the Apple – IBM partnership

Jobs 1.0

Back in the early 1980s, AAPL made a better personal computer than IBM, at a time when the PC was beginning to displace the minicomputer in corporations and when individuals were starting to become a viable market for computing power.

Steve Jobs made two strategic errors, however, that ended up preventing AAPL from exploiting its advantage, which ultimately marginalized his company and put it on the verge of bankruptcy.

–AAPL priced its PC at 2x -3x the level of its MS-DOS alternatives, providing an overwhelming economic incentive to put up with the clunkiness of an IMB or a Compaq.

–Jobs marketed solely to company IT departments, which at that time had no power to make purchasing decisions.  He completely ignored the CEOs and COOs who did.  This may have enhanced his counterculture image, but it effectively closed the door to any corporate sales.

Jobs 2.0, Groundhog Day–except better so far

Arguably, Jobs 2.0 repeated the same game plan as 1.0:  make high-end, high-priced consumer devices and ignore the corporate world.  

In the post-Jobs era, and after a whole lot of waffling, AAPL management has decided to stick with Page One of the Steve playbook and is continuing to define itself as a maker of high-end consumer devices.  On the other hand, it lived (by the skin of its teeth) through Jobs 1.0 and knows how that story ended.

That’s why I think AAPL’s just-announced decision to partner with IBM to sell mobile products to corporations is potentially very significant.  It suggests AAPL is no longer willing to be straitjacketed by the Jobs mystique.  This is a good thing, because growth companies only continue to prosper if they periodically reinvent themselves.  

Also, given the continuing ineptitude of Ballmer-led Microsoft, the corporate market is much more wide open to AAPL smartphones and tablets than AAPL had any right to expect.  

I’m not rushing out to buy AAPL on the strength of a single new venture.  But it’s a start.  It suggests that Tim Cook is doing more than rearranging the deck chairs.  It argues that we should also be on the alert for further signals of favorable change in the company’s strategy.






my take on Apple (AAPL)

In a comment on yesterday’s post, my friend Bruce asked for my take on AAPL. That’s my subject today.

The stock looks cheap to me.  Investors have had two big worries, I think.  One has been lack of recent earnings growth.  The other is the perception that the post-Jobs management of AAPL is completely at sea, cowed by the memory of Jobs and therefore unable to make decisions– as well as completely uninterested in whether the stock goes up or down.


–growth appears to be resuming.  Yes, modest growth, but Wall Street has understood for years that the heady days of the last decade are gone forever.

–AAPL has a stellar brand name and many rabid fans.  New products may re-energize them.

–the recent announcement of a 7-for-1 split offers the hope that management is more the simply caretaker of the Steve Jobs museum.

–in addition, conditions are right for investors to look at AAPL again.  I think 2014 is going to be a sideways year from here for the US stock market.  So a big, low-multiple, cash generative company where earnings growth is resuming and where management practices may be taking a turn for the better has a great chance to be an outperformer.  A 2.3% dividend yield doesn’t hurt, either.

To me, AAPL feels like the MSFT story, only in an earlier chapter.  MSFT has a stronger business.  But Tim Cook arguably has greater freedom to act, since he’s dealing only with the legend of Steve Jobs and not the physical presence of Steve Ballmer.  (Also, to give him credit, Cook has already fixed one of SJ’s mistaken pronouncements–that 10″ is the only tablet size anyone will/should want.  He appears to be in the process of fixing another, similar one–that the original iPhone screen size is the only choice anyone will want/need.)

Personally, I prefer MSFT.  But that may be because AAPL has historically been so uncommunicative that it’s hard to figure out what’s going on inside management’s heads.  In the strange way investors think, my attitude is arguably an investment plus for AAPL.  Better communication from AAPL would come as a positive surprise to Wall Street–and by itself result in a higher stock price.





Apple (AAPL) is splitting its stock, 7 for 1

AAPL’s 2Q14 earnings report last night was full of mostly positive surprises:

–earnings per share came in at $11.62.  That’s about 15% more than the Wall Street analyst consensus had expected, and higher, by about the same amount, than results in the same quarter a year ago.  It’s the largest margin AAPL has beaten the consensus by in years.

–the company is raising its dividend and increased its proposed share buyback amount by $30 billion

–AAPL is going to split its stock by 7 to 1.

Of these developments, I think the most important is the stock split.

stock splits

Academics will tell you two things about stock splits:

1.  Stock splits have no direct economic significance.  Its’ simply paper shuffling.  Instead of having one share that trades at, say, $560 you’ll soon have seven shares, each trading at $80.

