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How Apple Got Here (And What It Can Do to Get Back on Track)
Posted by: Fast Weekly (IP Logged)
Date: February 14, 2014 11:06AM
Apple (AAPL) stock has been a battleground for the last few years. Shares in the company had enjoyed a near meteoric rise, which ultimately culminated in a September 2012 high price of around $700 per share. Around the same time Steve Jobs, the cofounder and visionary for Apple, died. Then it's stock began to plummet, ultimately reaching its low of less than $400 per share in the summer of 2013. Since that time the share price has been on the rise again, and currently trades around $530 per share.
Chart Courtesy of Yahoo Finance
The share prices of many companies have risen or fallen drastically in the past couple years, but Apple is different. Under Steve Jobs' careful tutelage Apple released a string of remarkably popular and innovative products. Each one seemed to be a bigger hit, as well as a bigger seller, than the one that preceded it. These innovative consumer products, along with brilliant marketing and a shockingly sticky ecosystem, helped make Apple the tech darling of the last decade.
What I mean by sticky ecosystem is that Apples devices and services all integrate phenomenally well. If you have an iPad or iPhone, you likely have bought apps or songs from the iTunes Store for instance. Furthermore, when your existing iPad or iPhone wore out, you probably went and bought a newer model because all of the programs and files transferred seamlessly.
Also, there's the user experience. None of my friends complain about the usability of their Apple products. I have been known to complain about the absence of a USB port, however, but that's a matter for another time.
For nearly a decade it seemed Apple could do no wrong. Its products were wildly popular and its profit margins were heavily fortified. At a time when Samsung and others were giving away Android-based smart phones for free, Apple had customers lined up around the block to pay an extra $500 for the privilege of using their phone. The same goes for tablets and laptops. The $430 Toshiba laptop we bought for my wife last year compares to an over $1000 Apple MacBook Pro. Except that many MacBook owners will tell you their MacBooks don't really compare to typical laptops — they are superior.
Consider the table above, from GuruFocus. Apple has recorded a 38.1% annual revenue growth rate and more impressive, a 55.6% annual free cash flow growth rate over the past 10 years. Those numbers are tough to achieve over a short period of time, but simply remarkable over an entire 10-year period. Apple hasn't just put out a few good products, it has produced one top seller after another. It has been a remarkable run, but can it continue?
The bear case for Apple shareholder revolves around whether or not the company can innovate and grow without Steve Jobs. Since Jobs' death, Apple hasn't released any new “ground breaking” products. The critics complain that they are just rehashing existing products, while adding new features or upgrades. I would add that those “rehashed” products are still remarkably profitable, even if profit margins have slipped somewhat in the past year. The critics theory goes that without new and innovative products Apple will slowly sink into mediocrity. It's a tough life being a technology titan. You're only as good as your last blockbuster product.
Apple bulls see things in a more positive light. First and most importantly, they see Apple as a relevant technology company that has continued to mint money year after year. Apple reportedly has over $100 billion in its coffers, although only $41 billion of that is in the U.S. parent company. Until a bond offering last year, Apple had zero long-term debt. You read that right. It had many billions of dollars and no long-term debt. The company issued bonds because the interest rates were so low at the time that management decided they could earn a higher return on the capital than they would pay in interest to the bond holders. Provided management can invest that capital profitably, it was a good idea.
Apple has many options and a variety of tools at management's disposal. It has a $60 billion stock repurchase plan in place. According to the linked New York Times article, Apple bought back $14 billion worth of its own stock in the two weeks following the Jan. 27, earnings miss. Warren Buffett (Trades, Portfolio) is a fan of companies buying back their undervalued stock, saying essentially that no other activity can benefit shareholders as much. But are Apple's shares undervalued at current prices? It all depends who you ask.
Some big name investors have been touting the stock lately. Most notable is Carl Icahn (Trades, Portfolio), who has taken to Twitter to announce each and every one of his purchases. According to the linked CNN Money article, Icahn now has a $3 billion investment in the company. In his typically “aggravating” fashion, Icahn has been pushing Apple to triple the size of its stock buyback program. He supposedly has offered up other, less publicized, demands of the company's management. By and large Apple's management has ignored Icahn, which suits me just fine.
But the question remains, what could Apple do to get its growth story up and running again? It's great to buy back stock and pay an annual dividend (2.3% currently), but investors have largely yawned. I'm not advocating management give in to every Wall Street whim, but many believe that Apple has lost its way. I believe once Apple makes the decision to reinvent itself, it will grow and innovate again. Below are a few options I think would benefit the company in the future.
1. Expand its customer base. Management appears to be looking in that direction when it announced a strategic partnership recently with China Mobil Ltd (CHL), to expand Apple's market share in mainland China. Personally, I'd rather buy China Mobil (CHL) on that news than Apple itself. At the moment my instincts suggest Apple needs China Mobil's customer base more than China Mobil needs Apple's phones, and therefore Apple's profits in this deal is likely to fall.
2. I am not much of a fan of CNBC's Jim Cramer, but I think he touched on something the other day that makes a lot of sense. (I can't believe I just typed those words). Anyway, he said Apple should use some of its billions to buy top quality content. I think he was suggesting it buy Netflix (NFLX), which seems a little stretched to me, but I think it's a great idea for Apple to make a content acquisition. Both Disney (DIS) and Google (GOOG) can attribute a large part of their recent growth to their content purchases. Content drives web and cable traffic. Viewers seek out the best platforms and shows. With the right content acquisition, Apple could give its users another huge reason to stay in its sticky (read profitable) ecosystem.
3. Finally, Apple needs to keep pouring money into research and development (R&D). If it wants to remain, or return as, a leading edge technology company then it must hire the world's most creative engineers, and reinvest in its new products. If it is not management's desire to stay on the hardware side of the business, it's time for them to start investing in software, services, content, whatever they decide is next. My point is that, right or wrong, the company seems adrift. I don't know that Apple can ever replace such a dominant presence as Steve Jobs, but if management wants to be known for innovative products it better start producing those products.
There are many, many ways that Apple's management can begin to innovate and grow the company again. I believe once management makes up its mind what kind of company they want to run, and how they want to do it, Apple will be seen as getting back on track. Investors will reward the company when it starts growing/innovating again, and the stock price will go higher. Growth and innovation are what most investors want to see in a company like Apple. It's the very reason that Apple's (AAPL) stock currently trades at a PE of 13 while Google's (GOOG) stock trades at a PE of 32.5. Google has continued to grow and innovate. Meanwhile Apple has struggled on that front lately.
I do not currently have a position in AAPL, but I may initiate one in the coming days. This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell or hold any equities. I am not a financial professional. Unless cited otherwise, the information above is provided by GuruFocus and Yahoo Finance.
Guru Discussed: Carl Icahn: Current Portfolio, Stock Picks
Stocks Discussed: AAPL, DIS, GOOG,