Contributor: John Griffin
Title: Portfolio Manager
Firm: Wildehond Capital
Location: New York, NY
Notable Stock Expertise: ZLC, CVS, GME
Undergrad: Colby College
Post Grad: Wharton, University of Pennsylvania
Timeframe: 6 Months to 1 Year
Recent Price: $630.00
Price Target: $400.00
Brief Investment Thesis
The conventional wisdom is that Apple is a juggernaut that won’t be stopped. And so it may turn out. But it can’t be that simple. The reality is there are many potential pitfalls, some of which we can’t currently perceive, and some which are in plain view. To be very brief, my judgment is that product maturity and competition will cause both revenue growth and margins to decline. Below, I highlight 10 factors/issues that are of particular concern to me:
1) Apple is dependent upon two products for a large proportion of their revenue. And one of these products is no longer in the rapid growth phase of its lifecycle (recent quarter’s performance notwithstanding).
2) Apple requires constant innovation to maintain its growth trajectory, and there are reasons to believe that it is currently in a ‘lull’ with regards to innovation.
a. Correct me if I’m wrong, but the latest iPhone was not a significant improvement on the prior model, was it? Additionally, the iPhone is now on AT&T, Verizon, and Sprint. There just aren’t many potential catalysts for further sales “jumps”.
b. The new iPad wasn’t groundbreaking either. And more importantly, we can see that Apple is bumping up against some technological barriers. One is battery size/efficiency. Another has to do with user data cost. Many users of the new iPad blew through their monthly data allowances on their plans in just a few days. So, Apple can add all the features in the world, but if it is unaffordable for owners of the devices to use them…
3) Competition will be fierce(r). About 8 years ago, when Apple started its current run, its main competitors were MSFT and the PC makers. Tomorrow, GOOG and others will offer much tougher challenges than MSFT ever did.
a. Android has been rapidly gaining tablet share, and is on pace to overtake Apple in 2Q12! Meantime, iPad pricing has been declining modestly while costs have been slowly and steadily rising. These developments point to slower top line growth and to margin compression. Indeed, iPad margins have already begun to contract.
b. The story is similar for the iPhone. Competition is increasing, which will inhibit Apple pricing and force Apple to spend more for R&D etc. Again, sales growth and margins should disappoint as a result.
4) iTV will not be a significant profit generator for AAPL. TVs last 10 years, rather than 2 years for a typical cell phone, tablet, or notebook. Furthermore margins for the manufacturers are slim, to say the least. And I can’t foresee Apple being a content provider. So, perhaps I’m lacking some imagination here, but I don’t see iTV being a third massive profit center for Apple.
5) Has there ever been a more one-sided trade? I mean who isn’t long AAPL? Just who will the next marginal buyer be? It seems like everyone who did not own the stock has now ‘thrown in the towel’ and bought it. I mean heck, if you don’t own it, and it stays on a tear, then you are going to struggle mightily just to match your benchmark. And I suspect there are very few who are net short the stock. Indeed, a short position in AAPL is a career risk, given that most colleagues will think you are an idiot and your clients won’t think too much of you either. And if AAPL goes on to double again…well at least we’re still passing out 99 weeks of unemployment benefits here in the States.
6) Steve Jobs’ death was a game changer. Apple succeeded because of the creative genius of Steve Jobs. He can’t be replaced. Let me say that again: HE…CAN…NOT…BE…RE…PLACE…DDD. From what I understand (although I have no inside info here) he had laid out about 2 years worth of product development for AAPL before he became incapacitated. This is why his absence has not hurt Apple yet. But at some point in the next 9-18 months, it will. There is no way it cannot: A singular mind and spirit such as Jobs’ is exceedingly rare. How can his absence not be a huge deal?
7) If you believe the market is headed for markedly negative returns over the next 6 months, short AAPL may be a good way to play this.
a. Institutional cash positions are actually quite thin at the moment, and margin debt is relatively high. What happens when the market starts to falter? Investors sell liquid positions that have been winners (most of us would rather lock in profits than ‘monetize’ a loss). Nothing fits that bill more than AAPL.
b. Deep recession in Europe, recession in the US, and slower growth in Asia will dull consumer’s appetites for discretionary toys. And as foreclosures ramp up again post Robo-signing settlement, millions of people will actually have shelter expenses again. Yes, even Apple is subject to the laws of economics.
8) Was the dividend and share buyback announcement actually bullish? Yes, that’s a rhetorical question. Normally, when a growth company starts paying dividends, it is saying that it really isn’t a growth company anymore. Now it may be different for AAPL, since their cash hoard is SO huge. But if you intend to conquer the world, it actually helps to have a huge war chest. And if you intend to grow at a fast rate in a rapidly changing world, but perhaps you think you don’t quite need all the cash you have on hand, and want to appease your shareholders (but why do you need to appease investors when you are the hottest, most widely held stock on earth?)…well then you issue a special dividend, rather than commit to CFF OUTFLOWS IN PERPETUITY.
9) Apple is, and will continue to be, in direct competition with its suppliers. How can that not cause problems at some point?
10) Sometimes, you just have to call “bullsh**.” Apple’s market cap is now greater than the entire retail sector. Really?
So now, let me respond to a few (of the potentially hundreds of) criticisms to my thesis:
1) Critique: “John, even if you are ultimately proven correct, this could take 1-2 years to play out, and the stock could go to $1000+ before dropping to $400. Actually, on its current trajectory AAPL will surpass $1000 by the end of the summer! As it approaches $1000 I will be forced to cover my position at a big loss.” Answer: Well that’s your problem, not mine. I can ride this thing out. There are two solutions, however: a) buy puts rather than short the stock, or; b) start your position small and average in at $50 increments such that you will attain a full/normal position size at say $900.
2) Critique: “John, your concerns about the stock are surely priced in- look at the P/E ex. cash!!” Answer: Well first of all I think that forward EEs are too high. Second, ex. the cash the P/E should be lower as the cash provides ammunition for investments and reduces the risk of the B/S (to about zero, in this case). Third, Apple is dependent upon 2 products for most of its earnings, and (in theory, anyway) produces very discretionary products. As such, you should not expect Apple’s P/E to be higher than, say, a high-quality and well diversified consumer staples stock.
3) Critique: “John, even if the chances of you being right are > 50/50, the upside/downside risk is not in your favor. If you are wrong, you can lose > 100%. If you are right, you will be lucky to post a 50% return. In short, it’s just a dumb trade.” Answer: Yeah, I get what you are saying, although again one way to deal with this is to look at put options. Also, I fully recognize that you may know more details about the stock than I do, and said recognition does give me pause. But in this particular case I’m not relying on calculations, estimates, superior knowledge of details, and such. You see, I’m not playing my cards, I’m playing you.