The current Apple iPhone negotiations with China Mobile bring to mind the recent James Bond film Casino Royale. Bond loses the first major hand in a high stakes poker game to the nefarious Le Chiffre: “Oops … You must have thought I was bluffing Mr. Bond.” Adding injury to insult, Le Chiffre’s girlfriend poisons 007’s vodka martini. Bond is soon fighting for his very life. With a little ingenuity, and use of a portable defibrillator, 007 survives and returns to the table more determined than ever … Bond: “I’m sorry, that last hand (drink) nearly killed me.” The game’s finale is an “all in” show down. Le Chiffre thinks he has it won … Not so fast! Bond lays down a straight flush to take the $115 million dollar pot.

There is more than $115 million US Dollars at stake for Apple [AAPL] in China. Of that you can be assured. While there may be no poisoning of players’ drinks, the competitors at the table are deadly serious. And they should be. They have turf to protect. Nokia, for one, sold more than 50 million mobile handsets in China during the first 3 quarters of 2007. Research in Motion (RIM) is another key player. RIM recently signed a deal with China Mobile to distribute their Blackberry 8700 smart-phone. RIM has bet big on the China market.

Do these established smart-phone manufacturers really have anything to worry about? The Apple iPhone was once ridiculed as a device that was too expensive and ahead of its time to have any real impact on the one-billion-unit (world-wide sales projection for 2009) handset market. The early dismissal of Apple as a serious competitor in wireless is now being reconsidered in telecom boardrooms and within the wireless analyst community. The iPhone is to be ignored at risk of losing market-share, and possibly one’s job!

So here we are at the metaphoric poker (negotiating) table. Two power players, China Mobile and Apple, are now eyeing a pile of chips in the center of table. Steve Jobs may not have the combat skills of 007, but he knows how to capture the consumer’s imagination and he has the power to deliver an object of desire – Ai Feng (”Love Craze”). Ai-Feng is the iPhone and it’s a bone fide black-market hit. Despite the high cards that China Mobile holds, the savvy players recognize that Apple too holds a winning hand. And this does not have to be a winner-take-all game. There is plenty to share. An “iPhone exclusive” is not an offer that can easily be dismissed … even by the world’s largest cellular operator.

Deal or no Deal?

It is no secret that Apple and various potential China partners have engaged in some dialogue. Where do these “iPhone in China” negotiations now stand? The “in the know” parties are not talking. Yes there have been one or two statements for the media. The China Academy of Mobile Communications has commented and so too have anonymous Chinese telecom executives. But these short comments (and hints of disagreement over “revenue sharing”) appear to be for negotiation leverage rather than to enlighten. For now the truth remains a closely guarded state secret. That may be literally true. Despite the desire by multiple parties to bring iPhone to China in 2008, no Ai Feng deal has yet been announced. There has been plenty of “deal or no” speculation in the press. Some of these reports are fact-based and others are rumor. Inquiring minds want to know.

Who is Playing? China Mobile, Apple and … ?

There are two major mobile operators in China – China Mobile and China Unicom. China Mobile is the dominant wireless carrier with 356 million of some 523 million subscribers in China. Given China Mobile’s massive subscriber base, no question they are the most logical carrier-partner for Apple. There are alternative iPhone partners and China Unicom, for one, recently stated that they have “not begun talks with Apple” and they are “open to cooperating with Apple.” Much can be read between the lines here. If Apple has not yet approached the second largest wireless carrier in China (Unicom has 156 million subscribers), why not? Okay, I can think of a few reasons, but the overriding and obvious reason is that they remain in exclusive conversations with China Mobile. Apple would never completely close off their options to negotiate with other parties. In addition to the Unicom partnership option, there are several China retail distributors (D-Phone and Shenzhen Aisidi) that would love to help Apple sell the iPhone. However, when all options are analyzed, China Mobile is the name that keeps coming up. They have the massive subscriber base and full support of the China Ministry of Information. China Mobile will also be the first carrier to launch (Summer ’08) the new “built for China” 3G (TD-SCDMA) Network.

“iPhone in China” Questions and Answers

Since there are so many unknowns, we are left to speculate. Here comes the “wild ass guess” portion of the show. We’ll do this in the form of a series of “iPhone in China” questions followed by “best guess” (mostly out of thin air) answers.

