Apple: Gearing Up To Go 'Thermonuclear' In 2012?

| About: Apple Inc. (AAPL)
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How do you decide to buy, hold or sell a stock? It can be as complicated as choosing which babe you ultimately will settle down with (or why settle down at all?)! Aside from using basic fundamental and technical data to sort stocks, I often use "tipping points" (like I did shorting RIMM) to decide position sizing and trade decision. Apple (NASDAQ:AAPL) has had a few of these in 2011. Some major ones were:

  1. Steve resigned. I wrote "What's next for Apple?". Interestingly enough, it held up well after the news. Was it proof of the old adage that a sign of a bullish stock is for it to "climb a wall of worry"? The prevailing wisdom then was that Apple would not be as successful without Steve. While it is still too early to tell, it went on to trade higher after Jobs passed away.
  2. Steve passed away; by far, the biggest tipping point in Apple's history. Using one of Steve's quotes, I wrote "Apple: Connecting the dots backwards", to provide some thoughts on why it still had a lot of room to run. Apple traded at $370 then.
  3. Apple released Siri. Just like touch became a disruptive force in the mobile industry, I believe Siri will be Apple's next "silent" disruptor. The fact that it has been relatively low key only fuels my assumption that it will also be the next biggest disruptive force outside the mobile field.

Remember Sting's hit single released in 1985 titled "Russians"?

In Europe and America, there's a growing feeling of hysteria. Conditioned to respond to all the threats

In the rhetorical speeches of the Soviets

Mr. Krushchev said we will bury you

I don't subscribe to this point of view

It would be such an ignorant thing to do

If the Russians love their children too.

Growing up during the Cold War era, it was normal to hear or read media reports about how many and what type of nuclear armaments each side had and what would happen should there be a nuclear war. Both sides were frenetically building the infrastructure necessary towards the path of mutually assured destruction. In the end, Nuclear deterrent, kept the war "cold".

Interestingly enough, during that period, while the US kept their eyes off the ball (and piled more money into the arms race), Japan and India (and more recently, China starting in the late 90's) slowly produced the goods that used to be "Made in the USA". The USSR was ultimately dissolved into 15 post Soviet states in 1991. Its GDP has steadily risen since then.

Steve Jobs told Isaacson that he'd rather wage "thermonuclear war" with Google (NASDAQ:GOOG) than make deals to share its technology with the maker of the Android operating system. While it cannot be proven, it would not be far fetched to think that Eric Schmidt (a former member on Apple's board of directors) did share Apple's iPhone plans with GOOG. Also, does anyone remember what cellphones looked like before the iPhone was launched in 2007?

To think that Tim Cook isn't as shrewd as Steve would be a mistake; he just isn't as bombastic as Steve. Given that there isn't as much material relating to Tim as there is with Steve, I'll attempt to paint a picture of the man whom I think is very underrated as a leader and manager.

  • Steve was (according to almost any media source you can find) difficult to work with because he was demanding, opinionated and hell bent making Apple produce great products that married technology, humanities and liberal arts (even if it meant starting over from scratch or hurting your feelings!). Can you imagine surviving and succeeding in this environment for more than 10 years? Unless you enjoy and are really great at what you do, you cannot BS your way out of this milieu! Tim did and flourished. Apple's supply chain management is second to none. I used to marvel at Dells then, but the scope and gravity of Apple's operational empire makes the former look like a Lego assembly plant.
  • Unlike Steve, Tim (aside from family) has no other issues that would distract him from focusing on what he does best - running Apple. Seriously, up at 4:30am religiously to start his day? I'm still dreaming of Sport Illustrated's swimsuit models! Meetings on Sundays? Who would want to do that?
  • Unlike Steve, Tim is known to be a fitness enthusiast. I don't know of any serious fitness enthusiast that isn't regimented in their training habits. This habit usually translates in everything they do; they are usually methodical in accomplishing their goals.
  • Unlike Steve, who can be bombastic, Tim holds his cards closely and his moves are methodical. Like a good poker player, it is difficult to find clues contained in his public speeches as they are usually delivered with the same southern twang. He "loves Apple"; that is probably the only time you will notice any inflection in his tone. He comes across as quiet and calculating in a respectful way. He doesn't waste words in his sentences; they are delivered with purpose. I found his response delivered extemporaneously during Q12009's Q&A to be fascinating. Talk about clarity!

What tipping points available publicly can we observe that may give us a hint of what "thermonuclear" may mean to Tim? For the purpose of this article, how's this for clarity?

