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5by5 | The Critical Path #47: Impatient for Growth

This episode is recorded on the day after Apple’s second quarter earnings release. We go through all the income statement updates and discuss what went wrong (almost everything) and what went right (precious little). We use statements by management about India to answer the question of where the emerging market potential is for iPhone. Putting aside some of the missed opportunities or bad timings, the quarter is reviewed as less than the stellar performance we’ve become accustomed to but not bad all things considered.

via 5by5 | The Critical Path #47: Impatient for Growth.

  • Jony

    Damn about Q3…Horace was off by a mile! Shit was upsetting…it’s all your still my favourite analyst.

    • gbonzo

      In my opinion, Horace’s iPhone estimate was very good. He really saw a slowdown in that.

      • Jony

        off course, but I mean the iPad’s number’s were really messed up but china is probably the reason why. they just started selling there.

      • Jony

        off course, but I mean the iPad’s number’s were really messed up but china is probably the reason why. they just started selling there.

  • def4

    I think Apple deserves praise for sticking to their core values of product excellence.
    Integrity is tested in the rough times because there’s no need for courage or wisdom to hold the course when the sun is shining.

    As for India, where their brand has pretty much the opposite reputation it has in China, they have a long hard road ahead.
    Interestingly, I saw news just this week of a very interesting distribution deal with Indian operator Aircel for iPhone 3GS with unprecedently aggresive pricing.

    • Telecom Dude

      Re: India, is it the case that mobile users in India are looking for both function and value? I don’t know what the uptake will be for a 3 yr old iPhone which isn’t supported (much) in the latest iOS release.

  • Jeff G

    I have a hard time sharing everyone’s disappointment. Cash (by my calculation, went to $125/share). Sarcasm alert – “Oh no, terrible quarter cash only grew by $7.2 billion and too many people are not buying iPhone 4S because they are waiting for the iPhone 5!”

    I printed the chart describing Apple’s share price as a function of cash (which although abnormal in the industry – and what about Apple isn’t – has shown a strong correlation dating back to 2008. Here it is http://www.asymco.com/2012/05/07/back-to-the-balance-sheet/

    On paper i extended the trend line and plotted the next data point. Guess what!? It’s a nearly perfect fit. (I had to interpolate a little using my ruler and calculator, so Horace’s next update will undoubtedly be more precise, but I show this data point being just a hair under the regression line.)

    I have been using a rough cash multiplier, although imprecise I think it describes the slope of the data enough to be very useful. I drop the Billion out of Apple’s stated cash and equivalents and multiply that by result by 5. Apple happens to have just under a billion shares outstanding so total cash position is a reasonable proxy for cash/share in this estimate (I know there are more elaborate, or shorter ways of arriving at the figure, but their aren’t any simpler ways) If the past trend holds, I always expect Apple shares price to oscillate somewhere around that number.

    Here it is as of yesterday: $117.2 Billion cash and equivalents

    Drop the Billion = $117.2

    Multiply $117.2 X 5 = $ 586/share

    As I write AAPL is trading at $575 (<2% below the my trendline estimated fair value based on cash per share).

    Let's assume for the sake of argument, this relationship continues to remain fairly strong for another year or two. Do you think Apple will continue to accumulate any cash? How about in 4th calendar quarter when sales of iPhone 5 are contributing?

    It seems like lunacy to even ask that. Of course they will accumulate cash.

    I listened to the conference call and did my own dissection. Here are some highlights:

    1) New quarterly record iPad sales
    2) New June Quarter records for iPhone and Mac
    3) Highest June quarter earnings ever
    4) EPS of $9.32/share = 21% growth YoY.
    5) All products within target inventory ranges, except Mac, which is below target level.
    6) iPhone presence in Fortune 500 doubled in last 12 months
    7) iPad presence in Fortune 500 TRIPLED in last 12 months.
    8) iPad selling in 97 countries
    9) Sales to education grades K – 12 very strong (Mac and iPad new records)
    10) 150 million people using iCloud (9 month old product)
    11) Apple store revenues + 17% YoY, foot traffic + 12%
    12) Opened 9 new stores
    13) 100% growth in iPhones in China, year-over-year. Keep in mind, iPhones are # 1 profit generator.
    14) "We could not be more confident about our new product pipeline" – quote from call. Say what you want about companies trotting out the company rhetoric. I believe they have excellent reason to state their confidence!
    15) iOS6 coming
    16) Passbook , Apple TV and other "hobbies" have unknown and possibly disruptive potential.
    17) Enterprises purchasing iPhone as device of choice and writing specialized apps for them, reduce paperwork, processing time, saving money and increase customer satisfaction.
    18) I'm tired of enumerating things… you get the idea!

