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The Apple Cash FAQ

  • How much cash does Apple have?

To the nearest million, as of the end of September 2017, Apple’s cash and investments totaled $268,895,000,000. Note that this includes investments in the form of short- and long-term marketable securities. Long-term marketable securities are not always accounted as “cash” because strictly cash is considered a liquid asset and some securities may not be sufficiently so. Nevertheless, most analysts would agree that Apple’s securities are sufficiently liquid to qualify as cash. Note that for archaic reasons this cash is separated into US and non-US holdings with $17 billion located in the US.

  • Most businesses keep very little cash on their books. Why does Apple have so much cash?

Indeed Apple’s cash is extraordinary. It amounts to about 30% of its market capitalization. One reason is that Apple has taken many loans, totaling about $100 billion.

  • Whoa! Why would Apple need to take out loans? Does it have problems with cash flow?[1]

Quite the contrary, Apple’s operating cash flow is eye-watering. In the 2017 fiscal year (ending September) Apple generated $63,598,000,000 from operations. The loans are not needed to operate. They are used to pay shareholders.

  • Why does Apple need to pay shareholders?

Because it’s their money.

  • Wait, I thought you said this was Apple’s cash.

Apple is holding it for them but if it has more than it needs it’s obligated to return it. You see, If you were to look for “cash” in financial statements you find it on the balance sheet as an asset. Since it is growing and since a balance sheet has to balance, there has to be a liability that grows in proportion to offset the cash asset. That liability is called Shareholder’s Equity. This is a “debt” the company has to shareholders. If it pays out cash to shareholders then it zeros out an asset and a corresponding liability. The net is zero as far as Apple is concerned but shareholders get something in return for giving Apple money in the first place.

  • So hold on, it takes out loans to pay shareholders because it “owes them money” while it has too much money? This makes no sense.

Yes, welcome to tax laws. Although it generates more money than it can use, and that money should thus be returned to shareholders, some of the money is collected outside the US. US (and US only as far as I know) tax laws have a “repatriation tax” that is levied on money coming into the country. This has nothing to do with corporate taxes which are levied on earnings. So after paying shareholders with the cash it had in the US, Apple had to borrow money to pay shareholders money they had outside the US.

  • Why not just pay the repatriation tax?

Because then shareholders would get less than 70% of their money. They would probably complain and blame the managers for being incompetent. Such blame usually comes with a lawsuit attached.

  • What about the new tax law that lowered the repatriation tax rate?

Now Apple has no option but to pay the tax and repatriate the cash. It’s still a tax. The amount will be about $38 billion or about 15%. Previous repatriation “holiday” levies were around 10%.

  • How exactly does the company give money to shareholders?

The payments are called “dividends” and shareholders must treat them as income–a form of double taxation because these funds are after the company paid earnings tax and possibly repatriation tax. Apple does pay dividends regularly but because of tax inefficiency (i.e. because government policy discourages dividends) the company mainly buys its own shares and retires them.

  • Huh?

Yes, it makes little sense but the math is simple. If the company buys its own shares and makes them disappear then existing shareholders will end up owning more of the company, making their shares more valuable. They can realize the gain if/when they sell the shares (and pay capital gains tax instead of dividend income tax on the already (double) taxed profits.)

  • Does that mean that it is going private?

No. The owners of the company remain the same: whoever owns shares owns the company and they can be traded in public exchanges. In theory they could reduce the share count to a single share and there would presumably be a single shareholder who would own the company, making it “closely held” but the company’s managers are still required to report and act as if it was public. Going private usually means a set of shareholders agree not to allow the shares to float on the open market and thus to also keep the affairs of the company out of public eye. It reduces liquidity and is generally harder for shareholders to exit their investment. This has nothing to do with reducing the number of shares in circulation–which is what Apple is doing.

  • But buying shares does not seem to affect the share price so the shareholders are not benefiting from the repurchasing. Isn’t this a waste of cash? Aren’t the shareholders being robbed?

The share price is an argument between shareholders and potential shareholders on the value of the company. It should reflect reality but many times it doesn’t. Over time however the math catches up with sentiment. In other words realization that there are fewer and fewer shares available compels people to not sell them, increasing the price. Short term investors tend not to pay attention to this but they are not the shareholders who Apple wishes to pay back anyway.

  • Why doesn’t the company spend the money on other things? You said they return what they can’t use. Why can’t they use it?

