China May No Longer Be Apple’s Great Firewall

The iPhone maker is feeling the effects of an economic slowdown in its most important market.

Will Slowing iPhone Sales Rot Apple’s Core Growth?

China has been one of Apple's most reliable strongholds during its historic stretch of technology dominance. Even when sales began to level out in the U.S., Europe, and Japan, China was a buffer, promising a massive market of newly middle-class customers looking for a high-end, brand-name smartphone. Sales in Greater China, which also includes Taiwan and Hong Kong, grew 84 percent to $58.7 billion in 2015, making it the company's second-biggest market after the U.S. Apple Chief Executive Officer Tim Cook showered the region with praise at the time for its importance to the company's future.

Apple's reliance on the country is now being put to the test. On a conference call with analysts after its Tuesday earnings report, Cook said the company is beginning to see "economic softness" in the region, particularly in Hong Kong. China is no longer able to offset sluggishness elsewhere or counter the broader slowdown in the global smartphone market. Even with the Chinese New Year shopping season approaching, Apple is projecting its first quarterly sales decline since 2003.

“You need to take into account the business opportunities that we have but also the realities of an economic environment that is not ideal right now,” said Luca Maestri, Apple's chief financial officer, noting that sales in Brazil, Canada, Japan, and Russia also are being affected by global economic malaise.

Cook remains optimistic about China and vowed that Apple will invest through any downturn. And given the company's resources (there's still a whopping $216 billion on its balance sheet), he has the luxury of playing the long game. It has 28 stores in mainland China now and will have 40 by this summer. "We believe that this, too, shall pass," Cook said. "We aren't retrenching. We don’t believe in that. We are fortunately strong enough to continue investing, and we think it's in Apple's long-term interest to do so."

Demographic trends are working in the company's favor. Roughly 80 percent of people in the country are still using older phones that run on 3G networks. Those customers will be up for grabs when they finally decide to upgrade. In 2010, Cook said less than 50 million people in China were considered middle class, but by 2020, that number is expected to jump to 500 million. Apple is poised to benefit in the longer term if China shifts toward a more consumer-led economy, away from its emphasis on manufacturing. "I don't subscribe to the doom and gloom predictions," he said.

Even so, Tuesday's results make clear Apple is no longer a hyper-growth company that's riding the twin coattails of a booming smartphone market and buoyant Chinese economy. For the first time since Steve Jobs introduced the iPhone in 2007, the company is projecting that quarterly phone sales will fall. Sales in Greater China may also fall. Meanwhile, other products such as the iPad (down for eight straight quarters) and Apple Watch (no sales figures provided) show no signs of filling the void.

Apple shares were down 4.8 percent to $95.18 at 10:04 a.m. in New York and earlier dropped as much as 5.3 for their biggest intraday decline since Aug. 24.

In an interview after its earnings report, Maestri said Apple's expanding services business will be a source of future growth. The company generated $31 billion in such revenue from the App Store, Apple Music, iCloud, Apple Pay, and other services last year, he said, making Apple one of the biggest Internet services companies in the world. 

But investors remain skeptical, sending the stock down about 20 percent in the past six months. When it comes to evaluating Apple, they really only care about the iPhone. Without the benefit of a booming Chinese economy, Apple is going to have to gin up another product—can we get a car, perhaps?—to keep them happy.

(This story previously corrected store numbers in mainland China in the fourth paragraph.)

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