Ouch! Apple (AAPL) dropped over 6% in a day, recording the worst one-day drop in the last four years. Of course, the party-line explanation for the sharp drop is the recent increase in margin requirements for shares of Apple's stock. While this certainly is a factor for the magnitude of the move down, I believe that there are much more fundamental fears that have underpinned the painful decline from the peak of $705 per share. As obvious and as "irritating" as it may sound, the simple truth is that margin compression, according to several reports, is happening now.
Tablets: People Want 'em Cheap
According to a report from Digitimes, display panel suppliers are seeing as high as a 20% decrease in orders for the 9.7" line while orders for the firm's much cheaper and more svelte iPad mini continue to rocket on upwards. The sources further noted that in October 2012, 75% of iPad sales were mini while the rest were 3rd and 4th gen iPads.
Digitimes, which has its own research group, further estimates that 7"-class tablets will reach 75.6M in sales during 2013 while 10" tablets will drop from 60.3M units to 41.2M units in 2013.
Is anybody surprised? It seems unlikely that most users want to spend $500 - $1000 on a notebook computer, an additional $500 - $800 on a 9-10" tablet, and then end up with two mostly similar devices. The key here is that at the 10"-class tablets will more-or-less be rendered obsolete by touch-enabled notebooks and convertible designs such as the Dell (DELL) XPS Duo 12, the Lenovo Yoga 13, and the ASUS Taichi. As notebooks/convertibles become thinner, lighter, and sip less power, they will become the convenient all-in-one solution for those who want both a tablet and a notebook. It saves money, it saves time, and it just makes life a lot easier for the cash-strapped consumer in a bad macroeconomic environment.
But the 7" tablets: now those are something unique. While Samsung and others have developed what are commonly referred to as "Phablets" (which are basically super-oversized smartphones), I believe that the success of the iPhone form-factor probably indicates that people want to stick to small, sleek, and convenient for their phones. But for a general purpose media consumption device, a 7"-class tablet makes a lot of sense. It can surf the web nicely, play YouTube videos, check e-mail, and so on. The iPad Mini's wild success further points to the notion that the iPad Mini was the "tablet" people wanted all along.
So in addition to convenience, is there something else? Why yes. 7" tablets are cheap, cheap, cheap! I recently bought a Nexus 7 for $199, and even the iPad Mini (which seems to be, by all counts, a superior device to what the Android camp has) at $329 is a bargain compared to the regular iPad. At those price levels, the 7" tablets are excellent "second" devices. It's a lot easier to justify a $200 - $300 gadget than a $500+ one. Also, for education? A 7" class device is much cheaper, more portable, and arguably "better".
iPad Minis are lower margin products than the iPad. I firmly believe that, aside from folks who are extremely rich (or just tech nerds in general), there will be significant cannibalization of sales of the larger iPad by the iPad Mini. Smart move for Apple to have this product out to preemptively keep share away from Google, Samsung, and so on, but it highlights the reality of the direction of the pure tablet industry in general.
Smartphones: Welcome To "Good Enough"
Well, it's happened. Smartphones are "good enough". A modern Apple iPhone 5, Nokia (NOK) Lumia 920, or Motorola Droid Razr i, is really fast enough to do whatever smartphone related tasks that are necessary. These things have processing power and memory rivaling "netbooks" from 5 years ago, and all they need to do is run much less resource intensive apps, surf the web, and last long on a charge.
Now, there is certainly a lot of growth left in the TAM, especially in developing countries, China, and so forth, so I fully expect that smartphone sales will continue to grow at double-digits for the forseeable future. However, for Apple, I once again see very severe margin compression ahead. Why?
Well, like I said: the iPhone is good enough. It's fast, sleek, and lasts long. What will be the incentive to upgrade to the next model? A "bigger" screen? Is that really worth yet another $200 to the average Joe who can barely afford to pay his rent on time? Oh, and in developing nations - where people aren't either ridiculously loaded or willing to max out their three credit cards - the carriers don't take it to the groin like Verizon (VZ) and AT&T (T) do when it comes to subsidies. Want an iPhone? Cough up a month's worth of salary, please!
"Good enough" means that people will go for the "free" two-generations-behind iPhone. It gets them the "Apple" aura, but without the price tag. But the "Apple Aura" is probably not going to last too much longer at the high end, either. Not with the folks in the Android and Windows Phone camp willing to sell customers better hardware for cheaper (and thus take in much slimmer margins). Why should I buy a $200 iPhone 5 when Nokia will make my day with a superb $99 Lumia 920 (note to Apple perma-bulls: seriously, go try a high end non-Apple phone - they're quite good).
Apple's a great company that has built a superb brand. But, folks, they build computers, phones, and tablets. Apple neither designs nor builds the majority of the internals for its products. It does control its own software ecosystem, though, which would have been a major positive had Android not shown up on the scene for free.
Windows 8 is a far more innovative OS on the PC side of things. With touch capabilities as well as the ability to have your Windows 8 Ultrabook be your Windows 8 tablets, the iPad and the MacBook Air are both under serious fire. While it wasn't true a year ago, the PC vendors have finally gotten their ducks in a row and are producing some excellent designs with technical and aesthetic advantages over Apple's stuff.
I don't see too much more downside ahead in the near term for Apple shares as the fairly low P/E and net cash position provide a fairly significant buffer, but those expecting $1,000 anytime soon are likely to be disappointed. People say that Apple's too cheap based on its ~13x P/E. I would agree if I believed that the "E" would continue to increase. But the problem is, that "E" will inevitably get a whole lot smaller over the next couple of years as the smartphone and tablet become commodities. So Apple bulls, you will eventually get that 20x P/E, but I don't think it'll come from Apple hitting $1,000 per share.
And now ladies and gentlemen, you're welcome to tell me just how wrong I am in the comments section!
Disclosure: I am long T.