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Is Apple a Falling Knife?

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March 12, 2013 – Comments (1) | RELATED TICKERS: AAPL

Board: Falling Knives

Author: DaveyUK

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First of all, disclaimer: I bought Apple stock a few weeks ago at around $445. I'm planning to add to my position if the price drops below $400 with no material change in the business. I don't own any Apple products, and never have.

My analysis was very similar to Jim's - there appears to be a suitable margin of safety plus the potential for a very decent return.

On the business prospects, I'm kind of mixed. I don't think sales are going to fall off a cliff - in all probability I think they'll continue to rise, but not at the rate looking back over the past decade.

Do I think the business has a massive moat? Probably not. But they have some elements of a moat.

The lock-in effect is somewhat real - they have an ecosystem and there is some advantage for someone who has an iPhone to also buy an iPad, rather than, say, a Samsung or Google tablet. But the lock-in is only really there if the end user is buying lots of stuff off iTunes. For someone who still buys and rips CDs, for instance, switching platforms is going to be an inconvenience, but not a major ordeal.

The network effect isn't particularly strong, in my opinion. Most popular apps are written for both iOS and Android. The one area where there is some network effect is with FaceTime, and if there is some way that Apple obtains a monopoly (at least, in some geographical regions), then this might be it.

The other aspect of network effect is the "monkey see, monkey do" effect, whereby there are a large percentage of the population who don't particularly think and make decisions for themselves (although, obviously, they would individually claim that they do), and just buy what everyone else has. We could also view this as conforming to society's expectations. My perspective of this effect is that it's particularly strong in the US (where it almost seems taboo to say publicly that you have something other than an iPhone), but, by comparison, it's not so strong in the UK and I suspect many other places too. (My wife is from the US and I've spent enough time there to have formed an opinion.)

Certainly, I don't think there's any reason to believe that Apple's platform is going to become a monopoly in the way that Windows did.

As for the challenges facing the business, first we have the competition. I don't think the main issue here is market share percentages, and I don't think that market share is going to take a dive like Blackberry (totally different situation). The greater risk by far, in my opinion, is price competition that will drive down margins, particularly as all the leading devices are basically the same and thus there's a greater possibility that people will buy on price. This is especially true as Apple no longer has the technology lead. Depending on how you look at it, it's at best even, and at worst (from Apple's perspective), Android is now ahead. However, it would take a particularly critical feature to get everyone with Apple devices to switch to something else, until the next true generation of products comes along, which is probably a few years away.

Another key problem in the longer term is the replacement cycle, less so with phones, but certainly with tablets. In fact, one of the things I like about the mobile phone business is the replacement cycle, where people throw away their old phones every time they renew their phone contract (every 1-2 years), even if the phone still works fine and has not become obsolete.

With tablets, however, what reason is there to get people to move from last year's model to this year's? If we look at the PC industry, back in the 90's and early 00's, PC's were obsolete to the point of being useless after about 2 years and had to be replaced, but now PC's tend to last at least twice that long. We could find the replacement cycle of tablets suffers the same fate quite quickly and once everyone has one, no-one is throwing away their old one to get the new thing. This obviously depends on the level of innovation, which is hard to predict. And this is much less predictable than was the upgrade cycle of PCs, which was based almost entirely on computing power improvements, where the computing power requirements of software, for a long time, always slightly outpaced the hardware available at an affordable price.

Let's not forget, however, that Apple's current most key products - phones and tablets - are in a market that is globally growing. So even a reduced market share in a much larger market may still equal big profits, as long as margins don't get crushed.

Something I learned from Jim a year or two back, is that the main problem with a company like Apple is that there exists a relatively high probability that, if sales or profits do fall, it could happen comparatively quickly. In certain other industries, the time frames are much longer and are thus much easier to identify as long-term trends, usually with opportunities to exit before the share price falls off a cliff.

1 Comments – Post Your Own

#1) On March 12, 2013 at 12:15 PM, johnlatkins (< 20) wrote:

Beautiful top-of-the-range products. The Ferrari of the electronic world. Samsung etc will only ever have 'plastic' copies. I see Apple as part of the luxury market and should remain profitable even if market share declines.

 

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