Q: Will there be an iPhone launch in China in 2008?
A: Yes! And it is here (in China) now. The black market for iPhone is thriving [Psst! Wanna buy an iPhone?]. You can pick one up for about $680 US Dollars. But an “under the counter” launch is not what Apple and China have in mind. The official iPhone distribution won’t come until a deal is made with a front-line China carrier. It will almost certainly happen next year and the 2008 Summer Olympic Games are a logical launch date. This timeframe coincides with the new China 3G Network (TD-SCDMA) launch, and the Games are an ideal marketing venue.

Bottom line … China wants the iPhone and Apple wants China. It will happen. Stay tuned. It’s a good bet that come August 2008 we will see an “Olympic themed” China Mobile/Apple iPhone ad campaign.

Q: Is Apple negotiating with players (operators or distributors) other than China Mobile?
A: Possibly. It is highly likely that Apple’s primary negotiations have been with China Mobile. There are other potential partners including: China Unicom, Shenzhen Aisidi and Dixintong (D-Phone). Yet Apple appears to have maintained a respectful allegiance (talks only) with China Mobile. As with many negotiations, there have been some disagreements and perhaps a bit of gamesmanship. Chinese sources have released anonymous statements to the press …”Our business model does not entail sharing revenue with manufacturers.” Then more leaks to the press – “China Mobile’s talks with Apple quitted due to the divarication on revenue sharing.” ? Sounds ominous. Yet we later learn that talks never really ended. So what are these leaks all about? Quite possibly a tactic to shave the share of subscriber revenue that Apple has requested.

Bottom line … I do not believe Apple would engage with any parties other than China Mobile unless and until it is clear that a deal cannot be done on terms agreeable to both parties.

Q: What motivations does China Mobile have to make an iPhone deal with Apple?
A: China Mobile may have the biggest stack of chips (356 million subscribers), but the vast majority of their subscribers are pay-as-you-go. And China Mobile’s most valued (high revenue) customers – smart-phone owners on contract – are showing keen interest in the iPhone.

China Mobile might see an iPhone exclusive as a means to:
1. Address declining revenue-per-subscriber (iPhone will come with data-plan fees and fuel growth in fees payable to carriers by way of wireless value-added service providers).
2. Motivate millions of their pre-paid subscribers to go “on contract.” 287 million of China Mobile’s 356 million subscribers are pre-paid (pay-as-you-go).
3. Corral high revenue iPhone buyers who sans a China Mobile deal will buy the iPhone anyway … through the black-market or via another carrier.

When you buy an iPhone from China Mobile, you will go on contract and you will have a data-plan (”Monternet” platform) that will generate significant additional revenues. If China Mobile CEO Wang Jianzhou is looking for a testimonial, he need only ask AT&T CEO Randal Stephenson:

December 10th Randal Stephenson video interview with David Faber on CNBC [Topic: Revenue growth by way of data on wireless] –

“When somebody gets an iPhone in their hand, and here is an Internet capable device in the hand, that customer’s data usage doubles!” Stephenson continues:
“[iPhone] has raised an awareness, in terms of what is possible on a wireless device, like nothing I have ever seen! … Put an iPhone in my hands and I suddenly go from being a skeptic … to a believer!”

In consideration of the iPhone’s potential power to attract and retain China Mobile customers, it is probable that China Mobile has done some iPhone due diligence:
Rated the top smart-phone by Consumer Reports.
Time Magazine’s 2007 Gadget of the Year.
PC Magazine’s Readers Survey 2007 – iPhone …

PC Magazine: “iPhone owners passionately love their devices. In its first year on the survey, the Apple iPhone scored a stunning 9.1 out of 10 from our readers, beating the ratings that every other phone, from every carrier, in nearly every category, has received in the three years we’ve been including cell phones. The iPhone’s 9.6 scores in music and video playback might have been expected, but its 8.2 for call quality (a score significantly better than average), another 8.2 for coverage, and an 8.0 for earpiece volume show that it’s not just the i our readers like. They love the phone, too.”