2.  The stocks of companies that have stock splits tend to underperform for a period after the split occurs.


The second comment, while true, is, well, silly.  All the outperformance comes between the period when the stock split is anticipated by the stock market or actually announced and the date when the split takes place.

The first is also true–particularly in the United States (but not in many foreign markets).  But this doesn’t mean that the AAPL split has no relevance.

(See my post on stock splits for more details.)

Two reasons:

–stocks with very high per share prices tend to underperform.  Why?  I don’t know.  I think it’s because retail investors prefer to buy stock in round” lots (usually 100 shares).  This may be an echo from the days a half-century ago when trading costs were very high and when the commission for an “odd” lot (anything that isn’t a round lot) was particularly expensive.  For AAPL, this would be a commitment of over $50,000–too rich for a single position for most people.

Yes, it makes no sense.  But, whatever the reason, retail investors like stock splits and respond positively to them.

–more important, studied management contempt for shareholders, who after all are the owners of the company, has long been a key feature of the AAPL persona.  It’s part of the Steve Jobs legacy.  But it’s not a good one.  To me the stock split is a sign that the current management finally realizes how poisonous the Just-Like-Steve mentality has been and is beginning to shake off its shackles.

I don’t think this means AAPL returns to the super growth of its past.  On the other hand, I do think that, if I’m right about the attitude change, that the JLS discount multiple Wall Street now applies to AAPL stock will gradually disappear.  Just achieving a market multiple would imply a 30% gain in the stock.


rent vs. buy: digital goods

My daughter, who’s very interested in digital goods, suggested that I write about them.


They’re new, and they’re different.  Also, Laura supplied a lot of the information in this post.

Part of the difference between the digital goods we have now and their physical counterparts is in the nature of the beast(s).  Part, however, comes the desire of sellers–particularly Apple–to recreate the AOL-style “walled garden” that tethers the buyer to a given seller’s product line and secures fat profits for the retailer.

Some examples:

Generally speaking, for digital goods like e-books, or songs or movies, you don’t really own the digital copy you download.  You only have a license to use it.  Kindle owners found this out early on.  Amazon was inadvertently distributing 1984 without having bought the digital rights.  When the company found out–presumably when the rights holder called asking for money–Amazon simply went “Poof!” and made the book disappear from all the Kindles it had appeared on.  Apparently very few of the shocked Orwell fans had read the fine print in the Kindle service agreement.  It is kind of funny, though.

Usually, you can’t give your download to someone else.  You may be able to lend it for a short period of time, but maybe not.

The digital good may appear on all of your devices.   …or it may appear just on all your Android devices but not Apple, or vice versa.


The most peculiar aspect of digital goods, to my mind, is what happens with e-books in (if that’s the right word) libraries.  Many authors or imprints won’t sell e-books to libraries, so the selection is limited.  At least some sellers place counters in the downloads, so that the copy disappears after a certain number of borrowings.  It isn’t a quality control issue–a worry that the digital copy has somehow degraded;  it’s to mimic what happens to physical books, which eventually fall apart after repeated use.   In other words, it’s to force the library to pay again after a certain number of uses.


investment significance?

Maybe there’s none.

On the other hand, I think we’ve got to distinguish carefully between essential characteristics of digital goods and those that are a function of sellers’ desire to create closed “ecosystems.”  After all, the AOL walled garden lost any allure it had (I never got it) when people discovered there was a big wide world outside the AOL server farms that AOL got in the way of people experiencing.

I suspect the same will eventually happen with Apple–personally, I think this might be happening already.  As/when this occurs, I’d expect the price of digital goods in general to fall (maybe a lot).  A sharp separation will probably also emerge between high-quality content, whose unit sales will increase (again, maybe by a lot), and me-too content, which will disappear.






AAPL’s current problems = Steve Jobs’ legacy

To me, the most striking thing about AAPL’s most recent earnings report is that for the first time I can remember the company is showing the effects of overall industry weakness in its own results.

Before now, the combination of the attractiveness of its new offerings + geographical expansion had rendered it immune both to seasonality of demand and to the business cycle. No more—undeniable evidence that is products have become long in the tooth.

The problem AAPL faces in growing sales and earnings from this point onward is the direct result of the strategy Steve Jobs developed for the company. It’s also the same strategy that led to similar, though more severe, difficulties in his first go-round as CEO of AAPL—and which got him unceremoniously tossed out of the firm he helped found.

