AAPL - Apple Inc.

[rkbabang]

This even includes more esoteric and long-term things like releasing a new programming language (Swift) that you know a whole generation of coders will eventually learn because your platform is the most lucrative, further tying them to your ecosystem and distancing you further from what developers have to deal with elsewhere (Java on Android, ew) while offering them a more modern, more powerful language that will eventually make their lives easier.

 

I think Swift is more important than many people realize.  It further separates IOS app development from Android development.  Suddenly IOS development becomes easier and Android development becomes more of a pain.  Since most developers will write their IOS app first they now need to justify re-developing their entire app in Java for Android which probably won't make as much money as the Swift app you just finished for IOS.  How many will not even bother?  As Swift catches on I think you will see a greater amount of IOS-only apps.

 

Thanks for your thoughts.  I think you are looking at Apple in entirely the correct way.  The software+hardware approach is > hardware only  or software only.  Putting the two together is greater than the sum of the parts.  This is something many people don't get.    Also looking at the Watch as a 1.0 version is also something people aren't doing.  They are comparing it to the iPhone 6S which is what the 9th iPhone model?  Comparing it to the original iPhone and how relatively little that did and how people didn't know what to even do with it, is a better analogy.

 

[innerscorecard]

Some seem to think that Apple has to win people all over again all the time, but the facts are otherwise.

 

This. Imagine what would happen to AAPL's multiple if the market ever decided to weight Apple as a subscription model rather than as a seller of devices, risking to be dethroned at any moment. I view it as an embedded option with no expiry date, as long as Apple keeps moving the goal post by continuing to successfully differentiate itself.

 

Interesting rant, thanks for sharing it.

 

I think one reason Apple has "reverted" to a hardware multiple over the course of the last couple of months is that the initiatives which seemed most promising for subscription services have not been received as well as expectations have hoped for. I mean Apple Music, Apple Pay, and the rumored throwing in the towel on an Apple TV service, as well as the iPhone financing plans. The continued discontent with Apple's management of the iOS and Mac App Stores is also symptomatic of the perception that Apple simply can't do any service well.

 

The reaction may be overdone, but I think it's extremely unrealistic to hope for a subscription/services multiple for Apple.

[TheAiGuy]

Some seem to think that Apple has to win people all over again all the time, but the facts are otherwise.

 

This. Imagine what would happen to AAPL's multiple if the market ever decided to weight Apple as a subscription model rather than as a seller of devices, risking to be dethroned at any moment. I view it as an embedded option with no expiry date, as long as Apple keeps moving the goal post by continuing to successfully differentiate itself.

 

Interesting rant, thanks for sharing it.

 

I think one reason Apple has "reverted" to a hardware multiple over the course of the last couple of months is that the initiatives which seemed most promising for subscription services have not been received as well as expectations have hoped for. I mean Apple Music, Apple Pay, and the rumored throwing in the towel on an Apple TV service, as well as the iPhone financing plans. The continued discontent with Apple's management of the iOS and Mac App Stores is also symptomatic of the perception that Apple simply can't do any service well.

 

The reaction may be overdone, but I think it's extremely unrealistic to hope for a subscription/services multiple for Apple.

 

I think he means thinking of the iPhone purchase itself as a subscription/service -- an biannual hardware refresh that is financed for $27 a month ($650/every other year)

[innerscorecard]

I don't think that's going to happen anytime soon either, because there will always be uncertainty about whether the refresh cycle is going to lengthen just right around the corner.

 

That's always going to be the perception, because it's not a falsifiable proposition. The percentage of iPhone purchases that is financed could rise, and yet the fear of "good enough" soon will still be there.

 

So I think if you are investing in Apple based on the hope of a rerating on these kinds of grounds, you will likely be disappointed. The closest that was to happening was earlier this year when Tim Cook was on positive magazine covers - and still David Einhorn did not get the "premium multiple" he was waiting around for.

[intothebreach]

I think he means thinking of the iPhone purchase itself as a subscription/service -- an biannual hardware refresh that is financed for $27 a month ($650/every other year)

 

Correct. And while the iPhone is the most obvious example due to the fairly high rate of refresh, this subscription model actually applies to all the hardware where performance increases over time (Mac, iPad, TV, Watch, albeit all at much lower renewal rate, translating into a lower monthly "subscription" equivalency). Each of which adds up to the total as long as customers keep renewing and adding more products/services over time.

