Apple Stays Premium and Avoids Junk Business

Apple sold a record 9 million iPhone 5s and 5c smartphones during the opening weekend, topping last year's iPhone 5 sales of 5 million. Apple has not released a new mobile device for almost a year, but the new models look to recover lost market share from low-cost smartphones. How Apple performs in the Chinese market is significant, considering the potential sales China offers the Cupertino-based company.

Apple investors brimmed with bullish sentiment after digesting the sales number. Fear of slowing innovation and growth at Apple concerned some investors. Sales and profits slowed down last quarter compared to a year earlier because of a lack of new products to drive growth. Revenue came in flat at $35.32 billion, while gross margins drifted lower to 36.9% from 42.8%.

The iPhone is Apple's most profitable product, accounting for $18.15 billion on 31.2 million units sold last quarter. The iPhone 5s and 5c should strengthen sales growth in the mobile market. Apple forecasts fourth-quarter revenue to be near the high end of $34 billion-$37 billion and gross margins to be near the high end at 36% or 37%.

No room for junk
Analysts have questioned if the iPhone 5c is too costly for emerging markets. The iPhone 5c is a rebranded version of last year's iPhone with a plastic body. It costs more than $700 in some emerging markets, such as China, where wireless carriers do not offer contract discounts.

Some favored Apple chasing both premium and low-end markets, but the company decided to stay as a premium smartphone provider to preserve margins. "There's always a large junk part of the market," Apple CEO Tim Cook said in an interview with Bloomberg Businessweek. "We're not in the junk business."

The growing low-end smartphone market has attracted price-sensitive consumers to low-margin, low-cost vendors that offer affordable sub-$200 smartphones. Apple's market share plummeted in the second quarter against low-cost rivals using Google's Android platform. Apple captured 14.2% market share, down from 18.8% a year ago.

China invasion looms
Apple and NTT DoCoMo , Japan's largest mobile carrier, entered an agreement to sell the new iPhones. Apple has access to 61.8 million subscribers through DoCoMo -- an opportunity to broaden sales in Japan. Apple generated $2.54 billion in Japan last quarter, up 27% from a year ago.

DoCoMo lost 40,000 subscribers back in November as SoftBank and KDDI offered Apple's iPhone 5 to meet consumer demand. With the launch of Apple's iPhones, DoCoMo should expect subscriber growth in the coming quarters. DoCoMo gained 43,000 new customers in August, while SoftBank and KDDI added 250,300 and 209,200 users.

DoCoMo said Apple's handsets could account for 40% of its future smartphone contracts, adding pressure to domestic smartphone makers Sony and Sharp. Analysts project DoCoMo to generate 10 million iPhone sales per year.

Unlike Japan, Apple has performed poorly in China. Apple's market share halved to 4.8% last quarter. Sales in Greater China dipped 43% sequentially to $4.6 billion, down 14% from a year earlier.

China's mobile growth revolves around mid-priced and low-end smartphones. This challenges the $733 price tag for iPhone 5c in China -- almost four times the national ASP for smartphones. Less than 2% of smartphones in China sold at $700 during the first half of the year.

Source: Bloomberg

Apple's media event in Beijing on Sept. 11 raised speculation about a partnership with China Mobile . No deal materialized, since both parties cannot agree on acceptable subsidy amounts and revenue sharing. China Mobile, the world's largest mobile carrier, ended August with 750.42 million subscribers, making up 63% of China's 1.19 billion wireless accounts. Apple's lucrative partnership with China Telecom and China Unicom has allowed the company to sell its products to a combined 442 million customers.

Investors believe a deal is imminent. Apple's new iPhones support China Mobile's TD-SCDMA 3G and TD-LTE 4G networks. Apple's earlier models did not support these networks. The only hurdle left between the two firms is an agreement on a business model where both can benefit. A deal with China Mobile could generate billions in sales for Apple and help the company recover market share from Chinese vendors.

China Mobile has 158.69 million subscribers on its 3G network. This represents about 21% of its total installed base -- the lowest 3G adoption rate among the group. The 3G network generates higher revenues per user than other networks. China Telecom and China Unicom have 40% and 59% of subscribers on their 3G networks, respectively. If China Mobile comes to an agreement with Apple, it can use iOS devices to attract more 3G users to its high-revenue data plans and bolster profitability.

Bottom line
Apple's new iPhone models may add significant value for its shareholders if the company joins with China Mobile. China, Apple's second-largest market behind the United States, could grow 153% from now to 2017. Apple is set to triple the amount of stores in China from its existing eight to capitalize on the growth potential. Investors should expect more sales and profit growth in the second half of the year as Apple could unveil the new iPad and iPad Mini.

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Christopher DeSousa has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and China Mobile. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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