In July this of this year Asymco turns 17. In April of this year Apple turns 50.
This means that Asymco has been following Apple for one third of its life. I regret that it has not been for longer but oh, what a third it has been.
During 2009, Apple Net Sales were $46.7 billion. 17 years later revenues should comfortably top $500 billion.
Earnings per share (split-adjusted) in 2009 were 37c. This year EPS will be around $9.5.
Most importantly, at the end of 2009 Apple had about 107 million active devices (43 million Macs, 33 million iPhones and 30 million iPods!) Today it has 2.5 billion.
The increases in multiples:
23x Active devices, or a compounded annual growth (CAGR) of 20%
11x Revenues, CAGR of 15%
26x Earnings, CAGR of 21%
Apart from the customer love affair these numbers reveal, investors were awakened. 36x increase in Apple share price, from $7.5 to about $270. That’s 17 years of 23.5% growth.
The appreciation of the share price faster than the other underlying metrics reflects the undervaluation that existed for most of the last 17 years. Its value grew a lot more because it was too cheap to begin with.
That was perhaps my most important observation. A recurring undervaluation reflecting a perceived fragility. The more I studied and came to learn how the company operates the more I realized that the perception was wrong. It was in fact the opposite of reality.
When I started my “Apple model” in 2009 I did it out of indignation. I had access to a few analyst reports covering the company and, when looking at their forecasts and assumptions, I was shocked to read that they treated Apple as a computer company. Two years had passed since the iPhone launched and I had made the radical assumption that the future of the company would be determined by the dynamics of phones--later to be broadened into “devices.” This did not appear radical to me because five years earlier Apple had created the market for music players. A market it came to dominate. It seemed very rational to me that with the iPod (and iTunes), Apple had demonstrated that it was more than a computer company. Or perhaps more accurately, it was so profoundly different as a computer company that it redefined what computers were. Nonetheless, observers seemed stuck with the perception that once a PC maker, always a PC maker.
So here is my prediction today: Apple at 50 is no less capable than Apple at 20. Indeed, it is more so. This is because, even if it has not yet completed its quest, the company has sought self knowledge. A knowledge which I have sought to gain as a distant observer.
And so here I am, inviting you to come along with me on this journey.
Asymco is being re-launched. Apple at 50 is entering a new era. It has transitioned from Apple ][ to Mac to iPod, iPhone, iPad, Watch and Spatial Computing. But it has always been the company that brought computers to people and people to computers. The new era of computers that appear more like people is dawning and the connection between the two needs to be built. Only Apple is capable of creating this connection. And only Asymco is able to tell the asymmetric story of how it will happen.
Let’s learn together.
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Every major Chinese mobile maker, from Huawei Technologies to Xiaomi, saw major declines in a market that was down 23% overall, largely due to reduced subsidies and a shift in the timing of the Lunar New Year, Bloomberg News reported, citing Counterpoint researchers.
The iPhone 17 lineup, however, helped Apple to 8% growth, raising its share of the market to roughly a fifth, sharing the lead with Huawei. Cupertino, California-based Apple has seen its flagship product stage a major comeback since the September introduction of new models.
“Apple stood out as the only major brand to achieve year-on-year growth, and its market share reached the highest January level in the past five years,” according to the researchers. “The iPhone 17 base version now qualifies for government subsidies, boosting its value-for-money appeal and driving a 9% month-on-month sales increase.”
Investment bank Goldman Sachs discussed Apple Inc. in January. It reiterated a Buy rating and a $330 share price target on the firm. The bank discussed the firm’s App Store performance in its coverage. It outlined that the App Store spending trends were improving as spending grew by 7% in January to accelerate by one percentage point over December’s 6% growth. Goldman added that the App Store growth should contribute meaningfully to Apple Inc. Services business.
Along with Goldman Sachs, Bernstein also praised the firm. It reiterated an Outperform rating and a $325 share price target. Bernstein cited Apple Inc.’s record iPhone revenue and optimistic growth guidance to point out that the firm was correctly navigating the turmoil in the memory industry.
The Apple share count peaked at 26,549,208,000 shares in the third quarter of 2012. Today there are about 14,748,158,000 shares outstanding. The history of the shares outstanding is shown below:
Also shown in the second graph is the percent of the company owned by 10 million shares.
I highlighted a point representing the "halving" point, which is what I call the number of shares necessary for a reduction by 50% from peak share count. The halving point is 13,274,604,000 shares. Today's share count represents a reduction of 44.4%, meaning that there is 5.6% to go. The challenge in predicting when this point will be reached is that the rate of retirement is variable.
