million smartphones were shipped to operators and retailers in China last quarter as opposed to 23 million units shipped in the U.S. market. China shipments grew by 58% while U.S. shipments fell by 7% quarter-over-quarter, according to the report. ^[1] The growing Chinese demand for smartphones while a good sign for handset makers, also bodes well for Chinese telecom companies, such as China Mobile (NYSE:CHL), China Unicom (NYSE:CHU) and China Telecom.

China Mobile is not only China’s largest wireless services provider but also the world’s largest. It has a subscriber base of over 600 million, more than three times as many as its nearest competitor, China Unicom. We believe that this huge subscriber base is what puts China Mobile in a better position to tap the growing smartphone demand than its rivals in the wireless market.

See our full analysis for China Mobile’s stock here

Why increasing smartphone penetration is good for China Mobile

Smartphone penetration was only around 15% in China in 2010, but with increasing demand for smartphones, we expect penetration to grow quickly. China Mobile recently announced that it has over 10 million iPhone users subscribed to its network although it has no formal contract with Apple to sell the iPhone. Thanks to Apple’s network of stores in the country selling the unlocked iPhone and China Mobile’s offers of gift cards as high as $441 to its users who are willing to prepay for its Wi-Fi services to surf the web, China Mobile has been able to attract and retain iPhone users that do not mind paying the huge upfront charges for the phone. Not bad considering that users also have the option of buying a subsidized iPhone from China Unicom. China Mobile also subsidizes and sells a number of Android smartphones on its network.

The reason why smartphones are subsidized by carriers in return for long-term contracts is that smartphone users are widely recognized as heavy data users and bring a higher life-time value to carriers. The average revenue per user generated from someone using a smartphone is far higher than any other phone and this allows carriers to make back their money over the course of the contract period. Also, it allows users that would otherwise have not bought these expensive phones to use them and get addicted to their technology and fast data speeds, thereby driving future revenues for the carriers.

While in the longer term, subsidizing smartphones may prove beneficial, in the near term these promotional activities will pressure the company’s margins, the effects of which will start to weigh on the company as Mobile voice and internet services account for a huge chunk of our $58 price estimate.

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1. China in Smartphone Lead, WSJ, November 24th, 2011 [↩]