Apple Loses a Big One in China

China Mobile confirms that it has ended talks to team up with Apple on the iPhone. Maybe China Telecom is a better bet as a partner

Apple (AAPL) and China Mobile seemed like such natural partners. Apple, whose iPod has eclipsed all rivals, has been shaking up the telecom industry with its iPhone since last June. Like Apple, China Mobile enjoys overwhelming dominance in its market. Apple is king of the hill in digital music players while China Mobile rules in the world's largest cellular market. China Mobile's 370 million subscribers make the state-owned operator the world's largest mobile-service provider.

So investors cheered last fall amid widespread speculation that the two powerhouses were talking about teaming up to launch the iPhone in China. But even as smuggled versions of the iPhone (, 1/24/07) became trophy gadgets for the country's digital elite, talks stalled. And today, China Mobile made it official: Talks are off, a China Mobile spokesperson told reporters. Apple's Hong Kong-based spokesperson would not comment.

The problem for Steve Jobs, it turns out, is that he chose a potential partner with an even stronger hand than his. China Mobile has 70% of the Chinese cellular market and likely had 2007 profits of $11.4 billion, up 28% over the previous year, according to an estimate by Macquarie Bank. The company does that without having to bother with handset sales in China, where the U.S. model of operators buying phones from vendors and then selling them to consumers isn't popular.

Not a Lot of Options for Apple

It's not surprising, therefore, that China Mobile wasn't willing to go along with the sort of deal that Apple has cut with less formidable partners such as AT&T T. "They are just steamrolling over the competition at this point," says Dave Carini, an analyst in Beijing with research firm Maverick China. "Things just look great for China Mobile right now."

China Mobile's near-monopoly discourages some would-be partners from even trying. "China Mobile is the dominant player [and] they have such strong bargaining power," says Neil Shen, founding managing partner of Sequoia Capital China, the Hong Kong- and Beijing-based arm of Silicon Valley venture-capital firm Sequoia Capital. For anyone thinking about trying to do something related to mobile music in China, "it just makes life more difficult," says Shen.

So where does that now leave Apple? In the short term, without a lot of options. There's only one other company, state-controlled China Unicom, that's allowed to offer cellular service today in the country. The company has Houston Rockets basketball star Yao Ming featured in its ads, which could provide Apple with some of the pop-culture credibility it probably wants among young Chinese. But China Unicom has struggled for years after having been forced by the government to offer two networks, one using GSM technology and the other using Qualcomm's (QCOM) CDMA technology. And the company might not even be around much longer. Rumors have swirled for months among people who follow the telecom in China that Beijing will restructure the industry and merge China Unicom into a fixed-line operator.

China Telecom Might Be a Less Demanding Partner

Another possibility for Apple is to team up with China Telecom, the largest of the two fixed-line carriers. While China Telecom doesn't have a license to provide cellular service now, it has had mobile customers through its cellular-like PHS (personal handy-phone system) service, which allows customers to roam within a city using their fixed-line accounts. More importantly, China Telecom is vying to win permission to become a full-fledged cellular provider by winning a 3G license from the government, which has delayed the launch of 3G service in China until developers ready a local-made 3G standard called TD-SCDMA that Beijing hopes can compete against foreign-developed 3G technology.

As a new entrant to cellular, China Telecom might be more willing to accept Apple's demands, says Liu Bin, an analyst with Beijing market research and consulting firm BDA China. "China Mobile won't accept the same model as [Apple has] in the U.S., but if in the future China Telecom gets a 3G license, it may be a potential customers for the iPhone," says Liu. The product "is more of a market driver for small or greenfield operators," he adds. For China Telecom, "it could be more attractive."

Apple will probably need time, though, before a partnership with either China Telecom or China Netcom, the other fixed-line operator, becomes viable. Beijing's regulators have stalled the launch of 3G in China because Chinese engineers have been unable to iron out all the kinks in the homegrown technology. While trial networks are now up and running nationwide, the government still hasn't indicated when it will announce its policy regarding licensing. Many people in the industry had hoped last year that the government would move well ahead of the 2008 Olympic Games in Beijing this summer, but 2008 has arrived and there's still no word.

Trying to Avoid Embarrassment at the Olympics

The chances of the government doing anything in time for the Games are shrinking, adds Liu, since regulators will probably want to consolidate China's four telecom operators into three before the 3G launch. And restructuring can't happen so close to the Olympics, for fear that the result will be embarrassing technical glitches at a time when the world is focused on China as never before. That means Apple will probably need to wait much longer before it finally finds a partner for the iPhone in China.