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Month May 2011

Feature Tablets

Andrian Georgiev, a reporter from the Bulgarian business newspaper “Capital weekly” wrote an article for which he asked me some questions. My answers are below. The article is available here (Bulgarian).
Q: How many tablets will be sold worldwide this year and in 2012?
A: We can only guess the answer. The total will be constrained by parts shortages for 2011, but my estimate [through the end of 2012] is over 100 million. Perhaps even 120 million is possible.

Q: Do you think Amazon is working on a tablet? Could it be a game-changer?
A: If Amazon (or Facebook or Baidu) were to build a tablet the greatest innovation will be in their business models. In other words how they make money. I suspect Amazon’s hardware will be free or nearly free but users will be incentivized to buy content or other goods from Amazon. Similarly for other businesses that will take a hardware product and make it an accessory to their core business. In that regard the “game will change” because hardware will conform to “the application” above it. In other words, that the device will be an accessory to the service, not the other way around.

Q: Why is it so hard for manufacturers to create a tablet that rivals iPad?
A: The iPad is a collection of components. Some are easy to duplicate or to source. This includes memory, microprocessors, communications components. Other components are harder to find and may be expensive once found. This includes the right kind of batteries and the screen. Yet other components are impossible to find or duplicate. That includes software.

Some additional thoughts:

The changing of the game may not happen for some time. “Feature tablets” (analogous to feature phones) will however be viable as niche businesses quite soon. I believe “conforming” operating systems will be more popular with tablet makers than with phone makers.

The trouble with halos

The Mac grew at 28% while the overall PC market contracted at 3%. The Mac has outperformed the PC market overall for 20 consecutive quarters.

Prices increased sequentially and year-to-year.

I’ve mentioned the increasing shift of Mac mix to portables as a possible reason for the growth of the business. The Mac was one of the first to move to a portable form factor and has been pushing portability over performance for many years.

The following chart shows the relationship between growth and portable mix:

Combating superlatives fatigue

The following chart shows Apple’s growth for net sales and earnings over the last few years. I’ve used a grading system with color coding to show bands of growth.

It’s easy to become de-sensitized to the scope of these numbers, but it bears repeating: the growth has been steadily increasing since 2009.

These abstractions in growth can also be shown in a direct “before-and-after” view of the income statement.

This latter view gives an idea of how much bigger the company’s business is now vs. a year ago. Not just on the revenues but also the cost of these revenues and what is retained.

This story never gets old.

Windows generates less than a third the profit of iOS + OS X

While a lot of the credit for Apple’s success is rightfully assigned to the iOS franchises, the OS X business has more than quadrupled in five years. This has happened without drastic price fluctuations. Neither holds for the overall PC industry which has seen both volume and sales decline while prices have eroded along with profitability. On top of that, growth has nearly evaporated.

Even with this success, as a percent of total value created, the Mac accounts for a mere 13% of Apple’s profit. Including software as part of the OS X franchise implies that OS X is enabling about 20% of Apple’s profits.

iOS, on the other hand, is accounting for more than 75%. These two platforms combined amount to 96% of Apple’s profits (up from 50% four years ago).

The market values Apple's balance sheet, not its income statement

As I have tediously repeated in this blog, Apple’s share price has been de-coupled from its earnings for many years. Consistent earnings growth above 70% is not seen as valuable. As the chart below shows, there is no correlation between EPS growth and value growth.

With the outlying quarter when 154% growth was matched by a negative 50% price change, the correlation does not look much better:

If we cannot correlate share price with growth then what is being valued? This has been a vexing problem because growth is the traditional, and logical, metric of valuation. Share prices, by definition (net present value of future cash flows) reflect future potential. That potential is more sensitive to growth than to anything else.

But I’ve been leaving one factor out of the share price definition. Share price is NPV of future cash flows plus current assets.

Since future cash flows are being thrown out of the equation, the company must be valued as a multiple of its cash. Does this relationship hold true?

In the chart below I show the weekly closing price of the shares and the corresponding value of the interpolated cash (and marketable securities) per share over the last two and a half years.