Thursday, November 17, 2011

Examining Apple

David Nelson writes that Apple is doomed to slower growth and that Apple investors are living in denial.


As a longtime advocate of Apple as an investment, the Jaded Consumer was immediately intrigued. Several years ago on this very site, one could read about significant concerns arising out of the lightning-not-striking-twice problem facing Apple as an investment:
Apple had just returned to profitability from the long-suspected brink of death, and proceeded to grow sales so that its fixed investments were no longer consuming its revenues, and expanded margins by an order of magnitude. Apple introduced highly-successful new products that showed Apple could provide a worldwide online market place, and could deploy its operating system on mobile devices. While it's possible to deploy further new products, becoming recognized as a plausible going concern and growing gross margins to thirty percent are just not stunts one can repeat.
The link at the end of that paragraph is to a piece that includes this pearl:
The Future Is Not The Past
Apple's miraculous movement from 1997 to the present involved a movement from non-profitability to profitability. Margins improved by an order of magnitude. These are changes that can't happen twice.
So, the "news" that Apple can't repeat some of the most significant elements of its meteoric rise – the ranking increase of its world-recognized brand into the very top tier, for example – is not news at all. And everybody knows that doubling a $300B company is a different problem than doubling a $300M company. What's wrong with the easy conclusion that Apple's goose is cooked?

Apple has a margins advantage other manufacturers won't readily duplicate. Despite price declines in products, Apple is not a commodity vendor competing on price, but dominates its markets' capture of profit. Long garnering an outsized share of mobile profits, Apple now exceeds the handset profit made by all other handset makers combined (and has room to grow in units and in share). As Apple grows in its power to reach larger and larger addressable markets, its enormous advantages of scale will only increase its competitive advantage. Consider the difference in the effect of large volumes on the businesses of Dell and Wal-Mart: instead of paying for share like Dell (which must cut costs to move units against its competitors), Wal-Mart gets advantage from its scale. Apple's premier position promises to mature into a Wal-Mart like cash cow rather than a Dell-style yawnfest. Not that Apple's businesses are all headed from growth to stable maturity overnight – far from it. Apple has only just entered the top 5 PC vendors in Western Europe, for example.

And China has only a couple of Apple Stores. And South America hasn't been cracked yet. Russia? India? To claim Apple is done when it's just hit double-digit PC share in the US and hasn't yet done so worldwide is short-sighted, to say the least.

The end of the old piece on whether Apple had a safety net remains relevant:
The next ten years won't be the last ten years. They will, however, involve competition against some of the same players -- players Apple has apparently mastered fighting. They will be ten years of new hardware, new markets, and increasing price per unit of performance of component parts. Apple's addressable market will grow, and with it Apple's opportunities to reach out with sales opportunities.

If Apple's price becomes really crazy this suggests an excellent long-term buy. The question is: at what price have the shares become crazy enough?

On the other hand, in this fearful market and facing the liquidity concerns that it poses, there is no safe price for someone unable to tolerate short-term price collapses. The opportunities presented by this market are most attractive, I believe, to solvent investors who will remain without a need to liquidate positions for the foreseeable future.
Between then and now it's become clear that Apple's competitors include its former information services partner Google, and every handset and tablet manufacturer on the planet. Not just the smartphones; anyone listening to Tim Cook on the last call sees that Apple is aiming long-term at the entire mobile phone market. Looking at the evolution of the iPod ($499 at 5GB and fits into a pocket) to the iPod Nano ($129 at 8GB and clips to your sleeve), I don't doubt Apple has a plan to reach Everyman with an iPhone product. In fact, Apple was derided at the iPhone launch both by naysayers who declared phones were too difficult for Apple to master, and by competitors who laughed at the outrageous subsidized price of $499 – and it was a hit. Now – for the first time ever – Apple is selling an iPhone at a subsidized price of $0. That is the sort of change that dramatically alters the accessibility of the product, and grows its addressable market tremendously. Remember how Apple's quick iPhone price drop from $599 to $399 drove sales like wildfire into the holidays? Apple's iPhone 3GS and iPhone 4 models are still topping sales charts, not because they are new (they're old) but because their price is right. Imagine $0.

And in the meantime, Apple has launched a tablet product that has actually made the tablet market meaningful for the first time, and is the sole curator of the world's largest software store. Apple's huge transaction volume in its music, software, and hardware stores put it in an interesting position to become a major transaction processor itself (don't laugh, Apple considered becoming a telecom carrier in order to control the whole stack) – an important step in becoming a major conduit for RFI-enabled transactions based on Apple devices linked to iCloud accounts. Mastercard has a market cap of $46B, and Apple has better global brand recognition. Visa's market cap is about $75B. Suppose you didn't need to carry a wallet, just your phone? Making things simpler is part of the genius of Apple's broader pitch, and this fits right in.

Processing small charge transactions is a capability that – combined with Apple's demonstrated ability to offer $0 subsidized phones – places Apple in a position to become a fully-integrated payment system in developing countries where vendors have no infrastructure investment in traditional credit cards. I can imagine some markets in which Apple's capabilities could turn into enormous market advantage. And with $80+B in cash, Apple can create the banking back-end to ensure everyone is paid on time, all around the world.

Strategic investment, indeed!

Given Apple's enormous advantages of scale, its desire to improve both efficiency and control through integration of all the elements of the customer's experience, and the enormous fractions of the PC and mobile handset markets that remain open, it seems premature to conclude that Apple's growth is done. Rather, it's reasonable to conclude that Apple has found substantial room for growth and is exploiting that opportunity with the same quality of execution Tim Cook exercised before he became CEO.

UPDATE: The three major US carriers are struggling to fill customer orders. In the first three days of sales, Apple sold some four million iPhone 4S units in seven countries. Seventy countries will have access to the phone by year-end. The quarter's sales are likely to be brisk in comparison to the prior quarter: whereas the entire prior quarter saw Apple moving 17m units, Apple moved 4m in three days this quarter and is now rationing iPhone 4S units to retailers; Apple is still selling them by reservation before they arrive. Given the apparent shortages in evidence before the 70-nation availability has arrived, it's clear that even Apple's outstanding supply chain can't meet demand. Nice problem, eh? And this holiday, it appears Santa may be particularly good to Apple.

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