Apple (NASDAQ:AAPL) is set to announce its Q4 FY2012 results on October 25th. During the earnings call, we will closely watch the company’s iPhone numbers to see the seasonal impact that the iPhone 5 launch might have had on sales. Softness in iPhone 4S demand ahead of the holiday quarter may have also had a negative impact on gross margins. Geographically, China will be a big focus point this earnings call since the company is seeing huge revenue growth from the region and the new iPad was launched in the country last quarter.
However, Apple continues to face increasing competition in the mobile devices segment from both Google (NASDAQ:GOOG), which recently made a low-end tablet entry, as well as Microsoft (NASDAQ:MSFT), which is making a renewed push for Windows Phone as the third mobile ecosystem of choice this year. Long-term, however, we see China continuing to contribute heavily to Apple’s growth and the pent-up demand for the iPhone 5, together with the holiday season, leading to an exceptionally good holiday quarter.
We maintain our $700 price estimate for Apple’s stock, about 15% ahead of the current market price.
Apple’s China story
The iPhone’s global mobile phone market share has steadily increased from zero at the start of 2007 to around 5.4% in 2011. As a result, Apple’s iPhone sales have been growing at an average annual rate of about 90% every year. However, with the smartphone market in developed regions such as the U.S. saturating (U.S. smartphone sales grew y-o-y by just 9% in Q2), Apple is looking to maintain its historical growth rates by tapping fast-growing regions such as China.
Despite being only in the early stages of smartphone adoption, China 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.
New iPad sales to show China impact
The launch of the new iPad in China last quarter will have helped iPad sales along and mitigated the impact of seasonality to an extent. iPad sales in the June quarter had set an all-time record on the back of a successful launch of the new iPad. China’s addition and the nascent stage of the tablet market may help Apple beat that record this quarter.
However, the tablet market continues to see new competitors emerge, the most recent being Google which followed on Amazon’s footsteps to release its own $199 tablet. Google’s recent foray into the low-end tablet market with the Nexus 7 launch and the good gross margins on the product that teardown reports supported our view that the iPad Mini was on the way. Tuesday Apple unveiled this new device; however, considering that the iPad contributes less than 12% to Apple’s price estimate, we don’t see much of an impact due to such a launch on Apple’s value in the near term. To be precise, we see only about 5% upside to Apple from the iPad mini launch. (see Debunking iPad Mini Rumors – Part III)
A more potent threat, we believe, is Microsoft’s Windows 8 launch later this week. 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 the low-end tablet threat.