Baidu Says Apple's Chinese Revenue Will Fall 20% This Quarter

Baidu (BIDU 1.24%), the biggest search engine in China, recently claimed that Apple's (AAPL -0.57%) revenue in China would decline about 20% year over year when it reports its third-quarter earnings on July 26. Baidu bases that forecast on map queries of Apple's flagship stores across the country.

An Apple Store in Beijing. Image source: Apple.

Those map queries rose 15.4% annually in the last quarter of 2015, which nearly matched the 14% increase in sales for Apple in its corresponding quarter. But in the first quarter of 2016 (Apple's second fiscal quarter), map queries fell 24.5% annually and reflected Apple's 26% sales decline. That strong track record suggests that Baidu is probably right about Apple -- but should investors worry?

Why Apple is losing in China

Apple got off to a strong start in China in late 2014 with the iPhone 6. However, increased competition from domestic rivals and slowing smartphone sales across China weakened Apple's momentum over the past year.

Data source: Apple quarterly reports.

Apple's share of the Chinese smartphone market fell from 16% to 13% between the first quarters of 2015 and 2016, according to IDC. During that same period, Huawei's share rose from 11% to 16%, while the market share of low-end players Oppo and Vivo more than doubled.

But these companies are all fighting over a saturated market -- CCID Consulting analyst Liu Ruofei claims that China's smartphone penetration rate has exceeded 90%, and that users are more reluctant to upgrade. Gartner estimates that smartphone sales in China were flat in 2015, and are unlikely to improve over the next few years.

Apple's attempts to sell services in China have also been lumpy. It launched Apple Pay earlier this year, but it shut down iTunes Movies and iBooks within the country in April -- a mere six months after their initial launch. Meanwhile, Android-based rivals like Huawei and Xiaomi have already launched their own app stores and introduced rival payment systems.

What this means for Apple

Apple generated 25% of its sales in China during the second quarter, but its 26% decline also made it its worst-performing region worldwide. Only a single major market (Japan) posted annual sales growth last quarter, indicating that Apple's weakness in China is reflected worldwide. IDC expects Apple's iPhone shipments to fall 2% worldwide this year, marking its first year-over-year decline.

The iPhone 7 probably won't generate much excitement, since rumors suggest that its design will be nearly identical to the iPhone 6 and 6s. The device is expected to add a bigger camera but eliminate the 3.5-millimeter headphone jack -- a controversial move which might be a deal-breaker for some customers. Apple also recently expanded its design upgrade cycle from two to three years, indicating that it was running out of new ideas for its phones.

This means that Apple must look toward new markets like India for growth. Apple reported 56% year-over-year growth in iPhone sales in India last quarter, but it still controls less than 2% of the overall market, which mainly purchases lower-end devices. Most of Apple's market share in India comes from the older iPhone 5s. To convince those users to upgrade, Apple launched the cheaper and comparably sized iPhone SE, but the device is still pricier than many high-end Android devices.

The iPhone SE. Image source: Apple.

Baidu's probably right, but don't panic

Baidu was right about Apple sales before, and it'll probably be right again this quarter. But the company faces tough year-over-year comparisons, and investors shouldn't overlook its other sources of long-term growth across the country.

Last quarter, Apple noted that 80% of Mac buyers in China were first-time buyers -- indicating that Mac sales could partially offset weaker iPhone sales in the future. Apple Pay isn't a big source of revenue yet, but its impressive adoption rate (3 million Chinese cards added within the first two days) indicates that it could become one if its market share holds steady. It recent $1 billion investment in ride-hailing app Didi Chuxing could also give it a foothold in China's driverless car market.

Baidu's prediction looks bleak, but investors should remember that the weight of the iPhone -- which accounted for almost two-thirds of Apple's revenue last quarter -- will likely decline as Apple launches new services and products. That expansion should fuel more sustainable and diversified growth across China.