Research #Industry · 13 comments
Biggest share winner: Other.
The trend toward ZTE, Huawei and others taking volume share from the traditional incumbents continues. Smartphones continue to capture value share. Dedicated smartphone vendors HTC, RIM and Apple would make up the third biggest single vendor, starting from a very small base.
Looking over this three and a half year period, the change in the market is quite dramatic.
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Research #Industry #Nokia · 60 comments
Nokia must compete on an ecosystem to ecosystem basis.
In addition to great device experiences we must build, capitalize and/or join a competitive ecosystem. The ecosystem approach we select must be comprehensive and cover a wide range of utilities and services that customers expect today and anticipate in the future.
Nokia CEO Discusses Q4 2010 Results - Earnings Call Transcript - Seeking Alpha
These kind of statements are signaling that there will be fundamental changes announced.
Here are my guesses for the February 11 announcement:
This may seem like a radical departure, but in many ways it's not. Nokia has nothing to lose in the US as its platforms have zero traction. By maintaining Symbian for low end devices, they can still aim for differentiation where Nokia feels it still has distribution and cost leverage. This strategy will also allow speed in time to market.
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During the calendar year 2010 Apple spent nearly $2 billion in R&D. That is a significant increase from $714 million in 2006. However, as a percent of sales, R&D spending has decreased. Sales have grown more rapidly than resources hired to develop the products (or to sell them).
In Q4 2005 Operational Expenses (costs which are not tied directly to units of production--sometimes called fixed costs) were 14.2% of sales. In the last quarter of 2010, the ratio was 9.2%. Sales and administrative expenses (which include advertising, promotion and overhead) were 7.1% and R&D (which includes all engineering, testing) were 2.2%. As percent of sales both reached new lows.
The efficiency with which Apple creates sales is legendary. There can be many explanations for this but the most telling evidence of causality I can find is the small number of products in the portfolio. Tim Cook stated that given the sales value, there is more concentration of product at Apple than at any other company except perhaps an oil company. All the products Apple sells can fit on one average sized kitchen table and they generated $76 billion in sales last year.
How is this possible? First, a few words about the often misunderstood process of product development.
Most observers of technology are not aware of the pace of its development. It's natural to assume that most R&D costs are in the product creation, or early phases of development. Coming up with something new must be hard. But that's not actually true. Most R&D work is routine polishing of products and coordination late in the development cycle. "Productization" is far more resource intensive than "concepting".
It stands to reason that making go/no-go decisions early in the pipeline is a lot less expensive than making stop-ship decisions prior to launch.
I have no specific evidence that this is the case, but I guess Apple conceives of plenty of concepts, but chooses to move forward to develop and market very few. Most companies don't have the ability to decide early which products to launch and instead proceed with costly R&D and marketing in order to find out whether products will "work" in the marketplace. The proliferation of flawed products is a big cause of the inefficiency of product development.
But launching flawed products is also detrimental to brand value, something which rarely hits the books and is thus invisible to operational managers.
This uncanny ability to pick winners early in a long gestation period is my guess for why Apple is so efficient with OpEx. The question of how to develop this ability is left for another day.
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Research #Industry · 47 comments
‘Any argument that a pad is not a PC is simply out of sync,’ said Chiam. ‘With screen sizes of seven inches or above, ample processing power, and a growing number of applications, pads offer a computing experience comparable to netbooks. They compete for the same customers and will happily coexist. As with smart phones, some users will require a physical keyboard, while others will do without.’
‘Each new product category typically causes a significant shift in market shares,’ said Chiam. ‘Apple is benefiting from pads, just as Acer, Samsung and Asus previously did with netbooks. The PC industry has always evolved this way, starting when Toshiba and Compaq rode high on the original notebook wave.’
via Canalys reports global PC market growth of 19% in Q4 2010 (Canalys research release: r2011012).
Five years ago, back when Gartner and IDC were confused about what a smartphone was Canalys was on top of the market and was the first to correctly describe the smartphone.
