asset

Apple loves to talk about its stores. They do it in every conference call, keynote event and SEC filing. There is a monotony with the repetition of how many they have and how many they are building and how pretty they are. They start to seem like commodities.

But if they were commodities why aren't there any other networks of successful "vendor stores"?

The answer is partly in the odd integrated business model Apple maintains asymmetric to every other modular technology provider. Apple seems to want to control the relationship with the buyer. It's also partly in the uniqueness of design, an obsession with the brand. But still, that does not explain why can't it be copied.

The answer is in the economics.

To understand the cost of developing an Apple store, we turn again to the balance sheet. Fortunately for us, Apple reports details of a particular asset called "Leasehold Improvements." It's a substantial asset worth over $2.3 billion in the last statement. It represents "alterations made to rental premises in order to customize it for the specific needs of a tenant."

The following chart shows the change in that figure quarter-over-quarter.

Can we tie these expenditures directly to stores? I overlaid the number of stores opened in the same quarters as the expenses in the following chart:

There does not seem to be much correlation. But if we consider that spending happens before a store opens and shift the openings forward relative to expense by one quarter we have the following:

This is a very consistent pattern. The rise and fall in expenses is matched by the subsequent rise and fall in store openings. We can even see how stores seem to be getting more expensive with the amplitude of the waves increasing relative to the amplitude of the openings.

So if we are looking at store costs, just how much does one cost?

Over the time period illustrated, Apple opened 220 stores and spent $1.9 billion in fitting them out. That's about $8.5 million per store. It's been increasing so it's probably closer to $10 million lately.

That's an interesting figure by itself, evidence of how profitable they must be. But I turn the question again to competitiveness and the lack of response in kind.

The data shows that if a company wanted to duplicate this effort they would need to commit to spending at least $2 billion. And that's just for "fixing up" the sites. This figure does not include the lease itself, the cost to operate (including the tens of thousands of employees) or the inventory within. It also does not include the value of choosing the right locations (though maybe a follower could simply choose to locate in the near proximity to an Apple store.)

So assuming a competitor (e.g. Microsoft) did commit to this spending, how would they recover it? I'll keep this question rhetorical, but the hint must be in the unique way Apple is integrated as a business.

Balance Sheets are not typical targets of focus in software or services or "high tech" companies. Except for Cash, there are usually not much in terms of assets for analysts to contemplate. With outsourced manufacturing, even hardware companies don't maintain depreciable assets on their books.

Apple, as usual, is different. It turns out there is a lot there and there's a lot to learn from what's there. I've looked at the Cash and Long Term Securities in the past but in the next few posts I'll dive into fixed (non-current) assets. Specifically Apple's Property, Plant and Equipment.

Apple Inc. has selected North Carolina as the location for a new data center and will invest more than $1 billion in the project over nine years, Gov. Bev Perdue announced

via It's Official: Apple iDataCenter to North Carolina » Data Center Knowledge.

When Apple committed to the North Carolina data center in mid-2009 the iPhone was two years old. Only 26 million iPhones had been sold to date (about as many as Apple now sells every quarter.) Clearly if the commitment was on such a scale there must have been a plan. A big plan.

We don't know for sure if NC was used last week or whether it was handling only part of the load, but let's assume it was. What I want to think about is how much iCloud would thus cost and hence what would be the cost for alternative providers of such a service. That analysis might let us determine if "cloud" forms a substantial barrier to entry for competitors.

Beside the public statement above (which may have been designed for political benefit) can we find any evidence of what Apple spent on data centers? That's where the PP&E line comes in.

The following chart shows the Property, Plant and Equipment asset in Apple's Balance Sheet.

 

Each line represents a particular type of asset and its value at a particular point in time. I will now pay attention to the blue line, Land and Buildings. I'll look at the other lines separately.

Note that each line represent current value so it does not say directly what was happening in the quarter. However, if we look at the change q/q for a particular line we get how much new spending occurred in the quarter for that particular asset.

This change in Land and Building asset value is shown in the following chart:

Going back to 2005, there were minimal changes. Perhaps there is some significance in the $250 million spend in early 2006 or the nearly $78 million spent in Q4 2008, but there is a definite significance to the massive spending that occurred right after the NC commitment was made.[1] Some of that payment also included the old HP campus in Cupertino. "Local real estate experts said HP’s asking price may have been $300 million or more, but they also said the final amount may have been less."