Consensus estimates Apple to post about $138.4 billion in revenue and both GAAP and non-GAAP earnings per share (EPS) of around $2.67 for the December quarter. The numbers highlight at least an 11% year-over-year growth in EPS and revenue, but analysts are now tightening their margin forecasts despite favourable iPhone sales and AI roadmap.
In a note, Morgan Stanley analyst Erik Woodring reiterated an Overweight rating and an unchanged price target of $315, but cautioned investors that Apple stock could “trade sideways to modestly lower after earnings.”
The firm expects Apple to beat expectations, driven by stronger, more persistent iPhone demand. Woodring expects December-quarter revenue of about $80 billion, around 4% above consensus, and March-quarter revenue of $55.4 billion, about 8% above consensus, citing supply-chain checks and shipment data.
He said iPhone 17’s “strength remains underappreciated by the Street.”
Morgan Stanley sees cost assumptions as overly optimistic. The firm forecasts March-quarter operating expenses about 7% above consensus and a gross margin forecast 30 basis points below consensus, driven by rising memory costs.
As a result, Woodring sees limited scope for positive EPS revisions for Apple, even with a revenue beat.
Morgan Stanley also flagged potential downside risk to June quarter earnings, estimating EPS of $1.62 versus the consensus of $1.71, citing intensifying memory-related cost pressures. The firm also notes that Apple has historically underperformed the S&P 500 more in Q1 than in any other period.
Looking ahead to 2026
All things considered, Morgan Stanley believes Apple is positioned to outperform in 2026 as a wave of new products and AI-driven catalysts is set to shape the company’s growth trajectory. The firm particularly highlighted the relaunch of Siri in February and Apple Intelligence in June at Apple’s Worldwide Developers’ Conference (WWDC). Some notable introductions expected include its most “innovative iPhone in 10+ years (Foldable)“, plus the first smartphone powered by 2-nanometer chips, part of the iPhone 18 family.
The firm sees greater benefits from share gains and higher average selling prices, with Morgan Stanley underscoring an EPS of $9.77 for FY2027, roughly 7% above Wall Street consensus.
Earnings will be above consensus. All eyes will be on how margin guidance due to pressure from memory pricing. Every year it's another thing that is cause for drama. It never matters.
As we approach the earnings release for the first fiscal/fourth calendar quarter for Apple, it's time to look back three months at what the company delivered and guided in the previous quarter.
The summary for results for fourth (fiscal) quarter of FY2025:
Revenue up 8% year-over-year, a new September quarter record.
EPS was up 13% year-over-year.
Product revenue was up 5% year-over-year driven by growth across iPhone and Mac.
iPhone revenue was up 6% year-over-year, and set a September quarter record despite supply constraints faced on several iPhone 16 and iPhone 17 models.
The iPhone active installed base grew to a new all-time high and had a quarterly record for upgraders. Also, Apple reached a new all-time high for installed base of active devices.
Mac revenue was up 13% year-over-year, driven by MacBook Air. Apple grew in every geographic segment, with strong double-digit growth in emerging markets. Mac installed base reached another all-time high, with nearly half of customers who purchased a Mac being new-to the product.
iPad was down 3% revenue and but over half of the customers who purchased iPad this quarter were new-to the product. iPad also had a September quarter record for upgraders.
Wearables, Home & Accessories Revenue for the category was flat y/y. Apple saw a September quarter record for upgraders to Apple Watch, and over half of Apple Watch buyers were new-to the product.Both the Apple Watch and AirPods installed bases reached new all-time highs.
Services again set a new all-time revenue record up 15% year-over-year. Apple saw double-digit growth in both developed and emerging markets. Apple saw a sequential acceleration across the majority of the categories and set new all-time records across Advertising, App Store, Cloud Services, Music, Payment Services, and Video. Apple saw a double digit growth in Apple Pay.
Guidance was provided as follows:
We expect iPhone revenue to grow double digits year-over-year, which would be our best iPhone quarter ever. On Mac, keep in mind, we expect to face a very difficult compare against the M4 MacBook Pro, Mac Mini and iMac launches in the year ago quarter. We expect Services revenue to grow at a year-over-year rate similar to what we reported in the fiscal year 2025.
We expect gross margin to be between 47% and 48%, which includes an estimated impact of $1.4 billion of tariff-related costs. And so for the December quarter, we expect operating expenses to be between $18.1 billion and $18.5 billion. We expect OI&E to be around $150 million, excluding any potential impact from the mark to market of minority investments and our tax rate to be around 17%.
