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China to Become Apple's Top Market

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Apple Inc. (AAPL - Free Report) expects China to become its largest market in the near future. In a recent interview with the Chinese Xinhua news agency, Apple’s Chief Executive Officer Tim Cook expressed this belief.

On his second visit to China in less than a year, Cook met Chinese regulators and partners. He also met the China Mobile (CHL - Free Report) Chairman Xi Guohua, which is significant considering the fact that Apple is looking to build a partnership with the company for selling iPhones in China.

China has become an important market for Apple as the company continues to look for growth opportunities outside the U.S. and the Euro zone. According to IDC, smartphone shipments in China hit a new record with the addition of more than 60 million customers in the third quarter of 2012. On the other hand, the 3G penetration rate was just 20.0% of the total mobile subscriber base, which reflects significant growth opportunity, in our view.

Currently, China along with the U.S. contributes more than 10% of Apple’s revenue. Apple has 11 stores in China and Hong Kong. Revenues from China jumped 82.8% year over year to $22.79 billion in fiscal 2012. Apple noted that the growth was primarily driven by higher demand for its products among the affluent middle class in China.

However, Apple’s market share in China has declined significantly in recent times. According to market research firm IDC, Apple’s smartphone market share was under 10% in the third quarter of 2012. Apple was placed at #6, down from #4 in the previous quarter. Samsung topped the list followed by Lenovo (#2), local handset maker Coolpad (#3), ZTE Corp (#4) and Huawei (#5).

Recently, Finnish handset maker Nokia Corp. (NOK - Free Report) announced a partnership with China Mobile to sell Lumia 920T at a comparatively lower cost in China. This will further increase competition for Apple going forward.

Currently, Apple offers iPhone through partnerships with China Unicom Ltd and China Telecom Corp. However, both of them have a significantly lower subscriber base than China Mobile, which is the world’s largest telecom carrier in terms of users (707 million) and has more than 64% of mobile market share in China.

Although China Mobile and Apple have been discussing the chances of a prospective deal for some time, the telecom carrier’s incompatible third generation (3G) network prevented it from offering iPhone in China. However, China Mobile’s latest 4G network (TD-LTE) is ready and is expected to be launched nationwide by the end of 2013.

We believe that the removal of this technical obstacle will help the companies to forge a partnership quickly. Recently, China Mobile announced that it had set a target of selling 100 million mobile phones in 2013. A potential deal with Apple was looked upon as the primary driver behind this aggressive goal. 

According to Bloomberg, China Mobile also said that both the companies needed to agree on “benefit-sharing” before it could start offering iPhone in China. Although the outcome of the recent meeting between Cook and Xi Guohua is yet to be known, we believe that Apple needs to partner China Mobile in order to boost its sagging market share in China.

Apple is known as a hard bargainer. However, we believe that the increasing competition in the Chinese smartphone market and China Mobile’s massive subscriber base will compel the iPhone maker to soften its stance.

Apple recently rejected the rumors of a low cost iPhone for the Chinese market However, we continue to believe that Apple’s ability to innovate and grow in China, where the market is more cost-sensitive, will determine the company’s fortunes over the long term.

We maintain our Neutral recommendation over the long term (6-12 months). Currently, Apple has a Zacks Rank #3 (Hold).

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