[Part 2 is here.]

From a Bloomberg Gadfly piece - opening sentence - posted on Dec. 3, 2017: "Tim Cook is desperate to hold onto any remaining scraps of the China market." (I'd link it, but...nah.)

Sure sounds like trouble, doesn't it? Hardly a rare narrative these days. Just do a web search on, say, "Apple China Problem" on your search engine of choice. Apple's revenues have been in two-year decline in the region, and that alone seems to be all the naysayers and a decent amount of commentators need to know.

"Despite all this turmoil", however, Apple continues to be the (apparently quiet) absolute envy of the world, in one of the world's trickiest places to do business. Yes, even though Apple's annual revenue in that financial geography has slipped by around 25% since its peak in FY 2015.

Surely I can't be serious? Well this post/article, if nothing else, makes one main point.

Contrary to common, if not popular, belief, Apple's Greater China business (important proviso: up to this point) has actually remained completely untroubled while waiting for "iPhone X and Friends".

That's right, even though Apple, by its own admission, got caught flat-footed by weaker-than-anticipated iPhone demand during the iPhone 6s cycle.

The evidence for my "outlandish"-sounding claim? That surprisingly steady metric I've mentioned before, operating margin.

That's for Part 2, though. First, I build my case with some background and context.

* * * * * * * * * *

I. Apple in China, FY 2009 to the present

As I've noted before, most commentary...skeptical in tone about Apple in Greater China seems to stop tracking that revenue geography's (rev geo's) historical financials riiiiight around the time financials started tracking downward. If you're lucky, you'll get a data point somewhere in FY 2014. (And one particular well-known tech commentator devoted about 10 words to only one 2014 data point in a recent article.)

Honestly, that's disappointing, since Apple's had China-region revenues I'd consider "significant" ($1B and up) since FY 2010 - with the relevant historical information not particularly difficult to find. So, here's how things got started in China (implicitly defined by Apple as Greater China, ex-Taiwan until this fiscal year), as far back as Apple allowed us to see.

>>> "The Early Years": FY 2009 through 2011

FY 2009: The first (annual) data point. A mere $769M worth of revenue, against Apple's $42.9B in revenue for the year. (Aw, Apple was so "little" then!)

FY 2010: Then, an iPhone 4-fueled jump of nearly 260% YOY to about $2.76B in revs, compared to Apple's worldwide revenue of $65.2B (52% overall growth YOY).

FY 2011: What next? An even bigger jump of around 350% YOY to $12.47B in revs, compared to Apple's worldwide revenue of $108.2B (about 66% growth YOY). At this point, China became the second country in Apple's corporate history to ring in more than 10% of its total revenues, apparently "forcing" Apple (under GAAP) to specifically account for it in its 10-K filings.

>>> Something Greater: FY 2012 through 2015 [FN-1]

FY 2012: How to follow up revenue growth of around 15x from FY 2009? With another tremendous leap of around 90% YOY. Not a bad way to launch Apple's newest revenue geography of "Greater China". Apple managed a somewhat impressive 😏 $23.8B in Greater China revenue against worldwide Apple revenue of about $156.5B, nearly 45% higher than the prior year. (Roughly $1B of the Greater China total was Taiwan-based revenue.) At this point, Greater China's revenue share was just about 15%.

FY 2013: The first "slowdown". Ah, Remember the First (or Second) Great Apple Doubting of the iPhone Era? $AAPL shares fell from a split-adjusted $100 to $55 from around September 2012 to June 2013. iPhone 5, so the narrative went, wasn't a big enough leap forward compared to the larger-screened Android competition. Facing Mac and iPod headwinds and a turning point in iPad momentum, Apple eked out $170.9B in revenue (9.2% growth YOY). This was also the first very real deceleration of Greater China growth - though at $27B in regional sales, it still outperformed the corporate average with 13.4% revenue growth. (By the way, Tim Cook mustered a >99% board of directors approval vote in the preliminary proxy count.)

