THIS IS GOING TO HURT
By Robert Cyran
Apple sold 3.3 million iPads in the last quarter. That’s one
of the best starts ever for a consumer electronic device. It will probably sell
25 million, or more, tablets next year based on the trajectory of past hit
consumer goods. While Apple and its suppliers, like parts maker Samsung, are
celebrating, many firms will suffer. Breaking views has compiled a list of the
potential losers – from the obvious to the indirect.
PC makers and sellers: It stands to reason that if
companies and consumers buy iPads, they will cut back on competing electronic
items due to limited budgets. This effect probably hasn’t fully kicked in.
Early adopters are more willing to splurge on a new gadget. Yet Barclays
Capital points out there are already signs of cannibalization. The number of
lower‐priced
netbooks fell 19 percent in June compared to last year according to NPD. HP,
Dell and Acer earn little money on selling these devices. But if the iPad
starts to cannibalize higher‐margin items, selling PCs could
become a recipe for losses. Dell, for example, eked out less than a 3 percent
net margin last year.
Microsoft: It doesn’t take the IQ of Bill Gates to
figure out that reduced sales of computers running Windows would hurt
Microsoft. True, the company’s most recent quarterly figures were robust, as
users upgraded to Windows 7. But if PC cannibalization occurs, it won’t be
pretty. The company’s Windows division has astonishingly high margins – it
accounts for roughly a quarter of sales but half of operating profit. A small
fall in revenue would lead to a disproportionately large hit to
earnings.
Intel and AMD: Likewise, a shift from PCs to the iPad
would hurt the two chipmakers. Instead of using a chip whose roots lie in
desktop computing where Intel has its stronghold, Apple used one from the
cellphone world. Intel may catch up in designing low‐power
chips, but it could lose its quasi‐monopoly style margins if it
doesn’t. AMD, which perennially chases after Intel yet never catches up, would
take a harsher hit.
Software security companies: Apple’s devices are
generally perceived as having fewer security holes than Windows. While most PC users
install antiviral programs, many Apple users don’t bother. So an iPad shift
would hit software sales at security companies such as McAfee and Symantec.
True, the more popular Apple’s systems become, the more effort criminals and
hackers will make to crack them. But overall, antiviral vendors look like
potential losers.
Hard disk drive makers: Apple was one of the first
computer makers to eschew floppy disk drives. Likewise, the iPad could lead the
charge away from hard disk drives. The device employs NAND flash memory, which
is smaller and uses less power than the hard drives commonly used in laptops
and desktops. If the iPad cannibalizes these markets, companies like Western
Digital and Seagate would suffer. Moreover, Apple is already rumored to use a
third of the world’s supply of this memory. If it demands more, companies like
Samsung would be encouraged to ramp up production in more advanced plants.
That’s almost always a recipe for an eventual price crash and consequent use of
NAND in more consumer devices.
Cellphone producers: Apple says about half of Fortune
100 companies are testing the device. AT&T says business demand for the
device is robust. Since the iPad and the iPhone essentially use the same
operating system, the tablet could act as a Trojan Horse for the handset. Let
employees use one and you might as well let them use the other. And since
applications developed for the iPad often work equally well on the iPhone, the
platform is more attractive for developers. Nokia and Research In Motion appear
in danger of losing the app battle – if their phones are regarded as
undifferentiated commodities by consumers, their profit margins could
vaporize.
Bookstores: Other forms of collateral damage may seem
surprising. Take bookstores. It seems clear that most texts will be eventually
sold and consumed electronically. Amazon, Barnes & Nobel and Borders sell
electronic devices specialized for reading. Yet the iPad’s launch set off a
vicious price war in e‐readers. That suggests consumers
prefer gadgets like the iPad that can read email, play games and download apps
that perform other tasks. True, the book retailers have iPad apps that allow
for easy purchase of electronic books. But consumers can download several and
easily compare prices. Increased competition means margins on electronic books
are likely to fall.
