The global supply chain will likely change rapidly over the next decade, shifting away from China. Apple saw it coming in 2018 and will be aggressively investing a projected $430B in US tech infrastructure over the next five years, along with investing to a lesser extent in Malaysia, Thailand and Vietnam. While Apple is in a favorable position to navigate the shift long-term, I expect investor anxiety around the topic to ebb and flow in the years to come. In the end, I believe Apple will remain on top given the company is in a unique position with its financial resources and expertise to diversify.
What keeps Cook up at night?
When I meet with management teams, I often ask a softball question. What keeps you up at night? Even though it’s anticipated, I still ask because it can reveal one or two pressure points on any business. These pressure points are the key factors that will have an outsized impact on the business over the next 2-5 years.
Over the years in knowing Apple, I’ve witnessed the company navigate a spectrum of pressure points. Would the iPod trigger growth in Mac sales? Will consumers pay up for an expensive phone? Can production scale while maintaining profitability? Will US tariffs on China prevent the import of Apple products? Will the App Store take rate be impacted by regulation?
Over the past three years, the latest pressure point has emerged… How to navigate China? I believe this is one that keeps Tim Cook up at night.
Apple’s expertise is right for the job
Apple has done a masterful job navigating China dynamics over the past 20 years. It’s been so successful that most would agree Tim Cook wrote the book on building a business in partnership with China. Everything from ramping production to winning Chinese consumers, all whilst maintaining neutrality in the midst of tense US/China trade relations.
While Cook often gets the credit for Apple’s success in the supply chain given his operational roots, the substance of the diversification efforts over the past three years and the plan going forward has been led by Sabih Khan (in charge of Apple’s global supply chain) along with Jeff Williams (COO). That team will continue to shift production investments away from China. Of course, Apple is not alone in navigating this dynamic. BlackRock CEO and Chairman Larry Fink said in his 2022 annual letter: “The Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades.”
For the past year, the supply chain has been top of mind for every company. On Apple’s December 2021 earnings call, the topic was addressed:
Katy Huberty: Are you happy with the overall geographic exposure that you see in the supply chain today?
Tim Cook: There’s very little distance between a chip being fabricated and packaged and a product going out of factory. So, no, I don’t see that it makes a fundamental change in the supply chain.
The significance of this interaction goes beyond the supply chain disruption that we’ve experienced over the past two years. It’s about Russia’s invasion of Ukraine, and the years of tension between China and Taiwan. It’s about the future of that relationship and its impact on the global tech supply chain.
Taiwan 101:
Taiwan is about 100 miles off the coast of China with a population of 24 million. Taiwan produces about 90% of the world’s advanced chips used in everything from phones, computers, game consoles and weapon systems. This highlights the significance of Taiwan’s role in the global supply chain given that it will take a decade to fully move production to other parts of the world.
For centuries, the island has traded hands. In the twentieth century, it came under the rule of China. For the past 40 years, the island has operated under a policy of strategic ambiguity where China allows Taiwan to operate as an independent country with free elections, capitalism and military control. The catch is that they cannot refer to themselves as an independent country.
This strategic ambiguity approach appears to be wearing thin in Beijing. In October 2021, Xi Jinping commented that “Taiwan independence separatism is the biggest obstacle to achieving the reunification of the motherland . . . and the historical task of the complete reunification of the motherland must be fulfilled, and will definitely be fulfilled.”
Consensus interpretation of Xi’s comments is that it’s only a function of time before China regains governess of Taiwan. If, and when, China makes its move, it will further stress relations with the US along with companies doing business in China.
Big tech China exposure
While most multinational companies have China exposure, I wanted to narrow the conversation to big tech. Here’s how I size up the China exposure:
- TSLA: In 2021, 25% of Tesla’s revenue came from China. This year, I expect about 25% of production will come from China.
- AAPL: In FY21, 18% of Apple’s revenue came from Greater China and I estimate 85% of the company’s products are assembled in China.
- AMZN: I estimate that less than 1% of Amazon’s overall revenue comes from China. That said, about 37% of sellers are from China and the majority of products sold by US sellers are made in China. I estimate that about 75% of products sold on Amazon are manufactured in China. If something went awry with the China supply chain, sellers on Amazon would substitute products from a diverse pool of vendors. By comparison, there is little substitute for an iPhone if, suddenly, Apple can’t make them at scale.
- GOOGL: Google is blocked in China, but the company does have some of its hardware assembled in China. I estimate that hardware makes up about 5% of Google’s revenue.
- FB: Facebook, Instagram and WhatsApp are blocked in China. The company does assemble some of its hardware in China of which I estimate to equal less than 5% of revenue.
- NFLX: Netflix is unavailable in China and does not create original content out of China.
- MSFT: China accounts for about 2% of Microsoft’s revenue. Hardware manufacturing in China is less than 2% of the company’s sales.
Apple and China over the past 20 years
At its core, a measurable part of Apple’s success over the past 15 years has been powered by two Chinese tailwinds: production and sales growth.
- Production ramp. In FY21, I estimate that 68% of Apple’s overall revenue was assembled in China. Outside of China, the Mac Pro is assembled in the US., the Mac mini in Malaysia, the AirPods Pro in Vietnam and some iPhones in India.
- Sales growth. Apple began reporting Greater China revenue in FY11, when its 11.7% of sales increased to 18.7% of revenue in FY21, a growth of 70% y/y off of an easy comp. Prior to the pandemic, China revenue declined by 16% y/y in FY19, compared to a 16% increase in FY18. Notably, Apple’s reporting segment of “Greater China” includes Hong Kong and Taiwan. In FY21, revenue from Greater China was $68.3B, which matched Apple’s Services revenue. In other words, China revenue is as big as Services.
A sign that Apple remains in neutral standing with China leadership
Over the past three years we have monitored China’s primary social media platform, Weibo, to get a sense of how the Chinese government views Apple. Our thinking is that it would be easy for Beijing to influence Apple sales by steering conversations on Weibo. The site could be a logical point for the government to stir up a campaign to boycott Apple. This week, we searched Weibo with the key word “Apple product.” Out of the Top 50 hot posts, 61% of them are neutral, 23% are negative, and 16% are positive. Putting these together, we see the tone on China social media toward Apple as neutral.
Apple has been aggressively investing in the US for the past four years
I can rest well at night knowing that Apple has seen this coming. In 2018, the company outlined a five-year goal to invest $350B in the US including next-generation silicon development and 5G innovation across nine US states. In April 2021, the company increased that investment target by 20% to total $430 billion. That size of investment goes a long way. For example, Intel is expected to spend $20B on its Ohio chip factory. Using that data point as a measuring stick, Apple is allocating enough capital to build 20 fabs in the US. In the years to come, I expect more investment will be committed to the initiative.