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Summary

  • Apple has attracted bearish sentiment from value-oriented investors.
  • The bearish case assumes declining market share and product cannibalization amid the looming iPhone 6 launch. This thesis is a misguided rationale for shorting shares of Apple stock.
  • Apple shares are still priced to generate long-term alpha returns.

On June 9, 2014, Michael Blair's "I Was Wrong About Apple" was posted on Seeking Alpha. The title of the article did suggest a comeuppance, or a humbling Come to Jesus moment from Mr. Blair, who had admitted to maintaining a short position in Apple (NASDAQ:AAPL) "for well over one year." Over the past year, Apple stock has rocketed from an approximate, split-adjusted $55 toward $92 per share. Michael Blair, of course, has also been responsible for making good on larger dividend payments throughout this time frame. From this angle, we may only speculate that Blair's short Apple positions were part of a relatively minor hedging strategy within a much larger portfolio. If not, Michael Blair's take toward Apple may have already proven to be disastrous, financially.

Apparently, Blair took the opportunity to double down on his short position in conjunction with his latest "I Was Wrong About Apple" article. Michael Blair was to revise his price target downward from $450 ($64.29 split-adjusted) to "less than" $300 ($42.86 split-adjusted) per share. At the time, Blair's hecklers did concede that the lowly price targets would only be nominally realized after Apple's then looming seven-for-one stock split.

In any event, Michael Blair has emerged as the Seeking Alpha face leading the charge against Apple, due to his dogged determination. Misguided Apple bears, or haters, have highlighted declining market share statistics alongside prospects for product cannibalization out of the iPhone 6 in support of their economic thesis. Basic arithmetic, of course, may expose the Apple bears as walking contradictions. Do not short Apple stock. If anything, Apple shares still deserve a buy rating.

Apple is Still Best-of-Breed

A 2012 article written by Dana Mattioli for The Wall Street Journal compiled information from numerous sources to set parameters for the Apple demographic. Online travel agency Orbitz Worldwide (NYSE:OWW) had already claimed that Mac owners spent 30% more on overnight accommodations than their Windows-proficient counterparts. Orbitz went on to also conclude that Mac users were 40% more likely to book four- or five-star hotel rooms than were Windows PC owners. Mattioli supported the Orbitz report with statistics out of Forrester Research that calculated $98,560 in average household income for Mac owners. For the sake of comparison, Forrester estimated $74,452 in household income for PC owners.

In effect, Apple has emerged as a luxury and lifestyle brand. As such, aspiring consumers will happily pay premium prices to showcase Apple câché. Over the past five years, Apple has averaged 40.1% gross margins. Apple also closed out its latest fiscal year having pocketed a fat 30.6% return on equity. At current levels, Wall Street traders have applied an approximate $550 billion market capitalization price tag to the Apple business model. Apple is therefore trading for a relatively cheap fourteen times current earnings, if the consumer electronics company were to close out fiscal 2014 having generated $40 billion in net income. For the sake of comparison, Amazon (NASDAQ:AMZN) shares have priced out at above 500 times earnings over the course of the past year.

As a luxury brand, Apple will maintain pricing power at the same time that cost of goods sold is being reduced. Tim Cook, operations man, has been able to leverage Apple's immense buying power to play suppliers off each other. Teardown reports out of research operative IHS Technology may confirm that Apple has aggressively worked to drive down costs for component parts shared between the iPhone and iPad platforms. IHS Technology recently turned in bill of materials and manufacturing cost estimates of a mere $198.70 for the 16GB iPhone 5S that retails for $649.00. From there, Apple only paid an additional $19.60 to supply the bolt-on storage for the 64GB 5S that retails for $849.00. In many regards, the Apple story has far outpaced the fanaticism for Nike (NYSE:NKE) Air Jordan shoes. Each successive iPhone launch will remain a highly anticipated event for well-heeled consumers and the hipster set.