Published July 30, 2010
GRAVITY’S RAINBOW
By Robert Cyran
When should investors sell Apple shares? The group's push
overseas and into the business market still holds promise, as does the steady
stream of fresh gadgets such as Apple TV, unveiled by Chief Executive Steve
Jobs last week. Apple's trajectory should continue for some time, so its stock
– which has gained more than 40 percent each year for the past five – looks
attractive at 15 times estimated 2011 earnings.
But no company can grow sales at that pace forever. While it
may sound premature or even churlish to do so, Breakingviews offers up some
strategic cues that could act as warning signs for investors that Apple's
growth is slowing:
Discounting: While Apple computers and handsets
account for less than 5 percent of global unit sales, the company racks up
extraordinary profits on them. Its reputation for producing quality gadgets
means Apple can charge a premium over competing products. Its operating margin
is almost 30 percent. Even small gains to its market share result in
supercharged profit growth.
Apple has used the so‐called halo effect, rather than
price cuts, to gain market share. Its devices work well together. And users who
try one often adopt Apple's other products. This can be seen now in the
enterprise market, where Apple has traditionally been weak. The iPad appears to
be a big hit among corporate executives and professionals. This should increase
adoption of iPhones and Macs. Moreover, Apple appears to have avoided the
discounts typically offered to big customers. If salespeople want iPads,
there's nowhere else to turn but retail.
Apple could boost market share quickly by offering discounts
or cheaper devices. While this would bump up profits in the short term, it
would be a flashing yellow light because the high end of the tech market is
disproportionately profitable. While Apple could profit from
selling lots of low‐end gadgets, it's a tough place to make a buck because
of greater competition and lower capacity to differentiate products. Nokia's
operating margin on phones is around 11 percent.
Those in the commodity PC market aren't better – Dell's are
around 5 percent. There's a big risk, too, that selling cheaper goods could
tarnish the brand. A loss in the company's ability to charge an Apple premium
or a small fall in market share at the high end would hit profits hard.
Raising tolls: One way Apple has maintained premium
pricing for its gadgets is by improving them each year. In the case of the
iPhone, a large chunk of this improvement has come from the increased number of
applications that can run on the handset.
Partners who develop these bear much of the cost. Apple vets
the applications and distributes them in exchange for 30 percent of sales.
Apple hasn't historically run its online stores to maximise profits. Instead,
the goal has been to make the devices more valuable and entrenched. The result
is a virtuous circle. Consumers like the gadgets because they have become
increasingly useful, and software developers follow the customers. Apple could,
theoretically, extract bigger tolls – take 50 percent of revenue from sales,
for example. That increased revenue would fall right to the bottom line.
Yet developers could eventually turn elsewhere, and users
might follow. Google, for example, plans to take only a 5 percent chunk of
sales on games that it sells online, plus a small processing fee. Second,
ratcheting up the toll might invite regulatory attention, because it smacks of
anticompetitive behavior. While raising its revenue share could generate some
short‐run
growth, it would be a bad sign for the company's future.
Big acquisitions: Apple has $46 billion of cash and
investments on its balance sheet. Jobs may find this fast‐growing
stash comforting. But it isn't earning much interest. Apple has wisely avoided
big acquisitions.
When many companies see their growth slowing, however, they
often try to buy it through transformative acquisitions in the way Intel is
purchasing McAfee or HP buying 3PAR. Apple's cash could buy a majority of
companies in the S&P 500. Surely it could find a big firm that would
generate a better return than what it earns in the bank, right?
Don't count on it. Integrating two big companies more often
than not results in unproductive executive infighting and bloated expenses
instead of valuable new product innovations. Most damningly, sellers usually
extract the gains. Just look at Cisco. The firm is an efficient M&A machine,
yet its shareholders have received little benefit over the past decade from CEO
John Chambers' shopping. If Apple ever headed down this route, it would be a
sign that the firm has transformed itself into a lesser company.
