[Part 1 of the series is here.]

I. How Are Two Unquestionable Greater China Down Years Somehow Of No Real Concern? Because They Really Only Prove Dormancy in Proper Context.

I know what some of you are thinking. "Let's see you try to make an argument that sounds way too nuanced for its own good."

No one ever said I made things easy on myself! 😁

As I mentioned in Part 1 of this mini-series, when you look at the revenue trends - and even "completely forget" about the macro headwinds or any number of potential external factors from "allegedly boring iPhone 6s and 7 updates" to "the inevitable loss of massive market share to the competition" - you see an incredible anomaly that demands your attention.

The perfect storm of China Mobile carrying iPhone (6 and 6 Plus) for the first time, added to already high enthusiasm for the "big-screen" iPhone from mainland China and Hong Kong in general, meant that Apple's Greater China results reached simultaneously unprecedented and unsustainable heights in a single bound.

To me, there are two possible ways to approach the revenue declines to the high and mid $40B range in FY 2016 and FY 2017:

(1) "iPhone was on some level a 'fad', and Apple's overall Greater China business is in real danger, as the revenue declines themselves demonstrate."

(2) "iPhone demand was indeed 'pulled forward', now we have to see about the overall health of Apple's Greater China business with the explosive one-time sales event outlier out of the picture."

I elected the second, more-objective-less-dismissive approach.

Unless you're a very dedicated bear, or looking at a different theory of Apple difficulty in Greater China not involving numbers, it's hard not to notice that even the FY 2017 revenue number, while about 24% lower than FY 2015 (not factoring in substantial currency volatility), was still around 41% higher than FY 2014. Basically, Apple's recent results in Greater China only look lousy because of FY 2015.

So, starting around 18 months ago, I began looking into the Greater China underlying financials in a little more detail. I was surprised then by what I found, and I remain (pleasantly surprised) now - because Apple has been able to hold the line on overall profitability in Greater China even though iPhone revenues are clearly not what they were in FY 2015.

II. Greater China's Installed Base

About those two metrics I hinted at in the first section of my post. The first, which is more difficult to measure, is installed base of users. In Greater China, and particularly with China Mobile in the picture, that means largely iPhone users, very likely in a greater proportion than many other countries.

Knowing that Apple will never tell how many millions of customers in China have one or more of an iPhone, iPad, Mac, Watch, etc., what do we know about Apple's Greater China installed base?

Not that much, probably by design. I've done a reasonably diligent search of the FY 16-17 earnings calls and coverage, and I found one data point - which is, "China's" installed base grew 34% YOY as of FQ3 2016 (CQ2).

Why the quotes? Tim Cook suddenly - conveniently?...got a little less-than-specific about whether Taiwan and Hong Kong were included in that figure. Then again, mainland China does have the largest addressable market of the three regions...by far. 😂

But wait, there is more. In FQ1 2017 (CQ4 2016, more or less), Tim said:

"We set a new record for services in China, as the company did ..."

"We also saw 50% of our iPhone sales in China were to switchers and first-time buyers, which is a very high number that we're pleased with. Obviously, our total install base continues to grow there, in the strong double digits."

(Emphasis mine for both quotations; handy timesaver transcript courtesy iMore's Serenity Caldwell)

The trail on China installed base ends here, but strongly related clues remained. For FQ2 2017, Tim Cook said: "In Greater China, we were very pleased to see strong, double-digit revenue growth from both Mac and services during the March quarter." (transcript via iMore's Mikah Sargent)

For FQ3 2017, Tim made a brief mention of....yep, Services again, and while it again wasn't clear whether he meant "Greater China" or mainland China, the message was nonetheless free of ambiguity: "services grew extremely strongly during the quarter." (transcript via iMore's Mikah Sargent)

And finally, for FQ4 2017, Tim again: "We hit all-time revenue records for services — for Mac and for the PRC during the quarter." (transcript via iMore's Mikah Sargent) So, at the very least, when you unpack that multi-subject sentence, Tim very clearly touted all-time revenue records for Services in "PRC", also known as mainland China. Of course, Greater China did return to revenue growth that quarter.

Noticing a pattern here? Apple has been thoroughly unworried about China/Greater China's installed base, and all the while kept giving upbeat, albeit vague, statistics about Services growth "in spite of" the two consecutive year-on-year, full-year overall revenue declines.

As I've noted before, there's the iPhone unit growth story, and then there's the story of the ecosystem. Consumers, having taken ownership of their iPhone (and to a lesser degree, iPad, Watch, Mac, etc.), have their own demand curve, which doesn't follow a seasonality pattern; rather, it follows an actual individual demand curve. The consumer either buys into the Apple ecosystem via iCloud, apps, Apple Music, etc., or they don't.[FN-1] And if they happen to like the Apple ecosystem, perhaps they increase their engagement (overall Services spend) over time.

In terms of ecosystem, Apple's apparently done very well in (Greater) China in FY 2016 and FY 2017, having continually grown Services revenue, which, as should be fairly common knowledge now, drives margin above the corporate average.

Which allows us to smoothly transition to the second metric I mentioned at the beginning of this post, one that is easy to track - Greater China operating margin.

III. Apple's Silent, Unheralded Triumph: Scale-Independent Profitability in Greater China

The first chart only SEEMS complex because it contains so very many data points, but all you need to do for purposes of this blog post is focus on the line chart and the y-axis to the right (regional operating margin).

