Rarely if ever does the advantage of being a first mover transform into a ticket to long-term success, a business phenomenon nowhere more true than in the technology arena. AOL, Digital Equipment, and even International Business Machines (IBM) provide just a few examples of companies whose head starts did not produce lasting leads. Unfortunately, the same appears to be true of Apple (AAPL) - for the second time.
Remember, for practical purposes, Apple invented the personal computer, dominated the business for several years and then lost its lead to what people then called IBM-compatible computers - simply a name for computers that used the Windows operating system software on machines made with Intel (INTC) hardware. Steve Jobs' success in humanizing technology and creating a massive and fertile eco-system, which will lead to massive profits for many participants, is not destined to leave Apple as the most successful player.
Not to worry, you Apple fans. The company is in no danger of losing its franchise - it will always be favored by a coterie of devoted users willing to pay a premium price for a premium brand. The company maintains a small but solid market share in computers, suffering no danger or threats - at least for the next five years. The company's current niche looks more solid and larger than that of its personal computing legacy, since it can port applications across many different devices and has created a meaningful barrier to entry. But ultimately, Apple is about maintaining a niche whose participants are willing to pay up for quality. Apple has always been a Tiffany-type brand in computers, while other competitors have eventually looked more like Wal-Mart.
We expect profit growth for Apple, which burgeoned four-hundred fold since 2003, to slow. Consequently, we are reducing our Apple rating to Speculative. Any sort of meaningful growth in the coming years will most likely depend on Apple's introduction of new products, which appears to be a speculative bet since the passing of Steve Jobs.
The newest big thing in tech is mobile smart devices, ranging from smart phones to tablets to ultra-thin computers. The mobile explosion started with Apple's introduction of the iPod at the end of 2001. The device broke little technological ground but successfully converted clunky, poorly functioning portable music players into elegant devices capable of producing credible musical sound. More than five years later came the iPhone, then the iPad. Various upgrades further humanized and, thanks to its proprietary IOS operating system, integrated Apple's family of devices with one another.
Apple took its rewards, for a time, as the largest-capitalized company in the world. But as its upgrades became less and less meaningful, competitors ferociously entered the market, making Apple items increasingly into easily knocked-off commodities. Today Apple faces declining market share, and probably what will result in a losing battle in the developing world, where price plays a much greater differentiating role than it does in America. Specifically, Apple's market share in all mobile devices has declined worldwide to less than 15 percent. Not surprising, therefore, Apple's latest earnings were disappointing as profits barely budged and the company's guidance suggested that investors could expect little growth ahead.
While Apple has not completely fallen from grace, the difficulty of maintaining a product lead seems ever more clear, as with so many consumer product companies - and technology companies in general. Indeed, this increasingly looks all but impossible. Apple products will always have a market, but as true for computer and notebook lines, Apple is now redefining itself as a premium producer. On a best-case basis, the company may perhaps sustain growth near double digits. We do not completely count out the company, thanks to its enormous cash horde and a following that would latch onto any really new Apple product, and the shares that now sell at a modest valuation.
Ironically, Apple's relative fall has been met by Google's (GOOG) success. Ironic, because Steve Jobs held Google in fierce contempt, chiefly for what he called its predatory business practices. He accused Google of stealing the IOS system for its Android phone. Still, business is business, and Android now controls about 70 percent of the mobile market. Even more impressive is the degree to which Google dominates searches in the mobile arena. Well over 90 percent of mobile device searches use the Google engine - compared with about 65 percent for the desktop market. Given that searches are the portal enabling Google to monetize its business, that degree of domination goes a long way to explaining the company's continuing, stellar growth, of over 20 percent annually. Moreover, mobile searches still comprise only 11 percent or so of total searches, and we expect that percentage to rise sharply in the years ahead.
What looks particularly significant for the company is the relative cost of mobile searches - considerably less than desktop searches and declining. That explains the company's improving margins, and why the margins should continue to improve. Google also plans to introduce its own phone - which in turn explains why the company acquired technology assets from Motorola. Google also produces a tablet called Nexus that could become its first real hardware winner. The Nexus and Google phone have the potential to link in the same way the iPhone and iPad already intertwine .
In the longer term Google also has several initiatives that could pay off spectacularly. The driverless car, for example, widely viewed as a pie in the sky adventure, may move or even jolt the needle in urban transportation: Shared robotic cars in an urban environment could easily grow into a market worth a hundred billion dollars or more. Google also retains a nearly spotless balance sheet and has a projected free cash flow yield of 9 percent.
Therefore, so far the biggest winners, at least to date, in the mobile arena are Google and Amazon (AMZN), which we wrote about earlier. Keep in mind, every mobile device, whether a Samsung or Apple phone or a tablet of any manufacturer, allows the immediate purchase of books that one can read immediately, or spontaneous orders of virtually any consumer item except for cars and houses.