Simply, because it’s more than can be spent wisely. The company considers its mission to be very narrow: add value in specific areas where they can create tremendous value uniquely and under conditions (technologies and business models) they can control. Many such projects don’t require capital. Manufacturing, data centers and Apple stores require capital but R&D and sales not so much. Creating products is very cash efficient. For example, the iPhone–the most successful product of all time–cost almost nothing to develop; certainly nothing that required Apple to dip into its cash. Funding for the type of product development Apple does comes from existing cash flows and mostly consists of salaries for their employees.

  • What about acquisitions? Why not buy other companies?

It buys companies but usually small ones which are essentially acquisitions of teams and their intellectual property. Apple does not buy “business models” or customers or cash flows which is what large companies are valued for. Operationally, it’s also because Apple has a strong culture and it wishes to preserve it. Acquisitions dilute culture which is why integrations often fail. Statistically, large acquisitions are value destructive and the larger they are, the more likely they are to fail. Incidentally, when a company is acquired with cash that hole in the balance sheet is filled with something called “goodwill” which reflects some intangible value of the new asset. If and when the acquisition is deemed to have failed the goodwill is written off and so is shareholder equity. That’s how shareholders are robbed.

  • What about keeping it? Doesn’t having lots of cash make Apple more powerful?

As individuals we think that having lots of cash makes us rich. For companies it’s the opposite. Cash is a liability. If you come across a company that is cash rich and has nothing else, its enterprise value will be zero. Companies are valued on their future cash flows, meaning their ability to generate cash, not how much they managed to keep. In other words, cash is a measure of past success and investors are interested only in future value. That future value comes from the intelligent allocation of resources toward a valuable goal. A company rich in cash but poor in vision is likely to be taken private or broken up and shut down. Cash is an IOU to shareholders with a thank-you note for the support through the years.

Notes:
  1. Companies often borrow because they need to plug gaps in profitability, best measured as “free cash flow”. []

The iOS Economy, Updated

In its latest update on the App Store Apple reported that iOS developers earned $26.5 billion in 2017. A year ago the figure was $20 billion. The growth rate is then about 33%. The cumulative payments to developers can be calculated as $86.5 billion. This amount was generated in a span of less than 10 years, with the first billion paid by June 2010.

The following graph shows the history of cumulative payments and the corresponding payment rate (in $/yr.)

Note that this represents the payment to developers, not the spending by the customer. Apple keeps about 30% of the revenue.  The total spending on the App Store is then about 43% higher.[1]. The equivalent figures for spending on the App Store are shown below.

Notes:
  1. During the last year some types of app subscriptions have been priced by Apple at 15% of gross so I adjusted the payment rate to 72% for 2017 []

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The Sound of Music

One of the more common statements out of Apple is that “Music is very important to us.” This is one of those easily dismissed Apple platitudes. Like caring about products or customer privacy or other such nonsense. But if you pay attention you notice music is always a consideration for the company. The obligatory music act at the end of Apple events, the multitude of speakers and audio accessories in an Apple Store, the headphones branded Apple and Beats, the music-heavy ads. It’s as if Apple’s brand had a musical score.

And of course there is the history.

Steve Jobs not only put music at the heart of the brand but he re-built Apple’s business around music starting in 2001. The Rip, Mix, Burn campaign, the iPod and iTunes which not only oriented the company away from Computers but also disrupted the “record industry,” unbundling the album and destroying peer-to-peer sharing at the same time.

Apple was so powerfully oriented around music that I remember someone at Google in 2006 dismissing Apple as “that media company”.

So there is some good reason to honor music at Apple. If it wasn’t for music, Apple would probably not exist today.

But it seems that music has faded in importance or at least in mindshare. Music is the least exciting media type in an age of increasingly pervasive visual stimuli. AR, VR is what we’re supposed to dream of and of course screens, screen are everywhere. I note that at least in the US TV screens are now placed in public spaces bombarding us with imagery instead of speakers pumping out muzak.

Music has been relegated to offering personal space. We only use it through headphones to isolate us from the auditory pollution around us. Racks of audio components and enormous speakers are gone from our living rooms replaced with outrageously large screens.

And so pundits are calling for Apple to “do something” about video. To buy Netflix or to chase after content and build or buy properties. Look, Disney just bought Fox and Amazon is making movies and so is, apparently, everyone else.

But instead Apple sill sells songs and has a radio station. And it has a streaming subscription with “only” 30 million subscribers.

Even when it comes to original video content it rolls out a Karaoke show, of all things. It still maintains an app called GarageBand. It goes and buys Shazam, and paid $3 billion for Beats and still makes AirPods and is about to launch a speaker. Yes, a loudspeaker called HomePod.

How quaint.

