It is striking that Apple (AAPL) has fallen by almost 1/3 in market value over the last several months. At first, there was concern that there might be some market manipulation at work. Hedge fund short sellers or banks with large exposure to naked or semi-naked calls were the steely eyed culprits. However, it has become clear that these agents are not to blame, but rather, the blame can sit squarely on the shoulders of the gentlemen squatting on the Apple end of the quarterly conference call.
Growth investors are right to leave this stock. EPS was lower last quarter on a year over year basis and the upper range for guidance for the next quarter is $10.15/share. Further, we were assured on the conference call that the earnings would fall in this extremely low range with a large degree of confidence. In other words, do not expect more than $10.15/share next quarter. This is circa 20% below last year EPS in Q2 of $12.30/share. My personal guess is that the EPS will look like the following minus an unforeseen event (iTV, China Mobile, or larger iPhone).
At this point, it would seem counterintuitive to assume 20% year over year growth (which is what most models predict) as it will be very difficult for AAPL to do better than 10% growth. Further, if AAPL is correct in the guidance for next quarter it is safe to assume that after the next earnings announcement we might find an even lower floor for the AAPL share price than the current $440/share as I write this article. Here are some items that growth investors do not like:
- Less than 10% growth yoy
- Signals from management that new markets will not be pursued
- Signals from management that although the market shows demand for a product (larger iPhone) management will not pursue said product
- Confusing or misleading guidance
- Lack of press releases to quell rumor mills
The signals discussed above were summed up during the conference call when Tim Cook was asked about pursuing a lower price point phone for China and when the executive committee was asked about a larger iPhone. Of note was Tim Cook's response to the larger iPhone:
So, we put a lot of thinking into screen size [for the iPhone 5] and believe we've picked the right one.
There is money being left on the table because Apple will not make a larger phone. A sizable portion (circa 30%) of the high end smart phone market wants a 4.8" to 5.0" screen size on their phone. Tim Cook's statement does not eliminate the possibility of Apple ever having a larger screen size phone, but it does not make it seem like this is something that is coming out soon. A growth investor would view this as a mistake. There is no punishment to offering a large screen phone to those who desire to be in the iOS ecosystem. Losing those customers to a Samsung Android ecosystem is a catastrophe as those customers are unlikely to return from Android.
For the reasons listed above, Apple has lost its shine as a growth stock. Indeed, it is very possible that full year earnings for 2013 might be lower than those for 2012, especially if Peter Oppenheimer is correct and earnings for the next quarter come in at $10.15/share.
The second part of the argument is that with a lack of growth investors, value investors might step in. Value investors like companies that sell below or at the respective book value. There are other value investors that desire operating cash flow to be greater than enterprise value, amongst other such metrics. Value investors typically do not like companies that sell at 3-4X book value and that do not own their method of production. Apple is not a classic value investor buy and it will continue to not be for the near future. Value investors love tangible assets that can be sold in a fire sale if need be. A true value investor takes one look at Apple and says, "what if half the customers switch to android tomorrow?" Even performing a discounted cash flow analysis does not truly account for the risk of customers leaving the ecosystem. The answer to this question is that the moat is getting smaller and smaller and the impetus to leave the ecosystem due to enticing products such as larger screens and a more open software system is becoming greater.
Also, a value investor, like a growth investor, likes to see management that is open to growth. In this case, Tim Cook would have needed to make a statement about the "cheap" iPhone that would have gone something like this:
"Apple does not make cheap products. There will never be a cheap iPhone. However, Apple is aware of the needs of its customers and potential customers in China. Without sacrificing margins, I am positive that there is a way to serve the Chinese consumer a wonderful product at a variety of price points that will enrich their lives."
And to the larger iPhone comment, how about something like this:
"Apple is in the business of providing excellent products. We put a great deal of thinking into the size of the iPhone 5 and believe that a 4" display is absolutely optimal. We do believe, however, that there is a small sub-segment of the high end smart phone world that wants a larger display. We will continue to investigate if perhaps it might be in Apple's best interest to pursue those customers with a cutting edge product that has the wonderful functionality of the iPhone 5 and the larger screen size."
An interesting note is that there was a bit of smugness to both Peter and Tim on the call when it came to the supply constraints. Almost as though there was pride that the product was so great that they could not keep it on the shelf. I personally waited 3 weeks for my iPhone 5, however, I have friends (plural) who did not wait. They purchased Android based Samsung phones. Not being able to supply products to paying customers is not something to be smug about. Rather it is a question of competence. We are observing the Peter Principle in effect. The excellent supply chain management by Tim Cook has been replaced by an incompetent heir and Steve Jobs has been replaced by Tim Cook. While Tim Cook was good at his previous job, he has been promoted to his level of incompetence as the CEO.
In brief, the stock should have actually gone up after this conference call. The stock did not go down based upon poor earnings over the holidays. Rather, the stock went down based upon inept management and extremely low guidance for next quarter EPS. Anyone with ears and a calculator that listened to the cacophony on the Apple end of that conference call immediately sold their shares. That being said, there is a slight chance that Apple does plan to make a larger iPhone and that there will be a greater presence in China. The unfortunate reality is that Apple believes so strongly in the Jobs legacy of secrecy, sometimes for no reason, that anyone listening to the call cannot discern Apple's direction on these two extremely important decisions. Until those decisions are clear the growth investors will shy away and the value investors will wait until the stock hits a little over 2.5X book value (about $375/share). The painful reality is that there is a good chance that investors will continue to be MIA on this stock for the near term.
Additional disclosure: I may or may not change my positions over the next 72 hours and yes it is painful to be long AAPL at this moment in time.