Friday, December 21, 2012

Why I Left Apple (Apple is a Speculation)

OK, this title is meant to mock the book about Goldman Sachs with a similar title.  I have never worked for Apple, so this is misleading.
Warning:  This post has no data or any analysis.  It's just opinion, like a dinner table conversation with family on what worries me as an Apple shareholder (or former shareholder, current shorter) so maybe it's more of a rant or lengthy rambling.
So those looking for spreadsheets, data, channel-checks and information from Asian expert networks on Apple supplier order trends can skip this post.

Anyway, first of all, I do admit that a long Apple position has been the biggest dollar contributor to my performance this year; I owned the stock for much of the first half of the year.   And then I got short starting in October or so when I posted about that here (and got more comments (or close to that) than any other post, ironically).
It was on October 11, in my post titled "Crash?!"
I'm not proud of trading, but I admit that October was very good for my portfolio largely thanks to the Apple short (which I covered in November).
I do understand the long story for Apple.  It is incredibly cheap and it does have tremendous momentum.  Yes, Apple is not Motorola or Nokia.  Yes, it's not just a gadget but it's the eco-system.  And yes, a large market-cap is not barrier to further gains.   I agree with all of that.

The reason I got nervous and dumped my Apple shares was simply because I couldn't see Apple ten years out.  I couldn't see that when I bought the shares, but I bought it thinking I can buy at 10x p/e and sell at 15x p/e or something like that and then enjoy the earnings momentum along the way.   Let's put it this way; it was not a high conviction, buy and hold for a long time position in the first place for me.
What triggered my starting to short it was the incredible run-up in the shares and the incredible attention to the stock.  It seemed like everyone was buying Apple stock including dividend/income funds and things like that.  I saw folks on CNBC ridiculing the people who don't get Apple and telling viewers that it's really simple; just buy the stock and enjoy the ride.   People who don't get it are fools.  These people were from some sort of Apple shareholders' club (another thing that set off alarm bells).  The tone was enough for me not to want to be on board with them.
Yes, I know.  Julian Robertson and David Einhorn and many other incredible investors like Apple and I don't have any information that they don't have so they are probably right.
And it's not a good idea to make investments or trades based on these "feelings".  I rarely do so.  But sometimes, I get such a strong feeling about something that I can't help myself.  And I allow myself to make these trades that I couldn't explain to Warren Buffett or Charlie Munger as long as I don't lose money doing it.
Anyway, here are some things that bother me.  I really don't care about iPhone5 sales in China or how many iPads they sell this holiday season.  My concern has nothing to do with these near-term issues that the pundits seem to always talk about when they talk about Apple.
I finally finished the book about Jobs by Walter Isaacson.  I read a lot of books simultaneously, so sometimes it takes me forever to finish a book.  Well, I finally did finish it and I was surprised by something; I am actually now much more bearish about Apple than before I read the book!
I think in many ways, the importance of Jobs may be underestimated by current Apple bulls:
Who's the Product Guy?
People say that Jony Ive is still there and Tim Cook is doing well running Apple.  This is true.  But what scares me is that Ive may create ten or twelve (or more) models of something and then Jobs would come in and take a look at them.  He would pick the ones that look good, demand changes here and there etc.
He is the editor that is instrumental in perfecting the product.  Does anyone do that there now at Apple?  Who has that sort of vision that Jobs had?  Who knows what the customer wants better than the customer?  Even Jobs says that Cook is not a product guy.  So who is the product guy there now?  Could Ive have created those great products without Jobs' input and choosing/editing?  
Jobs insisted on doing no market research.  That's because he had an uncanny ability to create products and ideas without that.  Who there can do that now?
Reality Distortion Field
The energy and charisma of Jobs allowed "impossible" things to get done.  There are many situations where Jobs threw a tantrum and wouldn't take no for an answer.  Who has that power at Apple now?  As I said in another post, it is very interesting to note that Samsung (which is run by a charismatic founder/leader) was able to get things done in a fast changing world while Sony lost it's way after the passing of the founder Akio Morita (one can argue that he lost his way too long ago).
Apple products that put Apple back on the map after Job's return were so revolutionary and much of it was possible due to Jobs insistence on all the various aspects he wouldn't give up on.  It is questionable if anyone else could have done the same thing even if they had similar ideas.
Apple is great because they focus on just a few things and just do it really, really well.  I have read Tim Cook's recent interviews and saw his interview on TV.  He is impressive to be sure. 
But here's what scares me.  He says that Apple is not going to go out and try to do a whole lot of stuff.  They just want to do a few things but do it really, really well. 
This is a good idea when you have such an amazing product guy like Jobs.  But what happens when you don't have someone like that?   Cook is not a product guy.  How do they choose what to focus on next?  What if they choose the wrong thing?
I am a portfolio manager (of sorts) so I can't help thinking of analogies in the financial world.  George Soros is a brilliant trader.  He has built (at one time) a great organization that performed incredibly well.  He built up, no doubt, a culture of hard work and deep analysis and an intense focus on risk management etc.  He hired the top people from the top schools and/or competitors.
But would Soros organization perform as well without him?  I think history has proven that that hasn't happened.
Even if you have the best staff, if the ultimate editor, the one who chooses what to focus on and where to put the resources, things may not work out as well without the 'visionary'. 
I know this is not a good analogy at all, but I can't not compare.
If Jobs was a CEO that managed a company that created great products, then it would be a different story (like being the CEO of Fidelity instead of the head of a hedge fund who makes the key investment decisions).

