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Yesterday, news broke that Apple CEO Tim Cook had met with China Mobile Chairman, Xi Guohua in China. While there have been reports of discussions between Apple (NASDAQ:AAPL) and China Mobile (NYSE:CHL) since early 2012 with no deal in sight, recent catalysts such as Apple's poor performance in China and an impending low cost iPhone give reasons to believe that a breakthrough is around the corner.

While there has been a great deal of speculation about why a China Mobile deal hasn't formed, most of it has centered around the deployment of TD-SCDMA and the carrier's requirement for modems to support TD-SCDMA and global standards to enable roaming, which no modem could do. That problem was solved when Qualcomm (NASDAQ:QCOM) designed the first chip capable of meeting China Mobile's requirements which is ready for production, but there remains no deal with Apple.

The real reason there has been no deal was plainly stated by China Mobile's President, Li Yue who said "technology is not a problem, it's mainly about business model and benefit-sharing issues". Both Apple and China Mobile have significant concerns but recent developments have altered events enough that a deal with China Mobile now looks to be a certainty in large part due to the expected introduction of a low cost iPhone.

China surpassed the United States as the world's biggest smartphone market in 2012. Given this impressive growth and still relatively untapped smartphone market, Apple and China Mobile both stand to benefit handsomely as both change their technology to target new consumers.

China Mobile's concerns

Below, I will address the main concerns which likely prevented China Mobile from completing a deal with Apple.

Subsidies

Apple doesn't want to undercut local Chinese partners nor does it wish to give up on carrier subsidies which provide cheaper iPhones to consumers. China Mobile doesn't want to bleed itself to subsidize Apple's profits especially given its dominant position in the market.

China Mobile's competitors have been heavily subsidizing iPhones in order to gain market share and while this may have improved their subscriber figures, the discounts have been significant with China Telecom, the smallest of the big 3 Chinese carriers suffering the most.

A low cost iPhone will come close to solving this problem entirely. Subsidies will be less expensive for the carriers and Apple will be in a new negotiating position for minimum orders and subsidies, giving them a chance to offer fair deals to all their partners

China Mobile will soon launch LTE

At present, the iPhone users on the China Mobile network are forced to purchase the phones at full price from stores or other carriers and use the phone on a slow 2G network due to iPhone incompatibility with China Mobile's TD-SCDMA 3G network. While this hasn't necessarily impeded the growth of the 3G network's subscriber base, it has left money on the table from users who are able to afford the iPhone but have no reason to buy expensive data plans when their phones are unable to use them.

With China Mobile having just launched an expensive tender process for building 200,000 LTE base stations, the company will want users to buy more expensive data plans to increase the average revenue per user and speed up the recovery on their investment. Converting 2G smartphone users into LTE users would significantly increase their motivation to purchase more expensive data plans.

Minimum order requirements

With even Verizon, unable to sell all the iPhones it is contractually obligated to purchase and possibly owing Apple billions of dollars, there is reason for concern, especially for a carrier such as China Mobile where fewer customers are purchasing data plans and customers tend to prefer cheaper phones over the premium high end phones.

It presents a financial risk with limited upside given that China Mobile customers are already buying iPhones from other sources and using them on the network, giving users the option of using the iPhones without the carrier having to pay any subsidies to Apple.

This will no longer be as significant a risk when Apple launches a low cost iPhone, as demand for Apple's low cost iPhone 4 is already very high and will present less financial risk due to the popularity of Apple products, ability to compete in the lower end of the market and lower subsidy per device.

3G Competitiveness

While China Mobile has the lead in overall subscribers by a large margin, at last count, the lead is less impressive when looking at the number of 3G subscribers. These data heavy and more profitable consumers have been driven to competing carriers due to the lack of smartphone options and the inability for China Mobile smartphones to roam on other networks globally.

The result is that China Mobile has 129 million 3G subscribers versus roughly 100 million on China Unicom (NYSE:CHU) and 87 million on China Telecom (NYSE:CHA). 3G adoption is also progressing faster on the 2 smaller carriers than on China Mobile, meaning the company isn't able to convert its customers to more profitable data plans as quick as its competitors. This is due to the company losing profitable data users and retaining customers who purchase less expensive voice plans without any data.

China Mobile was also forced by the Chinese government, its owner, to choose a domestic LTE standard over the more recognized international LTE standards and as a result is again at a competitive disadvantage against its rivals. Whereas for feature phones this is of limited importance, for smartphones this may mean limited selection. An iPhone that supports its specific brand of LTE would enable it to compete on even terms for data plan customers.

Apple's concerns

Apple's own problems have been magnified after its most recent quarterly results which disappointed when it came to China. Below I've presented what I believe to be catalysts for Apple to form a deal with China Mobile as soon as possible.

Apple needs growth in China after a disastrous hit to sales

Apple's most recently quarterly results showed a disastrous 43% drop in China revenue QoQ and 14% YoY. This has some investors worried that Apple may be missing the mark in developing markets, losing out to cheaper competitors. These competitors range from the local and inexpensive smartphone manufacturers like Huawei and Lenovo to Nokia which maintains significant market share and brand awareness in developing economies. More worrying, on the quarterly conference call, Apple CEO Tim Cook offered no explanation for the reduction in sales even when asked directly, either unable to offer an explanation or unwilling. Pressure to increase sales and growth will have been magnified after such a poor showing from the latest quarterly results.

A deal with China Mobile would significantly increase the iPhone's presence in China and provide access to hundreds of millions of potential customers. China Mobile's userbase will eventually convert to smartphones and Apple needs to be one of the available offerings in China Mobile's stores in order to compete against local rivals.

Chinese partners are looking to lower cost smartphones to reduce subsidies and increase profits

Apple's existing partners in China, China Unicom and China Telecom are looking to reduce subsidies and increase profits through greater reliance on inexpensive smartphones. China Unicom has already made significant strides in doing so, reducing subsidies as a percentage of revenue from 18% in 2011 to 10% in 2012. Lower subsidies will impact the sales of Apple's less expensive iPhone 4 and make it more difficult to compete with low cost Android phones. On the high end, this will decrease Apple's competitive advantage versus other high end phones such as Samsung's Galaxy line.

In order to sustain growth in China, Apple will have to be able to reach more consumers as the customers of its current partners are going to become less likely to purchase iPhones due to their rising price.

Money is being left on the table

Apple's iPhone 4 saw explosive growth in China, with sales up 211% YoY, demonstrating significant demand for an inexpensive iPhone despite the lack of 3G support on the country's biggest carrier. A lower cost iPhone with less expensive materials than the iPhone 4, such as plastic casing, could provide a high quality iOS experience with higher margins and faster data speeds on the country's biggest carrier.

It is worth noting that rival Samsung (OTC:SSNLF) has already switched gears from selling primarily high end phones to competing more aggressively at the low end of the smartphone spectrum as local brands grab market share hand over fist by selling cheaper Android phones.

Conclusion

Recent reports suggest that the developed world may already be saturated when it comes to smartphones but the developing world has a long way both in mobile adoption and in the shift to smartphones over feature phones. In order to maintain growth, Apple will have to aggressively target and lock in consumers to the iOS ecosystem and doing so will require the cooperation of China's biggest carrier. While in the past, carriers have resented Apple's restrictions and requirements, increased domestic competition and the potential for a low cost iPhone make this an opportune time for China Mobile and Apple to finally launch a partnership.

Source: Why An Apple/China Mobile Deal Is Imminent