Let me preface my remarks here by coming clean about my past views on Apple (AAPL). In the last year or so I penned a number of bullish pieces on the Cupertino giant because I believed the growth expectations from analysts. I believed that innovation wasn't dead at Apple. I believed that the company could continue to be great without Steve Jobs. I'm here now saying none of those things came true and that Apple is in serious trouble.
The much ballyhooed event that occurred earlier this week was supposed to be something of a game changer for Apple. Instead, what we got was more incremental improvements in its existing product lines. Yes there was a new OS, yes the iPad Air is neat and yes the retina display on the Mini looks great. However, none of these things address the concerns I (and other investors) have regarding Apple's long term future. How long can it continue to sell the same devices year after year? How long will people settle for the same products that have existed in virtually their current forms for years? The answer, if market share is any indication, is not long.
In 2011, Apple had something like 65% of tablet market share. Last year, that number dropped to 54% and this year, Gartner expects Apple to be below 50%. Before you point out that one company owning 50% of a market the size of tablets is still amazing, you're right, it is. However, the amount of customers voting with their feet and buying Android is staggering. Where is the bottom in terms of market share for Apple? We don't know but this looks a little like BlackBerry (BBRY) did several years ago; "Yeah we're losing market share, but so what?" could probably be heard in the halls of the corporate campus of BBRY in years past. The fact is there are far too many very good competitors for Apple to maintain a 50% market share over the long term in my view and it looks like we'll see the market share number continue to fall as Apple clearly has no intention of innovating in the space any more. Making an existing product lighter is great but it's no reason to run out and buy one (not to mention the ridiculous premium one is charged for the Air model). Where are the new features that blow our collective minds? I don't see them in new iterations of the iPad and I think it's because Apple is out of ideas.
The company also came out with the retina display for iPad Mini, which, again, is great (and 100% telegraphed prior to the event) but it's no reason to run out and buy an iPad that you weren't already planning to buy. There were also the usual processing power and battery life upgrades but all of these things are evolutionary, not revolutionary, and we've seen it all before. I don't think Jobs would have settled for this long with Apple's current product lineup and incremental change after incremental change. Maybe we're all too spoiled by Apple's rise from a nearly defunct computer manufacturer to the largest company in the country but there is nothing to be impressed by anymore.
Perhaps even more disturbing, Apple cut prices on a version of its iPad Mini. This coming from the company that historically discounts sparingly and is notoriously strict with its retail partners in terms of ensuring the premium for Apple products is respected. Apple's margins have been falling for several quarters now due to a confluence of factors including lower ASPs and lower sales. In fact, for the first time ever, Apple sold fewer iPads in the June quarter this year than last year. The point is that the lack of innovation is catching up to the company's operating results and shareholders should be concerned.
When Apple has tried something new, the iPhone 5C, for instance, it hasn't worked. Yes, the 5S is apparently selling like hotcakes in relation to the C but I suspect Apple only had to raise its builds for the S because it was cannibalizing C sales. And besides, the C is just another iteration of the iPhone; it once again isn't innovative or disruptive, it simply seeks to compete in a slightly different way. I acknowledge the formula Apple has worked with for years has succeeded like no other and made it the largest company in the country. However, tech companies, particularly hardware suppliers like Apple, always have to innovate or they will go by the wayside eventually. Is Apple the next BBRY or Nokia (NOK)? Maybe, time will tell. But the company is well on its way with its lack of innovation and new products.
With EPS expected to have fallen a whopping 11% for fiscal 2013 to just under $40 per share, Apple shareholders experienced a violent revaluation of shares in the past year or so. This company went from constantly destroying estimates to suddenly missing them and then to declining earnings. Given Apple's inability to gain traction with the 5C and the marginal changes to the entirety of the iPad lines, I just don't see how the company will be able to post the 10% earnings growth that is expected for next year. You have a company with declining margins, falling ASPs, a stale product line and its competitors taking market share in tablets and phones every day. Where is the growth coming from? With iPad sales numbers declining YoY and the iPhone 5C clearly a bust, I suspect there is decent downside risk to analyst estimates at this point. Even if Apple can somehow manage to hit its revenue estimates, margins are declining so rapidly that EPS would likely still be light.
Apple looks cheap at only 12 times next year's earnings. In fact, 12 times earnings for a company with a declining customer base, declining margins and no catalyst for growth in the near to medium term is probably too generous. The fact is Apple gets the vast majority of its revenue when it sells a device; it doesn't have the luxury of a recurring revenue stream like Oracle (ORCL) or IBM (IBM), which, by the way, sell for only 10 and 9 times next year's earnings, respectively.
If you were fortunate enough to own Apple over the past three months you should take what the market has given you and get out. With declining market share, falling margins and no catalysts on the horizon, I think Apple could (and should) trade down to a multiple of 9 or 10. And given that I think there is a decent possibility for an earnings miss on next year's $43+ EPS estimate, fair value for Apple is likely in the $380 to $420 range based on $42 in FY2014 EPS and my PE range of 9 to 10. That is a long way down from where we are now (shares saw $700 last September and by April, were languishing below $400, so it could happen) but Apple is currently receiving a multiple it doesn't deserve and I think that the company will struggle to reach $43 in EPS next year without some kind of transformational new product. But given that Apple clearly has no imagination left whatsoever, I'm not holding my breath.