Ant Financial buying MoneyGram??......now I'm really getting irritated.....

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Alibaba - 1/24/17 Q3 Earnings Call....20 seconds of magic...

Rather than do an in-depth analysis of the earnings call, I'l just refer you to my analysis of the Q2 call "Just when I think....".  The numbers are a bit different but the content and direction is essentially the same.

Here are today's links:

Call
Presentation
Press Release
SEC 6-K Filing

The company continued to show enormous fake, organic revenue growth (54% YOY).  The market has responded accordingly, up $2.00 yesterday on the whisper numbers and $3.00 on the actual....the Analysts were salivating, using adjectives like "Tremendous", "Great", "Very Strong!"

....I'd actually like to add "unbelievable!" to the list.

I also won't take the time to ask how a "law of large numbers business" like Alibaba could:

1.) Increase Revenue by 45% year over year with only a 9% increase in Annual Active Buyers.
2.) Increase Cost of Sales (Excluding SBC) by 6.6% over the September quarter.  
3.) Continue to pay $500 Million +/- in dillutive Share Based Compensation (SBC) every quarter, including that which goes to employees of other "ecosystem" businesses.
4.) Continue to "buy" revenue indefinitely, consolidating the likes of Youku Tudou, Lazada and other money-sucking businesses into the pool of sludge.  InTime, another "strategic" acquisition, will most likely be consolidated next quarter.
5.) Increase PP&E US$407 Million in the quarter with no explanation.
6.) Increase Revenue guidance from 48% to 53%, implying continued, gigantic, organic growth.

Even though a discussion of the above would be entertaining.  I'd rather go a different direction today. 

Let's discuss the "20 seconds of real magic" in the investor call that merits dissection.....When Eddie Leung of Merrill Lynch finally asked a question I had always hoped someone would ask.  He wanted to know if Alibaba's merchant product mix had changed over time (Minute 29:40 of the call).  For his effort he received a rambling, confusing (at least to me) discussion from Daniel and Maggie about business segments.  Maggie also reminded Eddie and re-emphasized that they still disclose GMV, but will only disclose annually (and apparently also on "Global Shopping Day" with great fan-fare as described in the filing.) To his credit, Joe Tsai recognized the disconnect and stepped in (Minute 33:20 thru 33:40) :

"With regard to the eCommerce segment product mix, the big categories, soft goods, apparel, electronics, FMCG...those categories, the mix has not changed over time."

That's AWESOME!  He didn't mention any of the Wealth Management Products, Bad Debts/Loans, Industrial Products (Pipe/Steel/Fuel Oil, etc.), planes, Yachts, counterfeit liquor or any other of the weird things anyone can find by doing a quick search on any of the Alibaba sites. 

Since the IPO, Alibaba has never disclosed product mix.  Other than Daniel's occasional, odd, rambling discussions of "winter coats and cold/warm weather", investors have no idea which product categories and quantities are sold by Alibaba/TaoBao/TMall merchants.  They never have.  Like presidential tax returns, this information is apparently a closely guarded state secret.

Now, per Joe Tsai, we do know with certainty, that the mix has stayed the same, yet, the actual GMV breakdown has never been disclosed.  You'd think, since Alibaba is a super-duper-high-tech-big-data-cloud-computing-giant, they could just push a button and generate detailed and summary GMV data by SKU, vendor, region, product class/category, etc.  Yet, to date, they've not done so.  The only discussion of product mix I know of appears in the initial IPO filing:

Product Mix 424(b)4 IPO - pg 167
https://www.sec.gov/Archives/edgar/data/1577552/000119312514347620/d709111d424b4.htm

Pg. 164 of the filing states that China's 2013 Consumption as 35.8% of GDP.
Pg. 165 of The filing states that China's 2013 GDP was US$9.5 Trillion.
Therefore Total Consumption in 2013 was US$3.4 Trillion, per the filing.

Pg. 1 of the filing states Alibaba's 2013 GMV was US$296 Billion.

Here's the silly little chart describing what Alibaba sells compared to China's consumption (Pg. 167)

So we can see that the sandbox  ("Orange slices" above) that Alibaba played in back in 2013 (just prior top the IPO) amounts to roughly 16.6% of China's consumption or US$566 Billion (16.6% x US$3.4 Trillion).   Alibaba's 2013 GMV was  a remarkable US$296 Billion or 52.3% of total China Consumption for the "Orange slices" at the time.  Makes sense?

Per Joe, there has been no change in product mix.  Therefore, almost all of Alibaba's GMV is still comprised of Clothing, Footwear, Electronics, Home Appliances, Household Goods and Services.

The NBS, another repository for amazing fake data, describes that total Online Sales of Physical Goods in 2016 (Bullet #4) amounted to 4.194 Billion Yuan or US$612 Billion (CNY6.83/$1.00).

In 2016, the online retail sales reached 5,155.6 billion yuan, an increase of 26.2 percent compared with last year, among which the retail sales of physical goods was 4,194.4 billion yuan, up by 25.6 percent, accounting for 12.6 percent of the total retail sales of consumer goods, or 1.8 percentage points higher than that in last year.

So presumably, based on a simple extrapolation, in a few months Maggie, Daniel and Joe will report a GMV number somewhere north of US$650 Billion.  Alibaba's GMV will have grown from a gigantic figure, $296 Billion (52.3% of all Clothing, Footwear, Electronics, Home Appliances, Household Goods and Services), just three years ago, to significantly more than all of the on-line sales in China as reported by the NBS. 

