Some thoughts on Apple

Apple released their q1 earnings for 2019 on Jan 29, 2019. Approximately 10% of my portfolio is in Apple. I also have more exposure to Apple through Berkshire, another 10% position for me.

Apple’s Moat

Moat based on privacy

Apple is optically trying to sell itself as a privacy first company. This separates them from companies like Google & Facebook which are ultimately using user data to provide value to the users, as well as advertisers. Apple gets to price their products aggressively and does not need to worry about monetising the  user data.

Because Facebook and Google are ultimately funded through ads, it s difficult for them to compete with Apple on privacy.

And so much of your personal information — information you have a right to keep private — lives on your Apple devices.

Your heart rate after a run. Which news stories you read first. Where you bought your last coffee. What websites you visit. Who you call, email, or message.

— Apple on privacy

This provides Apple a built in moat that none of the existing smartphone makers can compete with. There will always be a market for a privacy sensitive hardware manufacturers. It may grow and shrink depending on the tides of customer sensitivity.

Moat based on a well rounded product that works

Apple devices have a significant resale value, unlike say Samsung. They are built to last a while.

Toni Sacconaghi

Okay. Tim, at your September event Lisa Jackson an Apple VP stated the company needed to quote design products to last as long as possible. And Apple’s clearly doing that by helping with the battery replacement program, iOS working on an older range of products et cetera. But I guess the question is why doesn’t that mean that replacement or upgrade cycles for iPhones should continue to extend going forward in part because that’s almost one of your objectives?

…..

Tim Cook

We do design our products to last as long as possible. Some people hold onto those for the life of the product and some people trade them in. And then that phone is then redistributed to someone else. And so it doesn’t necessarily follow that one leads to the other. The cycles — the average cycle has extended. There’s no doubt about that. We’ve said several times I think on this call and before that the upgrades for the quarter were less than we anticipated due to the — all the reasons that we had mentioned. So, where it goes in the future, I don’t know, but I’m convinced that making a great product that is high quality, that is the best thing for the customer and we work for the user. And so that’s the way that we look at it.

Standing by your product by replacing battery for free is something which only Apple does. I remember having an iPhone 4 whose battery used to run out in 4 hours. I went to the Apple store and even though the product was past warranty (15 months), I walked out with a refurbished iPhone 4s by paying 75 CHF difference!

The latest survey of U.S. consumers from 451 Research indicates customer satisfaction of 99% for iPhone XR, XS and XS Max combined. And among business buyers who plan to purchase smartphones in the March quarter 81% plan to purchase iPhones. Based on the latest information from Kantar, iPhone experienced a 90% customer loyalty rating for iPhone customers in the U.S. 23 points above the next highest brand measured.

— conference call, q1 2019

Apple has a track record of making well rounded, easy to use, well thought out products. They may not have the most cutting edge technology or hardware, but they get there at their own pace and with a great story. For example, Face recognition was a preexisting technology but Apple made it cool.

If you are a customer who does not need to worry about money, which phone do you buy? The answer will probably be Apple.

This gives Apple a disproportionate market share in terms of buying power. Even though Apple has only ~13% of market share in smartphones, Apple owners probably own > 50% of the worlds buying power.

Moat based on wearables

Apple Watch 4 is awesome!

It comes with a great story: FDA cleared heart rate monitor, fall detection for worried adults with old parents and a fast enough processor that is pleasant to use. It is getting rave reviews.

None of the other smartwatches come even close in terms of the eyeballs Watch 4 is getting. Even before Watch 4, Apple was the number 1 watch company in the world by units shipped.

The day is not far when people will consider buying iPhone because they want the watch.

Ideally, I would like to carry my phone in the pocket and do most of the light work on a watch. A watch paired with a bluetooth headset is great for doing quick calls, read notifications, perusing emails/messages etc. I generally run with my android phone for tracking. This is super annoying because it jiggles around in my pockets — if i got one in my running jackets. Most of the time I run with the phone in my hand. A great watch is the only thing I would not be annoyed about taking on a run.

All in all, I am excited about the future of Apple.

Tidbits from the Conference Call

I enjoyed the conference call.

Apple Music

And I’m very proud to say that nearly 16 years after launching the iTunes Store, we generated our highest quarterly music revenue ever thanks to the great popularity of Apple Music now with over 50 million paid subscribers.

Spotify has 87 million paid subscribers (Nov’18). It has a market cap of 24 billion.

Growth in Services

Apple’s service revenue for the year was $41 billion, growing 22% year over year. Apple expects the growth to continue at approximately 20% for the near future (until 2020 at least).

In particular, there is a 20% growth business embedded in Apple with $41 billion revenue and ~ 62% gross margin. Just for fun, we can compare it to AWS — which is a $26b business with 25% gross margin. Obviously, the total addressable market for AWS dwarves that of Apple services. Or maybe Apple pay can become a home run, who knows?

In any case, being conservative with a 40% profit margin for Apple services and paying 20 times earnings, was can easily arrive at a value for Apple services stub i.e., $320b (!) As a reminder, Apple has $130b in net cash and with approximately 4.8 million shares selling at $150 a share, it has an Enterprise Value (EV) of 590 billion. In particular, Apple minus services is selling for only $270 billion (!) This includes the entire hardware segment consisting of iPhones, iPads, Macs, Watches, Beats and so on. Obviously, the success of the hardware and services segment is tied. But, they are both successful businesses in themselves and if conservatively the services stub is worth ~ $320b then the rest of the company is selling very cheaply at $270b.

Buybacks

We repurchased 38 million Apple shares for $8.2 billion through open market transactions …

Apple somehow managed to spend $8.2 billion at the quarterly high of $215 which was the price of Apple shares at the beginning of October. Apple fell precipitously after that got to a low of $146 on Dec 24, 2018. Basically, they went ahead and spent a shit load of money at the beginning of October and then waited out when the stock fell.

it is our plan to reach a net cash neutral position over time.

I hope they are buying their stock hand over fist right now.

As I write this, the Q1 report is out. Happy reading!

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