Published Sept. 6, 2010
NUDGED
By Robert Cyran
Apple has taken a pre‐emptive antitrust strike. U.S.
regulators have grown increasingly worried by Apple's monopolistic potential in
the mobile phone market. The company's decision to publish rules governing its
online store, green‐light Google to advertise within applications and allow
developers to use Adobe may forestall government action.
The company run by Steve Jobs doesn't have a monopoly in the
smartphone market. But some of its behavior seemed to suggest it was getting
there. Apple barred big rivals like Google from placing ads within apps running
on Apple's devices like the iPhone.
In addition, Apple prohibited developers from using popular
Adobe Flash tools to build apps – a move that could have forced small companies
to choose whether to produce programs for iPhones or handsets powered by
Google's Android system. And the company's opaque standards for what could be
sold in its online store resulted in some curious decisions, such as Apple's
rejection of Google's VOIP tool.
Yet technology trust‐busting is a tricky thing. Once
established, monopolies are difficult to dislodge – as the history of Microsoft
and Intel has shown. The more people use a given technological standard, the
more useful and entrenched it becomes. And the monopolist usually has the
financial clout to punish any rival that dares enter the market. By poking
around Apple earlier this year, the Federal Trade Commission and Department of
Justice appear to have nudged the company ever so slightly toward more desirable
behavior. The three changes announced on Sept. 9 certainly help developers.
They have additional tools for creating apps, more clarity on how to get their
products in Apple's storefront, and a greater chance to earn a bit of
advertising revenue. Consumers should also benefit, since they should have even
more programs to run on their iPhones.
Apple's climbdown may be awkward, but it can't really
complain. If the moves make its devices more attractive to developers, that
should benefit sales. More importantly, they may reduce the chances of
governmental interference. Trust‐busters may not be particularly
effective in technology, but Jobs presumably would prefer spending the next
decade talking to Apple's engineers, designers and fans instead of its lawyers.
Published Sept. 9, 2010
MYSTERY OF THE FAITH
By Rob Cox
The mystique that Apple cloaks itself in when launching
snazzy gadgets has served its bottom line well. But that same opacity doesn't
translate well to corporate governance. It took Apple's board far too long this
week to reveal that, with its visionary leader Steve Jobs sick, 30 percent of
its shareholders wanted more information on how the company would be run in the
event he does not return to his position.
Given Apple's stunning success, the low profile of the
pension fund proposing the measure and the board's recommendation against, that
should send a powerful message. Late Thursday, Apple dropped into a regulatory
filing the fact that 172 million shares were voted in favor of a proposal put forward
by the Central Laborers' Pension Fund, which has under $1 billion of assets,
calling for the company to adopt and disclose an executive succession plan
policy.
With 400 million shares cast in opposition, or 70 percent of
the vote, the company clearly prevailed. But a more mainstream governance
proposal from a far larger investor, the $200 billion‐ plus
Calpers, did get passed against the recommendation of the board. And even with
the CLPF's effort, it's rare for non‐traditional proposals from
relatively unfamiliar special interests to capture so many votes. That's
particularly true when boards in good standing with their stockholders
recommend against them. Apple shares have, after all, roughly doubled in each
of the past five years, so shareholders should be happy.
The support for the CLPF suggests many investors do want the
company to be more forthcoming. That might also apply to the manner in which
Apple reported the voting at Wednesday's annual meeting. At the time, it said
shareholders defeated the succession planning proposal but it didn't reveal the
vote tallies, something that is standard procedure at many big companies like
Ford Motor and Goldman Sachs.
Apple instead slipped the results into a filing with the
Securities and Exchange Commission the following day. That smacks of
unnecessary reluctance to keep shareholders promptly informed. Whatever happens
to Jobs, the company needs to do better at separating the justified secrecy of
its product launches from keeping shareholders in the dark.
Published Feb. 25, 2011
WHAT’S IN A NAME?
