“Hello, My Name is David Nelson and I’m an Appleholic” – Redux
“Hello, My Name is David Nelson and I’m an Appleholic.” I confessed that to Newsmax readers in my article in late 2012. I was hopelessly addicted succumbing to the siren song of Apple products, spiffy stores and yes soaring stock price. Up until a few months earlier it was a must own stock for investors. Portfolio managers who weren’t on board were destined to underperform.
I carefully laid out the seven traits that all Appleholics possessed and had to admit, I suffered from them all. It was difficult to stay on the wagon with a parade of analysts coming on the tube daily saying I was wrong. They pointed to the valuation, the cash, the great line up of products, the ecosystem, yada yada yada.
With help and guidance from other recovering Appleholics, I lifted myself up off the mat and one by one addressed my demons. I continued to use their products, but opened my mind to others like Google’s Android (GOOG), Samsung and even briefly looked at Nokia (NOK). I cut the investment cord selling all stock and forced myself to stop looking at the price the moment I wake up in the morning.
Like all addicts, I suffered relapses. The first was several months ago when I binged on Apple (AAPL) stock but stopped out quickly. The second was more damaging when Wall Street raider Carl Icahn tweeted he had bought a significant position. Carl pointed out as others have the significant cash position, great line-up of products, yada yada yada. He went on to say he was having a nice conversation with Apple CEO Tim Cook, a dinner and who knows maybe even a breakfast.
I now had the perfect excuse to feed my addiction. A Wall Street legend was endorsing the stock and I could binge free of guilt.
For a while the euphoria filled me up and the stock continued to push higher. The anticipation of the new iPhone 5s and 5c along with Carl, was all the good news investors needed to bid up the price.
The first signs of trouble at the launch party emerged when Tim took the stage. The applause were polite and even the obligatory “whoo” was heard in the background. The streaming event certainly wasn’t the love fest we were accustomed to when Apple founder and technology icon Steve Jobs was the headliner. As the event pressed on, Apple investors everywhere felt like Jim Lovell of Apollo 13, when he called mission control and said; “Houston, we have a problem.”
No one expected the 5s to be revolutionary and it wasn’t. The 5s appears to be a descent update for the iPhone 5 with a faster processor, fingerprint technology but no bigger screen. The real disappointment was in the pricing point of the iPhone 5c. The phone is meant for emerging markets and by most accounts is priced too high to pick up market share. Investors were also concerned they didn’t announce China Mobile as a new carrier. This has long been rumored but to date hasn’t materialized.
Needless to say the stock sold off and forced me to re-examine my motives for owning it. In an email conversation with one of our smartest investors and also a long term Apple owner, we discussed the company and its evolution in recent years. He pointed out something that hit me in the face like a bucket of cold water. In the email he wrote:
“The big problem I have with Apple now is that it is no longer Apple the tech company — it is really Apple the iPhone company, and I guess it has actually been that for some time. The iPhone has become such a dominant part of the business that it doesn’t really matter anymore how the Mac is doing or how the other parts of the business are doing. Some other parts — iTunes, for example, are still important. I’ve been slow to recognize how fundamental a change this is. It is no longer a technology surrogate, but should probably be viewed more in the telecom industry group.”
If you think this isn’t dead on the money look at the chart below.
According to Goldman Sachs more than 52% of Apple Revenue comes from the iPhone. If you add the iPad at 19% you can see less than 29% of their revenue comes from all other products and services combined. A lot of Bulls point to the Apple ecosystem but iTunes/software and services represents less than 10%
Apple is no longer a tech company or a proxy for the tech sector. It is the iPhone company. Tim Cook and his team are trying to defend margins in a world drowning in new devices. The iPhones are certainly a premier product but the rest of the world has made their presence known and it will be virtually impossible for the firm to maintain their margin structure without giving up market share.
Earlier this year I had the pleasure of interviewing for Newsmax, Vanity Fair’s Bethany McLean. She pointed out then the issue of the iPhone dominating revenues. She went on to say; “Maybe it’s a little too strong to say it is under siege, but it certainly is a challenge and if you look at the track record over time of phone makers it’s not good” Boy was she right.
Tim Cook certainly has built a reputation as a master of the supply chain working under Steve. However, many including myself question whether Tim has the Vision Thing we look to in a successful CEO.
When the iPhone first came out, Apple literally caught the industry with their pants down. Its stock went on a run that will probably never be repeated. This kind of success breeds profits, complacency and with it an emotional attachment investors find difficult if not impossible to break.
Appleholics like myself have to come to grips with the fact that even if Apple (AAPL) gets beyond some of these hurdles and performs well in the future, it is not and likely won’t be a must own investment. There are plenty of growth companies in the technology sector, still in the early stages of their growth cycle. In a few years, in the same way investors encouraged the breakup of Microsoft (MSFT) to unlock value, Apple (AAPL) investors may ask the same of Tim. – David Nelson, CFA
Disclosure – Funds managed by David Nelson are long Apple stock at the time of the release of this post. however, reserve the right to sell at any time. Belpointe Asset Management, LLC (“Belpointe AM”) is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration with the SEC as an investment adviser should not be construed to imply that the SEC has approved or endorsed qualiﬁcations or the services it offers or that or its personnel possess a particular level of skill, expertise or training. For disclosures visit: http://belpointe.com/disclosures/
I wonder if, rather than being disappointments, the 5c and the 5s are a stroke of genius on the part of Apple. Wit the 5c, Apple has altered it’s previous strategy when releasing a new model of continuing the sell the outgoing model at a reduced price. What is the effect of this? 1. Apple sells a phone that is better than the outgoing 5, in some regards, but at a lower cost to manufacture because of the use of plastic. Higher margins. 2. The public gets a “new’ model rather than feeling like it it is settling for the outdated model of last year. Let’s see what the sales figures look like for the 5c.
And what about a sub $400 4s packed with iOS7 for the China market in addition to the 5c? I think there will be many takers.
And with the 5s, I think a lot of analysts are underestimating the power the new internal components will have on the future of this device. Rather than perpetuating the feature war with Samsung/Android, Apple has quietly changed the game again. 64 bit architecture, M7 chip, Touch ID all wrapped up in iOS7. This combination will spawn all new categories of apps and connected devices that were impossible with current phone technology. Controlling the hardware, operating system and tight controls on the apps give Apple an advantage that is not easy to replicate. I may be wrong about this…it won’t be the first time…but wathc what happens over the next year. I think we all may be surprised at the impact of this latest move by Apple.
Much of what you say is true but higher margins in this business is not sustainable. GM made the same mistake decades ago. They ignored Toyota coming in at the low end. They were happy selling Cadillacs at high margins. They never believed they would go upscale. TOY wiped out GM
You may be right. But I think the GM analogy is not what’s going on here. WIth GM, you had a company making a far inferior product to what the Japanese were building. They stopped spending on R&D and got comfortable. And the retooling necessary to compete with high quality Asian products was a long and costly proposition. That’s not the case with Apple. Apple still has no peer in the quality of their product. And no company invests more in R&D. Nobody thought the original iPhone could ever make it at $600 (just ask Steve Balmer). It was doomed to fail. Yet, despite the cost, they changed the industry. Now, we’re talking about sustainable margins. Apple has done the hard work already. The easy thing to do right now would be to give up some margin and fight for market share if the market demands it. Does anyone doubt that if Apple chose to cut their margins by 1/3, that they wouldn’t take over the industry. Apple has the luxury to play it either way. Remember the 1/3 price drop for the original iPhone? I’d rather invest in a company that has all the things we know Apple has going for it AND the ability to run everyone else out of business if they choose to cut prices (which only they can afford to do).