One of the biggest problems with owning Apple (AAPL) as an investment at this point is that it is owned by so many that it is almost too easy to get "caught up" in the hype and charge with the masses. On a day when Apple rockets up, it's all too easy to jump on board the bandwagon and extol the virtues of the latest-and-greatest iPhone or iPad product. It's just as easy to get caught up in the negative hype when talk of gross margin compression and high competition are the theme of the day.
While I am actually quite bullish going into the current earnings report (primarily due to the excessive pessimism that has surrounded the name as of late), it is critical to not be suckered in by the "obvious" reasons to just go out and buy tons of Apple shares. In particular, I cite this recent article from CNBC, "Apple Poised To Soar In 2013: Experts".
The 'Obvious' Catalyst Is Obvious
In particular, I would like to direct your attention to the following line from the article:
The coming launch of an iPad 5 and a new iPad mini will also help drive Apple's stock back up, Smith said.
Wait just a minute! Are you telling me that in a world where tablets are going to replace the traditional PC because tablets have become 'good enough', people will actually keep buying the latest-and-greatest iPads for a premium to their older brothers?
What is really different about this upcoming iPad 5? The iPad 3 got a 'retina' display, the iPad 4 added a faster processor, so what's the iPad 5 going to bring users? Yet another faster processor? If Wall Street really thought that additional processing power was anything close to important in today's 'good enough' computing environment, chip giant Intel (INTC) would not be trading at less than 9x earnings.
There's maybe one more "kicker" with the iPad Mini when we see the obvious move to a 'retina' display and attendant faster processor, but after that, what will drive a refresh cycle? Current PCs and tablets are 'good enough', right? To me, the 'good enough' factor means that mix will shift towards the older, discounted products which keep on getting 'better enough'. And that brings us to the next problem.
Shorter Product Cycles Are NOT A Good Thing!
The article then goes on to state the following:
Apple will bump up its product upgrade cycle for the iPhone to a six month cycle instead of a 12 month cycle, said Eric Jackson, Ironfire Capital founder and managing director.
How is this a good thing for Apple's business model? If a new phone is released every six months (and we are very near the point of diminishing returns, as we are in a 'good enough' world), then every six months, a previous flagship phone gets sent to the bargain-bin and then the 'good enough' effect kicks in again. Why should users buy an incrementally improved 'iPhone 6S' when the 'iPhone 6' is cheap and the 'iPhone 5S' is free with a contract?
The fundamental problem here really is: how much longer can you convince people to upgrade to an incrementally better phone, especially as these phones face intense competition for the 'good enough' medal? I once again see a mix shift towards the discounted older models that, now by virtue of the shorter product cycle, quickly become cheap and good enough.
R&D Costs Will Start To Rise
If Apple's product cycle gets shorter, not only will we likely see a mix shift towards cheaper (and lower margin) products, but R&D costs will skyrocket. In addition to actually designing the phone, Apple is now playing fabless semiconductor company! This raises the following concerns:
- As Apple's chips become more sophisticated, design and validation costs will skyrocket. How sustainable is this?
In order to make significant advances, Apple will be tied to the execution ability of its foundry partner. Rumors say Apple is ditching Samsung (SSNLF.PK), so it will probably be at the mercy of Taiwan Semiconductor (TSM) which is also busy supplying chips to everybody else in the industry. Just ask Qualcomm (QCOM) how strong the world's leading foundry is at enabling cost-effective, leading edge process technology in sufficient quantities (hint: "shortage" was the word of 2012)
Apple has a lot of money, sure, but ballooning R&D costs for a company that has run an R&D-light ship for so long and has enjoyed immense operating profitability in no small part due to this will hurt the bottom line.
Apple's still cheap, and I still think its earnings this quarter will do well and launch the stock back into the high $500/low $600 range for a little while. However, long-term investors need to very seriously consider the fundamental changes that are going on here. If Apple is really moving to shorter product cycles, then it is acknowledging that its competition is running circles around it and it needs to move faster to keep up (yes, folks, other players in the smartphone/tablet space are doing really good things; the Galaxy Note that's selling like hotcakes).
Oh and one more thing: Don't just buy Apple for the release of an iPhone 6 or an iPad 5. Newsflash: everybody knows that they're coming.