Apple is an iPhone stock and growth in China is just beginning

As much as it pains Apple shareholders to watch the stock drop to $500 from a high of over $700, we all need to learn to stomach the volatility and focus on the business performance.

Right now, Apple’s stock is driven by the market’s perception of iPhone supply and demand. It’s an iPhone stock more than anything else. This won’t always be the case, but it is for now.

China is an enormous growth market for Apple. This year China will make up about 15% of Apple’s total revenue. Back in April when Apple reported its Q2 results, Tim Cook revealed that sales in China had tripled year over year. He said “There’s a lot of headroom here in our view”.

That was 8 months ago. And we’re starting to see what Cook means. Apple just sold over 2 million iPhone 5 devices in a single weekend, inspiring the first-ever China-specific press release.

Apple hasn’t even cut a deal with China Mobile yet. For those unfamiliar with the telecom competitive landscape in the gigantic Asian country, China Mobile is the largest operator by a long shot. They’ve got over 700 million cellular subscribers, and pretty much all of the growth is coming from 3G (TD-SCDMA). Eventually this growth will shift to 3G (TD-LTE).

If Apple can strike a deal with the world’s largest carrier and capture 5% of its subscribers (presumably the wealthier among the total) then it amounts to 35 million iPhone sales. Let’s round the average selling price of the iPhone 5 down to $600 - we’re talking about $21 billion in new revenue. If these users are on a 2 year replacement cycle, we’re looking at $10 billion per year in new sales from one carrier deal.

Right now, Android is king in China. Apple’s share of the Chinese smartphone market is less than 10%. But in a country with over a billion mobile users, smartphones still represent the minority. In fact, only about one fifth of all cellular subscribers are even on the countries 3G networks as of now. Smartphone volume will continue to rise. As this happens, if Apple can recapture some share, as it seems to be doing with the iPhone 5 launch (and if they can get into China Mobile), the volume growth will continue to be impressive.

And then the halo effect kicks in. People who can afford iPhones in China can certainly afford iPads, and mostly likely Macs too.

What I’m really interested to know is if Apple has a strategy to compete with the mid tier smartphone makers in China. In the rest of the world, Apple keeps previous generation devices, currently the iPhone 4S and iPhone 4, on the market at lower price points. That's because there is a limit to how many people can afford a $600+ phone. We don’t want to see Apple competing the the guys making $100 Android phones, but there has to be a happy middle ground where Apple can grow its ecosystem while still enabling the wealthier customers to sport a more expensive and luxurious iPhone.

Apple is an iPhone stock, and China represents a pretty big opportunity that has yet to be fully tapped.