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Sentiment and musings: So what are the Apple skeptics saying?
Apple was the best performing stock in our coverage universe this past week, as the stock
soared 7.4% versus a 2.4% increase in the S&P 500. So far this year, Apple’s stock has risen
44.6%, heftily outpacing the 11.7% increase in the S&P 500. From a sentiment perspective,
the stock’s performance this year is clearly telling us that investors have become
increasingly bullish on the company’s prospects. With that said, we continue to be
surprised by how many investors we speak with that are still skeptical on the stock and the
Apple story. By highlighting this, we are not trying to say that the stock is under-owned; in
fact, while some of these skeptics do not own the stock, other skeptics own it because they
feel they have little choice. In a sense, the latter group appears to be reluctantly hugging
the benchmark and chasing the stock as it continuously seems to find new highs this year.
Indeed, we believe this partly explains the stock’s performance in the weeks after earnings
and after the new iPad release. Many skeptics we spoke with expected a pullback on both
events, and when that pullback failed to occur, they frantically rushed to buy the stock at
higher prices. We believe this is partially leading to the slingshot spikes in the stock.
Furthermore, these moves seem to be exacerbated by an underlying re-rating in the
multiple of growth stocks in general, and we would argue that Apple’s valuation had (and
still has) the most catching up to do in this respect. We remain steadfastly bullish on
Apple’s stock, even after this year’s rapid run. Nevertheless, in order to determine where
the stock is heading from here, we believe it is important to explore the skepticism that
naturally builds when such a large market cap stock appreciates so quickly.
We believe it is particularly important to focus on the skeptics that are “reluctant holders”
of Apple’s stock, as it seems reasonable to conclude that these investors may become the
lead steers that drive Apple’s stock performance in coming months. On the one hand, they
could exacerbate any correction that Apple’s share price experiences in the near term. This
is primarily because if the reluctant holders gain evidence to support their points of
concern, they will quickly become emboldened bears and sell the stock. On the other hand,
if these skeptics begin to believe that many of their concerns are overblown, they could
drive the latter stages of Apple’s re-rating process, producing a powerful continuation of
the recent rally in the stock price. As we analyze the concerns of the skeptics, we are
increasingly confident that the latter scenario will come to dominate Apple’s stock
performance the rest of this year.
The following represents our summary of the key arguments we continue to hear from the
skeptics, particularly the “reluctant holders.”
Skeptic argument No. 1: “Someone’s bound to come up with a better
mousetrap.” We often hear Apple skeptics discussing the latest components or
form factor changes from Apple’s competition, and they will inevitably argue that
it is much better than the current iPhone or iPad. Samsung is the latest hardware
competitor that is most often referenced by the Apple bears, while HTC was the
threat du jour in early 2011. These hardware-centric comparisons are often not
favorable for Apple because, if we line up Apple’s hardware features for any given
product, they are sometimes behind the curve on at least one or two elements.
While this is often due to Apple’s maniacal avoidance of “feature creep,” or more
often, an intentional tradeoff to preserve battery life, aesthetics, or processing
speed, it still emboldens the bears on each and every Apple product refresh.
Nevertheless, time and time again, we find that these hardware-centric skeptics fail
to consider the user experience and the underlying software and content platform.
Which phone is easier to use? Which tablet has more apps available for download?
Or which phone and tablet can be easily managed with one unified, cloud
platform? The hardware-centric arguments against Apple always tend to fail
because the vast majority of Apple product value now comes from the tight
integration of its hardware and the iOS platform. As such, the “better mousetrap”
argument against Apple has to come from the innovations of its platform
competitors, like Microsoft or Google. If these companies can erode Apple’s
software or content advantages, then third-party hardware companies may have a
better chance to compete. For now, however, neither Android nor Windows seems
to pose a material threat, so this particular bear argument is likely to fade in
coming months.
Skeptic argument No. 2: “Subsidies have to come down. The carriers
can’t sustain this.” On February 27, 2012, the Wall Street Journal published an
article discussing Apple’s dependence on carrier subsidies to allow the iPhone to
hit mass market price points (“iPhone’s Crutch of Subsidies,“ The Wall Street
Journal, February 27,2012). By looking at Apple’s relatively small smartphone
market share in Greece and Portugal, the author concludes that Apple’s iPhone
momentum could suffer if carriers begin to pare back the hefty subsidies they
currently offer. From Apple’s perspective, this would likely translate into a decline
in the $600-plus average wholesale price that has bolstered its iPhone revenue and
profit growth in recent years. While this article itself didn’t seem to impact Apple’s
stock over the past month, it has been an increasingly hot topic of discussion with
investors we have spoken with since then. In other words, this is the latest version
of the age-old argument that Apple’s prices and margins are too high for mass
market success. While we believe Apple will offer lower wholesale prices over time,
primarily to drive incremental growth in predominately prepaid phone markets in
emerging regions, we do not believe that substantial ASP and margin pressure in
subsidy (post-paid) markets is likely for several reasons. First, subsidies are not
just for Apple’s benefit: they are the primary mechanism that allows the carriers to
hasten the transition from legacy feature phones to compute-centric smartphones,
and any vendor that lags in this transition will likely suffer sub-par ARPU and
market share as this transition progresses. Second, Apple’s lowest-end iPhone has
already leveraged these subsidies (and Moore’s law) to reach a $0 price point, and
over longer-periods of time, the subsidies needed to reach mass market price
points will naturally decline with declining component costs. Third, the relative
strength of Apple’s platform has made its customers remarkably loyal, so any one
carrier that chooses to offer the device at a far higher retail price risks substantial
installed base erosion. So overall, without broad carrier collusion, we believe this
argument is unlikely to represent a material problem for Apple investors for the
foreseeable future.