FY 2014: The Mac bounced back nicely as iPod units and revenue both dropped by nearly half, but the main story was iPhone 5s. iPhone line revenue growth was nearly six times the amount of iPad's revenue decline year-on-year. Despite you know which iPhone lurking just around the corner, Apple rung up revenues of about $182.8B, representing 7% YOY growth. Greater China, once again, solidly outperformed the worldwide growth rate, ringing up 17.9% revenue growth to a annual total of $31.85B.

FY 2015: The iPhone 6 (Fiscal) Year. Here's when things started getting a little absurd.

$AAPL (the stock) broke through its prior all-time-high set in late 2012 on the strength of utterly mind-bending iPhone growth. The world's largest consumer tech-focused company, by miles, grew a staggering 28% to $233.7B (the current revenue record) thanks to iPhone line unit growth of 37% and revenue growth of 52%, fairly astonishing considering the already-lofty year-ago bases.

The iPhone results almost completely overshadowed the continuation of iPad's multi-year decline, more than making up for the 23% drop in line revenue that year. It also helped that iPhone was now a $155B business, to iPad's $23.2B.

Now, regionally speaking, Greater China revenues grew an absolutely explosive 84% year-on-year to $58.7B. To add a bit more perspective, the revenue geography now comprising about 25% of Apple's worldwide sales accounted for $26.9B of Apple's $50.9B total revenue growth for that banner year. That's right, slightly over half. Talk about outperformance!

Greater China also leapfrogged perennial second-place revenue contributor, all of Europe, in a single year, far outpacing Europe's perfectly respectable 14% YOY growth to $50.3B in sales - an all-time record for that revenue geography.

Cooler heads - of which there were some - sensed that such stratospheric growth from Apple at such lofty revenue levels just couldn't last. It may even have been mildly contrarian to call for Apple's revenues to decline in the year ahead. That read, as we now know, was absolutely correct.

>>> Something Lesser: FY 2016 through 2017

FY 2016

Apple's first YOY revenue decline in many years, and the Second (or Third) Great Apple Doubting of the iPhone Era. And in fact, Apple ended up making a mistake - in forecasting iPhone 6s demand, perhaps too giddy from the iPhone 6 wave...perhaps "overconfident" in its uncanny ability to resist broader global economic headwinds worldwide throughout calendar 2015.

The thing with forecasting. Assuming the hardware production capacities are sufficient, you'll end up with (1) too little product on shelves, (2) about the right amount, or (3) too much product. Outcome 3, arguably the least desirable, occurred.

Why? It was a mix of possible factors, but one of the most compelling reasons (to me anyway) wouldn't become clearer until the following fiscal year ended a few months ago. Regardless, here's (some of) what was known at the time.

• The aforementioned CY 2015 worldwide macroeconomic jitters (not a panic, to be clear, but definitely fair to say "jitters") caught up to Apple in its FY16, including...especially?...in China.

• Related: CY 2015's worldwide weakening of international currencies versus the US Dollar, including the yuan, also caught up to Apple.

• Hong Kong, where there had been a substantial amount of grey market/"iPhone tourism business", driven by an absence of a 15% import tax that existed in mainland China, strongly downtrended. Tim Cook noted the adverse impacts of a strengthening HK dollar impacting Apple's business there, a comment which, surprise of surprises, the media regarded...skeptically. Also in play: The impacts of China's April 2015 policy newly preventing residents of Shenzhen, who live relatively close to Hong Kong, from visiting Hong Kong for "shopping tourism" more than once per week. (See also: iPhone grey market.)

Every revenue geography except for Japan declined year-on-year in FY16, but Greater China most of all, falling 18% to $48.5B. This ~$10.2Bdrop comprised the majority of Apple's ~$18.1Bworldwide revenue decline for the fiscal year. As far as worldwide product line revenues were concerned, iPhone suffered most, with line revenue down 12%, or $18.3B in dollar terms. This was mitigated somewhat by a strong ~$4.4Bgain in Services and Apple Watch starting to boost Other Products to the tune of ~$1.1B,serving to nearly "erase" the revenue drops in iPad and Mac.

