One of the reasons for Apple’s (NASDAQ:AAPL) recent run-up to $500 is increasing optimism surrounding a potential deal with China Mobile (NYSE:CHL). Following a recent meeting between the CEOs of the two companies, fresh rumors have erupted about Apple being close to a deal with the carrier. What has raised hopes further is China Mobile’s chairman Xi Guohua commenting that “both sides sounded keen” during recent talks. However, both sides have been in talks since 2011, and it is too soon to say if the same will result in a deal this time around. Still, considering that Apple is expected to launch a cheaper iPhone for the emerging markets that should mitigate China Mobile’s subsidy concerns, a deal should materialize sooner than later. A potential risk for Apple here could be the kind of margin sacrifice it may have to make to rope in China Mobile.
China Mobile is China’s largest carrier by subscriber base and has about 750 million subscribers but is the only carrier to have not yet offered a subsidized iPhone on its network. The carrier runs a homegrown TD-SCDMA 3G network that is incompatible with not just the iPhone but also many other popular smartphones. However, Qualcomm has recently launched baseband processors that help smartphones access not only China Mobile’s 3G network but also its upcoming TD-LTE network, allowing Apple to finally launch a China Mobile-compatible iPhone without making design sacrifices. China Mobile, for its part, will be looking for a ‘hero’ device to promote its LTE network in the coming years as it looks to wrest back some of the market share advantage it has lost to rivals in the recent years.
$45 billion opportunity
A deal with China Mobile could alone add billions to Apple’s value. China Mobile had 10 million iPhone users in October 2011. In four months hence, it added another 5 million, implying an addition of almost 1.25 million iPhone users to its network each month. For the four months prior to October 2011, China Mobile had added the same number of iPhone users. Although we don’t have data for the subsequent months, we can conservatively assume the rate of adoption of unsubsidized grey-market iPhones on China Mobile’s network to have remained fairly constant in the past year.
Since China Mobile is expected to receive its 4G LTE licenses before the end of 2013, we assume the carrier will launch the low-cost iPhone only towards the middle of next year giving it enough time to have a LTE network up and running in many of the important Chinese cities. If it starts off by selling an additional 1.5 million iPhones every month, the carrier could end up with about 10 million additional iPhone activations in 2014.
Going forward, it could sell around 25 million additional iPhones in 2015 at a little higher than the 2014 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 2012. AT&T had about 21.3 million iPhone activations in 2012, and it ended the year with more than 77.8 million subscribers, taking the required percentage close to 27% in about five years for which it had the iPhone.
If China Mobile were to reach this percentage by 2020, 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 100 million additional iPhones by 2020 considering the more competitive dynamics at the low-end in China. Additionally, accounting for the potential margin hit of a China Mobile deal, we assume the iPhone average pricing to decline from about $600 currently to $350 and margins from about 50% currently to less than 30% by the end of our forecast period (2020). This increases Apple’s value by $45 billion and our price estimate to $650, an upside of about 10% to our current $600 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/4G 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.