Apple Underwhelms With Cheap iPhone But China Mobile Deal Still Likely

Apple’s (NASDAQ:AAPL) iPhone launch event turned out to be a dampener of sorts, as the company priced what was expected to be a significantly cheaper iPhone at a hefty $550 and did not introduce any new products such as an iTV or an iWatch. Further, at its Chinese event scheduled for Wednesday, the company announced the launch of the new iPhones on China Unicom (NYSE:CHU) and China Telecom (NYSE:CHA) but gave no indications about another widely anticipated China Mobile (NYSE:CHL) deal. While it is still possible that the company may announce new products and launch the iPhone on China Mobile’s network in the coming months, the markets did not take kindly to the disappointment. Apple’s stock fell over 2% after the event Tuesday, and is down another 4% in pre-market trading today.

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Margins and marketing play

By pricing the cheaper iPhone 5C so high, Apple seems to be more intent on maintaining its brand image than making a market share play. The iPhone 5’s discontinuance and the introduction of the iPhone 5C in its stead shows that Apple is more focused on defending its gross margins. The iPhone 5C is not very different from the iPhone 5 on the inside but is held together by a single polycarbonate shell, which likely makes the 5C cheaper and much easier to assemble than its premium counterpart which has an anodized aluminium casing.

However, more than the gross margin improvement, we believe that Apple is going to derive the most value from the additional sales that the iPhone 5C is going to help bring in. While nothing has changed in terms of the range of prices that Apple will offer on its iPhone family (with the 5C just replacing the older 5 at what would have been its new discounted price), the company now has two new phones to promote instead of the usual one. Additional marketing for the 5C is likely to help Apple sell the iPhone to many more people than it would have with the older-generation iPhone 5, especially in the developed markets where carrier subsidies help bring the phone’s cost down to a mere $99. At the same time, the price differential of only $100 lowers the risk of cannibalization of the higher end 5S.

Chinese market will be hard to penetrate without China Mobile

However, the same may not help Apple’s case much in the emerging markets, even in places like China where carriers have started subsidizing smartphones. The iPhone 5S and 5C will retail in China at an unsubsidized price of $867 and $735 respectively. Even with carrier subsides, Chinese subscribers have to fork out the entire cost of the phone at the time of purchase. The subsidy is instead adjusted against the service fees, reducing only the future monthly payments and not the upfront cash outlay.

Apple could still drive growth in the emerging markets by bringing other carriers such as China Mobile into its fold. With a subscriber base of almost 750 million and 3G penetration less than 20%, China Mobile is a big untapped opportunity for Apple. While Apple is yet to announce a deal with the carrier, one of the company’s handsets that runs on China Mobile’s network seems to have received a “network access license” from Chinese regulators. ^[1] Handset vendors generally tend to start selling new phones within weeks of receiving regulatory approval.

A China Mobile deal is essential for Apple to improve its fortunes in China, which has increased in significance to become its third largest market overall. Apple’s sales in Greater China declined by 14% last quarter. While Apple has been increasing focus on China, as its decision to include the country in its initial iPhone launch markets amply suggests, it is unable to access a vast majority of China’s wireless subscribers due to the China Mobile conundrum. While technological incapability to access China Mobile’s 3G network was one of the initial concerns, that doesn’t seem to be the case any more with Qualcomm’s new chipsets. A lack of agreement on a proper subsidy deal is likely to be the main issue here. Considering that the 5C isn’t priced at a level that will significantly reduce subsidy costs, investors need to watch out for more intricate details in a potential arrangement between the companies that might harm Apple’s margins should the China Mobile deal materialize in the future. (see Apple Could Sacrifice Margins To Bag China Mobile Deal)

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1. Apple Secures China Mobile Network License, WSJ, September 11th, 2013 [↩]