Apple: When should investors sell Apple shares? The group's push overseas and into the business market still holds promise, as does the steady stream of fresh gadgets such as Apple TV, unveiled by chief executive Steve Jobs last week. Apple's trajectory should continue for some time, so its stock - which has gained more than 40 percent each year for the past five - looks attractive at 15 times estimated 2011 earnings.
But no company can grow sales at that pace forever. While it may sound premature or even churlish to do so, Breakingviews offers up some strategic cues that could act as warning signs for investors that Apple's growth is slowing:
Discounting: While Apple computers and handsets account for less than 5 percent of global unit sales, the company racks up extraordinary profits on them. Its reputation for producing quality gadgets means Apple can charge a premium over competing products. Its operating margin is almost 30 percent.
Even small gains to its market share result in supercharged profit growth.
Apple has used the so-called “halo effect”, rather than price cuts, to gain market share. Its devices work well together. And users who try one often adopt Apple’s other products. This can be seen now in the enterprise market, where Apple has traditionally been weak. The iPad appears to be a big hit among corporate executives and professionals. This should increase adoption of iPhones and Macs. Moreover, Apple appears to have avoided the discounts typically offered to big customers. If salespeople want iPads, there’s nowhere else to turn but retail.
Apple could boost market share quickly by offering discounts or cheaper devices. While this would bump up profits in the short term, it would be a flashing yellow light because the high end of the tech market is disproportionately profitable.
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While Apple could profit from selling lots of low-end gadgets, it’s a tough place to make a buck because of greater competition and lower capacity to differentiate products. Nokia’s operating margin on phones is around 11 per cent. Those in the commodity PC market aren’t better - Dell’s are around 5 per cent. There’s a big risk, too, that selling cheaper goods could tarnish the brand. A loss in the company’s ability to charge an “Apple premium” or a small fall in market share at the high end would hit profits hard.
Raising tolls: One way Apple has maintained premium pricing for its gadgets is by improving them each year. In the case of the iPhone, a large chunk of this improvement has come from the increased number of applications that can run on the handset.
Partners who develop these bear much of the cost. Apple vets the applications and distributes them in exchange for 30 per cent of sales. Apple hasn’t historically run its online stores to maximise profits. Instead, the goal has been to make the devices more valuable and entrenched. The result is a virtuous circle. Consumers like the gadgets because they have become increasingly useful, and software developers follow the customers. Apple could, theoretically, extract bigger tolls - take 50 per cent of revenue from sales, for example. Those increased revenues would fall right to the bottom line.
Yet developers could eventually turn elsewhere, and users might follow. Google, for example, plans to take only a 5 per cent chunk of sales on games that it sells online, plus a small processing fee. Second, ratcheting up the toll might invite regulatory attention, because it smacks of anticompetitive behaviour. While raising its revenue share could generate some short-run growth, it would be a bad sign for the company’s future.
Big acquisitions: Apple has $46 billion of cash and investments on its balance sheet. Mr Jobs may find this fast-growing stash comforting. But it isn’t earning much interest. Apple has wisely avoided big acquisitions. When many companies see their growth slowing, however, they often try to buy it through “transformative acquisitions” in the way Intel is purchasing McAfee or HP buying 3PAR. Apple’s cash could buy a majority of companies in the S&P 500. Surely it could find a big firm that would generate a better return than what it earns in the bank, right?
Don’t count on it. Integrating two big companies more often than not results in unproductive executive infighting and bloated expenses instead of valuable new product innovations. Most damningly, sellers usually extract the gains. Just look at Cisco. The firm is an efficient M&A machine, yet its shareholders have received little benefit over the past decade from CEO John Chambers’ shopping. If Apple ever headed down this route, it would be a sign that the firm has transformed itself into a lesser company.
