Apple Faces China Mobile-Sized Stumbling Block Limiting China Upside Potential

In what could be a major blow to Apple’s (NASDAQ:AAPL) expansion plans in China, China Mobile (NYSE:CHL) may not be willing to ink a deal to carry the iPhone 5 anytime soon. After a recent meeting with China Mobile’s management, analysts with Deutsche Bank believe that the Chinese government, which has a controlling stake in the carrier, is ‘not supportive’ of an Apple deal due to the ‘heavy subsidy burden’ that carrying the iPhone would entail. ^[1] Apple already has iPhone deals with China Unicom (NYSE:CHU) and China Telecom (NYSE:CHA) in place, but will need the support of the country’s as well as the world’s largest wireless carrier to reach a bulk of the Chinese populace. China Mobile, with close to 700 million mobile subscribers, controls almost 65% of the Chinese wireless market.

This revelation comes just weeks after the iPhone 5 was launched with a Qualcomm LTE chipset that also had support for China Mobile’s proprietary 3G network. Until now, it had seemed that the only roadblock to a possible China Mobile deal was the lack of a chipset that was compatible China Mobile’s home-grown TD-SCDMA network. With this chipset, it seemed that Apple could finally release an iPhone on China Mobile after making a few minor tweaks. However, now it seems that we could see the stalemate between Apple and China Mobile extending longer than many anticipated. Considering China Mobile’s clout and the huge market opportunity that Apple would be missing out on due to delays, we might even see Apple reach a compromise on the subsidy issue.

See our complete analysis for Apple here

Apple’s China opportunity

The China Mobile deal notwithstanding, China presents a huge opportunity to Apple. Despite being only in the early stages of smartphone adoption, the country has already pulled ahead of the U.S. as the world’s largest smartphone market by volume. This is an incredible statistic given that 3G penetration in China stands at only about 18% currently. Considering the huge 2G subscriber base that the Chinese carriers are looking to upgrade to 3G, the potential for Apple to ride the boom is huge.

This is also borne out by the rapid pace at which Apple’s revenues from China are growing. Revenues from greater China, which includes mainland China, Hong Kong and Taiwan, in the July quarter grew 48% year-over-year and accounted for more than 16% of Apple’s overall revenues. This brought Apple’s FY 2012 first three quarter revenues from the region to $18.1 billion, already 36% over the $13.3 billion in revenues Apple managed to generate from the region during the whole of last fiscal year.

As the country grows and the average Chinese buyer sees an increase in buying power, we expect to see a growing shift in demand from 2G to 3G smartphones. The iPhone can help Apple tap this phenomenal growth in demand. Even Apple’s CEO Tim Cook acknowledged the immense potential that China presents when he said during the Q2 earnings call that the country was Apple’s “fastest growing region” by far and that the company was doing everything it could to market its brand in China.

China Mobile necessary for Apple

However, in order to unlock the tremendous potential that China offers, Apple will have to bag a China Mobile deal. The current 3G situation in China may not as heavily loaded in favor of China Mobile as in 2G due to most handsets’ incompatibility with its proprietary 3G network. (see China Mobile Needs To Step Up As 3G Growth Slows) However, the carrier’s huge subscriber base gives Apple an opportunity to double the iPhone’s addressable market in China. Moreover, it enjoys a superior brand image among the Chinese that has helped it add more than 15 million iPhone users, as of February 2012, despite not offering a subsidized iPhone offering. In fact, we estimate that a deal with China Mobile alone could cause Apple’s stock value to surge past $800. (see Apple Can Ride China Potential Past $800 With China Mobile’s Support)

This clout however puts China Mobile in a position to negotiate favorable terms to the deal. If Apple were to compromise on China Mobile’s subsidies, we could see Apple bearing a part of the subsidy burden and decreasing the impact of the higher prices on iPhone’s growth. We could also see Apple deciding to let customers pay prices higher than comparable unsubsidized iPhones on competing carriers, China Unicom and China Telecom, and avoiding margin pressures. However, China Mobile may balk at the latter idea since it puts it at the risk of losing potential 3G customers to rivals.

Either way, it seems penetrating China further will mean Apple having to compromise on either margins or iPhone sales. Both of these scenarios put a cap on the potential that Apple could have unlocked from China. You can move the trend lines in the graphs presented here to analyze different scenarios and come up with your own price estimate for Apple in each case.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. China Mobile, Apple license deal unlikely soon:Deutsche Bank, MarketWatch, October 4th, 2012 [↩]