Daily: Lower average selling price at Apple
I write quite a bit about Apple because it is a bellwether stock for the technology industry and the broader market, a defining company in the US equity market. Clearly, Apple is a money machine as it made over $40 billion in FY 2012 which ended on 29 Sep. With a market capitalisation of about $550 billion, that is a trailing P/E multiple of less than 14x earnings. So Apple is not what one would call a bubble stock. Compare this record to Google with a P/E of almost 22x earnings or even to Amazon, which made, at its best in 2010, just north of a billion dollars but sports a market cap well in excess of $100 billion and you can see that Apple is reasonably priced compared to other tech stocks if it maintains its current earnings.
But I have considerable doubts that Apple can indeed maintain its earnings. Over the past three years, I have moved from predicting huge market share gains for Android to believing Apple’s earnings growth would slow. Now I am warning that I believe Apple’s earnings could shrink within the foreseeable future. See my post on the Case Against Apple for a comprehensive look at Apple’s earnings. My conclusion there is that Apple’s earnings guidance is now based on a new volume strategy which is somewhat dependent on maintaining share or expanding market opportunities. This will come at the expense of margin and therefore represents a strategic shift for Apple. The iPad mini is emblematic of this new strategy. For non-gold subscribers, my daily on Amazon from October supplies some of the relevant outline.
To be sure, Apple still has more market opportunities. The article about Apple’s potential entry into mobile devices within the automotive market gives you a sense of this. But I believe those opportunities have dwindled. Here in this brief daily, I want to focus on a recent post on Apple’s average selling price because it rhymes with what I have been saying about “why Apple’s margins are eroding as it tries to maintain share“
Here’s what I wrote in October for silver and gold members:
Apple has been moving down market to thwart the Android threat. First, Apple has begun to offer cut rate older phones as a part of its line-up. It continues to produce these phones even after the new iPhones hit market. Apple then tiers pricing down to where the iPhone 4 is now available for free for a two-year contract after the carrier subsidy. Ostensibly, the margins here hold up because the cost of production is much lower after Apple has already ramped up production for these units. But there is the cannibalization issue.
Then there’s the coming iPad mini, which is Apple’s effort to thwart Android’s move into the tablet space where Apple is fantastically dominant. The iPad mini is expected to be unveiled next month helping Apple boost sales in the holiday selling season. The price point has been rumored to start as low as $199, matching Google’s Nexus 7, though $299 is a more reasonable guess that I have also heard. Either way, the problem here is not just the cannibalization of iPad sales as with the cut rate iPhones, but also the margins. The iPad mini is a new product. So the production volumes do not afford Apple a competitive advantage in terms of economies of scale. Apple will definitely eat margin.
Apple later admitted in its quarterly earnings report that this analysis was correct and that it is now going to eat margin. Here’s a corroborating excerpt from the piece on average selling price that I believe is key here:
According to new data shared with AllThingsD by Consumer Intelligence Research Partners (CIRP), the iPhone 5 accounted for 68 percent of total iPhone sales during its first month at market — significantly less than the iPhone 4S, which accounted for 90 percent of all iPhone sales during its first month of retail availability.
In other words, as a percentage of total iPhone sales, Apple sold more iPhone 4 and iPhone 4S units during the launch of the iPhone 5 than it sold iPhone 4 and iPhone 3GS units during the launch of the iPhone 4S. It also sold more lower-capacity devices.
What that means is that while Apple is selling tons of iPhones, it’s increasingly selling more of them at lower prices. The implications of that trend, if it is indeed a trend, suggest that by offering consumers the option of purchasing past-generation and lower-capacity devices, Apple is gradually compressing the iPhone’s average selling price (ASP). That’s worth noting because it may have an effect on Apple’s notoriously high profit margins.
CIRP is essentially saying what I have been saying: Apple is hedging its bets on margin and market share by selling cut-rate items like legacy iPhones. But while this may increase volume, it will reduce margins even as Android continues to increase share. Apple, a premium-priced seller, is now moving to more of a volume-based strategy to stop share erosion and this will have a negative impact on margins. I believe it will also erode earnings growth and eventually lead to earnings decline.
All of this should not come as a big surprise. In the links below, Michael Wolff writes that “Companies that acquire the nation’s imprimatur often, if not invariably, over-reach. It is a characteristic of American capitalism: the price of getting really big and overbearing is that you incur an inverse reaction.” I don’t agree with the Anti-Apple thrust of his piece but I do agree with his characterization of companies reaching the peak and having a difficult time staying up there. In Wolff’s version, it is overreach. I see it as a numbers game. Apple is simply too large and too profitable not to engender a competitive reaction which erodes market share, margins or both. Other companies want the profits Apple is making. That’s what capitalism is all about.
