What Tim Cook Must Do To Turn Apple Around, 2013 Vs. 2016

| About: Apple Inc. (AAPL)

Summary

Apple's share price appears to have fallen into another trough reminiscent of mid-2013.

Apple needs to convince investors that it has a future beyond iPhone.

Providing enterprise-class cloud services to its developer base could open up a huge recurring revenue stream while reassuring investors.

Back in May 2013, when Apple (NASDAQ:AAPL) was in a trough in its share price, I wrote an article titled, What Tim Cook Must Do To Turn Apple Around. At the time, many Apple fans questioned the very need for a turnaround, but a turnaround in the share price was much desired by Apple investors. Today, Apple investors face a similar situation in terms of share price and market sentiment regarding Apple. In this article, I'll revisit the recommendations I made then, as well as offer new ones that I believe would enhance growth and restore investor confidence.

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Source: Google Finance

A Trip to the Recent Past

In the April-June 2013 time frame, Apple's share price reached lows of split adjusted prices around $56/share, as the chart above shows.

It's not even clear that we've reached the bottom currently, but the recent performance of the stock demonstrates that market sentiment has turned somewhat against Apple. The experience in 2013 shows how disconnected market sentiment can become from reality.

In 2013, the negative perception of Apple was largely driven by Microsoft's (NASDAQ:MSFT) release of Windows 8 and Windows Phone 8 in the fall of 2012. These were supposed to kindle the rebirth of Windows and create new markets for Windows based tablets and phones. And, of course, Apple would bear the brunt of this new reassertion of Windows dominance. Combined with this was the belief that the commodity PC model would triumph once again, and Apple would be thrust back into its proper status as a niche player.

It took Mr. Market the better part of 2013 and 2014 to figure out that wasn't going to happen, but the dream of Wintel dominance just will not die. It has been resuscitated anew by Windows 10 and fueled by assertions of Peak iPhone and the imminent decline of Apple.

Not All Perception

I wanted to point out this recent history because I find that business and technology writers are not particularly good when it comes to history. My point is simply that market valuation is based on market perception, and Apple's current valuation is based very much on the market's current perception of Apple.

I wouldn't say that the perception is completely off base. Apple's revenue growth clearly slowed in the December quarter and looks to go negative for the March quarter, based on slowing sales of iPhone. I think the perception that Apple is too dependent on iPhone has some validity.

Whether we've seen Peak iPhone or not, there will be a peak eventually. All products go through a sales trajectory, and iPhone will be no different. There's still a great deal that Apple can do to forestall that peak, but Apple also needs to evolve its business model into one that is more services oriented. My new recommendation revolves around this. But before I go into the new recommendation, let me revisit what I recommended in 2013. My views have evolved since then, and Apple has evolved as well.

Market Share Importance

Back in 2013, I was a lot more concerned about market share than I'm now. I had a lot of arguments with fans who claimed that Apple didn't care about market share. Apple's management has been a little inconsistent on the issue. When an Apple product such as iPhone was gaining market share, management was only too happy to tout this fact. When market share falls, management tends to fall back on "we just want to build the best device."

Sometimes we get both messages in the same conference call, as we did this week. CEO Tim Cook fell back on the "We just want to build the best device message" for iPhone, but CFO Luca Maestri also touted iPad's 85% market share in the U.S. for tablets above $200.

Market share is about new sales share as opposed to usage share - share of current users. Apple announced on the December quarter conference call that it had reached a milestone of 1 billion current users of all its various platforms. But market share is important in order to ensure that the user base continues to grow.

Apple hasn't been doing all that badly in terms of market share, especially in calendar 2015. IDC's most recent report for calendar 2015 Q4 confirms that Apple gained market share in 2015, even when all the white box Android devices that IDC counts are included.

I prefer to exclude white box Android devices since they don't really contribute to Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) bottom line in any meaningful way. In the chart below, I show Apple's share of the top five smartphone vendors on a quarterly basis using IDC data.

Unit shipment growth slowed for Apple in calendar Q4 as Samsung (OTC:SSNLF) and Huawei easily outgrew Apple in unit shipments, as the chart below shows.

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When you look at Samsung's December quarter earnings report, it's obvious how Samsung was able to grow unit deliveries y/y. Samsung's smartphone revenue actually declined by 4% even as unit shipments were up by 14%. Samsung cut prices and sold more phones.

Giving Back to Consumers

Which brings me to my fundamental recommendation that I made in 2013 and reiterate today: compete on price. This is not a recommendation that Apple cheapen its products or do anything different in product design. This is about giving back some profit to consumers.

I agree that it's cool that Apple takes 94% of the smartphone industry's profit, but does Apple really need to do that? Is Apple's current cash pile of $215.7 billion not big enough?

It's already gotten to the point that Apple can't find anything to buy or invest in beyond what it's already doing, and Apple can't even give most of the money back to investors since it's sitting offshore.