    So,i'm struggling to muster any dissapointment. I'm not even disappointed with the market reaction, down 4%, versus up 44% YTD 2012. What would you have rather owned, the S&P 500? the Dow? Which do you think your are likely to have rather owned 2 years from now? Apple accumulating cash, or a bunch of S&P 500 companies complaining about recession/economy? (BTW, to S&P companies other than Apple, – we've had 47 recessions in 222 years, we will have 48th, probably soon, stop using them as excuses)

    If the next two quarters, taken cummulatively are equally as disappointing this quarter, then perhaps Apple may add $14 billion in cash? or more?

    And if the share price continues as a function of cash it would reflect that by continuing its long term up-trend and reaching modest new highs by the time 2 more calendar quarters pass.

    That's my take anyway…

    • Jony

      What are your predictions on the share, what will happen to it? Is this miss enough to sag the share/valuation down to 530 or even 500 levels?

      • Jeff G

        Best guess, I expect it to trade at new highs in the $660 – $675 range within 6 months.

      • Jeff G

        I don’t know about downside volatility, I have never been good at predicting prices based on short term or emotions. Even my predictions of new highs can be subject to so many unpredictable forces.

        I’m basing it on 5x times conservative increase in $billions of cash and equivalents over 6 months (thanks to Horace discovery of share price as a function of cash position)

      • Jeff G

        My first post was “awaiting moderation”. My best guess is 660 to 675 upside in six months.

  • Cecile

    It seems that there are a difference of 3 M I-Phones between Q2 and Q3 due to inventory differences according to T. Cook. In other words, 35.1 M Iphones sold officially in Q2 vs 26 M IPhones sold officially in Q3 (a rather steep decline) would mean that in fact, 32.1 M IPhones were sold in Q2 and 29 M IPhones were sold in Q1. So the number of Iphones sold, the revenue and the earnings from one quarter to another are somewhat manipulated / adjusted. If these adjustments were made, EPS Q2 would have been in the range of 11 (vs 12.3) and EPS Q3 would have been in the range of 10 (vs 9.35) and revenues would have been 36.5 B (vs current 35 B) for Q3 and 39 B (vs 40.5 B) for Q2. Earning  and revenue growth for Q3 would have come to 30% vs current 20% (75% earning increase for Q3) … More in line with what Aapl usually delivers.  
     
           
    Quote from Cook (Q&A session)
     
    “It’s important to understand as you compare our Q2 iPhone sales to Q3, there is a fairly large channel inventory difference that is embedded in that. As you recall, in January, we completed the iPhone 4S rollout in all the major countries, including China. It was our fastest iPhone rollout ever. We were also able to get the channel at a – within our target inventory range of four to six weeks by the end of March. And so what that did was, it increased sell in over sell through by 2.6 million units. In the quarter that we just finished, our sell in was less than sell through by 300,000 units. And so the net change in channel inventory across the quarter is about 3 million units. And so, I think it’s important to understand that to look at the underlying sell through trends”.
     
     
    All I-phones in channel inventory are counted as sold. This reduction in “channel inventory” is classical ahead of a release of a new product. This way of accounting allows Apple to adjust and to somewhat manipulate, from one quarter to another, the number of products sold (most I Phones are sold through indirect channel i.e. telecom companies / this is different for products like the Ipads sold in Apple Store where inventory are not accounted). Of course, at the end, the result is exactly the same. That is why probably growth with respect to products should be compounded for the past two to four quarters so as to really see whether the growth is actually slowing. I think Apple did that in order to avoid a panic in Q2, should the number of I-phones sold have declined too much. In Q3, the decline is accordingly even bigger but they have an excuse (consumers attitude who are delaying their acquisition ahead of rumors.

