"The Apple Conundrum": Why One Fund Is Not Buying The iKool-Aid

Tyler Durden's picture

Looking at the parabolic rise in AAPL shares in the past 3 months one would imagine that the company's product line up, so well telegraphed over the past several years, has changed, or at least has found a way to cure cancer, while expanding margins, and also providing loans to cash-strapped US consumers to buy its products exclusively. Truth is nothing substantial has changed - we have merely seen a ramp as every hedge fund and asset manager jumps on the Apple bandwagon (we fully expect at least 250 funds to hold Apple as of March 31: at least 216 were in the stock as of December 31 and then even Dan Loeb jumped in after) which is fun and games on the way up, but pain and tears when the bubble finally does pop. Many have attempted to warn the public about the latest manic phase of Apple expansion, but few have succeeded - such as the the reality of bubbles: they pop when you least expect them. Yet giving it the old college try, here is Obermeyer Asset Management's John Goltermann with an extended commonsensical approach to his perspective on the company with two main growth products, and why unlike everyone else, he is not buying the iKool-Aid.

Some excerpts from the letter:

Most members of the Obermeyer Asset Management team use Apple’s products and highly respect the company and its achievements. We recognize that it has built a cult-like following of both technophiles and ordinary users who aspire to own its latest and greatest gadgets. We recognize the elegance of its platform, the ease, convenience and life-enhancing attributes of its apps, the effortless delivery of media content and how it has even transformed entire industries. We recognize the style element of owning Apple devices, we recognize the status that people derive as Apple users and we understand the mystique the company possesses in the way it operates.

 

Given our shared appreciation for Apple as a company, why aren’t we making a place for it in client portfolios? We generally separate current and prospective investments into three broad categories: Yes, No and Too Difficult. In the case of Apple, we see this investment as Too Difficult. Let us explain:

 

With a market value of $550 billion, Apple now comprises 4.4% of the S&P 500 index and, all by itself, is larger than the entire utilities industry. With 932 million shares outstanding, every dollar move in Apple’s share price represents nearly $1 billion in net new capital flowing to its shares. For context, the median company size of those in the S&P 500 is $12 billion, so a 2% move in Apple’s stock is the equivalent of adding a whole new company at the median value to the index.

 

Since December 31st, Apple’s market value has increased by $172 billion, which is roughly the size of Johnson & Johnson, a large, well-established, innovative healthcare and consumer products company with a 125-year history. Johnson & Johnson has enjoyed many successes, has reinvested high levels of profit and is investing to expand its divisions, products and businesses. Apple attracted the same amount of investor capital in two and a half months that Johnson and Johnson attracted in its entire 125-year history.

 

...

 

Apple launched its first iPad in April 2010 and is now on its 3rd version, so the iPad has about a two-year shelf life for the company (it might milk a few more years out of each version, but the company’s business model is to continually launch new product iterations and slash prices on the older versions). Though it’s not disclosed in the financials, a guess would be that the new iPad will sell 26 million units its first year and 14 million in its second. If each version of the iPad earns $260 per unit, then Apple investors can expect somewhere in the range of $10 - $15 billion in total pre-tax profit for this newest version of the iPad. Unless investors thought Apple’s stock was way too cheap before the new iPad announcement, they seem to be expecting much more value to be delivered to shareholders from the iPad launch than can be reasonably be delivered by sales of the iPad device itself. The $172 billion increase in the company’s value far exceeds the approximately $15 billion that will come from the iPad, so it will have to come from something else. We don’t know yet what that “something else” is.

