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Michael Blair
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I retired as CEO of an Automotive Parts supplier, and manage an investment portfolio for myself and family. I have a BA in History from Royal Military College of Canada and an MBA from the University of Western Ontario. My first career was as a fighter pilot in the RCAF, and, following my MBA I... More
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  • A Potential China Mobile Deal For Apple Will Provide A New Avenue For Long Term Growth 7 comments
    Aug 20, 2013 10:32 AM | about stocks: AAPL

    Apple (NASDAQ:AAPL) will very likely release its lower priced iPhone September 10th and may at the same time announce a long awaited deal with the world's largest mobile phone system operator China Mobile (NYSE:CHL). China Mobile reports that it has over 700 million customers. It would not take very many of them to switch to an iPhone for the numbers to be significant.

    China Mobile's customer base is divided between feature phones and 3G, with 147 million 3G subscribers as at July 2013, according to its published information.

    If Apple could snag 10% of those higher-end customers, it could add 15 million iPhones over the next year. The question is how much this would move the needle for Apple.

    There is not a lot of information on the lower priced iPhone but some reports suggest it would have a wholesale price of about $340 and at that price yield a margin to Apple of about 40%.

    If those numbers are close, another 15 million customers would add $5.1 billion in sales and about $2.0 billion in annual profits for Apple, and, based on a 29% tax rate, an incremental $1.4 billion in net income, about $1.62 per share.

    The new phone is expected to sport a Qualcomm (NASDAQ:QCOM) chip capable of running on all of China's somewhat obscure networks.

    Assuming the price Qualcomm receives for its content is about $25 per iPhone and Apple does in fact sell an incremental 15 million devices through China Mobile, the added revenue for Qualcomm would be about $375 million with margins likely around 50%, thus adding $188 million to Qualcomm's operating income and $154 million to net income at Qualcomm's 18% tax rate.

    Both of these are definitely positives for both Apple and Qualcomm, but they are not big enough to spark a major rally in the shares of either company at these volumes. Could the volumes be materially higher? Certainly, and it is not hard to do the arithmetic. The table below sets out the impact on the net income of both companies at differing volumes.

    iPhone Volume

    Apple sales increase

    Apple Profit Increase

    Apple E.P.S. increase

    15 million

    $5.1

    $2.0

    $1.62

    20 million

    $6.8

    $2.7

    $2.13

    25 million

    $8.5

    $3.4

    $2.71

    30 million

    $10.2

    $4.0

    $3.24

    Qualcomm volume

    QCOM Sales increase

    QCOM Profit increase

    QCOM E.P.S. increase

    15 million

    $0.375

    $0.188

    $0.09

    30 million

    $0.750

    $0.375

    $0.18

    A China Mobile deal would be a major breakthrough for Apple over the longer term as Chinese cell phone users increasingly migrate to smart phones, providing an avenue for growth not previously available. Thus, while the short term impact may be relatively small, the longer term growth path is a key to Apple's future in this highly competitive arena.

    I believe the recent run up in the stock already reflects much of the benefit of this highly anticipated product launch and deal, so I would be cautious about adding to positions in the stock and for those of us who, like me, think the maturing smart phone market will limit Apple's upside potential over the next few years, selling into any strength may be in order.

    I am short Apple calls at a $500 strike maturing in January 2014 and short Apple puts at the same strike with an earlier maturity.

    Disclosure: I am short AAPL. 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.

    Stocks: AAPL
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Comments (7)
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  • Tales From The Future
    , contributor
    Comments (5789) | Send Message
     
    Without getting too technical I think iPhones would only run on the new Chinese 4G standard (China also has a slightly different standard here, but as the autor pointed out QCOM chips can handle this), not the Chinese 3G standard:

     

    "While the 4G licences are expected to be based on TD-LTE technology, rather than the more widely-used FDD-LTE, the new Qualcomm chips can handle both systems, saving Apple from a major re-design just for the Chinese market, albeit the world’s largest."

     

    If so, the China Mobile 3G subscriber number can only be taken as an indirect indicator.

     

    It will be important to see how fast 4G uptake is at China Mobile. I don't have these numbers right now, but here's a good article, the 4G rollout is only beginning:

     

    http://bit.ly/16IXsMc

     

    Ans here is an article from Morgan Stanley analysts re pricing in China:

     

    http://bit.ly/172Xzk5
    .
    20 Aug 2013, 08:14 PM Reply Like
  • Michael Blair
    , contributor
    Comments (4962) | Send Message
     
    Author’s reply » Thanks. Great data. I think even 13% of the China market will not be enough to really propel Apple earnings but it can't hurt either. The $486 price is the price to consumers - the $340 I used is the wholesale price to the carrier or distributor. If 3G is 147 million users, more expensive 4G will likely be fewer, although among 4G phones the Iphone will be very popular.
    20 Aug 2013, 08:31 PM Reply Like
  • Humble Eagles
    , contributor
    Comments (2218) | Send Message
     
    Michael, good point in that we are really talking about the wealthiest 20% on 3G right now, but also that the number is growing rapidly and would be very positive long term. However, the wealthiest 5% of CHL is still a big number at 35mm! Also, 147mm is bigger than VZ or T! Finally, I would not expect the ASP for CHL to be $340 with 40% margins. It should be much higher on both counts. Many of their wealthiest customers already have premium iPhones. Getting the latest model on their network will be a boost. 35mm customers at a little over a $500 ASP would be closer to 18Bn and I suspect your profit numbers would be about doubled. CHL would be huge! Thx for challenging the bull thesis!!
    22 Aug 2013, 10:26 AM Reply Like
  • Michael Blair
    , contributor
    Comments (4962) | Send Message
     
    Author’s reply » @Humble Eagles - anyone's guess I suppose. The users that have already purchased an iPhone are not likely to purchase the lower priced version being introduced which most reports suggest will be $340 wholesale price at 40% margin. To the extent that Apple sells a lot more fully priced iPhones that will be a big plus, but I expect most wealthy Chinese already have one if they wanted one. The 147 users already have a phone, and not all will upgrade day one or, if they do, may not choose Apple. I am seeing a lot of iPhone users move to S4, LG and HTC here in Canada.
    22 Aug 2013, 10:44 AM Reply Like
  • Sam Liu
    , contributor
    Comments (3864) | Send Message
     
    I bought one, no 2 HTC's what's next ...
    22 Aug 2013, 11:26 AM Reply Like
  • Humble Eagles
    , contributor
    Comments (2218) | Send Message
     
    Well, the key is that the newer phones will run their unique version of LTE, so I would expect a lot of upgrades. I am beginning to see a lot of chatter about the C replacing the 5 and not being as cheap as you are thinking. It would be a 400-500 dollar phone, with the 4S actually being the cheap phone. We will see.
    22 Aug 2013, 11:11 AM Reply Like
  • Michael Blair
    , contributor
    Comments (4962) | Send Message
     
    Author’s reply » @Humble Eagles - a lot depends. If the price point is too high the volume won't materialize, too low the margins get squeezed. I saw a JP Morgan item suggesting retail price of $486 was the sweet spot for 13% market share, which is consistent with wholesale price in the mid $350 range. Competition is not going to sit back and watch so a bit of a price war likely to erupt as well. Samsung well entrenched in China with all carriers, also Lenovo, HTC, Coolpad, ZTE, etc. Makes it a bit of a fun game to play in.
    22 Aug 2013, 01:09 PM Reply Like
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