  • Padova

    Horace, you “worry” about Apple’s inability for years now to enter the Indian market — but doesn’t India’s distribution system, soi-disant, also exclude Google, Microsoft and Samsung? Where does that leave India? Chinese merchants with Chinese items are capable over time of penetrating the multiple hurdles that you mention. But, then, where does THAT leave India?
    Thanks again for a wonderful hour with you

    • http://www.asymco.com Horace Dediu

      Apple has an integrated approach to reaching their market. It means having its own stores, flagship stores, closely monitored partner retailers or operator terms and conditions which are typically unique. Google is at the opposite end of the spectrum where distribution means updating files on an FTP server. Microsoft and Samsung are somewhere in the middle. India (and China previously) are extremely difficult to get going with Apple’s model. This is why Tim Cook refers to it as “cracking a code”.

  • Karthik

    Given the difficulties in India or other similar countries with HW distribution (multi-level channel set up etc), networks (few 4G or even 3G) and the price per device (which probably is a monthly salary for a majority, a better move would be to sell a spruced up 3GS (which then won’t be a 3 yr old device). Given the reduction in cost with making an A4 or an A4+ like chip (based on how semiconductor pricing per technology node goes year after year), why not bump up 3GS and offer that as an alternative. As of today, in these countries, they are looking to take on Samsung or LG (which have the latest or at least an n-1 generation HW and features) with a device like 3GS thats probably at n-3 (both HW and features as 3GS barely supports iOS 6). They some how have to make it attractive as thats how the telecom market works in these countries. They can’t surely offer 4GS given the pricing.

    How they approach this is the question. Would appreciate your thoughts on this.

  • Anthony Carlson

    A question for you, Horace – All things being equal, I would expect the trajectory of “music and other services” revenue to be similar to the iOS install base. However, the music and other services trajectory seems to be a bit flatter than the consensus trajectory of iOS install base. Is this simply because marginal new iOS customers either have a lower propensity to spend? Or is there a better explanation for this?

    • xynta_man

      I think we see these kind of numbers because of the markets, where iOS is growing the fastest, i.e. China – like many other countries, people there aren’t really used to pay for software or other content, even if they have to money for it. These kinds of things change very slow.

    • http://www.asymco.com Horace Dediu

      The accounting for revenues for Apps is agency based. Apple only records the revenues after payments to developers. The revenue is also blended with the other media types sold through the iTunes store which may not be agency-based.

  • Sidharth Dassani

    Horace, you are wrong about FDI not being allowed in retail in India. 100% FDI in retail is allowed in India for “Single Brand” stores . Apple can start its wholly owned retail stores in India if it wants since they will be selling only their own products. 100% FDI is not allowed in multi brand retail i.e. Walmart will not be allowed to set up a 100% owned retail store. They can however set up a 100% owned wholesale business .

    Secondly iPhone is pricing itself out of the market . Unlocked iPhone 4S retails for around $850 . When a customer sees Galaxy S3 at around $650 he will not think twice about which phone to buy. Infact the iPhone 4 is priced around $625 levels. Its also difficult to get iPhone in mobile retail shops. They are generally available only with Authorised Resellers / 2 telecom operators or a couple of large national retailers .

    Apple recently started selling the unlocked 4S for $499 in US . If they can reduce their prices for the next iPhone in India to around $650 in retail I am sure they will sell much much more than what they have been selling now.

    Another small point . I have seen many more Galaxy Notes (a phone I hate because of its size) in the wild than the iPhone

    • xynta_man

      Apple doesn’t only sell its own products in their stores – they also sell many third-pary products, e.g. accessories, complimentary devices, etc. Going “Apple products only” would hinder the Apple Store experience. Than again, if Apple thinks that it needs to do it, it will do it.

      You are right about the price though – the price factor is very important for markets without operators subsidizing the price of the device. Asian OEMs are just flooding those markets with cheap Android phones – sure, most of them suck and good Android device aren’t really that cheap, but most people don’t know or don’t care.

