Trying to See Apple From a Different Angle

Date: 02-02-2014
Source: The New York Times

The stock market doesn’t know quite what to make of Apple.

The company started out in the 1970s as a risk-taker and a rule-breaker, and for many members of Steve Jobs’s generation, Apple will always carry a whiff of sex, drugs and rock ’n’ roll. It retained some of that renegade aura even as it set off on a wild growth spree in the first decade of the new millennium.

By last September in the annual Interbrand survey, Apple had managed to depose Coca-Cola as the most valuable brand on the planet, using criteria like popular perception and financial performance. And based on the value of its shares in the marketplace, Apple has become the biggest company in the world, worth roughly 10 percent more, in the eyes of investors, than its nearest rival, the venerable oil giant Exxon Mobil.

Yet now that Apple is so big and so successful, it poses something of a puzzle for investors. Is it a gigantic tech growth stock that will expand even more rapidly in the years ahead? Or has it turned into a high-end consumer products company, one that is, at the moment, the biggest cash cow in the world?

These questions intensified last Monday, after Apple issued its latest earnings report. The numbers seemed to describe a mature company with enormous profits, a nearly $159 billion cash hoard and copious cash flow but modest overall growth — a stunning change from the Apple of only a few years ago.

“Basically, the market is beginning to value Apple as a consumer goods company today,” said Doug Kass, president of Seabreeze Partners Management. “It’s being valued like General Mills — a great company with great cash flow.” And with Apple, he said, you get a share of all of its idle cash plus a kind of bonus: the possibility that the company will somehow manage to come out with another world-beating innovation.

As recently as fiscal 2012, Apple was on a tear, with revenue that grew at an annual rate of 45 percent; that rate was 66 percent in 2011 and 52 percent in 2010. The latest earnings report portrays a much more sedate company.

In fact, a close look reveals evidence of slowing momentum in what is Apple’s most important profit center by far: the iPhone. While worldwide iPhone sales expanded — thanks in part to a new carrier, China Mobile, the country’s largest — sales in existing markets actually fell by 2 percent in the first quarter of fiscal 2014, according to a dissection of Apple’s earnings by Toni Sacconaghi, a technology analyst at Sanford C. Bernstein in New York. (For accounting purposes, Apple’s fiscal year ends in September, so it ended its first quarter in December.)

While Carl C. Icahn, the activist investor, announced on Twitter that he had been buying Apple shares, the overall market was clearly rattled by what many investors perceived as a lackluster performance. Apple shares dropped more than 8 percent on Tuesday alone, the largest one-day decline in a year. For the month, Apple fell by more than 10 percent.

Mr. Sacconaghi said: “This is a company where two-thirds of the total profits come from the iPhone, and the key take-away from the earnings report for me is that the iPhone’s addressable market — that is, the high end of the smartphone market — is increasingly experiencing saturation. When the biggest part of your business doesn’t have a lot of growth in it, that’s really worrisome.”

Apple acknowledged that its introduction of the iPhone 5C, a colorful model with last year’s technology, has been bumpy. The phone went on sale in September for $100 less than its top-of-the line model, the 5S, but the 5C has underwhelmed buyers in the United States and China.

Apple Market Cap
“Investors reacted to that,” said Mark Moskowitz, an analyst at JPMorgan in San Francisco. “It was an unfortunate misstep.”

While the problem of one specific phone model may seem trivial, he said, the 5C represented the first time that Apple had expanded the iPhone line under Timothy D. Cook, the chief executive who succeeded Mr. Jobs. “They just didn’t do a good job,” Mr. Moskowitz said.

There were some separate, technical reasons for slowing sales of iPhones in the United States. In a conference call, Mr. Cook said part of the problem “in North America specifically was that some carriers changed their upgrade policies” for new smartphones. “This restricted customers who were used to upgrading earlier than the 24 months that they’re allowed and stretched the time out to be a hard-and-fast 24 months,” he said.

In another quarter or two, he suggested, the effects of the new upgrade rules will have ebbed. And he said Apple’s sales in China would grow as China Mobile sells the phone in 300 cities; China Mobile supports it in 16 cities now. On the other hand, Lenovo’s acquisition of Google’s Motorola Mobility unit, announced last week, could add to pressure on smartphone profit margins globally. That could be more bad news for Apple.

For the company as a whole, Mr. Moskowitz projects sales growth of 8.5 percent in the 2014 fiscal year, while Mr. Sacconaghi puts it at 4 percent. In either case, that’s nothing to celebrate for a company that once expanded at a jaw-dropping rate.

In a sense, Apple’s size is its biggest problem. The company is so large that even if it comes up with a major new product or service — say, a full-fledged Apple TV or a beautifully designed, multifunctional wristwatch or a mobile payment service — it may not propel overall growth all that much.

The problem, Mr. Moskowitz says, is one that many companies would envy: “It’s so big that its success has put them under an ultramicroscope.”

For his part, Mr. Kass says he isn’t counting on growth. Apple is a good value now, he said. He likes it as it is — as a cash-generating consumer goods company.

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