SO WHERE DOES APPLE TURN FOR THE NEXT BIG ITHING?
Perhaps they don't need to 'turn' at all. Tim Cook often says his businesses have plenty of headroom
The treatment for the blood disease polycythemia vera (the name means "too many red cells") goes
back to the dark ages: Lance a vein and relieve the patient of a pint of blood. Phlebotomy treats the
symptom but not the condition. There is no cure; the blood-letting must be repeated indefinitely. This is
what comes to mind when I see how Apple intends to treat its polycashemia vera, its "too many
greenbacks" problem. Over the next few years, Apple will bleed off $45bn of excess cash through a
combination of dividend payouts of $2.65/share per quarter and stock repurchase of $10bn over three
years. (Also, as Tim Cook has stated, the buyback is a means to "undilute" Apple employees' stock
grants. Horace Dediu has a perceptive analysis here.) But why get rid of the excess cash? How dangerous
is it? And what exactly is "excess"? This is a matter of animated (and occasionally silly) debate. On one
side, you have die-hard company supporters who argue there's no such thing as too much cash, you
never know what the future holds. Management should ignore the "evil Wall Street speculators" who
call for dividends and stock buybacks, jeopardising the company's future just to line their pockets. On
the other side, shareholders (or, more accurately, the Wall Street fund-managers who represent them)
get nervous when a company's cash reserves far exceed its operational needs (plus a rainy day fund).
Management might develop a case of "acquisition fever," an investment banker-borne contagion that
breeds a lust to buy shiny objects for ego aggrandisement. It's a rational concern, and while Apple's
performance and cautious spending habits gives management a great deal of credibility, a cash reserve
that's rapidly approaching a full year of revenue (let alone operating expenses) became "really too
much" and led to last week's $45bn announcement. The $45bn figure is impressive … but will it be
enough to treat this chronic condition? In Fiscal Year 2011, Apple grew its cash balance by $31B. Using
very conservative growth estimates – well below the rates we've come to expect from Apple – we'll
assume an additional $40bn for FY 2012, $50bn in 2013, $60bn in 2014 … that's another $150bn. Even
after the $45bn phlebotomy, Apple's mattress will swell by another $100bn in the next three years, to
about $200bn. The patient will require repeated blood-lettings. A gaggle of observers would like to
remind us of their version of the Law of Large Numbers; not the statistical LLN, but the one that says,
using a simple example, that while 50% growth is relatively easy for a $10m business, it's nearly
impossible at the $100bn level. And, yet, this is very much what's in store for Apple in FY 2012. With Q1
revenue of $46bn in the books we can expect the annual figure to peg at roughly $180bn. (This isn't a
wild guess: AAPL pretty much sticks to the FY 20ZZ = 4 x Q1 FY 20ZZ formula.) This $180bn figure would
be an astonishing 70% increase in revenue compared to FY 2011 ($108bn). Astonishing but not
surprising; it simply continues a trend: 2011, the first full year of the iPad, was 66% above 2010, which
was 52% above 2009. Even in the midst of the financial cataclysm, Apple's 2009 numbers showed a 14%
increase over 2008, which showed a "customary" 52% increase over 2007, the year of the Jesus Phone.