There is also a clear cut-off on that spending at the end of 2010.

The total spending during this time adds up to nearly exactly $1 billion. If we subtract $250 million for the Cupertino expansion we still have $750 million that must have gone into NC.

Note that the original statement quoted above was $1 billion over nine years. We can see that Apple spent $0.75 billion in one year. On the building alone. This is why I consider this a down payment. It does not include any of the equipment in the plant. It does not include the cost of operation (incl. labor) or any development costs (R&D). In fact, it does not include any of the funds that would be part of the nine year commitment.

What this level of spending implies is that iCloud (and Siri and iTunes) are expensive. They may seem ephemeral and even trivial as services, but they require a staggering commitment few can make. Apple made that commitment and they made it early on, before the first quarter billion users were even on the horizon.

If platforms are moving from local to distributed and if value moves from selling things to "getting to know you" and if that knowledge requires infrastructure control then the number of companies that can participate in the market shrinks dramatically. Not only in terms of who has the capabilities, but who could even afford to acquire them.

The invoices Apple pays are shown above.

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Notes:

1. Apple's retail stores are not included in these figures as Apple leases them. The cost of the stores will be discussed in a separate post.

Технологии и наука | Хорацио Дедиу: Никой не иска да купи Research In Motion RIM - Капитал.

My thanks again to Andrian Georgiev for interview questions [Bulgarian] related to RIM. My answers to his questions (in English) are below:

Q: What should RIM do to reinvent itself? Should it stray from its business-oriented image?

RIM had begun to move away from a business image already in 2005 or so when it started its "Pearl" brand and a consumer-oriented strategy. The company probably foresaw that business customers would not be enough to maintain the growth they had become accustomed to. The strategy has led to a growing popularity in Latin America and other regions like the Middle East where the product is used as a low-cost alternative to SMS for avid texters. Even in the US, many teenagers use Blackberries instead of iPhones because they can use it for the BBM service (at a lower cost). I believe that it is not coincidence that iMessage was launched.

The company's salvation is not in branching into new markets but in establishing a credible platform. When Nokia announced that they would be the "third option" after the iPhone and Android ecosystems, they did not even mention the Blackberry. The fact that Blackberry is not seen as an ecosystem is the root of the problem.

Q: How should RIM accelerate the introduction of QNX?

QNX is a solid operating system and I believe RIM should have begun developing with it much earlier. By waiting long after the iPhone launched (and even after Android) to upgrade its OS, RIM missed a great opportunity. The foothold market the company had was wasted by not leveraging it into building a mobile computing ecosystem.

There is little that can be done to move any more rapidly now. Product development cannot be done any faster. What the company could do is to very carefully define why QNX based products are better than the competition and not rely on specifications. In other words, what jobs does their platform solve for users that current solutions don't address? I note that this is the problem with the Playbook. It's not differentiated on what it does to improve the life of the user.

Q: Should RIM move on with just one CEO?

The problem is not the number of managers but their view of the world. What would benefit the company is a better marketing manager where marketing is defined as understanding of user needs. Engineering expertise is not enough.

Q: What would you advice RIM to do in terms of R&D?

RIM is an engineering led company. Many successful companies rightly develop their engineering skills first because that is what allows them to create new products more quickly. This is true of Nokia and also of Apple and Microsoft in their early years. What is difficult is to allow marketing people to define products after that early phase. This is partly due to the fact that there is less respect for "Marketing" among engineers. Many see it as a "soft" discipline where there is little rigor. But this is not an accurate or fair picture. Great marketing determines what products should be built not just how they should be sold. Engineering can discover new products based on new technology becoming available, but Marketing can discover new products based on unmet user needs. Both need each other.

My advice would be to allow a way for R&D to absorb input from marketing.

Q: Do you think that RIM could be bought by a bigger company in the short-term?

Mature companies are usually bought for their assets and not so much for their vision or priorities. The opposite is true for young companies who are selling themselves to the public via IPOs. For young companies the vision or priorities of business models is seen as more important. When companies are only valued for their assets, they are usually very under-valued. When companies are only valued for their vision, they are usually over-valued.

