Apple's Next Leg Up: China

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With the recent 27.7% decline of Apple’s (NASDAQ: AAPL) share price from the September highs of $705 to the current levels of $509.79 as of this writing, there is no shortage of reasons to dump the stock being broadcast constantly by the various news outlets.  I have heard reasons ranging from “Apple is out of ideas” and “there is no more room for growth,” to “sell before capital gains taxes rise!”  While it may be factually correct to attribute some of this selloff to tax planning, the first two ideas don’t hold much water in my opinion.

I believe that Apple’s next leg up will come from one place.  No, not the “revolutionary” TV that everyone keeps speculating about.  While that may happen at some point, I’m certainly not holding my breath.  No, I believe the next leg of Apple will come from a market that already exists for the company, though not nearly to the extent of its true potential.  I’m talking about the market for Apple’s current products in China, one of the fastest-growing middle classes in history.

At the present time, about 15% of Apple’s overall revenues already come from China.  The company reported $5.7 billion in sales from China in the quarter ending in September, which is a 26% year-over-year increase.  I believe that Apple’s Chinese sales will drastically increase over the next several years, and that this will be a result of the long-awaited deal with China Mobile (NYSE: CHL), which seems most certainly to happen; it is just a matter of when.  Additionally, the previously mentioned emergence of the middle class will help Apple’s sales, whether or not China Mobile is selling their phones.

First, let’s discuss China Mobile.  The largest mobile operator in the world, they are the only one of China’s top three without a partnership with Apple.  China Mobile has a market capitalization of just under $230 billion as of this writing, and had 584 million subscribers as of the end of last year.  To give a perspective of just how dominant this company is, China Telecom (NYSE: CHA) has a market cap of $45 billion and 126.5 million subscribers and China Unicom (NYSE: CHU) has a market cap of $37.5 billion and 209 million subscribers.  So, China Mobile is 2.8 times the size of its two closest competitors combined based on market capitalization. 

However, the real potential of the iPhone can be seen in the EPS growth projections of these three companies.  According to Standard and Poor’s, China Mobile is expected to grow its earnings per share by 10% annually for the next three years, as opposed to 15% for China Telecom and 17% for China Unicom.  The analysts cited the iPhone as a specific reason for their growth projections, and even attribute some of China Unicom’s growth to being the first Chinese carrier to offer the iPhone.  China Mobile is certainly not going to stand idly by while their two biggest rivals gain market share.  According to Qualcomm (NASDAQ: QCOM), there are some chip modifications required before the iPhone 5 would even be compatible with China Mobile’s network, so although this makes it unlikely for China Mobile to offer the phone in the first half of 2013, it could prove to be a major catalyst for Apple from the second half forward.

Aside from the potential China Mobile deal, the unprecedented rise in the disposable income of Chinese consumers could be the real catalyst that leads the next leg up for Apple.  According to an analysis by China Market Research Group, the average disposable income of urban Chinese households was $3,000 in 2010.  That may not sound impressive by American standards, however considering that this has almost quadrupled from the disposable income level in 2000 ($760), it represents a very significant increase in the quality of life for Chinese residents.  In fact, since 1980, Chinese disposable income has grown more than tenfold. 

This rapid expansion of middle class prosperity will lead to more and more Chinese residents having the means to buy luxury items, such as the iPhone.  Considering the growth of the middle class, plus the fact that only about 13 million of the 919.5 million subscribers of the “big three” own iPhones currently, it is not hard to see the extraordinary potential in China.

 


KWMatt82 owns shares of Apple. The Motley Fool owns shares of Apple, China Mobile, and Qualcomm. Motley Fool newsletter services recommend Apple. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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