I don't want to talk about any specific company. I'm just making a general statement that we think competition is good. It makes us all better. And we are ready to suit up and go against anyone. However, we will not stand for having our IP ripped off, and we'll use whatever weapons that we have at our disposal. I don't know that I can be clearer than that. Tim, Jan 2009

Where can we expect the tipping points to come from in 2012?

From the Armaments in play:

  1. Cash. As I've written before, GOOG didn't purchase MMI solely for patents. They want to be in the handset business and reap AAPL like margins. What will Apple do with its cash in 2012? Please don't do what Samsung (OTC:SSNLF) did and spend the cash on a car compnay or HP overpaying for Compaq!
  2. Hardware; Apple does not want a rotten core. The current A5 chip is manufactured by Samsung, given that both are involved in an IP battle, why buy from a competitor when you can get it done elsewhere? A5, which uses technology from ARMH, was designed in house. Given the recent purchase of Anobit, it is pretty clear that AAPL prefers homebrews to reduce the risk of another betrayal. No wonder they bought PA Semi & Intrinsity. How far will Apples' own chip design team push the limits towards smaller, faster and more efficient processors and memory? Will this be the next source of disruptive technology?
  3. Software. iOS is being pushed further down the food chain. Will we see iOS and OSX combined one day? An iPod Touch can, using Wifi hotspots, can make free voice and/or video calls today. Where are the boundaries? AAPL's software, iCloud, Siri and iTunes just works seamlessly; will Siri be the next disruptive technology? What would it look like if it spoke the major languages and had countless content partners? The applications are mind boggling. Will the Windows powered phones be good enough to slow the Droids down? How will HTML5 impact the ecosystem and business model? What will they do to adapt?
  4. Content. Apple and Google do not own their own contents; they have to rely on media partnerships. Just like the music industry balked at AAPL's iTunes proposition, this song and dance will not be any different - media content delivery will be disrupted. Talk of Apple TV is premature until content is sorted out.
  5. Ecosystem. While apps (the lack of) have been mostly used to blame for the failure of competing devices, I happen to think this is only the tip of the iceberg given the most recent updates on iOS5, Lion, iCloud and now Siri. Once you own an iPhone, iPad and/or a Mac, it is really hard to consider using anything else. This unified approach to the user experience allows it to command premium pricing from its markets and its suppliers.
  6. IP Portfolio. Google's purchase of MMI, unless you believe their press release, is more of a hardware play than securing IP to protect the other Droid manufacturers. I cannot wait to see MMI's first droid phone hit the market and see what it does to HTC and Samsung.
  7. Product lineup. The iPhone, for the first time ever, is now available at every price point (i.e. 3GS at $0 with contract or the "4" at $99); 4S will also be available in China starting Jan 13th. HTC, RIMM and MMI have all warned; the only Droid that seems to be doing well is Samsung. Should iPad3 be released in 2012, will a sub 16GB $399 iPad2 be far behind?

From the Arms Dealers:

  1. Lawyers. In the 18 months before Jobs died on October 5, Apple sued HTC Corp, Samsung Electronics Co and Motorola Mobility Inc; the three largest Android users. It alleged that the phone makers stole Apple's designs & technology and asked courts to make them stop. Foss Patents does a great job keeping track of the litigation process. Apple's DNA suggests that this isn't about money. These IPs' were designed to ensure AAPL has the "best in class" products & experience. AAPL would rather have the competition design a workaround rather than dilute the AAPL brand experience i.e. they want a consumer to say "why can't this phone do what an iPhone does so easily?". Huge boon for IP legal firms for sure. Great profession to be in; win or loose, you get paid! How will this play out? If I was Tim; I'd be pretty pissed with my IP in the world is Android able to use the "slide to unlock" screen?
  2. Chip Manufacturers. After being burned by Samsung; it wouldn't be a surprise if Apple only picked suppliers that had no direct interest in the markets that Apple serves. TSMC fits the bill; will this trend continue?
  3. Content Providers. Just like Apple's experience with iTunes' launch in 2003, they would need the content providers' to back the service up to make it meaningful. It remains to be seen if Tim and his team could pull this off.
  4. IP Companies. VHC and IDCC come to mind. To discuss the merits of either company isn't in the scope of this article. What is the probability of Apple not planning out its IP requirements over the long haul? I believe they will only buy IP portfolios if the price is right and the IP is essential.
  5. Telephone and Cable companies. Judging by Verizons' latest earnings call, Apple is also disrupting that industry. As I've written before in a previous piece on Verizon (NYSE:VZ), I would not be surprised if VZ would try to find ways of mitigating the margin erosion directly or indirectly. Unless a client specifically asks for an iPhone, there will always an incentive for them to sell Droids! Data Plans will replace voice plans in the years to come. Cable company plans are like a record album with a couple of good songs but the rest of are crappy! Why can't consumers pay what you want per month; download the content access like apps and be able to watch it anywhere anytime via iPhone, iPad, Mac or Apple TV? Cable is ripe to be disrupted.