  • http://indtechie.com Sidharth Dassani

    Horace, you are wrong about FDI not being allowed in retail in India. 100% FDI in retail is allowed in India for “Single Brand” stores . Apple can start its wholly owned retail stores in India if it wants since they will be selling only their own products. 100% FDI is not allowed in multi brand retail i.e. Walmart will not be allowed to set up a 100% owned retail store. They can however set up a 100% owned wholesale business .
    Secondly iPhone is pricing itself out of the market . Unlocked iPhone 4S retails for around $850 . When a customer sees Galaxy S3 at around $650 he will not think twice about which phone to buy. Infact the iPhone 4 is priced around $625 levels. Its also difficult to get iPhone in mobile retail shops. They are generally available only with Authorised Resellers / 2 telecom operators or a couple of large national retailers .
    Apple recently started selling the unlocked 4S for $499 in US . If they can reduce their prices for the next iPhone in India to around $650 in retail I am sure they will sell much much more than what they have been selling now.
    Another small point . I have seen many more Galaxy Notes (a phone I hate because of its size) in the wild than the iPhone

    • Mike Wren

      The single brand retail law requires 30% sourcing from small and medium sized Indian businesses. IKEA can handle that and will be opening stores. Apple would have to sell a boatload of accessories made in India in their stores to qualify. Opening a factory in India like they did in Brazil to get around their protectionism wouldn’t qualify.

  • http://indtechie.com Sidharth Dassani

    @asymco:disqus another important point is that Apple has just recently started launching products in India on time. iPad 2 , iPhone 4S and new iPad were the first iPhone or iPad to be launched within 2 months of US launch. All other phones or iPads were launched almost a year after their US launch . This meant that people who really wanted these products already had them from abroad and they would not get the traction in local market . Indian customer will spend a lot of money on the latest and greatest but will certainly not spend huge money on a year old product .

    Apple is not as successful in India as they should be because they want to do business their way. They tied with couple of operators but operators dont drive purchases in India like in US or to some extent Europe . It is a 97% prepaid market where the customer is spending more on the handset cost than on operator bill. ARPU is lower than $5 per month and over 2 years people spend much less for phone bill than they spend for handset . Apple has to be competitive with Samsung if they are to be selling more phones . In advanced markets people may think about ecosystem but here it really does not matter that much . People buy the phone for what it is and not what is around it . So to succeed in India Apple has to build up retail presence and also be priced competitively since Samsung has all the mindshare and marketshare when it comes to smartphones .

  • albeesure

    Having listened to the podcast it feels like theirs a lack of perspective as to what Apple are trying to achieve. Obviously every company wants to make money but that can not be at the
    expense of the mission statement and the original goal. It is the mission statement that allows you to make money in the first place. Chasing the money rather than the mission is a recipe for long term disaster.

    Apple’s mission statement seems to be to operate at the highest level in the consumer space with products that are focussed on the demographic that would appreciate them. In other words they provide a handful of products for middle class or aspirational people with excellence being the hallmark of the product. The key thing is that they operate where the demographic is. That demographic isnt in India yet and it is only just starting in China.

    The new powerhouse countries coming through like China and India may on paper have huge economies, but the their GDP per person is terrible compared to established western economies. The opportunity is simply not there to sell to a billion customers in these regions. Demand is based on people with the “ability” to purchase. How many people in India or China have the ability to purchase products at the same price level as Germans or Americans? As fast as there middle class is growing the bulk of money in these economies are concentrated in the hands of a few. This is how it is in the begining of all capitalist economies. 

    So in reality, Apple being cautious in India is them being realistic. Their mission statement means they make a few top end products because that is what re-inforces their brand. They are very selective in what low priced products they sell, because it really will effect their brand if they cut too many corners. BMW do not make cheap hatchbacks for India to compete with the Tata. Neither will Apple follow that route.

    On top of that the whole of Europe is in recession. Europeans are being cautious with their spending and have been doing for years now. This had to be reflected in ipad sales one way or another. To me it’s obvious that ipad sales will more closely mirror general PC sales than iphone sales since phones in general are a) subsidised b) essential for everyone in western economies c) break more and need to be replaced d) are on a 2yr contract cycle.

    Phone sales will mirror the birth rate of any western economy because they have become essential. Ipad sales will not follow the trajectory of phones because they dont have these features.

    At the end of the day we can see why Apple hoard cash, and Steve never really cared about what analysts expect. I would not be surprised if Apple took the business private. They make a healthy profit doing what they want to do and selling to the people they like selling to. Only an investor not in touch with Apples goals (and purely in it for short term financials) can ever see these results as negative.