FY 2017

Which brings us, finally, to the recently-concluded fiscal year. Turns out, the fall from Apple's FY 2015 revenue peak of $233.7B wasn't especially precipitous, since FY 2017 closed out at $229.2B, about $4.5B shy of the record. Coincidentally, only one revenue geography failed to grow year over year, and that was Greater China, dropping about 7.7% YOY to $44.8B.

Optimism returned to Apple in a major way - even as the non-Wall Street commentators were (and are!) still concerned. Except, of course, for the seemingly-universal lingering doubts in Greater China.

"So, what excuses did Tim Cook and Luca Maestri give this time?"

Well, I guess it depends on what there is to make excuses for. So let's break it down a bit by quarter, since 2017 brought a nice increase in the amount of Apple earnings coverage.

• FQ1 2017: Assuming constant currency, Apple's overall Greater China revenue dropped around 8%, rather than the GAAP-reported, ForEx-impacts-included 12%. As far as mainland China was concerned, Apple's GAAP revenue change year over year was actually about zero, and +6% in constant currency terms. Thus, Hong Kong once again was disproportionately responsible for Apple's underperformance vs. rest-of-world (ROW), and totally responsible for the GAAP revenue decline. Much-appreciated iMore transcription via Serenity Caldwell here.

• FQ2 2017: Less detail here. Greater China revenues fell 14% overall YOY, against a backdrop of a 5% (presumably YOY) devaluation of the yuan. Once again, Hong Kong was cited as an underperformer, with its slumping tourist market. Earlier in the call, Cook compared Apple's first half FY 2017 Greater China revenue decline of 13% YOY to its 32% YOY decline in 2H FY16, and he did this half-year sequential comparison for a reason. iMore's transcription via Mikah Sargent here.

• FQ3 2017: Management optimism bubbling just beneath the surface once again, as Greater China's YOY rate of revenue decline slowed to 10%, bringing in a modest-since-FY-2015 $8B in sales. Why the optimism? Once again, per Cook, mainland China experienced flat growth in YOY GAAP terms, and in a "repeat" of FQ1 2017, would have been up 6% YOY in constant currency terms. As for Hong Kong, his commentary came with a signal: "Hong Kong continued to drag down the total Greater China segment, but on a sequential basis we're probably sort of at the trough of that, which is nice." (Emphasis mine.) Sounded a bit like the end of the iPad slide in a sense, huh? And aside from iPhone in general, Cook was full of positives for Mac, iPad, and Services in Greater China. iMore's transcription via Mikah Sargent here.

• FQ4 2017: Apple returns to growth in Greater China, no asterisks required - and no iPhone X required, either. A 12% YOY gain in overall regional sales, to $9.8B. ForEx pressures subsided substantially, with Cook reporting a 1% currency impact. Hong Kong's YOY revenue declines (the specifics of which, of course, Apple will never get into) were described by Cook as follows, echoing the iPad trough once again: "...the decline that we've been experiencing in Hong Kong moderated. And so it's still down year over year, but less so than it was. And part of that is the compare is an easier compare." iMore's transcription via Mikah Sargent here.

* * * * * * * * * *

II. Despite the Multiple Possible Reasons for Apple's Two-Year Revenue Decline in Greater China, One's a Better Fit for Occam's Razor

I'll readily concede that there's a variety of possible reasons for Apple's revenue decline in China, but it's silly to automatically assume, as some commentators have (let's be honest, they have), that their particular theory is head and shoulders above others.

How can I be so presumptuous?[FN-2] Well, they forgot the best - and if not the best, a really good - fit for Occam's Razor.

This simple, yet compelling, case is made by the following high-level numbers.

Outlier One

"Get outta here! These are the same numbers I just saw!"

Yes (it's just a starting point, there's one other on the way 😁), and what do you notice about FY 2015? Seems a little special, doesn't it?

