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Apple: Reporting Hides Large Profit

|Includes: Apple Inc. (AAPL)

Recently, an article entitled Apple Scales Back Orders for Its iPhones ran in The Wall Street Journal. The article alleged that a local government paid subsidies to Foxconn in order to reduce iPhone 6s production layoffs. This, of course, turned out to be bizarre fabrication.

While the local government of Zhengzhou announced a payment to Foxconn on December 27 of 2015, it was issued as a result of the company's workforce retention rate in 2014 - a year before iPhone 6s began production. ( The "subsidy" was in reality more of a reimbursement. Companies in Zhengzhou make contributions to an unemployment insurance fund. However if they meet certain criteria and maintain a redundancy rate of under 4.5%, which Foxconn did in 2014, they are entitled to be reimbursed for up to 50% of their contribution.)

How the Journal managed to tie this 2014 reimbursement to 2015 iPhone production is a mystery, but the narrative stuck. The Financial Times, Bloomberg, and the Apple blogosphere cited the Journal as evidence that Foxconn had, in fact, received subsidies to assist with iPhone 6s production cuts. They did not bother checking with local sources, nor did they incorporate Foxconn's refute of the original article. (The Financial Times article ran with the headline Apple shares fall to lowest level since October 2014 which was also not true. Lower levels were breached on August 24th of last year.)

Stories about Apple suppliers have been equally alarmist. For example, a big deal has been made about how Catcher Technology experienced a monthly revenue decline of about 17%. Omitted from the report was that revenues are actually up year-over-year by 14.2%. Nor was it mentioned that we saw a similar monthly decline at Catcher during December of 2013, yet iPhone unit sales grew by 17%, 13% and 16% year-over-year in the subsequent quarters.

The story with Foxconn is similar. In early 2013, Foxconn's quarter-over-quarter revenue decline was cited as a harbinger for disappointing iPhone demand. Hiring freezes were reported in factories that manufactured the iPhone 5. Again, in the ensuing quarters, iPhone unit sales continued to grow by 12%, 8%, and 6% year-over-year. In fact by the end of fiscal 2013 Apple had sold 150 million iPhones. Last fiscal year they sold 213 million units.

The more recent incarnation of this narrative, that Foxconn reported a month-to-month drop in revenue of 20%, has again been blown out of proportion. Do $3 billion in production cuts warrant a $130 billion decline in market value? Let's not forget that it is impossible to discern what percentage of this $3 billion reduction Apple accounts for, as Foxconn is also a major contractor for Dell, HP, IBM, and Sony, among others.

At 10 times last years earnings, Apple is trading at a valuation lower than it did during the height of panic in 2008. (Even then, it traded at an adjusted price of $11.80 or 12 times earnings.) If we factor in net cash, repatriated at a 20% tax rate, this valuation falls to 8 times earnings or a yield of 12%.

So, why all the negative hyperbole?

I suspect it is more a function of institutional incentives rather than economic reality. Many funds that liquidated their positions in Apple towards the end of last year were motivated in part by tax reasons. Consequently they need to wait thirty days before they can repurchase the shares if they want to access the benefits of a capital loss. Its difficult to quantify the impact that this has on market price, but it is certainly in the interest of many funds for prices to remain low during what is effectively a tax-based probation period. The financial press also has an incredible financial interest in capitalizing on popular trends. This zeal for viewership means that they are susceptible to the Holmesian trap of twisting facts to suit theories, rather then theories to suit facts. It is likely that when shares begin to rise, the Journal will run positive stories on the company, which may be just as sensational as the negative ones being reported today.