    • http://twitter.com/narenbalaji Naren Balaji


      demographic isnt in India” – Totally wrong. I’ve seen more Samsung Galaxy S3 & Galaxy S2 in India than all iPhone models put together. It’s just a missed opportunity.

      • albeesure

        US GDP per capita $48,387 India GDP per capita $1,389
        Even accounting for US population of 311m vs India 1.24 billion
        Its still not even worth the hassle right now. There just isnt enough people who could afford an iPhone at US prices to make it a “missed opportunity”.

      • http://twitter.com/narenbalaji Naren Balaji

        Please tell that to Samsung which is selling a huge number of S3 & Note in India!

      • Noah Berlove

        The middle class in India is around 60 million people, and greater than the population of England. There certainly are issues with doing business in India, but lack of potential customers really is not one of them.

      • albeesure

        The term middle class is relative. The absolute cost of an imported good
        has nothing to do with the relative cost of living in a country. You might be living
        well in the Punjab because great housing costs £500 a month whereas in London that would
        cost £2000. So what you can affored with disposable income is relative.

        I’m not saying there arent enough people in India to buy iphones.
        I just think the “billions of people” thing that Horace said is a bit misleading.
        Samsung dont make anything like the money per unit that Apple make off of sales
        and services assocaited with the iphone. 

        I kind of think its practically impossible to critisize a company with 113b in the bank. And who
        grow sales year on year and havent lost money in yonks. There doing the job
        there way and will get to all these regions in time, on their terms.

      • http://www.asymco.com Horace Dediu

        Average income in China would lead you to conclude the same thing but China will soon surpass the US as Apple’s biggest market.

      • Jeff G

        Naren, Thinks like you’ve “seen a lot” and Samsung “selling a huge number” are anecdotal only. Apple collected 73% of all smart phone profits in prior quarter. Now, it also looks like Samsung’s model may be subject to commoditization, attack from lower cost manufacturers. Call it a missed opportunity if you want, but I don’t know if that math is knowable. I’m guessing Apple knows a few things we don’t and on average is probably making some pretty wise decisions.

    • http://www.asymco.com Horace Dediu

      I wholeheartedly disagree with your assessment of Apple’s mission statement. I perceive the company’s mission statement is to make great products without regard to who buys them or how much they appreciate them.

      • Bruce

        “I perceive the company’s mission statement is to make great products without regard to who buys them or how much they appreciate them.”

        I support that, and would go farther than that. I think Apple wants to build great products for everyone. Apple’s design decisions often try to please the person who has never bought an Apple product before, even if it means annoying their current power users. This seems to be a recurring pattern. The idea of changing the world seems to fit with Apple’s culture.

      • Bruce

        “I perceive the company’s mission statement is to make great products without regard to who buys them or how much they appreciate them.”

        I support that, and would go farther than that. I think Apple wants to build great products for everyone. Apple’s design decisions often try to please the person who has never bought an Apple product before, even if it means annoying their current power users. This seems to be a recurring pattern. The idea of changing the world seems to fit with Apple’s culture.

  • http://www.facebook.com/people/Jeff-Silverman/1634666325 Jeff Silverman

    Horace, I have never once been disappointed by a podcast from you; except for this one. So first praise for everything to date which has raised my expectations considerably. My problem with your analysis is rather than looking at the lower growth rates in sales and profits, you seemed to take shots at management and their strategy particularly in India. I understand this could be a reason for the lower growth rates but certainly not in this quarter because no one expected more from india. On the same note in the podcast before this, you explained that Samsung could be disrupted by Chinese makers who do what Samsung did; sell me too oducts with lower prices- yet you seem to be arguing tat Apple should introduce more models and hit lower prices. If iphones were the reason for Apple’s failure to blow away their own guidance, I look at ATT numbers where Apple sold 3.7 million phones out of 5.1 million and where all of the other 1.4 million were 4g phones which Apple does not have. ATT is their most mature “market” and yet they are killing competition EVEN without the new iPhone. I am looking forward to your next few posts where you dig into earnings. I am very open to you criticizing management and Apple, but I hope it is for more believable reasons than India and the “possibility” of an ipad mini which would say they are following not leading. I post this very respectfully.