RIM's challenge is that nobody believes they have any vision and their assets are weak (no good ecosystem as I pointed out above.) So the price anybody would pay for RIM today would probably be far lower than what management thinks it's worth. And since they are still profitable they won't sell the company at a deep discount.

So my guess is that we won't see any acquisition soon.

Apple's cash for short-term and long-term marketable securities totaled $65.8 billion at the end of the March quarter. Cash increased by $6.1 billion.

The increase in cash is net of approximately $900 million for prepayments and capital expenditures related to the strategic supply agreements that Apple announced last quarter.

The following chart shows the historic cash, short-term and long-term liquid assets Apple holds.

As in previous quarters, the securities Apple holds are:

• Cash
• Money market funds
• U.S. Treasury securities
• U.S. agency securities
• Non-U.S. government securities
• Certificates of deposit and time deposits
• Commercial paper
• Corporate securitiesMunicipal securities

Although the asset classes are all liquid, those with longer maturity dates are classified as "long-term" securities (orange area in chart above) and are often not counted as "cash" in many financial databases.

The enormity of the overall size of this cash can be put into several perspectives:

• The funds are big enough to place Apple's CFO office in the top 100 largest fund managers in the world and larger than any hedge fund manager.
• Cash growth in one quarter was higher than the market cap of many companies. For example, if pre-payments were added back, the cash increased by about the market cap of Motorola Mobility.
• Current cash is worth more than Nokia, RIM and Motorola Mobility's market caps, put together.
• Apple's cash is worth half of Google's enterprise value.
• About two years ago, in January 2009 the stock traded at a price of $78 with at least one analyst placing a target of $70 on the stock. Today Apple's cash is worth $67 70/share.
• If you owned $100,000 of Apple stock, $19,000 of that would be cash and only about $80,000 would be "at risk" capital.
• If Apple had no revenues, the current cash would sustain operations (SG&A and R&D) for over 7 years or until the middle of 2018.

When analysts cite limits to the rate of Apple's growth on the basis of the "law of large numbers" I wonder if there is an implied limit to how big this cash pile can grow. By looking at the chart its size seems to be growing faster all the time.

 

[Updated] The cash per share figure was wrong. It is $70/share.

Yesterday RIM reported their quarterly earnings. The results were mixed to slightly negative and the shares were down 10% in after-hours trading.

I'll work through the smartphone market data at a later time but for now what I want to focus on is RIM's strategy which really means understanding RIM's intentions or their approach to the market. For that we have to go straight to the source: what management actually says. Trouble is, management often speaks in a jargon that is unfamiliar to people (sometimes unfamiliar to anyone outside the company).

Strategy analysis involves translation. So here follows the interpretation of Jim Balsillie's remarks during the conference call (transcript sourced from Businessinsider.com).