 

When we look at our cash flow models, assuming Apple can maintain its current operating margins (a heroic assumption in the face of increased competition in the tablet market), to justify the current stock price, it appears to us that Apple will have to sell about $2.6 trillion worth of total products and services over the next ten years. Last year’s revenues (for the fiscal year ending 9/24/11) totaled $108 billion. If Apple’s margins shrink, it will have to sell a lot more. This level of Apple product sales will make up almost 1.5% of U.S. GDP (of course it  also sells products outside of the U.S.). That means that with the average GDP per capita in the United States being around $50,000, each person must spend $750 on Apple products and services annually (since 30% of sales are domestic, this means that about $225 per U.S.  citizen would go to Apple every year). Since not all 310 million people in America use Apple, those who do need to spend a lot more and the vast majority of those sales will need to be on devices because iTunes sales do not bring much profitability.

Like we said: no stories here. Just common sense.

Full letter (pdf)

 

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SheepDog-One's picture

As a general rule, I say 'No thanks' to bubble mania stock ramps and sleep better. 

Aunty Christ's picture

Folks, Apple is a consumer products company, subject to the whims of its customers. There was a time when its products were out of fashion. They are hot now. There'll be a time when they are not cool anymore.

Conman's picture

i keep thinking the same, but it seems like apple is that attainable luxury item these days. Kind of like Coach bags. They are kind of expensive but not really out of reach for the avg consumer. So until it loses that status itll keep selling although Android tablets and phones od the same for less money.

Buckaroo Banzai's picture

Apple's products were out of fashion 15 years ago because they weren't that good. They've fixed that problem.

No, Apple will crash when they saturate their market, and can't launch new products quickly enough to make up the difference. Which isn't too far off.

Spastica Rex's picture

I will take issue with this. DISCLOSURE: I fucking hate Apple.

15 years ago System 7 was what Macs ran. It was far to what MS offered. I managed large installations of both; there was no contest. 15 years ago, MS was a juggernaut. Macs became eclipsed even in the education space. This was due primarily to marketing, and the tipping point that MS engineered.

I hope Apple dies; they are as evil as MS ever was.

vato poco's picture

Agree on the inevitable 'ran out of cool new gadgets to sell and crashed' thing. IIRC, there was a time when Sony was going to own the world. Sony still makes good stuff, but...the cachet - and the stock - ain't what it once was.

rosiescenario's picture

Please provide a date....on a lng enough time line....

JW n FL's picture

 

 

http://www.youtube.com/watch?v=0nipR-FEL_w

Newmont CEO on Gold Market, Peru Project Review

P.S. they are Hiring AROUND the World! and Can NOT! find enough people!

Village Smithy's picture

They fiddled while Rome burned, we played "Angry Birds" while our nation became a debt slave.

CheapBastard's picture

I never buy at the HIGH......

 

I'm a Cheap Bastard.

stickywicket's picture

this market is so narrow it is coming to the head of a pin! It's the pin head market:)

sojourner_man's picture

Can you say -- spell -- B U B B L E ??

And they insist one can't spot a bubble before it pops!

NotApplicable's picture

I got a new Acer tablet at work this week, and my iTouch is now collecting dust.

Dr. Engali's picture

 

Apple has a nice product and it's pretty cool ,but I also remember when there were lines to get the next version of Microsoft Office. Look at it now. It's at best a tolerated company.

beaker's picture

Reminds me of the Chairman of the Board listens to a report where every one of his managers tell him everything is so good that it can't get any better.

"Can't get any better?" he asks.

"That's right!"

"Excuse me for a moment, gentlemen.  I'll be right back."

Next the Chairman steps outside of the board room and calls his broker on his cell phone.  "Sell every fucking share of this company that I have!"

Widowmaker's picture

I share the concerns of the author, with one exception.

AAPL is eating pie from literally every other technology company out there from hardware mfgs to cable TV operators.

It is no longer as high of function of product innovation being the driver going forth (short term) as much as competition collapse.

 

beaker's picture

True, but is that priced in at these levels?  Remember that (at least in what was once a normal world) stock prices today reflect the outlook 12-18 months in advance.

penexpers's picture

We don’t know yet what that “something else” is.

