Apple (NASDAQ:AAPL) has changed from a high growth tech giant into a consumer products company and we are okay with that. Apparently, so is Mr. Buffett's Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) as it invested $1.5 billion in Apple this past summer (see Berkshire investment below). So why are we good with Apple even though its sales and earnings growth are slowing? And has Mr. Buffett changed his investment philosophy in buying into tech? Hardly.
Apple is a brand of many products. However, three of Apple's products, the iPad, iPhone, and iTunes, names are synonymous with their category and have become part of the English language. Additionally, the MacBook is what people under 30 mean when they say laptop. Brand power means recurring revenues and earnings. Despite having a "lackluster" year, with a "stale" lineup of products (as the bears would have us believe), Apple generated $73 billion in EBITDA on $215.6 billion in revenues. Both EBITDA and revenue figures are the second highest in the company's history. Apple will deliver the NEXT BIG THING, which will make it the first Trillion Dollar Market Cap Company. So, in Apple, we have consistent earnings power, an iconic brand, a great balance sheet, and the upside of the NEXT BIG THING.
So why do we choose to write about Apple, arguably the most followed stock in the world? What has the market priced wrong? PLENTY.
Apple is not rotting, and it is indeed a company that will bear fruit for years to come. If its history and culture prove anything, any displacement of any of its products will likely come from a newly introduced Apple product (think iPhones displacing iPods), and Apple will likely add to its (and our) lexicon with new products of its own invention or in just leapfrogging someone else's (see below history of product development) whose category we have yet to imagine. Yet the market gives no premium for its brand, nor for its history on ingenuity and execution.
Tim Cook himself has given us a glimpse into Apple's NEXT BIG THING. What is it? AUGMENTED REALITY. It could be Apple's biggest thing EVER! (See below to learn what Augmented Reality is, how it differs from virtual reality and how it will become part of our everyday lives).
It seems every quarter, every holiday season, and every upgraded product launch is put under a microscope and so called experts go on TV and try to explain to us how Apple is a dinosaur and in trouble since Steve Jobs' death. And those that are bullish, sound weak with little substance behind their sentiment falling into the bear's narrative on present quarter iPhone sales. I will attempt to provide the bull, the bear, and a look into Apple's NEXT BIG THING in order to eliminate the noise and nonsense that surrounds the most valuable company in the world.
The BEAR Case
- Stale lineup of products
- Cutting production of the iPhone 7 by 10%
- Last quarterly sales of the iPhone dropped for the first time ever
- Shipment delays for the AirPods
- Ho-Hum reception of the new MacBook Pro and its battery life short fall.
- Its current Market Cap leaves little room for error.
- Pressure to manufacture onshore could be a headwind
The above are reasons bears believe Apple's best days are behind it. While we understand each argument, we believe they are short sided and missing the obvious. Despite a "rough" year, Apple reported its second best numbers ever.
We do not believe the incoming administration will act irresponsibly with tariffs and demands for onshore manufacturing that will materially affect America's iconic technology company.
Our Bull Case
Let's look at the numbers of this "Disappointing Year."
Numbers at a Glance
|Price: $115.39||Revenues TTM: $215.6 B||EBITDA TTM: $73.33 B|
|MKTCap:$617B||POCF: 9.75||P/E: 13.97|
|EV: 637B||EV: EBITDA: 8.69||ROE: 36.1%|
The lists of some top companies that stand to benefit from repatriation include: Apple, $216 billion; Microsoft (NASDAQ:MSFT), $110 billion; General Electric (NYSE:GE), $110 billion; Pfizer (NYSE:PFE), $80 billion; IBM (NYSE:IBM), $65 billion; Merck (NYSE:MRK), $60 billion; Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), $47 billion; Cisco (NASDAQ:CSCO), $53 billion; Oracle (NYSE:ORCL), $51 billion; and Exxon Mobil (NYSE:XOM), $51 billion.
Repatriation of overseas cash is good for the American economy as a whole; it will make balance sheets cleaner, remove currency risks, etc., but we don't believe that this is a reason, in and of itself, to be long Apple. A bigger tailwind for these companies will be a lower corporate tax rate proposed by the incoming administration.
Berkshire Hathaway Investment in Apple
Warren Buffett is and has been a disciplined investor since he started back in the early 1960s. Mr. Buffett's and Berkshire's (BRK.A, BRK.B) investment criteria has not changed. However, Apple has changed. Apple offers the steady returns of a mature business, and the upside of the NEXT BIG THING. Berkshire clearly has invested for the steady returns, as it does not place "bets" on what may or may not be a future hit. Berkshire did not require a preferred instrument from Apple, and this past summer invested over $1.5 billion through open market purchases, in Apple.
History of Development and Execution
It has been almost 40 years since the Apple II became the first successful microcomputer, selling 1 million units. The Mac personal computer came out in 1984. iTunes 1.0 was release in January of 2001. The iPod media player came out in October 2001. The MacBook Air January 2008. iPad 2010. The Apple iPhone came out in January of 2007.