Jobs, to me, is so clearly more the product creator than CEO.  So in a sense, he is more like the talented hedge fund manager that puts up great performance figures with the help of a great staff.  He is definitely not the normal, CEO-type. 
This is a problem for Apple post-Jobs.
Anyway, back to the point.  For the next product, whether it's the iTV or whatever, they are going to focus intensely on something and if that something is not going to blow the world away, it can be hugely problematic.
I think there was a sense of relief after the first year post-Jobs, but all the developments since then were probably already planned out.  Perhaps there is more coming up that has already been planned for the next year or two. 

But what about after that?
I subtitled this post "Apple is a Speculation" because we don't know what comes after this.  I don't know that iPhone and iPad upgrades can continue forever like Windows was able to do for so long.  I do tend to think that the PC was much stickier than the iPhone/iPad.  Consumers love it, no doubt.  But it's not nearly as sticky, I don't think, as the PC.  The cost of switching out of a PC-based environment is huge (think of business use, not consumer use which is just emailing, internet etc.) 
Apple Got the Culture Right
The other thing that scares me is that Jobs loved Edwin Land of Polaroid and he told people that Land got the culture right.  Well, Land retired from Polaroid in 1982, died in 1991 and Polaroid was bankrupt by 2001.  Yes, that's almost twenty years, but still.  I don't know the financial history of Polaroid from 1982-2001.  I wish I had a tear-sheet from that period.  But I wonder how well they did after 1982.   And this is for a company that got the culture right.
Yes, people will argue that technology caught up to them.  But who is to say that can't happen at Apple?  I think Apple is terrified of Spotify, for example.   Many seem to like Spotify more than iTunes.

So Polaroid gets the culture right and goes bust in less than 20 years.  This may not happen to Apple.  But that doesn't mean Apple will keep doing as well for the next 20 years.

I keep coming back to Sony because it's so similar to Apple to me.  There is a lot that is different, but there are similarities.  People will argue that Sony made no-moat gadgets and didn't have the captive eco-system that Apple now has.  This is absolutely true. 

But the lead in eco-system seems to be shrinking versus competitors.  When I look at what people do on the iPhone/iPad, they seem to be either listening to music, watching a movie, shopping or playing games.  The interesting thing is that these things are very low cost.  What does that mean?  To me, it seems like that makes the cost of switching much cheaper.  When you only pay $2.99 or some such for a game, you will most likely easily abandon it if something more interesting comes along.

It's true that the iPad seems to be doing more and more in the business world; at my local 24-hour deli (NYC deli), they swipe credit cards on an iPad.   But at this early stage, they may not have a lock on any given area yet.

On the other hand, maybe Sony did well for a long time (it was founded in 1946) because they actually did do a lot of things. 

The annual reports from 1964 are available at the Sony website and it's fascinating to read through them; especially the old ones.

They were involved in many areas and were never really a one product company.  They had many failures but none killed them because they weren't so focused like Apple is today. 

Just for fun, I snipped some of these pictures from various old annual reports.

