Are These Really Apple's Potential Pitfalls?

Apple's (Nasdaq: AAPL  ) share price fell early last month amid speculation that the company seems to be losing favor with wireless carriers, which may reduce subsidies on the upfront cost of an iPhone.

The situation was aggravated by the fact that Verizon Wireless (NYSE: VZ  ) recently introduced a $30 charge for upgrading to a new iPhone model. Many felt that this could be a pointer toward mobile phone carriers cutting down on iPhone subsidies as well, without which the phone would cost a lot more than its normal price. How badly will this affect Apple's bottom line? Let's find out.

iPain for wireless carriers
Wireless carriers have suffered substantial erosion in margins, as they heavily subsidize prices of the popular iPhone. This has become apparent as Verizon's EBITDA service margin -- an important metric representing core profits as a percentage of sales -- has taken a big hit. In the fourth quarter last year, Verizon sold a record-breaking 4.2 million iPhones, which resulted in its margin dropping to 42.2% from 46.4% between 2009 and 2010. Others such as Sprint and AT&T also complained of a similar fall in margins as their iPhone sales skyrocketed.

But would Apple take a hit? Most definitely!

If wireless operators such as Verizon and AT&T remove even a part of their iPhone subsidies, Apple's sales would surely be hit, as the device would cost much more otherwise. After all, it's difficult to find a better deal than one where a device worth more than $600 is subsidized and sold for just $199. This would partially explain why Apple's stock declined over five days in a row around the same time as Verizon's announcement.

Opportunities galore
But, even if all these negative factors are taken into account, Apple probably still has lots of room to excel. The company's potential forays into new areas such as television sets and mobile-based payments are just two instances of huge sources of revenue in future.

Add to that a massive opportunity which Apple is yet to conquer -- the Chinese smartphone market. The company hasn't seen the kind of growth that peers such as Samsung are enjoying in China. Apple's share of smartphone sales in the region has been restricted to a measly 7.5% in contrast to Samsung's 24.3%. But all that could change once Apple partners with the biggest mobile operator in China -- China Mobile (NYSE: CHL  ) , with its stupendous 655 million subscriber base.

But for that, Apple would have to ensure that its iPhone would support the carrier's unique TD-SCDMA based network, which may be possible with the use of Qualcomm's fifth-generation Gobi baseband chipset in the upcoming iPhone 5.

The Foolish bottom line
Apple may face serious headwinds in the form of removal of carrier subsidies, but it's too strong to be majorly affected by this one factor alone. And given its huge potential, I'm not worried about Apple as an investment.

So what's your opinion? Let us know by leaving your comments in the box below.

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Keki Fatakia does not hold shares in any of the companies mentioned in this article. The Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Apple and China Mobile. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. The Motley Fool has a disclosure policy.
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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 03, 2012, at 1:21 PM, peto3 wrote:

    Thanks for the info, Kek - you learn something new every day ...

  • Report this Comment On May 03, 2012, at 1:50 PM, deemery wrote:

    If there's a charge to upgrade, but no charge for "new purchase," then what's to keep me from buying my next phone from ATT, and the phone after that from Sprint, etc, etc?

    There have been two great things about the iPhone:

    (1) how it's revolutionized the technology

    (2) how it broke the stranglehold by the carriers on features, etc.

    Independently of what I think about the iPhone itself (and I'm not a 100% fan), it's great that Apple managed to keep the hands of the Telcos from around my neck for buying/using a smartphone. Android wouldn't have been anywhere near the success without Apple doing this. (We'd end up with crippled, vendor-specific, incompatible phones, app markets, etc.)

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