Despite taking several measures in an attempt to prop up its stock market amid a struggling economy, the Chinese government's efforts aren't working. The Shanghai Composite Index is down more than 35% from its peak in June. Meanwhile, the government has allowed the yuan to decline against the U.S. dollar. These events have had a broader impact on the international markets and the international companies that do a lot of business in China.
Apple (AAPL 1.04%) is one such company that many investors have feared for several weeks will show a significant impact from the economic events in China. Last Monday, the company's stock fell as much as 13% from Friday's close before recovering later in the day. Part of the recovery was spurred by an email CEO Tim Cook sent to CNBC analyst Jim Cramer. The email was tweeted out by CNBC's Carl Quintanilla.
Why was Cook compelled to send a letter to Cramer, and what do investors need to know about what Cook had to say?
A strange update
There were a couple of strange things about this midquarter update from Apple. First of all, Cook sent the update directly to Cramer -- host of CNBC's Mad Money with Jim Cramer and co-anchor CNBC’s Squawk on the Street -- instead of posting it on the company's investor relations website. It's unclear what the reasoning was, and some outlets have been reporting that Apple may be facing an SEC investigation because Cook shared the information only with Cramer, who reportedly co-manages a portfolio that owns shares of Apple, instead of with all investors.
Secondly, as Cook points out in his email, the company doesn't give midquarter updates, nor does it provide commentary on stock movements. In this case, however, Apple was facing a 20% loss in its value in just over a week because of events entirely outside its control. But that's not without reason.
China represents Apple's second-largest market after the United States, generating $13.2 billion last quarter. More importantly, it's the region producing most of Apple's growth. Last quarter, China generated $7 billion more in revenue for Apple than the year before. All other regions combined produced $5.2 billion in additional revenue over 2014.
Therefore, a slowing Chinese economy could have a drastic impact on Apple's continued growth. Since stocks trade on the expected future earnings of the underlying company, investors sold off the stock. But Cook noted that iPhone activations in China over the past two weeks had actually accelerated, bucking the economic trend. He also said the past two weeks had notched the App Store's best performance of the year in China.
That gave investors reason to believe things aren't as bad as originally thought, but there are still a few things to worry about.
What Cook isn't telling us
First of all, Cook mentioned that the past two weeks had been the best for the App Store in China so far this year. The App Store metric is an interesting one because it reflects two things: new-to-iPhone purchasers who are loading up their phones with new apps for the first time, and the impact of the cumulative iPhone sales in the country. The impact of that second factor shouldn't be underestimated, especially considering App Store revenues account for just a fraction of what a new iPhone sells for.
iPhone sales took off in China following the release of the iPhone 6 and iPhone 6 Plus about a year ago. The new large screens were a hit, and the company saw unit growth of 87% last quarter, following significant revenue growth in the quarters following the new models' release. This growing number of iPhone owners will naturally lead to more App Store sales.
Moreover, Cook didn't mention how the currency devaluation could affect Apple's operations in the country. Will it raise the price of the upcoming iPhone models or eat the foreign exchange cost? With the currency falling 3% to 4% to the U.S. dollar, the decreased value of the yuan will certainly have a negative impact on Apple's third-quarter earnings even though the company continues to sell more and more iPhones in the country.
The fact is, continued unit growth was already baked into Apple's price, so the stock should have come down on the news, and it did. Whether it should have fallen as much as it did was unclear, and Cook certainly thought it needed at least a bit of clearing up. With the stock trading around $100 per share while operations continue to go well in China despite the economic downturn, it seems like a good time to buy more shares of Apple.