This is the laser disk that never really took off:

I don't know what this typecorder is.  I guess it's an early word processor.

Of course the big hit was the Sony Walkman.  This was created by the strong urging of Sony's CEO Morita.  People said there would be no market for such a product, but Morita, in a Jobs-like way, saw a market for this.

And here's a photo of the then largest color TV.  I thought it was funny given how big LCD screens are these days.

Anyway, Sony had the betamax fiasco and various format wars.  They have survived through the years precisely because they did a lot of things, I think.  (They would probably be bankrupt by now if they didn't have Sony Financial)
Of course, today, they may be involved in too much and may do nothing well.  But at this point, it's hard to imagine that they can do anything well.
Other Companies that Got the Culture Right
Recent cases where perfectionist, highly demanding, hands-on, detail-oriented founder/CEOs retiring that didn't go too well are Starbucks, Dell, Fast Retailing (Uniqlo).  Howard Schultz seemed to have gotten the culture right at Starbucks, and yet he had to come back to fix Starbucks.  Fast Retailing has a Steve Jobs-like CEO, Tadashi Yanai, who is highly demanding and has a good sense and feel for retail.  He retired once but since had to come back to fix Fast Retailing.   He too often talks about culture (he may not use that word); he often talks about developing employees etc.
I know there must be some successful cases, but these cases came to mind because of the style of the CEO; they were very hands-on.
In Apple's case, the runway of growth in front of them on existing products on upgrades and whatever was on the drawing board that Jobs put there may sort of mask this problem; Apple may very well be coasting on Job's achievement for now.
When people start to see this (which I think is already happening), it may be difficult for Apple to get a high valuation.
So, my thinking is that Apple will probably hit some bumps in the road in the not too distant future.  The stock price is cheap so it may not go down a whole lot, but it's only cheap if they maintain these high margins.  I have no proof, but I suspect that customers will see where all of their dollars are going and will eventually start to demand a better deal.  In an increasing competitive environment, why should Apple capture such fat margins?
I think Jobs was basically a genius product creator that was relentlessly demanding and would take nothing less than perfection.  He was the product guy of the century, maybe.  And Apple is very, very product dependent.  They don't sell a lot of products so whatever they come out with next MUST succeed.  Can they do this without Jobs?   This is yet untested. 
If H&M or Gap misses on their fashion for a season or two, they will suffer, but it probably won't kill them.
With Apple, they are like the portfolio manager that bets on two or three stocks.  When a genius is managing the portfolio, this can be incredibly successful.  But what happens when someone different takes over and still tries to manage a three stock portfolio? 

I don't know.   Apple may continue to do well for many, many years to come.

But I get the sense that the greatest asset at Apple was Steve Jobs, plain and simple.  Just as the best analysts and employees may help some star hedge fund managers achieve incredible returns, that doesn't mean that the analysts and employees will be able to continue posting those strong returns without the star.
And in anticipation of the people disagreeing, I understand the bullish argument.  Opposing views are always welcome here (or else why post publicly?).  But I just want to say that I am very well aware of the bull case! (Don't forget, it's the biggest dollar contributor to my portfolio this year).



  1. - Edwin Land retired in March 1980 (CEO) and August 1982 (chairman). Earliest Bloomberg quote, from July 1980, was $14. Stock was at $11 in August 1982. It ran up - mostly in 1985-1986 - to $40-50 for most of the late '80s before halving in 1990. It then slowly built back up to $60 in 1997 before collapsing to $20 by late 1998-early 1999. Got back to $28 in the Spring 2000 Bubble before going bust by the end of 2001.

    - Switching costs are highest for companies that design several in-house apps in iOS (for iPhone and iPad) as well as the related workflow. For individuals, paid apps, contact libraries, user configurations, etc. are all "switching costs" as you must rebuild these through time+money if you switch to Android or Windows.

