Apple's Bright Spot In China - Not Really That Bright

| About: Apple Inc. (AAPL)

The world's leading smartphone manufacturer Apple Inc (AAPL) has recently released its quarterly results that disappointed investors as its stock tumbled and Exxon (XOM) - temporarily - recaptured the crown of the world's biggest listed company. In mid-day trading on 25th January, Apple's stock fell by 2.32% to $440.4 per share as Exxon surpassed Apple's market cap by $5.23 billion. The sole "bright spot" in Apple's earnings was China. The country is Apple's third biggest market behind the Americas and Europe. Apple's quarterly revenues in China (including from Hong Kong and Taiwan) increased by 67% from last year to reach $6.83 billion. This was the biggest revenue jump that Apple reported out of all of its geographic segments.

Apple is clearly having an impact on this market, but so far, its numbers aren't really impressive. Here, it faces intense competition from Samsung (SSNLF.PK), Lenovo (LNVGY.PK), Huawei, Coolpad, ZTE (ZTCOF.PK) and Xiaomi Technology.

The Chinese smartphone market is growing and growing fast. In the final quarter of last year, 53 million smartphones were shipped to China representing a 64% growth from the same quarter in 2011. According to IHS iSuppli, shipments are expected to touch 268 million in 2012, which will be about one-third of the total global shipments, making China the world's biggest smartphone market. The Taiwan based Industrial Economics and Knowledge (IEK) believes that China's smartphone market would put an annual growth rate of 21% for the next five years. In such times, any company selling smartphones in China will witness considerable increase in revenues. Xiaomi, a relatively smaller player (as compared to Lenovo, Huawei or ZTE), often dubbed as China's Apple, sold 7.19 million phones in 2012 and generated record revenues of $2 billion. The company doesn't even operate in Hong Kong and Taiwan and neither does it partner actively with any of the domestic leading carriers. Instead, it sells most of its phones online through its website. Apple itself sold 2 million iPhone 5s in China in the first three days of its release in the country in mid-December. However, it all comes down to market share and in those terms, Apple has a long way to go.

Meanwhile, Lenovo, Apple's biggest Chinese rival, has delivered a strong performance that has beaten analysts' estimates for its third quarter ending December 31st 2012. The company earned record revenues and profits of $9.36 billion (up 12% year-over-year) and $204.9 million (up 34% year-over-year) respectively. Furthermore, its tablet and Chinese smartphone operations have now become profitable. Lenovo has sold more than 9 million smartphones in its previous quarter. The company is now aiming for smartphone market leadership in China while it continues to strengthen its position in international markets (India, Indonesia, Vietnam and Russia).

Apple is still the most popular brand of smartphones in the country. According to TrendForce and AVANTI research partners, Apple was at the top in China in terms of brand recognition followed by Samsung, Nokia, HTC and Xiaomi (Q3-2012). However, the Chinese market is and will be dominated by Chinese firms whose growth has come on the back of a variety of low-end handsets priced at around $160. Xiaomi is believed to have sold more of its relatively pricier models such as Xiaomi Mi2 -- equipped with a quadcore Snapdragon S4 CPU and Adreno 320 GPU that competes directly with iPhone 5 and Galaxy S3 -- priced at $321, than its entry level phone such as 1S, priced at $208. On the other hand, a 16Gb iPhone 5 sells for $848, almost 2.5 times as expensive as Xiaomi's high end phone.

To make matters worse for Apple, Chinese consumers are now going after larger screens -- the screen size of more than half of the ~60 million phones shipped in Q3-2012 is bigger than 4-inches. In fact, most of Lenovo's new line of products - Lenovo S890 (5-inch), S720 (4.5-inch), A800 (4.5-inch) IdeaPhone K5 (5-inch) K900 (5.5-inch) - boast more than 4.5-inch screens. Besides this, Apple also needs to partner with the local tech players, such as Baidu (BIDU) or Tencent (TCEHY.PK) and develop new applications to make its phones more appealing to the local audience.

Currently, Samsung is the market leader in China but Lenovo is rising quickly. Research firm Gartner has predicted that the latter will become the market leader before the end of 2013. Both Samsung and Apple's market share from 2011 til 2012 has fallen from 20% to 14.2% and from 10% to 7.9% respectively. On the other hand, Lenovo's share has more than doubled from just 5% in 2011 to 10.4% in 2012. Behind Lenovo, are Huawei and ZTE, with market shares of 9.5% and 9.1% respectively.

In essence, although Apple has sold millions of smartphones in China, it is still a small player whose market share is diminishing. Its growth in the Americas and Europe has slowed down to 15% and 11% (according to the recent quarterly release) indicating that the company is nearing saturation in the developed world. The emerging markets in general and China in particular could drive future growth for the long term. Apple has few options. Investors are waiting for it to either finalize its much anticipated deal with China Mobile (CHL), which has 87.9 million third-generation mobile services subscribers, or come up with a cheaper version of iPhone, otherwise Lenovo, Huawei, ZTE and Xiaomi will push Apple to the boundaries of the world's biggest smartphone market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.