 

This works as long as Apple can maintain customer fidelity/stickiness compared to the competition.

[Liberty]

I don't mind the lower multiple as long as the cashflows and ROICs are closer to those of a software company with very high renewals than those of a commodity hardware maker.

 

It's not like they have other uses for most of that cash, so I'd rather see buybacks at 7x FCF ex-cash than at 15-20x...

 

But Apple sentiment goes in cycles, and we'll see higher multiples again at some point. Maybe when China starts booming again, or if the tax code ever gets reformed and they can bring back all the cash, etc... iPhone 7 should also get people more excited since an external refresh always makes a bigger impact, even if the S years are just as solid functionality-wise.

[innerscorecard]

The thing I'm interested in is where gross margins go as revenue growth inevitably slows. The big fear in 2013 was that falling gross margins meant that the commoditization thesis was playing out. That particular commodification due to competition thesis was shown to be false by the iPhone 6 Plus, where more consumers were willing to actually pay more for an iPhone than they did before. The new version of the argument is that consumers will value future new iPhones less than they valued previous new iPhones, because their existing phones are good enough. And Apple seemingly can't move new product categories such as Apple Watch and Apple TV without aggressive discounting by third-party retailers.

 

I personally think the smartphones are still very far from being good enough. And for the reasons that Liberty has articulated, I don't see any competitor taking over the smartphone banner from Apple.

 

I think anyone can agree that Apple Pay, Apple Watch, Apple TV and the like have been less wildly successful than many hoped for. It wasn't so long ago that some fantasized that Apple Watch was the harbinger of Apple being awarded a "luxury" multiple.

 

If gross margin falls, it means that there is not merely uncertainty about Apple's future growth, but also whether it's possible for Apple to have a steady state where even when there's no huge revenue growth and growth in the installed base, people still dutifully update their devices every so often.

[Liberty]

I think he means thinking of the iPhone purchase itself as a subscription/service -- an biannual hardware refresh that is financed for $27 a month ($650/every other year)

 

Correct. And while the iPhone is the most obvious example due to the fairly high rate of refresh, this subscription model actually applies to all the hardware where performance increases over time (Mac, iPad, TV, Watch, albeit all at much lower renewal rate, translating into a lower monthly "subscription" equivalency). Each of which adds up to the total as long as customers keep renewing and adding more products/services over time.

 

This works as long as Apple can maintain customer fidelity/stickiness compared to the competition.

 

Phones are so inexpensive vs the value that they provide, they are much more personal and emotional devices than computers, and they are carried everywhere, making them wear out much faster than a computer that stays relatively static and protected. There are also many more opportunities for all kinds of new sensors and features that aren't available to PCs. The replacement cycle won't be like PCs for a while, we're not even 10 years into the modern smartphone era, things are still changing very fast.

[innerscorecard]

To me, smartphones are almost comically not good enough yet. The best example is the charging ritual that everyone goes through every so often in the course of life. That obsession with not running out of batteries, and altering behavior based on this limited resource, can't not be seen as laughable at some future point.

[TheAiGuy]

The thing I'm interested in is where gross margins go as revenue growth inevitably slows. The big fear in 2013 was that falling gross margins meant that the commoditization thesis was playing out. That particular commodification due to competition thesis was shown to be false by the iPhone 6 Plus, where more consumers were willing to actually pay more for an iPhone than they did before. The new version of the argument is that consumers will value future new iPhones less than they valued previous new iPhones, because their existing phones are good enough. And Apple seemingly can't move new product categories such as Apple Watch and Apple TV without aggressive discounting by third-party retailers.

 

I personally think the smartphones are still very far from being good enough. And for the reasons that Liberty has articulated, I don't see any competitor taking over the smartphone banner from Apple.

 

I think anyone can agree that Apple Pay, Apple Watch, Apple TV and the like have been less wildly successful than many hoped for. It wasn't so long ago that some fantasized that Apple Watch was the harbinger of Apple being awarded a "luxury" multiple.

