As China cri­sis bites, Ap­ple may have to eat hum­ble pie

Tim Cook’s bet on the coun­try helped make the tech gi­ant the first $1 tril­lion busi­ness but price rises may have pushed cus­tomers too far. James Tit­comb re­ports

The Sunday Telegraph - Money & Business - - Front page -

Ap­ple is fa­mous for sur­prises. Un­der Steve Jobs, its mer­cu­rial founder and for­mer chief, the com­pany be­came known for the­atri­cal prod­uct un­veil­ings that as­ton­ished and de­lighted fans in equal mea­sure. But last week, it had a dif­fer­ent sort of sur­prise up its sleeve, and not one it had planned. In a let­ter to in­vestors, Tim Cook ad­mit­ted that the com­pany had fallen short of rev­enue ex­pec­ta­tions by bil­lions of dol­lars.

Blam­ing a weak Chi­nese econ­omy, Cook said that iphone sales had dis­ap­pointed, send­ing shock waves through the rest of the tech in­dus­try.

The an­nounce­ment sent shares in Ap­ple plung­ing 10pc, the big­gest one-day fall in more than five years, rat­tling al­ready volatile global fi­nan­cial mar­kets.

Hav­ing lost its crown as the world’s most valu­able com­pany lit­tle more than a month ear­lier, Ap­ple’s mar­ket value pro­ceeded to slip into fourth place, be­low Google’s par­ent com­pany Al­pha­bet as well as Ama­zon and Mi­crosoft.

To many, the re­sponse seemed like an over­re­ac­tion. Cook said that Ap­ple had made around $84bn (£66bn) in the fi­nal three months of 2018, against a prior pre­dic­tion of be­tween $89bn and $91bn. That is still an as­ton­ish­ing amount of money.

“Ap­ple is far from the only com­pany in the his­tory of the stock mar­ket that has had to pre-an­nounce in a neg­a­tive fash­ion. No man­age­ment team is per­fect,” says Brian Baker, of Baker El­lis, an Ap­ple in­vestor. “This time they were a lit­tle bit off. Ev­ery­body makes a mis­take.”

Maybe so. But in Ap­ple’s case, such mis­takes are ex­ceed­ingly rare, prompt­ing ques­tions over whether its stum­ble last week rep­re­sents the end of the era of seem­ingly end­less growth in smart­phone sales that pro­pelled Ap­ple to a val­u­a­tion of over $1 tril­lion. If it is, can Ap­ple re­ally rein­vent it­self – and how?

As a com­pany, Ap­ple is no­to­ri­ously pru­dent about the fi­nan­cial guid­ance it gives in­vestors.

The last time it was forced to cut its fore­casts was in 2002, when Jobs ad­mit­ted that sales of its Mac com­put­ers were slower than ex­pected. There was no iphone back then, and the ipod was brand new. The com­pany’s rev­enues in that quar­ter were $1.4bn, less than 2pc of the “dis­ap­point­ing” sales fig­ure Cook re­vealed on Wednesday. The fact that such un­happy sur­prises are so rare makes them all the more shock­ing. Un­der Cook, Ap­ple has shed much of its old bravado and swag­ger. In­vestors have still done ex­ceed­ingly well, how­ever, as it has pro­duced some­thing else: re­li­a­bil­ity, growth, and a ca­pac­ity to gen­er­ate as­ton­ish­ing amounts of money.

Now, the first two no longer seem true. Ap­ple may still be mak­ing gi­ant prof­its, but last week’s un­sched­uled an­nounce­ment was a big blow to Cook’s rep­u­ta­tion as a safe pair of hands.

Just two months ear­lier, Ap­ple’s chief had as­sured in­vestors that its busi­ness in China was “very strong”, at a time when many be­lieved warn­ing signs such as es­ca­lat­ing trade ten­sions jus­ti­fied a more pes­simistic out­look.

Last week also re­vealed Ap­ple as a shrink­ing com­pany: its $84bn rev­enue pre­dic­tion was not only be­low its own fi­nan­cial fore­casts, but $4bn be­low what the com­pany re­ported a year ago.

A bad quar­ter is one thing, but the news also shook two of Cook’s key strate­gic pil­lars. The first was his full-blooded bet on China, now its big­gest smart­phone mar­ket, but one that Sil­i­con Valley has found dif­fi­cult to crack. The sec­ond was Ap­ple’s strat­egy of con­sis­tently rais­ing iphone prices, and re­ly­ing on con­sumers to keep on stump­ing up more.

