China Mobile Is a Game Changer for Apple

Apple reported record 2Q15 earnings with revenue up 27% on strong iPhone sales. While the iPhone 6 and 6 Plus continue to sell well across the world, it is clear that China Mobile is driving Apple's recent financial resurgence. Relying on data from Apple's 2Q15 earnings report and 10-Q, I estimate Apple earned $2 billion of operating income from selling 10 million iPhones to China Mobile customers last quarter. 

Despite being told for years that China would become a very important country for Apple, there had been little to show for it in Apple's financial statements. China's second and third largest mobile carriers, China Unicom and China Telecom, respectively, were selling iPhone but with sales starting at such a low base, the growth wasn't a factor when compared to Apple's other operating segments. In December 2013, after years of negotiation and business talks, China Mobile and Apple announced an agreement for the world's largest mobile carrier to sell iPhone. It took a number of months for momentum to build, but all signs now point to China Mobile being a very significant partner for Apple. 

While it can be difficult to put China Mobile's size in perspective, we are able to get a good approximation of just how significant the largest carrier in the world is by looking at customer data. It is important to segment China Mobile's 815 million customers by 2G, 3G, and 4G subscribers in order to better understand the number of customers that are realistically in a position to buy an iPhone (denoted in blue in Exhibit 1). China Mobile's 378 million 3G and 4G customer base is 50% larger than the combined 254 million subscriber base for AT&T and Verizon

Exhibit 1: Total Customers for Largest Chinese and U.S. Mobile Carriers

Heading into this week's earnings, I was confident Apple would sell more iPhones than consensus was expecting because Tim Cook had previously disclosed that iPhone supply/demand was not in equilibrium until February. In addition, given how close China Mobile's iPhone launch was in January 2014 to the Chinese New Year that year, this year's Chinese New Year would see a much bigger boost from China Mobile selling iPhone. Cook reiterated this as a key driver to the strong quarter on the earnings call Monday evening. 

We are seeing the result of Apple pushing iPhone into previously untapped territories in China thanks to its China Mobile relationship. Apple is confident its products are making headway into China's middle class. Exhibit 2 highlights how the addition of China Mobile now brings the realistic target market for iPhone in China to 654 million customers. If one were to assume the top 10-15% of these customers buy an iPhone, similar to iPhone's share of the global overall smartphone market, Apple would sell 60 to 100 million iPhones in China. Taking into account the average iPhone lifecycle (2-3 years), Apple would eventually be in a position to sell 25 to 40 million iPhones in China each year to this loyal customer base.

Exhibit 2: Apple's Target Market for iPhone in China (3G/4G Customer Mix)

However, recent data from Kantar suggests that iPhone sales share is not 10-15% in China, but closer to 25% and climbing. Accordingly, such data would suggest Apple is selling upwards of 60 to 70 million iPhones in China each year, with China Mobile representing close to 60% of that total. It is possible China Mobile is selling 10 million iPhones a quarter, nearly 15% of Apple's global iPhone sales.  Exhibit 3 highlights how China Mobile likely accounted for 40% of Apple's iPhone unit growth this past quarter. Excluding the impact from China Mobile growth, iPhone unit sales would have been up 24% year-over-year, still stronger than the growth experienced in 2014, but a bit less than the reported 40% growth.  

Exhibit 3: Where is iPhone Growth Coming From?

Apple likely made close to $2 billion of operating income from China Mobile last quarter. As disclosed in Apple's latest 10-Q, Apple reported a 90% year-over-year increase (up $3 billion to $6.7 billion) in operating income in Greater China. I suspect China Mobile was the primary driver of that growth.

Even though iPhone sales growth remains robust in various countries including Korea, Singapore, Taiwan, Vietnam, Canada, Mexico, Germany, and Turkey, I suspect they pale in importance to the type of unit growth numbers coming from China Mobile in recent quarters. The iPhone's near-term sales trajectory will largely be determined by the iPhone upgrade cycle and Apple's success with selling the iPhone to China Mobile's 378 million 3G and 4G customers. China Mobile has become Apple's most important business partner.  

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