 

If gross margin falls, it means that there is not merely uncertainty about Apple's future growth, but also whether it's possible for Apple to have a steady state where even when there's no huge revenue growth and growth in the installed base, people still dutifully update their devices every so often.

 

I care more about ASP of the iPhone than gross margins overall. If they sell a lot of sport watches, for example, the margins could fall but that wouldn't be a sign to worry. ASP of the iPhone is up a lot since 2013, so no worries there.

[intothebreach]

But Apple sentiment goes in cycles [...]

 

Which is a great thing for those of us willing to trade around their position. I keep selling a little when it reaches a new high, and adding a little when it gets closer to a 52-wk low (sometimes a lot... )

 

As for Apple Pay and Apple Watch, they are the versions 1 of Apple's entry into these markets. The iPhone and iPad were also viewed by some as less than wildly successful when they were introduced. Looking at today's iPhones and iPads, I'm really looking forward to see how these products evolve over time. I would include Apple TV if not for the negotiations with the networks that I have no clue how to handicap (guessing a best case scenario would be iTunes redux).

[Liberty]

I think anyone can agree that Apple Pay, Apple Watch, Apple TV and the like have been less wildly successful than many hoped for. It wasn't so long ago that some fantasized that Apple Watch was the harbinger of Apple being awarded a "luxury" multiple.

 

Expectations are a strange thing. Rumors and analyst reports say that something is expected, and then it doesn't happen, and Apple is somehow "late" despite never having announced a product... It's kind of the opposite of Google, which constantly releases info about "upcoming" stuff that never comes or is clearly vaporware, but they get the PR boost for it.

 

And then everything is kind of expected to be the next iPhone (despite the fact that it's clear that nothing will ever be, though the iPhone should remain the iPhone, which is good enough), so every time Apple releases something promising as a V1.0 and builds a new multi-billion business out of thin air, it's disappointing to the market...

 

Oh well, taking advantage of a variant perception is what investing is about. Time will tell who is right and who is wrong.

[innerscorecard]

The thing I'm interested in is where gross margins go as revenue growth inevitably slows. The big fear in 2013 was that falling gross margins meant that the commoditization thesis was playing out. That particular commodification due to competition thesis was shown to be false by the iPhone 6 Plus, where more consumers were willing to actually pay more for an iPhone than they did before. The new version of the argument is that consumers will value future new iPhones less than they valued previous new iPhones, because their existing phones are good enough. And Apple seemingly can't move new product categories such as Apple Watch and Apple TV without aggressive discounting by third-party retailers.

 

I personally think the smartphones are still very far from being good enough. And for the reasons that Liberty has articulated, I don't see any competitor taking over the smartphone banner from Apple.

 

I think anyone can agree that Apple Pay, Apple Watch, Apple TV and the like have been less wildly successful than many hoped for. It wasn't so long ago that some fantasized that Apple Watch was the harbinger of Apple being awarded a "luxury" multiple.

 

If gross margin falls, it means that there is not merely uncertainty about Apple's future growth, but also whether it's possible for Apple to have a steady state where even when there's no huge revenue growth and growth in the installed base, people still dutifully update their devices every so often.

 

I care more about ASP of the iPhone than gross margins overall. If they sell a lot of sport watches, for example, the margins could fall but that wouldn't be a sign to worry. ASP of the iPhone is up a lot since 2013, so no worries there.

 

But see, I actually do care about overall gross margin. I think if the general product mix carries significantly lower margins than iPhone, that really is a reason to worry, because it shows that Apple cannot purposefully create a product with the same unit economics characteristics as iPhone.

 

Let's not forget the public narrative around Apple Watch. Everyone was talking about the fact that Apple Watch was a positive harbinger for the future precisely because it was a fashion product that could justify high margins!

[Liberty]

Some here might enjoy this long-form podcast discussion with the former heads of Safari and iOS at Apple, talking about their experirence at the company. I haven't listened to this one yet, but the other episodes in the series were good. Don Melton swears every other word, so this might not be safe to play out loud in some settings..

 

Debug: 76: Melton & Ganatra episode IV: Management

https://overcast.fm/+I_JFBNKk

[Liberty]

Let's not forget the public narrative around Apple Watch. Everyone was talking about the fact that Apple Watch was a positive harbinger for the future precisely because it was a fashion product that could justify high margins!

