The list of once-great consumer electronics companies is long, but Apple has staying power because it has developed an ecosystem that connects success in one generation of devices to successive consumer purchases.
Apple is transcending the risks of the classic product cycle. Historically, consumer electronics companies have competed for the consumer's attention with the latest and greatest gadgets. Success of this type has proved fleeting, as brand loyalty is largely dead. For example, when shopping for televisions, customers look for the best combination of price and features, with few consequences arising when they replace a Sony with a Vizio. In handsets, the Motorola Razr was a breakthrough phone that dominated the market, but Motorola fell apart because it misfired on the following product cycle and lacked a connection that would pull the user from one generation of the Razr to the next. A Dell PC is easily replaced with a Hewlett-Packard PC, but for decades the user likely would be running Microsoft Windows. Apple is replicating what worked for Windows, minimizing the risk of losing customers between product cycles by using software to connect the user to not just a single device, but an ecosystem of applications and content spanning multiple devices and creating a relationship that survives the useful life of any single device.
The key difference for Apple is iOS, the operating system that spans the company's portfolio of devices. IOS envelops the user in an ecosystem of applications and content that makes it inconvenient to switch to another vendor's device down the road. A typical Apple user experience may begin with an iPod or an iPhone. The user builds a content library, a collection of applications, and routines that are not convenient to move to a competitor's device. Once the consumer enters the market for a replacement phone or additional device (tablet), the cards are stacked in Apple's favor because of the existing dependence on iOS. Once multiple devices are in place, the switching costs are magnified, because many people will be reluctant to replace their phone, tablet, and possibly other devices at the same time, but equally reluctant to split their Web and media consumption habits between ecosystems. Competitors' devices will not always be inferior, but Apple is capturing a large portion of a user base that is trading freedom of choice for an enhanced user experience.
Apple's economic moat may be widening with iCloud. We believe iCloud takes switching costs to the next level by creating a virtual presence in the cloud that encapsulates all of the consumer's communications, preferences, and content, breaking the tether to any specific device. The bond created between the user and the presence in the cloud is perpetual, and much stronger than the bond between a user and any specific device with a limited life span. The service itself may not generate tens of billions of dollars, but it secures the customer and makes it more desirable to interact with multiple devices.
The Apple story is not without risks. Co-founder and former CEO Steve Jobs was special, and even if those who follow him bring the rare combination of vision and ability to execute, it remains to be seen if they will inherit the moral authority that enabled Jobs to drive his agenda. Additionally, HTML5 and other platform-agnostic technologies could provide users with access to third-party applications on devices from all manufacturers. Finally, a stumble (albeit unlikely) on a product cycle in the early innings of smartphone adoption would come with a tremendous opportunity cost in terms of lost users. Users are only locked into Apple's ecosystem after they join, so as the nascent market emerges, each user that falls into a competitor's ecosystem carries away a significant loss of value. However, Apple already has established a narrow moat, and it will be some time before these issues present a risk to the growth of its customer universe.
Valuation
We are raising our fair value estimate to $560 from $530 per share to account for greater near-term momentum with the iPhone and iPad than we had originally forecast. The iPhone remains the cornerstone of Apple's consumer strategy, and few opportunities loom larger than the global handset market. The iPhone already accounts for more than 50% of revenue, and we expect this percentage to grow to more than 60% during the forecast period. We envision a total addressable market of approximately 1 billion smartphones by 2015, with Apple claiming approximately 28% of the market. The iPad and any other devices that may emerge will also contribute to Apple's success, but we find it very difficult to envision another device that emerges as an iPhone-scale winner. Likewise, the Apple halo effect from success in handsets and tablets will drive interest in PCs, but the opportunity to penetrate this mature market is limited relative to the emerging markets for portable devices, and we think the Mac will become a smaller portion of the Apple story over time.
We anticipate firmwide gross margins will fall during the forecast period from 40% to the lower-30% range. Though the firm's economic moat will drive impressive returns, we believe increased competition will provide some pressure on Apple's pricing power. Additionally, we believe Apple will trade margins for growth in the near term. Most likely, the firm will employ strategies such as concurrent availability of multiple iPhone versions at different price points to ensure the broadest possible market penetration. The impact on the financial statements should appear in the form of slight margin compression and revenue growth trailing unit growth in key segments.
We award Apple a high fair value uncertainty rating because of its dependence on the ultimate size of the addressable markets for smartphones and handsets. We are in the early innings of development for these markets. Apple's ability to penetrate and the size of the mobile computing market are by far the most critical assumptions for our valuation. Though we are comfortable with Apple's economic moat and its potential to increase its already impressive revenue, visibility into the size of the firm's addressable markets five years from now remains limited.
Risk
In our view, Apple's success during the last decade is largely attributable to the leadership of Steve Jobs, and his passing has dealt a heavy blow to the company. We think CEO Tim Cook is an able manager and Apple has an extremely deep talent pool. But we also believe Jobs' product- and user-focused vision had been instrumental to Apple's renaissance and had served investors incredibly well. There is clearly some continuity in the transition, and a full pipeline of Jobs-approved launches will drive the firm forward for a few years, but Jobs' death chips away at our faith that Apple can continue to innovate faster and better than competitors in the long-run. Ultimately, asking "What would Steve do?" is a lot easier than getting the answer correct.
Apple has created a powerful position in the minds of consumers, but its current feature set only creates moderate switching costs, in our opinion. Long-term value creation will be a function of Apple's ability to raise these switching costs with iCloud.
Finally, any stumble in the early product cycle as smartphone adoption sweeps the globe would come with a tremendous opportunity cost in terms of lost users. Users are only locked into Apple's ecosystem after they join, so as the nascent market emerges, each user that falls into a competitor's ecosystem carries away a significant loss of value.
Management & Stewardship
Steve Jobs' passing was a major blow for Apple, as he was an irreplaceable leader. Nonetheless, the co-founder of Apple established a sustainable culture and strategy for the firm and we expect the current management team has enough structure and momentum to deliver a long period of success. Jobs personally recruited much of the current management team, and most have worked with him for a long time. CEO Tim Cook came to Apple from Compaq in 1998. CFO Peter Oppenheimer has been with the company since 1996. Nonetheless, Jobs was special, and even if those who follow him bring the rare combination of vision and ability to execute, it remains to be seen if they will inherit the moral authority that enabled Jobs to drive his agenda.
The stock-option backdating scandal raises our stewardship concerns, but we believe aggressive moves by the board have enabled the company to turn the page. Apple has taken other steps in the right direction, including the appointment of lead co-directors in 2006. The majority of executive compensation is aligned with shareholder interests in the form of restricted stock units tied to long-term company performance. We applaud the board's long-term view in awarding Cook 1 million options vesting over 10 years, aligning his long-term interests with those of shareholders.
Overview
Financial Health:
The company has $30 billion in cash and short-term investments, holds another $68 billion in long-term investments, and generated more than $33 billion in free cash flow during fiscal 2011. It carries no debt.
Profile: Apple designs consumer electronic devices, including PCs (Mac), tablets (iPad), phones (iPhone), and portable music players (iPod). Its iTunes online store is the largest music distributor in the world; it sells and rents TV shows and movies and sells applications for the iPhone and iPad. In early 2011, Apple launched the Mac app store, an online store that sells first- and third-party applications for Mac desktop and notebook computers. Apple's products are distributed online as well as through company-owned stores and third-party retailers.
No comments:
Post a Comment