Wednesday, February 18, 2015

Will Apple Inevitably Lose Its Way?

This parody of Rene Magritte's painting struck me as being very appropriate for this post. My former colleague Michael Moe's firm, GSV Capital, listed the Top 25 Best Performing Stocks for the period 2004-2014, and Apple was number 9, growing its EPS at a CAGR of 54% over the period and its stock price at a rate of 37% per annum.  In absolute terms, Apple's performance was stunning looking at the growth of its market capitalization: it went from $26 billion at 12/31/2004 to $647 billion at 12/31/2014.  If the Apple of Steve Jobs' reign is painted in the middle, Mr. Jobs left current CEO Tim Cook with his portrait at the left. (not exactly proportionate, but you can see the idea.)  It is almost inconceivable performance, which is why it's unlikely to be repeated.

"Trees don't grow to the sky," as students learn in their introductory microeconomics classes. Also, as GSV notes, ",,if Apple were to notch the same stock performance in the next ten years as it has in the past ten years, it would have roughly a $40 trillion market cap--nearly 2x the entire U.S. Equity Capital Markets."  GSV also notes that no company has remained in the list for two consecutive ten year periods.  

We have always taken the position that Apple is a cult stock, namely most investors buy it for philosophical reasons, e.g. they love Steve Jobs, they work in creative industries that use Macs and want to support the company that makes their great machines, they work in public education and admire Apple's commitment to that market, they believe that Apple's mission is about much more than making money, or they believe that the stock is "cheap," selling at 11x estimated earnings, net of cash. Each one of these reasons has 5 or more variations for cult members. I have considered owning it many times, but couldn't pull the trigger--my loss for the past ten years.

What are some signals flashing yellow, besides those presented above?  Apple is flush with cash.  Most companies in this position have their investors clamoring for a return of the cash through dividends or share buybacks.  The company has arguably responded on both counts by planning to return $130 billion to shareholders through the end of 2015. No yellow here.

The company announces something called Project Titan, a skunkworks to design an electric car. Hello?  This is an industry far away from Apple's core competencies, and one which is cyclical, rife with competitors, and subject to all kinds of regulation, something that Apple strenuously avoids.  This project should sound about as exciting to Apple shareholders as Google's driverless car is to its shareholders.  I don't think either of the two Steves would be excited about this project.

More recently comes the famous Apple Watch.  Initial rumors had this device being the centerpiece of the company's projected foray into consumer healthcare monitoring, patient management and anything called e-health.  However, as the Wall Street Journal reported, none of these features made it into the product to be launched this April.  Besides some features not working or being to complex, the Journal writes, "And still others could have prompted unwanted regulatory insight.."  Okay, maybe, but electric cars?

The watch being launched needs to be near an owner's iPhone in order to have wireless connectivity, and so the Journal notes that it appears to be an add-on accessory to an existing owner's iPhone. Cultish iPhone owners may go for this, but surely new customers wouldn't want to jump straight into a new Apple Watch and iPhone at one go?  That's a big ticket.  

There is a range of price points.  At the the lower end, Apple Watch competes with FitBits and other established products in a crowded segment. At the upper end, the ultra models feature 18 karat gold casing and will retail above $4,000.  Even billionaire oligarchs and young tech company CEOs who have sold their companies to Google may think twice about this.  Isn't there more cachet in a Tag Heuer or some of the newer, ultra-luxury watch brands?  

CEO Tim Cook says to the Journal, "One of the biggest surprises people are going to have when they start using it is the breadth of what it will do."  And what is that?  Even the reviewers can't come up with the wonderful things.  

Probably, the first generation product buyers will be orphaned as the company eventually figures out what the product should really be. In this respect, the company would then appear to be more like Microsoft, which first launched Surface RT before realizing that it was rubbish and launching Surface Pro 3, leaving a lot of unhappy consumers.  

When Apple launched the iPod for music, it wasn't the first player in the market.  Creative Labs made a relatively inexpensive, functional, intuitive series of players called Zen that really served music lovers well.  But, Apple miniaturized the iPod, which was very important to consumers, and it launched iTunes that turned the music business upside down.  A key innovation and a market disruption, and it led to success.  So far, the watch looks like late entry with a placeholder product.  A definite yellow signal, but shareholders have to stay tuned.

What about emerging markets?  Is Apple ceding all but the uber-middle class to Chinese and other competitors?  Will Apple become the Louis Vuitton of electronic gear?  

If Apple wants to get into other businesses like making cars, wouldn't shareholders rather diversify their holdings themselves by buying an emerging car company?  Or, wouldn't they prefer to buy an emerging healthcare informatics company?  What is Apple all about?  Could the story end for shareholders like the third panel on the Magritte parody?  Who knows. 

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