Apple faces stunning, persistent peril from trade war

As a company, Apple (AAPL) is usually bulletproof. Unfortunately, the iPhone maker is hopelessly stuck in the middle of the U.S.-China trade war, and the real “shooting” has only just begun.

Apple is a prime beneficiary of globalism. It deploys assets where return on investment is greatest. This means its products are designed in Silicon Valley, components are sourced in Asia, and finished goods are assembled by partners in Chinese factories.

It’s a great business model … but one that the Trump administration wants to blow up.

Jack Ma is the founder and executive chairman of Alibaba (BABA), a $410 billion Chinese e-commerce giant. Although he does not write computer code or have extensive business experience, he amassed a $35 billion fortune by getting big trends right. At an investor conference last week he warned U.S.-China trade hostilities might last 20 years.

Ma believes the trade war is designed to impede the growth of China as an economic power. In the past two decades, that growth has lifted millions of Chinese out of poverty and into the middle class. They are moving to cities. They are becoming global consumers.

He argues there is no going back. The Chinese government will never back down.

Apple has benefitted mightily from the Chinese economic miracle. While privacy and intellectual property concerns have kept Amazon.com (AMZN), Alphabet (GOOGL), Facebook (FB) and Netflix (NFLX) from investing in China, Cupertino has gone the other way.

Tim Cook, Apple’s chief executive officer, has been a frequent guest of Xi Jinping, the Chinese President. Cook has toured factories and industrial cities. He committed in 2017 to invest $500 million for research and development centers in Shanghai and Suzhou. A year earlier, Apple took a $1 billion equity position in Didi Chuxing, a Chinese ride hailing company.

In 2013, Apple began building out a massive retail footprint in the country. Today, it has 41 Apple Stores in greater China. Outside of the U.S., where the company has 271 locations, China is the largest market. And with $44.7 billion in annual sales in 2017, the business accounted 20% of all sales.

The prospect of a prolonged trade war would be devastating. At least in public, Cook is putting on a brave face.

During the fiscal second quarter conference call in May, he told analysts China and the U.S. have unavoidable mutuality. As Cook sees it, China only wins if the U.S. wins, and vice versa. It’s a popular viewpoint, and probably true.

Unfortunately, it is politically untenable in the current environment. The Trump administration wants to reverse globalization. On many occasions during the presidential campaign, candidate Trump boasted he would bring iPhone manufacturing back to the United States.

While that sounds good on the surface, Greg Ip of the Wall Street Journal explained in a column this week that it would be a “hollow victory,” bringing back less than 60,000 jobs that are, at any rate, relatively low in the value-add process.

And that’s the risk to Apple shareholders. The company has a significant business in China. Its supply chain is there. Its profitability depends on deploying assets where the rate of return is greatest.

Both President Trump and President Xi are in a position to hurt each other by hurting Apple domestically.

For example, President Trump might impose tariffs on Chinese-made iPhones imported to the U.S. to coerce Apple to move manufacturing stateside. President Xi might make it more difficult for Apple to sell its products in China. According to reporting from the New York Times, the prospect has been discussed internally at Apple.

Limiting sales would be the logical strategic move. U.S. lawmakers recently levied bans on Huawei and ZTE phones. Reciprocal action would send the resounding message that China will not back down. Not ever. It would be a direct attack on an iconic American brand.

It would also hurt Apple, a lot.

In fairness to Cook, in 2017, Apple employed 77,000 people in the U.S. Most of those jobs pay very well. Employees get great benefits and perks. And the company has been a model for civic ethics.

Unfortunately, Apple is in the middle of a conflict where the combatants view it as expendable. Normally, the company deftly avoids this sort of thing. So far, it has. However, as hostilities escalate, and the generals become more desperate to up the ante, it’s hard to see how Apple gets away unscathed.

Jack Ma is right. The trade war is more likely to last 20 years, than 20 months or 20 days. The goal is to change the global order. Politicians, even after President Trump, will be emboldened to push for concessions. China will not relent. It can’t afford to go back.

Longer-term investors should recognize the risk inherent in Apple shares.

Also, in today’s market, you have the chance to profit handsomely in shorter-term trends in Apple and other blue-chips.

Best wishes,
Jon D. Markman

Leave a Reply

Your email address will not be published. Required fields are marked *

Comments 3

  1. JGD September 21, 2018

    China doesn’t have to go backward, they just need to quit stealing our IP. The business leaders who greedily sign up for these 51% deals or nothing are cheating their US stockholders. They took the easy way out at the expense of the US and the Chinese knew their greed would be the only leverage needed. The politicians have been shown to be nothing more than a bunch of sniveling weaklings who make side deals for their family members (read Peter Schiewzer), so you can’t expect them to stand up. When Trump is gone, it will be back to the spineless sniveling ways of before, lining their pockets. They should have a fiduciary responsibility to stockholders and Wall Street analysts should be holding them to it just like they should be on cyber security but they all let it slide as a cost of doing business.

    Reply

  2. Robert Baker September 22, 2018

    9/22

    Jon,

    I do hope you are wrong, &U that this TARIFF NONSENSE is just a phase President Trump is going through,
    that will end before the end of the year.

    China has to realize, that they CAN NOT POSSIBLY WIN A TRADE WAR WITH THE U.S.

    Reply

  3. John K October 15, 2018

    We have been in a trade war for many many years. No one is asking China to go back. We just want them to stop trying to leap-frog us by using crooked and unfair tactics such as forced technology transfer and espionage. All we want is an even playing field. And, President Trump realizes the reality of the unrelenting drive of the Chinese for hegemony by any means, and he is the only one that has the will fix it.

    Reply