Apple: Biting off More than It Can Chew?

Includes: AAPL, VZ
by: Semi-Standard Deviation

It seems as though everybody and their mother has an opinion on Apple’s (NASDAQ:AAPL) stock price these days. Well, at least everybody and their mother owns an iPod, and over the past six months, the stock has been the darling of Wall Street.

Since mid-July, shares have gained around 60%, profits have seen outstanding growth and their products epitomize ‘cool.’ But is Apple’s premium stock price warranted? Its valuations are high and dependent on outstanding future growth, which will be hard to deliver.
Apple’s most recent quarter saw year over year computer growth of 28 percent and iPod growth of 50 percent. Pretty impressive numbers, but can that kind of growth be maintained? When announcing the earnings, Apple lowered its guidance for the upcoming quarter, negating any push the stock might have received from the most recent quarter’s results (in all likelihood the results were already priced into the stock).

Getting Crowded in the Market
The Apple fanatics will come out and say that “they always put conservative estimates out” and that it shouldn’t be a sign of slowing growth. However, if we look at Circuit City (NYSE:CC)’s MP3 sales, they were flat year over year and Best Buy (NYSE:BBY)’s consumer electronics saw a modest 8.5% gain, mostly attributed to flat-panel TVs. The market is becoming saturated and a large portion of those 21 million new iPod users were gift recipients or consumers who are just finally catching on - people who aren’t going to drop another $300-400 on Steve Jobs’ latest masterpiece.

If we look at the latest product introduction, the iPhone, it is impressive, but that doesn’t cut it. The Blackberry dominates the business marketplace and you’ll be hard pressed to find a company willing to shell out the money for an iPhone, let alone a “Crackberry” user who wants to switch interfaces. The Treo has also established its presence in this marketplace. The iPhone is much larger than other music phones, granted it does have more capacity (4 or 8gb), but where does that added music capacity land it? No man’s land.

It doesn’t hold enough to satisfy the music junkie (who would have to carry around two “bricks” in his/her pocket, with the iPhone and an 80 gig iPod), while holding more music than someone, who just wants to load a few playlists, needs. Verizon (NYSE:VZ)’s disclosure that it turned down the iPhone is also an indication about expected profitability. Clearly Verizon has a solid place in the smart phone market, but if they projected the market for the iPhone to be huge, they would’ve found a way to deal with Jobs’ stipulations.

Also, the set price of $499 hurts Apple when consumers shop around for phones and find something with similar features going for $50-200. With margin contractions hitting the cell phone market and causing makers to halve their prices, this isn't the spot that Apple wants to start in.

Pricey Fashion
During this last quarter, Apple saw incredible growth. But that growth isn’t sustainable, as Apple will have to cut its margins to keep bringing in new customers. Their products are trendy and that will win buyers over in the short term: those who are willing to pay the premium price for the image that comes with owning an Apple product. They have been banking on this with their “I’m a PC/I’m a Mac” commercials, which brilliantly display the PC as a dorky, fashion-impaired thing of the past.

Eventually they will have to lower the price though, as the large number of PC makers operating on Windows has the ability to offer bargain prices in comparison to a Mac. When you bring Vista’s potential impact into the equation, all of this makes Apple’s valuations look a bit high.

Of course, Apple fanatics will scream and shout, pointing to features and ease of use that aren’t found anywhere else, all the while hailing Steve Jobs as immortal. People who thought Google (NASDAQ:GOOG) was overvalued when its P/E was at 30 might also chime in. It goes without saying that Apple is a dangerous company to doubt and will always have its core group of buyers who don't flinch at the price premium. In conclusion, we can see that the iPod's growth will slow and it will face legitimate contenders. Those who doubt the latter should look at Apple gaining share of a market once thought impenetrable by Microsoft (NASDAQ:MSFT)'s trumpeters.

In their other markets, their margins will have to come down for them to keep sales up. There is a lot of hype around the company (just watch the MacWorld video, I think there's a standing ovation after each sentence Steve Jobs utters) and hype can lead to big profits, but it can also precede a big drop (see: tech stocks in 2000). I'm not saying Apple makes a good short right now. But if there is a big run up in the price to the mid-90's and above, I would seriously consider it.

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