Apple's Next Big Thing - Augmented Reality
Augmented Reality is based on real surroundings but with enhanced toolsets, images, application and/or information that the user can interact with but distinguish between what is real and what is augmented.
Virtual Reality is a creation of a virtual world that is made to look real but is completely fabricated, wherein the user interacts with its contents and does not distinguish from their real environment.
Find Pokemon and Find Tim Cook's thoughts on Augmented Reality and its Future
From Apple's July earnings call:
Tim Cook: In terms of AR and the Pokemon phenomenon, it's incredible what has happened there. I think it's a testament to what happens with innovative apps and the whole ecosystem and the power of being a developer being able to press a button, so to speak, and offer their product around the world. And just a certain developer has elected not to go worldwide yet because of the pressure on their servers, et cetera, because of the demand. But I'm sure that they will over time.
It also does show, as you point out, that AR can be really great. And we have been and continue to invest a lot in this. We are high on AR for the long run. We think there are great things for customers and a great commercial opportunity. And so we're investing, and the number one thing is to make sure our products work well with other developers' products like Pokemon. And so that's the reason why you see so many iPhones out in the wild right now chasing Pokemons.
Cook later added: …I think AR can be huge. So we'll see whether it's the next platform. But regardless, it will be huge.
It's likely that the early wave of AR apps was premature, both in terms of technological capability and interest. Now that AR and VR and starting to gain some traction, Apple is placing its bets accordingly.
Execution is Key which is Why Apple Beats the Competition
Google's Glass failed miserably. Why? Too early and not enough practical uses. Apple's ability to recognize what we, the customer, will incorporate in our everyday lives sets Apple apart from the competition.
Apple's iPad wasn't Apple's idea. A full 10 years before Apple launched the iPad in 2010, Microsoft launched its touch input tablet computer. So how did Apple's iPad come to dominate the tablet space? According the Gates, Jobs "did some things better than I did. His timing in terms of when it came out, the engineering work, just the package that was put together. The tablets we had done before, weren't as thin, they weren't as attractive."
They All Want a Bite
In Cook's opinion, AR has much broader potential that can affect mainstream consumers, while VR looks like it could remain a niche for the foreseeable future.
Apple has the Best Execution
In 2014, Apple bought leading Augmented Reality company Metaio. After the acquisition, Metaio announced that its products that were being sold to over 1,000 clients would no longer be available. Yes, Apple clearly saw this acquisition worth more in furthering Apple's AR initiatives, than in building Metaio's existing business. Metaio came with a broad range of assets including new computer vision applications and developer tools. They were on target to creating Markerless AR experiences (this means that the application recognizes images that were not provided to the application before-hand. Meaning it figures it out on the fly. Pretty cool stuff) as well as Thermal Touch AR (uses the heat signature from your figures and turns any object into a touchscreen) interfaces for wearables and surfaces. Apple holds patents for a Head-mounted display system.
Apple is also hiring AR experts, including recruiting a top hire from Microsoft's HoloLens team. Adding to its portfolio, Apple bought facial recognition AR company, FaceShift, in January 2016. Apple acquired another AR startup this past year called Flyby Media. These acquisitions point to what could be a two-step approach by Apple into making AR the next big thing.
First AR iPhone, then AR Glasses
The dual camera in the iPhone 7 may help picture quality, but we suspect the goal is for 3-D depth maps that will power an augmented world using an iPhone. In November, Apple was granted a patent detailing an augmented reality mapping system that using the iPhone to overlay visual augmentation onto live video. This furthers our belief that Apple plans to implement an iOS-based AR strategy. 3-D and facial recognition appears to be an important function, which has obvious uses like greater personalization or and social experiences.
Apple is also believed to be developing smart glasses as a way to deliver an AR experience where Google Glass previously failed.
Integrating AR into the iPhone will be the first step, as Apple develops smart glasses.
Apple glasses would connect wirelessly to the iPhone, similarly to the iWatch. We believe the first rollout is in 2018, but see AR embedded in the iPhone software this summer.
At KORR, we believe that Apple might actually be able to pull off a can't-live-without-it eyewear/headset computer. Until then, we like the cash that Apple generates. So the way we see it, Apple offers great returns and great promise for the future.
Pokemon Go's earnings are estimated to be 10% Nintendo (OTCPK:NTDOY), 30% Niantic Inc., 30% Pokemon Inc. and 30% Apple.
At KORR Value (www.korrag.com), we typically stick to small to mid-cap listed stocks wherein we see a temporary disconnect between intrinsic value and market price. We believe over the time, the market is efficient and will eventually get the valuation right and close the gap.
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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.
Additional disclosure: We are long AAPL, and may add or sell our position at any time. Nothing written in this blog should be considered investment advice. Readers are encourage to contact their our investment adviser and do their own homework.
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