Q: The press is running stories that China Mobile and Apple have ended negotiations. Are these reports to be believed?
A: No! Statements were made to the press about an impasse over revenue sharing. When the “talks collapsed” rumors persisted in the media, China Mobile issued a statement to correct the record. Negotiations continue. It’s game on …

Q: It appears that China Mobile holds the cards to win on “no revenue sharing.” How can Apple possibly play and win this hand?
A: Apple to China Mobile (just a guess here): “Calling it ‘revenue sharing’ is actually a misnomer” … When a deal is eventually done, I expect the terms might describe ongoing “service fees” paid to compensate Apple for supporting initial carrier activation, and for providing technical support and ongoing iPhone upgrades via iTunes. These service fees will essentially be revenue sharing by another name. Semantics will be important given the public proclamations (“we don’t share revenue”) by China telecommunications execs. Calling revenue sharing by a more appropriate name, and clearing explaining the rationale for said payments, might be an important means to allow all parties to save face.

Is a monthly fee payable to Apple justified? Yes! iPhone is a revolutionary mobile device and Apple provides unique value-add. The first generation model has already undergone several upgrades. These enhancements bring greater customer satisfaction, encourage additional data-plan usage, and help carriers to retain customers. Moreover, Apple iPhone activation and upgrades are delivered and paid for by Apple without the need to involve carrier technology or customer support. Bottom line … Fee-sharing to compensate Apple for their ongoing service/support appears to be a reasonable request.

Q: Is it possible that Apple and China Mobile have already (quietly) reached a deal to launch iPhone in China?
A: Yes! After reviewing a number of stories and media statements, it appears that Apple is presently in serious negotiations with China Mobile. In fact, it is entirely possible that Apple and China Mobile have already sealed a deal. Why would such an important deal be kept secret? Simple. This is not the right time for Apple or China Mobile to make any public announcement. It would only invite non-stop questions about the “new 3G” iPhone model, the contract terms and revenue sharing, etc. This would be too much of a distraction for Apple during the Euro iPhone launch and holiday iPhone sales period. This would also be a distraction for China Mobile as they finalize their new 3G Network (TD-SCDMA) “go live” plans.

Q: Assuming no deal has yet been done, are there any spoilers who may have influence in China Mobile’s negotiations with Apple?
A: Research in Motion (RIM) and Microsoft, to be sure, will not be singing Apple praises. You can also list a few handset manufacturers (Ericsson, Motorola, Samsung, HTC, LG and Meizu) who have their China market-share to protect. The biggest spoiler in the crowd might be Nokia. Nokia sells more phones than anyone in the China. It’s hard to imagine that Nokia will stay silent while China Mobile and Apple play their hand. I keep envisioning a Finnish looking chap, peeking at the cards, leaning over the shoulder of Wang Jianzhou (China Mobile CEO) and whispering into his ear – “Raise the bet … Apple isn’t the only one with a cool touch-screen.” But Wang Jianzhou is nobody’s fool. The iPhone is a popular black-market device, and too potentially profitable to over-play this hand. So no more kibitzing Nokia! Have a Martini (shaken not stirred) and watch the game.

Q: The average Chinese salary is low by Western standards. Can they afford the iPhone?
A: Most of them? … an emphatic no! Hundreds of millions? … an emphatic yes!

The average urban Chinese worker the makes the equivalent of about $120 US dollars per month. The average middle class salary is the equivalent of about $641 US dollars per month. Chinese tend to spend less and save more than their Western counterparts. It is not uncommon for middle class Chinese to spend the equivalent of one month’s salary for a luxury item; particularly if that item (iPhone) has status and gets used every day.

What is most interesting is an October 2007 report on luxury goods consumption in China. The numbers tell a compelling story. China currently has:
An estimated 300,000 millionaires and rising.
A middle class of 250 million (making an equivalent salary of $550 to $1,000 US dollars per month) and rising.
A total population of 1.3 billion, that according to Ernst & Young, spent $6 billion US on luxury goods last year (2006).
And a prediction by investment bank Goldman Sachs that the percentage of China’s populace that purchase luxury goods will rise from 12 percent to 29 percent by 2015. This will place China second only to Japan in global consumption of luxury goods – worth an estimated $80 billion US a year.

