Seeking Alpha
Long/short equity
Profile| Send Message| ()  

Apple's (AAPL) recent introduction of the iPhone 5S and iPhone 5C was met with criticism that the iPhone 5C was priced too high to make a significant impact in emerging markets. Most commentary revolved around how Apple did not expand its addressable market enough with the pricing of the iPhone 5C and that Apple's growth prospects would be limited as a result.

While we do agree that the iPhone 5C is not going to attract significant numbers of consumers who could not previously afford an iPhone, we do believe that the impact of recent and upcoming agreements with major wireless carriers have been mostly overlooked. Japan's NTT DoCoMo (DCM) will carry Apple iPhones starting on September 20, and Apple has received regulatory approval for the iPhone to run on China Mobile's network. Although no deal has been announced with China Mobile (CHL) yet, most observers believe a deal is imminent. These two carriers are the largest in their respective countries, and greatly expand Apple's addressable market.

In a previous article, we estimated Apple's price floor to be $467 based on share repurchases and the dividend hike. The new carrier agreements should serve to boost EPS by at least $4.20, raising Apple's price floor to $500.

Results of T-Mobile Agreement

On April 12, 2013, T-Mobile (TMUS) started selling the iPhone. Since that date, the iPhone has represented 29% of T-Mobile's smartphone sales, with sales of 903,000 units during Q2 2013. This compares with the 100,000 iPhones per month that T-Mobile was activating prior to officially selling the iPhone. Thus the availability of the iPhone in company stores with carrier subsidies increased iPhone sales to T-Mobile customers by approximately 200%.

While iPhone sales at T-Mobile are still significantly below the 40% share that Apple has in the US, it represents a marked increase from the approximately 10% share that Apple had at T-Mobile prior to the agreement.

NTT DoCoMo Expectations

Japan's NTT DoCoMo will finally start carrying the iPhone 5S and iPhone 5C on September 20. NTT DoCoMo is Japan's largest wireless carrier with a 48% market share and it sold 16 million smartphones in the year ending March 2013.

NTT DoCoMo previously mentioned that it wanted the iPhone to represent no more than 30% of its smartphone sales. Assuming that NTT DoCoMo's smartphone sales increase to 19 million units over the next 12 months, iPhone sales at that target level would be 5.7 million units. If 10% of NTT DoCoMo smartphone users are currently unlocked iPhones (similar to T-Mobile), then the incremental effect of adding NTT DoCoMo as a carrier partner would be an additional 3.8 million iPhone units per year. We are going to assume a $300 gross margin per iPhone sale at NTT DoCoMo since it is likely to primarily sell the iPhone 5S. Shares outstanding are based on the numbers determined in our earlier price floor and share repurchase article.

Incremental iPhone Sales at NTT DoCoMo

3.8 million

Gross Margin per iPhone

$300

Incremental Gross Margin

$1.14 billion

Income Tax

$296 million

Incremental Net Income

$844 million

Shares Outstanding After Repurchase Plan

836.1 million

Incremental EPS

$1.01

However, more recent news indicated that NTT DoCoMo may have promised Apple that it would target 40% of smartphone sales for the iPhone. In this case, incremental iPhone sales would be 5.7 million and the net effect on EPS would be $1.51.

The iPhone's market share in Japan is similar to the US at nearly 40%, so both 30% and 40% appear to be reasonable targets for the iPhone at NTT DoCoMo depending on how the carrier promotes the iPhone.

China Mobile Expectations

China Mobile is China's largest carrier, representing 65% of the Chinese market. It also accounts for approximately 80% of Chinese high-end subscribers (defined as paying at least $16 per month for mobile phone services) according to Morgan Stanley. In October 2011, there were 10 million iPhones on China Mobile's network, and this had increased to 15 million by March 2012. This is an activation run rate of 1 million per month. The iPhone only had 8% market share among high-end subscribers at China Mobile versus 20% at China Unicom, which was Apple's first carrier partner in China. A similar increase in sales would push Apple's sales at China Mobile to 2.5 million per month, an incremental gain of 18 million units over the full year. We are going to assume a lower $200 gross margin per iPhone sale at China Mobile due to the possibility that Apple needed to give a better deal to China Mobile as well as the likelihood that lower priced iPhones such as the iPhone 4 will make up a significant proportion of sales.

Incremental iPhone Sales at China Mobile

18 million

Gross Margin per iPhone

$200

Incremental Gross Margin

$3.6 billion

Income Tax

$936 million

Incremental Net Income

$2.664 billion

Shares Outstanding After Repurchase Plan

836.1 million

Incremental EPS

$3.19

Effect on Valuation

The combined impact of the two new carrier partners would be to sell an additional 21.8 million iPhones, a 15% increase on trailing 12 month iPhone unit sales. As well, EPS would increase by $4.20, which is a 10% increase over our previous low end projections of $42.67 for FY 2015.

At a valuation impact of 8x EPS, these new deals would serve to boost Apple's price floor by $33.60, from $467 to $500.60. The impact of the NTT DoCoMo deal is roughly $8, while the impact of the China Mobile deal would be around $26.

Incremental EPS from NTT DoCoMo

$1.01

Incremental EPS from China Mobile

$3.19

Total Incremental EPS

$4.20

Effect on Share Price at 8x EPS

$33.60

Prior Share Price Floor

$467

New Share Price Floor

$500.60

Conclusion

The focus has recently been on how Apple's lower priced iPhone 5C model is priced at too high a level to significantly expand its addressable market. However, limited attention has been paid to how carrier deals with NTT DoCoMo and likely China Mobile will significantly expand the iPhone's addressable market. The deals will give Apple increased access to the 48% of the Japanese market and the 80% of the high-end Chinese market controlled by these carriers. Past data from T-Mobile suggests that these carrier deals can increase iPhone activations at those carriers by 200% over their prior activation rate from unlocked iPhones only.

The impact of the two deals should boost EPS by $4.20, raising Apple's price floor to at least $500. This is around 6% above Apple's latest closing stock price of $473. While the China Mobile deal has not been announced yet, the regulatory approval for iPhone use on China Mobile's network suggests that there is a high probability of this occurring soon.

Source: Apple: A $500 Price Floor With NTT DoCoMo And China Mobile Agreements