Clearly something is amiss.  The above, of course, isn't possible.

I'm beginning to believe that Joe, Maggie and Daniel are, as we say in finance, "just making this shit up".  It's as though a few weeks before the quarterly call, they sit down with an Excel spreadsheet, plug in the last quarters numbers and do some "what-ifs" as to what they think the investors might like to hear.  They come up with a script, muted only by what they think they can get away with, and put on their quarterly show.   

Obviously, if they disclosed detailed category mix data, it would be a relatively simple exercise to survey a statistically appropriate number of merchants and consumers, determine exactly what they are selling/buying, compare it to management's published figures/ratios and calculate, with great accuracy, the precise level of bull-shit being pedaled by these folks.


The SEC to the Rescue

As I mentioned a month ago in my post "Holiday wishes from a born again Investment Banker...." our new administration was about to appoint "the worst SEC Chairman in history", without my knowing anything about who was destined to be appointed.  It's not that I had anything against the unknown appointee at the time, my point was that the new chair, by default, would be the equivalent of a "goat trotting clueless into a mine field".  I have to say, now that the goat has been selected and the appointment has been made public, my expectations have been exceeded by a country mile.  The only thing you need to know about Jay Clayton, the new SEC Chair, is that he was one of the architects involved in the Alibaba IPO.  Moreover, not only has he never been a regulator, but he's spent his entire career representing the folks that he will now be regulating.  As I mentioned in my post (before I knew who the new Chair would be), Mr. Clayton will be the perfect "laissez-faire, less-government, figurehead who will spend his/her tenure making a few speeches, hobnobbing with corporate royalty and playing golf."  Yup....we picked the right guy. 

That said, I'd guess that the Alibaba and Yahoo! SEC investigations will be quietly closed without fanfare in the relatively near future.

Finally, I for one have to say that I'm absolutely thrilled that the SEC is finally going to stop bothering executives and management with these pesky investigations and let businesses finally get back to the task at hand.  Business people need to concentrate on the big, important things, like generating jobs for the "little people", creating shareholder value and of course, enormous insider wealth. The type of wasteful, time consuming administrative folly that the SEC has been engaged in must come to an end.  It stops here and it stops today.  

Like, for example a few years back, I recall how a now bankrupt, goofy Hotel & Casino group had tried to goose earnings by writing up the leasehold improvements of a failed coffee shop....could you imagine!.....and the SEC was all over them!....what a pain.  How's a guy supposed to make a buck? Here's the link to the hilarious, time-wasting investigation and "cease & desist" order.  I'm glad to know that, for the sake of the American people, that we can finally put this type of government harassment and injustice behind us.

With Mr. Clayton's appointment, Management will finally be able to put whatever numbers they'd like on filings without repercussion.  Executives can focus on improving their financial statements, making unverifiable claims and working naive shareholders into a frenzy with their impossible business models that have virtually no chance to succeed.  They'll be free to discover new fake revenue sources, nonsensical metrics-du jour and sprinkle misrepresentations anywhere they choose, like seeds upon the fruited plains.   To paraphrase Masa Son....the SEC will be "spreading happiness" all over the globe. 

Eventually, it will be impossible to tell whether Joe, Maggie and Daniel are committing Securities Fraud or just presenting "Alternative Facts" to keep their investors enthusiastic about the business.  

.....and apparently, nobody will care.


Additional Reading

NBS - 2016 Data http://www.stats.gov.cn/english/PressRelease/201701/t20170120_1455922.html

THRC  - SEC Cease and Desist
https://www.sec.gov/litigation/admin/34-45287.htm

Jay Clayton - Washington Post
https://www.washingtonpost.com/news/wonk/wp/2017/01/04/trump-to-tap-wall-street-lawyer-jay-clayton-to-head-sec/?utm_term=.8daf155b9e4a

BABA - Investor Call
http://edge.media-server.com/m/p/25qobdq7

BABA - Presentation
http://www.alibabagroup.com/en/ir/presentations/pre170124.pdf

BABA - Press Release
http://www.alibabagroup.com/en/news/press_pdf/p170124.pdf

BABA - 6-K
https://www.sec.gov/Archives/edgar/data/1577552/000110465917003802/a17-3083_1ex99d1.htm

Oooppss!.....US Foreign Policy is about to punch Apple right in the nose....

Ridiculous you say!  Absurd! Preposterous!  Deep Throat has lost his mind and has no idea what he's talking about!

Now.....this is the part where I beg you to keep reading......

Here's the question:

Does China need Apple/Foxconn more than Apple/Foxconn needs China?

Normally, I don't spend much time discussing or analyzing things that I don't believe could ever happen.  That said, we're in a brave new world now, where the formerly unthinkable seems to be occurring on a regular basis.  So what the heck, lets run through a scenario or two where a few poorly timed political missteps by our new, pro-business administration could establish a new world-class level of irony.

I'm referring of course to Apple, arguably, the greatest, most profitable and innovative American business of all time.   There's a good possibility that one of the largest (by Market Cap) publicly traded companies in the world could end up on the economic scrap heap in short order, along with the "Magnificent Seven" and other inevitable collateral damage if things don't go all that well with our new "Make America Great Again" plan.  (IMO.....America's always been great....I'd prefer to leave out the "again"....but it's already on the T-shirts & baseball hats.)

