Trade Tensions, Huawei and Apple

In 2017, the United States launched a trade investigation against China. Following the investigation, the U.S. imposed tariffs on billions of dollars’ worth of Chinese imports. This initiated the trade war between both parties. In December 2018, tariff hikes halted, allowing for trade negotiations between the United States and China that would ideally lead to a solution. Optimism of a trade deal began to lessen tensions; however, with trade negotiations slowing, the United States imposed further tariffs on an additional $200 billion worth of Chinese imports. China responded with additional tariffs on $60 billion worth of U.S. imports. From a U.S. perspective, the imposed tariffs make U.S. made goods cheaper and more readily purchased. With the trade war consistently in the news, I begin to wonder how this would affect the most popular companies in the United States and China presently.

Moreover, the most recent casualty in this trade war is Chinese technology firm, Huawei. While the issue has been framed as a national security decision, many analysts believe the United States’ stance towards Huawei to be related to trade negotiations. Business Insider wrote, “Security experts have been warning about Huawei for more than a year, but it’s only in the last week that those warnings have escalated into an all-out trade blockade on the company’s US partners” (Eadicicco). In the last year, officials have been concerned with Huawei’s cell towers. Huawei provides significant network infrastructure to the United States. Eadicicco continues to write, “as a hardware provider, Huawei needs to be able to deploy software the same way Apple deploys iOS updates. But as long as there was a pipeline from Huawei’s China headquarters to cell towers in the US, there would be a strong risk of Chinese surveillance agencies using it to sneak malware into the network” (Eadicicco). The United States has placed Huawei on the U.S. Department of Commerce’s entity list, meaning all domestic companies must seek approval before conducting business with Huawei. How does this impact Huawei? Many analysts state that the ban’s impact on Huawei’s U.S. segments will be significant. Google will “significantly scale back its business with Huawei in a move that would prevent the Chinese tech giant from putting Google’s software — including its Play app store and services — on its future handsets. As such, Huawei’s coming smartphones will not be able to run on Android, or at least the version of Android consumers are familiar with” (Eadicicco). Most of Huawei’s revenue is derived from Asia and Europe, but their U.S. revenues are projected to evaporate. While Huawei is one casualty from the trade war, could more be on the horizon?

Subsequently, China has retaliated to each round of tariffs imposed by the United States. How would this America’s flagship companies if China retaliated to the United States’ treatment of Huawei? Last week, Goldman Sachs reported that Apple’s earnings might decrease by 29 percent if China retaliates, crippling one of the United States’ top flagship companies. CNBC writes, “Analyst Rod Hall said in a note to clients that Apple’s earnings could drop by 29% if the company’s products were banned in mainland China. The analyst cut his price target on Apple to $178 per share from $184, representing a 4.6% downside from Tuesday’s close of $186.60” (Imbert). Hall also highlights that China generated more than 17 percent or $10.22 Billion in revenue during Apple’s last quarter. Furthermore, the vast majority of Apple’s reliance on China goes beyond sales. Much of Apple’s production capabilities and operations reside in China. Hall states, “Should China restrict iPhone production in any way we do not believe the company would be able to shift much iPhone volume outside of China on short notice… We believe that Apple is near its annual rapid ramp of new iPhone production to prepare for new device launches in the Fall so even a short-term action affecting production could have longer term consequences for the company” (Imbert). As Apple nears the fall release of newer devices, production restriction would limit Apple’s sales globally. Now, much of this situation remains hypothetical. China has given no indication of such actions; however, concern is not unwarranted. Regardless of Chinese action, Apple will likely see revenues fall in Asia. Political action taken against Huawei has fostered an anti-American sentiment within China’s tech community. CNBC profiled Dan Ives, an analyst at Wedbush Securities. Ives said, “3% to 5% of iPhone sales in China may disappear over the next 12 to 18 months because of the U.S. ban on Huawei” (Imbert). Analysts are beginning to believe that Apple will miss third quarter earnings expectations.

While Apple is facing uncertainty in China, the company might benefit elsewhere. Again, the U.S. ban on Huawei devices means the devices will have to run without access to the Android operating system. If customers are concerned about the options, performance and experience derived from their Huawei phone, customers may be more inclined to purchase Apple instead. The potential for customer switching lies outside of the U.S. and China. Huawei’s smartphones account for almost a quarter of the market in Europe in the fourth quarter of 2018, just behind Apple and Samsung Electronics Co. Globally, Huawei trails only Samsung for smartphone production. Could Apple actually experience a windfall from the Huawei ban?

Lastly, Apple’s response options in this situation are limited. Apple, like Huawei, is caught in the middle of a global power struggle between the United States and China. While we can project potential outcomes and the revenue impacts, navigating the current political climate will be challenging for Apple. Apple has known for a long time how dependent they are on China. Perhaps Apple will begin to move production away from China completely. Eliminating Chinese production is highly unlikely and nearly impossible, but Apple might consider diversifying their production capabilities. In January of 2019, Apple moved a portion of high-end iPhone production to India made possible through a deepening partnership with Foxconn. While many of Apple’s suppliers still reside in China, will production diversification become supplier diversification as well?

 

Gregory B. Raynal