Hmm, how about iTranshuman? You know those hipsters and trendies will augment themselves with iNanos to one and for all merge with the Apple's iHive.

 

WhOracle's picture

seems pretty obvious that something else is the true Apple TV set...

SoundMoney45's picture

Apple created the iPod to monetize the market Napster initially defined, and the iTunes store with Steve Jobs personally negotiating with the record labels. Apple created the iPhone by obtaining largely unconstrained phone behavior in exchange for exclusivity, again something Steve Jobs personally negotiated. A third, and perhaps a fourth industry redefining products appear to be currently priced into Apple.  That said, buying Apple now and watching it fall to 300 is still a better investment than non-ECB owned Greek bonds.  

devo's picture

This can't end well.

Huge pressure on Apple this earnings season.

monopoly's picture

Apple is a great company with great products. What we are arguing about is its valuation. Absurd to the extreme. I love Apple products but 600+. Sorry, cannot drink anymore Cool Aid.

And maybe, just maybe.......the break? 0

devo's picture

The products seem to be in decline, if you're being honest.

e.g. Ipad 3 overheating and underwhelming, iphone 4 antenna issues and underwhelming overall, no new products just reiterations of past products. They also charge a premium for dated specs, notably on laptops.

There's a lot of pressure to come up with new products. I guess they're banking on their TV set being viewed as revolutionary...but is that really going to fuel the growth engine? I imagine the price point will be too high for Joe Sixpack. Then he has to pay for cable on top of it? High end TV business is meh.

The one thing I admire about Apple is they understand aesthetics and form. Samsung is starting to design nice looking machines, and their specs are much better than a macbook.

 

devo's picture

Apple at $450 seems fair. An investor must factor in down side, not just upside (e.g. low forward p/e, etc).

Google is in for some hurt, too. For some reason investors never learn with Google. It gets crushed a lot and never breaks out. I think $550 is fair, though that's still risky. I had it at $490 last year and felt that was a good entry point. 

 

monopoly's picture

Remember, as Apple goes, so goes the market, at least short term. Confetti still looks good here. And our miners. Yikes, at some point the trade of the decade. But when???

monopoly's picture

BBY may have been the straw that broke the Techs back. Apple just following down. Best Buy is history. Slowly going the way of Circuit City. Amazon eating them up. But $200.00 for AMZN with .48 cents in earnings. I think not.

devo's picture

Amazon is a good short. I got it last earnings season.

Amazon's biggest problems is low (and lowering) margins. It's a big ouch.

carbonmutant's picture

Buyers will always pay more for leverage...

Diet Coke and Floozies's picture

This stock screams OTM Put Option... Nassim Taleb style.

I am a Man I am Forty's picture

I can rip this analysis apart easily.  These guys don't realize that stocks trade at multiples of earnings and the growth is coming from China, Brazil, iPhone5, iTV, corporations.  Focusing just on the US is stupid.  They have barely put a dent in China.

This blog has become the laughing stock of the world when it comes to Apple.  Why don't you post some analysis that is actually comprehensive and someone who understands that stocks trade at multiples of earnings.  The stock was also very cheap with its growth prior to this latest run up.

This is common sense.  Been defending apple on this board 200% ago.  When I see bullshit I call it out.

 

Buckaroo Banzai's picture

I've been a big AAPL defender. Everything you say is true. But if the entire market turns and tanks, and P/E's drop to an average of, say, 7... that means that AAPL is gonna take a big haircut, even if they keep growing.

This is a narrowing market and narrowing markets are traps.

I am a Man I am Forty's picture

if the market tanks, the market tanks, and everything will go with it, but that isn't what their analysis is based on.

Agent P's picture

It's hard for a company of Apple's size to keep throwing off exponential y/y earnings growth.  Even if they ramp sales in China, which keep in mind is still largely a wealthy country of pour people, are they really going to get people to drop iProduct v.X for iProduct v.X+1 every 12 to 18 months?  I would argue that trend is going to quickly decline in the Western world as well.  Look at iPad 3 vs. iPad 2...do you think the differences are worth the upgrade?  Also, look at product cannibalization...iPod sales in decline as iPhone sales ramp...what happens as smartphones and tablets converge? 