The most productive thing that Apple can do with its current profitability is give consumers a break in pricing. It's a win-win for consumers and Apple. Consumers, especially in emerging markets, get to enjoy Apple quality at more affordable price points, and Apple gains market share and an enlarged user base.

I acknowledge that accepting lower margins would not be popular with investors in the near term. It never has been. But Apple can certainly afford to give up some operating margin, which stood at almost 32% in the December quarter.

Recommendations Heeded

My other recommendations from 2013 have been acted upon by Apple to varying degrees. I recommended that Apple double R&D spending. It almost has doubled, increasing from $1.33 billion in calendar 2013 Q4 to $2.404 billion for the December quarter. Here's my new R&D recommendation: double it again. That would bring Apple's R&D spending more or less in line with its competitors.

In 2013, I recommended that Apple diversify the iOS and Mac OS product lines. Apple has done this, and it's been hugely successful for the company, especially in terms of offering consumers reasonable choices in iPhone screen size.

Apple should continue to diversify the iPhone product with a small screen iPhone. But please, not a regurgitated iPhone 5s. Apple should offer its new generation iPhone 7 phones in three screen sizes. They should all be identical in basic design, and they should all be new phones.

Apple also needs to better leverage the superiority of its ARM processor technology. Apple may make the fastest smartphone on the planet, but it's not readily apparent to consumers at the store counter. Apple missed an opportunity to bring iOS multitasking to the iPhone 6s Plus. iOS multitasking features such as slide over and split screen could have been implemented in the 6s Plus and would have provided consumers with a tangible discriminator against other smartphones. Hopefully, this oversight will be corrected for iPhone 7.

Apple still has much work to do on the Mac. Apple should provide touch screen capability for Mac OS X. If Apple is trying to keep iPad from being cannibalized by touch screen Macs, it isn't working. The cannibalization is simply being performed by Windows tablets and 2-in-1s.

Yeah, I agree that touch capable operating systems like Windows 10 represent a compromise. But Apple could still do a much better job of it than Microsoft. And there are many creative professionals who want to use a touch screen with professional software packages such as Adobe Creative Cloud. Right now, those pros have nowhere to turn except Microsoft.

Finally, I recommended that Apple take some risks. It certainly has, with the Beats acquisition and Apple Music, even the latest Apple TV. My latest recommendation: take some more and bigger.

The New Recommendation

To add to the old recommendations, I have just one central new one. Apple pointed to its cloud services as an important revenue stream in its latest earnings release. I was glad to see Apple put that in front of investors.

However, there's one huge gap in Apple's cloud services picture, and that's enterprise cloud services.

The closest that Apple comes to this is some cloud services that Apple offers iOS developers in the form of APIs called CloudKit. CloudKit allows developers to build cloud-based databases which would reside in Apple's cloud servers. Cloudkit apps have the ability to access these data bases.

It's a useful capability, but it's a small subset of the types of enterprise cloud services being offered by the major providers such as Microsoft, Amazon (NASDAQ:AMZN) and Alphabet. Ultimately, all cloud services revolve around server side programming in various forms. Think of this as apps that run on the cloud server rather than the user's device. Typically, these cloud side apps interact with the user's device through a browser or special purpose app. These cloud side apps power everything from Netflix to Google search.

Apple probably could never hope to compete with the big cloud providers, but it could provide server side programming to its sizable developer base who would undoubtedly find useful ways to incorporate this capability into their apps. Ultimately, this would make iOS apps more useful by allowing developers to offload more tasks to cloud-based computation.

If Apple enabled developers to build apps that would run as a service on Apple cloud servers, it would create a recurring revenue stream for Apple based on enterprise (developer) customers. And Apple could even get some more mileage out of Swift by using it as the basis for the server side programming language.

Investor Takeaway

I'm not overly concerned about Peak iPhone, but I acknowledge that the day will come, and Apple needs to be ready for it. Beyond diversifying its hardware product line, Apple needs to diversify its revenue sources.

I'm convinced that enterprise cloud services of the type I describe above are a huge opportunity for Apple. Apple has tremendous infrastructure and expertise that it can bring to bear on the cloud services problem. Apple just needs to put that capability at the service of developers so that they can develop server-side programs to augment their client side apps.

Many of Apple's existing cloud services such as iCloud drive and Siri already play that role of augmenting apps at the device level. Providing developers with a way to create server-side apps and services that go beyond what Apple provides would be a boon to Apple's developers and to Apple itself.

I think the opportunity is so large that Apple is probably already moving in that direction. The introduction of CloudKit was just laying the groundwork for the future. The bottom line is that Apple still has many potential revenue streams left to exploit in the cloud services area. I remain long Apple and consider it a buy for those with a long-term (several year) investment horizon.

Disclosure: I am/we are long AAPL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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