Kudos for being first again to recognize a re-defined market.
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Research #Market · 35 comments
The iPad and iPhone came, saw and conquered new markets. But since the products launched the question on every analyst's mind has been on how much have these products "cannibalized" their brethren the iPod and the Mac.
This notion of "cannibalization" applies when a product is designed to compete and "eat" the share of another product in a company's portfolio. It has some negative connotations since it implies loss but many times the thinking is that it's better to cannibalize oneself rather than have it done by a competitor.
But have iPhone and iPad taken share from their competitors?
The following charts compare the total units of iPhones vs. iPods and iPads and iPads vs. Macs.
The evidence does not show cannibalization.
Although both iPhone and iPad have crossed over and are selling more units than their internal competitors, the old guard has not faded away.
Indeed, the Mac shows resilience and the iPod, although not growing in units has maintained sales value. What we don't see is a clear gain for the entrants at the expense of the incumbents.
We can't be sure how long this happy co-habitation will last, but for now the new products are fine and young but not cannibals.
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When looking at unique visitors as a proportion of population, this site is more popular in Finland and Canada than in the United States.
Very impressed with Singapore and New Zealand who punch above their weight. UK is second in overall volume. Honorable mention to Australia, Sweden, Norway and Switzerland.
It's interesting to compare this list with Newsweek's ranking of the world's best countries.
The correlation is uncanny.
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As the highly profitable iPhone makes up an increasingly larger proportion of Apple's sales, the overall gross margin would be expected to grow.
Sure enough that's what's been happening.
The gross margin percent, which measures the direct or variable costs of production vs. price, shows a healthy rise in the last five years from slightly below 30% to around 40%. The Operating Margin, which also includes the overhead or fixed costs like R&D and SG&A, shows a similar rise, reaching about 30%.
Margin expansion while sales quadruple is a good indicator that a company is producing real value not just trading sales volume for profit.
Focusing attention on individual product lines, it's clear that the iPhone is the largest component of sales and of profits. We don't have specific product line-item gross margins from management, but we can estimate a figure for the iPhone by several means.
First, we can work out roughly what every other product line's margin is due to their longer histories. (Mac and iPod have reliable profitability estimates). What's left can be deduced to make up the iPhone's margin.
Alternatively, we can get estimates of the bill of materials and add in some of the other direct expenses like manufacturing, warranties, shipping and incidentals to get an estimate of the cost of production.
These methods allow me to guess at a margin for the iPhone of about 50% for the last quarter. Based on these inputs we can plot the gross margins for the entire company's product lines:
Overall, gross margins have reached over $10.3 billion in the quarter, increasing 543% from five years ago and 61% from a year ago.
That's great, but by knowing product line profitability we can get a better feel how the company changed strategically.
In the following chart I show the percent of gross profit captured by each product line.
What we can observe is that at the end of 2005, OS X based products made up nearly half the profits. The rest was mostly the iPod, which was not a software platform product.
A short five years later, OS X products which, although having grown in volume, made up only 22% of total margin. The rest was mostly iPhone but with significant contributions from iPad and iPod. What's most important to note is that the non-OS X profits are almost all powered by iOS.
iOS powers about 70% of Apple's current gross profits. Combined with OS X, 93% of profits are from platform products.
So again the question about Apple being a software, hardware or media company comes back. Perhaps, those categories are not relevant. Perhaps Apple is a platform company.
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As shown in the Apple growth scorecard, the company's earnings growth is continuing at 75% with the top line increasing at the annual rate of 70%.
The $59 billion of cash on the balance sheet has reached the equivalent of $64 per share yielding an enterprise value of $263 per share based on closing price of January 21st.
The stock price has been rising but not outside a narrow P/E band. The following chart shows the stock price and the 15 P/E and 25 P/E bands that have bounded it for nearly three years.
As previously observed, this overall share appreciation is not accounting for the growth in earnings.