AAPL is a high-end niche company. It aims to make distinctively designed, ultra-cool consumer electronics products that it sells to affluent customers who are willing to pay very high prices to be affiliated with the brand.

Historically, luxury brands like AAPL know they will lose their cachet if they develop lower-priced mass market offerings. So they don’t try. For, say, high-end clothing brands this isn’t a huge problem. They can change colors or fabrics and sell multiple versions of the same design to their fan base. That doesn’t appear to work for laptops or smartphones, perhaps because personalizing them with software and information is time-consuming.

However, this leaves AAPL able to boost sales only by developing new blockbuster products. Despite AAPL’s astounding success in creating the iPod and following it with the (even bigger success of the) iPhone, blockbusters are apparently not everyday occurrences.

In addition, Jobs saddled AAPL with two design decisions that, despite his belief that he could impose his taste on the rest of the world, have proved to be incorrect. The original iPad is too big and heavy. APPL has fixed this problem with the mini. Anyone who has used a Galaxy SIII knows the iPhone screen is small and cramped by comparison. Jobs’ ghost has so far prevented AAPL from understanding this.

Of course, the niche strategy does have one short-term advantage. It disguises AAPL’s shortcomings in developing software. But that’s a dubious plus, in my view.

AAPL can change. It has a lot of clever people working for it. And it has a ton of money. It’s most difficult problem, I think, is to have the courage to move on from the Jobs myth it currently embraces.


thinking about Apple (AAPL)

setting the stage

(I should say at the outset that, although at one time I owned AAPL for years, I don’t hold it now and haven’t for a long while (except for a couple of days in January).

Q:  What does AAPL do for a living?

A:  It makes smartphones and other mobile computing/consumer electronics devices targeted at affluent consumers willing to pay a premium price for the perceived superior aesthetics and more user-friendly software.

A mouthful.

in other words, a niche player…

If my definition is correct, AAPL has decided to carve out a niche for itself in the high end of the mobile device market.  It’s a very desirable and lucrative niche, one it dominates.  But AAPL is a niche player, nonetheless.  It’s a little like TIF or WYNN.

Like any market strategy, this one has its pluses and minuses.  Anyone listening to the AAPL earnings calls over the past few years can’t help having heard the persistent questioning from Bernstein about what the company would do once everyone who can afford a $600 smartphone already has one.

Move downmarket?  Unlikely.  TIF is the only company I’m aware of who has taken this path and not completely destroyed its brand image–thereby losing its original customers.  Better to lose low-margin sales in the mass market than to kill the goose.

Absent new blockbuster products, however, the price of maintaining the upmarket strategy for AAPL is that sales slow as volume-oriented manufacturers ride down the cost curve and churn out smartphones that retail for $100-$300.

That’s where we are now.

Tons of publicly-available-for-free data has been available for years showing where the smartphone marke, and AAPL, have been heading.  So this outcome can’t have been a surprise.

…with an “ecosystem”

Another characteristic of AAPL devices is the “ecosystem,”  which has tended to make customers more sticky.  All AAPL devices work well together.  All reside in a “walled garden” created by AAPL software–reminiscent of the way AOL worked back in the infancy of the internet.

on this description…

…the current PE of 10.8x–8.0x, after adjusting for cash on the balance sheet–seems crazy low.  It’s less than INTC’s, for instance.

is there more to the story?

There’s an obvious risk in securities analysis of taking the current stock price as the truth and trying to come up with reasons why  it is what it is, rather than taking out a clean sheet of paper and trying to imagine what the future will be like.  The Efficient Markets hypothesis taught in business schools despite overwhelming evidence that emotional storms of greed and fear that routinely roil financial markets, encourages this thinking.

Admittedly possibly being influenced by the recent swoon in the AAPL share price, I’ve been asking myself recently whether the conventional wisdom about AAPL, which is my description above, is correct.

I have two questions.  No answers, but questions anyway.

my questions

1.  Is the high-end niche defensible?

In most luxury retail it is.  In consumer electronics, it clearly isn’t.  Think: Sony.  Based on the (small) number of entrants in the mobile appliance market and the (small) number of products sold, AAPL may be closer to Sony than to Hermès.

2.  Is the “walled garden” a mixed blessing?

It certainly worked for AOL for a long while. But then the Wild West of the early internet was gradually tamed and customers discovered there was a much more interesting world outside the garden.

I don’t think AAPL aficionados have any intention of tunneling out–at least not yet.  But the inaccessibility of AAPL customers to GOOG has prompted the latter to introduce the “hero phone” later in the year through its Motorola Mobility subsidiary.  The idea seems to be to create an attractive, user-friendly, high-end smartphone, load it with GOOG software and sell it at cost.

