While reading David Nelson's article on the slowing of Apple (NASDAQ:AAPL) growth, I felt a sense of déjà vu. I had written an article several years ago discussing how Apple's next ten years could not possibly duplicate its prior ten years. And in that article, I linked to an even earlier article pointing out that:
Apple's miraculous movement from 1997 to the present involved a movement from non-profitability to profitability. Margins improved by an order of magnitude. These are changes that can't happen twice.
So, the "news" that Apple can't repeat some of the most significant elements of its meteoric rise – the increase in the ranking of its now world-recognized brand into the very top tier, for example – is not news at all. And everybody knows that doubling a $300B company is a different problem than doubling a $300M company. What's wrong with the easy conclusion that Apple's goose is cooked? Easy, right?
However, I reached a completely different conclusion. Apple's growth hasn't saturated its opportunity in the global market for phone handsets (and Tim Cook has made clear it views its long-term market as the handset market, not a high-end niche within the broader handset market). Or for that matter its opportunity in the PC market (where Apple has just hit double-digit share in the US, and just cracked the top-5 vendor list in Europe without hitting double digits). And Apple's growth has only given it a margins advantage.
As I wrote a while back when discussing the relative moats of Dell (NASDAQ:DELL) and Wal-Mart (NYSE:WMT), Apple doesn't take share by paying for it (as Dell, a commodity vendor, does by lowering its profits). It uses growth to improve its operating efficiencies and to become even more capable of delivering more for less at higher profit.
Yes, Apple has historically sold high-margin products at a premium price. However, as discussed in this old piece, Apple's advantages in intellectual property and in operational execution have driven its profit higher even as it has been able to cut prices. (Four years ago, for example, Computerworld finally described Apple's hardware pricing as "on par" with that of other PC manufacturers, and expressed surprise that some major manufacturers were unable to match some of Apple's premium features, and that PCs upgraded to comparison with Apple SKUs could look shockingly overpriced.)
And Apple hasn't squandered its advantages. Apple now earns more profit in mobile handsets than its entire field of competitors combined. It's outgrown Lenovo in its home market of China, and as it's bucked bearish trends to grow share in declining markets. In China, Europe, and other geographies in which Apple has but a slim share of the PC market, Apple's margins advantage places it in position to take the lion's share of profit to be had as these markets grow and mature. The 300 million middle-class Chinese admire the Apple brand like no other, and Apple has only a couple of storefronts in the country. And China is a growth market. By the way, the Chinese buy phones, too.
But ahh, you say, Apple is out of new tricks. It's played its hand and is just spending the rest of its years pulling its one win off the table. This is, of course, not a new argument. We heard it when the iMac profit was no longer a surprise. We heard it when the iPod profit was no longer a surprise. We heard it when Apple's global leadership in notebooks was no longer a surprise. We have heard that Apple's one trick is no longer news so many times that it has honestly become tiresome.
I'm no great fan of Wal-Mart, but think for a moment about its market power and what it's like to compete against it. As Apple's CPU and handset businesses have scaled, Apple has demonstrated enormous market power. Heck, even before then: When Jobs pre-bought a bunch of air shipping capacity for the holiday season so far in advance it got preferential pricing, and Apple really didn't have tens of millions to lose because the iMac was new and Apple had just returned to profitability, Apple was the only vendor that could deliver custom-configured machines to late-shopping customers in time for the holidays. By that time, nobody in the air shipping business had space left to sell because Apple had bought it all at discount.
Apple then invested hundreds of millions in Samsung's LCD plants. Its competitors spent a few years having to make do with displays it had rejected. Then Apple pre-bought Flash storage – with a 10-figure prepayment – and competitors weren't able to build hardware at demanded rates because Apple had pre-bought the production.
In other words, Apple's ability to do interesting things to create operational efficiencies and exploit opportunities has dramatically increased with its means. It's been suggested that nobody outside Apple can guess what innovation lies in store, but that's not entirely true. We can look at what Apple is doing and imagine very well what kinds of things Apple could do to create value.
Since Apple has $80B-plus in cash (more than Visa's entire market cap), it has flexibility to do things with parts sourcing and infrastructure development that most competitors are simply unable to match. And what opportunity it faces. Apple's transaction volume – it runs one of the most effective retail operations on the planet plus a multibillion-dollar online sales empire encompassing the largest software applications market and the world's largest music store – places it in a strong position to operate as a transaction processor itself, thus improving margins in every business segment that processes charges through third-party payment systems (charge cards, debit cards, etc.).
With the quantity of Apple devices multiplying and Apple viewing the whole handset market as its lawful prey, Apple is in a position to roll out a vertically integrated payment system that bypasses costly intermediaries ... then to roll it out as a product in markets in which there is no mature payment processing infrastructure. Where payment infrastructures do exist, Apple will presumably compete in wireless payments. Apple can do all this without the huge cash outlay required to buy Visa, simply by routing around Visa where possible and relying on Visa (or Mastercard) to fill gaps wherever convenient. You didn't think that data center in North Carolina was really needed to stream music, did you?
Now, back to that thesis about the decelerating sales. A strong argument can be made based on new carrier deals in foreign markets where Apple's brand is strong that Apple's iPhone growth is way, way far to the left of the curve globally and has lots of time before it's fighting uphill to grow. Moreover, Apple's infrastructure investment appears to telegraph an expectation of 100% growth in iOS devices in 2012. 100% growth isn't what I'd call slow growth. It's what I'd call robust but plausible growth over the near term.
Of course, some of Apple's infrastructure investment may be intended for some strategic project other than supporting iOS – improving its ad business, competing with Google on search, building a transaction processing infrastructire to improve margins across all business lines – but none of them smell of the decay of an old, built-out business trying to keep the lights on by burning cash.
It's always useful to remind one's self that past performance is no guarantee of future results. However, it's also worth reminding one's self that you can't profit from outstanding investments with a strong thesis if you are too fearful to recognize opportunity. The fact that the "Apple is done with its growth phase" meme is so contagious is exactly why Apple is plausibly mispriced: it's got the PE of a company that's not about to double its biggest business line, because everybody in the US (and sees only other US consumers) thinks everyone on the planet has already bought an Apple product (and won't replace it next year or buy another).
Invest as you will, but as for me and my shares, we will stay right where we are for now.