The trailing twelve months' earnings were $17.91 per share. Therefore the P/E ratio is now 18.2. Excluding cash, the P/E is at 14.7. However, that's based on 2010 levels of earnings. Those earnings are increasing very quickly.
To account for earnings and their growth, I developed the following chart which shows the P/E and P/E/trailing-Growth for the stock.
The P/E is fluctuating on either side of 20 but when considering trailing growth, comparable companies, the macroeconomic conditions and guidance the value of the company is reaching new lows.
Earnings were 75% higher in 2010 than the year before. So based on the growth, the rule-of-thumb ratio P/E/trailing Growth (P/E/tG) is 0.24. This ratio (where 1.0 is seen as "fair value") is the lowest since July 2009, during the first months of recession recovery. The trend for this ratio is down (see the burnt orange line in the chart above). It's not far from hitting the lowest point during the recession at 0.17.
Now I'd like to reminisce a bit about that point in time. The stock had bottomed at $78/share[1]. It was trading at barely 3x cash and a P/E of 11 but growing 3x that level (32% in the slowest recession quarter but averaging much higher).
So today we are at a similar point in valuation. The cash is at $64/share, shares are priced 5x that amount and the growth is 4x P/E[2]. Although analyst targets are less comical, there is still the sense of extreme despondency when looking at the valuation ratios.
Unlike two years ago there aren't the same dark clouds on the macro horizon. The company is also not as cautious on its guidance (guiding 63% EPS growth must be a new record for a post-holiday quarter) and there is talk of bubble in valuation for comparable companies. Netflix, Amazon, and ARM have eye-watering valuations relative to growth.
And to round out the tragic tale, Apple's P/E is, once again, at a discount to the S&P 500 P/E (14.7 vs. 16.57 respectively).
Given the new low in valuation contrasted with optimism on behalf of many (including management), on some forums there is discussion about Apple becoming the target for a take-over.
There is some perverse merit to this logic. With $64 in cash, $25/yr in earnings and 75% growth it's so cheap that if credit were available, it would make a tempting candidate. Private equity could take it private and use the gigantic cash flow to pay off debt (in about four years). In bygone days, this would have been an easy pitch.
Alas, the capital markets may not have liquidity for the size of the market cap Apple holds and I don't see any competitors able to get the leverage for an acquisition either. Or can they?
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Notes:
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Research #Mac #Market · 54 comments
Apple set a new record for Mac sales in the fourth quarter. This was not a surprise. The growth was perhaps a bit lower than some expected (including me) but it was still a healthy 23% and 8x the PC growth rate. The Mac has outgrown the PC (and hence has gained share) for 19 quarters straight, nearly five years.
What's more interesting is where the growth came from. Every region outgrew the market. Asia-Pacific led with a 67% year-over-year increase, almost 10x the market. Japan grew at 56%, which is about 6x the market, and Europe and the United States both grew in double-digits despite both markets contracting overall.
Looking over a longer time frame, the Mac has nearly quadrupled in volume in five years. In the last quarter of 2005, Apple sold 1.2 million units. In the latest quarter it sold 4.1 million. So the performance has been relatively good.
One significant reason for the growth has been the shift from desktop to portables. The lines show how the percent of portables went from about 50% to 70% of units and sales in four years.
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But what was surprising was that the average selling price increased to $1,313, up from $1,253 and nearly even with last year's $1,324.
Prices in the PC industry tend to fall. Actually, to be more precise, they tend to collapse. Compare the Mac's price trend with the rest of the industry as seen in the chart to the left[1]. It shows the Mac Average Selling Price which is what Apple books from selling into the channel vs. the retail price of PCs in the US.
The chart tells a partial story. The PC figures are retail while the Mac figures are wholesale. Furthermore, the PC figures include Mac, so stripping out the Mac would show the PC prices to be even lower. Lastly the Mac figures are global whereas the PC figures are US only.
But what I want to focus on is not the absolute difference, rather the relative value difference, which is diverging: The average PC went from $795 retail at the end of 2007 to $615 in November 2010. That's a drop of 22%. In the same time frame the Mac went from $1,539 to $1,313 wholesale, a drop of 15%.
