Financial Mail - Investors Monthly
Apple remains investors’ delight
Apple devotees carry on handing over cash, but Tim Cohen wonders how long it can continue like this
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’