Investment Commentary
With the death of its co-founder and longtime CEO Steve Jobs, Apple Inc. is at a crossroads.
The freshness and uniqueness of its products have gradually faded and the company is facing stiff competition across the globe.
Technological innovation always runs its course, and it seems that Apple has reached its peak in terms of innovation and brand reputation. While it continues to be able to generate impressive sales from existing products, its products have become more commoditized and are no longer unique in their respective segments.
The life of innovation in any company lasts from a few years to a little more than a decade, but the dominance by one company in a real market economy never lasts more than 20 years. The reason behind this is actually pretty simple—the next generation is always a step ahead of the previous one in terms of innovation because it was educated (and thus became more immersed) with the latest ideas.
With profit margins approaching 40 percent, Apple is the exception in an industry where price competition and new technologies typically drive margins down to around 10 percent. There was only one Steve Jobs, so with his passing, Apple has to rely on its workforce to compete. Much like Sony Corp. in the 1990s, competitors are catching up and the pressure on margins will be huge.
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[tok id=b0f1d8c3752a9bc54bd6e2dd4dde9aeb partner=1966]In light of recent controversies surrounding Apple’s offshore tax treatments, e-book pricing, harsh labor conditions from subcontractors in China, Apple’s current brand loyalty will be tested. A huge portion of its profits come from its iPhone business, and with its competitors (for example Samsung) improving in terms of quality and ease-of-use, a price war will break out inevitably. Already, Apple is reportedly planning a cheaper, more basic version of its iPhone to better compete on pricing, especially in emerging markets.
Apple’s current margins are unsustainable. Within the next two years, in order to keep its revenues at current levels, it will need to increase sales volumes while likely cutting profit margins below 20 percent. This would result in a per share earnings hit of around $20, with further downside risk.
Its massive stockpile of cash-on-hand will cushion the fall in its stock price, but one risk is the large number of additional shares issued to employees and management. Over the last 10 years, shares outstanding have increased by more than 200 million, and more shares are coming to market. After paying taxes on its overseas cash hoard, Apple will likely need to use a portion of its cash for stock buybacks.
Over the next two years, the upside potential for Apple shares may be between $500 and $600, with a downside of $300 or below.
There is always a chance that Apple will launch a new innovative product in that time (iTV, iWatch, and so on) but then there is no guarantee it will be a hit. The fact is that the numbers are increasingly stacked against Apple.
Our recommendation is to avoid Apple until the smartphone commoditization battle is over.
Warren Song and Frank Yu are contributors to the Epoch Times.
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