Cook es­tab­lished China as a pri­or­ity al­most im­me­di­ately af­ter tak­ing charge of Ap­ple. In 2012 he be­came the com­pany’s first chief ex­ec­u­tive to visit the coun­try, as sales of smart­phones boomed.

Un­like its Sil­i­con Valley peers Face­book, Google and Twit­ter, whose ser­vices are banned by in­ter­net cen­sors, Ap­ple has pros­pered in China, and bowed to Beijing’s con­trols. Apps such as The New York Times have been re­moved from the iphone’s App Store, and users’ data is stored on Chi­nese servers.

Cook’s fo­cus on China paid off and by 2015 it was sell­ing more iphones there than in the

US. But since then, it has not grown as quickly as it would have liked.

Since 2015, Ap­ple’s rev­enues out­side of China have in­creased from $176bn to $214bn, a 20pc rise. In China, how­ever, they have stag­nated. In the com­pany’s fis­cal 2018, sales in the coun­try were $51.9bn, against $53.4bn in 2015.

Ac­cord­ing to data from IDC, Ap­ple’s mar­ket share in China has now con­tracted for six

Ap­ple may still be mak­ing gi­ant prof­its, but last week’s an­nounce­ment was a big blow to Cook’s rep­u­ta­tion

straight quar­ters. “It’s a sat­u­rated mar­ket and the econ­omy is es­sen­tially in re­ces­sion,” says Ryan Reith, an an­a­lyst at the firm.

While the com­pany ac­counts for al­most half of phones sold in the US, and a sim­i­lar pro­por­tion in Bri­tain, in China it has just 9pc, ac­cord­ing to Coun­ter­point Re­search.

This puts it in fifth place be­hind do­mes­tic man­u­fac­tur­ers Huawei, Vivo, Oppo and Xiaomi, which have moved on to Ap­ple’s turf by in­tro­duc­ing hand­sets with high-end spec­i­fi­ca­tions – of­ten at a sig­nif­i­cant dis­count.

De­spite this, Cook has re­mained bullish on China un­til re­cently. “We could not be more pleased with how we’re do­ing … ev­ery­where I look, I feel re­ally good about how we’re do­ing in China,” he told in­vestors less than a year ago.

While the iphone has a ca­chet that its Eastern ri­vals do not, a swell of pa­tri­o­tism amid mount­ing trade ten­sions is seen as push­ing Chi­nese con­sumers to Huawei and oth­ers. Last month, a Huawei ex­ec­u­tive was ar­rested in Canada af­ter be­ing charged by the US govern­ment with break­ing sanc­tions. Wash­ing­ton is seek­ing ex­tra­di­tion, and Ap­ple has been seen as one po­ten­tial vic­tim of an anti-us back­lash in China.

Sev­eral of the Ap­ple ser­vices that give it a key ad­van­tage in West­ern mar­kets, such as its imes­sage app, Ap­ple Pay sys­tem, and App Store, do not play quite the same role in China.

Reith says that this is down to Wechat, China’s dom­i­nant mes­sag­ing app, which is also a por­tal for fi­nances, games and mu­sic. Wechat works just as well on ri­val phones as on the iphone, which means cus­tomers are less in­clined to pay the sig­nif­i­cant pre­mium to buy an Ap­ple phone that they do in the US or Europe.

“[Ap­ple’s ad­van­tage] cer­tainly doesn’t ex­ist to the ex­tent that it does in the West,” Reith says. “In China, any­body us­ing a high-end de­vice or a low-end de­vice, they all spend most of their time in Wechat.”

Smart­phone users may be will­ing to pay more for an Ap­ple de­vice when times are good, but as the eco­nomic pic­ture in China wors­ens, the price dif­fer­ence be­tween an iphone and a lo­cal ri­val starts to mat­ter a lot more. And Ap­ple has made that dif­fer­ence only more ap­par­ent in re­cent years, rais­ing fears the brand may have reached a tip­ping point.

One of Cook’s great suc­cesses has been in in­creas­ing rev­enues from iphone sales, even as the num­ber it sells has flat­lined.

Ap­ple has never been a bud­get brand, but as of late it has be­come su­per-pre­mium. The most ex­pen­sive iphone XS Max costs up to £1,449, al­most dou­ble what the dear­est iphone 6S Plus cost three years ago.

