Apple as Another Sony?: Talking to Michael Whalen
First, happy Memorial Day to all of our service men and women around the world and at home (see my comment on Breitbart.com).
Over the past decade, I have been discussing the tech sector with my brother Michael Whalen who is currently the Head of Digital Rights Administration for TuneSat,LLC. TuneSat’s audio fingerprint technology monitors hundreds of TV channels in 14 countries and crawls millions of websites. Mike is a professor at NYU and The City College of NY, a two-time Emmy® Award-Winning composer as well as an internationally-known recording artist. In terms of reference points, let’s just say that Michael put me on to Apple Inc. (AAPL) over a decade ago, just before the introduction of the iPod and iTunes. He has been watching the transformation – maybe decomposition – of the media industry from the front row. I caught up with him last week in NYC. -- Chris
RCW: So Michael, we have not spoken in some time about the tech/media sectors. Let's start off with the obvious topic, namely AAPL. A year ago this company could do no wrong and the stock was neat $700, but now AAPL's future prospects are very much in doubt and the stock is below $450. Vast piles of cash is just not the same as growth, I suppose. How do you see AAPL today and going forward?
MW: Ah, AAPL... it's pretty clear that their transition from being a innovation company to a company that manages the innovation they've already created is just about done. Look at their pipeline - it's all improved versions of what we have already got: lighter iPads, faster Macs and iPhones with more stuff. Beyond the endless rumors of a really expensive television, Tim Cooke's big idea seems to be AAPL moving from the hardware business to the information business – namely iCloud.
RCW: Is that a bad thing? How many new gadgets can any company spawn in a decade? Why do I feel a sense of déjà vu?
MW: It's highly debatable whether AAPL iCloud is making the inroads that they predicted. AAPL is building military-grade data centers around the country - but the jury is out on the short-term wisdom of this strategy. In other words, how many times can you re-sell me my own iTunes library over iCloud? For the long-term, this idea MIGHT work but then anyone who is serious about being in this business is looking at how data services have become commoditized and they're everywhere - - with the price slashing and much lower margins that come with it. Look at the Amazon (AMZN) business data services - they have more "virtual servers" than just about anyone and they're feeling the downward price pressure. So, the "data wars" have started to happen and the overall picture is muddy at best.
RCW: Agreed on AMZN cloud servers, which is a great but commodity product. How can anyone compete with irrational players like AMZN or Google (GOOG)? So what would you do?
MW: I think AAPL's best play is to take what's left over cash from their very ill-advised stock buyback plan and to start BUYING technology companies. If they don't have the creative wherewithal to do it internally - they have the checkbook to make some serious strategic acquisitions. Here's idea #1: buy companies OUTSIDE of media, technology and entertainment.
RCW: So, what, steel mills? I know you are not very keen on the media space as a store of value. Where do you go in terms of M&A if you are AAPL?
MW: The television networks and film studios, which are looking to be bought (did someone say Sony (SNE)?), aren't worth their current valuations. It's already a buyer's market out there. So staying away from "media" companies is smart. But how about alternative energy companies? There are all kinds of conversations about "wireless electricity" and optimizing solar. You need energy to power all those servers - right? (laughs).
RCW: You’re kidding, right?
MW: AAPL has some major decisions to make and building a new billion dollar campus in Cupertino (Steve Jobs' design) is further evidence that they're looking in the wrong direction.
RCW: Agreed. I have to chuckle hearing your analysis. For all of those years when AAPL could not get out of its own way operationally, nobody would have ever suggested that they become an M&A platform. It’s easy to buy when you spend other people’s money. Now that AAPL is the top dog in a declining space, do you really want them to start buying more operating assets? Your comment on SNE is very telling here because it reminds me of AAPL today. What value do you see in the media space? I am not sure that I'd want AAPL to spend my money on deals. Isn't the stock buyback the best course?
MW: You'd think that the stock buy-back would be "prudent" for AAPL. However, what kind of economic weather is AAPL preparing itself for? Are we rolling up the drawbridge in Cupertino and getting into a siege mentality? If the widely anticipated "depression" on 2008 hasn't happened yet in the United States – does APPL know something we don't? Frankly, they've done very well as a publicly traded company predicated mostly on the "heat" of their brand. I assert that if Steve Jobs was still at the wheel at APPL he'd be taking that money and putting it into development. So, given that they have about 45 billion dollars left over (mostly offshore - by the way), I would like to see them investing outside of their declining space. There is VERY little value in the media space long-term.
RCW: As you and I have discussed, entertainment as an economic proposition seems to be sliding backward into a model where artists have sponsors rather than revenue. Think the Middle Ages here. If you are not Tom Cruise, then the studios can’t monetize your content. What does any media company do with a pile of cash?
MW: The Internet media business is a business that moves at light speed. People under the age of 21 don't "view" content - they devour it. So, as a response, the film studios have become banks to finance the few "big" movies they do produce and they are making fewer and fewer of those pictures. Also, they have co-opted their investments into bite sized clusters that almost eliminate their risk – but these projects don’t build anything for the future either. The studio bosses are patting themselves on the back with their 2012 numbers - but they know in reality that the party is over. The future of media is about being a lean, mean and a profitable machine.
RCW: That does not sound bad. But explain why the major media companies are not building foundations for future revenue?
