Apple’s Earnings: China’s Growing Role And The New iPad’s Impact

Apple (NASDAQ:AAPL) is set to announce its Q3 FY2012 results on July 24th. During the earnings call, we will closely watch the company’s iPhone numbers to see the impact that a bigger China presence has had on sales. China will be a big focus point for us this earnings call since the company is seeing huge revenue growth from the region and we expect Apple to sign an iPhone deal with China Mobile (NYSE:CHL), the largest wireless carrier in the world, soon. Also of special interest will be the iPad unit sales, which will have been bolstered by the launch of the third-generation iPad in March.

However, Apple faces increasing competition in the mobile devices segment from both Google (NASDAQ:GOOG), which has recently made a low-end tablet entry, as well as Microsoft (NASDAQ:MSFT), which is making a renewed push for Windows as the third mobile ecosystem of choice this year.

See our complete analysis for Apple stock here

Apple’s China story

Apple’s momentum since the start of the year has been impressive, with the stock rising by almost 50% as iPhone sales continued their impressive performance in the last quarter of 2011 into 2012 as well. Coming off an impressive holiday season as the iPhone 4S set new records, many expected a slight slowdown in sales in the March quarter. However, Apple’s iPhone 4S launch on China Unicom and China Telecom helped prop up sales in Apple’s fastest growing market and almost made up for the seasonal drop in iPhone sales in most developed markets.

Revenues from greater China, which includes mainland China, Hong Kong and Taiwan, in the March quarter grew threefold year-over-year and accounted for almost 20% of Apple’s overall revenues. This brought Apple’s FY 2012 first half revenues from the region to $12.4 billion, just shy of the $13.3 billion in revenues Apple managed to generate from the region during the whole of last fiscal year.

Going forward, China holds a lot of promise considering the huge 2G subscriber base that the carriers there are trying to transition to 3G (3G penetration is currently only about16% in China). Apple’s China figures this quarter will probably reaffirm the huge potential that China holds for the company and make a compelling case for a China Mobile deal.

We believe that the deal is very much possible considering Qualcomm’s recent announcement of a Gobi reference platform that supports China Mobile’s TD-SCDMA network as well as the TD-LTE 4G network it is testing. This deal is very important for Apple as it instantly doubles its current addressable market for the iPhone in China and can act as the next big boost to its stock, given that the iPhone accounts for more than half the company’s value by our estimates. We estimate that this deal has the potential to add a minimum of another 15% to Apple’s value, taking our price estimate past $800. (see China Mobile In Talks To Offer The iPhone; Can Alone Take Apple Past $800)

This is just the effect of an increase in market share for Apple’s iPhone. However, if carrier subsidies cause Apple to maintain its current pricing, as opposed to the declines that we show, the upside could be much higher. Another significant upside could come from an improvement in gross margins helped by the growing economies of scale as Apple expands its presence in China.

iPad sales to show how the new iPad fared

iPad sales last quarter were rather muted as the new iPad was launched late in the quarter and customers probably held off buying an iPad until the new one was launched. iPad sales came in at 11.8 million units, about 150% higher than the year-ago quarter but 25% lower than the previous quarter. However, the new iPad had a tremendous opening, selling over 3 million units in the debut weekend itself and we see the full impact of the launch in its first full quarter of sales this quarter.

Going forward, we see the iPad performing well in the absence of meaningful competitors in the tablet market and the very nascent stage that the market is in. The launch of the new iPad in China following the recent resolution of the Proview case will help bolster iPad sales in the coming quarters.

Google’s foray into the low-end tablet market with the Nexus 7 launch and the good gross margins on the product that teardown reports have revealed may mean that an iPad mini is on the way. However, considering that the iPad contributes less than 12% to Apple’s price estimate, we don’t see much of an impact on Apple’s value. To be precise, we see only about 5% upside to Apple from an iPad mini launch. (see Debunking iPad Mini Rumors – Part III)

A more potent threat, we believe, is Microsoft’s Windows 8 launch later this year. Microsoft plans to make Windows 8 available on both PCs and tablets, and a lot of PC as well as smartphone manufacturers are expected to jump in on the offering to tap the nascent tablet market. Microsoft has a widely installed PC base in place that it can leverage to pose a big threat in the young market. Moreover, it can also leverage its partnership with Nokia to push for an integrated experience across all devices, mobile or PCs, in order to create a viable third ecosystem. The fact that Microsoft’s two-pronged attack with the Windows Phone 8 and Windows 8 could endanger Apple’s iOS ecosystem advantage, causing iPhone sales to be impacted as a result should give Apple more reason to worry than Google’s low-end tablet threat.

Submit a Post at Trefis Powered by Data and Interactive Charts | Understand What Drives a Stock at Trefis