Apple's China Mobile Problem

| About: Apple Inc. (AAPL)

Well, it looks like the "pump" based on the rumored Apple (NASDAQ:AAPL)/China Mobile (NYSE:CHL) deal is being undone as Apple announces that it's "still in talks" with China's largest carrier for a deal to sell subsidized iPhones. The market isn't particularly enthused with this news and is, as expected, "selling" this rather negative news. With that in mind, this goes to show one key "problem" for Apple here: China Mobile holds all of the cards.

China Isn't The US

While roughly 40% of smartphone subscribers in the US are happy iPhone users (I'm one of them), and while the majority of Apple's sales indeed happen outside of the US, it's difficult to ignore the fact that Apple simply doesn't have the leverage in China that it does in the US. In fact, Apple is at a distinct disadvantage since China does tend to favor products built within its nation's borders. Samsung (OTC:SSNLF), a South Korean giant, has dominant market share within China due to sheer scale and marketing might, but Chinese vendors such as Lenovo (OTCPK:LNVGY) and ZTE (OTCPK:ZTCOF), also hold pretty non-trivial share (and Xiaomi, the "Apple of China" is seeing some pretty great traction for its phones).

In short, while Apple makes great products and has a non-trivial amount of share within China, it is by no means dominant. The company's products are viewed as "nice" but certainly not "necessary" as the iPhone is here in the US. This means that investors that view Apple from a US-centric perspective are likely to miss the big picture.

China Mobile's Got Apple By The Stem

The China Mobile subsidy deal will happen, but Apple is probably going to have to make some really tough choices - and it'll probably include either sacrificing margins (i.e. low subsidies but still US carrier-like prices) or restricting its addressable market (i.e. low subsidy, high price).

At any rate, Apple shareholders will lose. Either the analysts will complain about further margin compression (which is what has helped to drive a Y/Y profit decline in FY2013) or they will complain that Apple is not more aggressively trying to gain share in what is still the most interesting secular growth market for compute devices. It's hard to see a really "favorable" outcome here for Apple shareholders.

What Now?

Apple shares are probably going to drop from here, quite possibly testing the 50 day simple moving average of $528. If the stock successfully tests and bounces off this moving average, then as long as the company doesn't "miss" a quarterly earnings report or as long as the China Mobile deal, when announced, isn't on terribly unfavorable-to-Apple terms, then the stock could resume its steady climb.

However one slip, one miss, and the shares will probably be re-priced to a meaningfully lower multiple until a major catalyst comes in and helps to reverse perception. This could mean an expanded lineup of high end iPhones (especially a higher margin one at the top) or a new device category. The company could also announce a bigger buyback and/or a fatter dividend to cushion any blow (although these are short-term solutions, not long-term business ones).

At any rate, Apple needs China Mobile more than China Mobile needs Apple, and it's probably important to keep this in mind while thinking about the potential impact of any such deal to Apple's financials. It'll be accretive (Apple isn't going to take a loss on phones), but it may not be to the degree that would be seen if those incremental units were sold through carriers in the US.

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.