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Does Apple Need A Next Big Thing?

|Includes: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) this year has traded between $550.00 and $420 and currently is priced at $452.00. The 52 week high and low was $705.07 and $419.00, respectively. How can a business value decline 33% in the last 6 months, especially on back to back record posting revenues? Simple, investors are panicking because of Apple's indecisiveness with its huge cash pile coupled with increased competition from Google (NASDAQ:GOOG), Samsung, and Amazon (NASDAQ:AMZN) which may impact its gross margins. Apple has been a classic momentum stock where the fundamentals continuously improved, to the point where investors kept piling in regardless of price, and when the air was let out of the balloon, many market participants forgot why they bought the stock in the first place. I believe that now that the company is trading at these levels it has become attractive, and long-term investors should begin a dollar-cost-averaging program to accumulate the stock.

Apple has a market capitalization of about $423 billion. Apple ended 2012 with $137 billion in cash or $145 per share ($94 billion is overseas and subject to taxes if repatriated). Apple is a cash cow and in 2012 generated $46 billion in free cash flow. With all this cash I believe it would be in the best interest of shareholders if the company increases its dividend as I do not see it making any large-scale acquisitions in the future, but rather to continue making smaller acquisitions, so they do not need all that cash sitting there idle. Recently Apple purchased WiFi Slam for $20 million. WiFi Slam uses GPS tracking technology to map indoor locations, this acquisition may have been made to help IOS mapping software as previously Apple decided to not preinstall Google maps on its iphone . It is too early to tell how this acquisition will add value to Apple, or if there are more in the pipeline, but Apple's CEO Tim Cook needs to realize that hoarding $137 billion in cash in a low interest rate environment is beyond irresponsible.

Competition is fierce in Tech, but Apple may have a few aces up its sleeves. The company has a trailing twelve month P/E ratio of 10.23, and had back to back quarters of record producing revenues with $36 billion in the 4th quarter of 2012 and $54.5 billion in the 1st quarter of 2013, yet the stock dropped from $680.00 to $452.00. Apple reported for the Fiscal 2012 revenues of $156.53 billion, net profit of $32.96 billion, earnings of $44.15 per diluted share, and gross margin of 43.9% vs previous year 2011 revenues of $ 108.28 billion, net profit of $21.86 billion, earnings of $27.68 per diluted share, and gross marginof 40.5% respectively (Source Apple Investor Relations). Apple's core money makers are the iphone and ipad, but companies such as Google, Samsung, and Microsoft are willing to spend billions to capture pieces of its market share, however from the numbers we see that Apple continues to increase the number of units sold for iphones, ipads, and macs.

In 2012 Apple sold 125,046 million iphones up 72.97% yoy, 58,310 million ipads up 80% yoy, 18,158 million macs up 8.50% yoy, 35,165 million ipods down 17.5% yoy. According to Strategy Analytics the top two selling smart phones in the world are iphone 5 and Samsung Galaxy S3, with short product cycles and different introductory dates these two phones continue to compete for the top spot. Samsung will release its Galaxy S4 in late April in the UK, while the iphone 5s is expected to launch in late June. Tmobile will finally get the iphone5 in late April so this should give a boost to Sales for Apple as Tmobile is the 4th largest wireless carrier in the U.S. Some Apple fans wait patiently for a bigger screen version of the iphone while others have made the switch to Samsung Galaxy S3, it remains to be seen who will win this race. Apple continues to excel in innovation with ipad. Sales of ipad in 2012 accounted for 20.7% of total revenues at $32.42 billion, and ipad has 43.6% share of the market, while its nearest competitor Samsung has 15% market share (Source IDC). I expect ipad sales to grow and revenue to grow even with more inferior competition coming to market at lower prices; however an eye will be kept on Apple's gross margins. New products such as Google glass get all the lime light in the news but with an expected price tag of $1500, it remains to be seen if this new technology will be purchased by the average consumer. Apple was not the first to introduce the mp3 player; however they were the first to combine hardware and software into an easy to use music device known as the ipod, who is to say that they can't repeat this process and introduce better "smart glasses".

Another potential catalyst for Apple is if the company can come to terms with China Mobile (NYSE:CHL) to sell the iPhone. China Mobile has 710 million subscribers (Source CHL Investor Relations), more than any other telecom in the world, but thus far Apple hasn't been willing to amend its pricing to coordinate with the company. I understand that Apple wants to maintain its premium pricing, but to be blind to the changing industry dynamic is extremely counterproductive. There is no doubt that Samsung and even Blackberry (BBRY) with the Z10 have materially closed the gap with the iPhone. Similar to P.C's or flat screen TV's, there is very little doubt that smartphones and tablets will become commoditized products, with little differentiation between them. While Apple's biggest competitive advantages are its brand and its enclosed operating system, which makes it somewhat challenging to switch to another brand, the reality is that if like Blackberry, Apple doesn't give the user the experience that they are expecting, loyal customers will leave. This is especially relevant with the larger screen phone because in my personal opinion the current iPhone screen size looks ridiculous when it is next to a Samsung or even a Motorola.

If you are a market participant that sold Apple just because the stock price dropped then I'd be wary about buying again because you most likely aren't in the stock for the right reasons. Apple has the ability to resolve its primary issues and when it does indeed do it, I'd expect the stock to rally. Apple should start by doubling or tripling the dividend, which it could afford to do, and this cash is simply sitting on the balance sheet earning a meager interest. Apple needs to come out with a larger screen phone as an option for customers that would prefer that. I believe that because one of Apple's marginal competitive advantages is its eco-system, the company would be wise to introduce a lower-cost phone at least for emerging markets. This would help the company build the brand abroad, and the higher volume should reduce Apple's cost of goods sold even further. Lastly, I believe that Tim Cook needs to find a way to make a deal with China Mobile. Clearly, the company doesn't want to sacrifice its attractive margins in the U.S. and abroad just to win one company's business, but Cook needs to find some common ground where a deal can happen. The sooner Apple embraces the fact that margins will drop and adjusts its business model to maximize profitability in spite of that, the more transparent the company's future profit potential will become. Cook's laissez-faire attitude about the dividend is likely the most disconcerting thing for investors who have already been spoiled by the genius of Steve Jobs. Tim Cook needs to be more of a CEO than a COO, and when that happens I believe Apple could rally to $650 based on multiple expansion, and earnings stability from the potential catalysts that I mentioned previously.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.