FY 2007, in which the iPhone contributed a smallish $483m, generated a "mere" 28% revenue increase
above 2006, the memorable year when iPod revenue surpassed Macintosh sales, $7.7bn vs. $7.4bn. One
conclusion sticks out: Apple has escaped the lay version of the LLN because it repeatedly breaks into
new categories. The "foundation" Mac business couldn't fuel such growth. Can this last? Can Apple
create (or co-opt) another $100bn category, add a fourth member to its iTrio: iPod, iPhone, iPad? The
rumoured Apple iTV (whether it's the black puck or a "magical" HDTV set) is offered as a candidate for
another iPhone/iPad disruption. I'm skeptical. As discussed here and here, I don't believe Apple can turn
TV into another $100bn iMotherlode. Unless Apple comes up with a $650 ASP (Average Selling Price)
black puck that will be enticing enough to be bought in iPhone numbers and renewed as frequently. This
would require content and (cable) carrier deals for which Apple's cash might bend the wills of content
and transportation providers. Another possibility, advanced by a friend of mine, would be for Apple to
disrupt the digital camera business. Not in the way the iPhone has already eaten into the "snapshot"
market, but by offering a real, non-phone camera, with bigger sensors, lenses, and, as a result, bigger
body. While technically far from impossible, a look at Canon's and Nikon's books shows this isn't a
$100bn sector. Canon's revenue, including printers and professional non-camera optics, is $44bn with
fairly thin margins (COGS in the 70% neighborhood); Nikon's revenue is about $1B. Too small to move
Apple's needle. So where does Apple turn for the next big iThing? Perhaps they don't need to "turn" at
all. Recall Tim Cook's oft-repeated party line: All our businesses have plenty of headroom. Read the
transcripts of past conference calls (here, here and here, courtesy of Seeking Alpha) or assay Cook's
recent appearance at a Goldman Sachs conference. The mantra is clear: We have a small market share
in the huge smartphone segment; iPad sales are growing even faster than the iPhone's; Mac revenue is
growing at a healthy 25% pace in the (still) huge traditional PC market. Up to the advent of what I can't
help call the Apple Anomaly, we had two bins for companies. Bin One held stable companies, businesses
with modest, predictable growth rates. As they didn't require huge amounts of money to feed the
engine, much of their cash flow was returned to shareholders as dividends. And, when they needed cash
for inventories or plants, they could borrow it, issue bonds providing ''guaranteed'' income (I simplify).
Bin One stocks are boringly/pleasantly predictable. Bin Two companies are ''hot'', fast-growing high-tech
businesses. They require lots of cash, most often harvested on the stock market. Cash-flow and future
requirements are such they rarely issue a dividend. Bin Two stocks are pleasantly/dangerously hot.
Apple straddles both bins: it generates obscene amounts of cash and it still grows much faster than the
rest of the high-tech world. Summarising Tim Cook's position: Yes, we'll pay dividends and buy shares
back. And No: We have no intention of becoming a stodgy Bin One company. Apple's chief implicitly
assumes the people he leads will continue to come up with winners in each category, an assumption
respectively disputed and wholeheartedly endorsed by the usual suspects. So far, doomsayers haven't
had a great run. But just you wait, they say: In The Long Run Apple Will Fail. They will be right, of course,
but when? In the meantime, the company is still left with a $100bn cash "problem." This must be by
design: Apple's board could dial cash down to, say, a healthy $40bn. Why not do so? One possible
explanation is that Apple is playing a game of "projection," they're creating the perception that they can
buy or do anything they want: Wage a price war against Samsung, corner the supply of critical
components and force competitors to pay more, create a second source for key modules, buy major
distribution channels. The problem with such speculations is that Apple is already doing some of the
above. For example, keeping the intuitively more expensive (display, battery, LTE module) new iPad at
the same price points as the iPad 2 continues the price war Apple started with the original iPad's
surprising $499 pricetag. Also, Apple has already disclosed that it has committed some of its cash as
forward payments to suppliers. And strategically creating or even buying a semi-conductor plant to cut
Samsung off won't cost tens of billions. For reference, the latest Intel fabs cost in the neighborhood of
$5B each. In any event, one can't see Apple's culture adapting to the esoteric semi-conductor
manufacturing sector. This leaves distribution. Could the company acquire, say, Best Buy or an
international equivalent? These companies are (relatively) inexpensive: Best Buy's market cap is less
than $10bn —for a reason: lousy margins that, in theory, Apple could prop up. But, in reality, hese are
complicated businesses and would be a nightmare to restructure: Imagine getting rid of all the brands,
pruning and retraining staff. Highly implausible. We know Apple's business model: Make and sell highmargin hardware, rinse and repeat every year, everything else is in service to the elegant hardware
experience of the Dear Customer. If we stick to our search for places to invest $100bn, we're left with a
big question mark. The only scenario left for the big number is a hedge against political risk in China or
against an economic nuclear winter. Apple would use its cash reserve to pull through and reemerge
even stronger than its competitors.