Here's the problem:

First, let's get real.....Apple doesn't manufacture anything.... nothing ....zilch ...zip.  Really.

Apple is an Engineering, Consumer Products, Supply Chain, Intellectual Property, Industrial Design and marketing phenomenon/ behemoth/ juggernaut.  But it  doesn't "make" squat. About 15 years ago Steve & Tim closed the last of the US manufacturing facilities (remember the white painted walls and "cool" employees who all looked like Crosby/Stills/Nash & Young after they just finished their Woodstock set? "Teach your Children Well?") and like the rest of American tech  (HP/Dell/Compaq/ etc.) outsourcing was the new battle-cry and everything went over to Asia to cut costs.... Foxconn, et. al. was born.

David Barboza at the NY Times just published a tremendous article describing how the iPhone City came about. I absolutely encourage you to read it. In my three sentence summary, the article provides great insight as to how the Chinese government has funneled billions of dollars in tax credits, incentives, land, infrastructure, concessions and an available and a compliant workforce to Foxconn and Terry Gao  (Foxconn CEO) in order to get the Chinese outsourced electronics manufacturing ecosystem off the ground.  Fast forward, today Foxconn is by far Apple's largest supplier and is intimately involved in the manufacture of virtually every Apple product. In just six(6) years Foxconn built the iPhone City, Zhengzhou manufacturing complex, bonded zone, air transport hub and distribution center which today produces half of the worlds iPhones, 500,000+ phones a day, when running full tilt.

Interestingly, Apple's biggest problem and in fact, a threat to its very survival, is the incredible success of its business model.  Let me explain.  Apple has enjoyed incredible margins (Apple's profits are roughly 90% of the entire Smart Phone industry worldwide, although the company accounts for only 12% of industry sales) which have been subsidized by the Chinese government and cheap/forced labor.  Contra to claims of the new administration, Apple has actually done an incredible job of taking advantage of the opportunity presented by Foxconn and the Chinese government, not the other way around.  The obvious downside is that should this relationship somehow sour, Apple's production needs are so great that it would be nearly impossible to get alternate supply chains, production lines and/or any sort of disaster recovery plan in place in time to save the business.  In other words, unless Apple has secret manufacturing facilities somewhere that they've not disclosed to shareholders and a few hundred thousand fully trained production employees on call at some gigantic temp agency that we're unaware of, Apple could be in big trouble. 

Here's the boilerplate language in their last 10-K (and every filing) that nobody ever reads, but in this particular case it's absolutely relevant.  The below "see I told you that could happen" language is provided to prevent, or at least limit the impact of shareholder lawsuits.  No need to actually read it, I'm just pointing out it's there:

APPLE 10k Annual Report - pg.10 Boilerplate

The Company depends on component and product manufacturing and logistical services provided by outsourcing partners, many of which are located outside of the U.S.

https://www.sec.gov/Archives/edgar/data/320193/000162828016020309/a201610-k9242016.htm#s7141C8F9300451B981539768A645E29A

Over the last decade Apple has created and built some of the most brilliant consumer products imaginable.  The company has chosen to accept huge indirect foreign government assistance, generating gigantic profits, hoarding cash, to the delight of shareholders, in lieu of diversification. Unfortunately, by taking these cost savings to the bottom line, not diversifying its manufacturing process and adequately accounting for contingencies and potential supply chain interruptions, as any undergraduate risk management student might identify, the business is now at risk.  In defense of Apple management, if they would have chosen to continue to manufacture products in Cuppertino and other US facilities, Apple would most likely be a low margin also ran in the smart phone business.  The industry and indeed, our world as we know it, would be much different than it is today. 

Enter the New Dawn of MAGA Foreign Policy

The recent confirmation hearings, Inaugural Address and POTUS Tweets have been enlightening. Here are a few select snippets from the Tillerson confirmation hearings.  I invite you to watch the entire testimony provided in the C-Span links (Part 1, Part 2 & Part 3) below and come to your own conclusions.

Tillerson:

Part 1- Minute 56

"We cannot continue to accept empty promises like the ones China made to pressure North Korea to reform, only to shy away from enforcement.  Looking the other way when trust is broken only encourages more bad behavior.  It must end.  We cannot be accountable though if we are not truthful and honest in our dealings."

Part 1 - Minute 59

"We should also acknowledge the realities about China.  China’s island building in the South China Sea is an illegal taking of disputed areas without regard for International norms.  China’s economic and trade practices haven’t always followed commitments to global agreements.  It steals our digital property and is aggressive and expansionist in the digital realm.  It has not been a reliable partner in using its full influence to curb North Korea.  China has proven a willingness to act with abandon in the pursuit of its own goals which at times put it in conflict with American interests.  We have to deal with what we see, not what we hope.  But we need to see the positive dimensions in our relationship with China as well.  The economic well-being of the two nations is deeply intertwined.  China has been a valuable ally in curtailing the elements of radical Islam.  We should not let disagreements over other issues exclude areas for productive partnership."

So apparently, when China is "acting with abandon" in conflict with American Interests, they must be dealt with immediately, yet we somehow need to recognize the "positive dimensions of our relationship" as well.  Makes sense...I guess.  Of course, the above are not the only instances of this tone, there's similar "bad girlfriend" banter throughout the hearing.  These are just the immediate quotes that jumped out at me.

