How the China Mobile Deal Will Benefit Apple

After more than five years of negotiations, Apple (NASDAQ: AAPL  )   announced it has entered into a multi-year deal with China Mobile (NYSE: CHL  )  to offer its smartphones to the carrier's 760 million customers. According to a joint statement, both the iPhone 5s and 5c models will be available via China Mobile's retail network and Apple's stores as of Jan. 17.
 
The deal could help Apple capture more market share in the second-largest economy, where its smartphone market share is only 12%, well below Samsung's (NASDAQOTH: SSNLF  )  20%. Morgan Stanley suggests 12 million additional iPhones could be sold in China after the deal, while analysts from RBC Capital Markets forecast the deal could boost Apple's top line by $10 billion. But, how exactly will Apple benefit from this deal?
 
The deal
Although financial details of the multi-year agreement have not been released, the partnership will provide Apple with direct exposure to the world's largest mobile market. The size of this market is roughly three times the combined number of U.S. consumers who subscribe to mobile plans offered by Verizon Wireless and AT&T.
 
Apple's star products, the iPhone 5s and 5c models, will be available for pre-registration from China Mobile's official website beginning on Dec. 25, and will be sold via the carrier's retail network starting on Jan. 17. The phones will work not only on China Mobile's 3G network, but also on the new 4G TD-LTE network, the latest generation of high-speed mobile broadband access, which will be available in 16 Chinese cities including Beijing, Shanghai, and Shenzhen. This is a huge improvement for iPhone users, who currently rely on 2G connections.
 
The China Mobile effect
According to Apple's 2013 annual report, China generated $25.47 billion in annual revenue. Subsidized iPhones could radically change this figure. According to analyst Katy Huberty, the deal with China Mobile may add 12 million new iPhone sales for Apple in 2014.
 
Assuming an average price of $650 each, 12 million devices translates into $7.8 billion in additional revenue for Apple. Furthermore, if we consider that Apple's operating margin from smartphones is 33%, the Cupertino-based company could easily get an extra $2.5 billion profit from this deal.

Apple depends on China Mobile
From now on, Apple may find it hard to keep its traditionally high operating margin. The company may have sacrificed either margins or addressable market to make the deal happen, because it has less negotiating power than China Mobile.
 
This is because analysts and shareholders have long been waiting for a deal with China Mobile that would allow Apple to capture significant market share in the second-largest economy. Therefore, you could say Apple needed this deal to avoid a big disappointment.

Samsung may counter-attack
Clearly, this deal gives Apple more power to compete against Samsung, which saw its market share in China for the third quarter of 2013 jump to 21%, up from 14% a year earlier, according to Canalys.

To protect its market share, Samsung will have to counter Apple with aggressive discounts, or the release of a premium, innovative device.

Final Foolish takeaway
Apple's partnership with China Mobile is a huge opportunity to capture market share in the second-largest economy. The deal could easily bring more than $2 billion in additional operating profit to Apple next year.

However, investors need to assess at least two risks here. First, Apple's operating margin in China may decrease. Second, Samsung may speed up the release of new smartphones, or adopt aggressive discounts to protect its leading position in China.

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