But all the cynicism around music is tone deaf to the sheer emotion that music can create. Music touches people like nothing else. I’ve seen young and old cry and burst with joy listening to music. For its low bandwidth, music delivers enormous emotional bandwidth. It always has and always will. It’s not obsolete and will never be. Music imprints itself in hearts and remains there for a lifetime.

It’s poetry for the senses.

Business models for music will come and go but music consumption is increasing. Access to the long tail has meant genres proliferated and production has spread to everyone who cares to try to make music.

And so it is that more people listen to music on their widescreen iPods in more places and more times than ever before.

Apple realizes this and the acquisition of Shazam and the launch of AirPods and of HomePod are to serve music.

Siri or intelligent assistance are nice new services but they are not in lieu of the need for music. Chatty robots are appealing to intellect. Music appeals to the soul. These new products are in service of music because music is what people hire far more than advice.

HomePod will surprise not because it will be a better at chatting. It will surprise because it will cause you to sit down and listen in awe.

Organic

This is a good one.

Horace and Anders discuss Apple earnings, the iPhone X and take listener questions.

When Watch surpassed iPod

The last time Apple reported iPod unit and revenues was for the third quarter of 2014. Thereafter the product segment called “Other Products” was used to include what was formerly the iPod segment and the “Accessories” segment. Exactly two quarters later Apple began to sell the Apple Watch. Apple Watch was not broken out as a separate product segment and remained a part of Other Products along with iPod touch, Beats, Apple TV, and Apple-branded and third-party accessories. Soon the HomePod will also join the Other products.

The combined iPod, Accessories and “Other” product sales are shown in the following graph.[1]

Note that an attempt is made to estimate the contribution of Apple Watch to the mix. The method is simple: if you can estimate the non-Watch sales trajectory then the Watch is the difference between Other total and this trajectory.

If we discount the iPod, the non-Watch revenues come down to Apple TV and Beats, mainly.  Note that the data shows the contribution of Beats (Q4 2010) but it’s hard to parse specifically the growth of Beats. Since the Watch launched we also saw the introduction of AirPods and new Apple TVs, both of which probably contributed to some growth to “Other excluding Watch.”

We can take a stab at the first 6 quarters of Watch by projecting Other with some nominal growth. Thereafter Watch can be modeled using growth assumptions. Apple stated that growth was above 50% during the past three quarters. There are a few quarters where we must make guesses but overall the picture that emerges, shown below, is fairly robust. Note that I’ve included estimates for the fourth quarter of 2017 assuming continuing 50% growth. This is driven primarily by the launch of the LTE-enabled Series 3.

The result is a cumulative sales value of $14.3 billion and a volume of 40 million units (based on average pricing assumptions).

 

But what most catches the eye is the transition from iPod to Watch. Watch entered nearly at the same time as iPod bowed out. Its contribution to sales seems to mirror the iPod as well. The interesting question then becomes if the Watch will eventually match and indeed exceed the revenues from iPod.

I’d say the better question is _when_ Watch will overtake iPod. From a revenue point of view, I believe next year’s fourth quarter will see the Watch generating higher revenues than the highest quarter for the iPod.[2]

In terms of yearly unit sales it may take longer. The biggest year for iPod units was 2008 when about 55 million iPods shipped. Watch is now running at about 16million. If it could sustain 30% growth then it would take until 2022. 40% growth would mean 2021 and 50% 2020.

It’s not easy to predict growth but my bet remains that Watch will get there eventually becoming the third most popular Apple product. Perhaps even second.

Overtaking the iPod is quite an achievement considering that the iPod was once synonymous with Apple itself. Although Watch may overcome iPod, Apple may never be known as the Watch company. That’s perhaps for the best. I’ve noted before that Apple was once seen as the Apple II company, became the Mac company then the iPod company. Now of course it is thought of as the iPhone company though it’s no more that than it ever was any of the other things.

 

 

Notes:
  1. Two quarters include estimated iPod revenues: Q4 ’14 and Q1 ’15. The iPod contribution is estimated with a simple extrapolation using the previous four quarters’ average rate of decline []
  2. That was in Q4 2007 when iPod managed $4 billion. []

Does the iPhone 8 have what it takes to be a success?

Source: ¿El iPhone 8 tiene lo que se necesita para ser un éxito?

The above interview was conducted October 17 with Carlos Morales
Editor en Jefe, Forbes Digital (Mexico).

The source questions and my answers in English are below:

How can we read the fact that the new iPhone lineup raised so little noise? There was no massive lines outside the Apple Stores and people demonstrated almost zero interest in the new models compared with the hype motivated by the iPhone 7.