Based on these forecasts my estimates for the top, bottom and middle lines are as follows:
Revenues: $140 Billion (+12%)
EPS: $2.70 (+12.5%)
iPhone: $78.9 Billion (+12%)
Mac: $9.4 Billion (+4%)
iPad: $8.5 Billion (+5%)
Wearables: $12.9 Billion (+10%)
Services: $30 Billion (+14%)
If there is an error in the above I would guess it's in iPhone being too low and the iPad/Mac and Wearables being too high. Nevertheless, I think this will be Apple's biggest quarter ever with significant growth acceleration on the top and bottom lines. [Notable will also be a rapid acceleration in R&D spending (+25%) as suggested by guidance.]
As we head into this blockbuster quarter, Apple shares are trading at a P/E ratio of 32 to 33, a significant drop from above 35 during previous few quarters. During the last three months, the share price has declined about 15% as Mr. Market looked at the money mountain above and decided he wanted none of it.
Apple’s relationship with China has always been a point of worry for investors. Nine years ago Carl Icahn sold his entire stake in Apple due to China fears. In April 2016 Reuters reported that "Icahn had been a huge cheerleader of Apple, acquiring a stake in the company almost three years ago, repeatedly calling the investment a `no brainer.'" In an open letter to Apple Chief Executive Officer Tim Cook in May 2015, Icahn had argued that shares of the iPhone maker were worth $240 ($60 split adjusted), about 90 percent more than they had been trading. At $240 a share, Apple's market cap would be $1.4 trillion, Icahn asserted. But Icahn, who owned 45.8 million Apple shares at the end of 2015, said China's economic slowdown and worries about how China could become more prohibitive in doing business triggered his decision to exit his position entirely.
Icahn’s stake when he acquired the shares was worth nearly $3 billion and he sold it for about $5 billion. A $2 billion profit. But China worries kept him from holding until today when his shares would have been worth $36.6 billion, thus foregoing $31.6 billion in profit.
Leaving $31 billion on the table (not including dividends) seems a high price to pay for a misidentified anxiety on China.
The public reasoning was: "But you worry a little bit, maybe more than a little, about China's attitude."The Chinese government could `come in and make it very difficult for Apple to sell there … [They] can do pretty much what [they] want there,' Icahn said. Earlier [that] month, China shut down Apple’s iTunes movies and iBooks stores within the country, following Beijing's introduction of regulations in March 2016 imposing strict curbs on online publishing, particularly for foreign firms."
That was 2016. Today the concerns appear to be:
Slowing sales due to rising competition from Chinese brands
Slowing sales due to Chinese economic slowdown
Tariffs and other barriers to trade affecting pricing in the US
Geopolitical threats to supply chain, including processor manufacturing in Taiwan
Should today's investor worry about China more or less than Icahn did in 2016?
In the case of competition in China, we have to understand that China does not have a free market or "laissez-faire" economy. The clue would be the middle “C” in CCP which, importantly, has a monopoly on political power in China. In spite of an ideology hostile to private property and market economics, the fact that Apple not only is allowed to operate in China but also is the market leader in urban (read: wealthy) areas and indirectly employs millions of workers and empowers millions more developers should be seen as something of a miracle. It continues to operate only insofar as the CCP allows it to continue and the CCP is nothing if not calculating. Clearly, China has seen Apple’s presence in the market (both as producer and seller) as beneficial. One could argue about who benefited most but overall deals happen (and persist) because both parties benefit.
The competition has been improving lately, but when has it not?
Fundamentally, from the consumer point of view, the competition question is moot since the alternatives are not iOS. The iOS ecosystem is incredible from a value-generation point of view, and Android has been clearly contained as a threat. (A nostalgic footnote. Recent talk of Alphabet being forced to sell Android is a wonderful reminder of the question I asked many, many years ago: why should a search engine need an Operating System (or a browser), but more about this later).
Chinese macroeconomic worries are not new (see Icahn’s from 2015). In most economies cycles are natural but in China there has been such a long expansion (since at least the 1990s) that a slowdown is considered a huge threat to stability. A recession would be seen as an existential threat. The CCP intends to manage its way through economic stress—one of the defining aspects of their semi-controlled economy is that “the state knows best” and markets can and should be controlled. This won’t last but the consequences are not likely to be catastrophic. China’s economy is probably large enough to avoid sharp changes which gives management enough time to muddle through. I would not say that this worry is unwarranted but rather that the changes are gradual enough to allow for some strategic planning.
The Tariff question has been partly touched on in a previous post. But the flip-flopping on the topic suggests that it’s a bargaining method similar to holding a gun to your head while threatening someone else that if they don’t do what you ask for, you’ll pull the trigger. Then relenting when they say nice things. Then repeating it.
Tariffs do not affect the customer relationship with the brand.
In 2016 Icahn’s worries were not geopolitical (they were just political) but has the world become more unstable since? The Covid pandemic was the trigger for much of this instability and we are still dealing with the consequences globally. However the bigger forces behind global changes are demographic and the subsequent loss of growth in China (and Russia) are causing authoritarians to find external threats to stay in power.
