Reduction/sale of Apple Inc. June 13, 2017
We have reduced and, in a few cases, eliminated your holdings of Apple Inc. (AAPL). This decision was driven by a sense that the Company may be reaching a transition in which its constituency of stakeholders changes from growth investors to more traditional dividend investors, the type of people who want to own mature companies. The rationale for buying this company in early 2014 included a belief that the expanding hoard of cash that the company maintains offshore would soon be repatriated, much of it paid out in the form of dividends and significant share buybacks. This was premature and in fact with the international success of iPhone offerings and growth of app sales, the company has continued to be a growth story while allowing its offshore assets to continue growing.
Recently, at Apple’s World Wide Developers Conference, the principal innovation highlighted was Home pod, an apparent attempt to catch Amazon and Google with their digital assistant offerings (Echo and Google Home). However, Apple is planning to ask about twice the selling price as its competitors for this product when available in the fall. Some believe that the uniqueness proposition that is Apple is eroding as Samsung, Google and Amazon encroach with products that are technologically the equal or near-equal of those offered by Apple. It is difficult to know if products or capabilities will continue to drive Apple revenues. Apple watch has not been a runaway success, but the iPhone continues to be a leading product for higher net worth consumers. The recent developer’s conference suggests the company is developing improved software for its products that may offer virtual reality and augmented reality capabilities as well as embedded artificial intelligence.
The company does not appear to be perfectly competitive in the cloud storage area as is Amazon and Microsoft, but services are slated to become an ever increasing revenue generator for the company.
Yet, Goldman Sachs analyst Simona Jankowski projects a leveling of overall sales for the company by 2019. At the same time, she sees growth in dividends of over 15% per year and significant share repurchases, both supportive to the stock’s price. If Apple’s future appeal is to be generated by rapid dividend payouts and share buybacks, the Republican-controlled federal government must successfully lower corporate tax rates and provide a tax holiday for offshore money. A failure to pass meaningful legislation in this direction, this summer, could hurt share price in the near future.
There is another direction the company could go: management could decide to utilize its cash through an acquisition. Apple has a gap in its entertainment offerings: Apple TV has been around for many years, yet it is primarily a conduit for content provided by others. By comparison, Netflix and Amazon Prime Video provide a more “sticky” experience available from other platforms (smart TV’s and Blue ray devices). In order to augment the Apple ecosystem, Credit Suisse analysts believe there is a possibility of Apple making a massive acquisition (Netflix or Disney are mentioned) And finally, consider automobiles. On June 5 Tim Cook, Apple CEO confirmed rumors that the company is investing in the development of autonomous vehicles. This could lead to a turbo-charged company or result in frittering away of $billions in assets on a failed effort. The Apple project included manufacture of electric vehicles, according to a Bloomberg news article in early June. It appears this has morphed into a focus on a more universal autonomous driving system possibly combined with ride sharing.[2] Visionaries seem to agree that transportation in ten years will begin to look very different from what it does today, but is this something to bet on in 2017? We think it too early and that this project, like any pioneering effort, holds significant risks. Yet, there is a strong case for maintaining a modest position in Apple based on the possibility that the iPhone eight will prove to be a homerun. Further, the company’s strong ecosystem, the Apple experience across many platforms, will continue to generate strong free cash flow. Credit Suisse describes what it terms an “annuity” income (free cash flow) of $75BB per year based on offerings such as iTunes, App store and incremental updates to products and software. Services are predicted to become 33% of sales by 2020, and these offer the highest margins of any offering by Apple. Behind this we believe there will be a secular conversion of shareholder base from growth oriented investors to income oriented stakeholders. So, today’s decision to reduce exposure to Apple is simply based on the concern that after the spectacular rise that has happened for the share price over the past 12 months, it may be that most of the immediate good growth news is already built in and a meaningful correction could be at hand, at least until iPhone 8 is actually available for purchase in about four months. Many of our clients appear to be somewhat over exposed to equities, based on ongoing reviews of their risk tolerance, so funds generated by this reduction may very well go into fixed income investments. Although positions for some clients have been reduced and direct holding eliminated, Apple remains a significant component of mutual funds and exchange traded funds owned by our clients. [1] It may be startling to realize that Apple’s liquid assets are large enough to allow it to swallow Walt Disney & Co. currently valued at about $172,000,000,000 based on share price. [2] The company has invested a relatively small $1BB in Did a Chinese ride sharing system