Perhaps it's because FY 2015 skipped over

• $35B

• $40B

• $45B

• $50B

• and somehow $55B too

In the space of a single fiscal year. To give some additional sense of scale...Apple's Greater China's rev geo, in FY 2015, while hampered by not-inconsiderable ForEx and China macroeconomic headwinds:

• achieved YOY revenue growth ($26.86B) that was, itself, around 50% higher than Facebook's global revenue (~$17.9B)in their own FY 2015;

• reached a revenue level equivalent to a Fortune 50 company in 2016, a bit ahead of Disney ($55.6B); and

• mustered an astounding $23B in rev geo segment operating margin, which was (1) close to double Facebook's $12.4B operating income (FY 2016); (2) far higher than Intel's $12.9B operating income (FY 2016); and, even after factoring in reconciliations, (3) surprisingly close to Google's worldwide operating income for FY 2016 ($23.7B).[FN-3]

So...yeah. It was kind of an epic year for Greater China. And, at the same time, an epic outlier year. Which is a point that few people seem to give much credit.

Outlier Two

Speaking of epic outliers, here's one more (and really, the outlier most responsible for the outlier - confused yet? 😄). When the much-anticipated iPhone 6 and 6 Plus became available,

-- a single carrier, with over 800 million customers,

-- both officially carried any iPhone for the first time, and began rolling out its LTE network in earnest.

That giga-carrier is China Mobile. And if you need a sense of consumer demand for iPhone on China Mobile before it supported anything resembling broadband data?

Back in 2012, there were 15 million unlocked and formally unsupported iPhones on the network, somehow chugging along on 2G CDMA.

Two years later, TD-LTE support arrived. Around the time of the iPhone 6-series launch (Oct. 2014), China Mobile reported just over 54 million 4G customers. One year later, that number had increased to a staggering 267 million. (It's now around 634 million, against a total customer base of around 884 million.)

Everyone paying attention sensed this was a recipe for amazing sales, but just about no one in this cohort had any idea just how amazing sales would be. How do I know? Here's what professional Wall Street analysts were thinking about Apple's fiscal 2015 in late August 2014:

Note the average of $197B; the high estimate of $210B; and Apple's beating the high estimate by close to $25B.

In retrospect, the pessimist/bear read looking ahead was correct: With Apple enjoying unfathomable growth in Greater China throughout FY 2015, there really was no way it could last. It was, in fact, an unsustainable iPhone "sales nova" of sorts.

Unsustainable Longer-Term Demand, or Unsustainable Pace?

But there's more to the story.

Yes, the average-to-bullish read on Apple (whether Greater China-specific or worldwide) for FY 2016 and maybe 2017 was wrong...meaning those of us who were too optimistic (that included me, of course) had some serious recalibration to do.

Yes, "negative growth is never good".

Yes, Apple still has the burden of proof to show it can someday grow Greater China revenues, and profits, to new all-time highs sometime in the foreseeable future.

And Apple can't ignore the various other challenges inherent in China, whether it be dealing with the the Chinese government, any number of unfortunate smartphone OEM copycats, the platformization of smartphone-OS-agnostic apps such as WeChat, etc. The competition in this market is intense, and the threat of actual state interference is non-trivial.

Accepting all of this to be true, let's see how Apple's fiscal 2012 through 2017 went from an overall (cumulative) revenue perspective.

The six fiscal years spanning 2012 through 2017 saw Apple bring in approximately $234.6B in combined Greater China revenue. Whatever you think of that number 😐, when you chart the cumulative sales (flatlining sales = very very bad), you may notice something interesting:

You know how people often talk about S-curves in business? Well, this...doesn't look all that much like one. To this humble blogger, it looks an awful lot like three distinct trendlines, and it's quite remarkable how linear these phases are.

Note also the slopes of the extrapolated lines. The red trendline, of course, represents a striking accelerated burst of sales growth, and the green line a slowdown from the red line's "pace" (sales velocity). However, the green line is still a significantly faster sales velocity, for all the year-on-year revenue declines, than what had been seen from FQ1 2012 through roughly FQ4 2014 (black trendline). Thanks to the magic of modern operating systems, it's easy to make a parallel copy of the "pace lines" to see how they all compare. And you really don't require any measuring tools to see how the green velocity trendline is closer to the pace set by the red trendline.

