On Sunday night, Apple Inc. (NASDAQ:AAPL) announced that it had inked a deal with China Mobile Ltd. (NYSE:CHL) (HKG:941). Many investors believe that the deal could be accretive to Apple earnings and share price. Already at least one analyst is out with a new report analyzing the deal. Aaron C. Rakers, CFA of Stifel has issued a new note on the topic. He believes that Apple Inc. (NASDAQ:AAPL) could sell 10 million extra iPhones due to the new arrangement. Below is the full note from Rakers.
As we and many others have reported over the past few years, Apple’s ability to have the iPhone supported by China Mobile would be an important growth driver; albeit the terms (i.e., subsidy arrangement) of this deal are not yet disclosed. This comes quickly after China Mobile’s official 4G TD-LTE launch last week. China Mobile will commence retail availability of the iPhone on January 17, 2014 and offer pre-registration via the company’s website on 12/25. We retain our estimate of incremental EPS from a ramp at China Mobile could total in the $4-$8/sh. range after the first 12-months of support. We are not changing our forward estimates; however, our model leaves us to think about the potential for up to +10M incremental iPhone sales to materialize into the March 2014 quarter. We note that after the China Telecom iPhone launch in March 2012, Apple’s estimated China iPhone shipments [sell-in] sequentially increased by ~3.6M to ~5.7M in C1Q12; China Mobile’s 3G subscriber base currently stands at ~4x that of China Telecom upon initial iPhone support. We move our target price from $600 to $650, or 8.6x EV/EBITDA on our C2014 estimates (not yet reflective of China Mobile ramp).
Aaron C. Rakers, CFA of Stifel on Apple Inc. (NASDAQ:AAPL) China Mobile Ltd. (NYSE:CHL) (HKG:941) agreement.
Apple Inc. (NASDAQ:AAPL) China Mobile 4G TD-LTE Ramp in 2014.
Apple’s iPhone 5s/5c will be supported across China Mobile’s entire subscriber base totaling 763.3M subscribers exiting November; ~181.1M 3G subscribers. This compares to China Unicom and China Telecom’s total mobile subscriber base standing at 278.6M and 185.5M, respectively. In total, China Mobile, China Telecom, and China Unicom had a combined mobile subscriber base standing at 1.227B; 402.6M 3G subscribers (~33% penetration). Apple’s press release reports that China Mobile’s combined 2G/GSM, 3G/TD-SCDMA, and 4G/TD-LTE networks include over 1.2M base stations. 4G TD-LTE services are currently available in 16 cities with an anticipated ramp to 340 cities covered by the end of 2014 (+500,000 base stations). China mobile is targeting the sale of more than 100M total 4G TD-LTE smartphones in 2014 – initial partners at last week’s launch event being Samsung, Lenovo, and Xiaomi. With the 4G TD-LTE launch, China Mobile stated that it would look to provide end users better subsidies on 4G TD-LTE smartphones in order to streamline the adoption of 4G going forward.
Investor Expectations on March Guide/Results – Margin Implications, True 3G Subscriber Base, & Early-2012 China Telecom Ramp = Proxy? With a deal now announced, we/investors will be gauging Apple’s iPhone expectations/results for the March 2014 quarter. Below we summarize what we think will be the key focal points:
Margin Profile – Assuming ~40% GM% on iPhone into China Mobile. Apple Inc. (NASDAQ:AAPL)’s press release does not provide any color on the pricing, and thus how we should think about the margin implications as it relates to the ramp at China Mobile. Investors will be gauging the impact of any differentiated (more favorable) subsidy structure that could have come as part of the arrangement with China Mobile. Our $4-$8/sh. incremental EPS reflects a gross margin estimate of ~40% on these incremental sales. As we/investors will now question the margin implications of the China Mobile deal, we are once again left to think about our analysis of Apple’s significant capital investments into the supply chain as a driver of product velocity – possibly not just the initial iPhonee 5s (and now to a lesser extent 5c) and the ability to proliferate availability into China upon the initial launch, as well as launching support into Japan’s NTT Docomo, but also setting up favorably for the ramp of availability into China Mobile as 4G TD-LTE build-outs materialize in 2014.