Tillerson v.Rubio & Menendez (1:15:00 through 1:40:00)

Oddly, when questioned repeatedly by Senators Rubio and Menendez, describing horrific, gruesome accounts of Russian military executions and actions against civilians in Chechnya and Aleppo, Mr. Tillerson began a familiar theme that would recur throughout the hearing:

“I do not have sufficient information”

Senator Rubio would continue to press:

“None of this is classified, Mr. Tillerson. These people are dead.”.....
“That’s why I asked you about whether Vladimir Putin was a war criminal, something you declined to label him as,”......
“I asked about China, whether they were one of the worst human rights violators in the world… I asked about the killings in the Philippines. I asked about Saudi Arabia being a human rights violator, which you also declined to label them. The reason was not because I was trying to get you involved in the international game of name calling. But in order to have moral clarity, we need clarity. We can’t achieve moral clarity with rhetorical ambiguity.”

Further, Senator Menendez continued the theme:

Mr. Menendez: "For all of the answers you have given me, does the President-elect agree with you?"

Mr. Tillerson: "We have not discussed this specific area."

Mr. Menendez: "???  On page three of your statement you say.....'In his campaign President-Elect Trump proposed a bold commitment to advance American Interests in foreign policy.  I hope to explain what this approach means and how I would implement this policy if confirmed as Secretary of State'.  I assume that to some degree you have had discussion about what it is that the world view would be in order to understand whether you can execute that on behalf of the person you work for."

Mr. Tillerson: "In terms of principles that will guide it, yes, sir."

Mr. Menendez: "I would have thought that Russia would be at the top of that list considering the actions that have taken place."

Mr. Tillerson: "That has not occurred yet, Senator."

Mr. Menendez: "That's pretty amazing."

Mr. Tillerson's answers to the pointed, direct questions put forth by Senators Rubio and Menendez illustrated a strange lack of information and/or unwillingness to at least acknowledge Vladimir Putin as a bad actor in Chechnya, Crimea, Ukraine and Aleppo while simultaneously showing little hesitation regarding a possible US response to China's alleged illegal activities in the South China Sea. I might ask why? Will our new foreign policy require that we talk tough with expansionist trading partners, drawing a line in the sand, only when they commit atrocities and slaughter hundreds of thousands of civilians? Then and only then will we rise up as a people, driven by a sense of compassion and our moral compass.  We will band together as one and require, dare I say demand! ...."more information"??  Along with Senators Rubio and Menendez, I'm a bit confused. 

In stark contrast, at the WEF conference in Davos, a few days ago Xi Jinping gave a carefully scripted, and if sincere, inspiring keynote address remarkably different in tenor, content and direction than what we're seeing in Washington today. I'd invite you to watch the speech in its entirety, but here are a few tidbits describing the tone:

“Some people blame globalization for the chaos in our world,”.....“That’s not the case"… "Pursuing protectionism is like locking oneself in a dark room. While wind and rain may be kept outside, so are light and air"… "No one will emerge as a winner in a trade war.”

This speech was as remarkable as it was expected.  Xi and his government have no choice but to continue to scour the globe for naive capital in order to keep their fragile, flagging, facade economy disguised as as something other than a debt fueled Ponzi scheme.  The Chinese economy, like the rest of the world, has become precariously dependent on continued, ever-expanding, debt fueled, bubble-iscous, globalization and easy money. Like it or not, we're all in this together.  When a butterfly flaps its wings in China... ..iPhones don't get delivered in Des Moines.   Interestingly, Xi apparently realizes this but refuses, despite his Davos rhetoric, to take the necessary steps, opening markets and capital flows, to reap the full benefits.  In an odd role reversal, America has taken nearly all of the steps to facilitate real globalization, but is retreating from same as a result of a growing nationalist, "America first" wave of political and institutional distrust.  

That said, is it likely that Xi will fully open China's economy?  Establish open borders, adhere to the rule of law, freedoms of the press, privacy and speech?  Will the Politburo provide for the enforcement of basic civil and human right protections for the Chinese people?   Nearly 100 years of communist rule, with all of the authoritarian infrastructure and trappings that go with it, would suggest not.

On the other hand, here in America, is it likely that the new administration is simply saber rattling?....rallying support for the isolationist "Make America Great Again" vision? ...is all of the "my way or the highway" bluster about 35% tariffs, "I love war, especially with nukes", bringing jobs back at any price and reasserting a global military order as the "new Sheriff in town" just a series of reality TV rants initially intended to get elected and garner attention?   Is it probable that every scenario and eventuality re: our new isolationist path has been fully and painstakingly analyzed?  Will the implementable policies that are truly beneficial to the American people be pursued and those that are not will be cautiously cast aside?  Is it possible that none of this knee-jerk, half-cocked isolationist policy is actually going to be executed and we're just in for a few years of great theater? Unfortunately, the POTUS Twitter feed, confirmation hearings, inaugural address and nearly every piece of evidence available suggests otherwise.  Just once I'd like to get the feeling that everything our government is about to undertake has been fully thought through and the potential ramifications have been measured.  The NSA, CIA and Pentagon all play "war games" and manage models intended to determine "how many men?", "what's the collateral damage, human and financial cost?", "What's the outcome, possible repercussions and probability of success?".  I hope I'm wrong, but I'm not aware of any such exercise when it comes to implementing trade policy.  I'd like to see a FED, GAO or White House Study entitled "What happens when we blow up our trade relationship with China?"  To my chagrin, I've not seen anything remotely like that to date.