    • http://www.asymco.com Horace Dediu

      My criticism is that Apple has not found a way to serve the billion users in India. Perhaps they cannot be served and there is nothing more that can be done. The title of the podcast should serve as a clue to how I think about the question (I concede that it’s not always easy to discern what I’m going on about.) You can read an update on cracking the India code in today’s post: http://www.asymco.com/2012/07/26/cracking-the-india-code/

      • Mike Wren

        Samsung has a 46% share of the Indian smartphone market and is expecting 60% this year. Apple has a 3% share. 929 million Indians have cell phones just behind China with 1.04 billion. The iPhone has a 19% smartphone share in China. Horace’s concern is warranted. If Samsung can figure out India so can Apple. Every emerging market has its own idiosyncrasies.

  • http://twitter.com/narenbalaji Naren Balaji

    India – Apple simply missed the opportunity – through a series of missteps on pricing, distribution & release dates

    1) Pricing
    How could they even justify pricing iPhone 4S at $150 more than Unlocked US iPhone 4S price?
    Customs duty on mobile phones = 1%
    Value Added Tax = 5%

    2) Distribution
    Why distribute through mobile operators?
    In India, phone distribution is usually done though retailers – since all phones have to be unlocked. People don’t go to mobile operators to buy phones in India.

    3) Release Dates
    Samsung phones are released in India BEFORE they arrive in US, while iPhones take at least 2 months before they’re released in India

    Anyone who thinks there is no opportunity at Apple’s iPhone ASP is mistaken.
    I see Samsung Galaxy S2, S3 & Note all around me – all of these are sold at unlocked phone prices & people still buy!

    • Jeff G

      Naren, what is the profit margin on those Samsung phones? Seeing them, and having them make money for the company are two different things.

      Apple’s stock has climbed thousands of percent, including 44% YTD.
      Do you think they are really concerned about what a layman consideres “missed opportunity” They have thousands of internal analysts and totally tuned in business and technology people who evaluate this stuff constantly. They will strike when they know the time is right.

      They have been criticized at every turn, on every product, yet somehow the “dummies” (according to every armchair critic) at Apple seem to keep churning out hit products, profits and a massively growing empire in terms of units sold and overall ecosystem.

      • http://twitter.com/narenbalaji Naren Balaji

        I’m not talking about Samsung phones in general. I’m seeing higher-end Samsung phones all around me (S2, S3 & Note). Last year when S2 was introduced, most retailers couldn’t keep up with the demand – they kept running out of stock every week – That’s the kind of popularity Apple is known for!

        I’m sure Samsung has good margins on the higher-end models (S2, S3 & Note).
        & Samsung doesn’t seem to be lowering it’s margin for the “multi-layer” distribution

        US Unlocked Galaxy S3 price ~$600
        Tax in India (6% ) ~$36
        Retail price of Galaxy S3 in India ~$690
        Retailer margin + Distributor margin ~$54

  • r.d

    100% FDI was only allowed in January 2012.
    Apple trying buy land would be nightmare.
    Going thru multiple channels is what drives the price of iphone up.
    Ruppee is now 56 to $1. It used to be 44.
    You have bribe at every level to get multiple approvals for every single
    thing which takes months. You have to higher locals to do the bribing.
    AirCel selling 3Gs at 9,999 is for 2G data rate plan.
    Average Indian have $1 per month ARPU so no amount subsidizing
    will help especially Indian compare to $200 subsidized price of US.
    Most of the of dealers buy grey market from Singapore illegally
    and sell without warranty. Apparently the Indian consumer doesn’t know
    about after sale service if Apple creates their store, they still have to contend
    with grey market.

  • Pingback: Cracking the India Code | asymco

  • http://michaelkdawson.com/ TrendRida

    The call was painful to listen to. After the Sept miss, they were much
    more optimistic and guided up. This time they stayed with their conservative guidance.

    I wonder what lessons Apple takes away from this Q? A six month sales cycle on iPhone followed by a six month wait for the next iPhone is disturbing. Was the 4S half-baked? AMZN plows cash back into its biz and its stock is being rewarded. What is Apple doing with its cash? Is its cash strategy to complicated for the Street to understand? How about explaining it better?