MW: You might have seen the strategy of Netflix (NFLX) to create "high end" content for their customers. In some ways, this strategy has paid off in the short term by converting some of the “boo birds” on Wall Street to stop telling investors to sell after 2 very long years and give the company a second look. Their shows have created some positive buzz and their subscriber base is over 40 million worldwide. The bad news is that they cannot possibly keep spending money on content and over-priced licenses. Reed & Co. at NFLX have done a good turnaround but their moves are just a version 1.0 of the realignment that I am talking about. Said another way, you won't see Netflix spending $100 million on another series EVER again or certainly not without a lot of cooperative help/risk sharing. And investors will have to hold their breath again when their major licenses come due.
RCW: So more of the same “withering away” of the economic model for new content we talked about last year? Does this movie have a happy ending?
MW: Said simply, internet-based media companies will have to be transformed to make whatever money they're going to make in a DAY or a weekend. Their production and operational costs will have to be almost literally zero. Look at GOOG and the new subscription channels they are offering. YouTube earns money at about $25 million dollars an hour in advertising. However, look at how lean these new content channels are and will be. No one around Eric Schmidt is urging GOOG to write a big check to an A-list actor. They don’t NEED to. Also, most of this new Internet content will be made for phones and mobile devices. Yes, we have seen for some time now that people want their entertainment on the move and no one wants to pay for the content. So, welcome to an entire industry looking for "back end" money or the ability to monetize eyeballs somehow some way. There won’t be any money in the front end.
RCW: You’ve been describing this process for some time, where legacy content is losing value and only super brands can attract eyeballs. Does this really mean that all other content goes begging?
MW: The monetization of endless catalogs of audio and video content over long periods of time with ancillary licenses and sales are OVER as well. So, when SNE Pictures is up for sale – what is SNE selling? They'll tell you it is brands that people know and can be capitalized in the future. This is not really true because the future they're talking about is 5 - 7 years. They won't tell you that the generation of people who would buy "The Godfather" in any format a decade ago isn’t buying anything anymore.
RCW: Well, I give Spotify $9 a month. Your point about SNE is interesting, though. Once upon a time, SNE came up with some clever, albeit derivative consumer products like the WalkMan. Remember that? Kind of like the many "new" AAPL products in that they were a refinement of an existing product/functionality. New technology allowed SNE to make a tape recorder or TV smaller, better, portable. But much of the SNE product line was basic conventional TVs, cameras and sound equipment. Is AAPL the next SNE in a sense that they are now being eclipsed by new technology and use trends? Remember when AAPL kicked SNE et al out of the professional audio/video segment? The other day, our cousin Billy Demarco, a veteran TV animation artist, told me he is almost ready to take his studio back to PCs after a decade on the MAC. Is the age of AAPL over?
MW: Let’s talk about SNE first. It's pretty clear when you parse through their "shiny" numbers from Q4/2012 that water is flooding into the SNE engine room. Third Point Capital has made an offer to create an "IPO" for 15 - 20% of SNE's entertainment business. The idea here is to put together a war chest of cash to fund the electronics division of SNE. Frankly, SNE would be happy to SELL the entertainment division if it meant the bleeding would stop and the rapidly shrinking asset that they paid top dollar for over the last 15 years would just go away. SNE needs to reestablish itself in the technology space. But the problem is that the market they want to reclaim has all but disappeared.
RCW: Wait, is this another benefit of technology?
MW: Some 20 years ago, it was brilliant to have a consumer electronics company and a media company together. Now, you have competing balance sheets, foggy outlooks for both sides. SNE's real problem is that their overhead versus cash flow is killing them. They have the infrastructure of an "old" media company with the declining sales of a new one. You can only fire so many people from a large, legacy company before it completely implodes. SNE’s content side could be relevant again but not riding shotgun with an ailing legacy sister company added to a own mountain of operational and market issues. In this environment, the culture of innovation that spawned devices like the WalkMan, BETAMAX video, Blu-Ray video and more isn't possible. When you're trying to survive - the creative juices don't flow very well.
RCW: No indeed. One of the reasons that the Bank of Japan is printing money like crazy is a desperate effort to save old line companies like SNE. The Koreans, Taiwanese literally chased the Japanese out of the device business. But tech hardware, like autos, is a commodity business that eats capital. So where does this annihilation of value in both hardware and content leave AAPL? Everyone assumes that “content is king.” Does that sound correct in your view?
MW: I think AAPL has been smart to stay OUT of the content creation business. However, I think you're assertion is correct - looking 3 to 5 years out - AAPL's position will be weakened due to inroads made by HUNDREDS of technology companies – not by a single huge competitor. GOOG is not the AAPL killer – but rather the tiny new companies that will nibble all of the giants into irrelevance. The age of hardware made by large, dominant brands is OVER. In this environment, killer software and popular apps can take hold for VERY little money (or overhead). There is so much downward pressure on hardware prices that more and more major companies will opt out of the hardware business. The model in simple terms is to be a data and information systems company.
RCW: IBM was the early first mover example of running away from hardware. What’s the bottom line on AAPL for you?
MW: It's interesting to note here that Third Point Capital dumped a huge position in AAPL in February. It's dangerous for even professionals to jump in and out of the mud in the media space - the pieces are moving very quickly. But vast arbitrage opportunities do pop up.
RCW: It’s just the wonder of the free market in operation. Thanks, Michael.