Rather, the number one priority seems to be reaffirming America's place as the dominant economic and military super-power on the planet, scorching whatever earth lie behind us, taking no prisoners along the way without any regard to, or consideration of, the economic cost to every man, woman and child on the planet.  For the sake of our economy, as Hillary Clinton, to her political regret, accidentally described on Wikileaks, we can only hope in this particular case that our government's Public Position is much different from our Private Position. 

You're Fired!

As part of the new Administration's clean slate initiative, parting with tradition, but following the "blow it up and figure out how to fix it later" play book, there are no extensions being granted to the current diplomatic corps.  US Ambassadors were fired and required to leave their posts as of inauguration day on a "no exceptions" basis, potentially leaving diplomatic posts with important countries open, possibly for months. Fortunately, in a preemptive move to ostensibly hit the ground running, the new Administration has already selected Iowa Governor Terry Branstad as the new Chinese Ambassador, apparently acknowledging the importance of the US/China relationship. Presumably, Terry will be the voice of reason on all that is China. His relationship with Xi goes way back to the 1980's when Xi led an agricultural research delegation to Iowa, is on a first name basis with most of the larger Chinese soybean and pork-belly importers and is considered an "old friend" of the party. Terry will be a guiding light, providing valuable insight when examining complex diplomatic questions like:

"Where exactly is Taiwan and why did the Chinese get so pissed off when we took that phone call?"

As you may have heard, this little phone call caused quite an uproar with Chinese officials, putting diplomats in a tizzy, citing the disruption of the "One China" policy. Calls for "revenge" rang out. Not that saber-rattling, diplomatic fits are all that uncommon, after all, indignant opposition is part of any good politicians tool kit. The reason I brought this up is to illustrate how any miss-step, calculated or accidental, on the world stage has consequences. A capable diplomatic corps manages the intended consequences of their government's actions, while eliminating, or at least limiting the occurrence (by defining what they hope will be a predetermined outcome) of any unintended consequences.  In an ideal world there should never be any unintended consequences. 

Apple's Bloody Nose ...

Let's look at globalization another way....the American people believe that outsourcing Apple's manufacturing to Foxconn cost American workers roughly 1.3 million high paying factory jobs (Foxconn's headcount) give or take...or at US$75k/yr. in wages and fringes, about $100 Billion a year in payroll.....and they are pissed-off....so much so that they've elected a new administration as a reaction to this this type of outsourcing.  Framed a bit differently, what's actually happened is that the Chinese government has provided (or could provide) nearly every American with an amazing smart phone at a huge discount.  Foxconn workers put in long hours at a pittance wage when compared to what US Workers demand (that's why Foxconn landed these tech/production jobs in the first place). The Chinese government printed money (in order to land the jobs) provided financing, land, infrastructure and all sorts of other goodies to make sure the hard working Chinese people were employed and iPhones were being built.  If iPhones and iPads were made in America, without the Mao-nopoly Money subsidies it would have pushed the cost of these devices far beyond what most people might be able to afford. Because of the wage differential, pesky US environmental and worker safety/protection laws (generally we don't have to build nets around our high rise dormitories to keep employees from jumping to their death in order to get out of work the next day) as well as the higher cost of un-subsidized capital, if these great little devices were  "Made in America" they would cost thousands of dollars, few people would own them and most of us would still be using flip phones or "less cool" Smart phones.  If it weren't for Apple, Samsung would have a dominant share of the US Smartphone market and the phones would still be made at at Foxconn-like facilities or any of the other usual outsourcing suspects.

So what did the Chinese get out of this?  Many Chinese folks got a job, and nearly everyone in China got a "cheap" smart phone!  China has become the most "connected" country on the planet. Once the cheap, subsidized phones were distributed to the Chinese citizens, the CPC also had a great tool to track the every move of its population.  (Authors Note: Here in the US we allow Mark Zuckerberg, Sergey Brin and the phone companies to track our every move, ostensibly for "marketing" purposes, and we're apparently OK with it.  I guess, as always, it's a matter of perspective.)   Today, at the end of the Foxconn production line, the inventory count goes something like "One for Apple....one for us....One for Apple....two for us....etc.) these phones are sent to unauthorized Chinese distributors and sold/resold on TaoBao/T-Mall/Alibaba for a fraction of the Apple price. Unfortunately, Apple turns a blind eye to this IP Theft because they have no choice.  Nearly all of their products are made in China and legitimate Apple revenue in China amounts to roughly 25% of their total revenue.  They have no legal recourse or leverage, and thus have to look the other way.  

Again, hypothetically speaking of course, let's say that there is a colossal diplomatic misjudgment or miscommunication and we end up sending a carrier group (or two) into the South China Sea or perhaps our tanks roll into Pyongyang after Kim Jong Un sets off some unappreciated intercontinental ballistic fireworks.  The first thing that most governments might consider when these squabbles erupt is sanctions, cutting off trade and diplomatic relations with the opposing/offending side.

Beijing could kill three birds with one well placed stone with a Chavez like nationalizing of the Foxconn manufacturing campuses in mainland China.  Apple and the Taiwanese economy would be crippled and the Chinese would get "free" iPhones.  They'd simply rename the products "XiPhones" and "XiPads" and sell them on Taobao, T-mall and probably Amazon and eBay (getting around any retaliatory tariffs) at a fraction of their current cost.  Again, Mainland sales already represent 25% of Apple's revenue so the Apple volume, some  iPhone City jobs and all of the illegally seized intellectual property (The Chinese government has never been a big fan of US IP rights anyway) would immediately transfer over to the new Chinese SOE, and the largest, by volume, smart phone business in the world would be "transferred" from the US to China, courtesy of US foreign policy.  