Here's another way to visualize the above chart.

Same chart, only I added two mysterious blue lines and three numbers. Why?

If you look closely, you'll notice that I approximated the points at which Apple rang up one-third of its Greater China sales for this time interval. (Recall that FY 2009-2011 Greater China sales were a "modest" combined $18B or so, to the point of being amusingly "not material" in context.) As I noted, it's only an approximation; nonetheless:

• It took Apple around 11.3 fiscal quarters to generate its "first" $78.2B in Greater China revenues (for this time interval).

• Apple then needed only 5.5 fiscal quarters to generate its "second" $78.2B. Essentially, it rang up the same amount of sales in about half the time, a massive increase in relative sales velocity.

• The "most recent" $78.2B took about 7.2 fiscal quarters to generate. Slower than 5.5 (fiscal quarters per $78.2B), but much closer to that high velocity than 11.3.

Note also how these "$78.2B checkpoints" correspond surprisingly well with the three indicated trendlines.

There's a "Good Kind" of "Oversaturation"?!

So, to wrap up Part 1, what might Occam's Razor lead us to? Considering the macroeconomic conditions and the dramatic uptick in (iPhone-driven) sales velocity in Greater China in FY 2015, the market, as some in Wall Street like to say, "pulled forward" far too much consumer demand for Apple to sustain longer-term.

Yes, that's a type of market oversaturation - which usually leads people (including myself) to think: "That's bad".

Starving the near future of iPhone unit sales, however, did not mean that consumers tired of the iPhone!

Some very quick back of the napkin math suggests that Apple sold comfortably over two hundred million iPhones over the past six fiscal years in Greater China (Assumption: 65% iPhone revenue mix, $675 iPhone ASP). And very close to two-thirds of Apple's lifetime Greater China revenues have been realized within just the past three fiscal years.

Considering further that Apple's Greater China relative sales velocity (even during the slowdown period of FQ1 2016 or so - present) does not appear to be waning, the simpler and more likely scenario, as somehow contrarian as it may sound, is that

(1) a decent majority of current iPhone owners in China are reasonably happy with their purchase, and

(2) a large number of the more recent iPhone 6 and later owners just aren't quite ready to replace it yet.

In the end, if Apple is able to retain "enough" of the Greater China iPhone 6 and later customer base, it actually bodes better for Apple, because

• it was able to bring more customers into the Cupertino fold earlier than analysts expected, and, critically,

• before the Android OEM competition could get them as smartphone customers first.

Is that an "apologist" take? Sounds counterintuitive? Well, next article, I'll show how the millions of Greater China-region customers that Apple gained "early" are continuing to make their presence known in a key financial metric today, amidst Apple's supposed "continued struggles" in the region. Stay tuned.

[Part 2 is here.]

___________________

Footnotes:

[1] In case you were wondering, yes, these figures do account for Apple's reconciliation of retail revenue for FY 2012-2014 (incorporation of geography-based Apple Retail sales into each of the revenue geographies, see here). As best as I could tell, Apple's FY 2009-2011 data on China appears to have included Retail sales.

[2] Where's the fun in blogging it completely safe? I'm taking one heck of a "contrarian" position anyway, but it's the one I genuinely believe in, given the data that's right in front of all of us.

[3] Yes, it's not entirely "apples to apples". Greater China operating income is net of COGS, direct operating expenses and advertising, but also excludes R&D, worldwide corporate marketing, etc. In any case, Apple does reconcile the "excluded expenses from segment operating income". The reconciliation was $14.3B out of $74.3B in segment operating income for FY 2015; ratio it out (19.2%) and apportion evenly to Greater China, and the "estimated true operating income" in Greater China of ~$18.57Bis still pretty impressive, and around 50% higher than Intel or Facebook's FY 2016 operating income numbers.