Ap­ple re­mains in­vestors’ de­light

Ap­ple devo­tees carry on hand­ing over cash, but Tim Co­hen won­ders how long it can con­tinue like this

Financial Mail - Investors Monthly - - Front Page -

The big­gest com­pany in the world is of­ten a sym­bol of its times. Oil com­pany ExxonMo­bil held the hon­our over many years in the past, un­der­lin­ing a grow­ing world’s need for en­ergy. PetroChina did like­wise, and when it hit the top spot in 2007 and 2010, it also sig­nalled the rise of the Chi­nese econ­omy. Shop­ping chain Wal­mart has been close to the top hand­ful for many years, re­flect­ing the global shop­ping cul­ture of the noughties. In­vest­ment com­pany Berk­shire Hathaway is of­ten in the frame too, re­flect­ing the in­creas­ing pop­u­lar­ity of in­vest­ing.

But the cur­rent ti­tle holder, com­puter prod­ucts com­pany Ap­ple, is in a league of its own.

Ap­ple’s cur­rent mar­ket cap­i­tal­i­sa­tion of $693bn means it is now al­most twice as large as the com­pany that was its near­est ri­val at the start of 2014.

Ex­cept for a brief pe­riod in 2007 dur­ing which PetroChina held the hon­our, Ap­ple is the most valu­able com­pany that ever ex­isted. If you cared to com­pare GDP with mar­ket cap­i­tal­i­sa­tion (which re­ally you should not) Ap­ple is al­most twice the size of South Africa.

Ap­ple is Muham­mad Ali in the era of Ge­orge Fore­man. The com­pe­ti­tion is strong, but Ap­ple seems lighter, faster, more skil­ful and more adept than its ri­vals. For years, Mi­crosoft ruled the roost in the IT sec­tor, but to­day its rev­enues and its prof­its are less than half those of Ap­ple.

There are a few com­pa­nies whose rev­enue matches Ap­ple’s, no­tably Sam­sung Elec­tron­ics, the mak­ers of the iPhone’s main ri­val smart­phone, the Galaxy se­ries. Both com­pa­nies recorded rev­enue of al­most $200bn last year. But the lower down you go on the in­come state­ment, the more Ap­ple’s mar­gin prow­ess shines through.

Ap­ple’s earn­ings be­fore in­ter­est and tax were more than twice those of its Korean coun­ter­part over the past year.

Seem­ingly in­tent on thumb­ing its nose at its doubters, Ap­ple re­ported re­sults early this year for the last quar­ter of 2014 that just blasted past an­a­lysts’ es­ti­mates, grow­ing quar­ter-on-quar­ter rev­enue by 48%.

“Ap­ple is an enigma. In terms of prod­uct de­sign, it keeps its com­peti­tors guess­ing and its public hun­gry.

“Most com­pa­nies would be pe­nalised for do­ing the things that Ap­ple does re­flex­ively and re­peat­edly. But the com­pany, and its share price, have some­how con­nived to live a charmed life,” says Toby Shap­shak, edi­tor of Stuff mag­a­zine and the Fi­nan­cial Mail’s IT colum­nist.

The quar­terly boost was the re­sult of two things: a new iPhone and a new ter­ri­tory, China. The com­pany sold 74-mil­lion iPhones in the quar­ter, 30,000 phones an hour. Sales of the iPhone 6 mod­els rose 70% in China.

Shap­shak speaks of the Ap­ple “halo” ef­fect, a re­sult of mak­ing prod­ucts that con­sis­tently sur­prised on the up­side.

For new CEO Tim Cook, the past quar­ter must have been par­tic­u­larly grat­i­fy­ing. For the past three years since he took over from leg­endary founder Steve Jobs, the con­ven­tional wis­dom was that it would be al­most im­pos­si­ble for Cook — or any­one — to fill the shoes of his pre­de­ces­sor.

Yet the larger iPhone 6 mod­els, which some say Jobs would never have per­mit­ted, have proved a hit, and Cook’s judge­ment has been af­firmed.

For po­ten­tial new in­vestors, the suc­cess of the com­pany poses a prob­lem: can a com­pany that

Ap­ple is Muham­mad Ali in the era of Ge­orge Fore­man

has per­formed this well for this long keep go­ing like this?

Its vi­tal statis­tics are de­mand­ing but not grotesque. Ap­ple is trad­ing at roughly 16 times earn­ings. Its gross mar­gins, around 40%, are ac­tu­ally smaller than those of its some­time ri­vals Google and Mi­crosoft.

If you look past the as­tound­ing re­sult of the past quar­ter, it is pos­si­ble to see some po­ten­tial prob­lems for Ap­ple.

First, the com­pany has be­come very de­pen­dent on the iPhone. It ac­counts for 70% of to­tal sales. The next most popular item, the iPad, is now only 12% of sales, and th­ese are de­clin­ing sharply, by 21% in the lat­est quar­ter.

For Ap­ple, it’s clear that grav­ity will prob­a­bly grad­u­ally pull the com­pany away from its prod­uct-fo­cused growth strat­egy to­wards what it de­scribes as “ser­vices”. Ap­ple will launch the iWatch later this year, but an­a­lysts are pen­cilling in very mod­est num­bers.

