At the end of 2014, while serving as YCharts Director of Research, I wrote what turned out to be my most widely-reviled stock valuation ever — a report on Millennial Tech darling, Apple AAPL. I actually got hate mail about that report from Apple fanboys even after I left YCharts because I dared to analyze Apple’s revenue growth projections in a way that was realistic and fact-based.
When I saw the news today that Apple’s revenues had fallen unexpectedly, I thought back to that stock report and thought I’d post a few excerpts from it.
From my perspective, today’s earnings announcement speaks to two main issues:
- The reliance of Apple’s business on its first mover advantage in the world of mobile telephony
- Foreign currency translation effects
Apple fanboys probably took umbrage to my opening paragraph, which characterized the company as a “failed computer company.”
Apple is a failed computer company. If not for an emergency cash injection by Microsoft MSFT in 1997, the name Apple would now be nothing more than a nostalgic entry on a Wikipedia page in the same way that Atari, Commodore, Sinclair, Tandy, and Kaypro are.
But unlike its defunct competitors, Apple sprang out of the ashes of its personal computing defeat as a glorious phoenix. Its present incarnation is that of a purveyor of internet-connected portable entertainment devices—a product category that it has defined as its first mover and shaped as its greatest innovator.
Every success it has had in the last 10 years—every jump in revenues and profitability—has been a result of its status as a market leader in mobile entertainment, and its entire product line-up at present is comprised of products and accessories that support (or are being superseded by) its iPhone franchise.
The problem is that opportunities to define a new product categories happen only rarely. As such, Apple’s future growth depends less on its ability to innovate than on its ability to compete successfully within well-defined market constraints.
But looking at it objectively, Apple is a failed computer company rescued by its strategic decision to apply computer technology first to mobile entertainment and then apply the whole lot to telephony. Take a look at Apple’s average computer sales growth in the years from 1990- 2003:
Mac was dead as a computing tool until the introduction of the iPod in 2004. After that point, the Apple computer became an accessory to its smaller, more entertaining brethren:
My conclusion was that as went the iPhone (or some other innovative form factor) there went the company:
This author published research on Apple about a year ago [N.B. a report I authored for IOI in 2013], and in the process of that research, saw how clearly Apple’s jumps in revenue were tied to two factors:
- New product releases
- New mobile carrier agreements (after the launch of the iPhone)
In the early days (mid-aughts), Apple’s products were enormously differentiated and unique. Every product release was a little piece of tech history. However, more recently, the competition has caught up, and the release of the iPhone 6 plus shows that, to a certain extent, Apple is playing catch-up with other device makers like Samsung SSNLF, that have succeeded with new form factors.
Yes, every new Apple product release comes with great fanfare, and yes, the iPhone 6 release broke three-day opening weekend sales records. However, each broken sales record naturally represents a smaller and smaller proportional growth of the installed base, and the smaller kick per release will create more launch-related risk and anxiety in the future.
Aside from the issue of having to compete in a more crowded, competitive market now, Apple also faces currency headwinds similar to those I discussed in my recent article on IBM. Apple does an enormous amount of business overseas and sells its products in local currencies. The rapid strengthening of the U.S. Dollar means that these foreign revenues are worth less in dollar terms. This should not be an issue to owners of the stock as long as its costs are denominated in the same currency as are its revenues. Looking at Apple’s gross margin, it does not show much or any contraction, which leads me to believe that it has a natural hedge, but I do not follow the company close enough to know this for certain.
Probably more of an issue to Apple owners is the fact that a great deal of the cash on its balance sheet is stashed overseas. At the end of 2014, it had more than $134 billion and that figure can only be higher today. Apple does not want to repatriate these funds because by doing so, it will be subject to U.S. taxation. As such, when thinking about Apple’s cash, it’s best to mentally deduct some (30%?) of the value because a U.S. shareholder simply does not have access to the entire amount. Keep that in mind the next time you hear a TV pundit saying that Apple is trading at a really low multiple if you adjust for the cash on its books!
The valuation I did while at YCharts showed a most likely value in the $145 / share region. Considering that the stock is now trading for less than $95, it may be time to refresh my valuation model!
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