 

You don't think it's too early to judge either way? We don't even have sales numbers, much less margins, it's a version 1.0, and it has been out for only 2 full quarters...

[Viking]

Liberty, please keep publishing your notes... They are a great read.

 

One bucket you did not mention was customer service. One of the main reasons I purchase goods at Costco is they have outstanding customer service; I KNOW if I have an issue I can take it back and they wil look after me. Apple also has outstanding customer service. I personally could give 4 or 5 examples in the past 6 months alone of where I was pleasantly surprised by the service I was given either at an Apple Store or online.

 

 

The customer service angle has really hit home for me recently; my son is looking to buy a computer to use primarily for gaming (not my first choice as a parent but he is using his money that he earned). He decided he wanted to buy a laptop from Lenovo. He purchased the laptop online; they delayed his delivery date twice (totaling a one month delay). He decided to cancel his order with Lenovo (rather than wait). He was able to cancel his order but only after talking on the phone with a number of people for a couple of hours and over a couple of days (people who need to sign off were not around). Absolutely brutal customer service. He decided to purchase a Dell laptop. The computer showed up about two weeks ago. He experienced issues with the wifi and the screen started going completely blank. He called the help desk today and the Dell troubleshooting guy suggested he get his screwdriver out and remove the battery from the back. I got involved and suggested if he was already having multiple issues with the device he should return the device ASAP, get his hard earned $ back (while he could) and find a better option. He was transferred to 4 different people at Dell over a 2 hour period to get this done; the best part was he was told at one point that there was only one person who could Process the return of his device and that person was not available and would call him back sometime in the next 24 hours (the call centre was in India I think). I got involved at this point and they 'found' the guy. Bizarre.

 

I am not saying that Apple customer service is perfect. However, compared to 'the industry' they are miles ahead. Having excellent customer service does a couple of things. It builds incredible loyalty. It provides a marketing angle (these happy people tell their friends about their great experiences). This also allows Apple to charge a premium for their devices. There is a reason Apple is the number one BRAND in the world today; this position has been earned in small, incremental steps over the past 20 years.

[giofranchi]

I wrote a few thoughts on Apple in my investment journal. It's kind of stream of consciousness, so it might not all make sense or address everything. Apologies in advance:

 

Thank you very much for sharing your thoughts! :)

 

Basically, I reckon AAPL a sort of monopoly (they control 92% of earnings, right?) in a still growing market. And usually, if well managed like AAPL seems to be, that is a very good thing to own.

 

Cheers,

 

Gio

 

[giofranchi]

Liberty, please keep publishing your notes... They are a great read.

 

+1! ;)

 

One bucket you did not mention was customer service.

 

Also design, no? Imo AAPL is software + hardware + services (customer service included) + fashion. They have to keep designing great looking products, no?

Of course, the fact they control practically all the earnings of the smartphone industry helps.

 

Cheers,

 

Gio

[Viking]

I think one of the main reasons that Apple trades at times at such a low PE is they do not focus on Wall Street when they run their business. One of the reasons I love Apple as an investment is they constantly talk about making decisions and running the business for the long term. Wall Street is focussed on the next quarter. Wall Street wants nice predictable quarterly and annual growth and results. This is not how Apple's business works.

 

I get the sense that Apple often works on two and three year development cycles (major refreshes). Look at most of their products (hardware and software); many do not receive major annual updates. iPhone seems to get major upgrades every two or three years. What this does is cause their quarterly and even annual sales to swing quite dramatically (to show very different growth rates); not very predictable or smooth quarter to quarter or even year to year.

 

If you look at Apple and if you smooth out the quarterly and annual swings you get a company that is still growing very well (and yes the growth rate is slowing as the company gets larger).

 

The challenge they are going to have this year is two fold:

1.) continued US$ strength will impact revenue and earnings by about 6-8%

2.) launch of iPhone 6 (larger screen) resulted in much higher sales in fiscal 2015 than normal due to pent up demand for larger screen phone; this may make it difficult for Apple to post much in the way of year over year unit growth in iPhone for next 12 months.

 

The Bears will say we have reached 'peak Apple' and that iPhone units have topped and will begin their inevitable fall. My guess is this is a primary reason the stock is currently trading at less than 12 times prior year earnings.

