Apple Growth Fears Are Overblown As China Is Just Getting Started
After peaking at $700, Apple ( AAPL ) has declined by more than 25% and even threatened to fall below $500 on Monday. A big reason for the recent bearishness has been concerns regarding a possible slowdown in iPhone demand that were fueled by reports of Apple cutting its iPhone 5 orders for the first quarter of 2013. This is important because the iPhone accounts for over half of Apple's value according to our estimates. While cutting orders may mean that Apple is starting to see competitive pressures on iPhone demand, we see this as only one of many reasons why Apple may have wanted to slow the production.
Firstly, Apple could have placed a huge manufacturing order for the iPhone 5 anticipating supply chain bottlenecks and that the smartphone may be difficult to manufacture with good yields initially. As yields improved over time, however, Apple may have decided to cut orders to avoid channel overfill and manage its working capital better. Secondly, coming off a potentially strong holiday quarter, iPhone demand is naturally expected to see a slight slowdown in the next quarter. Thirdly, there has been speculation that Apple could release new iPhones in six months instead of its usual yearly cycle. If so, it would make sense to cool down manufacturing in the quarter ahead of the new phone's launch.
China Key To Sustainable iPhone Demand
Moreover, with the emerging markets such as China still largely untapped by Apple, we do not see a slowdown in the demand for the iPhone in the near future. In fact, Apple announced on Monday that it sold over 2 million iPhone 5 units in the first weekend of sales in China, making this its best ever launch in the country. We expect the launch to help shore up Apple's market share in the region, which dropped to the sixth place last quarter as people deferred purchasing an iPhone in anticipation of the new release.
China is a huge largely untapped opportunity for Apple considering that the country has already overtaken the U.S. as the world's largest smartphone market by volume. This is an incredible statistic considering that China is only in the early stages of smartphone adoption. 3G penetration in China stands at only about 20% currently and is growing strongly. Considering the huge 2G subscriber base that the Chinese carriers are looking to upgrade to 3G, the potential for Apple to ride the boom is huge.
However, Apple currently sells the iPhone through the smaller two of the three carriers in the country, China Unicom and China Telecom. A deal with the largest wireless carrier in the world, China Mobile, remains elusive until Apple can work out a subsidy deal with the carrier. How soon that will happen is open to speculation considering the Chinese government's possible opposition to the huge iPhone subsidies. (see Apple's China Potential Could Be Limited By A Subsidy Compromise With China Mobile ) But knowing that the carrier's 3G growth has been hurting due to unavailability of the iPhone, such a deal should not be too far along. This deal is very important for Apple as it can instantly double the iPhone's current addressable market in China and act as the next big boost to its stock given that the iPhone accounts for around 55% of the company's stock value currently. (see Apple Can Ride China Potential Past $800 With China Mobile's Support)
The important thing to note here is that despite not having a China Mobile deal, Apple hasn't performed too badly in China so far. Revenues from greater China, which includes mainland China, Hong Kong and Taiwan, in the September quarter grew 26% year-over-year and accounted for 15% of Apple's revenues for the fiscal year. This brought Apple's FY2012 revenues from the region to about $24 billion, about 80% growth over FY 2011.
As the country grows and the average Chinese sees an increase in buying power, we expect to see a growing shift in demand from 2G to 3G smartphones. The iPhone can help Apple tap this phenomenal growth in demand. Penetrating China could however mean margin pressures as the company negotiates carrier subsidies with China Mobile and competes with the increasingly popular Android phones. With cheap Android smartphones seeing huge demand and the pricing war gradually dragging prices down to sub-$100 levels, Apple will do well to avoid this segment for as long as it can without sacrificing growth. It therefore bodes well that Apple is only just getting started in China and has ample opportunity to drive sales in the country without having to drop prices anytime soon. A deal with China Mobile is however key to unlocking most of that potential.