This will not play out quickly. There are worries but we should consider China (and India, and Africa) as sources of non-consumption that can and will be addressed with production. So the worry here is again structural and slow-burning. I would argue decades in the making.
Not much has been said about the benefit to Apple of its China strategy. Many assume that lower costs and access to a large market are all that has been gained. But it’s much more complex than that. The access was not to a lower cost base but also a much more agile and flexible production infrastructure. The flexibility allows for a very tightly coupled value chain. The result is a reduction in inventory and a rapid time-to-market which is essential to Apple’s integrated product/software/service rhythm of yearly launches.
I’d argue that without the flexible, at-scale production system China allowed Apple would not have been able to succeed at reaching a billion highly satisfied users. The world would have been awash with cheap Android phones and very few iPhones, a repeat of the PC model where hardware was largely irrelevant.
The challenge of the future is to take this model globally and either transplant it to India and other places or to scale it in such a way that it can be distributed to many centers of production. Toyota famously not only created a product system that reduced cycle time and inventory but did it with 400 plants globally. I certainly hope that the Apple Production System will also be celebrated one day as the “machine that changed the world”.
Come learn more about the Apple Production System at the ACTIVE conference.
It’s not unusual to see articles consisting of lists of reasons why Apple is facing an existential crisis. Agonizing and hand-wringing about Apple been a meme for decades, so much so that it had its own web site, The Apple Death Knell counter and the "Pray" for Apple imagery was a thing since the 90s. The original article from June 1997 offered 101 tips on saving the company starting with outsourcing hardware or scrapping it entirely.
Although the imminence of death has always been persistent, what’s changed over the years were the causes. There are far too many to recall or enumerate but I have through personal recollection and pattern recognition grouped them roughly into three categories:
Irrelevance due to low market share, i.e. insufficient network effects for its platforms which will eventually drive users away. This is fundamentally a size problem.
Insufficiency in capital/resources/talent/management. This includes the death of Steve Jobs, the departure of various other managers and historically the low spending on R&D. This is more qualitative but still fundamentally a problem of being too weak.
Externalities including but not limited to: law suits, regulations, taxes, technology standards. This includes everything from the absence of the Beatles in the iTunes store to confiscation of assets or extortion by governments. Extreme versions are antitrust cases alleging monopoly status. This is a problem of being too big or too strong. (Contrast with the first two categories)
For instance, during the last Apple Investor Event, I highlighted a typical article citing a list of problems for Apple. It was Titled “5 problems facing Apple it won’t talk about at is April event”. Published in August 2024 it cited the following:
Maintaining profitability. Citing a drop in operating margins in 2020(!) the problem was stated as a need to maintain momentum.
Antitrust regulation. Citing EU and US investigations against Apple and other Big Tech companies. Money quote: “reports have surfaced that several tech companies in China are actively testing ways to circumvent Apple’s new privacy update”).
Lawsuits in general, Epic trial in particular.
A lack of diversity in the management team. Essentially, insufficient DEI.
Competition. Google, Blackberry, Dell, Fujitsu, Microsoft and Samsung are cited.
When I read this I thought it must have been AI generated (hallucinated more likely). The dates did not make sense (August publication predicting an April event) and the competition cited was obsolete (Blackberry? Fujitsu?). It was a random list of Apple news framed as problems. Rather than try to refute them, I realized that it did not matter. The objective of the author was not to illuminate but to discharge something, anything, as long as it was negative.
Since last August a lot has happened. A new US administration, a new set of problems. Judging by the share price and news flow, Apple bashing is once again in vogue. (Incidentally, the stock price reached an all-time-high in December 2024 at nearly $260/share, a substantial increase from $170 or so six months earlier.) Today everyone and their editor is jumping into the scrum writing lists of Apple problems.
The pattern however seems a bit different this time. Almost all the catastrophes Apple has are externalities. Let’s try to enumerate them (inspired by Bloomberg.)
Tariffs. Consequences include presumably negative impact to company’s operations, product development and device prices.
Antitrust. A US Department of Justice lawsuit for allegedly anticompetitive practices. Similar actions by the European Union, South Korea, Japan, India, etc.
Lawsuits. Apple must stop taking a commission on in-app purchases and subscriptions paid via the web. Epic again.
Distribution deals (Google antitrust). The threat of losing a $20 billion-a-year deal with Google for default search placement.
AI delays: the risk of falling even further behind its tech peers
Competition in China.
What these examples seem to share is that, except for the AI execution, they are externalities and thus of the third category. They are therefore problems related to being too successful.
