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Taiwanese tech companies feel Apple's pain

TAIPEI Key Taiwanese suppliers to Apple made their fortunes on iPhones, iPads and MacBooks. Now, their reliance on the U.S. tech giant has left them struggling as their biggest client faces flagging sales amid a weakening global appetite for premium electronics devices.

Sales of iPhones have fallen for two straight quarters, ending an eight-year growth streak for the popular device. The iPhone has been squeezed by more affordable Android phones offered by main rivals including China's Huawei and South Korea's Samsung Electronics.

The average sales price for iPhones is deteriorating due to the launch of Apple's lower-priced SE phone. Apple is also losing ground in greater China. Combined sales in mainland China, Hong Kong and Taiwan dropped 33% in the quarter ended June.

Taiwan's stumbling tech supply chain has contributed to a 17-month decline in exports. The local economy entered a technical recession in the third quarter of 2015, though it ended in this year's April-June period. Investors are concerned, as no groundbreaking product is in sight that might help the island's tech companies break out of the current doldrums.

"Apple now is facing pricing pressure, with competitors offering cheaper smartphones," said Arthur Liao, an analyst at Taipei-based Fubon Securities. The phones "can be expected to start selling at a lower price, like notebooks did when the notebook market became saturated," he said.

A major issue facing Taiwan's tech supply chain is that there does not seem to be another innovative product that can fuel growth over the next few years similar to what notebooks and smartphones did over the past 15 years, Liao said. Adding to the woes is the uncertainty of whether new technologies such as connected cars and devices, known as the internet of things, may translate into commercial potential anytime soon, he said.

In the first half of 2016, Apple and its suppliers suffered from the failure of the iPhone 6s and iPhone 6s Plus to outsell the iPhone 6 and iPhone 6 Plus, the most popular Apple smartphone models so far. The company is now bracing for a lukewarm second half, with low market expectations for the next premium model, to be unveiled in September.

SURGING SHARE PRICES Apple shares have gained more than 1,000% over the past decade. However, the stock lost close to 10% between the beginning of this year and July 26, when it closed at $96.67.

While many suppliers have benefited from Apple's prosperity, the scale is not comparable. Largan Precision, currently the highest priced stock on the Taiwan Stock Exchange, gained more than 400% over the past 10 years.

Largan Precision has been the sole iPhone camera supplier since 2007, when Apple launched its first phone. Its irreplaceability has helped the company boost its performance and stand out among suppliers.

Taiwan Semiconductor Manufacturing Co. (TSMC)'s share price rose more than 200% in the past decade to 175 New Taiwan dollars on July 27, while major chip assembler Advanced Semiconductor Engineering gained about 32%.

IPhone assembler Pegatron advanced 123% since it was listed in July 2010 to close at NT$77.6 New Taiwan dollars on July 27 this year. However, the share price of Pegatron's bigger rival Hon Hai Precision Industry, also known as Foxconn Technology, dropped by more than half in the past decade -- partly due to stock dividends, and partly due to the manufacturing giant's perennial struggle to maintain growth and improve its razor-thin margins.

Even as Apple's health deteriorates, the company's assemblers have become even more reliant on it for revenue. According to Foxconn's 2015 annual report, the Taiwanese company got 53.6% of its sales from Apple last year, up from 50.3% in 2014. In the first three months of this year, Apple contributed 54.8% of Foxconn's sales.

In the report, Foxconn noted the ongoing decline of the average selling price of smartphones and reiterated its strength at cutting costs. The world's largest contract electronics maker also revealed that its number of employees fell by around 70,000 from a year earlier to 830,000 at the end of 2015. The company has been aggressively increasing the use of automation on its production lines.

Pegatron relied on Apple for 60% of its sales last year, up from 51% in 2014.

MUTUALLY DEPENDENT However, Apple's relations with suppliers are not a one-way street.

Foxconn churns out more than 100 million Apple phones in the central Chinese city of Zhengzhou every year, at a facility that is located next to an airport to ensure the products can reach consumers as soon as possible. Without Foxconn's second-to-none mass production capabilities, and to a lesser degree, Pegatron's help, Apple would not be able to deliver its popular phones to consumers worldwide.

Yet Foxconn and Pegatron share only a shred of Apple's profits. Foxconn's net profit margin is perennially below 4% and Pegatron's less than 3%, while Apple's is steadily above 20%.

Several component makers are also heavily dependent on Apple for revenue. In 2015, Apple contributed about 60% and 50%, respectively, to sales at Largan Precision and metal casing supplier Catcher Technology, which provides components for both iPhones and MacBooks, according to a July note from Goldman Sachs.

While component makers' margins are close to or even better than Apple's, at the end of the day Apple still enjoys a higher return-on-equity ratio -- a key profitability measure investors use to choose between potential investment targets -- than its suppliers.

Some unlucky companies can even lose money on their Apple ties. Taiwanese touch-module supplier TPK Holding, which generates more than 40% of its revenue from the U.S. company, said 70% of its operating losses of NT$2.7 billion ($84.2 million) in the second quarter came from its business with Apple.

TPK has been struggling due to fierce competition with Chinese rivals and the iPhone's earlier switch to a different technology for its screen touch function. TPK now only supplies iPhone's home button and iPads.

It is not easy for Taiwanese suppliers to find new growth areas, said Jeff Pu, an analyst at Yuanta Investment Consulting. Companies could try to branch out into technologies other than smartphones, but it would take a long time to compete effectively with existing players, he said. Some companies, such as Largan Precision, have tried to win more orders from Chinese smartphone brands -- but that may become increasingly difficult as China seeks to boost its domestic supply chain, he added.

As another option, "suppliers [may] need to depend on Apple even more by securing orders for different components," Pu said.

Nikkei staff writer Chien Chia-hung contributed to this report.

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