What Balsillie Said	My interpretation
First of all, what we announced is Gingerbread. This is not Honeycomb. I don't know what the number of Honeycomb apps is, but it's not very many. Whereas Gingerbread they've got lots of them.	RIM will support Android apps in the PlayBook tablet. As there is not one Android, I need to clarify that RIM will not support Android tablet (Honeycomb) apps but Android phone (Gingerbread) apps. So RIM's tablet will support Android phone apps even though our tablet does not actually have a phone in it, but requires tethering to a BlackBerry for cellular data.
You've got the volume of the handset apps, so if you're looking for the tonnage of apps, or some kind of long tail stuff, you've got it.	This support means there will be many apps including apps that are not very popular. We don't like supporting unpopular apps. We like a few good quality apps but this approach allows us to offer all kinds of apps.
At the end of the day, people are going to want performance.	However, many apps will not run smoothly.
You're just not going to get things like gaming and multimedia, you're not going to get the speed going through a VM interface. If you want content, or Flash type stuff, or you're looking at AIR-type, evolving web-type assets, that's what you're going to do.	Games and graphics will not run well through emulation. For processor intensive experiences we will have native execution options or browser apps.
There's no compromise here. You've got the tonnage of apps. And you've got the performance. Do I think the tonnage is overplayed? Yes.	By supporting emulation of Android apps we can offer a large catalog of so-so apps while having a small portfolio of high quality native apps.
But if you think it's about having a couple hundred thousand apps, there you go	For people who value large selections, they can go to one store.
Do we believe it's about super high performance? Yes	But for those people who value quality, they can come to our store.
I'll just offer that observation that today broadly in the world without any specific comment on us or our competitors, there are multiple ecosystem patterns that need to be considered	Beside emulation and native we also think there are many other ways to deliver applications.
Do we believe it's about full web fidelity? Yes.	For example, Flash.
These are concepts that were really relegated as not technically possible, which we're doing here. This is a no compromise environment.	Because of Moore's law, Flash is becoming viable on a mobile device.
If you want to work on Android, great. Do we think people will want to migrate web assets? Yes	Then there are browser apps.
Do we think they're going to want super high performance native assets with the SDK? Absolutely	We will have our own native SDK.
You think they're going to want to use their Flash based stuff for an offline Flash/AIR type environment? Yes	And support Flash.
I'm just not interested in these sort of religious application tonnage issues.  I really think we put that issue to bed.	We have a new platform but catalog sizes can no longer be used against us.
And if you think the whole world's going to want to develop for Gingerbread, fine. Do I think that's going to happen? Then why is there a different environment for a tablet? And you know about the performance issues and you know about the app volume issues, cause it's tough. And that's why QNX matters	Google's ecosystem is fragmented, Android apps are not able to rely on competitive hardware and there is too much competition. That's why developers should target QNX (which is unfragmented, built on fast hardware and there are few apps on it).
Is this stuff going to go more in the browser and HTML 5 and more native? These are going to be strong trends. But if you want these app players for different VMs -- and don't forget we have 25,000 BlackBerry 6 apps	Browser apps will increase in value and we also have legacy BlackBerry apps.
So, at the end of the day, we believe this is going to be about performance. It's going to be about enterprise greatness.	But we believe in a future with native applications running on QNX.
Things like multi-threaded capability, symmetric multiprocessing. We believe it's about an uncompromised web. We believe it's about enterprise security. True multitasking, not with suspension -- and that matters because you're going to want to run these things in the background.	Because QNX is a robust operating system with PC-like performance. It also supports a good browser.
But I'm out of the religious war on tonnage, which I'm delighted.	However, before QNX takes off, we will provide access to catalogs of apps which are built for other platforms.

TOKYO (Reuters) - Shares of Sony Corp rose nearly 3 percent on Tuesday as traders cited media reports speculating that the Japanese electronics maker could be a potential acquisition target of Apple Inc.

via Sony shares up on speculation of Apple interest - Yahoo! Finance.

There's a sucker born every minute. That phrase, (erroneously) attributed to a major benefactor of my Alma Mater, continues to ring true today.

Although Steve Jobs once admired Sony, the company today contains nothing of value to Apple. A disruptor is unlikely to buy the company he just disrupted. Would Sony have bought Westinghouse? Would WalMart have bought Sears? Would Microsoft have bought IBM in the 1990's?

When considering an acquisition the chances are that the asset being purchased is going to ask a premium price. So the buyer has to answer this question: what is it about the asset that makes it worth more than the market price?

There are three (and only three) sources of value that a buyer can buy:

1. The resources (intellectual, physical, contracts, channels or employees)
2. The processes (the algorithm of how those resources are put to use)
3. The business model (the way the assets and processes and applied to create profits).

A company like Sony has some resources but its processes and business model are obsolete. Should Apple pay a premium for Sony's assets? I don't see a reason why.

One of the most hotly debated subjects in the mobile phone business is the importance of market share. It's also a topic of lore in the PC industry. Briefly the two arguments are:

• Market share matters more because it drives network effects which ultimately drive competition out of the market, creating the opportunity for monopoly rents.
• Profit share matters more because profit is the only fuel that can drive innovation. Any macro downturn or shift in strategy can cause a company to cease investing in unprofitable projects.

The old disruptor's adage: "Be hungry for profits and patient for growth" is challenged by the equally disruptive: "Grow share with lower prices in exchange for new revenue sources."

There are many rich anecdotes to support each strategy, but how about some data? Fortunately we have some: the market and profit shares for vendors covering 80% of the world's largest technology market over a three year period. The vendors are a good proxy for the market, the time frame is long enough to cover seasonality and anomalies and the market is very big (over 1.2 billion devices) and very broad (world-wide).