Tariffs are a problem because Apple relies on massive scale and thus requires integrated production which creates concentration in production centers which are difficult to redeploy. Antitrust is a problem because Apple is too big and thus dominates developer distribution. Lawsuits center on having too much control—related to antitrust. Google antitrust remedy forces a decline in distribution revenue for browser search—a predicament coming about Apple’s enormous leverage vis-a-vis Google. Being so big means there is only one way to go: down, hence Chinese competitors gaining share. Lastly, AI execution problem is more Category 2 problem but would not be an issue if Apple did not insist on Privacy for its customers, something which caused much of its success with customers that it got too big.
Incidentally, profitability is now higher than ever, top line growth is consistent, bottom-line growth is even faster, the company is guiding growth in-line with current trajectory, the number of customers is at a new record, churn into the platforms continues, Apple is winning against non-consumption, capital is pouring into shareholder pockets and R&D spending is soaring. Cue the charts.
What the casual observer might note missing from the Doomed listicles is any mention of customer satisfaction, loyalty, acquisition and retention. The things the company actually talks about on earnings conference calls.
Do these externalities of tariffs, antitrust remedies, distribution dissatisfaction and non-iOS competition make any impact on how customers perceive the company?
We'll discuss this in the next few posts, as the lead up to presentations at ACTIVE: The Apple Investor Conference on Tuesday June 10th, the day after the WWDC25 keynote.
In yesterday's post, I proposed a way to inspect the Google-Apple distribution deal. It could be understood as a flat-rate deal where default placement of Google search in Safari is paid for with a constant run rate. This was the assumption for a few years with estimates for this run rate ranging widely.
Alternatively, it could be understood as a commission rate where payments are in proportion to ad sales. This is the 36% commission rate that has leaked during the antitrust trial.
Finally, it could also be seen as an access fee for each individual. This is the 17c/user/day that seems apparent from my calculations.
If one were to critique these options, I would disqualify the flat rate as unfavorable to Apple since the user base grows and behaviors can shift. The distribution commission sounds ideal but it would be problematic to enforce. How exactly can one track the precise income obtained by Google for each use of search, maps or YouTube on iOS or MacOS devices reliably enough with an audit trail for Apple to inspect?
For these reasons, I believe the fee of $x/user (or possibly active device as a proxy) makes more sense. The burden would be on Apple to prove that they have such active users/devices while Google could sample their metrics to confirm. Data on active users and devices are figures that Apple already supplies publicly and a method for determining them likely could stand scrutiny by outsiders. The server logs showing active devices can't be too onerous to share.
And so that's the model I'm going with. Having said that, the formulation of compensation for what is a complex distribution deal is likely complex. The abstraction to users/devices is one we have to live with given the challenges of inspecting the invisible.
That's the model of the present. The future however is clouded by the potential interference of authorities. In this case, an antitrust prosecution of Google is asking whether the way Google buys distribution is anti-competitive. The legal arguments are beyond scope here but the gist of it is that buying exclusive distribution when you are dominant may close options to not-so-dominant competitors.
The consequences, if we are to believe the commentary, are that the deal with Apple could be declared illegal and thus, stay with me here, Apple would lose a lucrative source of income.
Let me repeat this for emphasis: If Google were found guilty of anti-competitive behavior, Apple would be punished.
Let me expand for emphasis: If Google were found guilty of anti-competitive behavior, Google will be forced spend far less and be marched off a gangplank to swim in far greater profits.
Given this commentary one wonders why Google's management and legal team aren't begging the judge to rule against them and why Google shareholders aren't hoisting the prosecuting team on their shoulders.
The deal between Google and Apple exists only because both Google and Apple find it to be a better alternative to not having a deal or having any another deal. It does not exist because Apple benefits and Google doesn't or that Google benefits and Apple doesn't.
As I've explained the first post in this series, Google's benefit is distribution or access to 1.3 billion very valuable customers. For this they pay quite a lot and Apple receives quite a lot in turn. The relationship is shown in this illustration:
But—and here you should pay close attention—Apple also pays something for that benefit. Apple's $26b+ income from Google's TAC payments are in exchange for offering access. To Google. Not to someone else. And not to itself. Apple's costs are opportunity costs.
If Google had not offered the area marked with a question mark in the image above then Apple would have found alternatives. Alternatives that it's saying no to today.
Apple's alternative to the deal is what needs to be studied.
Could, for example, Apple have signed Microsoft for Bing access in Safari? Sure! They probably didn't because, as they declared, the quality of Bing would not be as good and as a result most people would switch out of it and thus result in lower revenues. Then again, perhaps Apple could make a fortune from Microsoft. Apple could have enabled Microsoft to rise to 40% market share in search, and also improving its quality. How much would that be worth to Microsoft? How much additional opportunity could Microsoft create from establishing such a strong consumer-facing franchise—something they have struggled to obtain even with vast expenditures. Surely Microsoft could be convinced to split revenues 50/50 for what would be all marginally zero-cost new upside!
