Albert Einstein once said "If at first the idea is not absurd, then there is no hope for it." When you work your way through Apple's (AAPL) filings and you witness their year over year free cash flow and other stellar metrics, absurd is the adjective which comes to mind in considering a short thesis on the company.
Nevertheless, in what follows are some potential warning signs with regards to AAPL's market share in Africa, as well as some underlying fundamental flaws in investor psychology in light of the number of hedge funds which hold AAPL.
Emerging Market Dilemma: Apple & Africa
While living in Uganda, there was something I found astounding which birthed my interests into forming a short thesis on AAPL. It was simply that iPhones were a rare commodity. In fact, from dialogue with my Ugandan colleagues and from surveying cell phone vendors, we approximated that 1 out of every 75 phones would be an iPhone. At this, it would be an older model; a 3G, 3GS, or 4. Furthermore, if it were a newer model, it would be owned by an expatriate. It was clear that there was a higher percentage of iPhones owned by expatriates than by nationals and any iPhones owned by nationals more than likely were older models. Why was this?
When it comes to emerging markets, Wall Street mainly focuses on GDP growth per a given country as an indicator for a country's future growth rate. What is often not focused on, but is important to do so for multi-national companies would be Africa's GDP per capita, per a given country. At present there are 54 countries which make up the great continent of Africa. The mean GDP Per Capita of all 54 countries is $3433 USD, with the highest GDP per capita being less than $18,000 USD. Selling iPhones in Africa is not dissimilar to how they're sold in the West. Apple finds vendors and negotiates a price, supplies them, and reaps a profit. But just how profitable has Africa's market been for Apple? Not very. Vendors want to sell the iPhone in Africa, but to do so at the pricepoint Apple would agree to for them to incur a profit would be impossible. Take Orange Telecom (ORAN) for example. In East Africa, Orange is one of two networks which dominate the mobile phone providers and coverage networks [MTN Group LTD - (OTCPK:MTNOF) - being the other] as they offer the most coverage and bandwidth for any smartphone users. Currently Orange offers the iPhone 4S 16GB for 1,699,000 UGX (Uganda shillings). The current exchange rate for one U.S. dollar (USD) to one Uganda shilling (UGX) is currently $1 USD = 2544 UGX (1 UGX = .0039 USD). Doing the math this means the iPhone 4S is selling for ~$668 USD. That seems like a high premium for an older model. If that's not expensive enough, try the iPhone 5 16GB starting at 2,159,000 UGX, bringing the total to ~$849. That's a steep price tag for an iPhone even by Western standards. It becomes even more expensive when you realize Uganda's GDP per capita is ~$1300 USD. Hence, the iPhone 5's unit cost equals 65% of what the average individual makes per a year in Uganda. Does anyone see a problem here?
Apple loyalist will be quick to say that Uganda is but one of 54 countries in Africa, these figures don't tell the overall tale. Sure, Uganda is just one of 54 countries in Africa. But what's interesting and frightening for Apple in Africa is that Uganda had the 26th highest GDP per capita, meaning there's 28 countries with a lower standard of living.
iPhone 4s 16 GB for 1,699,000/-
iPhone 4s 32 GB for 1,899,000/-
iPhone 4s 64 GB for 1,999,000/-
+ 1 month super combo
iPhone 5 16 GB for 2,159,000/-
iPhone 5 32 GB for 2,599,000/-
+ 1 month super combo
On AAPL's next conference call, it would be interesting to hear their response to any of the following questions:
- How many iPhone units have you sold in Africa and what percentage of them were bought by nationals?
- How many authorized stores do you currently have in Africa?
- At what rate are your margins expanding in the developed world compared to the rate competitors are gaining market share in the third-world?
It's fair to say that Africa is not AAPL's target market. And that's okay. They have found tremendous success and margin expansion in their other markets. Besides, Africa is only the second largest mobile phone market in the world! Currently there are over 650 million mobile phone users in Africa, surpassing the number of users in both the US and Europe. Thanks to Facebook (FB), Google (GOOG), and Twitter, access to search engines and social media has become free and compatible for low-powered phones. A ramification from this is that now over 72% of Africans from age 15-24 have mobile phones. Even in the remotest villages I have traveled to in Africa, cell phone usage was prevalent.
What troubles me in terms of AAPL's need to enter the third-world with more traction is that it will only be harder to do so because of the traction already made by their competitors. Low-powered smart-phones produced by Samsung (OTC:SSNLF) and Nokia (NOK), more affordable dual-sim qwerty phones by China's Tecno (these were growing in popularity while we lived in Africa), and even Blackberry (BBRY) have left little ground for AAPL. In fact, NOK and SSNLF together currently account for more than 50% of the mobile phone market in Africa, mainly through a combination of low-powered, more affordable simple-phones and low-powered smartphones.
What About China?
While AAPL's future growth in China looks more promising compared to Africa, they still have quite the ground to cover. This in part is due to the markup which China Telecom (CHA) made on the new iPhone 5C, which gives it a 27% higher pricepoint that last year's iPhone 5.
This does not bode well for AAPL in the world's largest mobile phone market while competitors account for more market share. To further underscore this point, I believe fellow Seeking Alpha contributor Vincent Ho said it clearly when he wrote (see full article):
Undoubtedly, China will become the key strategic focus over the next several years. A plan certainly follows along with such statements but on balance Apple's presence is still primarily in its home turf of North America with 253 retail outlets there. The iPhone has captured 25% of the market share in the US. In comparison, there are only 11 Apple stores in China which is a very telling figure that its strategy in China is barely getting started. If Cook is honest about making China Apple's largest market look for substantially more investment and Apple stores there in the future.