Don't get me wrong, Apple will continue to churn out great products that people will want, but as soon as one product fails to generate the growth people have come to expect, the stock is going to correct hard.

I am a Man I am Forty's picture

you are correct, this will eventually happen, the question is when, I think there is at least 2 years of growth from here, then who knows, can't see any further than that.  And I don't think people need to upgrade from the iPad 2 for the iPad 3 to have great sales.

Agent P's picture

I'm more skeptical than you.  I think a big miss will come within the next 12 months.  iPhone 5 will be successful, but I think iTV (the actual set, not the current STB) whenever it is launched is going to be a flop...I think Apple is going to feel the need to push into a totally new product line as marginal growth in tablets and phones slows from fewer people upgrading to each new iteration.  If iTV is the chosen path, look out!  TVs are very price competitive, and I think few people will be willing to shell out premium dollars for a status symbol that they can't show off in public.

Full disclosure though, I thought the iPad was going to be a non-event (why does anyone with a laptop and a smartphone need a tablet?)...I couldn't have been more wrong on that one.

Kudos to you for making money in the stock...just be careful not to become so enamored with the company that you fail to see the turn.  

FranSix's picture

AAPL is the HM of the contemporary deflation.

vh070's picture

Geeze I wish I could spend only $225 per annum on Apple.  But with a family of five who won't tolerate minimum spec, it's probably somewhere around 10X's that.  And I'm still holding back: it's way past the time to update my 13-year old Cinema Screen with a new, bigger screen that will probably cost 1/3 the sticker price (1/4 if I go off-brand).  My bro', who's got a family of six, doesn't spend any less.  Dang but if we didn't create a monster!

Dingleberry's picture

I like Apple. I use their stuff a lot. But Apple is like Harley Davidson. It may not be the best, but having one makes you feel like you have a big dick cause it costs the most and makes you looks cooler than your friends.  Same with Apple. Kids use it as a status symbol. Period. End of story.  They can't afford "real" status symbols like Beemers or McMansions, so they judge each other by their having the latest and greatest iPhone.  In other words.....IT'S COOL TO OWN AN IPHONE.  Eventually, Apple will come down to earth. And another company will be "cooler".   But if you can make some money by striking the iron while it's hot, good for you. Just don't load up on this shit for junior's college fund.

Stubert's picture

Why couldn't Boom Bust Blog just write something that is as easily understood as what Obermeyer Asset Management just wrote?

q99x2's picture

( . i . )  Me ipads.

rosiescenario's picture

There are a couple of items not discussed that could prove to be black swan events for AAPL: their Chinese supplier is forced to pay workers a living wage thereby halving Apple's margins; the FDA announces that iPads are the major cause of erectile disfunction; employment increases in the U.S. so demand for time wasting toys drops; there is a mega solar flare disrupting the internet for one month and frying solid state devices; Al Quaida decides that iPads could be the letter bomb for this century and begins introducing iBombs through bogus eBay sellers....all programmed to detonate simultaneously at some time in the future; the Feds put a new vice tax on iPads; or, an event no one could possibly have foreseen craters demand for Apple's products....perhaps they spread a dose of H5N1 worldwide?

Whats that smell's picture

I recall hearing in 1999 or 2000 that Palm had more value than Boeing.

I am a Man I am Forty's picture

yeah, that handheld address book was so bad ass

chunkylover42's picture

Looks like two guys in their 50s completely missed the run in AAPL and can't believe it.

Bob Bercy's picture

Who are these jokers? There are 310m people in the US and 6.7billion in the rest of the world and he does his "analysis" on the base of the US. How charmingly and typically parochial. Get a passport dude...