China will jump ahead of the U.S. this year to be the world's largest smartphone market by volume, according to IDC's latest market figures released last Thursday. IDC expects China to increase its share of the growing smartphone market by over 800 basis points y-o-y to about 26.5% by the end of 2012, pushing U.S.' market share down to below 18%. China first began outselling the U.S. in smartphones in the second half of last year, helped by carrier subsidies and the proliferation of the sub-$200 Android segment. The growing Chinese demand for smartphones, while a good sign for handset makers, also bodes well for Chinese telecom companies such as China Mobile (CHL), China Unicom (CHU) and China Telecom.
China Mobile is not only China's largest wireless services provider, but also the world's largest. It has a subscriber base of close to 700 million, more than three times as many as its nearest competitor, China Unicom. We believe that this huge subscriber base is what puts China Mobile in a better position to tap the growing smartphone demand than its rivals in the wireless market. But it needs to first get its 3G act straight, else it risks squandering the huge opportunity that awaits it (see China Mobile Needs To Step Up As 3G Growth Slows).
Opportunity huge once 3G compatibility issues are overcome
3G penetration is only around 18% in China currently, but with the increasing demand for smartphones, we expect penetration to grow quickly.
China Mobile announced at the start of 2012 that it had over 15 million iPhone users subscribed to its network despite having no formal contract with Apple to sell the iPhone. Thanks to Apple's network of stores in the country selling the unlocked iPhone and China Mobile's offers of gift cards as high as $441 to its users who are willing to prepay for its Wi-Fi services to surf the web, China Mobile has been able to attract and retain iPhone users that do not mind paying the huge upfront charges for the phone. Not bad considering that users also have the option of buying a subsidized iPhone from both China Unicom and China Telecom. China Mobile also subsidizes and sells a number of Android smartphones on its network.
But the behemoth hasn't been able to capitalize on its huge 2G subscriber base as well as it should have yet. As of July 2012, China Mobile had 69 million 3G subscribers, only about 13% ahead of 61 million that subscribe to China Unicom's 3G network. In the month of July, China Mobile managed to add only about 1.9 million 3G subscribers, in stark contrast to the 3.1 million that China Unicom added during the same month.
A big reason for China Mobile's under-performance has been its homegrown TD-SCDMA 3G network that is incompatible with most popular smartphones currently available in the market such as the iPhone. This requires handset vendors to come out with specially crafted phones for the carrier's proprietary network, which has proved to be a huge deterrent.
However, 3G adoption is still in its very early stages and smartphone as well as chipset makers will eventually start focusing on China Mobile's 3G network to tap China's burgeoning mobile base. We believe that the iPhone, for one, will arrive on China Mobile's network soon considering the seriousness with which Apple is considering China and Qualcomm's recent announcement of a Gobi reference platform that not only supports TD-SCDMA but also multiple LTE bands (see Qualcomm Paves the Way for an Apple-China Mobile iPhone Deal). China Mobile is the only carrier in China that is currently testing out a TD-LTE network and could be the first to launch the high-speed technology in the country.
When that happens, it will help China Mobile promote 3G better and gradually transition its huge 2G base to 3G, eventually taking an unassailable lead over its rivals.
The subsidy-ARPU tradeoff
But in order to drive 3G adoption, China Mobile will have to bear the subsidies that are associated with smartphones, such as the iPhone. The reason why smartphones are subsidized by carriers in return for long-term contracts is that smartphone users are widely recognized as heavy data users and bring a higher life-time value to carriers. The average revenues generated from someone using a smartphone is far higher than any other phone and this allows carriers to make back their money over the course of the contract period. Also, it allows users that would otherwise have not bought these expensive phones to use them and get addicted to their technology and fast data speeds, thereby driving future revenues for the carriers.
While in the longer term, subsidizing smartphones may prove beneficial, in the near term these promotional activities will pressure the company's margins, the effects of which will start to weigh on the company as its mobile voice and internet services division accounts for a huge chunk of our $59 price estimate.