June 23,2009

Apple's Slow Boat to China Gains Speed as iPhone Gains Block-Buster Consumer Acceptance

By Thomas Wilkins,CFA

The robust launch of Apple’s newest version (3G S) of its iPhone with sales in the US of over 1 million units during the first three days should wet the appetite of a Chinese wireless carrier to obtain an exclusive distribution contract as AT&T has done in the US. With selling prices at US$ 199 for 16 gigabytes of memory and US$ 299 for a version with twice the memory and a three contract at higher prices non-3G phones, the size of this market should be a strong persuasive point for doubtful Chinese negotiators. This is some real money. 

A recent positive opinion for Chinese consumers comes from Cynthia Meng, an analyst at Merrill Lynch, who feels a 3G rollout by China Unicom could begin in the fourth quarter of 2009.

There has been a long history of hype about the negotiations between China Unicom and Apple. This is the not the first time someone has gone out on a limb predicating a conclusive agreement between these two companies. Some of the market noise stems from the fact that China Uniom’s chairman, Chang Xiaobing, leads the Chinese negotiators with Apple but the lack of a completed contract is most likely due to high selling prices and lengthy service contracts. The market hype reflects the lack of competition in the bidding process after the apparent breakdown in negotiations between Apple and China Mobile. Another reason justifying the hype is that partnering with China Unicom would come free of any modification of iPhone’s microprocessor as China Mobile is using it own proprietary, China-made wireless standards.
Skeptics believe that Apple is in the driver’s seat and will stand firm on financial arrangements for an exclusivity contract. The seller’s market profile disturbs those who feel that the Chinese licensee will be squeezed profit wise. But there is one slowly evolving fact that may tilt the tables for the optimists, who feel that China Unicom could make a profit with Apple’s 3G phone. That is the robust sales figures and momentum. Apple has sold 21.4 million units of the iPhone 3G in 22 countries. iPhone has become more than a wireless telephone but is gravitating towards a hand-held computer which has attracted over 50,000 third-party application, some free to download and some having a fee, such as games, entertainment, travel, sports, and business. iPhone customers have downloaded over 1 billion "apps" (applications).  In a few days, the newest version goes on sale in Australia and Japan. As the launch for the newest 3G version is exceeding forecasts by investment analysts, many are upgrading their forecasts for sales.
Shaw Wu of Kaufman Brothers who has earned a five star rating at Yahoo Finance Analyst Performance Center for his research on Apple has raised the forecast after learning of the robust launch.

Eventually, the momentum of robust sales should push a China telecom into the arms of Apple. One unusual advantage that Apple is offering its customers is the right to upgrade for free their operating system without having to buy a new phone. 6 million customers jumped on the offer and downloaded the new iPhone 3.0 software in the first five days since its release. This is almost unheard of in the computer world which normally sees new product launches with improved productivity as a way to extract money out of its customers.
Regarding China Unicom’s stockholders have already given "CHU" listed on the New York Euronext Stock Exchange a strong relative strength rating, placing it in the 85 percentile according to a recent report by Standard & Poor’s. However, this could theoretically be dismissed as a dead cat bounce after the stock fell from almost US$25 per share in early 2008 to US$8.56 in early 2009. Currently, the stock is up 54% from its 2009 lows but still down approximately 55% below its 2008 high. 
Standard & Poor’s currently has a sell recommendation on the American Depository Shares in New York for China Unicom based on S & P’s opinion that  "even though China Unicom is a leading company in its market and has a history of profitability, its operation have high fixed costs, large ongoing capital expenditures, and lack of geographic diversification. The company is also experiencing increased competition." Standard & Poor’s is estimating that 2009 Operating earnings will be US$ 0.89 per share. 

Michael Meng at Citi Asia Pacific China in Hong Kong has a price target of HK$8 for China Unicom rather its June 22 closing price of HK$ 10.48. The stock in Hong Kong is selling at 20.6 times Mr. Meng’s estimate for 2009 and 22.4 times his 2010 estimate. He points out that China Unicom’s additions for May were down 40% month over month. "We believe China Unicom is now focusing efforts on the Sept 1 WCDMA soft launch and that sub growth is likely to remain weak in the rest of Q2 and probably Q3, without major promotion of GSM." However, he pointed out that the other China telecoms, China Mobile and China Telecom, shad lower growth in May versus April.
If China Unicom does take on an exclusive license from Apple, then the acquirer should not be constrained by credit if such is needed to launch the iPhone in China.


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