The Buzzards are waiting...

Fallout from the battles currently being waged is inevitable. We have seen how it has disrupted Nokia, RIM, MMI (later sold to GOOG) and HP (WebOs on the block) just to name a few. Which other company has designs on the post PC era (aka the Mobile World)? I can only think of one other company that can come to the market with a unified platform close to Apple.

What to expect in 2012...

  1. Analysts will continue to ignore the growth story. What incentive does an analyst have in assigning Apple a higher multiple than the rest of his/her peers? Simply, if an Analyst is as clueless as the peer group he/she continues to be employed. If they stuck their neck out and were wrong; job prospects will dim. In this economy, no one wants to risk that. If you want any further proof, just look and see if all the buy side analysts for RIMM still have their jobs.
  2. Like the iPhone, an iPad2 may be available at a price level between the Kindle Fire and the lowest priced iPad3 (with 32GB?) or the $199 to $399 sweet spot. What better way to push the rest to compete at the sub $199 market?
  3. Apple started the year at $411; I wouldn't be surprised to see it at $535 by year end. I'd love more but will WS assign it a higher multiple in 2012? Of the mega caps (>$200B), only GOOG and APPL have had over 30% eps and sales growth during the last 5 years and yet both are assigned WMT like multiples.
  4. Droids won't be the threat; Windows8 and the Win powered phones from NOK (for now) will be - assuming it can leverage MSFTs' huge user base. I wouldn't be surprised if HTC and/or Samsung diversifies more with Windows powered phones if they see Lumina to be a hit as there is definitely nothing stopping MMI from making its own Google powered phones.
  5. China and Latin America (Brazil, Mexico and Chile) will fuel Apples' growth for the next couple of years. No doubt China is a huge potential market for Apple; however, it also comes with a risk - doing business in Asia isn't like doing business in North America.
  6. The "noise" about channel checks and rumors about Apples' product portfolio will continue. Filtering the noise and maximizing the retracements provided will continue to be the key in adding incremental returns.
  7. The Steve Jobs discount will now be replaced with the Tim Cook discount (as the Street will always question how this mega cap can keep on growing over 40% YOY).
  8. Siri's continued evolution.
  9. BigMac! Lost amidst the iPhone and iPad success is Apple's consistent ascent in the Enterprise market.

The biggest threat may come from the enemy within. If you took a cursory look at most of the previous market darlings (Apple, by virtue of its low valuation, isn't there yet), their fall from grace can be directly correlated to mismanagement. Consider what happened to RIM as I've written in my article "What I've learned shorting RIMM"; they had everything going for them and yet they imploded. Here are some of the "tipping points" that I'll be watching:

  • Just like a good family needs a good figurehead; companies need good leadership that can navigate the company's path thru good times and bad times. Fish does stink from the head down.
  • Without good leadership, infighting may lead to the outflow of disgruntled talents (whether it is by choice or they have pursued other opportunities, aka lost the power struggle). It takes time for the impact to be felt. Maybe Scott Forstall may decide he wants to launch his own start up.
  • Managements' response to competitive offerings or entrants. I'd like to see how their thoughts translate to strategies being implemented to mitigate the risk. Remember Lazaridis' reaction to the possibility of a phone having an MP3 player or camera?
  • A disconnect between market data (e.g. ComScore) and its own financial performance. This is usually when companies start changing the way they report data and/or start "spinning" the truth.
  • Apple finally gets rewarded with Amazon (NASDAQ:AMZN) like multiples.
  • Apple, as its retail staff expands, forgets how to manage it effectively and efficiently. I used to like shopping at Best Buy (NYSE:BBY), but my experience with rude and unattentive staff during the holiday season was a huge turnoff.

When Apple (and its management) stops disrupting itself, it may signal the moment where it has really jumped the shark. Until then, it is just all noise competing for your attention - an article that suggests Apple is only worth $100 would sure get more views than anything else. When faced with uncertainty, I always try to connect the dots backwards to see what my next trade plan would be.

At the time of writing, AAPL was at $403 with earnings coming out on Jan 24th. Are we going to hear about channel check weakness a week or two prior to earnings? One thing is for certain, when it comes to understanding Apple, the Rashomon effect will continue.

Disclosure: I am long AAPL, MSFT.