Carl Icahn recently announced a long position in Apple (NASDAQ:AAPL), which has now unequivocally reclaimed the title of the most valuable publicly traded company on the market. Icahn's announcement, coupled with buzz building ahead of Apple's upcoming September 10 announcement(s), has caused the shares to rise meaningfully from their 52-week lows, closing a smidge above $500 in the most recent session. It is my view that shares have very little upside potential from current levels.
Icahn Won't Stop Android From Eating Apple's Lunch - The Tablet Example
Apple isn't a bad company (it's a great one!), and I'm certainly not of the school of thought that the company "lacks innovation". The company makes solid computing devices, and provides a top notch software ecosystem. Unfortunately, while this holds true, the trajectory of consumer-oriented computing is clear: better, faster, and cheaper.
Take, for example, the recent launch of the second generation Google (NASDAQ:GOOG) Nexus 7, designed and built by ASUS. This is an absolutely gorgeous tablet with superb hardware and software. Pure, unadulterated Android is an absolute treat, and a quad core Qualcomm (NASDAQ:QCOM) Snapdragon 600 @ 1.5GHz, a 1920x1080 high quality IPS panel, and a sleek form factor make it the mainstream tablet to beat. The iPad Mini, in contrast, offers a much less flexible OS, inferior hardware, and a higher price point. To drill the point home, here is a comparison of what consumers get with the new Nexus 7 vs. the iPad Mini:
|iPad Mini||Nexus 7 (2013)|
|Processor||Apple A5 (1GHz dual core Cortex A9, PowerVR SGX543MP2)||Qualcomm APQ8064 (1.5GHz quad core Krait 300, Adreno 320)|
|RAM||512MB DDR2||2GB DDR3|
|Connectivity||WiFi, Bluetooth 4.0||WiFi, Bluetooth 4.0, NFC, Wireless Charging|
Clearly Apple still enjoys what are categorically obscene margins on its iPad Mini, while its competitors are willing to live off of razor-thin margins to provide a much superior product. While it could be contended that Apple's "moat" is in its software ecosystem, it is clear that Google's Android continues to gain traction in the high volume growth segments of the market. So, Apple will either be forced to become a niche, high end player in both tablets and smartphones, or it will have to get down and dirty and start to sacrifice its gross margin profile and try to offset it with higher market-share/revenue.
In larger (10"-class) tablets, the market is seeing significant saturation. The whole appeal of tablets is that they are cheap, portable, and convenient. When the iPad was the only good game in town, $500 - $800 for the tablets seemed reasonable, but the broad shift to smaller tablets (a space where competitors continue to outmaneuver Apple), coupled with increased competitive pressure, make me believe that significant profitability, revenue, and market-share concerns will continue to weigh on the shares for the foreseeable future.
The same fate awaits the iPhone. Despite sales being up +19% Y/Y in the June quarter, the high margin game can only be sustained for so long. Smartphones are well on their way to becoming cheap commodities (if they aren't already), and while Apple seems to be accepting this with the iPhone 5C (does the "C" stand for "cheap"?), it does not bode well for the company from a longer term perspective. The iPhone 5 reminds me quite a bit of the iPad Mini - it's yesterday's technology today, and this is what drives the high margins. Eventually, Apple will either need to start selling better devices for the same price as its competitors, or it, too, will become a high priced, high margin niche device.
Apple At $700? Don't Get Burned, Again
Apple is a company with a market capitalization of $456B and sales of $169B on a TTM basis. In an environment in which competition is getting fiercer [and believe me, it will be very tough for Apple to gain momentum in China with the likes of Lenovo (OTCPK:LNVGF) and ZTE (OTCPK:ZTCOF) around], and in which the high end is likely slowing, it's really tough to make the case for Apple at $700. If Apple can actually grow its earnings so that it would trade at roughly a 10x TTM multiple at those levels (i.e. $70/share EPS), then that would be one thing, but financial engineering only goes so far. Apple is on track to earn $39.09/share in the current fiscal year, which represents an 11% Y/Y decline. As gross margins continue to come under pressure, and as the company continues to ramp its operating costs (particularly in R&D) to try to maintain its position (chip and software engineers aren't cheap, nor are hardware design engineers), I believe the sell-side estimates of $42/share for FY2014 may prove too aggressive. Even so, a very liberal 12x multiple to those estimates yields a target price of ~$504, right about where shares trade today.
If you're buying here because you're hoping for "Apple $700 Mark 2", then I think that this may be overly optimistic. Even at current levels, shares look pretty overbought, and while I'm sure that Icahn's involvement might keep a floor under the stock (and even drive ~10% upside to $550 from here), I wouldn't expect miracles. Apple's had a great run, but the fundamental story is still as risky as ever, and as a result am likely to stay on the sidelines.