Let's take a look at some numbers below: Apple's 2016 10k;  and two pro-forma presentations: 1.) What Apple's P&L might look like the first year of a "Nationalization"; and 2.) What the company might look like on a "Stabilized - Go Forward" basis after the shock of having it's China Assets, Inventory, Intellectual Property and Market confiscated.

Of course, the above are just "back of the envelope" estimates intended to illustrate the financial implications to Apple of a Trade War gone awry, but they should be at least directionally correct. Of course, Luca Maestri (Apple CFO) probably has very accurate, detailed financial/risk models describing what I'm pointing out, but for obvious reasons, I'd doubt that he'll bring them up in a next-quarter-earnings-focused Investor Call. Bullet points from the above analysis are as follows.

• In the "Nationalization Year" Apple's Net Income swings from a $45 Billion profit to a $42 Billion Loss and Apple's $600 Billion Market Cap is virtually wiped out.
• An enormous amount of money must be spent to duplicate the Foxconn manufacturing process on American/safe soil.
• Increased US Labor Cost will require sophisticated process improvements and automation (i.e. fewer employees) to remain price competitive with Samsung and other competitors.  My "guess" based on ratios is that roughly 115,000 US manufacturing workers would replace 500,000 Chinese workers.
• "Go Forward" profitability and shareholder returns will be much less given un-subsidized increased US Costs to Manufacture. 
• Given the size and scope of the disruption, there is a good chance that Apple won't succeed in the emergency conversion of their business model without a Tarp-like bail out.
• Fortunately Apple has a war chest of about $238 Billion in cash, equivalents and marketable securities they can use to start looking for alternatives to Foxconn.  Is it possible to build manufacturing plants and a fully functioning supply chain on US Soil in time? Is Apple capable of hiring an army of fully trained employees to fill Foxconn's production void in time to rescue the business?   

So hopefully, as I type, Tim Cook is scouring the globe and talking with state governors, Senators and the POTUS looking for relatively immediate, viable, alternative production capability.

So I'll ask the question again:

Does China need Apple/Foxconn more than Apple/Foxconn needs China?

I hope you will agree that the answer to this complex question is now obvious.

If "The Core" pulls the trigger....Apple is sauce.

Final Thoughts on "MAED in America"....(Mutually Assured Economic Destruction) 

Of course the Apple example described above is just the poster child for the isolationist dilemma. Any American Business or Industry that has substantial relationships with China (Retail, Clothing, Footwear, Consumer Electronics, Construction Materials, Steel, Aluminum, etc.) or any targeted trading partner (Mexico, etc.) are all at risk. The cost and of raw materials, process and goods we import will increase dramatically, supply/availability may be limited, increasing prices to US Consumers, or in the case of Apple products, potentially killing the business all together.  The last fifty years of Globalism simply can't be unwound without a painful disruption.     

The real issue is that the American worker (I include myself in this group) when compared to much of the world, because of gigantic productivity gains, has become accustomed to doing relatively little "work" while, for those of us who still have jobs, receive ever increasing paychecks.  Personally, my day consists of thinking deep thoughts, managing/evaluating risk, using computing power to help make good, efficient business decisions and magically, insurance companies we represent send us checks.  There's much less "work" involved in my business than there used to be.  Paperwork and process is automated.  Filing and documentation is virtually automatic.  We accomplish three times as much work with the same staff.  This "do more with less" phenomenon has taken over American business.  It no longer takes a crew of ten men to put on a roof, two guys, some power tools and pneumatic nail guns get the job done in half the time.  It no longer takes a year and an army of skilled carpenters, tradesmen and laborers to build a home.  A few guys, using pre-fab factory produced building materials, "assemble" a house on site in just a few months. Employees generally don't carry or move materials on the shop floor anymore.  Factory automation, for the businesses that have chosen to remain in America, has eliminated the lions share of the jobs that the American worker has come to believe were "shipped overseas".

If America is to "get these jobs back", or what remains of them, is it likely that the US worker will have a "Rosie the Riveter" moment?....rising up in patriotic harmony, working long hours for next-to-nothing, not to save America from a foreign military threat by making tanks and B17's, but to stave off an economic threat, to be redeployed to make iPhones and other "cheap plastic stuff" keeping Apple and Walmart in business?  Or is it more likely that we, as Americans, continue to handle the transition like we did with the clothing, textile, athletic shoe, construction material, auto, etc. industries?  I'd suspect that rather than take a huge pay cut, we'll prefer to have someone else do the heavy lifting at a discount and continue to reap the benefits of their toil.  Because of incredible productivity gains, only the highly skilled will be able to earn a paycheck, the rest of us will rely on some form of "universal basic income" and continue to buy our cheap phones, clothes, gadgets and plastic stuff on-line at Amazon, E-Bay and, dare I say, fake businesses like Alibaba.

The populations of both countries face an odd dilemma..... In America we must hope and pray that the Administration's public position is fake and we will continue along an, albeit modified, pro-globalization private position.  The Chinese people are hoping and praying that Xi's "open China" public position is becoming a reality and that the CPC has no private position.

