After spending the better part of yesterday digging deeply into Samsung's (OTC:SSNLF) analyst day materials, it has become clear to me that Apple (AAPL), over the long haul, stands very little chance against the Samsung behemoth. While Apple's products truly are wonderful, and while its engineering prowess is certainly very impressive, it's clear that Samsung will brute-force its way into taking more and more marketshare from Apple at the high end while at the same time will enjoy key structural advantages in the low end that Apple would - at least in its present form - not be able to match.
Apple needs to start getting much more aggressive if it is to survive and thrive against the Samsung assault and it needs to move quickly.
Samsing Owns Nearly The Entire Smartphone/Tablet Bill Of Materials
Samsung builds the following:
- Apps processors (it even builds them for Apple)
On the other hand, Apple relies on third parties for just about every one of these. In fact, while Apple has been attempting to move away from dependence on Samsung for many of these components, it has been one of the key enablers of Samsung's semiconductor manufacturing strength. When you're building the apps porcessors (as well as potentially modems) for every iPhone and iPad, then that's going to help drive reinvestment.
Samsung, of course, leverages this great cost structure to not only flood the very high growth low end market with smartphones, but it also pushes the envelope at the high end at prices that match (or even undercut) what Apple provides. Let me show you an example.
Galaxy Note III versus iPhone 5S - An Example
The most obvious comparison is the Galaxy Note III versus the iPhone 5S. For $299 with a contract, Samsung sells users the following:
- 5.7" 1920x1080 display
- 3GB of RAM
- Either Snapdragon 800 or Exynos 5 Octa SoC
- 32GB of storage
Apple, on the other hand, gives you the following for $299 on contract:
- 4" 1136x640 display
- 1GB of RAM
- Apple A7 SoC
- 32GB of storage
Now, thanks to the superiority (to many customers, anyway) of iOS and the power of the Apple brand, Apple can get away with offering "less" hardware for the same price, but just how much longer can this last?
It's clear that in order to preserve its margin structure, Apple could not, say, offer 2GB of RAM to go with its new flagship (and moving to 64-bit - which leads to a 20-30% increased memory footprint - without increasing the RAM size seems to be indicative of this). But Samsung has no problems sticking in 3GB of RAM and calling it a day since it produces its own DRAM.
The same thing on the display side of things. Since Samsung builds its own displays, it can not only invest in next generation display technology to gain an edge on competitors, but it can also afford to put such displays in the devices that it sells at very attractive cost structures. Apple, on the other hand, needs to pay somebody else's margins for its displays, which is why it's not as aggressive on the display front on smartphones as its competitors are.
Finally, Apple has to pay for the fabrication of its applications processor. In fact, it pays this margin to Samsung. Samsung, on the other hand, builds many of the applications processors that it uses in smartphones (although not all as Samsung uses plenty of Qualcomm (QCOM) silicon built at TSMC (TSM) - for now. This will likely change as Samsung does more silicon in-house)
What Can Apple Do?
Apple needs to stop wasting money on buybacks when there is still plenty of growth ahead. It should use this money, in no particular order, to do the following:
- Buy Micron (MU) so that it will have DRAM and NAND sourced in-house, thereby significantly improving its cost structure. This not only benefits the phones, but the Macs, too. Apple can also make a mint actually selling DRAM to the other players. Apple also gets NAND flash with such a deal, which will only continue to become more important going forward
- Buy a semiconductor logic foundry. It's clear that Apple has the volumes to sustain a leading-edge semiconductor foundry, and if it wants to really improve its cost structure here, owning a semiconductor foundry and funding the development of world-class semiconductor manufacturing technology is probably the way to go. I am sure Mubadala is just itching to get Global Foundries off of its hands, so perhaps either a full ownership of that company - or a big fat equity stake - would be the way to go there.
- Bring display manufacturing in-house. Apple should either outright buy a company that can build its device displays for it (again, Apple has very nice scale with iPhone, iPad, and Mac), or it should make a very big equity investment in such a firm. Sharp Corporation would only cost Apple ~$5b (assuming a 40% premium to current market price)
So, how much would it cost for Apple to do all of this? Well, buying Sharp would probably cost the company about $5B, Micron would probably cost $30B (slightly over 50% premium to current price), and buying Global Foundries may cost at most $20B. All in all, we're looking at a shopping spree of about $55B. While this is certainly not a trivial amount of money, it'd all be a much more effective way to create shareholder value than an the absolutely insane (I mean this as negatively as possible) $150B buyback that Icahn is trying to push management into pursuing. I get that Icahn wants quick returns today, but Apple needs to focus on delivering long-term value. Buying back stock when there's another leg of growth to be had is simply foolish.
In fact, Apple should probably issue stock to do most of these deals. Yeah, it dilutes the shareholders, but so what? If Apple can successfully integrate these acquisitions, then they should eventually drive meaningful top and bottom line growth and the share price could be at well over $1000 as it would be in a position to take back significant share from Samsung and own the majority of the smartphone space.
Will Apple do this? Probably not, but the point is that Apple needs to drive the next leg of its growth, and it needs to do so by becoming much more like Samsung (and beating it at its own game thanks to its own advantages). Samsung, at its analyst day, says that it sees a path to $400B in revenues by 2020. Apple needs to be able to see the same or this stock will be dead money at best and set to decline substantially at worst.