What About All Those Hedgies Who Hold AAPL?
During the first quarter of 2012, Zero Hedge published an insightful article on how many hedge funds owned Apple at the time. That was well over a year ago and much has changed for AAPL since then. Despite there now being 40% less funds which own AAPL today, one thing, however, hasn't changed and that has been notable fund managers buying AAPL. What's more, the size of their transactions have even increased. During Q2 of 2013, AAPL remained in the top ten holdings of hedge funds with the following notable buys:
- David Einhorn added to his AAPL position in early 2013. The main points in his thesis is that the company in undervalued from a fundamental standpoint, coupled with the hope that AAPL will launch revolutionary products overtime (just as a footnote, Einhorn is one of the managers I follow most as I believe Greenlight runs an great business with lots to learn from).
- During Q2, George Soros opened a new position in AAPL
- Carl Icahn reportedly over a $1 billion position in AAPL
A Further Word on iCahn: Carl Icahn, while a legend in the game, has entered companies with an intent to alter business dynamics, as well as put pressure on boards and executives. In the past, companies which Icahn entered were in jeopardy of going under and honestly did need to be restructured. Icahn has kindly approached AAPL through meetings with CEO Tim Cook and on the surface it would seem he only holds a large position in the company. Don't let this be misleading. While CNBC and other media outlets focus on Icahn's attempt to persuade Tim Cook to do a major share buyback, which obviously would increase the value of AAPL, barely anyone has articulated what Icahn may do if Cook doesn't do this and if Icahn doesn't get his way.
When Icahn hasn't got his way with other companies it turned pretty ugly for a while, during which time the company's share price sometimes suffered until a material decision came to fruition. This presents three questions for the investor:
- Will Icahn take a more aggressive activist approach towards AAPL if they don't initiate a buyback of the volume Icahn is calling for?
- Will Icahn begin simply to close his position over a period of weeks?
- Or, will Icahn simply hold his AAPL position and go his merry way?
History would suggest it's not the last option. As someone who has invested in AAPL before, this presents a troublesome dilemma that doesn't offer a favorable risk/reward relationship.
My overall point in highlighting the differing fund managers who own AAPL is that it is buying which causes a stock price to go up, not selling. The more shares which have been bought and held can increase the probability of shares being sold over time, not re-bought, unless something systemic from an operating standpoint occurs (e.g., change in management) or a defining catalyst (e.g., new product launch). This presents a danger to investors. Take away even a fourth of the hedge fund managers who currently own AAPL and what would that do to the stock price? Not to mention, if sales were to slow or products were to disappoint, what would happen if even more fund managers begin to close their positions coupled with further analyst downgrades? AAPL fanatics of the world will defend AAPL through differing valuations, citing their FCF, EV/EBITDA, tax strategy, and ecosystem. But if those fanatics aren't fund managers in control of large positions, they'll have little effect on how the stock trades and will only continue to buy after a rally, or try and catch a falling knife. After all, as the old saying by Peter Lynch goes, "Dumb money is only dumb when they listen to smart money."
The Hope For Further Revolution
If you have ever watched the YouTube video of Steve Jobs unveiling the original iPhone, you can look back and say that product was truly groundbreaking and brought the onset of an AAPL revolution. Other than that, perhaps only the preceding iPod and subsequent iPad have been a comparable product from AAPL which could be considered groundbreaking. This is to say that iPhone 3G-iPhone 5S were not new products at all, but modifications of an existing product. iPhone 2G and iPad 1 were original, new products and that is what has led the way for AAPL's apparent success in recent years. This is not to say that iPhone 2G's sales haven't be exceeded by subsequent iPhone devices, but the iPhone 2G and iPad 1 were the products which defined a game change in the consumer electronics industry.
This is important to note because this is the fundamental hope in many investors theses: AAPL will continue to rollout industry defining products and do so ahead of all of AAPL's competitors. The inherent assumption in this thesis, however, is not whether AAPL will or won't produce more amazing products; they will. It assumes that future AAPL products will continue to be purchased at the rates with which they have and what the consumer's response will be. This is what made the iPhone truly revolutionary - cell phones with the web are nearly a necessity today. A MacBook, iPad, or Apple TV, are far more discretionary than the iPhone. This simply means that a limit has been formed as to how many AAPL products a consumer will need, will want, and will buy. Thus, it will only be a matter of time before the margins become so compressed due to lowering price points or competitors offer something received more favorably that AAPL's market share will begin to erode to the point of warranting a decision to close a position on AAPL. This is how the market treats companies.
For now I believe AAPL is a tremendous company and can offer a great investment opportunity on the long side in the near-term. At the same time, this next earnings report will be decisive as to how the market views and trades AAPL. I'm expecting them to beat estimates largely due to the reports on their North American 5C sales. These sales will add to AAPL's already enormous stock pile of cash which forms a great base for AAPL's value. Regardless, the reality is that eventually AAPL may begin to lose market share as fast as they've obtained it. At this, bullish AAPL analysts will herald success at any year over year growth rates in emerging economies, while failing to mention AAPL's competitor's success. After all, any sales, however large or small, in a market where you previously were not or have just entered will constitute growth. Over time, my concerns here leads me to be bearish on the stock. Therefore, at the right time, when the aforementioned points become evident, don't be afraid to short AAPL, even if it's against the herd.