China Mobile Primed for $59 as China’s Smartphone Market Blossoms

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China will jump ahead of the U.S. this year to be the world’s largest smartphone market by volume, according to IDC’s latest market figures released Thursday. [1] IDC expects smartphone shipments in China to increase 52% this year to around 137 million units, giving it a 20.7% market share by the end of the year. Although the U.S.’s market share will still be just a hair behind at 20.6% , the gap will only widen over the coming years. China first began outselling the U.S. in smartphones in the second half of last year. The growing Chinese demand for smartphones while a good sign for handset makers also bodes well for Chinese telecom companies such as China Mobile (NYSE:CHL), China Unicom (NYSE:CHU) and China Telecom.

China Mobile is not only China’s largest wireless services provider but also the world’s largest. It has a subscriber base of over 650 million, more than three times as many as its nearest competitor, China Unicom. We believe that this huge subscriber base is what puts China Mobile in a better position to tap the growing smartphone demand than its rivals in the wireless market.

See our full analysis for China Mobile’s stock here

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Opportunity huge once 3G compatibility issues are overcome

3G penetration is only around 14% in China currently, but with increasing demand for smartphones, we expect penetration to grow quickly.

China Mobile recently announced that it has over 15 million iPhone users subscribed to its network although it has no formal contract with Apple to sell the iPhone. Thanks to Apple’s network of stores in the country selling the unlocked iPhone and China Mobile’s offers of gift cards as high as $441 to its users who are willing to prepay for its Wi-Fi services to surf the web, China Mobile has been able to attract and retain iPhone users that do not mind paying the huge upfront charges for the phone. Not bad considering that users also have the option of buying a subsidized iPhone from China Unicom. China Mobile also subsidizes and sells a number of Android smartphones on its network.

But the behemoth hasn’t been able to capitalize on its huge 2G subscriber base as well as it should have yet. As of January, China Mobile only had around 54 million 3G subscribers to around 43 million subscribed to China Unicom’s 3G network and close to 39 million on China Telecom’s 3G network.

A big reason for that has been its homegrown TD-SCDMA 3G network that is incompatible with most smartphones currently available in the market such as the iPhone. This requires handset vendors to come out with specially crafted phones for the carrier’s proprietary network which has proved to be a huge deterrent.

We believe that Qualcomm’s recent announcement of a baseband chip that supports China Mobile’s networks will finally make it possible for Apple as well as other vendors to release compatible smartphones on the world’s largest carrier. (see Qualcomm Paves the Way for an Apple-China Mobile iPhone Deal) When that happens, it will help China Mobile  promote 3G better and gradually transition its huge 2G base to 3G, eventually taking an unassailable lead over its rivals.

The subsidy-ARPU tradeoff

But in order to drive 3G adoption, China Mobile will have to bear the subsidies that are associated with smartphones such as the iPhone. The reason why smartphones are subsidized by carriers in return for long-term contracts is that smartphone users are widely recognized as heavy data users and bring a higher life-time value to carriers. The average revenues generated from someone using a smartphone is far higher than any other phone and this allows carriers to make back their money over the course of the contract period. Also, it allows users that would otherwise have not bought these expensive phones to use them and get addicted to their technology and fast data speeds, thereby driving future revenues for the carriers.

While in the longer term, subsidizing smartphones may prove beneficial, in the near term these promotional activities will pressure the company’s margins, the effects of which will start to weigh on the company as its mobile voice and internet services division accounts for a huge chunk of our $59 price estimate.

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Notes:
  1. IDC: China to pass US in smartphone shipments in 2012, ItWorld, March 15th, 2012 []