Apple’s China “Crisis”

It’s been a strange week for everyone in the market – but especially Apple. In a rare turn of events, CEO Tim Cook threw caution to the wind and came out publicly, calming the market about Apple prospects, even in the face of the Chinese market collapse. But China is a mixed bag of opportunity and danger for many, including Apple. Maybe there’s a reason that “crisis” in Chinese is a combination of two characters – danger + opportunity. The implications for Apple?

Roller coasters are a lot of fun when they’re in theme parks. But on Wall Street, no one loves a roller coaster ride — or, as we’ve experienced this week, an inverse roller coaster ride.

Most coasters start with a long and suspense-building climb before the plunge. This week’s wild ride in the stock market got right to the point and kicked off with a 1,000-point stock drop right out of the gate. Tuesday’s open had the appearance of a turnaround, but despite getting up by as much as 400 points throughout the early buildup, the market went cold right at the end of trading, and wiped out the day’s gain.   

But the U.S. markets bounced for real this time on Wednesday and managed to close 600 points up — combined with gains as of the time this article was written. By the midway point in Thursday’s trading in the U.S., most of the early week losses had been erased.


Yet concerns persist.  

Chinese market instability is what set off the six-day stock sell-off, and the Chinese outlook remains a concern.

“The downward trend has not changed. The market is on track to bottom out,” said Shenzhen-based Yang Delong, chief strategy analyst at China Southern Asset Management, in an interview with The Washington Post. “The rebound [in China] is a technical rebound. It is the market self-correcting after several recent big drops.”

And while bad news for China has proven to be tough for the entire global economy, it is particularly hard on Apple. Investors were so worried about it Monday, that Apple’s stock briefly dipped below $100 per share. The situation turned around — with a surprising intervention from Apple’s chief himself — but some Apple watchers are still nervous.

As it turns out, Apple is in an unusually interdependent relationship with China – and faces more than average risk from economic weakness overseas. Which means that while others in the global economy may be hopping off the roller coaster this week, Apple may have merely been getting a taste of things to come.  

A Diminished Market For Goods

While the fireworks were particularly bright this week, concerns about Apple’s exposure to China have been cropping up for the last month and have been one of the factors that has contributed to the 23-percent erosion in Apple’s stock price during that period.   

Apple has been a favorite brand of the emerging Chinese middle class. Sales in-nation are growing faster than they are worldwide – and Apple’s global sales are pretty strong.  

But, Apple’s Chinese sales growth has been astonishing.  

Last fiscal year, China generated $29.85 billion in sales – a 135 percent pick up from three years earlier. During the last quarter, iPhone sales shot up 87 percent — but the general smartphone market in China only grew 5 percent, indicating that it has quite a lot of potential ground to capture.  

And Apple will like be looking west for that growth, particularly as the U.S. market is approaching saturation with the latest iPhone release‚ and there’s no apparent successor to the iPhone as an alternate revenue generator, at least so far. However, Apple’s continued success in the Chinese market depends on a Chinese middle class that continues to grow, thrive and feel comfortable spending.  

Which, it should be noted, China’s premier Li Keqiang has every confidence it will, as he believes the general economic conditions in China are much better than currently believed.

“Fundamentally, the overall stability of the Chinese economy has not changed, and positive factors sustaining a turn for the better in the real economy are accumulating,” he said in a meeting Tuesday, state media reported.

And that’s a view the premier of China seems to share with Apple CEO Tim Cook.

“I get updates on our performance in China every day, including this morning, and I can tell you that we have continued to experience strong growth for our business in China through July and August. Growth in iPhone activations has actually accelerated over the past few weeks, and we have had the best performance of the year for the App Store in China during the last two weeks,” Tim Cook wrote in a note to Jim Cramer on Monday, hoping to soothe investors who had becoming unusually sell-happy with their Apple stock.  

“Obviously I can’t predict the future, but our performance so far this quarter is reassuring. Additionally, I continue to believe that China represents an unprecedented opportunity over the long term as LTE penetration is very low and most importantly the growth of the middle class over the next several years will be huge,” Cook added.

Sure, tell that to the Chinese middle class guy whose stock market fortunes just got wiped out. Chinese stocks, generally, have lost half of their value in this latest rout. And the emerging middle class investor may be feeling a lot less confident about spending money on anything, much less a pricey iPhone. Building that shaken confidence is why the Chinese government is taking such extraordinary steps to pump liquidity into the market.

Which could create big headaches for Apple.

Selling In Yuan, Paying In Dollars

The relative strength of China’s economy and middle class is only part of the equation for Apple. Since the way China smoothes out its economy is unusually important to Apple, a very devalued yuan is a big problem because of how Cupertino pays and gets paid in China.  

When Chinese consumers buy iPhones, they pay in yuan. And because Apple as a general rule doesn’t change its retail price in response to currency fluctuations, a big drop in the value of Chinese currency means they are making less per unit sold.

This means Apple can continue selling a ton of phones to the Chinese middle class — if the yuan is entirely devalued, they won’t be taking in as much revenue as they want to be. And given that last quarter 27 percent of Apple’s revenue — and 50 percent of their revenue growth — came from China, that is not a small hit to their bottom line.  

Now you might be thinking “right – but doesn’t Apple manufacture most of their stuff in China? So they’re losing retail dollars – but saving big on manufacturing costs, right?”

Wrong. Apple doesn’t pay its big suppliers like Foxconn and Lenovo in yuan – those contracts are all negotiated in dollars. Meaning while a weak yuan can reduce Apple’s revenues, it will have no lowering effect on their costs. Boeing faces a similar issue in China – though their sales are priced in dollars, not yuan, so they are somewhat less exposed than Apple.  

In short, Apple needs its Chinese customer base stable and spending, but it also needs them to be spending a home currency that has not been radically devalued, or that spending won’t be helpful enough.

The Hazy Outlook

Of course, in the marketplace, any number of things can change. The China picture is drawing a lot of doom and gloom predictions now, but if market volatility slows down going into fall, concerns could still abate in much the way the Chinese premier (and Tim Cook) thinks they will.

Apple could also see a secondary product emerge to provide an income stream comparable to the iPhone. This week, IDC released figures that indicate Apple has shipped 3.6 million of its wearable device – implying it has been somewhat more successful than some analysts had projected. That follows reports from Best Buy that the Apple Watch was a big enough hit to actually boost the stores earnings.  

However, while getting to the No. 2 spot in the wearable world (behind FitBit) in a short time is a notable accomplishment, it seems at least for now the Apple Watch won’t quite have the mass appeal the iPhone does.  

Which means Apple probably still needs China — and will be watching very closely to see just how the recent economic unrest will work itself out.