The only question is how to measure success. One measure is how various strategies benefit the asset owners, i.e. the share holders. Benefit to society, employees and consumers are very difficult to measure. But share holder benefit is easily obtained by measuring change in share prices.

So, here are two charts:

1. The percent change in market share vs. percent change in share price for the top mobile phone vendors.
2. The percent change in profit share vs. percent change in share price for the same vendors. (see note 1 for time frame discussion).

I showed the R-squared value of the correlations. (See note 2 regarding LG and Samsung). At r-squared of 0.36 share price is not well correlated to market share while at 0.76 it is rather well correlated to profit share. To a financial analyst this would seem obvious. After all, share price reflects the present value of future cash flows which are clearly coupled to profit and hence to profit share growth. However, as many technology observers would point out, market share determined the success of Microsoft and Google, and to some degree Nokia.

High market share can cause competitors to be starved of components or ecosystem developers. At the same time, high profit share can cause competitors to be starved of capital.

What does this analysis add to the argument? Note that this data covers a hardware business. Is hardware relevant? It does not scale as rapidly and has a short shelf life. It's also notoriously difficult to distribute. However, outside of the service revenues for cellular voice and data, device hardware is the only pool of money that has any material dimension in the industry. It's also the pool of money with the highest margin in the industry. For the time being and the foreseeable future, hardware is the only business model worth anything in mobile computing.

The data shows that in this particular but substantial market profit share is closely correlated to shareholder value creation. It also shows that profit loss is closely correlated with shareholder destruction. The dominant data comes from Apple and Nokia, which appear to be polar opposites in performance on both measures.

In other articles I've shown how profits have shifted from incumbents to entrants in the smartphone disruption. This shift has resulted in direct benefit and loss to the owners of the two asset classes. To suggest that market share alone is a determinant of "success" in the device market must exclude the effect on shareholders and, ultimately, the management and employees of the companies concerned. The virtuous/vicious cycles will be fed by the profit variable more than any other.

I don't think the market share argument holds water in this market and this data supports my belief. It may be that as value shifts over time away from hardware the benefit will shift as well, but business models alternatives to hardware have not emerged after ten years of experimentation. If anything, the idea of selling hardware as a way of capturing service revenue was pioneered by RIM and perfected by Apple. Nothing I've seen so far is challenging this model. Whoever attempts to siphon the device pool of money (which has remained fairly constant over the smartphone disruption) needs to solve system-wide problems like the dependence on the network and the life-cycle of portable electronics.

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Notes:

1. The dates when performance was sampled are are July 1 2007 to July 1 2010. The latest quarter (3Q10) has not been included in this data as it has not been fully reported. The data will be updated with the latest quarter as soon as it's possible.
2. For many competitors the share price is dependent on more than performance in the mobile phone market. In particular, LG, Samsung, Motorola and Apple have diversified product lines which affect their share prices. Two of those companies (LG and Samsung) are conglomerates and their share performance is dominated by businesses other than mobile so I did not include their data in the correlation measure (though their place on the chart is shown). Motorola and Apple's stock prices were, to a very large extent, driven by their mobile phone performance over the same period so their data is included in the correlation analysis. The other vendors have been primarily focused on mobile phones.

Acer chairman J.T. Wang recently predicted that Apple’s share of the tablet market would decline precipitously as new rivals emerge, falling from nearly 100 percent to 20 to 30 percent.

via Apple Will Retain At Least Half the Growing Tablet Market, Says Analyst | John Paczkowski | Digital Daily | AllThingsD.

So let me get this straight: A PC vendor...

• that did not consider building tablets because they failed to see an opportunity
• that, once introduced, dismissed the iPad as a failure
• that has no software assets to couple to an alternative offering
• that cannot license software assets that compete because none exist
• that does not understand what jobs the device is hired to do vs. what his current products do
• that has no ecosystem to couple to an offering
• that cannot market products any cheaper than the incumbent

...should be taken seriously when predicting share for products that do not exist?

The latest litigation lollapalooza over Android reminds one of the old web adage that if you're not paying for content, you're the asset being sold.

That's certainly one of the consequences of the Android licensing model. The mobile phone vendors with no software intellectual property are pawns in a game between IP holders. It's clear that Microsoft and Apple and Oracle (and perhaps Nokia) have IP issues with Google. But it's the licensee device vendors which are most often the accused. Whether Google indemnifies or not is an open question, but the evidence is that the vendors are exposed.

