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The Car Bundle Paradox

The EV car market is booming. The graph below shows the global market for plug-in electric cars (plug-in hybrid (PHEV) and battery (BEV)–BEV are about 70% of total). The data is split between 2019 and 2020 with further distinction between the main regions.

EV (PHEV+BEV) units sold 2019, 2020 by region.

There is an additional detail in the delineation of Tesla’s shipments into these regional markets. To that point Tesla’s market share of all EV cars has remained roughly equal from 2019 to 2020.

Tesla share of EV car market and share of all cars.

The big story of 2020 was the growth of European EV shipments. Those who follow the market know that new EU penalties for CO2 emissions have come into effect, causing much of this increase. Indeed, previous surges in the US and China have also been driven by new incentives and/or disincentives.

As an aside, it should be noted the absence of Japan from this EV story. It’s quite a shock, really. Japan is responsible for a large percent of all cars sold through its national heroes Toyota, Nissan, Honda, Mitsubishi (and Subaru, Suzuki, Mazda, Isuzu) and has been a driving force for innovation. The absence of a local market for EVs is a glaring indicator of lack of industrial policy. Unlike the US, Japan does not even have an oil industry, importing all its supply (while the US is a net exporter.) Yet the US produces and consumes far more EVs than Japan. This should give pause. One wonders what would happen if Japan followed Europe in providing incentives for EVs in the “JDM” market.

Japan and “Other” countries aside, there was growth. But much remains to be done. The overall industry is far larger, as shown in the following graph.

EV growth and global light vehicles 2019, 2020.

Nevertheless, optimism abounds. With an increase in market capitalization of about 648%, Tesla is now the most valuable automaker in the world.

Tesla, the champion EV maker has taken 17 years to reach 0.65% market share.

Market capitalization of the auto industry (top 25 firms) and the market size (in units delivered).

Actually, as the graph shows above, Tesla is now almost as valuable as the entire auto industry was a year earlier. But the rest of the industry did not collapse. The top 24 companies (i.e. apart from Tesla) increased their market capitalization from $901 billion to $1266 billion during 2020. That’s a 40% increase during a year when sales fell by 15%. Quite an achievement.

Overall the market capitalization of the top 25 automakers more than doubled from $1.0 to $2.1 trillion. This begs many questions, mainly, how would such profits ever be generated.

To put a finer point on it, if we divide the market capitalization by units produced we get a figure of value that allows a historic perspective.

A measure of valuation by units of production.

Historically car companies were valued at $8,000/yr. 2019’s value was about $10,000 which makes sense given some inflation. But the drop in volumes coupled to increase in valuation brought the ex-Tesla cap/unit to an eye-watering $16,400, a 64% increase in one year.

Tesla’s valuation is on a different level. It went from $291,361 to over $1.6 million/car sold. Roughly this is 100x rest of industry.

But if we continue to pull the thread there’s yet another story to consider. The car industry (i.e. making and selling and servicing cars) is not the only way to deliver “miles” to citizens. There are multiple “modes” and services that deliver transportation.

There are also the ride hailing and micromobility which are positioned on different “jobs-to-be-done” than cars. The market capitalizations of ride hailing and micromobility are shown below

Adding the value of ride hailing and motorcycles and bicycles.

Note that micromobility is only measured by the value of motorcycles and bicycles whose markets are measurable and applying a 1.1 multiple to those sales yield a rough estimate of market cap.

It’s hard to get a measure on these jobs but I’ve taken to heart the idea that what you measure is most important in seeing what’s next and have been dividing the “market for miles” into short, medium and long distance trips.

The “Car Bundle Paradox”: The demand for travel vs. value of modes for travel by trip distances.

In the view above we get a sense of the scale of perceived value for businesses serving various trips. The inverted nature of valuation positioned on trips is, I believe, worthy of further analysis.

As the car today is a bundle, the design and engineering efforts are directed at serving the longest of long trips (with the largest payloads.) But the demand is for short trips.

If the car is to be unbundled (as the Personal Computer was into laptop, tablet, phone, wearables) then one can imagine that devices designed for short trips would accrue the value of those trips (and their popularity).

The absence of value in short trips is a paradox. Or perhaps it’s just an opportunity.

