Apple Likely To Launch Cheaper iPhone At Sept. 10 Event

by Trefis Team
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Apple (NASDAQ:AAPL) has sent out invites to a media event scheduled for September 10, where the company is widely expected to launch its next-generation iPhone. What is likely to set apart this year’s event form the previous ones is that Apple faces immense pressure from investors to launch a cheaper iPhone model for the emerging markets. The largest technology company in the world has seen its shares decline by over a quarter in the past year as its smartphone market share declined and profits plateaued amid increasing competition from rivals such as Samsung (PINK:SSNLF). Growth in the high-end smartphone market, which Apple has been primarily targeting, is slowing down while the low-end market is burgeoning with a solid rise in demand from emerging markets such as China and India. Penetrating these low-end markets is likely going to be Apple’s strategy going forward, but the interesting question in front of investors will be the margin hit it might have to take in order to do so.

Considering Apple’s brand and high-end forte, we believe that Apple will target the mid-end market first with its first cheaper iPhone release this year. Such a strategy will help Apple minimize its brand dilution while opening up the low-end markets for entry in the coming years as it discounts the older models with each subsequent release. Launching a cheaper iPhone could also help Apple sign on China Mobile as a carrier partner, which could be hugely value-accretive to shareholders.

Our $600 price estimate for Apple is about 20% ahead of the current market price.

See our complete analysis of Apple here

Emerging market focus essential

Apple’s recent quarterly results show that it has started increasing its focus on the mid-end smartphone market. Last quarter, the company took an ASP hit to sell more of the older and discounted iPhone models into sales channels in the emerging markets. Bucking the seasonal trend, Apple shipped as many as 31.2 million iPhones during Q3 and posted y-o-y growth of 20%. However, a higher sales mix of lower-priced iPhone models caused ASPs (average selling prices) to decline by 4% over the same period last year.

A good sign for Apple here is that despite selling cheaper iPhone models, gross margins held up pretty well and came in at the higher end of the guidance at about 37%. Not only does this mitigate concerns about Apple’s ability to generate good profits at the mid-end but also shows that the iPhone remains the more popular choice when pitted against Android at similar price points. The latter can be seen not only from the increased emerging market demand for the discounted models last quarter but also that half the smartphone buyers at AT&T and Verizon chose to buy an iPhone at a time when Samsung had just launched its latest generation Galaxy S4.

It is here that coming up with a cheaper iPhone will prove value-accretive to Apple. Not only will such a move help Apple take on Android in emerging markets but also target first-time buyers who are likely to contribute the most to smartphone growth in the future. This is true not just for the emerging markets but also developed ones such as the U.S. as well. According to a recent UBS report, almost 68 million customers in the U.S. upgraded their smartphones last year, down by about 9% over 2011.

China Mobile is a big catalyst

Despite its focus on emerging markets, Apple’s China story has been floundering in the absence of an iPhone deal with the largest carrier, China Mobile, which accounts for about 65% of the country’s wireless subscribers. Revenues from China last quarter declined about 43% sequentially and 14% y-o-y. With subsidy concerns likely to be the main factor holding up talks between the two, we believe offering a cheaper iPhone will help Apple decrease the per-phone subsidy costs and potentially bring China Mobile aboard. 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.

A China Mobile deal could alone add billions to Apple’s value. Considering that China Mobile had been adding iPhone users at the rate of 1.25 million per month in 2011-12 in the absence of a compatible 3G network, we can expect the carrier to add an additional 1.5 million when it initially launches a low-cost iPhone on its network. Going forward, the carrier could sell as many as 200 million iPhones by 2020 if we take AT&T’s 27% iPhone penetration of its user base in 2012 as a benchmark. If we take a more conservative figure of 100 million and account for the ASP and margin hit as a result of the increasing mix of low-cost smartphones, we arrive at a fair price estimate of $650 for Apple – about 10% ahead of our current $600 price estimate. (see Apple Has A $45 Billion Opportunity If China Mobile Deal Materializes)

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.

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