Is the Smartphone Market in China Maturing? (CHL, AAPL)

There were 1.28 billion mobile phone users in China by March 2016, by far the greatest number in any single country. This enormous but still-maturing market could be an excellent opportunity for producers and investors.

Smartphone Penetration in China

Most sources cite 2011 as the start of the Chinese smartphone revolution. By 2012, China overtook the United States as the world's largest smartphone market, during which an estimated 208 million units reached Chinese consumers. There were as many smartphone users in China as all European countries combined by the end of 2012.

As many as two-thirds of all mobile users owned smartphones in 2012, according to research conducted by Nielsen. Another study in 2015 by the Groupe Spécial Mobile Association (GSMA) found that there were 913 million smartphones in China specifically, up from 805 million in 2014. However, some individuals had multiple smartphones, so the number of unique smartphone subscribers was 691 million. Eventually, smartphone saturation could change lives and businesses in China as dramatically as they have in the United States.

The GSMA projects one billion 4G smartphone connections in China by 2020. By comparison, there were only 100 million such connections in China during 2014. This growth is being buoyed by massive infrastructure development for 4G networks, especially the time-division duplex long-term evolution (TDD-LTE) project by China Mobile Ltd. (NYSE: CHL).

The OEM Hurdle

Apple Inc. (NASDAQ: AAPL) and Samsung Electronics Co. Ltd. (OTC: SSNLF) are the largest foreign players in the Chinese smartphone space. They have each claimed the top market share in China during the 2011-2015 period, although Apple clearly had a better year in 2015. The two corporations are bitter rivals, but they should be more concerned about China's burgeoning original equipment manufacturers (OEMs). Domestic companies have seen rapid growth in China since 2013, and many are outcompeting Apple and Samsung with cheaper, sleeker products.

China's largest domestic brands include Lenovo, Huawei and Xiaomi. Xiaomi was the rising star until 2014, when it overtook Samsung as the largest provider in China. Apple and Huawei were the big winners in 2015 and took turns claiming the top spot throughout early 2016. Huawei was particularly impressive, topping the market for year-over-year growth and gains in average selling price. Other Chinese producers, such as Vivo, OPPO and Gionee, also show strong trends in China and India.

Thanks to their low price points, Chinese smartphones successfully undercut many expensive American and Korean options. A May 2016 Gartner report said smartphone purchases "were driven by demand for low-cost smartphones in emerging markets and for affordable 4G smartphones."

Striking a Maturing Middle Class

There have been two significant economic forces at play in the Chinese smartphone market. The first is China's ascending middle class. Average nominal yearly wages in China more than doubled between 2008 and 2015. The World Bank estimates real incomes rose from $2,050 in 2006 to $7,400 by 2014, an increase of 260%. More than 700 million Chinese escaped absolute poverty in the last generation. This is the largest such economic liberation in world history.

The second significant force is a drop in smartphone prices. Phones became cheaper at the same time that real incomes rose, generating the perfect environment for high sales. Falling prices are a common feature in the technology sector, and China's price drops have been driven by intense competition and high supply.

Legal and Regulatory Opportunities

Since 2012, the Chinese government softened its stance on foreign players. Chinese smartphone designers acted in concert and have been more willing to negotiate license agreements with foreign telecommunication companies. Investors should pay particular attention to new agreements and the potential earnings they represent. For example, Qualcomm Inc. (NASDAQ: QCOM) President Derek K. Aberle spoke during his second quarter 2016 earnings call and reported an upward adjustment in estimated device shipments based on China's growth, whereas most other markets were shrinking.

Source: Is the Smartphone Market in China Maturing? (CHL, AAPL)