Apple Takes Aim at China
Apple Inc. (NasdaqGS: AAPL) revealed its long-awaited low-cost smartphone yesterday, along with a fully updated high-end version, among other innovations.
Here’s what the company lifted the curtain on at its long-awaited launch event:
- iPhone 5C: The company’s new lower-cost smartphone has many of the same features of the current iPhone 5, including the A6 processor. However, it will come in a plastic, rather than an aluminum case, in a variety of colors, but the company was careful not to position this as a downgrade. Apple designer Jony Ive called it “unapologetically plastic.”
The 5C is primarily aimed at consumers with lower gadget budgets, most importantly in emerging markets like China (more on that below). The 16 GB version will cost $99 with a two-year contract in the U.S., while the 32 GB model will go for $199.
- iPhone 5S: The latest version of the iPhone 5 features the company’s new 64-bit A7 processor, which it claims is up to twice as fast as the previous generation. The camera is also improved, and the device includes new technology that allows users to unlock it using their fingerprints instead of a PIN. It comes in an aluminum case that’s available in three colors, including gold. iPhone 5S pricing will start and $199 for the 16 GB model and go up to $399 for the 64 GB version.
- iOS 7: Apple’s new mobile operating system, which will ship on both new devices and be available to current iPhone users September 18, sports an updated look and new features like improved multitasking and AirDrop, which lets users share files with nearby iOS devices.
The company also announced a couple of important strategy shifts. For example, it will curtail its practice of selling the previous two versions of the iPhone at deep discounts and instead will eliminate the iPhone 5 entirely. However, it will continue to offer the iPhone 4S for free on a two-year contract.
That’s likely an attempt to stem the company’s contracting gross margins, which have narrowed for five straight quarters as more users opt for older versions of the device, paying little or nothing upfront. More of those users may now opt for the 5C at a minimum of $99 over the older 4S.
Missing from the event was the smartwatch that Apple is rumored to be developing, which some thought may be revealed in light of main competitor Samsung Electronics’ (OTC: SSNLF) recent release of its Galaxy Gear smartwatch.
Analyst Response Was Lackluster
Investors generally panned the launch, sending the stock down 2.3% on the day, to $494.64. Analyst response to the new devices was mixed, with some concerned that the new phones wouldn’t stand out enough from previous models to grab consumers’ attention.
Jefferies analyst Peter Misek was early out of the gate with a thumbs-down: “We think sell-through will be lackluster due to the lack of differentiation, elongating replacement rates, and smartphone growth shifting to the very low end and to ~5-inch screens [the iPhone still sports a 4-inch screen],” he said in a note quoted by the Financial Post. Mizek continues to rate Apple shares as a hold with a $450 price target.
Milton Pedraza, chief executive of the Luxury Institute research firm, reiterated Misek’s disappointment over screen size. He hopes the company will develop a third, bigger iPhone as a premium model to serve its older users: “Lots of people need a bigger screen,” he told the New York Times. “Their vision is going, and their fingers are not as dexterous.”
Just a First Step?
Meanwhile, Isaac Balter, chief market strategist for Oracle Investment research, saw the new iPhone 5C as just the first step before it launches the next batch of innovative new products. “We need to let Apple go after their market share and then bring in innovation for the next wave,” he told the Times.
Jan Dawson of Ovum Research picked up on that sentiment, giving further indication that Apple events later this year and into 2014—not yesterday’s—may be where the real action is. “Apple needs to demonstrate in the coming months that it has other product lines that can start to make up for slowing growth and falling margins in the iPhone and iPad,” she told Reuters. “That’s a tall order.”
China Mobile Deal Would Be Huge
With the iPhone 5C, Apple is moving to address its weakness in emerging markets, particularly China, home to about 1 billion mobile phone users. It’s hard to underestimate the opportunity the country represents for Apple: one-third of all smartphones are now sold in China, more than the U.S., India, Japan and the U.K. put together.
Still, the iPhone controlled just 4.8% of the Chinese smartphone market in the second quarter, according to research firm Canalys. That was good for seventh spot, well behind No. 1 player Samsung, at 17.6%, and a bevy of local competitors.
The iPhone 5C starts at 4,488 yuan ($733 U.S.) without a contract in China—where consumers usually pay upfront for their phones, only receiving a subsidy later—which still makes it a high-end device by Chinese standards.
At that level, the 5C, like its predecessors, will face strong price competition from cheaper homegrown smartphones. Eighty percent of competitor Huawei’s phones, for example, sell for less than $200.
As well, Apple remains cut off from most of the country’s mobile users because it doesn’t have an agreement with China Mobile (NYSE: CHL), China’s (and the world’s) largest wireless carrier, with 745 million subscribers. To put that in context, the largest U.S. carrier, Verizon Wireless, has 100.1 million users. As a result, iPhone sales are limited to China Unicom (NYSE: CHU) and China Telecom (NYSE: CHA), with just 266 million subscribers between them.
As we’ve reported previously, Apple has been in talks with China Mobile for some time about inking a deal, with an agreement now rumored to be close, if not already signed. If so, it would greatly expand Apple’s reach in the country, significantly boosting iPhone sales volumes.
Still Appealing for Shareholders
The company still faces risks, such as a heavy reliance on the iPhone and iPad, which combined account for 72% of its revenue, but it possesses a number of important strengths, as well.
For one, it controls one of the world’s most recognized brands, ranking No. 2 on Interbrand’s latest survey. The iPhone also remains a strong seller. In Apple’s latest quarter, it sold 31.2 million of the devices, up from 26 million a year ago, beating Wall Street’s expectation of flat sales volumes. The unexpected jump helped Apple top consensus revenue and earnings forecasts.
Moreover, as Investing Daily managing director John Persinos pointed out in a July 5 article in our Personal Finance newsletter, Apple continues to ramp up its R&D spending while at the same time rewarding investors.
“The company plans to spend over $3 billion in research and development in 2013, a 40% increase over last year’s R&D budget, to develop a host of new products such as a smart watch and a smart television that are compatible with the Internet,” he wrote.
“Apple has no debt and over $100 billion in cash on its balance sheet. Management intends to spend this ample cash on R&D, acquisitions, share buybacks and dividend increases, all good news for shareholders.”
Those buybacks could be helped by a recent revelation from activist investor Carl Icahn, who said that he has taken a large position in the company and plans to push CEO Tim Cook for more share repurchases.