We continue to highlight Apple’s ~3-5 year (we estimate 3 year) depreciation cycle for investments into its Machinery, Equipment, & Internal-Use Software balance as an important gross margin consideration given the amount of accelerated depreciation impact seen in the GM% over the past several quarters. If Apple’s capex spending was to change than we believe this GM% headwind could be evaluated as a potential tailwind going forward – please seen our report published on 10/30 for a review of these trends; other interesting 10-K disclosures.
China’s True 3G Subscriber Base? China Mobile’s reported 3G subscriber base figures continue to be a point of relative confusion. In short, we believe investors should/will question how we should think about the true subscriber base legitimately positioned to upgrade to an iPhone and/or how many of China Mobile’s subscriber base is already using unlocked iPhones. For example, as part of the 181.1 million total 3G subscribers reported exiting November 2013, it is important to remember the questions that have surrounded the inflation of China’s overall 3G figures. In early 2012, reports surfaced suggesting that the then reported total 3G subscriber base actually reflected approximately 80 million true 3G subscribers. There have been questions surrounding China Mobile’s 3G subscriber base as it relates to full 3G data plan usage versus the extensive usage of China Mobile’s Wi-Fi (possibly a reasoning for Apple’s press release to also highlight China Mobile’s 4.2 million Wi-Fi access points – thus pointing out both the 1.2 million cell network coverage and Wi-Fi coveragequality networks to support the iPhone 5s/5c customers). China Mobile reported the sale of ~66 million TD handsets in 1H2013, a 1.5x yr/yr increase; reporting that 90% of these were smartphones. However, China Mobile also reported that ~25 million of these sold devices were subsidized.
China Telecom Ramp as a Proxy? Remember Carrier Sell-In. When China Telecom commenced support for the iPhone in March 2012 (note: China Unicom commencing in October 2009), Gartner estimated that Apple’s iPhone shipments into China (sell-in) stood at ~5.7 million for C1Q12, an increase from 2.1 million units shipped in the prior quarter.
At this time, China Telecom had a total 3G subscriber base totaling 44 million (exiting C1Q12), which compares to China Mobile’s current reported 3G subscriber base standing at ~176 million (or ~4x the size of China Telecom at the time of the iPhone launch). If we were to very simplistically say that all of 3.6 million seq. increase in iPhone sales realized in C1Q12 was reflective of the China Telecom ramp, this would equate to approximately 8% of the firms 3G subscriber base – 8% of China Mobile’s 3G subscriber base would current stand at ~14 million. Apple had reported Greater China revenue at $7.6 billion in the March 2012 quarter, an increase from $4.08 billion in revenue in the December 2011 quarter. Based on our current model, we estimate an iPhone installed base in China to represent approximately 20% of the addressable (China Unicom + China Telecom) 3G subscriber base exiting C3Q13.
China Importance (15% of Total Revenue; 31% Operating Margin) . Apple Inc. (NASDAQ:AAPL) reported Greater China revenue at $25.4 billion in F2013, or totaling approximately 15% of total revenue – important to note that this excludes Retail revenue, which is reported separately in total. Greater China revenue totaled $5.733 billion (15.3% of total) in F4Q13, which reflected a 5.6% yr/yr increase (+31% seq.) vs. a 14% yr/yr decline in the June 2013 quarter. Apple also discloses Greater China operating income at $1.770 billion in F4Q13, or equating to a 30.9% operating income margin, which is down from the company reporting a peak Greater China operating margin at 49.5% in F2Q12 (March 2012). According to Gartner’s estimates (sell-in), China shipped approximately 5.9 million iPhones into China in C3Q13, equating to approximately a 6.4% shipment share. This compares to Samsung having shipped an estimated 16.2 million smartphones into China during C3Q13. Apple’s capex plans in F2014 include an expectation of 30 new store openings with two-thirds of these openings outside of the U.S.
Apple Inc. (NASDAQ:AAPL) Target Price Methodology/Risks
Our $650 target price reflects a weighted valuation methodology using a 13x P/E, ~8x EV/EBITDA, and 12x EV/FCF multiple on our F2015 estimates, as well as a modest weighting to our 10-year discounted cash flow model, using a ~9% WACC and a low double-digit revenue growth rate over the next couple of years, followed by a low single-digit growth rate thereafter.