Mauro Tibone, EBX Columnist

Apple – Don’t Show Me The Money… But The Products!

Mauro Tibone, EBX Columnist

Apple Inc. is not only one of the largest and most iconic corporations in the world. To my eyes, it is also a stockholders’ darling trying to regain its shining reputation. Seems only yesterday that the Apple share price was ripping through new highs for several years in a row, reaching an all-time high of $702 in September 2012 with an astonishing market capitalization in excess of about $658bn. It is hard not to be mesmerized by a 50-fold increase in market capitalization over 12 years.

What happened in the last year or so is all too familiar for those who dabble in tech stocks investing: a sudden recognition that expectations reflected in the stock price were loftier than warranted by the rapidly changing competitive landscape.

As Pimco’s guru Mohamed El-Erian wisely put it, Apple’s brand name got disconnected from reality and valuation, while competitors, particularly in the smartphones and tablets arena, were beginning to catch up.

Following this stark return to reality, investors hammered Apple all the way down to a recent bottom of $385 at the end April. Since then, the share price seems to have stabilized, hovering in a range between $400/$460.

The abundance of news and market commentary on Apple is mind-boggling, which makes it a fascinating story to follow. To a certain extent, all this noise makes it also hard to invest, because with such a wealth of information and commentaries, it is very hard not to assume that everything has already been discounted in the share price.

Nonetheless, when I look back to the most relevant news spanning over the last 12 months about Apple, I cannot help but notice that this company has been on the front pages, mostly for the wrong reasons.

Mega-trials on patent disputes, formal apologies to China for allegedly poor customer service, a botched update of its operating system iOS6, ballooning costs for building a spectacular new headquarters, lawsuits from disgruntled hedge fund shareholders (i.e. David Einhorn) unhappy for the way that Apple’s humongous cash pile of $145bn is being managed. If all this was not enough, now the US Congress is investigating its questionable, albeit probably entirely legal tax practices, which allow Apple to lower substantially its tax base through foreign subsidiaries.

The list above could actually go on, but each item covered and dissected ad nauseam by the media, actually brings me to the point I am going to make. Which is precisely that Apple has become more and more a ‘show me the products’ kind of story, differently from most other stocks that tend to be (to paraphrase Jerry Maguire) ‘show me the money’ stories.

It is obvious to all investors that Apple is still generating a spectacular level of profitability, despite a contraction of its gross margins from 48% to about 37% in the most recent quarter. That makes it in financial jargon either a ‘value trap’ or a ‘screaming bargain’.

Investors bullish on Apple are pointing out that its cash pile provides a more than adequate buffer to navigate through a transition period, during which new products (new wearable devices or perhaps an iTV) and revamped smartphones and tablets models will bring new life to flagging sales and falling profits (albeit still high). Apple valuation multiples, based on broad consensus estimates, would not be justified, unless the market was not leaning towards the notion that Apple is almost a broken story.

I tend to believe that although the market is not always right, in the case of large capitalisation stocks, it is wise to listen to what the share price is telling us.

The recent rebound in Apple shares has probably more to do with short covering (investors who bet hard on a falling share prices during the 1Q13) based on the view that the 2Q13 and 3Q13 would be weak and new product introduction would be slow or disappointing.

The share price rebound also indicates that the market has favourably received the company’s capital allocation plans, which entail significant debt issuance at low interest rates, expanded share buybacks and increased dividend returns to shareholders.

Now it is time for Apple to deliver again on the ground that really matters for the long term: product innovation.

Apple seems to be losing (at least on the surface) the innovation race against Google, which is far more open to demonstrate its R&D prowess and even more importantly to investors, its flexibility to adapt to the changing tech ecosystem.

Google Glass represents an example of the above reasoning, where it seems that Apple is falling behind in the wearable computing device race. Apple’s CEO Tim Cook is entitled to play down Google Glass as a potential mass-market item, but as a reluctant and always late adopter of any tech gadget, probably even I for one would jump on that product at the right price point.

Samsung’s surging market share in smartphones and tablets, together with the likes of Microsoft, Amazon or resurgent smartphone makers like Nokia, RIM and other Asian OEMs, is pointing to intensifying competition.

Apple’s market share in tablets has already fallen in the 1Q13, from 58% to 39% if compared to a year ago. I would find surprising that the same trend we have seen in smartphones over the last 12 months would not develop in tablets as well.

The new Apple iPhone and a cheaper version to be launched later on this fall will no doubt mitigate market share erosion, but I wonder if these steps are not belated. Most of all, will they answer the main question: can Apple still deliver innovation with must-have products?

It would be simplistic just to point out that nothing has come out of Cupertino in the last 7 months. Apple’s CEO Tim Cook, while delivering somewhat vague promises for new products, appears more at ease steering the ship on financial engineering and tax manoeuver than inspiring the younger generation with cool products.

However, product differentiation is becoming more problematic with the smartphone and tablet mass market. Price seems to drive consumers rather than brand alone, as witnessed by Samsung, with its unparalleled ability to penetrate new markets and product categories. Hence, the urgency for Apple to introduce more rapidly new eye-catching and lower price models in order to be able to compete in emerging markets, if not to gain market share, at least to avoid being marginalized.

My view is that given the progressive decline of PCs, the new frontiers of growth in tech will likely be wearable devices and the transformation of the TV in a multifunction media hub for all portable devices.

It would be wrong to say that Apple will not be able to match Google’s head start in wearable devices, but it could mean they will have to play catch-up, becoming a price taker instead of a price setter. Given that about three- quarters of smart phone features can be performed on wearable devices like Google Glass, it is not hard to imagine that this could be a product enabling us to change the way we communicate in the future, displacing a good portion of smartphones.

On the TV front, it appears to be difficult for Apple to launch an iTV soon enough to avoid that competitors such as Microsoft’s XBox One and Roku will not have a strong presence with their entertainments units and streaming players. By the time that Apple can deliver anything more innovative than its current offering, it could be difficult to make inroads in that market.

History tells us that making money out of television sets is a very difficult proposition. In the last two decades scores of large TV sets makers have not managed to maintain their leadership and/or profitability. It is questionable that Apple can achieve that without launching an earth-breaking new device. Assuming Apple can do that, what will be a meaningful sales volume/market share for their P&L, assuming they will likely address the high-end segment?

In general, it is fair to say that few technology stocks have demonstrated the ability to fend off competition and protect above normal profitability over an extended period of time. When it comes to consumer electronics, the likelihood of that happening is even lower.

Apple under the leadership of Tim Cook seems a very different animal than under enormously revered Steve Jobs. I sense that investors would rather have more clarity on the product front rather than on cash management and taxes before jumping on board again big time. Hedge funds flows seem to indicate a lingering scepticism at best on Apple’s future, judging from the relatively muted money flow in the stock.

If the smart money is still on the fence, I would opine that the average retail investor should take heed from this and wait for the ‘iClouds’ to dissipate, before buying more Apple shares.

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