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Apple Pay’s Pay Day

IN a recent release, Apple reported that “more than 90% of stores in the US, 85% of stores in the UK, and 99% of stores in Australia accept Apple Pay.” This is encouraging but a very small view for the global Apple Pay picture. How can we assess where Apple Pay is and how do we even measure success? My expectation six years ago was that Apple Pay would be a “$1 billion business” by 2020. Now that 2020 has ended, how was my six year prediction?

I always recommend counting customers rather than (or before) dollars so let’s begin with that. According to one source Apple pay users worldwide reached 507 million by September 2020. This is about 50% of iPhone users and therefore a decent adoption rate (starting as it did six years ago.) The data shows a growth rate of about 66 million in 2020 but a deceleration from 150 million the previous year. This data is obtained through surveys as there is no reporting from any participants.

There is a smattering of other samples about transaction volumes, mostly behind pay walls, but the overall story of adoption is typical: an s-curve where we are either at the point of inflection or slightly after it. If we are half-way then perhaps saturation will occur in another six years.

More concerning is the distribution of these users. A lot of the data that is collected on mobile and online payments (and mobile wallets) is US only. Historically the US was a good place to measure technology adoption as the US was usually the leader. The automobile, PC and many other consumer technologies saw their market defined by the US.

But not so much anymore. The digital mobile phone broke the rule. Today mobile payments is breaking it again. Note that although the iPhone is over-represented in the US (as share of all phones) Apple Pay point-of-sale support is under-represented in the US.

According to one survey, in mid 2018, there were an estimated 38 million Apple Pay users within the United States, and 215 million outside (5.5 times more!) Outside the US mobile payments are nearly 100% accepted by default but in the US the support is patchy and characterized by active intervention to deny.

I’ve used Apple Pay everywhere in Europe without friction. From vending machines to highway tolls to drive-throughs, public transit and parking meters. I can recall one failure to do so in the last six months (a state-owned gas station).

The same cannot be said of the US. Where at WalMart and Home Depot there is the capability of support but an incomprehensible refusal to do so. One rumor about why Home Depot denies it is because they were hacked once and are paranoid about any technology. Walmart may be spiteful due to margin/cost, valuing a few basis points over customer satisfaction, convenience, hygiene and employee productivity. These holdouts are the laggards. Perhaps there is some pride in denying their customers a basic convenience but there certainly isn’t profit in it.

It gets even weirder when it comes to banks. In the US almost all banks immediately supported Apple Pay as an extension of their bank cards. In Europe the banks became the holdouts, rolling out support slowly and perversely.

So when you consider the dependencies of Apple Pay:

  • Sufficient number of users with iPhones/Watches (check)
  • Support from Banks (great in US, spotty outside)
  • Willingness of retailers to accept (sluggish in US, perfect outside)
  • Availability of points-of-sale equipment (universal by now

It’s an impressive achievement.

My expectation six years ago was that Apple Pay would be a “$1 billion business” by 2020. This was based on a take rate of 15 basis points ($15/$10,000 in transactional value). Juniper Research, which regularly examines payment transaction markets, now expects that Apple will see global Apple Pay transactions of $686 billion by 2024.

At that 15 basis point rate it amounts to $1.03 billion. Thus this particular research suggests that I was off by 4 years, making the $1 billion pay day a 10 year target rather than six.

But maybe that is no fault of Apple’s. The transaction volume is also equivalent to 52% of the proximity mobile payment market. Half the addressable payment market is a pretty good market share for a company holding 25% of the smartphone user base.

Apple’s Fourth Calendar Quarter 2020

As a rule, I don’t like to make a forecast for Apple’s performance during quarters where there is no guidance. There is a good reason why there is no guidance. The management does not feel confident that there is enough information to make a reasonable prediction. Keep in mind that the management has very detailed, very frequent updates on their business metrics.

Anyone who has run a business knows that signals of performance are abundant and one can only imagine how many signals arrive at Apple HQ from the 1.5 billion active devices, tens of thousands of points of sale, and a vast network of resellers. There are also billions of interactions in services. Then there are search queries, store visitor counts (online and physical), developer payments, app downloads, content downloads, subscriptions. All this information is collected and analyzed on (probably) a daily basis.

