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Apple Inc (AAPL - Analyst Report) recently lost a copyright infringement lawsuit filed by a group of eight Chinese writers and two publishers, according to news agency Reuters and Associated Press (“AP”). The Beijing No. 2 Intermediate People’s Court found Apple guilty of violating Chinese copyright laws and has ordered the company to pay a fine of 1.03 million Yuan, according to AP (1.00 million Yuan as per Reuters).

Earlier this year the group filed a lawsuit against Apple alleging that its App store has sold a number of apps that contained unlicensed version of their books. As per Reuters, the authors demanded approximately 10 Yuan in damages, while AP quoted the amount to 12 million Yuan.

According to AP, the Beijing court has awarded 605,000 Yuan to one publisher and 21,500 Yuan to the other publisher. Of the authors, Mr. Han Ailian has been awarded the biggest compensation of 186,000 Yuan. Although Apple said that it takes the copyright infringement claims seriously, it declined to comment on whether it will appeal against the judgement or not.

Currently, China is the world’s largest Internet market with approximately 538 million users at the end of June 2012. Of these more than 72% are mobile Internet users. However, piracy is a significant problem that costs billion of dollars to companies and government interventions have been of minimal effect till date. We also note that there is significant lack of clarity in Chinese intellectual property laws, which have for long been accused of bias in favor of domestic companies.

Although China continues to remain the most focused growth region for Apple, the company has faced significant legal worries in 2012. In February, Apple was sued by Proview Technologies for the “iPad” trademark, which prevented it from launching iPad in China. Apple eventually settled the lawsuit for $60.0 million in July 2012.

Apple has also faced significant criticism due to relationships with its Chinese suppliers and accused of ill-treating its workers and endangering the environment. To clarify its own position with respect to these misdeeds, Apple published a list of suppliers, which received the maximum amount of its spending in January this year. Apple also announced that it will give access to Fair Labor Association auditors to facilities in its supply chain and allow them to publish their findings.

In such a scenario, this is the second time Apple lost a copyright infringement case in China. In November this year, a court ordered Apple to pay 520,000 Yuan to the Encyclopedia of China Publishing House for copyright infringement. Although Apple’s policy involves strict scrutiny of its third party apps for any copyright violation, we believe that these lapses will hurt its popularity in China. Moreover, the company can face significant government regulations going forward.

We continue to believe that Apple’s ability to innovate and grow in China, where the market is more cost sensitive, will determine the company’s fortunes over the long term. We expect Apple to continue to forge partnerships with local telecom providers in order to increase its penetration in the Asia-Pacific region going forward. The partnerships will help it to provide devices compatible with local 3G and 4G networks, thereby boosting its subscriber base going forward. This will also provide it a significant competitive edge over Samsung and Google over the long term.

We maintain our Neutral recommendation over the long term (6-12 months). Currently, Apple has a Zacks #3 Rank (Hold).

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