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Apple Profit Surge Fueled by China Teachers to Furniture Makers

Li Wenhua, a 35-year-old school teacher in Beijing, left work early last week to buy an iPhone -- even though she didn’t need it for work and wasn’t planning to use many of its features.

“A lot of people in my office use it and said I should get one, so I did,” Li said as she exited Apple (AAPL) Inc.’s Joy City Mall store. “I chose it just because it’s beautiful. I like the style.”

The must-have sentiment helps explain why China made up 20 percent of Apple’s sales and fueled a 94 percent profit surge last quarter. Hundreds of miles from Foxconn Technology Group plants where iPhones are built, shoppers in Beijing, Shanghai and other cities are flocking to the devices and making their country a centerpiece of the company’s growth strategy. Like Starbucks Corp. (SBUX) and Yum! Brands Inc., Apple is benefiting from rising wages that give Chinese citizens more disposable income.

“China has an enormous number of people moving into higher income groups,” Apple Chief Executive Officer Tim Cook said this week on a conference call with analysts. “There’s a tremendous opportunity for companies that understand China, and we’re doing everything that we can to understand it and serve the market as good as we can.”

Apple sold 35.1 million iPhones in the fiscal second quarter, an 88 percent increase from a year earlier, and higher than the average estimate of analysts surveyed by Bloomberg. That came after the January release of the most recent version of the iPhone in China and 21 other countries.

‘Zero to $13 Billion’

China accounted for $7.9 billion of Apple’s $39.2 billion in sales in the period that ended March 31. In the first six months of this fiscal year, Apple’s sales reached $12.4 billion in China, almost matching $13.3 billion, the total for all of last year. Before the iPhone’s debut there in 2009, the company had less than $1 billion in annual sales in China.

“I don’t know of any other company that has driven its sales from virtually zero to $13 billion in a few years,” said Donald Straszheim, a senior managing director who heads China research at ISI Group LLC in Los Angeles. “There’s a growing appetite for Apple products.”

Once considered a niche computer maker with a smaller international footprint than competitors such as Hewlett-Packard Co., Apple has used products including the iPhone and iPad to become one of the world’s biggest electronics makers. The Americas made up only 35 percent of sales last year, down from 48 percent in 2007. In the same period, sales in the Asia- Pacific region, which includes China, grew to 21 percent from 7 percent. Last quarter, international sales made up 64 percent of the total.

Offsetting U.S. Declines

Sales in China and other countries last quarter helped make up for a drop in iPhone sales in the U.S., where the new model went on sale in October. AT&T Inc. (T) and Verizon Wireless, the largest U.S. carriers, said iPhone sales fell last quarter compared with the previous three-month period.

In China, Apple sells its products from six company-run retail outlets and its online store, as well as a network of thousands of authorized resellers. Wireless carriers such as China Unicom (Hong Kong) Ltd. (762) and China Telecom Corp. also sell the iPhone. Lines of unauthorized sellers sell the company’s gadgets a short walk from its flagship stores in Beijing.

The appeal extends beyond the iPhone.

At the same store where teacher Li bought her device, Chu Fuzhan, a 42-year-old manager in a furniture-manufacturing business, said he was buying a new MacBook to go along the iPhone and two iPads he already owns.

‘Quality and Style’

“Everywhere around the world, people love the quality and style of Apple products, and now people want that in China too,” Chu said. “I wanted to be part of that.”

Photographer: David Paul Morris/Bloomberg

Tim Cook, chief executive officer of Apple Inc. Close

Tim Cook, chief executive officer of Apple Inc.

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Photographer: David Paul Morris/Bloomberg

Tim Cook, chief executive officer of Apple Inc.

Mac sales rose more than 60 percent in China last quarter, compared with 7 percent globally, Cook said this week.

Apple’s growth probably won’t slow any time soon. According to a report published last year by Credit Suisse Group AG, China may generate almost $30 billion in sales for Apple by 2015.

“They are just scratching the surface with China, with the iPhone being the highlight,” said Chris Jones, an analyst at Canalys in Palo Alto, California. “There’s still a tremendous amount of upside as they get more carriers and more points of sale in the market.”

Apple will get another boost if the iPhone becomes available on China Mobile Ltd. (941), the world’s largest mobile-phone carrier, with more than 660 million users. China Mobile said last month that it and Apple are “working very hard together” on an agreement to have China Mobile carry the iPhone.

Siri in Mandarin

Even without a formal deal to provide an iPhone with a service contract, more than 15 million China Mobile customers are using an iPhone on the company’s 2G network.

To extend its appeal in China, Apple may need to add features tailored to Chinese users, said Nathan Washburn, an assistant professor at the Thunderbird School of Global Management, who studies business management in China.

Many Chinese iPhone owners use separate phones for texting because the Apple’s device isn’t well equipped for Chinese characters. Siri, the voice-recognition software in the new iPhone 4S, doesn’t work with Mandarin, though Apple says the tool is coming this year.

“They need to be sure the product is tailored to the needs of the Chinese market,” said Washburn. Failing that, many customers may regard it as a status symbol with limited appeal beyond that, he said.

Pelted With Eggs

Apple will also need to manage the expectations of the Chinese public eager to own its gadgets. Police were called in to break up a crowd that pelted an Apple store with eggs in January after growing frustrated that iPhone sales were delayed.

The company is hardly alone in attempting to benefit from the spending power of Chinese consumers. Samsung Electronics Co. and other phone makers using Google Inc.’s Android operating system are outselling Apple, said Shaun Rein, managing director of the China Market Research Group. The company ought to release its products sooner in the Chinese market, he said.

“Apple is a good story in China, but they are succeeding in spite of themselves,” Rein said. “They are winning because they have a great product, but they are underperforming when it comes to localizing and understanding the China market. They should be releasing products in China first.”

In a sign of China’s growing importance to Apple, Cook visited the country last month, meeting with government officials and touring factories where its devices are made.

‘Exclusive Few’

The visit came after the company had faced criticism about its labor practices in the country, including excessive overtime and unsafe working conditions.

Foxconn is putting in place changes, such as higher wages and reduced overtime of assembly plant workers. Investors and analysts will be watching to see whether the new policies will reduce Apple’s profit margins. Gene Munster, an analyst at Piper Jaffray Cos., said the impact could be minimal, with costs bringing margins down by 1 percentage point over time.

In another example of the challenges of operating in China, Apple also has been entangled in a legal fight there over the trademark for the iPad. Proview International Holdings Ltd. (334), a Hong Kong-listed company, has claimed ownership of the name in China, an assertion Apple says isn’t true.

If Apple faces obstacles in China, there was no sign of them at the bustling Apple store at the Joy City Mall.

Chu, the furniture worker, summed up his desire for Apple products by saying, “I wanted to have the experience of being one of the exclusive few.”

To contact Bloomberg News staff for this story: Adam Satariano in San Francisco at asatariano1@bloomberg.net; Edmond Lococo in Beijing at elococo@bloomberg.net

To contact the editors responsible for this story: Tom Giles at tgiles5@bloomberg.net; Michael Tighe at mtighe4@bloomberg.net

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