Apple's growth hinges on China, new devices

SAN FRANCISCO Thu Apr 26, 2012 10:59am IST

Customers enter the Apple flagship retail store to purchase the new iPad in San Francisco, California March 16, 2012. REUTERS/Robert Galbraith/Files

Customers enter the Apple flagship retail store to purchase the new iPad in San Francisco, California March 16, 2012.

Credit: Reuters/Robert Galbraith/Files

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SAN FRANCISCO (Reuters) - Sometimes even eye-popping results are not enough.

Apple Inc's (AAPL.O) shares rallied on Wednesday on the back of another spectacular quarter that included soaring iPhone sales in China, but the naysayers are still asking if the most valuable American company might need yet another revolutionary product in the next year to sustain its sizzling growth.

The skeptics certainly lost some credibility when the company's shares surged 9 percent on Wednesday, adding about $50 billion to Apple's market value, but some have not been silenced.

Their case is based on the law of large numbers - it is going to be more difficult for Apple to grow as fast the bigger it gets - and on the unforgiving nature of the technology business that can turn heroes into has-beens overnight.

The bulls point to emerging markets - in particular China, whose mobile market is the world's largest and far from saturation - and upcoming products like a 4G-enabled iPhone 5 and the oft-rumored Apple TV, as sustaining astonishing growth such as the near-doubling of net income in its second quarter.

But the bears, with a longer-term view, fear that Google (GOOG.O) Android devices will eventually put pressure on Apple's margins in China as they have elsewhere, and wonder if Apple will be successful in tacking on another blockbuster consumer device to its portfolio.

Sales in China, particularly, are key for Apple to maintain its pace of revenue growth in the longer term, said Carolina Milanesi, consumer technologies analyst at Gartner.

"That's the big question," she said, referring to market share in China. "From an affordability perspective, I think the opportunity is there to allow it to maintain that growth or at least not to see an immediate drop in sales."

In products, "TV seems to be one that everybody is looking at," she added.

Shorter term, over the next year, some investors and Wall Street analysts note that Apple's sales of the all-important iPhone could flatten out over the next few quarters as consumers await the next version of the popular smartphone.

Apple's own revenue forecast was more conservative than usual for the fiscal third quarter, a period during which an upgrade of the iPhone or iPad are unlikely.

"We note that iPhone product cycles appear to be getting increasingly pronounced, with fiscal first quarter and second quarter benefiting from very strong iPhone 4S product cycles in the US and China, respectively," said Toni Sacconaghi, analyst with Bernstein Research, adding he expected the next couple of quarters to see "more sluggish unit sales."

But for now, sales of 35.1 million iPhones in the last quarter saw Wall Street analysts extend their love affair with Apple shares with a slew of hiked stock-price targets as concerns eased that the company was losing market share in the cut-throat smartphone market.

At least 14 brokerages revised their targets on the stock by $40 on average, a day after the company posted a quarterly profit that blew past Wall Street estimates.

Apple shares closed up almost 9 percent at $610 after touching an intraday high of $618 for an advance of 10.3 percent, the biggest single-day percentage gain by Apple shares in more than three years. The shares prior to the earnings had seen an unusual two-week decline.

Apple, as 4.2 percent of the S&P 500, gave U.S. stocks a big shot in the arm on Wednesday, driving the Nasdaq .IXIC to its biggest single-day gain of the year.

"Last night, Apple's performance once again demonstrated how quickly Apple fever is spreading around the world and this trend continues to drive meaningful upside in the company's financial results," said Topeka Capital Markets' Brian White, who raised his stock-price forecast to $1,111 from $1,001.

CHINA ROARS

Sales in greater China accounted for about 20 percent of Apple's $39.2 billion quarterly revenue, a three-fold increase from a year earlier. The numbers showcased Apple's sky-rocketing growth in China, which made up just 4.5 percent of its revenue in fiscal 2010.

Sales there are on track to nearly double this year, with a combined revenue in the first two quarters of $12.4 billion. That is almost level with revenue from China of $13.3 billion in all of fiscal 2011.

Giri Cherukuri, head trader and portfolio manager for OakBrook Investments in Illinois, said Apple had room to grow in China but would also look to other developing countries with large populations - such as India, Brazil and Russia - to keep up the pace of sales.

"They are methodically just growing country by country, both just building Apple stores in these countries and building distribution," Cherukuri said. "That's partly why you are getting strong numbers now. When a new iPhone or iPad comes out, they can rapidly deploy those all over the world."

In China, Apple has yet to seal a contract for the iPhone with China Mobile (0941.HK), the world's largest mobile operator in terms of subscribers, with 660 million users. A deal with the carrier for the next iPhone has the potential to considerably boost iPhone sales in the country.

"The main challenge for Apple is to penetrate China Mobile's 600 million subscribers. The numbers look pretty good now, but would be much better with China Mobile," said Nomura analyst Huang Leping.

But doing business in China has its challenges. Apple has faced a raft of negative publicity in China in recent years, including worker suicides at its supplier Foxconn Technology (2354.TW), accusations of environmental pollution, and copyright and trademark infringement.

Now, Apple also needs to find a way to stop users who hack into the iPhone's software to download free apps or solicit services from e-commerce sites to download apps at a fraction of their cost in the App Store or iTunes Store.

Many deep-pocketed companies have attempted to crack the Chinese market, tempted by a large and growing middle class. But regulations that favor and protect local businesses, plus a lack of understanding of the market, have stumped many.

Wal-Mart (WMT.N) has struggled against local rivals. But other companies -- such as carmaker General Motors (GM.N) and KFC parent Yum Brands -- have been more successful in penetrating the market. In Yum's (YUM.N) case, China accounts for more than 40 percent of the company's profit.

MARGINS DELIGHT

Apple's strong results on Tuesday came after a 13 percent decline in the company's shares over the past couple of weeks that erased about $78 billion from its market value.

Following the earnings announcement, analysts discounted worries about rising competition and pricing pressures, noting the company's stronger margins of 47.4 percent in particular.

"Apple's margin upside has the most important long-term implications for the story," said Goldman analyst Bill Shope, who raised his target price on the stock by $100 to $850.

Chief Executive Tim Cook took Apple's helm shortly before co-founder Steve Jobs died in October, and was immediately subjected to a discussion of whether he embodied the same vision and foresight needed to keep the company at the forefront of innovation.

A smart TV - dubbed iTV by Apple watchers - is seen as the next product to drive the next phase of growth. While Apple has neither confirmed nor denied it was working on a TV, Jobs told his biographer, Walter Isaacson, about reinventing the television set and how he had "cracked" it.

Many on Wall Street expect Apple's version - and perhaps Jobs's vision - to be unveiled later this year or next year.

So strong is the speculation that investors are likely to be disappointed if Apple does not launch a device for the living room, Cherukuri of OakBrook Investments said, adding however that a television-like product is "pretty certain" at this point.

"It can't just be a piece of hardware," Gartner's Milanesi said of the possible TV, adding that it would have to "drive a similar replacement cycle as you see in the iPad or iPhone."

(Additional reporting by Melanie Lee in Shanghai, Tenzin Pema and Himank Sharma in Bangalore; Editing by Andre Grenon and Muralikumar Anantharaman)

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