This article will explain why there are dramatic similarities between the Apple story today, and what transpired a couple decades ago. The basic underlying business economics from the past era will assert themselves over the longer term, resulting in a similar outcome. Apple's percentage share of the desktop and Laptop market is stuck in the low teens. Since most of their growth and 80% of profits come from the iPhone, I will focus this article on the mobile phone area.
History has a Tendency to Repeat Itself
Most people do not want to see the similarities with the past, because they are financially and emotionally invested in expecting a different outcome.
Because there is a generational separation between many business cycles, the younger bulls that have, or are experiencing success in the current cycle, believe that older people are not wiser.
The most recent dramatic example of a repetitive business/economic cycle was the financial crisis caused by overleveraged consumers and banks. The Great Depression was caused by banks allowing investors to buy stocks with just 10% down, resulting in high leverage throughout most of the economy. The removal of the Glass-Steagall law allowed banks to package very low or no down "liar loans" into securities that were sold to investors. Even though investors were not themselves leveraged 10 to 1, the underlying mortgage backed sausages were leveraged at 10 to 1.
Besides a new generation without personal memory, mistakes are also repeated because of slight variations between the cycles. Hubris created by many years of success allows for numerous rationalizations amongst investors. 21st century bankers had created even more leverage in society than what caused the Great Depression, but very few of our leaders could understand the risks, or wanted stand up to large financial interests.
In the mobile phone space, as a subsector of consumer electronics, there have been numerous different profit leaders, none of which lasted longer than 5 years or so. Prior to Apple, the last leader, Blackberry , was thought to be so indispensable, that it was nicknamed after a highly addictive narcotic. It turns out that the supposed addictive qualities of Blackberry was a huge mistake, because consumer electronics trends mutate rapidly, based upon ever evolving technologies.
Apple earns almost all their profits from the sale of hardware, not from services. The bulls argue that Apple will forever command significantly higher profit margins than any consumer electronic company in history, because of their ecosystem. But, Blackberry also had an ecosystem, as did Apple in the 1980s and 1990s.
The four most dangerous words to investors concerning large business trends are: "this time is different".
The current bulls on Apple do not want to understand the similarities to what happened a couple decades ago.
The key to the success of Microsoft and the near death of Apple, was based upon the Windows ecosystem, that was open to numerous hardware manufacturers, and specialized software products.
Apple's higher priced products were not favored by businesses, which resulted in a continually falling market share. The lower market share became self-reinforcing, as business software developers would not produce versions for Apple. Apple ended up with a 10% market share of people who did not need access to business software, and could afford the higher prices. The business software of the 1990s is the equivalent of what today is called "Apps". Because Apple created the first touch screen smart phone, and the first successful touch screen tablet, there is currently a large amount of Apps, which is why investors do not see the parallels with the past.
From the above linked article dated August 7, 2013 :
"Android smartphone shipments grew a whopping 73.5 percent between the second quarter of 2012 and Q2 2013, according to research firm IDC s latest numbers. 187.4 million Android-powered phones shipped in the most recent quarter, representing 79.3 percent of all smartphones shipped during the quarter. The next closest smartphone platform was iOS, which shipped just 31.2 million units, accounting for 13.2 percent of overall share. What's causing the big Android bump IDC says the Samsung Galaxy S4 was a strong driver, but LG, Huawei, Lenovo and ZTE also had really good quarters with shipments in the double digits. The Android platform represented a win for almost everyone playing in that sandbox, however, as even small manufacturers saw success targeting small, niche markets in developing countries with affordable smartphones.
The big takeaway here is pretty clear, in terms of the top two players: Android is on fire because of choice, availability and price point in emerging markets focused on shifting to smartphones from feature phones on limited budgets. That means it's even more crucial to watch what Apple debuts this fall in terms of a low-cost iPhone device, which is rumored to be based around the iPhone 5 and sport a plastic back that's cheaper to produce."
So, on a worldwide basis, Apple's iOS is only 13.2% of last quarter's phone shipments. While Apple currently has a large installed smart phone base in the US, the present shipment trend will reduce their share dramatically over the next few years. More importantly, the recently announced "cheap" iPhone 5, is not inexpensive enough to staunch market share losses in either the US or overseas.
Cloud Music Service Trend Will Eliminate Apple's Key Ecosystem Strength
Apple gained a key ecosystem competitive advantage a decade ago thru the creation of iTunes, for the purchase of music. In my opinion, iTunes was the real glue of the Apple ecosystem.
But, today there are numerous music services, so that people do not need to buy individual songs, in order to gain access to their specific tastes in music.
Google launches streaming music service ahead of Apple shows that Apple is no longer innovating faster than competition.
In this article, How to Migrate Your Music from iTunes to the Cloud, is a summation of the current music situation:
"Just because iTunes was so revolutionary, and is still so ubiquitous, doesn't make it the best option for consumers to collect and access their music with these days. As your library grows, iTunes sometimes slows - and besides, a growing number of people want to be able to access their stuff anywhere without having to deal with transferring files around manually, like some sort of music sys admin. Aren't computers and the internet supposed to take care of stuff like that for us? The answer is floating above you: the cloud, where you can store all your tracks so they can beam down at you like so many rainbows.
From this article, Streaming music services are gaining fast in U.S. market:
"Streaming music services like Pandora online radio are gaining fast among US listeners under age 35, a survey showed Tuesday.The NPD Group survey found subscription-based and free Internet radio services accounted for 23 percent of the average weekly music listening time among consumers between the ages of 13 and 35 in the fourth quarter of 2012.That compared with a share of 17 percent the previous year. "Driven by mobility and connectivity, music-streaming services are rapidly growing their share of the music listening experience for teens and young adults, at the expense of traditional music listening methods," said NPD analyst Russ Crupnick. The survey also showed a shift to listening to music on mobile devices, with fewer people listening to CDs and digital music files."
It is clear to me that Apple's iTunes is being eclipsed by free and subscription based music services. As competitive music services become the mainstream way of listening to music, Apple users will feel more comfortable migrating to Android based phones. Since Apple only has 13% share of current global smartphone shipments, the installed base percentage share will dramatically over the next few years.
Cloud based service providers are the future of mobile devices
Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Google, Salesforce dotcom (NYSE:CRM), and others are the clear leaders in cloud based services, while Apple seems to be badly lacking in this area. The Siri service is a loss producer, which was badly overhyped. The Apple mapping service is another example of Apple failing to execute in the cloud based service area.
Apple has excellent operating system know how, and decent hardware abilities. But, the Asian competitors have now met or exceeded Apple's hardware, at price points dramatically lower than what Apple needs to maintain its current gross margins.
Most people who buy new iPhones are not paying the outrageous prices that Apple charges to the carriers, which subsidize the costs thru long term contracts. It is only a matter of time before consumers and the carriers refuse to pay 50% more for an equivalent, or inferior piece of equipment. At that point in time, Apple will end up in the same position they were in the 1990s.
Apple has the second largest market cap in the world, so when growth and margins contract dramatically, the price of Apple's shares will have a commensurate drop in price.
Apple is going into debt and consuming a large portion of its cash hoard to support its stock price, which appears to be a long term strategic error, in my opinion.
Future profitability in mobile phones is tied to cloud based services, such as search, in which Apple is not the leader.
As smartphones become increasingly commoditized, Apple hardware margins will collapse. While Google and others will continue to generate massive profits from cloud based services, only a tiny percentage of Apple's current profits are derived from those services.
Bottom line, Apple's current profitability is unsustainable, which means the stock is a value trap, similar to all other consumer electronics leaders of the past.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.