    - Sony was a great stock to own from 1995 to 2000 (8-bagger). Was also good from 1987 to 1990 (3-bagger). Take a lead in a market (portable tape/TV and portable CD/big-screen TV), grow volumes, harvest massive operating profit. The challenge is moving up the value chain/finding a new high-volume+high-margin product once the current one starts getting competition and, eventually, commoditized. Apps - both proprietary (Siri, iTunes, iCloud, etc.) and 3rd-party - will allow Apple to stave off competition in a certain product space for longer than Sony. User experience is also more different/harder to replicate due to differences in software+the way the software and hardware interact. That said, AAPL needs to find more products to be a sustainable earnings grower in the long run. Personally I think TV is a good candidate. It will also cannibalize other markets - similar to Sony and AAPL until now - such as video-game console, small TVs, laptops, netbooks, etc.

    - AAPL has a very strong bench. The book, while good, does not give insight into judging whether the bench is good/bad vs. Samsung, Qualcomm, Google, etc. Also, a major part of Sony's problem was stretching itself too thin with thousands and thousands of SKUs. It was no longer the best in every, or even most, of its markets. It also diverted its deep bench to so many projects that even Sony was stretched thin. AAPL does not have this problem nor do I anticipate this will happen.

    - One problem I do see is that content guys (video/music/TV channels) don't want Apple to have "too much power" (aka cheap, easy access to content). Sony had this problem as well and it contributed to its downfall (no buyin to proprietary formats like Minidisc). AAPL does allow the content guys to make their own apps and put them on iOS though. Unfortunately they are not (yet) the 30% tolltaker for most of these, excluding some publications.

    - At the end of the day, AAPL is even cheaper than the 10x P/E that you used (use true FCF and ex out the cash on B/S). At the same time, it is really impossible to model 10 years' out. To me a lot hangs on whether the iPad can evolve into a true laptop replacement as Tim Cook foresees or if it stalls out/is surpassed by Windows/Android. I do have faith in iPad and think AAPL is far ahead here with a huge (350m PCs/year) market ahead of it. However I do admit I may be wrong. To go short AAPL on "overbought sentiment" alone is certainly not a trade based on fundamentals. However, congrats for making money.

  2. Wow, thanks for the comment! Lots of good info in there. Yes, Apple is not really a strong short. I did short it but with a tight leash and in the future I will continue to short it only with a tight leash (meaning I would never let it run up into a big loss as some of the short specialists do).

    I definitely don't have a 400 page reason to short this thing, lol... like Ackman's HLF. So it's nothing like that at all...

    Having said that, even if it's not a great short, I would not feel comfortable putting a lot into this thing as a long term buy; I wouldn't recommend it to friends like I could with BRK or KO to hold and don't worry about...

    Thanks for the comment.

  3. I have always had this uneasy feeling about apple all year long all we hear on financial business shows is Apple Apple And more Apple any investors that had bought the stock back in 1998 when it traded believe or not under five dollars should have sold their shares when they reached 500 dollars. No company grows to the sky forever apple will be no exception.

  4. Your analysis is far more thoughtful than mine. I too got out in October however I did not have the courage to short like you. The 'Apple is going to $1000' crowd was also making me nervous like the Dow 15000 crowd in 2000. My chief concern is not enough razor blade revenue to go with their fantastic razors. If you rely too much on gadget sales (as I feel the current price of Apple does), sooner or later you are in for a big disappointment. There are more far ways to screw up in the future than to continue the success. But like you said, they may continue to execute in the next few years - I just don't like the odds of it.

  5. Thanks for this piece. Even though Apple remains in my Too Hard pile, I'm a sucker for stories of the inimitable nature of SP Jobs. I really can't think of a current tech executive to compare him with.

    "I read a lot of books simultaneously, so sometimes it takes me forever to finish a book."

    Have you considered creating a year-end list of recommended reading?

    1. Hi,

      It would be an interesting idea to post recommended reading, but I am not that current in terms of book-reading. I'm reading two really old books on Polaroid, for example. So my reading list wouldn't really be current and as interesting as others who are reading the books that came out this year, for example.

      If I find really good books worthwhile, I will post about them. But I'm not really inclined to post reviews on the books out there now unless I had something I had to say about them that I really wanted to say (otherwise, there are plenty of book reviews out there and many books out there are really good).

      And if I wasn't so lazy, I would keep the Brooklyn Investor bookstore more up-to-date. But again, there too, I wouldn't want to just stuff it with new books; I intend that to be more sort of a personal bookshelf; books I really enjoyed more than usual.