In other words, the Mac price premium at the end of 2007 was at least 93% and it now is at least 114%.
So here's the real surprise: How does the Mac gain share while increasing its price premium over the PC?
The only answer I can offer is what I already wrote on the Mac in November:
...something changed with PCs when the laptop became “good enough”. With portable computing, the job the PC was hired to do evolved. It was more important that the product be well designed (for aesthetic value, usability and reliability) than just fast and spacious. The microprocessors were plenty fast but what mattered more was low power consumption, a low profile and tighter integration with software.
In other words, computers became re-integrated. You only need to touch the MacBook Air to understand why.
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Notes:
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When I wrote suggesting that the "best use of cash" was not acquisition but integration of manufacturing under the Apple control umbrella, the rumor that set off that discussion was that Apple was financing new facilities for its suppliers.
Those rumors were quashed, but we now know there is something to them.
During the September and December quarters, we executed long-term supply agreements with three vendors through which we expect to spend a total of approximately $3.9 billion in inventory component prepayments and capital expenditures over a two-year period. We made approximately $650 million in payments under these agreements in the December quarter, and anticipate making $1.05 billion in payments in the March quarter.
Apple Management Discusses F1Q11 Results - Earnings Call Transcript - Seeking Alpha [my emphasis]
So Peter Oppenheimer confirmed that Apple is using its cash as a loan facility for its manufacturing partners. It's not for the first time either. Apple used the same leverage to ensure the supply of flash memory for the iPod line in 2005.
Philip Elmer-DeWitt reminds us Tim Cook confirmed:
The deal, he said, is similar to the one Apple cut five years ago:
"As you probably remember," he began, "we signed a deal with several flash [memory chip] suppliers back at the end of 2005 that totaled over $1 billion because we anticipated that flash would become increasingly important across our entire product line and increasingly important to the industry. And so we wanted to secure supply for the company.
Partly as a result was a dominant position in the music player market that is still paying off today.
The use of capital to pre-pay for production is not therefore new. What we saw last quarter however is that it's using capital to ensure there is additional capacity.
In other words, Apple Inc. pre-buys additional capacity by using Bank of Apple capital as a loan facility to bring more capacity online. How to judge this use of capital depends on your perspective:
This strategy is not without risk. Those loans are forward contracts on production. The risk is that production is unneeded and hence the loans won't be "paid back". But Apple knows demand and supply in this market better than anyone else, so it has an unfair advantage over the market. So the rewards are probably out of proportion to the risk.
By buying an option on production, not production itself Apple has a clever way to "own factories" without actually owning them: gain control over marginal increase in production without the impact from CapEX or depreciation.
The return on that option will never be seen on the OI&E line in the income statement and the cash once recycled back into the balance sheet will seem to be sitting unrewarded. But the return on that capital will show up in the bottom line by way of margin and top line expansion for years to come.
The committed capital is still tiny, but a proper analysis of Apple's cash management would be to look at the return on cash as more than the return on treasury bills.
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Apple's CFO guidance statement:
We expect revenue to be about $22 billion, compared to $13.5 billion in the March quarter last year. We expect gross margins to be about 38.5%, reflecting approximately $50 million related to stock-based compensation expense. We expect OpEx to be about $2.35 billion, including about $250 million related to stock-based compensation. We expect OI&E to be about $50 million, and we expect the tax rate to be about 25.5%. We are targeting EPS of about $4.90.
via Apple Management Discusses F1Q11 Results - Earnings Call Transcript - Seeking Alpha.
This is a particularly aggressive revenue growth forecast of 63% (note again that Apple's P/E has dropped to 18 and 14 ex cash and 10 on a forward basis) . Since Apple always guides very conservatively, the likely figures for the top and bottom lines are likely to be higher.
How much higher? Here are my estimates (growth in parentheses is year over year).
Looking a bit further ahead, earnings suggest the company is now trading at a forward P/E of about 9.5.