It's clear, at least to me, that both the Chinese and US Governments possess ample financial firepower to destroy the other's economy (along with their own). Symbiotic US and Chinese business relationships and interests have become so interdependent and intertwined that disruption of same would be catastrophic for the daily lives of both Chinese and US citizens.  Hopefully, all of the political blustering, chest thumping, Tweets and threats of "Revenge" are just propaganda intended to vilify the evil foreigners and galvanize each country's respective population in support of its current leadership.  If that's true, it will be business as usual, and disruption will be kept to a minimum.

Alternatively, if this level of animosity is real, and both the Politburo and our Government choose to go the scorched earth route, both US and Chinese citizens will suffer unimaginable economic pain. US Asset values will again be reset, wiping out Trillions of dollars of net worth.  The FED will be forced to open the spigot again, providing unimaginable levels of liquidity in order to prevent systemic defaults and collapse.  Inflation will rear it's ugly head and the purchasing power of the dollar will plummet.  All of those high paying "Make America Great Again" jobs will fail to materialize.  We're talking about good old fashioned depression era bread lines and civil unrest.

On the other side of the Pacific, facilities like iPhone City as well as much of China's manufacturing infrastructure will be retooled or mothballed, causing massive unemployment.  Much like in the US, all of the fake Chinese assets, real estate and business values will be reset.   Despite heroic efforts by the PBOC, loans, bonds, wealth management products and all of the fake shadow bank assets will finally default. The newly minted net worth of the hard-working Chinese people will be destroyed. Another big party at Tiananmen Square wouldn't be hard to imagine.

The Chinese will blame the Americans and the Americans will blame the Chinese.....and so it goes....

Interestingly, in the United states we have a relatively civilized method for dealing with civil disobedience.  We do our best to disburse the crowds, but if something goes awry and folks get shot, we put it on Youtube, Twitter, CNN and other "fake" news outlets.  The authorities apologize, promising a full review.  They conduct a fake criminal investigation and trial consistently exonerating the government sponsored shooters who are always found to be acting "well within the bounds of the law".  The trial is often followed by a sternly worded Federal report demanding systemic change.  That report is nearly always followed by a wrongful death civil suit awarding the family of the deceased dissident, either by settlement or jury award, a sizable amount of money.  The process takes a few years and is extremely costly, but in the grand scheme of things, considering government authorities, in their zeal to keep the peace, caused the death of a US Citizen on video for all to see, this template would seem about as fair as any.  Albeit acknowledging on a personal level, if one of my loved ones were a victim, my opinion of "fairness" might be radically different.

Like many aspects of the CPC, the Chinese system for dealing with protesters, dissidents and people seeking to have their voices heard, as well as the journalists, Youtubers and WeChat-ers trying to cover it, is a bit more efficient and far less costly.....these people and anyone asking about them simply disappear.

Perhaps that's why so many Chinese citizens want to move here?  I also have a few American friends who are expats living in China, enjoying the experience.  They're not in tin roof shacks and they have a comfortable life, well above the poverty level that a half billion Chinese have become accustomed, but not surprisingly, my friends always look forward to coming "home".  In American business, we refer to that as a "competitive advantage".

God Bless America......    

Additional Reading

POTUS Tweets

https://twitter.com/realDonaldTrump

Tweeting Foreign Policy

https://www.nytimes.com/video/world/asia/100000004851379/china-responds-to-trump-tweet-on-north-korean-missiles.html

The "One-China" Policy - China's Reaction to Trump discussions with Taiwan

https://www.nytimes.com/video/world/asia/100000004824316/chinas-foreign-ministry-on-taiwan.html

China's Foreign Minister - Seriousness of the "One-China" policy

https://www.nytimes.com/video/world/asia/100000004817279/china-concerned-at-trumps-one-china.html

Time - "China will 'take revenge' if the 'OneChina' policy is disrupted" - Tsai-Ing Wen meets with Ted Cruz and Texas Governor

http://time.com/4628279/china-taiwan-trump-cruz-tsai-ing-wen/?xid=homepage

NYT - IPhone City

http://www.nytimes.com/2016/12/29/technology/apple-iphone-china-foxconn.html?emc=edit_ta_20161229&nlid=70198410&ref=cta&_r=1

US President believes Jack Ma to be a "Great Entrepreneur" ... "Jack and I are going to do some great things".

http://www.usatoday.com/story/tech/news/2017/01/09/donald-trump-meet-alibabas-jack-ma/96345262/

NYT - Trump/Ma video

https://www.nytimes.com/video/business/100000004861537/trump-and-alibabas-founder.html?rref=collection%2Ftimestopic%2FTrump%2C%20Donald%20J.&action=click&contentCollection=timestopics&region=stream&module=stream_unit&version=latest&contentPlacement=6&pgtype=collection

US Ambassadors - Blanket "You're Fired"

http://www.nytimes.com/2017/01/05/us/politics/trump-ambassadors.html?_r=0

Whitehouse ties to AnBang Insurance

http://www.nytimes.com/2017/01/07/us/politics/jared-kushner-trump-business.html?action=click&contentCollection=Politics&region=Footer&module=WhatsNext&version=WhatsNext&contentID=WhatsNext&moduleDetail=undefined&pgtype=Multimedia

Jay Clayton - Op Ed NYT

https://www.nytimes.com/2017/01/07/opinion/sunday/will-jay-clayton-protect-investors.html?_r=0