 

But we will get through the 'challenging' year (fiscal 2016) and then Apple will again show nice growth (fiscal 2017) and the stock will take off again. What I love is Apple is spending more on R&D than they ever have and this spending will likely result in much higher revenue, earnings and stock price over time. Lumpy? Yes. Higher? Yes. Works for me.

[Liberty]

Liberty, please keep publishing your notes... They are a great read.

 

One bucket you did not mention was customer service. One of the main reasons I purchase goods at Costco is they have outstanding customer service; I KNOW if I have an issue I can take it back and they wil look after me. Apple also has outstanding customer service. I personally could give 4 or 5 examples in the past 6 months alone of where I was pleasantly surprised by the service I was given either at an Apple Store or online.

 

 

The customer service angle has really hit home for me recently; my son is looking to buy a computer to use primarily for gaming (not my first choice as a parent but he is using his money that he earned). He decided he wanted to buy a laptop from Lenovo. He purchased the laptop online; they delayed his delivery date twice (totaling a one month delay). He decided to cancel his order with Lenovo (rather than wait). He was able to cancel his order but only after talking on the phone with a number of people for a couple of hours and over a couple of days (people who need to sign off were not around). Absolutely brutal customer service. He decided to purchase a Dell laptop. The computer showed up about two weeks ago. He experienced issues with the wifi and the screen started going completely blank. He called the help desk today and the Dell troubleshooting guy suggested he get his screwdriver out and remove the battery from the back. I got involved and suggested if he was already having multiple issues with the device he should return the device ASAP, get his hard earned $ back (while he could) and find a better option. He was transferred to 4 different people at Dell over a 2 hour period to get this done; the best part was he was told at one point that there was only one person who could Process the return of his device and that person was not available and would call him back sometime in the next 24 hours (the call centre was in India I think). I got involved at this point and they 'found' the guy. Bizarre.

 

I am not saying that Apple customer service is perfect. However, compared to 'the industry' they are miles ahead. Having excellent customer service does a couple of things. It builds incredible loyalty. It provides a marketing angle (these happy people tell their friends about their great experiences). This also allows Apple to charge a premium for their devices. There is a reason Apple is the number one BRAND in the world today; this position has been earned in small, incremental steps over the past 20 years.

 

You are absolutely right about customer service. IMO this goes with the stores, where they also do classes for people who might otherwise be scared of technology, where you can try the products, and they do a lot of basic repairs in the back. The good service plus knowing that there's actually a place you trust where you can go gives a lot of people a lot of peace of mind that they don't get by going to Best Buy or the Verizon store or whatever.

 

Amazon is another company that has built a lot of trust over time through customer service, and as long as you can maintain that trust, it'll give you a competitive advantage over others who don't have it (in fact, a lot of people trust Amazon so much that they buy without comparing prices elsewhere -- something that I've done often).

[mals]

Liberty, please keep publishing your notes... They are a great read.

 

 

Amazon is another company that has built a lot of trust over time through customer service, and as long as you can maintain that trust, it'll give you a competitive advantage over others who don't have it (in fact, a lot of people trust Amazon so much that they buy without comparing prices elsewhere -- something that I've done often).

 

Liberty - thanks for sharing your stream of consciousness. :)

 

And agree with your observation about the importance of customer service - I for one would buy from Amazon even if they were charging somewhat more than other less trustworthy retailers...

 

As for Apple's customer service, I have had people call me and talk about how they love Apple customer service and how thankful they are that they did not buy a Samsung phone because they could not survive for days without a working smart phone.

[rkbabang]

Liberty, please keep publishing your notes... They are a great read.

 

 

Amazon is another company that has built a lot of trust over time through customer service, and as long as you can maintain that trust, it'll give you a competitive advantage over others who don't have it (in fact, a lot of people trust Amazon so much that they buy without comparing prices elsewhere -- something that I've done often).

 

Liberty - thanks for sharing your stream of consciousness. :)

 

And agree with your observation about the importance of customer service - I for one would buy from Amazon even if they were charging somewhat more than other less trustworthy retailers...

 

As for Apple's customer service, I have had people call me and talk about how they love Apple customer service and how thankful they are that they did not buy a Samsung phone because they could not survive for days without a working smart phone.