Could Apple have developed its own search? Sure! They probably already did. Internet Search is a lot easier in 2023 than it was in 2007. Costs for computation, communication and storage drop exponentially while the number of internet hosts has stopped growing. Apple uses indexing in Siri and each iPhone, Mac and iPad runs a local search engine (Spotlight). Again, there are reasons why this is not as good or easy as signing Google up. But on the other hand, perhaps Apple could be making a killing on search. Why accept a 36% commission from Google when they could take 100% of 40% of all Search?
But most importantly, a declaration that this deal is invalid simply means that Apple and Google would craft another deal that would work around the restrictions. And that new deal would probably turn out to be more beneficial to Apple.
Why, I hear you ask?
Because Google would ask for the changes! Google would be forced to re-negotiate because they lost at trial. If that were the case, Apple would naturally ask for concessions. The most certain outcome would be that Apple will be paid even more for access to its users.
How much more? Remember that Google must ensure access to Apple's customers. According to my calculations Apple customers deliver almost 40% of its advertising revenues. The 36% commission suggests that there is plenty of head-room. Apple could ask for 50% and meter the results on a different basis. This would be a 39% increase in pricing for distribution.
This would result in a deal worth $41 billion/yr.
To implement workarounds, the companies would need to bridge their servers in order to ensure metering along new metrics. There would a great deal of complexity. But it would be worth it because both would find such a deal better than alternatives.
Fundamentally, the relationship between Google and Apple exists and will continue to exist because it is mutually beneficial and a better alternative to any other agreement or no agreement. If the current deal is found unsound, for whatever reason, a new deal will be created because it will need to be created.
Apple sits in a better position today than it ever did. Its customer base is growing while its pricing power with consumers is growing. In contrast, Google is the process of explaining that it did not break any laws. This while losing Android users to Apple. How does this lead to a vulnerability for Apple?
What we are witness to here is Apple increasing its distribution pricing power while simultaneously decreasing its opportunity costs.
The idea that Google being found guilty of anti-competitive behavior would result in a "hit to Apple earnings" is preposterous and fails on first inspection. The exact opposite is the likely outcome.
Are Apple and Google competitors or are they partners?
Prior to the launch of the Android operating system, Apple and Google collaborated on many projects. Google Search was predominant on Apple products including the (at the time) new iPhone. The iPhone also launched with support for Gmail and had native Google Maps and even YouTube. Google was a cornerstone supplier for the new smartphone.
After the launch of Android only a year later, the relationship changed. The two companies came to be viewed as mortal enemies. The perception that Android was disruptive to Apple—insofar as it undercut the pricing power of the new touch-based user experience—was universal. The "zero price" of Android and its licensing by all other phone makers suggested a competitive collapse was imminent for the fledgling iPhone. Android phones were far cheaper and "good enough." If not immediately, then with the resources of all phone makers and Google itself, Android would surely soon overtake the iPhone in performance along all dimensions. It took a great deal of courage to argue otherwise.
But, over time, the notion that the iPhone would continue to exist became more widely held. Holding on to a "premium" positioning, iPhone seemed to be have pulled a rabbit out of a hat, perhaps because of Steve Jobs' reality distortion field or because of magical marketing. Nonetheless, doubts over long-term growth persisted.
Having survived Android, Apple was still seen as vulnerable to a multitude of Google initiatives including Chrome and Chromebooks, a range of Google Pixel phones (enabled by the acquisition of Motorola and HTC.) The entry of Google wearables (enabled by the acquisition of Fitbit), Glasses, the Play Store, YouTube content, Google productivity apps, Google cloud, Google TV, Nest, Google Assistant and numerous other services were all cited as nails in the iPhone coffin. This is all before the age of Crypto a new generation of AIs came into fashion.
Throughout this period the iPhone continued to increase its audience, growing its base of users not only from smartphone non-users but also from so-called "switchers", that is, those who moved from Android to iOS. Apple has benefitted from this net positive switching for at least five years now as most of its addressable market has already adopted the smartphone. There are about 1.2 billion iPhone users and it's far more likely that a new iPhone user today arrives from the 3.5 billion Android users than from the 3.2 billion people who don't yet have any smartphone. That is because those who don't yet have a smartphone today are also likely to not yet have access to electricity, cellular networks or money.
Indeed, it is Android that seems to be in a precarious position. The ecosystem is bleeding not just high-end users but also from fragmentation. Chinese OEMs in particular deliver their own experiences and code bases, eschewing Google services altogether. Large OEMs such as Samsung are seeking to differentiate with their own experiences and ecosystems and accessories and chafe against Google's hardware offerings. Upgrade rates to new Android versions are poor. Support of hardware beyond a few years is lacking. But, most fundamentally, Google has not developed a business model that directly fuels development of Android.