  6. Interesting article, particularly with respect to your discussion on culture and post-Jobs era. I am long Apple at $420 and have hung on all the way up to $700 and back now. Will be interesting to see what happens over the next year. Good call on the short in October.

  7. Thanks for calling out that part of this being cheap hinges on them being able to maintain margins.

    At the end of the day, they've created a $500B valuation. VC's, competitors, and even their mom's are going to be looking how they can build a company to take public as similar comps. Intel is pushing for better mobile chips that competitors can use, Google has really bright workers on the Android OS who then get 6 other hardware companies to work on it, and Microsoft isn't giving up on mobile either. This applies to both tablets and phones. Desktop/laptop makers are also working on creating better designed items.

    The point is that this is sexy. This is exciting, people are drawn to it, and there will be rapid change, which isn't likely in their favor. Maybe under the leadership of the right person, this can work, but I would say that the odds of this are slim, but further, the odds of them caring about the shareholder are even smaller.

    Jobs never had a great time with his shareholders. The folks who voted on their behalf fired him from his own company. There has to still be some hate. Why would they really even release capital to shareholders? You can do a DCF valuation all day long, but if management is going to use every penny till the day it's gone, it's not worth anything. I'm guessing they had to start a dividend and buyback simply to avoid getting sued. Apple hasn't been happy with its shareholders and quite frankly, we're probably a nuisance to them, except to the extent that we provide them with an "exit strategy" so they can avoid being tied to any struggles the company has after they sell.

    I'm not saying this will occur, I just haven't found a reason to trust them yet. I don't know if they'll do the right thing and scale the company down at the right price.

    My final point... for $500B, you can go on a shopping spree and buy tons of businesses with deep moats. You could acquire Uhaul, you can buy Google, and you'll still have over $300B.

    Apple may be a great business - it's not immediately obvious to me though, and so it isn't worth bothering with at this point. I find it far easier to stick to something boring and slow changing.

  8. " I saw folks on CNBC ridiculing the people who don't get Apple and telling viewers that it's really simple; just buy the stock and enjoy the ride."

    Silly contrarianism like this is merely...silly. Apple is still an underowned stock by Institutions. Inst'l demand dwarfs retail demand.

    Also, when people talk about the Geeeeeeenius of Jobs, they never mention how he almost ran the firm into the ground and had to be fired to save the company. Yes, he came back with a 2nd act, but I'll take first-act Cook over 1st-act Jobs any day. Also, Cook was CEO for about 2 years before Jobs died. If he wasn't doing a good job, Jobs would have let everyone know.

    They don't have to maintain margins at their current level to continue to earn more money. The size of these pie[s] will always be growing. The more people talk about 'OMG $500Bn!' and less about the actual valuation, the better long Apple is.

  9. The recent hating on Apple by every journalist or pundit on TV is pretty amazing. They are creating a smaller phone so now apparently the sky is falling! Growth will slow so, again, the sky must be falling! Margins may go down! Forget the fact that the total profits and cash flow still goes up though.

    I don't know. The company certainly makes more than enough money to justify a higher market cap. Yet, seems like everyone is anxious to be the first one to talk about the downfall.

  10. What do you think of the earnings release? Did you close your short?

    1. Hi,

      No, I am still short now. I am in and out of this as I trade it tightly, meaning I want to be short but I don't want to lose money on it so won't ride it up and let any loss accumulate.

      I did listen to the cc and things are OK for the most part, but I really didn't like too much how often Cook kept going back to "we are focused on making the best product". It is good that they do so, but it has sort of turned into this automatic replacement for "no comment". It was a bit unnerving to listen to the last conference call and not at all a confidence booster for longs, I don't think (and the stock price reflected that).

      I don't really care too much about quarter-to-quarter results as you can see in my two AAPL posts. My concern is a longer term issue. What's next after the iPhone?

      Bulls keep saying that Apple did this, Apple did that and others have not. But as I said in my other post, I think it's more like "Jobs did this, Jobs did that..." and Jobs is no longer around.

      I think the market is starting to realize that too.

      I really don't know what is going to happen to Apple over the long term. I think it can do OK; it's not going to go bust or anything like that. AAPL existed and did just fine for many years after Jobs left the last time. But it wasn't a hot stock, though.

      This is what may be the future of AAPL again. Won't go bust, but may not be the hot, innovative company it was when Jobs was there.

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