Also when guidance is given, it’s usually a month into the next quarter. The company will have already seen about a third of the quarter already pass before they predict the next two thirds.

This last quarter in particular was even more difficult given the delays in launching the new iPhones and the dynamics related to the broader portfolio.

And yet, the company feels that they can issue some “insights on our expectations”. Here is what was said about three months ago:

These directional comments assume that COVID-related impacts to our business in November and December are similar to what we’ve seen in October. […] [W]e expect iPhone revenue to grow during the December quarter despite shipping iPhone 12 and 12 Pro 4 weeks into the quarter and iPhone 12 mini and 12 Pro Max 7 weeks into the quarter.

We expect all other products in aggregate to grow double digits, and we also expect services to continue to grow double digits. For gross margin, we expect it to be similar to our most recent quarters despite the costs associated with the launch of several new products. For opex, we expect to be between $10.7 billion and $10.8 billion. We expect OI&E to be around $50 million and the tax rate to be around 16%.

Luca Maestri, Chief Financial Officer

So, given this information and some hints from IDC, Gartner and CIRP and China I’m willing to offer some estimates:

  • iPhone Revenue: $63.9 billion
  • Mac Revenue: $9.3 billion
  • iPad: $7.4 billion
  • Services: $15.1 billion
  • Wearables & Home: $12 billion
  • Net sales: $107.8 billion
  • Gross margin percent: 37.7%
  • EPS: $1.48 (Growth: 19%)

Of course, this is very speculative and I don’t have a lot of confidence in it. If anything it may be on the high side.

I don’t expect there to be guidance for the next quarter with a resumption of guidance only after the pandemic has largely subsided (probably Q3 of this year.)

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The Entrant’s Guide to Automotive Industry (updated)

I wrote the initial guide almost exactly six years ago. Also known as “The 10 Commandments of Automotive” it’s time to re-visit it to see how and if anything has changed.

The rules listed are empirical observations. The patterns show how things are and have been and hint at what can and cannot change. Capacity utilization and capital allocation are perhaps the most basic root causes for how the system operates.

Capacity utilization has meant that incumbents needed to produce large quantities even if they were not doing so profitably (1st commandment). The capital invested in plant and equipment had to be amortized. This meant it was difficult to enter with a low volume strategy. Indeed all entrants that succeeded did so with “people’s cars” (2nd commandment) which were destined to mobilize entire nations if not continents.

As production orientation absorbed all attention, innovation in production determined the cycles of dominance. First Ford, then GM, and finally Toyota refined the production system (3rd commandment.) Eventually every producer would adopt the “best practices” but the innovator would have years if not decades of competitive advantage.

The political implications of the automobile became a dominant question as it effectively terraformed its environment. Cities, ancillary industries and even our climate were affected. This meant infrastructure, tax policy, land use policy and financial systems became dependent on automobiles. In return governments began to regulate, creating a symbiosis between government and automakers. (4th commandment).

New technologies were plentiful but they all got absorbed by the industry. Mechanical, chemical and material sciences, computation and communications were all sustaining. (5th commandment.) New fuels, microprocessors, wireless technologies; these immense evolutions did not change the structure of the industry.

As new countries became prosperous they not only adopted cars but they adopted car production. The Europeans were first with the technical invention but the US was first with mass production, followed by Western Europe, Japan, Eastern Europe/USSR, Korea, China and now RoW. (6th) Each new entrant had the advantage of hindsight and would be more efficient, at least for a while.

Low volumes were left to “luxury” brands which survived by solving a different job than transportation, namely that of status signaling. Eventually the low- and high-end merged into brand holding companies. Capacity was traded and cross-ownership, joint ventures and “badge engineering” was widely practiced. Governments kept competition at bay for national champions, mostly. (7th commandment)

Cars grew to over 1.2 billion installed base and, including commercial vehicles, reached 100 million units of production/yr. The problem that arose was that the infrastructure could not keep up. Urbanization was growing faster than motorization and land became scarce. Cars need land. Lots of land. For roads but also for parking (3 spots for every car in use, at least.) As global prosperity increased and as prosperity meant a car the struggle to find room for these modes of transport grew intense. Most users now found the car to be a constraint rather than a liberation. (8th commandment.) Parking and congestion were problems highly evident to the motorist but the externalities of exclusion of public space and emissions became highly evident to the governors who, you remember, are in a symbiotic relationship.

