Thursday, January 24, 2013

Apple As The New RIM

As former market darling Apple (AAPL) has seen its stock price continue to fall, it has increasingly piqued the interest of value investors. At a market cap of $450 billion and twelve-month earnings of over $40 billion, Apple's P/E is barely over 10. Considering the company has no debt and cash equivalents of almost $140 billion, the valuation appears very compelling indeed.

But Apple is now officially growing slower than its market, suggesting others (including rival Samsung) are eating some of its lunch. Could this be a temporary situation, allowing the long-term investor the opportunity to purchase a company with a moat at a discount?

It wasn't long ago that Research In Motion (RIMM) found itself in a similar position. I know this from first-hand experience, because I started buying shares in the maker of this once ubiquitous product far too soon as they fell from grace.

What happened to RIM and what may be beginning to happen to Apple appears to be a characteristic of this fast-changing industry; one has to continually innovate just to stay in the same place.

Contrast this with the industry Microsoft dominates: operating system and the Office suite of products. Microsoft hasn't innovated much in the last 15 years, but it has still shown enormous profit growth because of the nature of its industry. Network effects take massive precedent over innovation. Many companies could probably (and some have) created more intuitive, faster designs. But without a network of existing applications (or documents) that can run on such a platform, most users have shown an unwillingness to switch from Windows (or Office). As a result, breaking Microsoft's grip on this industry has thus far proven impossible.

Does Apple enjoy the same kind of moat? Certainly it does to some extent. The range of apps available only to Apple products undoubtedly offers some advantage, along with the brand appeal that this company has cultivated. But absent substantial innovation, it may not be enough of a moat to ward off future declines. Samsung is already demonstrating that the Android platform is proving good enough for an increasing number of new phone buyers/upgraders.

Also consider that RIM enjoyed some very similar advantages when it dominated the scene. I overestimated the strength of these advantages when I purchased shares far too early. Specifically:

1) The network effects of BBM were easily overcome by the features and functionality that the iPhone offered over the clunky Blackberry (at least they did in the US; in countries where network charges represent a higher share of income, BBM has helped RIM hold its own)

2) Security and corporate customers did not force professionals into keeping their Blackberries; in fact, the opposite occurred, with BYOD advocates pushing corporations to open up to different platforms.

3) Economies of scale in the form of R&D and marketing spend per unit that market leaders usually enjoy appears to have been worth little; in this industry, the innovations appear to come from superior processes, not dollars.

The one competitive advantage that existing firms do appear to enjoy in this industry is barriers to entry. It has proven very difficult for newcomers to innovate their way into a decent market position, as this requires simultaneous relationships with carriers, developers and consumers, something that appears difficult to build-up all at once. This feature of the industry has likely saved RIM from bankruptcy, and even kept it in a position where it may once again succeed if it can out-innovate its limited number of competitors in its next product cycle.

While I don't expect Apple to fall behind technologically to the same extent as did RIM, risks to Apple's strong current position remain. In this industry, the market leader can be toppled to "also-ran" in a hurry. So while Apple is clearly cheap compared to its recent earnings and earnings capacity, a value investor may require more of a margin of safety than normal, considering that downside risks are particularly high in this industry.

Disclosure: Author has a long position in shares of RIM


Anonymous said...


Thanks for your analysis. Great to see a well-written article on Apple from the perspective of a value investor.

Thought you might like this contrarian article on Apple: It's consistent with your analysis, although differentiates between RIM and Microsoft's economic moat vis-a-vis Apple. Do you agree there is a difference between Apple and RIM, as a result of RIM's singular (successful) product line and Apple's "multiple points of failure" (as you've discussed on this site before)?

Big Fan

Anonymous said...

I think P/E doesn't matter.Value investors pay too much emphasis on it.If AAPL has a P/E of 10 it does not mean it is cheap and therefore a buy.The street is giving it a low p/e knowing that its earnings growth will not be the same in the forseable future.I think AAPL is a strong sell here.

Anonymous said...

A strong sell on what basis? Anon, what metrics do you prefer? If Apple's earnings growth is in decline, then what is its intrinsic value factoring that into your analysis?

Anonymous said...

What do you think will happen to RIM after next week's launch? Thanks in advance?

Saj Karsan said...

Hi Anon1,

Yes I do agree Apple's moat is stronger than RIM's was, however, that could just the result of hindsight bias.

Hi Anon4,

I have no idea

Brett @ wstreetstocks said...

I don't think that Apple will turn into RIM. However, they will become like the arch rival Microsoft. They will likely increase the dividend during the next few years and the company will become an income investment. The growth story is over.

Adam Gaglio said...

The problem with the analysis of RIMM was that value investors were looking at the situation quantitatively. You could point to their ROE or any of several metrics to show that it was cheap. The problem is that this is total context dropping. RIMM is not a US Treasury, it's a business that needs to be evaluated qualitatively as well. Everyone (even the bulls) acknowledged that Blackberrys were garbage. Compare that situation to aapl now and I don't see any fundamental similarities. Apple is still growing, still has a sterling reputation, and still sells the Cadillac of smartphones. I cannot claim any unique knowledge on the direction of Apple or the smartphone/tablet industries but I do know that the company does not look to be collapsing but it's priced as though it is.

Anonymous said...

Apple is a strong sell on Margin squeeze basis.Margins in Apple in the foreseable future will be lower.
If you listened to the last earnings call Apple has stopped providing guidance.So the company is slowly being valued as a hardware company compared to a software comany like Google which is discovering new ways of monetising on the mobile front.
I think what Google did with Android was brilliant.
I see the move similiar to what Microsoft did with DOS when IBM was selling PC's.The result was a decade of stellar growth from Microsoft from the 80's to 90's.

Anonymous said...

Hi Saj,

I'm curious on whether you've pulled the trigger yet on Apple given the continued price decline since your original posting.

With a P/E now under 9, a dividend yield of about 2.65%, among many other factors consistent with Fisher-style and Buffett-style value investing (both qualitative and quantitative), the current stock price seems to be a generous gift from Mr. Market.

I'm having trouble understanding Mr. Market's apparent fear that Apple could be in a decline reminiscent of RIM, despite likely short-term sales decline in iPhones and iPads, medium-term margin compression and an increasingly rivalrous industry landscape. However, I may have been drinking the Apple Kool-Aid for too long and I wish to avoid the mistake that I believed many brilliant (including yourself) finance colleagues were making by holding onto RIM as a long-term value play.

I originally bought into Apple during the 2008 downturn based on a contrarian hypothesis of a shifting competitive landscape (among other things). I was fortunate in the accuracy of my predictions, but now it's highly likely that my results are contributing to overconfidence biases in my reasoning on (1) my own abilities, (2) Apple's competitive prospects, and (3) the impact of rivalry on long term industry profitability. I'm hoping to flush out these biases before concentrating my portfolio too heavily in Apple.

It would be great to hear if you've managed to determine an entry point with a margin of safety that factors in the somewhat unique risks of the technology sector. Objective analysis from a like-minded value oriented investor on Apple would be much appreciated.

Big Fan.

P.S. Buffett apparently "swung for the fences" in his early years with a heavy portfolio concentration in GEICO. Do you have clarity or rules of thumb that you follow on heavy portfolio concentrations in a few well-researched stocks?

Saj Karsan said...

Hi BF,

I have not pulled the trigger, but will continue to consider doing so. My opinion in the article still holds: I just don't know if the competitive advantages apple clearly has are enough to compensate for the fast-changing tendency of its industry.

A recent article by Brooklyn investor probably does a better job of illustrating my thoughts than I can myself:

Anonymous said...

Thanks Saj.