Un­til now, Ap­ple had seemed to defy grav­ity: in its most re­cent quar­ter, the av­er­age sell­ing price of an iphone was $793, up from $671 three years ago.

Ap­ple man­aged to push through price rises even as crit­ics said that the newer ver­sions of its phones had fewer of the ma­jor tech­no­log­i­cal leaps that pre­vi­ous mod­els did.

But last week’s sales warn­ing showed that, per­haps, con­sumers have been pushed beyond what they are will­ing to pay for a phone.

While Ap­ple blamed the Chi­nese econ­omy and the prospect of a trade war with the US, a sit­u­a­tion out of its con­trol, for its strug­gles in the coun­try, it also ad­mit­ted that China was far from the only fac­tor at play. “In some de­vel­oped mar­kets, iphone up­grades also were not as strong as we thought they would be,” Cook said. He said that the stronger dol­lar had meant higher-than-nor­mal price in­creases in some coun­tries, and that cut­ting the price of re­place­ment bat­ter­ies had also been a fac­tor.

James Abate, a man­ag­ing direc­tor at Cen­tre As­set Man­age­ment, sold his shares in Ap­ple shortly be­fore last week’s an­nounce­ment. “The excuse of China is not re­ally the right cause … some peo­ple have an aver­sion to spend­ing over $1,000 on a new phone,” he says. “The rea­son why we sold Ap­ple was that for the first time con­sumers were re­luc­tant to up­grade.”

Now, Ap­ple is left with the night­mare that in­vestors have feared for years: a sat­u­rated smart­phone mar­ket, with lit­tle room to raise prices. Daniel Ives, an an­a­lyst at Wed­bush Se­cu­ri­ties, said last week’s an­nounce­ment will be a “defin­ing mo­ment for Cook”, but one that leaves him with an un­palat­able choice. Ei­ther he chooses to ride out a pe­riod of weak sales and hope fu­ture iphones are good enough to en­cour­age up­grades, or cut prices now and take the hit to Ap­ple’s fat profit mar­gins.

The lat­ter would be an un­usual move for a com­pany un­used to ad­mit­ting to mis­takes, but an­a­lysts be­lieve it is the most likely course. Cook pointed to “a num­ber of steps we are tak­ing to re­spond” to the dis­ap­point­ing sales fig­ures, in­clud­ing mak­ing it eas­ier for users to trade in their older iphones for new ones.

“We can’t change macroe­co­nomic con­di­tions, but we are un­der­tak­ing and ac­cel­er­at­ing other ini­tia­tives to im­prove our re­sults,” Cook said.

All of this, how­ever, could be seen as just tinker­ing around the edges.

The best-case sce­nario for Ap­ple in­vestors would be a mag­i­cal new prod­uct that re­places the iphone. Ap­ple has poured bil­lions into re­search and devel­op­ment in re­cent years. But this seems un­likely.

Cook has said that Ap­ple is work­ing on driver­less car sys­tems, but progress is un­clear, while other com­pa­nies such as Al­pha­bet’s Waymo ap­pear more ad­vanced. The com­pany is also in­vest­ing in aug­mented re­al­ity (AR), a new form of com­put­ing that im­plants dig­i­tal ob­jects into the real world. So far, how­ever, there ap­pear to be few im­me­di­ate uses beyond gam­ing. The al­ter­na­tive, smart glasses that put vir­tual ob­jects di­rectly in a user’s vi­sion, are years away from be­ing good enough for ev­ery­day prod­ucts.

Last week, Cook pointed to the progress it has made in some more re­al­is­tic new ar­eas. Sales of the Ap­ple Watch and Air­pod head­phones, the two most suc­cess­ful prod­ucts launched since Jobs’ death in 2011, have risen by 50pc in the last year.

Sales of Mac com­put­ers and ipads are ris­ing af­ter a tough few years. And its ser­vices divi­sion, which in­cludes apps and mu­sic stream­ing, reached a new record. But noth­ing comes close to the iphone, which still makes up two thirds of Ap­ple’s rev­enues and re­mains one of the most prof­itable prod­ucts on earth. Few items are re­lied upon as much as our smart­phones, and it is hard to imag­ine that chang­ing any time soon. Nav­i­gat­ing the end of its growth story will be Cook’s big­gest test yet.

‘China is not re­ally the right cause … some peo­ple have an aver­sion to spend­ing $1,000 on a phone’

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