The “Made in USA” label and the management description of the “hero” seem to me to indicate it’s targeted directly at the large concentration of AAPL customers here in the US.  It’s an open question whether GOOG/Motorola can create a smartphone that’s attractive to iPhone users, or whether they’ll consider switching.  But a technologically inferior PC sure did undermine the Mac with consumers in the 1980s almost solely because it was a lot cheaper (btw, the Mac lost out to IBM with corporate customers because it had no clue how to sell to them).  And the wireless carriers will certainly welcome the “hero,” assuming it works well.

AAPL’s 2Q13–some answers, still some questions

the report

After the New York close yesterday AAPL reported its 2Q13 earnings results (AAPL’s fiscal year ends in September).  Revenues were $43.6 billion, up 9% year-on-year.  EPS, however, were down 18% yoy, at $10.09.   The latter figure was slightly ahead of the Wall Street analyst consensus of $9.97, a number that been ratcheting down in recent weeks.

The company guided to flattish sales in 3Q13, with mild margin contraction.

It announced a 15% increase in the quarterly dividend to $3.05 a share, meaning a current dividend yield of just over 3%.

APPL also intends to buy back $60 billion in stock before the end of calendar 2015.  That would be 15% of the company at current prices.  AAPL now has $147 billion in cash, of which $104 billion is held outside the US.  It won’t touch the foreign holdings for the buyback.  Instead, it will issue bonds in the US to get the money it needs.

This piece of financial engineering will have two impacts.  It will boost the growth rate of EPS by at least an additional 5 percentage points per year.    And the financial leverage will increase AAPL’s return on equity from its already heady 25%+.

The stock was initially up about 5% on this news.  Then, during the conference call, AAPL management said it won’t have its next new product launch until fall.  The gains evaporated and were replaced by a slight loss.

what’s going on

Two factors:

margin erosion

1. smartphones

As I see it (remember, AAPL is pretty opaque), the emergence of Samsung as a competitor in the high end of the smartphone market,where AAPL makes its biggest profits, has caused that segment to mature faster than AAPL had expected.  Unit volume growth is now coming mainly from emerging markets, where the price of AAPL’s cutting-edge phones is too high.  The company is selling older models (iPhone4s) there, at discount prices–and therefore reduced margins.

2. tablets

A year ago, it looked to me like 2/3 of AAPL’s tablet volume was from its newest model iPads.  Today, unit volumes are much higher, but less than a quarter are the newest 10″ iPads.  The rest is a combination of iPad minis (a runaway success) and bulk sales of iPad2s to institutions.   Both of the latter are at lower margins.

My guess is that we’re at or near a gross margin low point now.

continuing PE multiple contraction

The maturing of the smartphone market has been actively discussed in the financial community for a couple of years.  In my view, worry about this possibility is the main reason that, despite booming sales and earnings, the price earnings multiple on AAPL’s stock had contracted from the high teens to around 12 by the second half of last year.  Relative to the market, the multiple went from a premium of 25% to a discount of 25% over the same time period.

Unpleasant for holders, maybe, but understandable.

Over the past 6-8 months, however, the multiple has contracted further, both in absolute terms (to under 10) and relative (to a discount of more than 40%).  In fact, yesterday’s Wall Street Journal had an article comparing AAPL with HWP and DELL.  That’s kind of like comparing night and day–the single thing I can see that ties AAPL to these two truly terrible companies is the similarity of their price earnings multiples.

Yes, when fast growers begin to slow down, the PE contracts, often violently.  And because a good portion of the contraction is an emotional thing, the multiple shrinkage is usually greater than one would expect.  But even seeing this process over and over, I didn’t imagine that a fundamentally sound company like AAPL could be trading at 9x in a market trading at 15x.

where to from here?

Note, first, that I’ve been wrong about the stock for a while.

I think the stock buyback makes economic sense, and it will probably at least stabilize the AAPL stock price.  I don’t think the addition of debt to the capital structure will have any effect.

It may be a big stretch, but to me the 15% dividend increase says that’s what AAPL’s board expects its earnings growth rate over the next few years to be, financial engineering aside.  I think that’s a reasonable assumption, and could be conservative.

AAPL management would do the most for its stock by being more forthright with investors about current business challenges and how it plans to deal with them.  That’s not likely, however, if the 2Q13 earnings call is any indication.

That leaves holders waiting for new product announcements–and subsequent earnings acceleration–at summer’s end.