With the singular, continuing exception of Japan, a true outlier for Apple (magenta line), the mostly-undisputed second place in operating margin throughout FY 2016 and FY 2017 goes to none other than yes, Greater China (green line). Rest of Asia Pacific, the third-place geographic segment (black line), did get close to Greater China's operating margin in FQ4 2016 and especially FQ1 2017, but the rest of the time, the profitability gaps in basis point terms were: nearly 400 basis points, twice (1H FY16), over 480 basis points, twice (FQ2 and FQ3 2017), nearly 600 basis points (FQ4 2017), and nearly 700 basis points (FQ3 2016).

Now, to be fair, there was a Greater China operating margin dropoff to 34.45% in FQ4 2016, a level not seen since FQ4 2014. However:

• as you can see from the chart, operating margin per region can be volatile at times (see FQ3 2016 results for Rest of Asia Pacific, Americas, Europe and Japan, while Greater China operating margin actually went up a single basis point!);

• it's kind of a one-off event, seeing as how operating margin for Greater China hasn't dipped below 37% since; and

• for FQ4 2016, Japan operating margin dropped right along with Greater China's, about 458 basis points sequentially to Greater China's 415. (And despite that, worldwide segment operating margin increased about 40 basis points on the strength of the other three revenue geographies.)

In any event, the 34.45% operating margin "one-off" in Greater China did not disturb its consistent ordering as second-most-profitable rev geo for Apple, Inc. Nor did it break Greater China's streak of being more profitable on an operating margin basis than the blended (worldwide) operating margin average since FQ4 2014:

I left the Greater China Revenue bars in to help underscore just how impressively stable operating margins have been (overall) despite the recent revenue volatility downtrend. Quarterly revenues from FQ1 2016 through FQ4 2017 have ranged from $8.004B to $18.373B, but operating margin has not been nearly as volatile, even with the FQ4 2016 dip.

Note how, for instance, Greater China's FQ2 2017 revenues, at a "middling fourth-place" amongst the FQ1 2016- FQ4 2017 dataset, nonetheless managed the second-highest quarterly operating margin despite revenue leverage of about 58% the amount of the mind-boggling FQ1 2016. Not only that, FQ2 2017's operating margin of 39.38% was only 185 basis points from the FQ1 2016 all-time record, despite that greatly diminished revenue leverage. It's true that FQ3 and FQ4 2017's operating margins aren't quite as impressive - then again, tech news and the rumor mill were being absolutely bombarded by current-demand-dampening new iPhone chatter, and news of some strange iPhone design bearing a notch in the display. Additionally, iPhone X didn't actually become available anywhere in the world until November, which is already some weeks into FQ1 2018.

So all in all, I think my thesis that Apple has achieved scale-independent profitability in Greater China is still holding up pretty well considering.

Put differently: While Greater China as a whole, through most of FQ1 2016 - FQ4 2017, was cooling off in terms of iPhone unit sales, the new and existing iPhone userbase there was quite enthusiastic about Apple Services, which bodes well for customer satisfaction with the product plus ecosystem, as well as a key hardware sales metric, repurchase intent.

And Apple has clearly awakened from dormancy in the region, as FQ4 2017 results show. With iPhone X now readily available, can it keep the momentum going throughout FY 2018?

Bonus Section: The Approaching Normalcy of Greater China Financials (Probably)

To wrap up, I have two simple, yet informative "bonus charts" which both make a point and help set the stage for evaluating future Greater China success/less-than-success analysis.

Both charts communicate the following point rather forcefully: Apple has never known "stability" in Greater China over the past five fiscal years. There was extreme volatility to the upside starting around FQ1 2014, followed by six consecutive quarters of year-on-year downturn, "helped" in large part by the brutal year-ago hypergrowth compares of FY15.

Another possible myth busted along the way: "Apple had an unbroken string of revenue/operating income growth in Greater China." On a quarterly, year-on-year basis, that was not true of revenue (see FQ3 2013 on the first, revenue chart) and especially not true of operating income, surprisingly enough (note the three consecutive quarters of year-on-year operating income decline in FY13 on the second chart).

Over the long term, I'm sure Apple wouldn't mind the stereotypical corporate ideal of predictable, unexciting, gradual year-on-year growth in revenues and profitability. Say, year-on-year growth rates between 5-10%, quarter after quarter. Apple may never exactly get that, given seasonality and its higher-risk/higher-reward business model, but it's nonetheless safe to say that the sheer variance in growth/decline over the past few years is set to greatly narrow, particularly in Greater China.

When those lower-volatility days arrive, it'll be a lot easier for everyone to see what Apple's truly capable of in Greater China. Two to three years' worth of data points (perhaps less), even on charts as humble as the two above, may do much to settle the continuing debate over Apple's relative fortunes in this incredible opportunity (and undeniable challenge) of a market.[FN-2]

[Part 1 of the series is here.]

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Footnotes:

[1] It's true that iPhone users in mainland China have certain content restrictions regarding books and movies (nominal revenue for Apple in the region) and VPN apps. However, they still do have access to the rest of the App Store, in addition to Apple Music, iCloud (yes, soon to no longer be operated by Apple itself), AppleCare extended warranties, and so on.

[2] The less volatile the data points, the less complicated the read. A majority of data points in, say, the +0 through +15% revenue and operating income band would read bullish. A significant amount of future YOY data points consistently indicating negative growth would, obviously, read bearish to varying degrees.