Skeptic argument No. 3: “The law of large numbers is bound to take
over.” This is probably the most common bear argument we hear on Apple, and
ironically, it has been a popular source of skepticism since Apple was a much
smaller company. The reality is that this “law” is true in many respects. Over time,
Apple’s growth rate should come down, given its already massive revenue and
profit run rates. With that said, we believe this is a flimsy bear argument for
several reasons. First, Apple’s multiple is already at levels more common for much
slower-growing companies: Apple grew earnings by nearly 120% yoy last quarter,
and it was rewarded with a 2012 P/E multiple that expanded from 11X to 13X. So
we now have a market multiple on a hyper-growth company, which we still think is
far too low. Second, we asked about this concern when we interviewed Tim Cook
at the Goldman Sachs Technology and Internet Conference last month, and he
stressed that Apple’s share in its core markets was still remarkably low, so there
are still plenty of opportunities for hefty growth. For instance, despite Apple’s
rapid iPhone unit growth last quarter, it still only had 24% smartphone market
share and 8% of the total handset market. As such, this bear argument may linger
going forward, but its impact on Apple’s share price should continue to be
inconsequential.
As we look at each of the aforementioned concerns, it becomes clear that they are all only
the latest reincarnation of several key bear arguments that have surrounded the Apple
story over the past decade: (1) “Apple is a hardware-centric company that is dependent on
hit product cycles, so one flop and it’s over”; (2) “Apple’s hardware margins are so much
higher than its competitors, there has to be a reversion to the mean”; and (3) “Apple is so
big it has to be near a plateau.” While Apple’s financial performance has allowed it to plow
through these bearish concerns in recent years, the stigma of this skepticism eventually
drove the valuation to sub-market multiples in 2011. Nevertheless, we continue to believe
that most of these bearish arguments are based on a critical flaw: they all treat Apple as a
hardware company in commoditized markets, when we believe Apple is actually a
hardware company that happens to own one of the most resilient software platforms in the
history of the computing and communications industries.
The customer switching costs inherent in iTunes media content, the applications from the
App Store, iCloud and even Siri, continue to make it increasingly likely that a large portion
of the growing installed base of Apple customers will upgrade to other Apple devices in the
future. This gives Apple room to explore bold innovations, since one sub-par product
refresh is unlikely to increase installed base churn. It also provides a competitive moat that
is wide enough to allow Apple to reduce its product prices at a slower pace than the
decline in the costs of its underlying components (supporting margins that its hardwarecentric
competitors cannot match). And finally, the leverage inherent in a platform that is
based on one OS, a common set of hardware components, and a growing army of thirdparty
peripheral and software developers allows Apple to continue to invest heavily in
platform-enhancements and new products that should attract new users to expand the
company’s loyal and increasingly profitable installed base.
With that said, while we think the current bear arguments on Apple are off base, there are
real long-term risks for the company. If Apple fails to innovate and competitors can come
up with platforms that more than compensate users for the costs of abandoning their
iTunes media, apps, and the management capabilities of iCloud, then the installed base
could begin to erode and Apple’s ability to harvest above-average margins will fade. Or like
many technology platform leaders in past decades (such as IBM, AT&T, and Microsoft),
unforeseen regulatory restrictions could inherently limit platform expansion and
monetization. Nevertheless, in Apple’s case, these risks still seem fairly remote and years
away at this point. This, coupled with Apple’s ex-cash P/E of 11X CY2012 EPS and 9X
CY2013E EPS, suggests the skeptics need to re-evaluate their concerns.
Apple remains our top pick, and we would continue to be aggressive buyers at current
levels. We reiterate our CL-Buy and 12-month, P/E-based target price of $660. Key risks
include worsening macro conditions, supply chain disruptions, increased platform
competition, and poteEntial legal and regulatory restrictions. |
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发表于 2012-3-18 11:45 PM
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