Apple (NASDAQ:AAPL) seems to be making renewed efforts at wooing China Mobile (NYSE:CHL) this year. In his second visit to China in less than a year, Apple CEO Tim Cook met with China Mobile executives last week and discussed “matters of cooperation”, raising optimism that a potential iPhone deal is on the cards. While both companies have declined to give specifics of the current negotiation process, Cook said he expects China to become Apple’s most important market in the “not too distant future.” This may not be an indication that his talks with China Mobile are making good progress, but a deal with the world’s largest wireless carrier by subscriber base would no doubt help Apple meet that guidance quickly.
The iPhone maker has already signed deals with two other Chinese carriers, China Unicom (NYSE:CHU) and China Telecom (NYSE:CHA), but a deal with the world’s largest wireless carrier has so far remained elusive due to potential “benefit sharing” concerns. Using its over 700 million subscriber base as a negotiation stick, China Mobile seems to be looking to cut a better subsidy deal (or a possible app revenue share) with Apple. On the other hand, the carrier needs access to the iPhone to stem the decline in market share it is experiencing in the lucrative 3G market. Considering the current market dynamics, we expect both parties to reach a compromise and sign a deal sooner rather than later. This could be the next big trigger for Apple’s stock as it nearly doubles the company’s addressable market in China and could cause our price estimate to increase by 5% to $750 – around 50% upside over the current market price.
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iPhone May Soon Arrive on China Mobile
China Mobile’s proprietary TD-SCDMA 3G network has so far been a big stumbling block in the way of an Apple-China Mobile iPhone deal. The network is incompatible with most smartphones currently available in the market, including the iPhone. This requires Apple to come out with a specially crafted iPhone for the carrier’s proprietary network, and this has historically proved to be a huge deterrent.
However, with Apple using one of Qualcomm’s recently launched baseband chips that supports not only China Mobile’s 3G network but also its 4G TD-LTE network, which is still under trials, technical issues should no longer be a big deterrent for Apple to release the iPhone on the world’s largest carrier. (see Qualcomm Paves the Way for an Apple-China Mobile iPhone Deal)
China Mobile has so far managed to overcome its 3G shortcomings by building out a nationwide Wi-Fi network. But the unavailability of an unsubsidized iPhone on the nation’s largest wireless carrier is a serious deterrent to widespread 3G adoption. The fact that as of March 2012, China Mobile still managed to add about 15 million iPhone customers – customers who had not only forked out the full price of the iPhone but have also had to make do with China Mobile’s 2G network – is testimony to its huge untapped potential.
Upside to Apple from a bigger China play
Our estimates for Apple’s market share do not take into account the availability of the iPhone on China Mobile’s network. However, should it happen, the upside could be huge.
China Mobile had 10 million iPhone users in October 2011. In 4 months, it added another 5 million implying an addition of almost 1.25 million iPhone users to its network each month. For 4 months prior to October, China Mobile added 5 million iPhone users. So we can assume that the rate of adoption of unsubsidized iPhones on China Mobile’s network has been fairly constant.
Assuming that China Mobile gets the iPhone in October this year when the ‘iPhone 6’ is released, and that it starts off by selling the subsidized version to an additional 1.5 million users every month, it could sell around 5 million additional iPhones in the last quarter of 2013.
Going forward, it could sell around 25 million additional iPhones in 2014 at a little higher than the 2012 rate. For arriving at the long-term average sales, we look at AT&T’s percentage of iPhone activations to total retail subscriber base for 2011. AT&T had about 17.5 million iPhone activations in 2011, and it ended the year with more than 76.5 million subscribers, taking the required percentage close to 23% in about 4 years for which it had the iPhone.
If China Mobile manages to reach this percentage by 2019, it could be selling close to 200 million additional iPhones a few years out. In our analysis, we are taking a more conservative estimate of 120 million additional iPhones by 2019. Additionally, accounting for the potential margin hit of a China Mobile deal, we assume iPhone average pricing to decline from more than $600 currently to about $350 by 2019 and margins from >50% currently to about 35% in 2019. This increases our price estimate to $750, an upside of about 5% to our current $710 price estimate.
You can move the iPhone pricing trend line in the chart below to make your own forecast for Apple’s value.
Our assumptions are contingent on China Mobile actually leading the 3G race in the same way as it has dominated 2G. The current 2G scenario is heavily biased in favor of China Mobile, but its 3G advantage is not so significant. If China Mobile is unable to leverage its huge 2G lead and turn it into a 3G advantage, the scenario may not play out as described above. Having China Unicom and China Telecom in the bag may help Apple cover a bit of lost opportunity in China Mobile, but for the China story to play out, its largest wireless carrier must deliver.