Apple at Risk of Becoming an ‘Also-Ran’ – Published in Noozhawk on Monday, October 28, 2013

To many, Apple is more than simply an electronic gadget manufacturer. Some even define who they are by having the latest, greatest Apple products, standing in line for hours and even days to be the first to buy the newest iPhoneiPad, etc. But now that Steve Jobs has been absent for two years, is Apple at risk of becoming just another consumer products company? My answer is no, Apple is not at risk of becoming an also-ran, it alreadyis one.

The Jobs Mojo is Gone

Soon after Jobs died, I wrote a column questioning Apple’s ability to continue innovating new, revolutionary products. So far, in the time since Jobs died, Apple has released numerous evolutionary products — new versions of the iPhone and iPad, but has not released any truly new, revolutionary products to rival its current lineup.

My concern was then and is today that without Jobs, the company will not maintain its ability to produce the kinds of products that can propel revenues and earnings at rates that justify Apple’s lofty valuation.

Brain Drain

Jobs had the unique ability to both attract and maintain top-quality personnel at Apple. Without his leadership, charisma and demanding standards for innovation and polish, many of the best of the best creative minds that were responsible for the great products Apple is famous for will eventually leave to pursue other ventures. This “brain drain” is quite common in companies that lose charismatic leaders, and those that become large and inefficient, stifling innovation and creativity. Apple is now one of these bloated behemoths that young, talented, creative rebels tend to avoid like the plague.

The Icahn Factor

Investor Carl Icahn recently established a large position in Apple, purchasing 4.7 million shares to date, or about 0.5 percent of the outstanding shares. He just sent a letter to Apple CEO Tim Cook, demanding that Apple spend its giant cash position to buy back shares. Icahn wants Apple to repurchase $150 billion of its stock, which he calculates will raise earnings by 33 percent, using a repurchase price of $525 per share. He stated in a Thursday call on CNBC that his average cost is $440 per share. At a current price of about $530, he is up $90 per share, or about $423 million. He’s pledged not to tender his shares, if Apple decides to use a tender offer to repurchase shares as he demands.

The reality is that Icahn is not a long-term investor, contrary to his rhetoric and that of the company. He is in the stock for a short-term gain, and will exit his position in the near-term. He did the same with Netflix, which he purchased at $58 per share and sold for five times that amount.

Apple already announced a $100 billion share repurchase and dividend program in March 2012, and pledged to buy back stock for more than $10 billion a year until 2015. After David Einhorn of Greenlight Capital sued Apple earlier this year as part of a campaign to get the company to give away more of its cash pile to investors, Apple announced a quintupling of its existing share repurchase plan. Under the proposal, it pledged to buy $60 billion in stock by 2015 and to raise its dividend of 15 percent to $3.05 a share.

I doubt that Apple’s board will be swayed by Icahn — at least not to the tune of $150 billion in stock repurchases. It may offer to increase the buy-back pledge by some significant amount. The reality is that Apple doesn’t need $130 billion in cash, its current cash balance, and must do something with that cash to enhance shareholder value. I’m not a big fan of share repurchases because it’s really just short-term financial engineering to push up earnings, rather than a strategic investment of cash to grow revenues and earnings.

Share repurchase programs are a last resort. They indicate that management cannot find anything better to do with a company’s cash. What they should be doing instead is investing more in research and development, buying other companies with new and innovative technologies, increasing marketing, entering new markets, etc. The fact that Apple cannot find anything better to do with all that cash tells me that management is not doing enough to find opportunities to build the company.

As companies grow, they find it harder and harder to generate strong growth in revenues and earnings. This is because they are attempting to generate growth as a percentage of an ever-increasing revenue and earnings base. As an example, a company generating $100 million in revenues can generate 10 percent growth by adding $10 million to its revenues. A company like Apple that generated $156 billion in revenue last year must grow revenues by $15.6 billion to achieve 10 percent growth. As you can see, it’s a lot tougher to maintain solid growth, the larger a company becomes. This is why it is so critical for companies like Apple to use their cash effectively.

With regard to Icahn’s stake in Apple, I would say that his involvement in the company — buying stock in Apple from below $440 per share — has been instrumental in pushing the share price back above $500. If we assume Icahn started buying around the $430 level, and the stock has already added $100 points per share, we could say that he has certainly been a driving force in the stock’s ~23 percent gain from when he began buying shares.

While I agree with Icahn that Apple stock prices would rise if it were to spend $150 billion to buy back shares, the reality is that, using his estimate of a 33 percent increase in earnings and assuming a similar valuation to today, Apple should only go up about another 10 percent from its current level.

If you are a short-term investor like Icahn, 10 percent sounds pretty good, especially if you are already up on the stock as he is. However, if you are a long-term investor, 10 percent should not be a significant motivator.

Further, although I believe Apple’s shares would spike if it announced an increase in its buy-back, I also believe the impact on the stock would be temporary. To really make the stock move up consistently over time, and by a good percentage, Apple’s management team must produce real revenue growth. Based on their current track record, I’m not convinced this is possible.

As great as Apple has been, its trajectory is similar to many other companies that were once high-fliers and eventually tanked. BlackBerry is probably the best example. Not too long ago, Blackberry had a cult-like following, so much so that people referred to the device as a “crackberry.” Here is a five-year chart of BlackBerry:

 

 

As you can see, the stock was trading above $80 per share a few years ago and is now just above $8 —10 percent of its high. Back when this stock was a high-flier, if we told anyone who owned the stock that it would drop below $10 per share he or she would have said we were nuts. Apple is at risk of doing the exact same thing. For anyone who doubts this, just look at the company’s own history: As recently as 2003, the stock was trading at $10 per share. Any stock, regardless of how popular it may be today, can become the biggest loser in the future.

My final point is to simply let the market tell us what Apple’s prospects are. Even with the recent rebound for $400 to the $530 range, Apple is far below its all-time high of a year ago of $705. With the Standard & Poor’s 500 trading at an all-time high, and the technology sector powering ahead, if Apple’s prospects were as rosy as Icahn and so many others claim, its shares would also be at or at least near all-time highs.

The market is sending a clear signal that Apple is in its twilight as a major market leader.

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