The case for Apple

On Wednesday I sent out a transcript of a long chat the Agora team had about Apple. Today I explain what Apple needs to do to turn a profit for its investors.

On Wednesday I sent out the first part of the transcript of a long chat the Agora team had about Apple. As I said then, Apple’s a weird company. It’s the world’s most admired technology company… and it trades on a p/e you’d expect to see in a rusty old steel mill.

So what gives? On Wednesday I gave a bit of background on how we got to this point. Today I explain what Apple needs to do to turn a profit for its investors.

BT = Ben Traynor, SK = Sean Keyes, GF = Glenn Fisher, FH = Frank Hemsley

Apple’s biggest competitor

BT I have a question for you then, Sean. What’s the bull case for Apple?

SK Okay so we know Apple is going cheap, it’s on a p/e of 8.

That’s a pretty low bar. They question is, can Apple grow sales? And the answer to that question comes down to how frequently existing users are willing to upgrade their phones.

I think I’ve already covered the sort of defensive case for Apple, why I think its existing profits are sustainable. (That was Wednesday’s email – you can see that here.)

At a p/e of 8 I guess the market thinks that people aren’t going to keep upgrading their iPhones at the same rate, that maybe they think that the iPhone 6 and 6 Plus were a huge hit and people will be happy with them and they’ll just keep them and they’ll be good enough.

In that sense, maybe Apple’s biggest competitor is not Android but the last model of iPhone. So, that’s the bear case.

The bull case is that Apple… let’s say Apple will be able to continue surprising and delighting people with their new phones, every second September, they’ll come up with something that all the existing iPhone owners have to have. And in addition to that, it’ll add customers who’re upgrading from Android. That’s what it comes down to, really.

They want to develop a subscription model for iPhones, where you pay something like $32 a month to Apple and that entitles you to the newest iPhone every time it comes out.

That indicates their change in mind set. I think that they understand now that their biggest competitor isn’t Samsung or Android – it’s the 2015 or ’14 model of the iPhone. And I guess the bet is whether their industrial design department is good enough that they can surprise and delight everybody and come up with something that people want to shell out for every second year.

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Closing the optionality stable door after the horse has bolted

BT But they don’t have to be the only ones who innovate though because they didn’t invent the tablet, they just made the first really shiny, really good, really popular one. So, the innovations could potentially come from outside. And on the subject of innovation, I’ve got another question for you Sean. What’s their optionality stable like? And I’ve just made the term up but it’s basically…

SK Don’t ever say that again.

BT Every major tech company… well, you can finesse it but every major tech company has a sort of lab somewhere that’s working on stuff. I know Apple have been involved… I don’t know how long but I know they’re involved with cars, for example. Everyone knows about Google’s driverless cars… If you can buy something which is on not a ridiculous rating and which is doing interesting stuff that will probably go nowhere, but one of them could go to the moon and that’s kind of for free.

SK That’s the thing. Apple could come up with a driverless car which is a fairly big hit and it might not even dent their share price because the iPhone business is so flipping huge.

BT That’s a good point.

SK It’s the biggest company in the world. Well, Google might surpass it soon but it’s such a huge company that…

BT But if it started to get somewhere and some of what they did started off at the bottom line and there was enough excitement, that could be rated more highly. It could again be rated for growth more than it currently is.

SK If Apple started getting involved in lots of different projects though, like Google is doing, I’d be worried that they’re losing their focus. That’s how they’ve been so successful: they’re the best at hardware, so they make five or so essential pieces of hardware. And then sell the hell out of them at a big mark up.

Does Tim Cook have it?

GF I know when you look at a company, one of the things you focus on are the entrepreneurs behind these things. Obviously, we have lost Steve Jobs. We’ve got Tim Cook. Does the market still have faith in their ability to drive change and to figure out the market?

SK So, do they have the trust of the market?

GF Yes.

SK I think so. There was a rough enough period for the stock a couple of years ago before the launch of the iPhone 6 and it was a short time into Cook’s reign. At that time people weren’t sure he had the magic fairy dust and that he could lead Apple. They didn’t know whether he had the right vision for the company.

And then, after that, Apple had a string of hit products and the iPhone 6 and so everyone got back on board with Tim Cook.

The thing is though, Tim Cook is still just executing on a strategy Steve Jobs set out years ago. Apple is still benefiting from Steve Jobs’s reign in a sense: the investments they made, the decisions that they took are paying off and they’ve crushed their rivals and they’re sitting at the top of the smartphone market. They’re sitting pretty and they’ve got Jony Ives and his design team turning out these most desirable phones and they’re making money hand over fist.

But I think it’s a legitimate question to ask whether the strategy and direction Tim Cook is setting out will set them up for success five years from now.

GF They did also employ Zane Lowe.

SK They did employ Zane Lowe. That’s what I was coming to.

GF I have a problem with Zane Lowe and I feel as though it was a bad hire.

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“Apple’s year in beta”

SK There was an article in The Verge a few weeks ago called “Apple’s Year In Beta”. It was about how, in 2015, Apple’s new product launches were a bit sub-par by their standards. So, they had Apple Music which was fairly well received but not to the same…

GF It’s not got me yet.

SK Yes, not to Apple standards. Apple News, again, another fairly good release.

BT Isn’t this generally the way of a lot of things. I mean, the iPhone, the first version wasn’t up to the standards of later versions. It takes a couple of innovations sometimes.

SK Well, looking backwards they all get better.

BT That was, again, their excuse for the watch. There was a lot of briefing about how the watch was like it takes a couple of versions.

SK I don’t know if I agree. I think that looking backwards obviously the later iPhones or iPods are better but that’s just progress. I think at the time when the iPod came out it was 1,000 songs in your pocket. And people were blown away by it.

BT Well, the iPod, definitely, I think right out of the gate was a paradigm shift. The iPod obviously was but it was still a bit buggy, it still had things to work out.

SK But anyway, I guess the point is that you could legitimately ask whether their focus is where it ought to be. In my view what they’re best at is hardware products, just making great products which are centred around hardware and their software is good but not amazing. And you could ask whether the investment decision they’ve taken this year and new products they’ve launched this year are right up there with the very best they’ve ever done and whether they’re going to lead to the kind of profits we saw this quarter in the future, in 2018.

GF In a very trite way it’s the first argument in the relationship but eventually all those arguments spill out. We don’t know.

The dollar is killing Apple

SK And I’ve got one more note, actually: the dollar is very strong, Apple makes two-thirds of its money overseas. The dollar is up 20% in trade-weighted terms, so basically the dollar is really weighing on Apple.

BT I was going to ask you about that. Has that been factored in because the dollar has strengthened an awful lot? Apple obviously reports in dollars, like you say, makes an awful lot of money overseas, so other things it will suggest lower earnings and it will report them. Has that been factored in?

SK Well, right. That’s one of the factors that weighs on the price, as I said. The dollar is up 20% on a trade-weighted basis and two-thirds of the sales are overseas, so you can do the maths for yourself as to what that costs Apple.

How about this: Apple lost more money to currency fluctuations than Google makes in a quarter.

FH Are you advising us to buy Apple?

BT No one is advising anyone to do anything.

FH Or are you advising us to sell Google? What was your advice?

SK Use that term advisedly.

BT Sean’s advice will be published through the usual channels.

SK Yes.

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