Apple: A China Syndrome That Could Explode

Feb.17.12 | About: Apple Inc. (AAPL)

Of late much has been written about Apple (NASDAQ:AAPL) and it's overall business in China.

Much of it swirls around two central themes; AAPL pulling iPad from Amazon (NASDAQ:AMZN) in China which was an Apple decision (read some of the details), and the labor issues within China and Apple's reliance of Foxconn as well as other manufacturers (which Tim Cook addresses head on).

The real issue, when you get down to it, is how much money will Apple make when the issues get settled? Would that be yet another reason to own AAPL at its current PPS?

By my estimates, AAPL is undervalued at least by 100%, and is a bargain right now.

Apple Inc. (<a href='http://seekingalpha.com/symbol/AAPL' title='Apple Inc.'>AAPL</a>)

The China Equation

Let's put aside the iPAD/AMZN issue for a moment, and let's just focus on the iPhone sales in China. Katy Huberty of Morgan Stanley (NYSE:MS) lays it all out this way (in this recent article);

She assumes:

  • That there are roughly 150 million high-end subscribers in China currently paying at least RMB 100 ($16) per month for mobile phone service.
  • That China Unicom (NYSE:CHU), currently Apple's only official carrier, has 15 million of those subscribers, or roughly 10%.
  • That late this year or early next, Apple will begin selling next-generation iPhones through China Mobile (120 million high-end subscribers) and China Telecom (15 million).
  • That because 20% of China Unicom's high-end subscribers buy iPhones, the other two carriers' subscribers will follow suit. (8% China Mobile's high-end customers already use iPhones, even though they get only 2G service.)
  • Assuming 20% penetration, Apple should see, at a minimum, 24 million additional iPhone sales in 2013, adding $6.50 per share to the company's bottom line.
  • As the iPhone catches on and the middle class expands, that number could grow to nearly 40 million next year, adding $10 to Apple's earnings per share.
  • Eventually, says Huberty, the iPhone in China will reach penetration levels comparable to those of AT&T (NYSE:T), where 63% of smartphone customers currently choose iPhones.
  • In Morgan Stanley's bull case scenario, Apple within a couple of years will be selling an additional 57 million iPhones per year in China alone.

Basically, with all things being equal, business within China alone will more than double within the next two years, just with the iPhone. To put that into perspective; if China iPhone sales reach 60 million per year, added to Apple's EXISTING global sales of 68 million iPhones in 2011, it doubles Apple's overall business in the sector.

Ok, are you seeing where I am headed with this?

Now, is it really a stretch to assume that the iPad issues in China will be resolved within the same time frame? I realize that there have been many negative articles written about the China/Apple "relationship" and how (it is a match "made in hell") and if iPad sales are banned in China then Apple stands to lose $1.4billion in revenue (which is a guess because Apple does not give out numbers of sales in China on the iPad) and if it is accurate it is far eclipsed by the revenue of the iPhones anyway.

The new iPad is almost upon us and will probably be more spectacular than its predecessors in my humble opinion. By a show of hands, how many of you truly believe that the China/AMZN/Apple issue not be resolved in time to make a huge splash in the brand spanking new Apple stores within China?

Nobody. That's what I thought. Well seriously, I certainly believe that the issues will be resolved soon enough for Apple to sell an extraordinary number of iPads in China, which would turn that $1.4billion dollar "loss" of revenue into a potential "gain" of $3-5billion in revenue from China alone, just on iPads (my own "guestimate" by the way).

Perhaps this sums up the "feeling" in China;

"At a Gome electronics store in Beijing, Zhang Junqi, 30, said the lawsuits won't deter him from buying an iPad."

Regardless of how this winds up, consumers will still buy iPads anyway.

What Does This Mean For Apple's Share Price?

If my estimates are even close to being on someone's radar, and the sales of iPhones double just in China (which doubles ALL sales now) and the sale of iPads in China gets back on track as I believe it will, plus the new product launches in every other part of the world continues its amazing run, then does doubling of the share price seem totally outrageous?

My goodness, it STILL might be undervalued!

My Opinion

Any pullback or correction in Apple share prices could offer an opportunity to new investors as well as existing ones.

If Apple announces a dividend or a significant split of its shares, even more investors could flock to it.

I think staying where it is now, without the dividend or stock split is still an opportunity for investors to profit handsomely. With the aforementioned tactical maneuvers by Apple, I cannot even place a guess right now.

Disclaimer: Please remember to do your own research prior to making any investment decisions. This article is not a recommendation to buy or sell any securities or stocks and is the opinion of the author.

Disclosure: I am long AAPL. I own Leaps, not actual shares.

Disclaimer: Please remember to do your own research prior to making any investment decisions. This article is not a recommendation to buy or sell any securities or stocks and is the opinion of the author.