Clearly the pressures were building for drastic improvements in how transportation would be allocated. My response was to promote micromobility, the idea that small is better and smallest is best and that the tendency of the industry to supersize its offering in the face of increasing constraints was classic innovator’s dilemma. Incumbents could respond by rapidly changing their portfolio to include a wider variety of form factors and while they broadened the portfolio (e.g. Audi went from 4 models in the 1960s to 40 in the 2000s) they did not go below a certain line (the 500kg line). They also did not modularize their production system. Production (body-in-white, paint, engine and final assembly) remain in-house while parts are outsourced. (9th commandment) This was peculiar to me and indicated a deeper structural issue.

Instead of a pivot downward, the industry keeps chasing size, mass, volume, power, range. Most trips are short but all the engineering goes toward the long tail of highly improbable distances and loads. (10th) Always the answer to this dilemma is that you build what customers demand. Well, which customers are you asking? Under what circumstances are you framing the question? Well, never mind, let’s build electric versions of the same cars.

These constraints determined the outcomes for the industry for a century and are predicated on decisions allocating limited resources and capital based on we might call classical microeconomics; but all within a bigger political and indeed geo-political context.

So what has changed?

This classical model has one potential flaw: The assumption of capital as a limited resource. An odd thing happened in the last decade. Capital has not only become really cheap, in many cases it has reached a negative cost. This is evident in negative interest rates. When I observed this I thought something fundamental was broken. If there is so much capital that people are paying you to keep it for them then a lot of this “classical microeconomics” begins to break down.

The firms that are husbanding capital can be “disrupted” by those who squander it. Those who observe discipline and pursue efficiency can be defeated by those who are undisciplined and inefficient.

Holy cow!

This entrant’s guide is a rationalization of what governs one of the largest activities we engage in. And yet it may be undermined by an imbalance. The evidence is in the capitalization (and hence free capital availability) to entrants who have little to offer except a dream. The incumbents who thought they could sustain through technology transitions are being out-spent and having their access to what is still limited (raw materials or components) curtailed.

Need more proof? Tesla has single-handedly doubled the value of the automobile industry in a year when overall volumes and sales shrank.

That means that either there will be twice as many cars as we have now or they will be twice as expensive or they will be twice as profitable. And all that will happen really soon. We can’t have twice the cars since there will be nowhere to park them. We can’t double the price unless we double our wealth. We can’t make them twice as profitable unless we disable competitive forces and change the production system.

Or, it could be that half the assets (all the other automakers) are worthless.

Something has to give. The paradoxes multiply.

Into this will, one hopes, step Apple. Things are about to get really interesting. Stay tuned.

App Story

App Store spending was $1.8 billion in the last week of 2020, up from $1.42 billion the previous year —an increase of 27% vs. an increase of 16% from the previous year.

On 1/1/2021 App Store spending reached $540 vs. $386 million for 1/1/2020. This was an increase of 40%. The previous year’s increase was 20%.

Developers selling through the App Store have now earned more than $200 billion since the App Store launched in 2008.

The previous year’s figure was $155 billion, making the 2020 total $45 billion, a 30% increase from $34.5 billion average of the previous two years. Assuming a proportional increase, overall ecosystem transactions rose to $675 billion in 2020. This places Apple’s valuation at a 3.2 multiple of its yearly ecosystem value and each customer is valued at approximately $1400.

The history of App Store revenue and the growth rates involved is shown below.

NB: A substantial amount of App Store revenue is derived through subscriptions which now total about 600 million.

A simple summary is that the App economy accelerated its growth in 2020. This implies an economic value reaching $1 trillion/yr. within two years. It would behoove the investor to evaluate the value of Apple as a multiple of its ecosystem as well as a multiple of its customer base.

As I have repeated over time, the strength and resilience of Apple is in its customer base. Strength in terms of willingness to spend for quality and value and resilience in terms of sustained satisfaction. As that base grows to well over 1 billion people and as this billion are exposed to an increasing spectrum of value options (products, services and ecosystem) the company becomes indispensable.