The proof is in the fact that HTC is paying Microsoft for the use of Android. It's conceivable that Microsoft also asked Motorola for Android royalty payments but were rebuffed. It's also possible that since HTC is still a large scale Windows Mobile licensee, they were given a way out of the Android IP trap by Microsoft. We don't know if there were confidential deals between LG and Samsung on this issue (as they are both committed to the Windows Phone platform but shipping Android). In either case, Motorola may be forced to do the same and pay (Microsoft) for Android.

It's understood that Google gains some value from Android but also has hidden costs from it as well. Now the licensees have to recognize their hidden costs of the platform as well. There is the IP tax but also the question of control over one's destiny. Google is selling the vendors as an asset class to advertisers. Is that a positive consequence for their brands?

Only on Asymco...

Let your fingers do the walking through Apple's income statements since FQ1 2005. Glide effortlessly through juicy bits of assets and liabilities. Slide your finger through nineteen quarters of financial goodness.

A special bonus: included is a separate visualization of Apple's liquid assets: cash, cash equivalents, Short-term marketable securities and Long-term marketable securities. $$$$$!

Brilliant to use and look at on both iPhone, iPad and iPod touch:

Get it here.

AAPL Balance Sheet v2 using your iOS device.

You will need to have Roambi™ installed on your iPhone, iPad, or iPod Touch to open this file. (It's free!) Tap Here To Install.

Read more about ADDs in Asymco's ADD Page.

My recent exposé of Apple's cash (and cash equivalents and long-term securities and short-term securities) drew quite a bit of attention, which is good. Because it needs to be demystified. However, the story does not end there. Part of the problem of cash is that the liquid stuff can often itself change in perceived value due to mis-management.

Cash has to be valued on the basis of what's to become of it. So what can become of it?

The value in liquid assets can be returned to shareholders in the form of a dividend, which means double taxation on profits; not the best idea usually. Or it can be returned in the form of share re-purchase which tends to have only a temporary effect on share prices, again not a great return. The value can also be increased by means of investment in projects that return higher than what investors expect their cost of capital to be. This is the best option but investment is difficult when the amount involved is so big that no project or set of projects could possibly cost enough to employ the capital. Finally, the value can be completely destroyed through large acquisitions.

I say destroyed because the history of large acquisitions is almost universally known to be value destructive (1). The urge to M&A is why cash on the balance sheet for large companies is usually discounted and share prices "get no credit for it." This is plaguing Apple with a P/E ex-cash in the teens.

Is this fair?

Companies faced with low growth are more likely to blow their cash on desperate acquisitions than those with high growth, but the best way to judge the probabiliy of cash evaporation is by looking at management track records.

Which leads us to Microsoft.  Their pursuit of Yahoo shows how desperate they had been in trying to catch Google and how poorly that would have turned out. Having failed only because Yang refused to sell, Microsoft would have gone through a large part of its cash and even raised debt to finance a dud.  With this propensity, it's no wonder that Microsoft's cash is considered an endangered quantity.

Microsoft used to have the largest cash position in tech. They still have $44.5 billion--a mere billion or so less than Apple. Some of the value already evaporated on dividends and medium sized acquisitions ($500 million for Danger that ended up as Kin(dling)). The chances that they'll blow billions again on desperate means to chase competitiveness are high. I would say it's a certainty.

On the other hand we have a high growth company like Apple that has not traditionally spent money on business acquisition. (They do spend on asset acquisitions--IP, code, developers but not on new business models.) Thus, on reputation alone, Apple's cash can be considered "safer" and hence worth more than Microsoft's.

Whether Apple can expose that cash to risk that enhances its value is another matter, but their CEO is on the record stating that "it's not burning a hole in their pocket" and the CFO repeats every quarter he is intent on its preservation.

This, in my opinion, makes the difference between Apple's $45 billion and Microsoft's $44 billion a lot more than $1 billion.

(1) Various studies have shown that at least 50% of acquisitions have been rated as failures. See failure rates by various studies charted below. Source: Prof. Dr. Thomas Straub (2007) "Reasons for frequent failure in Mergers and Acquisitions"