Apple’s (NASDAQ:AAPL) long-awaited deal with China Mobile (NYSE:CHL) has been inked, and while that agreement gives the iPhone maker access to more than 700 million new mobile customers, the company’s victory in the smartphone battle in the world’s largest smartphone market is by no means assured.
Apple has been losing market share in China as the number of available lower-cost smartphones grows. According to current rankings, the iPhone maker controls just a 6 percent share of the Chinese market, falling behind Samsung (SSNLF.PK), Lenovo (LNVGY.PK), Yulong, and Huawei, per research firm Canalys.
The comparatively high price of the iPhone has much do with how much market share Apple controls and how competitive China’s three main wireless carriers — China Mobile, China Telecom (NYSE:CHA), and China Unicom (NYSE:CHU) — can be.
In a recent research note acquired by Barron’s, Credit Suisse analyst Colin McCallum noted that the iPhone joining China Mobile’s smartphone lineup will create some changes in the Chinese market: it will raise subsidy costs for all three providers and make the overall smartphone market more competitive; the cost of subsidizing the device will also impact China Mobile’s profit.
McCallum also wrote that he did not “wish to over-exaggerate the impact of an official Apple-China Mobile deal.” The wireless carrier already has approximately 35 million iPhone users on its network, operating unlocked Apple devices on China’s biggest cell network, which indicates that the iPhone is already a proven commodity. More importantly, both China Mobile’s competitors — China Telecom and China Unicom — have sold iPhones for years, and Apple is losing market share in the country.
Yet the iPhone will still have a significant effect on China Mobile’s finances in 2014. “Given the high cost (and high subsidy level) per unit, and our view that Apple will no doubt have required a volume commitment from China Mobile, we believe the deal will have an impact on China Mobile’s total subsidy budget for 2014,” wrote McCallum, per Barron’s.
Based on the assumption that Apple will require a volume commitment of 5 million units in 2014 and that China Mobile will employ a similar subsidy policy as China Telecom and China Unicom, the analyst calculated a total subsidy bill of 10.3 billion renminbi for the full year. He also reminded investors that since China Mobile’s fiscal 2013 budget was only 27 billion renminbi, the additional subsidy burden represents a “meaningful” 36.1 percent year-over-year increase.
Apple’s iPhones will launch on China Mobile’s new 4G network. The rollout of that network is still in its early states, and McCallum remarked that his firm was surprised China Mobile concluded the deal with Apple so early. As a result, Credit Suisse lowered its estimate for earnings before interest, taxes, depreciation, and amortization in fiscal 2014.
In the note seen by Barron’s, McCallum wrote he believes the iPhone debut on China Mobile’s network will create larger subsidy expenditures for both China Telecom and China Unicom. For China Telecom, he predicted subsidy costs to increase from 32.9 billion renminbi, or 23.7 percent of sales, to 35 billion renminbi, or 25.3 percent of sales. Comparatively, China Unicom will see costs increase by 10 billion renminbi to 95 billion renminbi. Credit Suisse reiterated Outperform ratings on China Mobile and China Unicom, and a Neutral rating on China Telecom.
As for Apple, Wall Street expects the tech firm to sell an additional 20 million to 30 million units because of the partnership. That figure may represent a small portion of the Chinese smartphone market, but it is significant compared to the 150.2 million iPhones the company sold last year. Thanks to the deal with China Mobile, Apple could sell as many as 20 percent more iPhones. But the problem is that many analysts see China Mobile as the only source of growth in sales next year.
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