Worst Case Scenario: Is Apple the New Microsoft?
On September 21, 2012, Apple (NASDAQ:AAPL) stock established an all time high at $705.07 per share. From there, Apple share prices were to quickly break down towards a multiyear nadir of $385.10, on April 19, 2013. At the time, frantic Wall Street analysts, such as Steve Milunovich of UBS, were slashing Apple financial estimates in light of weak iPhone 5 sales.
Apple stock, however, quickly recovered towards $550 heading into 2014 as a value play. Activist investor Carl Icahn described his recent decision to load up on billions of dollars worth of Apple stock as a “no brainer.” Apple shareholders, however, must take note of the fact that the iPad and iPhone platforms do account for more than 70 percent of Apple’s top line revenue. Apple now collects the lion’s share of profits within mobile, as does Microsoft (NASDAQ:MSFT) within the personal computer market.
The regular business cycle, of course, does shift through growth and maturity stages. At worst, the Apple ecosystem is becoming increasingly commoditized, with the likes of Microsoft, Samsung (SSNLF.PK), Google (NASDAQ:GOOG), Nokia (NYSE:NOK), and even Amazon (NASDAQ:AMZN) entering the smartphone and tablet space. As a beta stock, Apple investment performance would largely track that of the S&P 500 Index, while financial managers approve regular dividend and buyback increases out of Cupertino. Going forward, Apple shares may recover from what may be an inevitable correction within the broader market to advance towards an $800 price target within the next 24 months.
The Federal Reserve Board
Several economic indicators have signaled that recovery from the Great Recession has remained weak. Today’s domestic economy may be most notable for its wealth inequality. The U.S. Bureau of Economic Analysis (or, BEA) has estimated that the financial industry generated more than 20 percent of U.S. gross domestic product over the course of the past several years. The BEA groups together banking, insurance, and real estate beneath this one financial umbrella. In order for the U.S. economy to maintain traction, it is logical for Washington to structure policy favorable to Big Banks that borrow cheaply and invest capital at higher rates of return.
The Federal Reserve Board has been tasked with the contradictory dual mandate of managing the domestic economy towards full employment, while also maintaining a stable price level. To do so, the Federal Reserve trades government securities through open market transactions, lends out cash through its discount window, and establishes reserve requirements at member banks. With the use of these tools, the Federal Reserve Board can set interest rate targets and thusly, influence the economy. In recession, the Fed literally creates cheap money, or a low interest rate environment, structured to encourage lending, spending, and investment.
The Federal Reserve Board first dropped its federal funds target rate to an unprecedented zero amid the 2008 housing bust and credit crisis. Federal Reserve and Treasury officials have also supplemented the monetary easing with the Trouble Asset Relief Program (or, TARP), the Term Asset-Backed Securities Loan Facility (or, TALF), and Operation Twist. The acronyms generally refer to asset buying programs out of The Fed designed to inject financial markets with liquidity. The Federal Reserve has recently announced intentions to purchase $75 billion worth of government bonds and mortgages per month. Going forward, Apple will be operating within a domestic economy of tepid growth at best.
In terms of market capitalization, Wall Street has now applied a $505.9 billion price tag to the Apple business model. At this scale, Apple can survive a looming domestic slowdown, outlast mobile competitors, such as BlackBerry (NASDAQ:BBRY) and Microsoft, and consolidate strength further upon recovery. To do so, Apple can leverage both its goodwill and international presence to drive profits.
Forbes has already identified Apple as the world’s most powerful brand heading into 2014. Forbes staff writer Kurt Badenhausen estimated that the Apple brand alone was worth $104.3 billion. Apple also closed a deal with China Mobile to pitch product to the carrier’s 760 million customers. During the latest 2013 fiscal year, China accounted for $25.9 billion in sales at Apple. In all, Apple’s foreign markets generated $104.7 billion out of the $170.9 billion in 2013 total net sales at the consumer electronics company. Going forward, Apple may actually benefit from a weaker dollar, upon the repatriation of overseas profits.
Apple’s goodwill, or the halo effect, extends over a closed and horizontally integrated ecosystem that includes the iPhone, iPad, Mac, iTunes, and iPod platforms. The iPhone has emerged as central to the Apple ecosystem as it accounted for $91.3 billion in fiscal 2013 revenue. Apple brand loyalty has translated into fat gross profit margins above 35 percent.
Numerous social critics have maintained the theory that Apple consumers have happily paid up to remain part of the “in” crowd. Apple has yet to buckle to consumer advocacy pressure to slash prices, despite desperate attempts from competitors to garner market share. A series of patent infringement lawsuits between Apple and Samsung may serve as evidence that the mobile market has indeed matured. Similar to Microsoft and the PC, Apple can leverage its near dominance above a mature market to mint stable cash flow for several years.
The Bottom Line
In 2004, Microsoft authorized a one-time $3 special dividend. In conjunction with this authorization, Microsoft detailed plans for regular dividend increases and share buy backs totaling $75 billion over the next four years. At that time, The Economist speculated that these series of moves would handsomely reward Microsoft shareholders over the long-term. In retrospect, however, Microsoft shares have offered little to nothing in terms of alpha capital gains over the past decade. Today, Microsoft is a mega capitalization stock that closely tracks the S&P 500 Index and U.S. GDP growth rates.
Similar to Microsoft, Apple is also notable for its cash hoard. Apple closed out its 2013 fiscal year with $146.8 billion in cash and investments above a total $83.5 billion in liabilities on the balance sheet. Last year, Apple did generated $53.7 billion in cash flow from operations. Of this amount, Apple spent a net $24.0 billion on investments. Apple banked a net $3.5 billion increase in cash, after paying out $10.6 billion in dividends and buying back $22.9 billion in stock through 2013. Last year, Apple also tapped the bond market to borrow $17 billion.
These borrowings will help Apple finance its ongoing plan to return $100 billion in capital back to shareholders through dividends and stock buybacks by the end of 2015. At worst, these aggressive plans may signal that Apple, similar to Microsoft, has exhausted growth opportunities. Conservative investors may still consider collecting Apple dividend payments while waiting patiently for the next big thing to develop out of Cupertino, California-based headquarters.