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Why China Will Likely Continue to Take a Bite Out of Apple

Apple is coming off a 26 percent sales decline in Greater China, the steepest drop among its regions. More worrisome: The greatest risks lie ahead.
Image: Apple logos are seen in stores in Shenzhen
Apple logos are seen in stores in Shenzhen on Sept. 21, 2015. On a bustling street in China's southern boomtown of Shenzhen, more than 30 stores carrying Apple Inc's iconic white logos peddle pre-orders for the new iPhone, a gadget that has become a status symbol among many better-off Chinese. But the world's second-largest smartphone vendor only has one official store in Shenzhen and five authorized dealers in the area.Reuters
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Apple is coming off a 26 percent sales decline in Greater China, the steepest drop among its five regions.

More worrisome: The greatest risks lie ahead.

That's the view of a growing chorus of experts and prognosticators concerned about the unpredictability of the Chinese government.

Earlier this month, China shut down iTunes Movies and iBooks just six months after Apple introduced the services there. Billionaire investorCarl Icahn told CNBC on Thursday that he sold his Apple shares because "you worry a little bit — and maybe more than a little — about China's attitude."

Analysts from UBS and Goldman Sachs have published recent reports discussing China's potential power to thwart Apple's growth, and Eurasia Group founder Ian Bremmer said earlier this week that China is very likely to limit Apple's access to the country's consumer base.

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Looking at the competition, it's clear that history doesn't favor Apple.

Google, Facebook and Twitter are shut out of China, while enterprise vendors IBM, Cisco and Hewlett-Packard have struggled in the world's second-biggest economy because of government-favored domestic rivals.

For Apple, it's a massive overhang. Greater China (including Hong Kong and Taiwan) accounts for 25 percent of revenue and has supplied the majority of its growth, thanks to the rapid expansion of the Chinese middle class.

"It bears watching whether the recent ban of Apple's iTunes and iBooks stores in China has broader implications for how friendly the environment remains for Apple to grow its business in the country," Goldman Sachs analyst Simona Jankowski wrote in a report Wednesday following the company's disappointing second-quarter earnings release.

Apple shares plunged 10.3 percent this week as of Thursday's close to $94.83

Jankowski, who still recommends buying the shares, pointed out that the dramatic drop in revenue from Greater China came after five-straight periods in which growth exceeded overall expansion.

Apple CEO Tim Cook refused to sound the alarm. Hong Kong represented "the vast majority of the weakness," with sales in mainland China falling 11 percent, Cook said on the earnings call. When removing the impact of currency swings, mainland revenue was down 7 percent.

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Cook also reminded investors that comparable figures were particularly difficult in the quarter because mainland revenue a year ago surged 81 percent on iPhone and Mac sales.

"And so as I back up from this and look at the larger picture, I think China is not weak as has been talked about," Cook said. We "may not have the wind at our backs that we once did, but it's a lot more stable than what I think is the common view of it. And so we remain really optimistic on China."

However, Cook didn't address the geopolitical risks, which are very real. An Apple spokesperson declined to provide further comment.

Apple has just been through a high-profile battle with the FBI over whether the company should be required to help law enforcement unlock an iPhone tied to the San Bernadino, California, terrorists attacks.

The Justice Department, in attempting to refute Apple's claim that it won't compromise consumer privacy, said in a legal filing last month (citing Apple's data) that the company helped the Chinese on 74 percent of requests for iPhone data in the first half of 2015.

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Apple broadly disputed the claims as an "unsupported, unsubstantiated effort to vilify" the company. But coupled with the forced closure of two Apple services, it sparked a bigger debate about how far the Chinese are willing to go in pressuring the company and to what degree Apple would cooperate.

Bremmer of the Eurasia Group said he could see Apple facing the same types of issues that have hampered Facebook, which like so many U.S. websites, is banned in China.

"I'd be very surprised in five years' time if we see Apple having the kind of access to the Chinese consumer that they presently enjoy," Bremmer said.

— CNBC's Jacob Pramuk and Matthew J. Belvedere contributed to this report.