 

I agree with all of the above.  I'll add in that what is even better than great customer service is never needing it.  I've got an iPhone, an iMac, and I've owned iPads and iPods of various types for years.  I've never needed to contact Apple for anything.

 

[TheAiGuy]

The thing I'm interested in is where gross margins go as revenue growth inevitably slows. The big fear in 2013 was that falling gross margins meant that the commoditization thesis was playing out. That particular commodification due to competition thesis was shown to be false by the iPhone 6 Plus, where more consumers were willing to actually pay more for an iPhone than they did before. The new version of the argument is that consumers will value future new iPhones less than they valued previous new iPhones, because their existing phones are good enough. And Apple seemingly can't move new product categories such as Apple Watch and Apple TV without aggressive discounting by third-party retailers.

 

I personally think the smartphones are still very far from being good enough. And for the reasons that Liberty has articulated, I don't see any competitor taking over the smartphone banner from Apple.

 

I think anyone can agree that Apple Pay, Apple Watch, Apple TV and the like have been less wildly successful than many hoped for. It wasn't so long ago that some fantasized that Apple Watch was the harbinger of Apple being awarded a "luxury" multiple.

 

If gross margin falls, it means that there is not merely uncertainty about Apple's future growth, but also whether it's possible for Apple to have a steady state where even when there's no huge revenue growth and growth in the installed base, people still dutifully update their devices every so often.

 

I care more about ASP of the iPhone than gross margins overall. If they sell a lot of sport watches, for example, the margins could fall but that wouldn't be a sign to worry. ASP of the iPhone is up a lot since 2013, so no worries there.

 

But see, I actually do care about overall gross margin. I think if the general product mix carries significantly lower margins than iPhone, that really is a reason to worry, because it shows that Apple cannot purposefully create a product with the same unit economics characteristics as iPhone.

 

Let's not forget the public narrative around Apple Watch. Everyone was talking about the fact that Apple Watch was a positive harbinger for the future precisely because it was a fashion product that could justify high margins!

 

Well, it depends on how you think of the watch. I think of the watch as having strategic value that's independent of its profitability and I don't expect economics like the iPhone for, really, any product by any company, ever.

 

The unit economics is more a question of pricing -- I don't think the market for the watch is as large as the iPhone and will be at some point demand constrained, so I expect the unit economics to be a function of how much volume Apple wants from the watch (i.e. they view it has strategic value) vs how much they want it to be its own profit center.  I assume Apple wants to make money on the thing and keeps pricing at good margins but I don't really know (they can get what ever margin they want on the watch if they don't care about volume).

 

I think the public narrative around Apple is kind of dumb, so I'm less interested in what others' expectations for the product are. To me, it looks like a product that will be around for awhile and ship in large enough volume to justify the capital invested it (whether it justifies the attention of senior management is a different question).

[Picasso]

Not sure if it's been mentioned on the thread before, but Apple Pay has been a bit silly in some aspects.  Just a couple examples I've experienced.

 

I made a large purchase with Apple Pay and they needed to call in for authorization.  Well, I didn't have the card that was on that Apple Pay account (they needed info from the card) so it was this whole crazy thing of setting up my wife's card with Apple Pay (Discover was having 10% cash back with Apple Pay) in order to get it to work.  Maybe large purchases aren't a common thing with Apple Pay, but looks like you need to bring your card anyway.

 

Then I was at CVS buying like $10 worth of stuff and used Apple Pay.  Low and behold it asked me to insert my card since it had a chip.  So yet again I had to pull out my card (this time I was smart enough to bring that card with me) to complete the transaction.  Apple Pay was just introducing an extra step in the process which made it somewhat annoying. 

 

Neither of these are the end of the world but I just found it interesting.

[Liberty]

CVS has tried to disable Apple Pay in the past and I'd not be surprised if they were not fully on board yet. I don't think this is Apple's fault, but over time, holdbacks should be fewer and fewer.

 

The large purchase thing is probably a rule from the card issuer, not necessarily something Apple controls, but I suspect that the process will be streamlined over time. Maybe they can issue a special token from the software so that you can reply to the phone questions without the physical card (would be more secure anyway).