China Telecom Looks for iPhone Leverage in 3G Race

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (Trefis) -- China Telecom(CHA) announced last week that it added close to 2.8 million subscribers in January, about 87% of which subscribed to 3G. The company now has close to 130 million subscribers and is a distant third behind China Mobile(CHL) and China Unicom(CHU).

But the gap is narrow when it comes to 3G. China Telecom will hope that the iPhone 4S launch on its network next week will close the gap with its nearest 3G rival, China Unicom, which launched the 4S last month.

See our complete analysis of China Telecom here.

At less than 14%, 3G penetration in China is very low. This gives small wireless carriers such as China Unicom and China Telecom more opportunity to compete with China Mobile. With more than 650 million subscribers, China Mobile is the largest wireless carrier in the world and has three times as many overall subscribers as China Telecom. But when it comes to 3G, the advantage is less clear. As of January, China Mobile had around 54 million 3G subscribers compared to China Unicom's 43 million and China Telecom's 39 million.

Leading the 3G race currently is China Unicom, which has been adding the most number of 3G subscribers on a monthly basis. Not only is China Unicom the only carrier to sell the iPhone for now, it also started the trend of selling lower-cost 3G smartphones in China.

Adding 3G subscribers will help China Telecom increase its ARPU levels as 3G smartphone users are huge data users as well. But the subsidies associated with selling an expensive smartphone such as the iPhone to drive sales will cause its margins to contract.

China Telecom announced that it is planning to offer the iPhone 4S for free with a two- or three-year contract. This, along with increased marketing spend on promoting the phone, will have a near-term pressure on the margins.

We have seen China Unicom's EBITDA margin for its mobile division decline sharply since the end of 2009, when it first started selling the iPhone. But its ARPU levels have also increased sharply since then, pointing at the long-term benefits of subsidizing 3G smartphones. Moreover, the strategy of selling low-cost smartphones alongside the iPhone will provide some relief to the margin pressures.

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Is the iPhone too expensive?

By Rick Aristotle Munarriz

Ask anyone in this country what an iPhone costs, and most will say that Apple's (AAPL) iconic smartphone starts at $199. Models with more storage capacity will set stateside buyers back an additional $100 or $200.

However, this isn't what Apple is making. The world's most valuable tech company rang up an average of $659 per iPhone (including attached services and accessories) during the holiday quarter.

Who pays the lion's share of the difference? Wireless carriers are willing to subsidize more than $300 per phone, knowing that they will more than make that back by locking owners into two-year contracts. It's not pretty. Sprint (S), which was the last of the three leading carriers to begin offering the iPhone, isn't expected to turn a profit until 2015.

And it's not just carriers. Retailers are also hurting when consumers choose an iPhone over a higher-margin Android device. RadioShack's (RSH) gross margins took a beating during the holiday quarter, and the iPhone's availability through all three major carriers at its stores was one of the culprits.

Now let's go overseas. You've seen the long lines and even riots at Apple Store locations in China. However, it's a different story in parts of southern Europe, where carriers can't subsidize smartphones.

The Wall Street Journal wrote yesterday about the iPhone's weak market penetration in certain countries. According to market tracker IDC, just 9% of the smartphones sold in Portugal are iPhones. In Greece the market share drops to a mere 5%.

In the U.S., Android phones don't sell for a lot less than iPhones. If you're willing to rock a 2009 handset, carriers will even give you the iPhone 3GS for free with a two-year wireless contract. However, in countries where handsets aren't subsidized, it's hard to justify a $680 iPhone 4S when a perfectly capable Android phone costs less than $200.

Apple's challenges in Europe aren't new. A study by Kantar Worldpanel ComTech two months ago showed that the iPhone's market share was slipping in Germany, France, Italy, and Spain.

The obvious rebuttal here is Apple's blowout fiscal first quarter. With or without continental Europe, Apple sold a whopping 37 million iPhones this past quarter. However, it does lead one to wonder if Apple's premium pricing is opening too wide a door for Google (Nasdaq: GOOG ) and its army of Android developers to exploit the smartphone market as it penetrates the balance of the market.

Apple's stateside response has to keep older models around at lower price points, but given the rapidly evolving marketplace for both iOS and Android, that 2009 gadgetry has never felt so stale.

It's hard to knock Apple and its ability to carve itself the thickest slice of the industry's profits, but Android's European invasion is really just the beginning.

Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story. The Motley Fool owns shares of Google, RadioShack, and Apple. Motley Fool newsletter services have recommended buying shares of Apple and Google. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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