Apple: Here It Comes

Apr.17.12 | About: Apple Inc. (AAPL)

The hits just keep coming.

A couple of weeks ago I said this:

This is a firm with an operating margin of 34% with a huge percentage of it from hardware. What's their P/E if that gets cut in half?

You think it won't? Oh yes it will. This sort of operating margin always attracts competition. It is the reason that our operating margin at MCSNet -- a nearly-pure services business -- was one of the most-coveted and secret numbers we had. Nobody heard that number in general circulation because it would have immediately drawn people to try to figure out how we were doing it, to be immediately followed by someone forcing us to lower prices in order to keep customers, thereby destroying it.

There is no way to prevent this from happening folks, especially as you grow larger, except through attempted monopoly control of a market or other unlawful acts. If you do not engage in those acts then someone will be willing to do what you do at half your margin and the entire premise of your alleged stock price disappears. And if you do engage in them then you will eventually be stopped, as someone will sue or prosecute.

Yep. I came pretty close to top-ticking it thus far too. But Apple is now piling on its own demise (as a stock), as the rumors of a "mini Ipad" are circulating.

It's likely that if the device exists it will be soaked through and through with the blood of those too foolish to sell the stock -- even here, down 10% from recent highs. Why?

Because this is a desperation move. It will compress hardware margins. And that in turn will depress profits in absolute terms even as revenue may be flat or continue to rise.

Samsung likely forced this with their upcoming Galaxy tablet releases, already announced and in the pipeline. Sammy is taking the wood to the iScrewTheCustomer pricing model and ratcheting down the cost for consumers, which is what competition is supposed to do, and this trend is going to continue, not abate. Apple formed its business case on single-source iron-fisted control over operating margin by having "the one" that it stirred up an iFanboi brigade to support, using that to drive bargains that were good for Apple but terrible for everyone else.

This works right up until someone else analyzes your business model and costs, then figures out how to build something at least as good as what you have but 30% cheaper and gets that into the marketplace. Then the bubble-style valuation model you have built, claiming "it's not a bubble!" through distortions in the ordinary course of business (e.g. hardware margins three times that of historically-normal levels) is exposed and suddenly your stock doesn't look so cheap any more.

Profit margins on hardware are very difficult to sustain over 10% for long periods of time. Someone always comes after you and this is not going to be an exception to that rule. But that in turn means that you either must cut your own prices (and margins) to compete or watch your market share get diced up into little tiny pieces by a bunch of guys wielding machetes.

Apple has no way out of this trap; it simply must deal with materially-lower forward margins on its hardware products, and in doing so it will come under increasing price pressure. This in turn is likely to lead executives right up to the edge of where forced errors occur, especially if the stock gets cut in half, and I suspect it might.

Disclosure: Lightly short and more likely to add to that position over time than cover it, eyeing major support in the $400 area.