Bloomberg - Impact of a US/China Trade War

https://www.bloomberg.com/news/articles/2016-12-13/trump-s-china-bluster-threatens-u-s-exports-and-supply-networks

Apple Not Likely to Move Production to US

http://www.forbes.com/sites/greatspeculations/2016/11/22/why-its-unlikely-that-apple-will-move-iphone-production-to-the-u-s/#79ac472c2fd7

1980's Vintage Video of the Apple Manufacturing Process

http://professornerdster.com/steve-jobs-painting-factory-waste/

Terry Branstad - US Ambassador to China

http://www.reuters.com/article/us-usa-trump-china-branstad-idUSKBN13W0H3

Rex Tillerson's Confirmation Hearing Video - China 1:00; 2:28

https://www.c-span.org/video/?421335-1/secretary-state-nominee-rex-tillerson-testifies-confirmation-hearing&live

http://www.marketwatch.com/livevideo?siteid=bnbh

Mr. Pompeo - "Russia has reasserted itself" & China "Creating real tension".

http://www.reuters.com/video/2017/01/12/russia-has-reasserted-itself-aggressivel?videoId=370903941

Steve Jobs eMail re: Foxconn Suicides

https://www.macstories.net/stories/steve-jobs-email-conversation-about-foxconn-suicides/

Venezuela Nationalizations/Asset Seizures under Chavez

http://www.reuters.com/article/us-venezuela-election-nationalizations-idUSBRE89701X20121008

http://www.forbes.com/sites/stephenpope/2017/01/14/at-davos-china-seeks-the-limelight-as-trump-takes-charge/5/#7c61e4d25a33

http://www.forbes.com/sites/riskmap/2016/12/13/trade-in-asia-the-liberalization-agenda-where-to-from-here/#62e221c3173e

Tiananmen Square

http://www.independent.co.uk/news/world/asia/tiananmen-square-what-happened-to-tank-man-9483398.html

Chinese Aircraft Carrier passes through the Strait of Taiwan

http://www.msn.com/en-us/news/world/china-says-its-aircraft-carrier-leaves-taiwan-strait/ar-BBy8BP4?ocid=iehp

Marko Rubio grills Tillerson on Russia

http://www.thedailybeast.com/articles/2017/01/11/marco-rubio-drills-former-exxon-ceo-rex-tillerson.html 

Tillerson Hearing  - Rubio & Mendez (1:15:00 through 1:40:00) - part 1

https://www.c-span.org/video/?421335-1/secretary-state-nominee-rex-tillerson-testifies-confirmation-hearing&start=4431

https://www.c-span.org/video/?421335-1/secretary-state-nominee-rex-tillerson-testifies-confirmation-hearing

Tillerson Hearing - Part 2

https://www.c-span.org/video/?421335-3/secretary-state-confirmation-hearing-part-2

Tillerson Hearing - Part 3

https://www.c-span.org/video/?421335-4/secretary-state-confirmation-hearing-part-3

Xi Jinping - Davos

http://www.reuters.com/article/us-davos-meeting-china-idUSKBN15118V

Xi Jinping - Davos video

http://www.cnbc.com/2017/01/17/chinas-president-xi-jinping-takes-to-the-stage-at-world-economic-forum-in-davos.html

Xi Jinping - Full Video - Davos Keynote Speech

https://www.youtube.com/watch?v=Sl3lYYbQL6o

End of the "strong dollar"

http://www.cnbc.com/2017/01/17/trump-just-signaled-death-of-clinton-era-strong-dollar-policy.html

Ron Paul on Hillary Clinton's "Public and Private" positions

https://www.youtube.com/watch?v=-U9IrnpmeAA

Chicago Tribune - American Business No Longer Welcome in China

http://www.chicagotribune.com/business/ct-american-companies-in-china-20170118-story.html

China has fewer tools to deal with it's mess...

http://www.wsj.com/articles/china-to-have-fewer-tools-to-keep-economy-humming-in-2017-1484924348

Trump - Inaugural Address

https://www.nytimes.com/interactive/2017/01/20/us/politics/donald-trump-inauguration-speech-transcript.html?emc=edit_ta_20170120&nl=top-stories&nlid=70198410&ref=cta&_r=0

How Much does it Cost to Make an iPhone?

https://www.marketplace.org/2014/05/20/business/ive-always-wondered/how-much-would-all-american-iphone-cost

Apple Supply Chain

http://www.supplychain247.com/article/is_apples_supply_chain_really_the_no._1_a_case_study

Apple Product Costs

http://www.macworld.co.uk/feature/apple/where-are-apple-products-made-how-much-does-iphone-cost-make-trump-3633832/

The Economist

"The idea running through Mr Trump’s diplomacy is that relations between states follow the art of the deal. Mr Trump acts as if he can get what he wants from sovereign states by picking fights that he is then willing to settle—at a price, naturally. His mistake is to think that countries are like businesses. In fact, America cannot walk away from China in search of another superpower to deal with over the South China Sea. Doubts that have been sown cannot be uprooted, as if the game had all along been a harmless exercise in price discovery. Alliances that take decades to build can be weakened in months.

Dealings between sovereign states tend towards anarchy—because, ultimately, there is no global government to impose order and no means of coercion but war. For as long as Mr Trump is unravelling the order that America created, and from which it gains so much, he is getting his country a terrible deal."