Deconstructing Market Share Data

2010

2011

2012

2013

Q2 2013

Q2 2014

Apple Revenue

$65.2B

$108.2B

$156.5B

$170.9B

$43.6B

$45.6B

iPhone Revenue

$25.2B

$46.0B

$78.7B

$91.3B

$23.0B

$26.1B

iPhone Unit Sales

40.0M

72.3M

125.0M

150.3M

37.4M

43.7M

iPhone Revenue Per Unit Sold

$630.00

$636.24

$629.60

$607.45

$614.97

$597.25

iPhone Percentage of Apple Revenue

38.7%

42.5%

50.3%

53.4%

52.8%

57.2%

Source: Apple Investor Relations - SEC Filings

On April 24, 2014, Apple filed its second quarterly report for fiscal 2014 with the Securities and Exchange Commission. Be advised that Apple's second quarterly period of fiscal 2014 ended on March 29, 2014. During this latest quarter, the iPhone generated $26.1 billion, or 57.2% of Apple's $45.6 billion in total net sales. For the sake of comparison, the iPhone accounted for $1.8 billion, or 5.7% of Apple's $32.5 billion in fiscal 2008 revenue. That year, the iPod and Mac delivered a respective $9.2 billion and $14.3 billion in sales to the Apple top line. Over time, the iPhone emerged as the primary gateway into Apple's leading ecosystem for computing, telecommunications and entertainment.

Seasoned Seeking Alpha contributor Michael Blair, of course, has seized upon any alleged weakness within the iPhone line to go on the attack against the Apple Empire, at large. The Blair Protocol, however, has dismissed the importance of return on equity amid a particular reverence for nominal market share statistics. A brief review of Michael Blair's Seeking Alpha submissions may confirm the idea that this retired executive is banking upon gains in Android, Windows and BlackBerry market share to materialize largely at Apple's expense. Firstly, these apparent gains in rival market share have failed to materialize throughout the industrialized world. Secondly, the Blair Doctrine and the "I Was Wrong About Apple" article have unwittingly exposed the bait-and-switch tactics of relatively marginal mobile players. Google (GOOG, GOOGL), Amazon and Microsoft (NASDAQ:MSFT) are all notable for literally giving away product at cost, in order to drive traffic towards higher margin businesses.

On June 4, 2014, research firm comScore published its April 2014 U.S. Smartphone Subscriber Market Share report. Be advised that the title of the report was somewhat misleading, as comScore statisticians actually presented averages of data taken from the quarter spanning between February 2014 and March 2014. Apple closed out this February-March quarter with 41.4% shares of both the U.S. smartphone original equipment manufacturer and operating system markets. Despite the warnings out of the Michael Blair camp, Apple lost only 20 basis points in share off both markets through this latest quarter. Meanwhile, BlackBerry (NASDAQ:BBRY) and Microsoft combined to carry a meager 5.8% of the U.S. smartphone subscriber market. Again, the Blair Doctrine had already made the assumption that BlackBerry and Microsoft were set to steal share away from Apple.

For his efforts, Michael Blair has played up reports of relatively weak Apple results throughout Brazil, Russia, India and China (BRICs), alongside various other emerging market regimes. Again, nominal market share statistics are somewhat misleading. Most likely, Apple executives would be willing to concede defeat within the developing world, in order to maintain fat gross margins approaching 40% throughout the business. Last month, the beleaguered BlackBerry brought its Z3 handset to the Indonesian market. Prior to that event, BlackBerry negotiated a deal with contract manufacturer Foxconn for the Taiwanese company to design hardware and manage inventory. This cost-cutting arrangement will further help BlackBerry supply cheap product to the global marketplace. Misguided Apple bears have somehow managed to juxtapose prime aged beef at the finest downtown steakhouse against a $2 extra-value meal from McDonald's (NYSE:MCD).

The iPhone 6 and Product Cannibalization

2010

2011

2012

2013

Q2 2013

Q2 2014

Apple Revenue

$65.2B

$108.2B

$156.5B

$170.9B

$43.6B

$45.6B

iPad Revenue

$5.0B

$19.2B

$30.9B

$32.0B

$8.7B

$7.6B

iPad Unit Sales

7.5M

32.9M

58.3M

71.0M

19.5M

16.4M

iPad Revenue Per Unit Sold

$666.67

$583.59

$530.02

$450.70

$446.15

$463.41

iPad Percentage of Apple Revenue

7.7%

17.7%

19.7%

18.7%

20.0%

16.7%

Source: Apple Investor Relations - SEC Filings

The term "phablet" takes its name from the fact that these machines bridge the technical gaps between traditional smartphones and tablets. Online technology magazine Pocket Lint identified the Nokia Lumia 1520 and Samsung Galaxy Note 3 as the best phablets on the market heading into 2014. For now, the Samsung Galaxy Note 3 represents the gold standard of the phablet movement. The Galaxy Note 3 weighs in at 168 grams, and stands 6 inches tall by 3.1 inches wide. Perhaps most importantly, the Samsung Galaxy Note 3 features a 5.7-inch screen that presents graphics in 1080 X 1920-pixel resolution. For the sake of comparison, the Apple iPad Mini with Retina display features a 7.9-inch screen that presents graphics in 2048 X 1536-pixel resolution. The typical tablet consumer may be in the market for the 32GB iPad Mini with Retina display and Wi-Fi connectivity that retails for $499.00.