Ser­vices, on the other hand, are al­ready a sig­nif­i­cant part of the com­pany, and Ap­ple’s unique mix­ture of soft­ware and hard­ware could ease the tran­si­tion.

Al­ready, sell­ing ap­pli­ca­tions on be­half of out­side de­sign­ers and a host of other ser­vice of­fer­ings con­sti­tutes about 10% of sales, not far off the sales of desk­top and lap­top com­put­ers, which were about 12% of sales last year.

“Ap­ple’s strat­egy dis­plays re­lated di­ver­si­fi­ca­tion. Those who ar­gue that its suc­cess is down to a sin­gle prod­uct do not ap­pre­ci­ate the con­sid­er­able syn­er­gies across Ap­ple’s prod­ucts and ser­vices, nor the con­tin­ued devel­op­ment and strength­en­ing of Ap­ple’s ecosys­tem,” War­wick Busi­ness School pro­fes­sor of strat­egy Loizos Her­a­cleous com­mented in an anal­y­sis of Ap­ple’s re­sults re­leased to the press.

Ac­cord­ing to Her­a­cleous, the strate­gic im­pli­ca­tions of Ap­plePay have not been ap­pre­ci­ated by most peo­ple. “Not only is the rev­enue po­ten­tial huge, with Ap­ple’s of­fer­ing al­ready ben­e­fit­ing from the ex­ist­ing mar­ket pen­e­tra­tion of its de­vices; mar­gins are also very healthy and the ser­vice has syn­er­gies with the iPhone and the iWatch, help­ing to so­lid­ify Ap­ple’s strat­egy of build­ing and con­trol­ling a prod­uct and ser­vice ecosys­tem.”

This may be true, but de­vel­op­ing the ser­vices side of the busi­ness does come with risks. One of Ap­ple’s re­cent mis-steps has been try­ing to com­pete with Google Maps. Ap­ple’s Maps of­fer­ing was so dis­as­trous, it be­came the butt of jokes.

The shift to ser­vices may be there, but it’s not Ap­ple’s happy hunt­ing ground.

The suc­cess of Ap­ple has re­sulted in an­other cu­ri­ous prob­lem: what on earth do you do with so much money?

The ob­vi­ous an­swer, which Ap­ple first ini­ti­ated in 2013, was to re­turn cash to share­hold­ers. But this is on a scale that re­ally bog­gles the mind. In 2013, Ap­ple un­der­took to spend $40bn on div­i­dends and $60bn on share buy-backs by the end of this year. That pro­gramme was ex­panded in 2014, so that the to­tal buy-back play would come in at $90bn last year, and its to­tal dis­gorge­ment of cash would amount to $130bn. That would be one of the largest cash-re­turn pro­grammes ever un­der­taken.

Re­turn­ing cap­i­tal at that rate would sug­gest a lower level of cash on hand, but Ap­ple is adding cash at such a rate that it will have more cash when the pro­gramme is fin­ished than when it started. Ap­ple had $137bn in cash in 2013, and it now has $150bn.

Imag­ine that. The prob­lems some peo­ple have.

The com­pany only re­ally has two choices now: to find some very ex­pen­sive ac­qui­si­tions or to ex­tend the pro­gramme.

The lat­ter seems the more likely op­tion, since one of the re­mark­able things about Ap­ple is that its ap­petite for ac­qui­si­tions has al­ways been small. Why buy growth when you can build it in­ter­nally? It seems log­i­cal to say this, but few com­pa­nies have ever shown that level of dis­ci­pline in the face of such a huge cash pile.

There is a third op­tion which, on the face of it, seems rather coun­ter­pro­duc­tive. Ap­ple could raise debt to bal­ance its cash hold­ings.

Although the strat­egy seems nuts, Ap­ple has in­creased its debt ag­gres­sively re­cently to about $40bn. That too is a Cook in­no­va­tion; Jobs could never stand debt un­less he re­ally couldn’t avoid it, and in his lat­ter years he could avoid it and did. But hav­ing both debt and cash does po­ten­tially have tax ad­van­tages, depend­ing on where they are sit­u­ated in the com­pany, although those are usu­ally short-lived be­cause the tax man is a highly in­cen­tivised en­tity and th­ese loop­holes are typ­i­cally closed even­tu­ally.

We live in the era of the con­nected de­vice, with its trail­ing tail of re­lated nov­el­ties, like “ecosys­tems”, “plat­forms” and “syn­er­gies”. Other com­pa­nies like Face­book, Google and more re­cently Alibaba have big stakes in this brave new world. But none has man­aged to carve out such a well de­vel­oped, wall-to-wall prod­uct and ser­vice of­fer­ing as Ap­ple. It may not last, but, for now, it’s im­pos­si­ble not to be awed by this gar­gan­tuan cor­po­rate achieve­ment.

For Ap­ple, it’s clear that grav­ity will prob­a­bly grad­u­ally pull the com­pany … to­wards what it de­scribes as ‘ser­vices’



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