Apple (NASDAQ:AAPL) touted its opening weekend sales of the newly launched iPhone Monday, exceeding expectations with a record 9 million unit shipments which sent its shares higher by 5% during the day. Although this figure is about 80% higher than the 5 million iPhone 5 units sold during the same period last year, it must be kept in mind that Apple has two new handsets, the 5S and the 5C, to sell this time around. Apple also added NTT Docomo in Japan to its carrier partners and two new countries to its initial iPhone launch markets, one of which is China. Both these new additions are likely to have contributed heavily to the impressive launch numbers.
Still, the fact that this caused Apple to issue an optimistic financial forecast for the quarter means that the iPhone 5S and 5C are selling better than many had anticipated. As a result, Apple now expects its fiscal Q4 revenues to come in it at the high end of its previous guidance of $34-37 billion. While the company didn’t break down the sales mix between the 5S and the 5C, it did say that it had exhausted its initial supply of 5S handsets. Strong demand for the 5S as well as better margins on the 5C caused Apple to issue a positive update on gross margins, which it now expects to be closer to the high end of its earlier 36-37% guidance.
We maintain our $600 price estimate for Apple, about 20% ahead of the current market price.
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5C to increase the market for iPhones
Margin improvement is one of the main reasons behind Apple’s introduction of the 5C this year. By pricing the 5C at a high $550, Apple is more intent on maintaining its brand image than making a market share play. The iPhone 5’s discontinuation and the introduction of the iPhone 5C in its stead shows that Apple is more focused on defending its gross margins. The 5C may not be very different from the 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 predecessor which had an anodized aluminum casing. It will be interesting to see where Apple’s gross margins trend towards in the coming quarters as the sales mix of the 5C increases post the initial launch euphoria which might have caused the sales to skew towards the 5S due to the higher number of purchases made by hard-core Apple enthusiasts.
More than the gross margin improvement, however, we believe that Apple is going to derive the most value from 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, as is being seen in the initial launch.
Deal with China Mobile essential
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 are being sold in China at unsubsidized prices of $867 and $735 respectively. Even carrier subsides do not lessen the pain as Chinese subscribers have to fork out the entire cost of the phone at the time of purchase. The subsidy is then 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.  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)Notes: