Is Apple worth it?

This is a slight change for me because I am going to briefly mention an individual stock: Apple. There has been a lot of chatter about Apple recently because of the monster move it has sustained in the first four months of the year. Bloomberg reports that Apple gained more than $250 billion in market share in just four months to April 9. That’s more than IBM’s current value. Other impressive figures are being bandied about like: Apple is worth more than the entire retail sector combined, Apple is worth more than Microsoft, Google, Nokia, and RIMM combined, etc. While these numbers are impressive, I am sceptical. Last year at this time, I was asking: When will large cap tech stocks start paying dividends? because companies begin to destroy value when they have excess cash on the balance sheet that cannot be properly deployed and they resist dividends. So I am very happy to see Apple paying a dividend. I see this as a good sign.

I have liked Apple for a long time. My sister recently reminded me I recommended the stock to her 8 years ago but she never bought it and so she kicks herself she says. But, my earlier love of Apple as a stock has waned over the past eight years, particularly in the past few months, mostly because of valuation. As I wrote here earlier, Apple’s ascendancy in the S&P500 is more indicative of narrowing market leadership than anything else from a technical perspective. That has me worried. Moreover, I expect margins at Apple to compress as it competes for growth in an increasingly competitive market for mobile phones and tablets. Android has continued to make huge inroads and at some point either Apple’s market share erodes or eventually they are forced to compete at a lower price point. In fact, I expect compression to begin sometime this year, pressuring shares.

More than that, Apple’s share price depends not just on margins but on mobile growth, smartphone adoption rates, and market share in that order of specificity. Basically, Apple is riding the mobile wave as the best and smartest competitor in the business. Apple has a defensible business model that works at the right valuation despite my harping on the lack of ‘openness’ at Apple. Moreover as mobile and tablet adoption rates remain high in developed markets and Apple maintains a high market share, we can count on prodigious growth. All of this is, unfortunately, baked into the stock price, which has seen a dizzying rise of late.

The first problem here is market share. Google certainly seems to be taking the market share approach, basically giving away the OS in order to drive up adoption and benefit from network effects that had kept Apple the App king to date. Two years ago, I had noticed that the number of Apps ported to Android increased. Now the gap has closed entirely.

The second problem is mobile growth and smartphone adoption in the developed economies.  The growth rate is still high but growth in the cloud- and mobile-related computing revolution is going to slow in developed economies and the growth will begin to come from emerging economies. Two recent articles highlight the problem:

Google’s Android operating system (OS) is now the most popular smartphone platform in China, according to a report from Analysys International that analysed sales in the world’s biggest smartphone market from the first quarter to fourth quarter of 2011.

Android’s share of sales more than doubled, according to Analysys, to rise to 68.4 percent from 33.6 percent. Those figures put it well ahead of Apple, which saw the percent of iOS device sales increase to 5.7 percent from 4.1 percent.

According to the report, Android is now China’s most popular smartphone operating system, taking the top spot from Nokia. The Finnish firm saw sales of its Symbian-powered devices plummet by more than half to now account for 18.7 percent.

Report: Android now rules China’s smartphone market, after doubling its sales in 2011

That was China. Here’s India:

As Apple wades through patent battles and criticism over working conditions in other parts of Asia, it faces a different kind of resistance in India: a consistently low customer base.

Rival Android-based phones and BlackBerrys overshadow Apple’s flat 2.4 per cent market share as they continue to be increasingly popular with the country’s youth and business markets.

Analysts say the reach of the Android operating system across global and domestic brands attracts millions of low- and mid-budget customers in India, as does the wide variety of apps available in the Android Market.

“In India, there are 17 global and Indian brands that offer about 125 Android phones between them. So essentially the price range and the choice of models make it attractive… especially to college-goers and corporate users,” Jayanth Kolla, partner at Bangalore-based technology research firm Convergence Catalyst told beyondbrics. “There are several models already available that are under $100… [and] the user experience on them will improve going forward this year.”

By comparison, an iPhone costs upwards of $400, a deterrent for all but the most dedicated Apple fans in India. The technology giant sold only about 75,000 units here last quarter, a tiny 0.2 per cent contribution to its global sales of 37m.

“I don’t think Apple even wants to catch up with Android in terms of numbers in India… [They] have their own target aspirational customers who will go and pick up an iPhone if they want,” Kolla said. “Price is a basic factor here, and as long as you have devices only available in excess of Rs20,000 they can’t compete with lower-priced devices.”

Android phones collectively made up about 30 per cent of smartphones sold in India last year. This was second only to Nokia (46 per cent) but Android devices are expected to outstrip the Finnish brand this year.

India: Android outpacing iPhone | beyondbrics | FT.com

These articles fit into my thesis of how the smartphone market will develop as the high end market saturates.

I see this as a land grab right now. The operating systems that can grab as much share as possible while people are upgrading from cheapie phones to inexpensive Smartphones will win. Right now Android is leading the charge.

And so, expect Apple’s growth to slow. You could have said this at any time over the past two years but the fact is Apple is a well-run organization. I believe that with the tablet space becoming more crowded, premium mobile phone adoption rates, and more growth coming from emerging markets, this will now begin to erode growth at Apple.

Bottom line: Apple is a great company that makes great products. But the run-up in shares requires more digging into the numbers to see what justifies this valuation increase. More data to come after we crunch some numbers.

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