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Is Apple Inc. vs. the FBI Really About China?

By Leo Sun – Mar 3, 2016 at 6:23AM

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Apple investors should consider what the tech giant’s battle against the FBI means for its sales in China.

Apple (AAPL -1.96%) is receiving lots of media attention for denying the FBI's request to unlock an iPhone used by a terrorist in the San Bernardino shooting last December. Apple has argued that doing so would violate First Amendment rights, expose its users to more hackers, and set a "very dangerous precedent" for future investigations regarding mobile devices. Many of Apple's Silicon Valley peers support its stand against the FBI, but the public's opinion is mixed. A recent Reuters/Ipsos poll found that 46% of Americans agreed with Apple's stance, 35% disagreed, and 20% were undecided.

Fewer news outlets have discussed the case's impact on Apple's business in China, its fastest-growing market. While it openly defies the FBI in the U.S., Apple has repeatedly altered its security and censorship rules in China to suit the government's needs. Would losing a case against the FBI stateside cause problems for Apple in China? Let's dig into  Apple's behavior in both markets to consider the question.

An Apple Store in Beijing. Source: Apple.

Apple's delicate balancing act in China
Over the past few years, Apple has censored iOS apps that Chinese authorities disapproved of, moved Chinese user data to servers operated by state-owned China Telecom, and reportedly let the government conduct security checks on all Apple devices sold on the mainland.

According to the state-run Beijing News, CEO Tim Cook told Chinese officials that "there were rumors that Apple built backdoors in its devices, and let third parties have data and access those devices, but that was never true and ... we would never do that in the future either."

While it looks like Apple is giving in to regulators in China while defying the FBI, the U.S. government also placed Apple in a tough position internationally. Ever since the Snowden leaks in 2013 revealed the NSA's PRISM surveillance plan, U.S. tech companies have faced increased suspicions abroad regarding built-in backdoors accessible by the U.S. government. Therefore, if Apple complies with FBI demands to build backdoors into its own devices, its sales could be adversely affected in major markets like China and Europe.

Microsoft faced similar problems
The current situation involving Apple resembles an ongoing case against Microsoft (MSFT -0.04%), where the Department of Justice requested access to an American customer's emails stored on an Irish server. Microsoft denied that request, stating that since the emails were stored in Ireland, the DOJ should send a request through the Irish government.

Microsoft's argument was struck down, and it lost an appeal in July 2014. That same year, the German government warned that Microsoft's Windows 8 could be used as an NSA backdoor when paired with a certain surveillance chip. Shortly afterward, the Chinese government banned Windows 8 from its government computers.

Microsoft refused to hand over the emails and appealed the case again, where it continues to be argued in the Second Circuit Court of Appeals. Last September, DOJ lawyers declared that the U.S. government had the right to request the emails of anyone in the world, as long as the provider was headquartered in the U.S. Therefore, it wasn't surprising when Microsoft recently joined other tech giants in supporting Apple's similar fight against the FBI.

Two major risks in China
If Apple loses its fight against the FBI, two things could happen in China. First, sales of Apple devices across the Greater China region, which generated nearly a fourth of its revenues last quarter, might decline. That would be bad news for Apple, since China was the only geographic region which posted double-digit sales growth last quarter.

Source: Apple.

Second, the Chinese government would likely cite the FBI case as precedent to request similar backdoors to iOS devices. James Lewis, senior fellow at the Center for Strategic and International Studies, recently told the Los Angeles Times that he suspected that the real reason for Apple's defiance was its "desire to persuade the global market, and particularly the China market, that the FBI can't just stroll in and ask for data." Lewis also stated that he couldn't "imagine the Chinese would tolerate end-to-end encryption or a refusal to cooperate with their police, particularly in a terrorism case."

Stuck between a rock and a hard place
Tim Cook has framed Apple's battle with the FBI as a "human rights" battle. While that might be partially true, it's also a fight to ensure that other countries don't consider its devices to be extensions of the government's surveillance programs. Winning a battle against the FBI could also prevent the Chinese government from making similar backdoor requests, which Apple might not be able to challenge as easily.

Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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