I still believe Apple will have a good Q1 because this volume strategy works for the holiday selling season. See the article below on IBM’s analysis on Apple dominance of holiday sales. But, after the holiday season is over, the cracks will begin to form as the relentless Android device product cycle begins. Expect a cheap Amazon phone next fall to further cement this effect.
“China’s tablet PC market grew 62.5 percent in the third quarter from the previous year, dominated by Apple Inc’s iPad which snared more than two-thirds of sales, an industry report said on Wednesday.”
“According to a study released by IDC, Apple’s iPhone and handsets operating Google’s Android operating system will combine to overtake the share of enterprise customers using RIM’s BlackBerry, which for years has been the stalwart OS of that segment. “
“How much longer can Apple maintain the high margins it has long commanded for devices like the iPhone? Not much longer, says Pacific Crest analyst Andy Hargreaves, who believes the company’s gross profit per device has risen as high as it will ever go.
Hargreaves says the cost of goods sold for an iPhone 5 is higher than expected — about $370 (seems a little high, no?) — and he figures that will trim Apple’s overall gross margin for the December quarter to 38.8 percent from 40 percent. “Apple’s gross profit per unit has likely peaked,” Hargreaves theorized in a research note to clients. “Declining gross profit dollars per iPhone and volume sales of iPad are driving lower gross profit per unit of Apple product sold.””
“Holiday shoppers weren’t just buying lots of Apple gear this year; they were buying with Apple gear, with iOS users shopping more than three times as much as mobile users on Android. “
“Sales of Mac hardware to U.S. businesses grew by 49.4 percent year over year in the September quarter, posting continued growth while PC sales shrank.”
“For the past few years Apple has set the pace in the tablet market, but with Amazon’s Kindle Fire range and Google’s Nexus 7 gaining a significant foothold in the compact market, it’s started to fall behind. Now Apple has hit back with its own compact slate: the 7.9in iPad mini.
It might have taken its time, but Apple has tackled the problem with gusto: the iPad mini is the most physically accomplished tablet on the market. At a mere 7.2mm it’s considerably slimmer than the Fire HD and Nexus 7, and its weight of 308g makes it lighter as well.”
“Over the past two years, pundits have focused on living room TVs as the most likely new market for Apple to expand into, but evidence suggests that the company’s next big step for iOS is more likely to involve the automotive market.”
“Apple’s annual capital expenditures report came in $2.3 billion higher than anticipated, which has led one analyst to believe Apple could have put a significant amount of money into key but struggling supplier Sharp.”
“The decision to dump Google’s maps for its own, and the changes at the top of the company to eject Scott Forstall and John Browett point to a subtle downward trajectory”
“It is one of the world’s largest hedge funds, with $121bn under management, but its name is virtually unknown in financial circles. Braeburn Capital is not operated from the top floor of a Manhattan skyscraper or a plush Mayfair townhouse. It is located in a quiet suburb of Nevada’s capital, Reno, and it belongs to Apple.
In a nondescript building opposite an abandoned restaurant, a small number of advisers have been charged with investing the cash pile Apple has amassed thanks to the seemingly insatiable global appetite for its consumer electronics.
That pile has grown from $9bn when Braeburn was established in 2006 to more than $120bn (£75bn), according to Apple’s financial results on Thursday. That is a shade less than the $130bn Bridgewater Associates, the largest hedge fund in America and probably the world, has under management.”
“The iPad Mini is a direct response to 7-inch competitors, but despite claims that it is somehow a more complete experience, it still fails to challenge the Nexus 7 and Kindle Fire in one key area: price. Google and Amazon’s tablets retails for $199. The iPad Mini is priced at $329. Apple will likely sell plenty of iPad Minis based on the brand alone, but will it be enough?
The release of the iPad Mini feels almost like a defensive move on the part of Apple and along with the iPhone 5 signals a huge shift. Gone are the days when Apple’s products push the boundaries of innovation and set the standard for the market. Due to the companies stubborn refusal to stray from the one-size-fits-all approach of Steve Jobs, Apple is the caboose on the 7-inch money train while Google and Amazon are the engineers.”
Just like Microsoft, Apple’s evolution from smart tech company to global uber-brand contains the seeds of its own destruction
“With 6.1 million total smartphones activated in the quarter, Apple’s iPhone accounted for more than 77 percent of AT&T’s smartphones. Though Apple remained dominant, AT&T noted that sales for Android and Windows smartphones also reached record levels.”