Apple upset the shortsellers’ apple cart ( you should excuse the pun) this week when it made several surprising announcements. Were Steve Jobs alive and still driving this train, surprises would have come in the form of some exciting new product that none of us ever knew we needed. Instead, this past quarter, Apple’s biggest surprise was that it sold more outdated smartphones in China than almost anyone had expected. Since sales were not so great across the other product lines and across geographies, what is really shocking is the enthusiasm generated by Apples’s sales of 2.5 year old 4s phones to customers of China Mobile who apparently like its low price point.
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At the time the 4s was released in October 2011, Engadget reviewed the phone by saying “it’s a new spin on an old phone.” So even then it was just a device with a few improvements: a better battery life, better camera, a faster processor and a bigger memory but nothing to compel Apple fans to run out and buy it.
Funny, then, that what analysts and investors got excited about after the March Quarter earnings call was that Apple sold several million copies of a rather old phone that drove down ASP’s (average selling price) by $40 across the board. That’s why even as it sold 43.7 million phones vs. 37.4 million a year ago, units rose 17 percent but revenues grew only 13%. Now, one would expect that a production line running for more than two years, perhaps almost three, would be quite efficient. Therefore, as one would also expect, margins increased to 39.3% from 37.5% despite the lower price point.
Apple announced that China Mobile and DoCoMo were the principal new customers this quarter . The 4s drove iPhone sales up 28% in China and good that it did. Phone devices are now about 57% of all of Apple’s sales. If they can’t maintain that juggernaut without resorting to sales of an old device in new lands, they are in for some serious problems down the road as competition increases from Android and now Microsoft since its purchase of the Devices and Services Business of Nokia on April 25th. As much as it is derided, the Windows platform is growing far more rapidly than you might expect in emerging economies. If there is one thing Nokia knows (knew) how to do, it was to produce cheap reliable phones in quantity.
In other important categories, iPad sales declined to 16.35 million from 19.5 million a year ago. Mac computer sales were 4.1 million vs. just under 4.0 a year ago. The once disruptive, exciting and innovative iPod is now less than 1% of overall sales. That is a pattern followed by any device from any manufacturer once it is long in the tooth and/or superseded by more modern technology.
Some time was spent on the call trying to explain why the iPad had such a poor quarter saying there was some pipeline filling at this time last year in preparation for the launch of the iPad mini. I don’t recall them calling attention to the benefit they got from that last year. They also mentioned a related rebalancing of inventory levels as a factor and predicted better results going forward. There is no question that the iPad has been enthusiastically adopted by educational channels in a dominating way. They claim that many corporations are buying them and writing their own Apps for them. That is not surprising.
I love mine and take it with me everywhere I go. But so far, I have seen no reason with successor products to the one I have to replace it because they are fairly expensive if they connect to a mobile network and if they have a lot of memory. My screen developed a crack late in the extended warranty period and they gave me a new iPad 2 to replace it even after the iPad 3 had come out. I was offered no inducement to upgrade so I didn’t. I will buy a new one someday but Apple must give me a reason to do so.
Probably of more importance in causing the stock to jump was the further unlocking of Apple’s cash hoard. The biggest news was the first stock split since 2005 in the amount of 7 new shares for one old one. The 6 new shares will be paid on May 15 to holders of record on May 12. One thought is that the stock price is too high for Apple to be included in the Dow Jones Industrial Index (a price weighted index) and this is a step in the right direction to eliminate that concern. That said, Apple must find some better growth path going forward than what it has displayed in the last few years, especially since its stock peaked at $705 in September 2012. If not, it will follow Hewlett Packard in and out of the Dow 30 very quickly, if it ever gets there.
CEO Tim Cook talked about the undervaluation of Apple stock at this time. For that reason the company will borrow more money to expand its share repurchase program by 50% from $60 billion to $90 billion. Of the original amount, $46 billion had already been spent. The dividend was also increased. Because cash in the U.S. is down to $11 billion, the company will float more debt to pay the dividends and fund the repurchases. With debt so cheap, why not? They continued to attack the U.S. tax system which will penalize them for repatriating their cash, a theme they have been on for a while. It is important to remember that 66% of their business is outside the U.S. so it is not surprising that their cash flow just keeps accumulating where it is earned around the world.
The Q2 forecasts the company announced were for seasonally lower revenues of $36-38 billion and margins of 37-38%. Some of that is normal seasonal variance but it reflects the fact that Apple’s lineup needs some new products to be able to grow in the ”off seasons” and the sooner the better. While it waits to release its new products, there is no question the company is priced at a reasonable multiple for a “growth” company. It is that word “growth” that is the key to the Apple conversation. The phone companies are becoming less willing to subsidize expensive smartphones, another issue that doesn’t bode well for Apple to maintain its prices. Otherwise, for now it is just a financial juggernaut that has refused to reprice its portfolio to match market conditions as the world of Smartphones, its principal business, becomes commoditized. Eventually that will not have a happy conclusion.
While dozens of analysts raised their estimates and price targets in lock step this week, a handful expressed concern about future growth and were more circumspect about Apple’s future than Mr. Cook was during his conference call.
Joan E. Lappin CFA Gramercy Capital Mgt. Corp.
Of the companies mentioned in this article Mrs. Lappin, Gramercy Capital and its clients own shares in Nokia and Microsoft at this time. To follow Mrs. Lappin on Forbes.com click on the button at the top of this column. To follow her on Twitter: @joanlappin. For information about Gramercy Capital: email@example.com