This week Barclays downgraded AAPL, pulling an “outperform” rating from its’ shares for the first time in 10 years. That, in itself, is noteworthy, the reason, not so much. I haven’t read the report. I haven’t read anyone else’s opinion on it. The summary seemed to be that AAPL would be no better than MSFT moving forward, at least as far as stock performance. It’s interesting for sure, but not exactly a revolutionary thesis. If this opinion was a product, it would be the iPod shuffle. While similarities abound, one could argue the correlation is about as noteworthy as a chart of the 1929 DJIA to today...and who would buy into that?
Both companies were founded by technology visionaries that are now two of the largest corporations in the world. As of Friday, AAPL, the most valuable in the world and perhaps its’ most iconic brand, sported a market cap of roughly $468 billion while MSFT was valued at about $315 billion. Both are mega caps. Check.
Each had their iconic CEO”s step away from day-to-day operations and in both cases, right when their business had never been better. Bill Gates relinquished the CEO title to handpicked successor Steve Ballmer while Steve Jobs left the CEO title to his handpicked successor, Tim Cook, albeit under different circumstances. We know how MSFT performed under Ballmer, some fear Cook could be in for a similar fate. Check.
Both companies have loyal user bases and operate in what some see as increasingly mature businesses. Each has sustainable cash flows that support a decent dividend and/or capital allocation structure favorable to shareholders. Check.
The similarities end there, at least for now and to suggest otherwise in the Spring of 2014 is a little, well, let’s just say if Andy Dufresne was questioning the Barclays analyst he might ask, “How can you be so obtuse?”
In the past quarter, which was apparently a disaster, AAPL grew revenues by 5.6% to a record $57.6 billion dollars. This was buoyed by a better mix of higher end iPhone sales, the 5s vs the 5c, and record iPad sales which grew 13.5% year over year.
Interesting that AAPL did so well on the high end and disappointed on the “low end” when EVERY analyst said they needed a “cheaper” phone to compete globally. The data simply doesn’t support that. BMW doesn’t sell a mid-size hatchback and Michael Kors doesn’t sell designer fanny packs for a reason.
While iPhone growth in North America appears to be peaking, growth in Latin America was 76%, Middle East/Africa 65%, Japan 40%, China 20% and even central and eastern Europe produced double digit growth. Not bad, especially as the China numbers don’t reflect a recent launch on China Mobile, which will increase the user base even more.
MSFT”s quarter was solid. It was Ballmer’s last as CEO and the company has since named Satya Nadella its’ new chief executive. It was a nice way for Ballmer to leave, who was basically handed the keys to the Titanic hours before hitting the iceberg. He certainly missed areas of growth, but when a ship that size is moving that fast, it’s hard to change direction.
Nadella previously headed MSFT’s cloud services division which doubled revenue year over year. MSFT appears to be one of the few large cap blue-chips that is actually monetizing “the cloud”. Certainly a nice feather in the cap, but to be expected thanks to their dominant enterprise business.
I think Nadella was probably the best choice for the position, especially internally. Additionally, Amy Hood, MSFT”s CFO has emerged as a superior executive during the Ballmer transition over the past year, her presence there should not be discounted and is critical to MSFT moving forward in my opinion. So don’t think I’m suggesting to bail on MSFT just yet either.
MSFT, who joined the tablet business in the bottom of the 8th inning with the score 8-1, also reported strong growth in Surface sales to to nearly $1 billion or just about even with AAPL iPod sales, which DECLINED 52% year over year. No mention of Zune in this past report.
Curiously absent from MSFT”s quarter was a breakdown of their retail stores, which have been a disappointment to say the least. I suppose that would be like asking a 450-lb. man to include his weight on his online dating profile when he has “a great sense of humor”. Apple retail stores were up 9% year over year and boast about 21,000 visitors weekly. Ask Wal-Mart if they would like that growth.
MSFT bulls point to XBOX One as a catalyst moving forward. I find this argument slightly comical as the XBOX business has been around for close to 15 years, yet they’re “going to own the living room” today or tomorrow? I doubt it. I owned the first XBOX two weeks after it came out, they don’t own my living room.
One red flag for MSFT was a 3% decline in Windows OEM. I think it’s fair to say that Windows 8 has been about as successful as the retail store experiment. This is pretty much par for the course as any Windows user over the past 20 years can attest, about every other reboot of Windows has been flawed, deeply in some cases. What’s more troubling is that Windows is still the butter to MSFT’s cash flow bread, at least for now.
Of course margins on software are stellar, then again iTunes margins are pretty good too and that business GREW 19% year over year for AAPL. Plus, don’t tell anyone iTunes and the AppStore is exactly a new business yet continues at 20% growth. Also, AAPL’s chief competitor in that business doesn’t give the content away for free. Applelonians no longer pay for any OS upgrade, mobile or otherwise or AAPL’s “office suite” . Remember when Windows was close to 200 bucks to upgrade WITHOUT the latest edition of Office? Those days are over.
Not surprisingly, MAC continues to take share in PC and continues to grow despite overall weakness in that market. Certainly a Windows PC is a less expensive proposition up front but when you factor in software, both operating and security, the value seems diluted at best. Maybe I’m crazy.
It’s entirely possible that AAPL could suffer the same fate as MSFT, but I wouldn’t classify them in a business with “intense competition in all of their markets” which MSFT said themselves in the press release this past quarter.
Additionally, AAPL has 600 million (or so) active users that contribute about $48 a year to the AAPL ecosystem. If one was to value each user just at the actual money spent and didn’t consider iTunes Radio and other advertising opportunities, an iTunes/AppStore business would be valued at close to $30 billion dollars just on its own. You don’t hear that a lot.
I’ll spare you the “stickiness” of the ecosystem, that’s well known, yet the 600 million credit card accounts offers an exciting opportunity..no? Even without an iWatch, iTV, whatever, it seems to me that a mobile payment platform supported by AAPL and possibly using the fingerprint technology deployed on the 5s might be more stable than say...bitcoin? Perhaps it would be adopted faster as well? I’m just spit-balling here.
Time will tell, for all the talk about new AAPL products and services, we certainly haven’t seen them recently which makes them no better than MSFT in that regard. However, examining just one piece of their business that is maturing in its original market, while it is still expanding globally, seems sort of “amazing” and what amazes me most is that so many “have been taken in by it.”
If you want to indulge this fantasy, be my guest, but don’t make it mine...or something like that.
I am long AAPL.