I don’t know about you but I don’t like waiting in lines. I don’t think Apple considers waiting in lines to be a good user experience for its customers. Over the years Apple has been able to improve availability and online orders so that lines can be eliminated. I suggest a better way to gauge interest in new models and that would be to look at sales. Sales seem to be going up even as lines have been going down.

The iPhone 8. What do you think of the fact that the iPhone 7 is outselling the iPhone 8?

Is it a fact? I think this notion is coming from a survey of operator stores in the US over a short time period. The mix of phones has never been known and is a matter of speculation. The only data we do have is the average selling price derived by dividing the revenues by the number of units sold (and ignoring deferrals). This price set a new record during the last 12 months. Expectations are that it will increase to another record again next year. I might add that this has never been observed in the phone business as far as I know. The opposite has been the trend.

Whats the outlook for the the iPhone 8 vs the iPhone 7 and the iPhone X?

The iPhone 8 is likely to be the best selling model over the next 12 months. The iPhone X will be the best seller in the first quarter but I expect it will come second during the following quarters. The iPhone 7 will end up 3rd.

What do you think about the smartphone prices, aren’t they too high? How far can they be stretched ?

Smartphone prices are very low. World-wide, average smartphones sell for less than $300. You can see a break-down by region here.

iPhone prices are, on average, more than double the average of all smartphones. Note that apple’s latest line-up also includes the cheapest iPhone ever with the SE now starting at $350.

I don’t think the average selling price will increase in 2018 globally. It will probably decrease as it has for a long time. Average iPhone prices will increase but probably only by $10 or so.

The iPhone price tiers are well understood. I published an analysis here:

More important however is that the iPhone remains priced at about $1/day, no matter the model, and as such the value users perceive is very high. The most expensive iPhone costs about 8 cents per hour of use, 1.4 cents each time you unlock it and 1 cent for ever 25 interactions you have with it (touches or taps). On a per use basis the iPhone is extraordinarily cheap. I know of no consumer product that is cheaper. This is determined partly by the intensity of use and by the high resale value (I assume 30% residual value after 2 years).

Do we really need a borderless OLED display in a smartphone? What about the face recognition technology?

Having no borders means you can get a screen that is bigger than the iPhone Plus in a phone the size of an iPhone. I think users will value getting more screen in a smaller phone. I certainly would. Having OLED means it can be curved a bit and also have nicer, truer black.

Face recognition saves time and is more secure. I don’t know another way of making the experience better for something that you do 30,000 times a year.

What do you think about the Apple Watch, which seems to be—finally—on the right track?

The Apple Watch has been on the same track for 2.5 years. I don’t see any change in that trajectory.

 

 

Orthogonal Pivots

Microsoft has announced that by the end of the year the Groove music service will be phased out. Users are being offered the option to move their music libraries into Spotify.

This brings to an end a long story of Microsoft in the music distribution business. It started nearly 15 years ago with technologies in Windows that allowed for purchase and playback of various media formats. Microsoft sought to enable a large number of music retailers to market music through its formats and DRM and transaction clearing.

Services such as AOL MusicNow, Yahoo! Music Unlimited, Spiralfrog, MTV URGE, MSN Music, Musicmatch Jukebox, Wal-Mart Music Downloads, Ruckus, PassAlong, Rhapsody, iMesh and BearShare and dozens of hardware players licensed Windows formats. Almost all of these services have shut down and the devices disappeared.

The next stage was to offer an integrated experience through the Microsoft Zune player and Zune Marketplace music service. This too failed and was replaced by the Xbox Music brand in 2012. On July 6, 2015, Microsoft announced the re-branding of Xbox Music as Groove to tie in with the release of Windows 10.

There was a time when Microsoft was thought of as the certain winner in media distribution. Inserting media into the Windows hegemony was classic “control point” strategy: owning the access points was a sure way to collect a tax on what transacted through the network.

Instead we are facing a market where media is consumed through new access points: phones, tablets and TV boxes. Netflix, Spotify, Roku, Google, Amazon and Apple are all offering distribution and some are investing in original programming.

It’s perhaps worthwhile to recall that Microsoft and Apple both started their media efforts around the same time. Apple’s iTunes is 16 years old and the iTunes Music Store opened in 2003, almost 15 years ago. Today Apple is transitioning to streaming with 30 million subscribers. The graph below shows the history of subscription growth to Apple Music and Spotify.

Apple Music is a small part of Apple Services (part of the orange area below).

On a yearly basis Apple Services are this year crossing the $50 billion gross revenue run rate. This year Apple released a new Apple TV 4K and is releasing a new smart speaker called HomePod.