Q: What is the potential market-size for Apple iPhone in China?
A: Let’s look at the total mobile user base and pencil in some “back of the napkin” estimates for iPhone. Coming up with 2008 sales numbers may be difficult given the many variables surrounding the official launch date. My sales guesstimates will therefore extend to end-of-year 2009.

As of Spring 2007, there were 523 million mobile subscribers in China (356 million are with China Mobile). The density of subscribers in major cities (Beijing, Shanghai, et al.) is impressive. Virtually 100% have a handset (factor in that many urban-dwellers own more than one phone). As in most nations, high-end (smart) phone owners are the minority – approximately 5%. While this percentage is small, that 5% totals to 26.2 million smart-phone owners. Many are prime candidates for an iPhone. Now add in the fact that the middle class populace in China is growing rapidly and will soon be looking to upgrade their mobile phone and net connectivity experience.

End of Year 2009 iPhone Projections in China Market:

Assume iPhone captures a modest 2% of the 95% (.02 X 496.85 million) cell phone owners in China who presently do not own a smart phone = 9.94 million “moving up” to an iPhone.

Assume iPhone captures 25% of current smart-phone owners (.25 X 26.2 million) = 6.55 million moving to a better smart-phone.

This totals to 16.5 million iPhones in China by the end of 2009. Assuming iPhone launches in August of 2008, this would represent sales over a 17-month period.

Looking out over the next five (5) years, sales numbers for iPhone in China could be enormous. Apple’s iPhone operating system and innovation could very well keep iPhone at the front of smart-phone pack for years to come. Now factor in a recent survey indicating that 80 million mobile users in China ready to switch to 3G. Wireless Intelligence analyst Joss Gillet predicts that China Mobile’s own 3G (TD-SCDMA) connections could reach 100 million users by 2012. Add in another 50 million or so from other carriers and you are looking at huge base of potential iPhone owners.

Q: Who are the China cellular players and what role do they have in this China Mobile / Apple iPhone stakes?
A: The chart below lists a few …

Q: Who said what, and when?
A: See chart below …

Q: Much seems to depend on China’s new 3G protocols. Will China’s 3G be ready in 2008?
A: It appears that China’s new 3G (TD-SCDMA) standard will indeed be ready in time for the 2008 Summer Olympic Games in Beijing. But there are no guarantees and there have been previous “it’s coming soon” missed timelines.

Q: Will iPhone be usable throughout China under the new 3G standard?
A: The new China 3G protocols will not be able to cover all of China for years to come. Hence the new (rumored to be under development) next-gen Apple iPhone chip-sets may need to be compatible with several 3G standards,* and theoretically could be launched in China regardless of whether the new TD-SCDMA standard is ready or remains “under-construction.”

Q: We know that 3G is coming to China, but not much else. Is there any information regarding the status and extent of 3G coverage in China?
A: While China has not yet assigned any 3G licenses, there have been a number of TD-SCDMA “tests.” Experimental TD-SCDMA networks trials began running in four (4) cities in 2005. These test have now been expanded. Deployment scale TD-SCDMA trials began running in ten (10) China cities in April 2007. The Beijing Summer Olympic Games may be the “go live” timeframe for TD-SCDMA.

Here are the cities that should be running the new standard by Summer 2008:
(from North to South)
1. Shenyang
2. QHD
3. Baoding
4. Tianjin
5. Beijing
6. Qingdao
7. Shanghai
8. Xianien
9. Guangzhou
10. Shenzhen

It is no coincidence that six of the ten cities in the China 3G test group are 2008 Olympic Games host-cities. You can also add Seoul (Korea) into this test group. SK Telecom is also running this new China TD-SCDMA trial.

Q: Will China continue to support additional 3G standards until TD-SCDMA is ubiquitous?
A: The official ten-city China tests are using TD-SCDMA handsets (w chip-sets) that support multiple 3G standards – TD-SCDMA + GSM + GPRS. Supporting multiple protocols will ensure that there are no gaps in voice coverage. It’s interesting to note that these China tests also support 3G video-telephony (3G-324M). Now that would be a fun next-gen iPhone feature, wouldn’t it?

I am sure there are many more questions that were not addressed here. Please let me know if you feel that I missed something important. Comments and questions are welcome:

Happy Holidays!

Full Disclosure: The author is long Apple [AAPL] shares at the time of writing.