Sharing some thoughts on China’s regulatory crackdown, which has been largely focused on the tech sector, and some thought on how this might impact Apple.
Tech crackdown…
- The focus of actions by Chinese regulators seems to be on antitrust issues and handling of user data. These issues are very similar to the antitrust issues we’re seeing in the US. The emergence of platform companies w/ network effects that lead to winner take all or winner take most dynamics, which results in a few companies with monopoly power. There are a couple key differences however in China. The first is that they can deal w/ these issues swiftly (which they are) w/out the lengthy political process required in the US. No compromises required. And second, is that most of the tech stocks they are cracking down on are “offshore” stocks, listed outside of China. Chinese investors have limited options to buy shares of these companies. It’s created a divergence in China A share “onshore” indexes (more weighted towards industrials, financials, staples) and broader China indexes (heavy tech concentration). https://www.wsj.com/articles/tech-crackdown-hits-chinese-stocks-just-not-in-china-11623231001?mod=article_inline
What does this mean for Apple? … Apple is not immune however there are some mitigating factors…
- China is a huge market for Apple and is essential to their supply chain. Greater China (which includes China mainland, Hong Kong and Taiwan) is mid to high teens % of sales.
- Apple has already made multiple concessions to Chinese regulators on how they store Chinese consumer data and removing apps from their app store as requested. So they’ve been accommodating to the government. In 2016, China passed a law requiring that all “personal information and important data” that is collected in China be kept in China. China could shut down iCloud in the country if Apple did not comply with the new cybersecurity law. So Apple moved the personal data of their Chinese customers to the servers of a Chinese state-owned company (essentially giving the gov access). And they actively remove apps related to topics that the government forbids, like the Dalai Lama, Tiananmen Square, anything that’s critical of the Communist party etc. Chinese iPhones even censor the emoji of the Taiwanese flag and their maps suggest Taiwan is part of China.
- https://www.nytimes.com/2021/05/18/technology/apple-china-investigation.html
- https://www.nytimes.com/2021/05/17/technology/apple-china-censorship-data.html
- https://www.nytimes.com/2017/07/12/business/apple-china-data-center-cybersecurity.html?action=click&module=RelatedLinks&pgtype=Article
- China might be afraid to go after Apple too hard given Apple is a huge employer there and b/c of China’s reliance on the US for key technologies related to cutting edge semis.
- Most of Apple’s assembly occurs in China (though China accounts for little in the value of components). The Chinese government spent years attracting the manufacturing of products like Apple’s devices. Foxconn (a Taiwanese company) is the largest private employer in China and Apple is their largest customer accounting for over 50% of revenue. Foxconn’s manufacturing facility in Zhengzhou is where about half of all iPhones are manufactured. The government reportedly subsidized the plant, built necessary infrastructure, gave tax breaks to Foxconn and created a special customs zone to make iPhone sales into China easier. This manufacturing facility has become the lifeblood of Zhengzhou, which is often referred to as “iPhone city.”
- China is dependent on foreign technology (especially the US) for semiconductors, particularly in leading edge semis. They have been trying for years, but don’t have the ability to produce leading edge chips which underpin basically all advanced technology products across sectors – from smartphones, to airplanes, to enabling AI. The top priority of the “Made in China 2025” plan, which is geared at narrowing their technology gap, is developing a domestic semiconductor industry. They are doing this because they fear their dependence on the rest of the world for this technology. And also rising labor costs are narrowing their labor advantage, pushing government efforts to move up the value chain. China accounts for about 45% of global semiconductor demand, ~90% of which are imported. In fact, they spend more on importing semis than on oil. Many of those chips get sent to China and put into devices that are then exported. China’s primary input to the iPhone is low cost labor; the high value components come from elsewhere. Part of the risk for Apple is that it’s not quick and easy for companies, like Foxconn, to shift manufacturing capacity. Ultimately, China might fear damaging the US’s most valuable company given their reliance on the US for semiconductor technology.
Tutoring…
- The government has also focused their regulatory crackdown on the education sector. New rules would force tutoring services for “compulsory years of education” to be run as not-for-profit operations, introduce fee standards, ban the companies from capital-raising and foreign ownership.
- Why are they doing this? Spiraling education costs have deterred families from having more children – the government is now looking to encourage births after ending their one-child policy in 2016. In May, they increased it to 3 children. “The purpose is to ensure that kids get proper education. It’s not to wipe out the entire market and destroy everyone’s portfolios.” I’ve linked a couple interesting articles from the WSJ on the subject.
What’s next?
- Authorities could later turn their focus to other areas that they consider out of control, such as healthcare and property – “These sectors are areas where the most painful reforms have to be done.”
Sarah Kanwal
Equity Analyst, Director
Direct: 617.226.0022
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square, Suite 500
Boston, MA 02109
$AAPL.US
[category equity research]
[tag AAPL]