The contrast between Microsoft and Apple is most visibly between the Mac and PC. But the story of how media paralleled mobility and how Microsoft struggled with both is perhaps a cautionary tale.

Microsoft saw the limits of modularity when new product categories emerged and when new user behaviors were created. They attempted to pivot into being more integrated but those efforts also failed. The efforts continue today with Surface devices; looking forward they will continue with AR/VR and perhaps a pivot of Xbox..

But the long arc of history shows how hard it is to succeed in vertical integration after you build on horizontal foundations. Generations of managers graduated from the modular school of thought, specializing rather than generalizing. Now they are facing an integrated experiential world where progress depends on wrapping the mind around very broad systems problems.

Entire industries are facing this orthogonal pivot: media, computing and transportation come to mind. Huge blind spots exist as we see only what we’ve been trained to see.

S3X Appeal

On July 3rd, Elon Musk handed over the first 30 Model 3s and tweeted

“Production grows exponentially, so Aug should be 100 cars and Sept above 1500.”

He added,

“Looks like we can reach 20,000 Model 3 cars per month in Dec”.

In 2016 he stated

“So as a rough guess, I would say we would aim to produce 100,000 to 200,000 Model 3s in the second half of [2017]. That’s my expectation right now.”

He confirmed this estimate early in 2017

“Our Model 3 program is on track to start limited vehicle production in July and to steadily ramp production to exceed 5,000 vehicles per week at some point in the fourth quarter and 10,000 vehicles per week at some point in 2018.”

Overall 2018 production guidance has been 500,000 units and 1,000,000 units in 2020.

The company shipped 220 Model 3s in the July, August and September months. This is well below the expectation of 75,000 that the 2016 guidance would suggest[1] or the 1,630 that might be suggested by the “production grows exponentially” July proclamation.

I entered the Q3 production data and kept the previous run rate predictions for Q4 and 2018 and 2020 in the following graph.

 

Notes:
  1. 100,000 to 200,000 for the second half of 2017 suggests an average of 150,000 for the six months or 75,000 per quarter []

Silicon Valley

You’ve probably heard of Jony at Apple but probably don’t know about Johny.

Jony is a celebrity executive known as the face of Apple Design. Johny is the executive in charge of custom silicon and hardware technologies across Apple’s entire product line.

Under Johny’s leadership, Apple has shipped 1.7 billion processors in more than 20 models and 11 generations. Currently Apple ships more microprocessors than Intel.[1]

The Apple A11 Bionic processor has 4.3 billion transistors, six cores and an Apple custom GPU using a 10nm FinFET technology. Its performance appears to be almost double that of competitors and in some benchmarks exceeds the performance of current laptop PCs.

A decade after making the commitment to control its critical subsystems in its (mobile) products, Apple has come to the point where is dominates the processor space. But they have not stopped at processors. The effort now spans all manners of silicon including controllers for displays, storage, sensors and batteries. The S series in the Apple Watch the haptic T series in the MacBook, the wireless W series in AirPods are ongoing efforts. The GPU was conquered in the past year. Litigation with Qualcomm suggests the communications stack is next.

This across-the-board approach to silicon is not easy or fast or cheap. This multi-year, multi-billion dollar commitment is rooted in the Jobsian observation that the existing supplier network is not good enough for what you’re driving at. Tiny EarPods, Smart Watches, Augmented Reality, Adaptive Acoustics require wrapping your arms around all parts of the problem. The integration and control it demands are in contrast to the modular approach of assembling off-the-shelf components into a good-enough configuration.

There are times and places where modules are adequate and times and places where they aren’t. The decision depends on whether you are creating new experiences or new “measures of performance” vs. optimizing for cost within existing experiences or measures of performance.

The very notion of a microprocessor is a rejection of the discrete component designs that preceded it. Earlier computers had central processors made up of many discrete components. VLSI stands for Very Large Scale Integration with emphasis on Integration. As computing has progressed toward ambience and ubiquity the idea of using discrete components became normative again but that was not considered sufficient by Apple.

So while the “Silicon” in Silicon Valley has come to be seen as an anachronism, silicon development today means competitive advantage. The only problem is that it takes years, decades even to establish competence. The same duration that it took for the building of Apple as a design-centric business fronted by Jony Ive.

Apple also now needs to be understood along the dimension of silicon-centric engineering as led by Johny Srouji.

Notes:
  1. Trailing 12 months’ PC shipments 265 million. Equivalent iOS devices 281 million. Not included are Apple processors in Apple TV. []