This is quite the opposite of the perceptions widely held even a few months ago.

In other news:

  • Apple added 52 new territories to Apple Music.
  • Apple TV is now available on over 1 billion screens in over 100 countries and regions, providing access to buy or rent over 100,000 new release and classic movies and TV shows
  • Apple Pay is accepted at more than 90% of stores in the US, 85% of stores in the UK, and 99% of stores in Australia
  • Apple Books now draws over 90 million monthly active users
  • Podcasts are now available in over 175 countries with programming in more than 100 languages
  • More than 85 percent of iCloud users are protected with two-factor authentication

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Apple in mid-2023

The Apple product line-up for 2023 is almost completely decided. This is not conjecture but simply an observation of the lead times for developing the types of products that Apple offers. The integration of hardware, software and services, often cited as the key to Apple’s sustainable competitive advantage, has a great cost: the time required to develop in an integrated fashion is far longer than the time required to develop in a modular fashion.

2.5 years is not a long time. The development process on truly new products could take 4 to 5 years. Apple Silicon, new Operating Systems and new services could all take longer than 2.5 years. The products we just saw launch this year were planned and engineered at least 2 years ago. The more integrated, the more time is needed. Wearables, AI/ML and process engineering are additional examples of long arcs of development needed to reach products.

This does not mean we can predict what these products will be. We don’t have visibility to the process but Apple management does and they will make decisions now on adjacent dependencies in the business. For example, visible efforts in planning the use of cash, the carbon offsetting, capital expenditures and R&D are all synchronized to the roadmap and hints may be read into this data.

The biggest hints are the R&D spending and the company’s capital return program. Combined they show a confidence in the roadmap that is hard to overestimate. First, R&D is reaching new highs of about 7% of sales (on a trailing 12 months’ basis, see graph below). This is almost the same as the spending on SG&A which has declined as a percent of sales from above 12% pre-iPhone.

Of course sales have increased significantly over the time shown in the graph below and the absolute spending is shown the following graph. R&D spending is over $5 billion/quarter or about $20 billion/yr. Some of the results of this will be seen in 2023 or beyond.

Next, capital returns. The company is returning almost all the cash it generates and is reducing its cash balance. It has returned about half a trillion dollars to date. Dividends paid has reached $100 billion and share buybacks about $400 billion. This is the largest capital return in US history.

The company has declared its intention to reduce net cash to zero. This means it will still have substantial cash due to loans in the form of bonds but no “excess” cash will be held by the company. This is in contrast to the strategy under Steve Jobs where he sought to keep as much cash on hand as possible due to the need to weather potential storms, Tim Cook’s Apple is being very “casual” about cash.

Steve Jobs had his reasons for hoarding cash. The company had been through periods of existential crisis. The absence of cash jeopardized its independence and it was something he vowed never to happen again.

However if that strategy would be maintained to this day, as the graph shows, the company would have cash of nearly $700 billion today. It would make Apple the world’s largest hedge fund, by far. Second only to a very few sovereign funds. Given a conservative cash preservation mandate it also means that that capital would largely go unrewarded because the return on it would have been minimal, negligible. Not to mention also the target it would paint on the company’s balance sheet.

So given the trajectory in net cash being so consistent, it’s probable that the goal of net zero will be reached mid 2023.

That leaves the question of what will happen at that time?

The answer is nothing. Nothing will happen. The capital return programs will probably be ended and additional cash generation will be paid as dividends going forward. That’s it.

Rather than suggesting a change, the capital return program (and the R&D program) suggest a lack of change, consistency. The company management is anticipating a steady capital generation rate, a steady product roadmap (with predictable growth) and a steady customer base (with predictable loyalty).

This future for Apple in 2023 may seem boring. But that’s exactly the plan. This is a plan that the company management has been making for a long time and has been executing for a long time. The plan is to be boring on the business side but exciting on the customer product side.

Consistency has been the characteristic trait of the Tim Cook era. It is a smoothing of seasonality with services. It is the clockwork delivery of product updates, regardless of macro and externalities. It is a growth in user base consistent for a decade.

It is perhaps because more people believe that consistency is the future that we have Apple’s P/E ratio now in-line with its peers. Paradoxically, being boring is what makes Apple shares so exciting today.