Put simply, Android is not a profitable product. It's not designed to create revenues. It's designed to reduce costs.
To understand this, we have to understand Google's business. It's not very complicated. Google's revenues in the last quarter are segmented as follows:
The colors above indicate the major categories. Blues are Advertising, yellow is "Other" and red is Google Cloud. Other Bets, consisting of research projects, is a 0.4% rounding error. Apart from Search which is about 60%, each major category is about 10%. Advertising as a business model is about 78%.
To Alphabet's credit, Advertising as a business model has been reduced from 94% a few years ago. Much of that credit goes to Cloud which is a B2B business and has completely different resources, processes and priorities than Search. The "one trick pony" label is less applicable to Google today.
Search however, and the ancillary properties, are still, by far, the largest sources of revenues and profit. Note that Android itself is missing from this mix apart from Play Store which is a direct Android extension. Play does contribute somewhat as part of "Other" but the OS itself is an enabler across all these categories.
While not directly producing revenues, what Android does is perhaps even more important. It helps reduce the amount Google has to pay to access its customers. Think of Search as a system which takes queries in and puts results out. These results are what advertisers pay for and the queries are what Google pays for. The output depends on the input. That input is harvested from many users. Access to those users is not free. The cost can be paid by building access directly (Android) or by paying for access to someone else's property (Apple, Windows, or Firefox). In old-school business terminology this is called distribution.
Distribution is often ignored or considered a superfluous "middleman" to be bypassed. But distribution is foundational to any business. It is, effectively, other people, outside your company, helping you sell your product because they have access to the customers. They get paid for that access, often with a percent of sales. Stores are distribution. Wholesalers are distribution. Resellers are distribution. Without distribution scale cannot happen. Distributors help both producers and consumers by creating access.
Access is also provided by what we call infrastructure. Just like you can't travel by car from your house to your destination without roads, all access to products and services is effectively infrastructure. If you own the infrastructure then you have to pay to build it and maintain it. If you don't own it you have to pay to use it. All infrastructure has value and all infrastructure has costs.
This all makes more sense when recalling the historic birth of Android. At the time (2006 to 2008) the worry for Google was that Microsoft's mobile operating system (Windows Mobile née Windows CE) would be licensed as was Windows. That is to say that all phone OEMs would take a license for a nominal fee and build Windows Mobile phones. Microsoft would thus dominate the mobile computing market the way it dominated the PC market (with market share above 95%). Microsoft would then ensure that Bing search was the default on all devices running Windows and Windows Mobile, thus blocking access to what was expected to be the next 3 billion users while capturing all search ad dollars ad infinitum.
If Windows Mobile were to dominate, Google would be denied distribution, at any price. It would thus be relegated to, at best, 10% market share of mobile search. This would be an existential crisis.
In this setting, Apple was an ally for Google. Apple was not a search engine provider and was very welcoming of Google search on a nascent Safari browser. Whereas Explorer would block Google search, Safari would offer default placement. Not for free, but for a reasonable cost. Google was a "go-to-market" partner for Apple and it was a symbiotic relationship.
However, the expectation of Google at the time was that Apple would be no more successful with iPhone than it was with the Mac: A fringe of "creative" or "fanboy" quirky oddballs. This was not just Google's expectation. It was everyone's expectation.
Android was built to counter a Microsoft mobile OS monopoly with a "zero cost" option vs. Microsoft's end-user-license model. Microsoft made money selling software. Both system software (Windows) and application software (Office.) Google would give away system software (Android) and services (Gmail and Docs) but make money on advertising.
A genius move. Phone OEMs would much rather pay zero of the OS on their phones than for the non-zero Windows Mobile license. [On a $200 retail cost phone (and thus $90 bill of materials) a $8 OS license is a huge cost.] Google's Android did indeed block Windows Mobile from getting a foothold in the post-PC era.
But it did so by taking some short cuts. Android itself was an acquisition in 2005 (for $50 million, with a keyboard interface) and, in response to the iPhone, a new touch user interface was developed. It so happened that this interface copied as closely iOS as Windows had copied the original Mac. This perceived theft was such an affront to Steve Jobs that he declared war on Google.
It was important to ask (as few did) why did Google need to develop an OS, only to give it away. Was its business that robust if it needed to expend enormous energy and capital to build an enabler? The answer is, of course, distribution.
Google was initially not paying for distribution as most people just typed "google.com" into their browsers. As the URL field became a search field, Google could still expect PC users to make Google.com their search bookmark, one click away.