The iPhone 6 will be somewhat of an extension of the 5S/5C release, where two separate handsets were largely differentiated from each other according to price and specifications. Alternatively, the iPhone 6 will call attention to the matter of size. Numerous technology outlets have speculated that the looming iPhone 6 launch will separate into two separate 4.7 and 5.5-inch screen handset wings. In terms of size, the 5.5-inch iPhone 6 would fall just within phablet territory, as defined by research firm International Data Corporation. Both IDC and Michael Blair have suggested that the phablet movement will ultimately erode tablet sales growth. On May 29, 2014, IDC actually revised its year-over-year tablet unit sales growth rate estimate downward from 19.1% to 12.1%. In all, IDC has projected 245.4 million units in tablet shipments for 2014. Be further advised that the tablet market is coming off torrid 51.8% year-over-year growth through 2013. IDC has cited the shift toward larger smartphone screens in conjunction with slower inventory turnover rates as rationale for its lowered tablet sales estimates.

Bears, however, must recognize the idea that product cannibalization is oft encouraged and the order of the day at Apple. Again, the iPod racked up $9.2 billion, or 28.2% of Apple's $32.5 billion in 2008 total net sales. By 2013, the iPod accounted for a mere $4.4 billion, or 2.6% of $170.9 billion in total net sales. The iPhone and iPad, which may both convert into music players, have literally rendered the iPod obsolete. Be further advised that the iTunes, software and services operating segment has held steady to contribute roughly 10% of annual total net sales over the course of the past several years. Diehard Apple consumers, or fanboys, have refused to vacate the iOS ecosystem. As such, Apple will remain poised to carry on its trajectory of cannibalizing its own product, while still generating growth, in the aftermath of the iPhone 6 launch event.

The Bottom Line

Michael Blair's arguments may carry more weight if he were to have proposed a short for the entire Web 2.0 complex. The possibility does exist for the likes of overvalued Facebook (NASDAQ:FB), Twitter (NYSE:TWTR), Amazon and Pandora (NYSE:P) shares to take down Apple stock through contagion and a Black Swan event. Web 2.0 stock market investments have remained an obvious haven for speculative capital amid the current zero-rate regime. Online retailer Amazon now trades for a pricey 515 times estimated earnings. Blair, however, has apparently remained long in BlackBerry, Hewlett-Packard (NYSE:HPQ) and Intel (NASDAQ:INTC) shares, while doubling down upon his short position in Apple. Although his puts may be deeply out-of-the-money, it is somewhat endearing that Michael Blair appears committed to the belief that Windows and Android ecosystems would deliver some type of deathblow to Apple. Going forward, however, long-term investors may be best served to turn a blind eye toward the Apple bear camp, at-large.

Apple closed out its latest Q2 2014 books with $150.6 billion in cash and securities above $85.8 billion in total liabilities on the balance sheet. The $85.8 billion in liabilities did include $8.3 billion in deferred revenue and $17 billion in long-term debt. The $8.3 billion in deferred revenue will ultimately be removed as a liability and recognized upon the income statement. The $17 billion in long-term debt actually appeared as part of a plan to return more than $130 billion back to shareholders through stock buybacks and dividends by the end of calendar 2015.

Last February, The Wall Street Journal reported that Apple spent $14 billion to buy back its own stock in the aftermath of disappointing financial results released on January 28. On this date, Apple stock last traded hands at a split-adjusted $71.53 per share. Tim Cook then exploited the short-term decline in shares to get "aggressive" and load up on outstanding stock at bargain bin prices. Going forward, the built-in Tim Cook put will remain far above Michael Blair's recommended $42.86 Apple price target. Opposed to Michael Blair, both Tim Cook and billionaire investor Carl Icahn may agree to describe any decision to load up upon Apple shares as a "no-brainer."

Source: An Open Call To Apple Bears For Debate