By Robert Cyran
Measuring a brand's worth is an imprecise art. Apple's has
nevertheless been deemed the world's most valuable. At $153 billion, according
to a new survey, it accounts for about half the company's market capitalization
and nearly 10 times its estimated value five years ago. Tech companies also
populate the top ranks. There are good reasons they dominate the list – and why
they're prone to big swings in value.
The survey, by a subsidiary of WPP, estimated the earnings
resulting from big brands and attempted to put a multiple on them to account
for future growth. The result is a tech‐ heavy list. Google's, at $111
billion, ranks second, IBM is third and Microsoft fifth. This not only reflects
the growing importance of hardware and software on the economy, but also how
consumers spend more time online socializing and shopping. Facebook scored the
biggest increase – its value nearly tripled to $19 billion. And Amazon's brand
overtook Wal‐Mart's.
There are also economic reasons tech firms rate so highly. A
large chunk of what they make is intangible, and therefore hard to capture on a
balance sheet. Coding skills and patents are valuable, but not easily measured.
Further, technology is often a winner‐take‐all
game. Network effects mean people want to use the same software or systems as
their friends or employer. That helps explain why Apple's distinct label
accounts for so much of its worth compared to, say, Exxon Mobil, whose name is
estimated to represent just 4 percent of its $414 billion market value.
Brand calculus nevertheless remains a squishy concept. Is
Microsoft's really worth $78 billion, or does its extraordinary market power
account for the brand's value? Yet there's obviously something in a name. Just
look at the premium prices Apple can tack onto its computers or gadgets – or
how carefully it guards the use of its name. Apple isn't alone.
Google's most valuable real estate is its front page. It only puts its own logo
there, instead of ads, to avoid diluting or sullying its own brand.
Times still change, however. And evolution happens faster in
tech, with new invasive species popping up regularly. Nokia lost more than a
quarter of its brand value in a year, according to the survey, as users
switched to Android‐based and Apple handsets. Yes, a name has value, but it
is far from timeless. Published May 9, 2011 PIRATE BOOTY By Robert
Cyran Apple has thrown the music industry another life vest. Its
new iTunes Match service lets users listen to songs on any device for $25 a
year. Significantly, it also works as an amnesty of sorts for customers with
ill‐gotten
tunes in their hard drives. It looks a concession to piracy – but it at least
offers a path to more revenue.
While other music services, such as Amazon's, allow
customers to store music remotely, Apple's offers a clever twist. It compares
digital signatures of music already stored by customers to the 18 million songs
it sells on iTunes. If there's a match, the user gets rights to listen to that
content on any device. That makes it quicker and easier than services that
require files to be uploaded. It also doesn't distinguish between legal and
illegal content.
Apple will hand over 70 percent of the revenue it generates
from the service to the music industry, according to people familiar with the
plans. Labels and singers could use the money. Digital downloads haven't come
close to making up for the cliff CD sales went over. The value of recorded
music sold globally has shrunk by 40 percent over the past decade, to about $16
billion, according to the industry's global trade group.
It is noteworthy Apple could even sign a deal with major
record companies. The industry has fought hard against piracy, filing expensive
lawsuits against everyone from Napster to geeky teenagers. It could of course
continue to pursue such cases. But offering a path for pirates to go legit also
looks like a pragmatic way to cash in.
Apple's history certainly helps. Digital revenue has been
one of the few sources of growth for music companies. And the company led by
Steve Jobs has played a huge part. The iTunes store has sold 15 billion songs
since its inception in 2003. And Apple's U.S. share of legally downloaded music
is about 70 percent, according to NPD. Whether Match will be a hit remains to
be seen. But Apple may again be the recording industry's best chance for
another platinum seller.
Published June 6, 2011
COGNITIVE DISSONANCE
By Robert Cyran
Could Apple be worth $1 trillion? It’s conceivable. The $342
billion iPhone and iPad maker became – if only briefly – the most valuable
company in the United States when it surpassed Exxon Mobil on Aug. 9. Yet its
sales have been surging 80 percent a year, and profit faster. And Apple trades
roughly in line with the growing U.S. market – and at less than half the price‐to‐earnings
multiple it fetched in 2006, when revenue growth was much slower.