But on mobile devices, the friction of the constrained interface meant that defaults mattered. Mobile was going to require new distribution economics. Devices were going to be in the hands of many more people, who, since they did not have full-size keyboards, would type less and who would interact in new (and very succinct) ways. One click away was one click too far.
With Android (and Chrome) Google set defaults for its services across the platform. If Android was the OS then Chrome would be the default. If Chrome was the default, then Google Search would be the default. For these Android-sourced queries, Google would not pay for distribution. Or, more precisely, would only pay to build and keep Android. Thus the more Android there was, the cheaper it was to obtain search queries for Google. Google had built its own highways: it owned the infrastructure that connected users to its services. These roads were for Android users. And what about iOS users?
Over a 15 year period the smartphone went from essentially zero to 5 billion users. It became so important to those 5 billion people that they keep it with them every waking moment, use it 100 times for a total of 5 hours each day. That adds up to 182,500,000,000,000 interactions a year and, as a result, it has changed behavior, politics and humanity itself.
Throughout this period, the relationship between Google and Apple changed. From being allies, to mortal enemies to, as we shall see, partners. We have to understand this new relationship that has emerged and its consequences.
The next post will explore the relationship in detail using the lens of the deal structure that exists. A deal which is not public and largely unexamined.
Apple has so far returned $761.5 billion to shareholders. 143.3 billion in accumulated dividends and $618.2 billion in share buybacks. These are the gray areas in the graph above. The question that often comes up is: isn't this capital return program a misallocation? In particular isn't buying back shares and retiring them a waste of money?
By definition, it cannot be. The mechanism of buying shares and retiring them is a process of returning retained capital to shareholders. The other ways this can be done are through dividends (periodic or one-time) or the sale of the company (liquidation). Ignoring the liquidation option which does not make sense for viable companies, the decision between dividends and buybacks comes down to a tax efficiency question.
The result is, however, roughly the same: retained earnings, which are stored by the company as cash typically (net value for Apple today is $57.2 billion), are an asset balanced by a liability to the shareholder called Total Shareholder Equity (valued today as $60.3 billion.) As such, the retained earnings belong to the shareholders. It's why they own the company. It's what their cash share of the value in the company is.
It's also surplus to the company's needs. Had the company needed this cash, it would have spent it on building the products and services it sells or operations that maintain or grow the business. Those expenses appear in cost of sales (COS) or cost of goods sold (COGS) or in operating expenses Sales, General and Administrative (SG&A) or Research and Development (R&D). If it's not spent this way then it drops to the net income line and, crucially, is subject to taxation (about 12% to 15% for Apple). After taxation, once returned, it's taxed again as either capital gains (in the case of buybacks) or dividend income. These rates vary on the jurisdiction of the owner and the current tax policy.
Note that the spending on R&D includes development of future projects which are not directly related to current products. Engineering of current products is expensed against COGS. R&D for Apple ($29.4 billion in last 12 months) is significant, having grown to 9% of sales, as the graph below shows.
For the company to decide to return capital it really does mean that it has no good ideas on how to spend it given what the company knows it can and cannot do. It's a judicious decision and one which honors the relationship between owner and manager with fiduciary responsibility to the owner.
Still, doesn't that mean it's wasted?
No. Giving it to the shareholder means that the company says "It belongs to you, I don't know what to do with it on your behalf, so here, you figure out what to do with it." The shareholder can then make an allocation decision that suits their sense of what is valuable or useful. The return is a deferral of decision to the owner rather than their agent.
To the extent that once returned, the capital is misspent, that is on the spender, not on Apple.
Consider the alternatives. Instead of returning capital, what some managers decide to do is to re-allocate those retained earnings to acquire other companies with the promise of value creation through synergies. However these are often huge wastes of money. The new asset is recorded as "goodwill" on the balance sheet, offsetting the retained shareholder equity. As the synergies fail to materialize, the asset (goodwill) is written off, and shareholder equity decreases accordingly, and so, value evaporates or is transferred to the owners of the acquired company who cash out above market value.
Acquisitions are a process of picking the pocket of shareholders.
The alternative might be to spend heavily on R&D. That is more admirable but the amount involved is enormous and it's very difficult to find enough people and projects worth pursuing without turning R&D into an academic organization. Remember that with R&D at $7.4 billion per quarter, the company is spending 41 times more than it did in 2006.
And doubling or tripling R&D, even if possible, would impact margins to such an extent that Apple's profitability would show very poorly indeed. That would collapse share prices and decrease share-based compensation, limiting the possibility of recruiting talented engineers. It would bring quite a lot of negative consequences.
Another exercise to undertake would be to ask what would happen if the mechanism of share buybacks were made illegal. It was not always legal anyway. That is left as an exercise to the reader.
