Apple (AAPL) and Microsoft (MSFT) have been eternal rivals. Traditionally, they competed over operating systems, basically. However, recent developments have altered this rivalry, which has now migrated to the handset arena. Microsoft acquired Nokia’s (NOK) handset business in the hope of catching up with some of the lost ground. But this won´t be easy. So, is Microsoft a good long-term investment now or is Apple still the king in this device-driven world?
Late for the Party
Last week, Microsoft announced the purchase of Nokia´s Devices & Services business -and related patents- for approximately $7.2 billion. But, why buy a business that has not been doing well lately and seems to have lost the “smartphone-revolution train?"
Well, this action can only be understood as part of a transformation plan implemented at Microsoft. The company intends to become a devices and services company, shifting away from its software-focused model.
Although some analysts consider this purchase to be quite promising, I believe that, when added to Steve Ballmer´s (Microsoft’s CEO) recently announced retirement, the short-term uncertainty is just too much. The market seems to have reckoned this as well, as the stock fell about 6.7%.
Several issues concerned shareholders. For starters, the Nokia acquisition put an end to the speculation around an accelerated stock repurchase plan, which many expected would be announced on Sept. 19. Furthermore, the purchase will result in the addition of 32,000 employees to Microsoft’s structure, which already has 99,000. This, added to the fact that Nokia’s handset business was not very profitable (and isn’t expected to become profitable soon) will exert considerable pressure over Microsoft’s margins.
On the other hand, this week started a little bit better, with the announcement of the Xbox Music service becoming available for Apple's iOS and Google (GOOG)'s Android. Also, the company publicized the launch of the second wave of its Surface tablet on Sept. 23. These news seem to have done some good for the firm's stock, that rose about 1.6% during Monday Sept. 9.
So, currently trading at 12 times its earnings, at about a 15% discount to the industry average, is this stock a buy? I have my doubts. It seems to me that Microsoft is late to the party and will be playing catch-up with Apple in the smartphone and tablets segment for a while still. And, although there are several signs of Microsoft´s position ameliorating in important markets such as urban China and France, I still feel quite bearish about this stock.
China Mobile: A Huge Opportunity
Opposite to Microsoft, Apple greatly profited from the smartphone revolution. Already the leader in the U.S., some believe that sales could reach a limit soon. However, this does not seem to be the case in my view. Tomorrow, Sept. 10, the management will unveil its new iPhone and other related products and, unless the reviews are really bad, results should be quite good, as usual.
Sales could continue to grow in the U.S. However, the greatest potential going forward resides in the Chinese market which, since last year, is the largest smartphone market in the world. This week could be determinant for Apple’s future in China. Many expect a deal with China Mobile (CHL) to be officially announced before Friday. This contract could result in about 17 million additional iPhone sales in 2014, which would lead EPS to rise approximately $3.25. Most of the gains are expected to derive from the new iPhone 5C, a cheaper model which will be shipped to China and will generate greater gross margins on the back of lower production costs.
Another important catalyst can be found in the potential partnership deal with NTT DoCoMo (DCM), a Japanese carrier that has about 60 million users, and could unlock further profits in overseas markets.
Trading at 12.4 times its earnings, slightly above Microsoft’s valuation, but offering a more predictable and profitable future (at least in terms of consensus EPS growth rates), Apple still looks like a buy and hold case.
If last week was crucial to Microsoft´s future, this week will be determinant for Apple´s outlook. Having beat Microsoft in the devices war in the past, Apple seems poised to do it again, even against a stronger Microsoft that now holds a standalone handset business. This week´s news could push Apple stock to greater heights, thus closing the entry point now available. I´d say, buy and hold while the shares are still reasonably valued.