Apple now trades at about 11 times estimated earnings for
the fiscal year ending September 2012. The S&P 500 Index is valued at about
10 times next year’s earnings. But Apple’s sales growth is not far off 10 times
faster than that of the average company. The gadget producer also sits on $76
billion of cash and investments.
To get at this dissonance another way, consider Apple’s PEG
ratio. This hints at the price of growth by dividing a company’s PE ratio by
its projected percentage earnings growth. A smaller figure suggests a company
is cheaper. Apple’s is 0.2. That’s low compared to growth darlings. Burrito purveyor
Chipotle Mexican Grill, for instance, comes in at 2.1, and Salesforce.com at
13.2. Pandora and LinkedIn aren’t even expected to make money.
Alternatively, put Apple on the same PE multiple it traded
on in 2006, and it would be worth almost $900 billion. A premium for today’s
faster growth could get it to $1 trillion. Apple can’t be so cheap just because
Steve Jobs is in precarious health. True, Apple already sells more per quarter
than it did in all of fiscal 2007, and it takes more and more success to move
the needle. Growth could easily slow.
Yet the smartphone and tablet markets are young, the
company’s customers show remarkable fidelity, and areas such as television are
ripe for new gadgets. Moreover, Apple’s return on equity is almost twice what
it was in 2006, suggesting it has pricing power. Maybe investors simply can’t
fathom so large a company.
A $1 trillion Apple would mean adding all of Microsoft,
Google, Intel and Amazon – and more – to the firm’s current market
capitalization. Perhaps Apple is correctly priced, the market too expensive,
and growth stocks grotesquely so. But something doesn’t add up. In relative
terms, Apple should be worth far more.
Published Aug. 9, 2011
WELL‐SEEDED ORCHARD
By Robert Cyran
Few companies are as indelibly linked to an individual as
Apple is to Steve Jobs. Not only one of the founders, he led the company from
near bankruptcy to become one of the most valuable companies in the world. News
on Wednesday of his retirement from running day‐to‐day operations is a blow – even if
it was both inevitable and expected. But investors haven’t yet wrapped their
minds around the powerhouse Jobs built.
For the time being, Apple will still be able to call on
Jobs’ uncanny sense of consumer tastes and shrewd marketing skills. He was
elected chairman of the board and will presumably guide and advise the company
as long as he is physically able. It’s nevertheless reasonable to surmise his
illnesses, first disclosed seven years ago, are taking a harder toll.
Meanwhile, his replacement, Tim Cook, is not just capable but has had several
stints in the CEO’s seat, during which there were no noticeable hiccups. Cook
may not have Jobs’ ability to marry design with technology or to inspire
engineers to extraordinary heights.
Nobody does. But the fact Jobs anointed him successor should
add a bit of luster to his persona. More importantly, Cook has proven he can
manage astonishing growth. Despite that Apple now sells more per quarter than
it did per annum just a few years ago, it is still increasing revenue at an
annual rate of more than 80 percent. This growth, in a way, shows how hard it
has been for investors to separate Jobs from Apple.
Despite its extraordinary expansion in sales and
profitability, the company is valued at about the same earnings multiple as the
S&P 500. That makes little sense, unless it reflects worries about Jobs’
health or, worse, a repeat of the troubles Apple experienced after Jobs left
back in 1985. What’s more, following the news that Jobs resigned as CEO, in after‐hours
trading Apple shed some $20 billion of market value.
Once the initial shock wears off, however, investors should
be able to focus on just how good Apple is. Each of its stable of iPads,
iPhones and Macs feeds the growth of the others. Apple’s customer base is
growing and loyal. The smartphone and tablet markets have yet to hit their full
stride. New ground in TV is bound to be broken. Having Jobs around to lead the
$350 billion company through this next phase would be preferable. But soon
enough, it ought to become apparent that Cook and Jobs’ legacy will be a pretty
potent combination.
Published Aug. 25, 2011
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