First, let me begin my bearish take on Apple by making one thing clear: I think Steve Jobs is a clueless idiot bereft of original or interesting ideas.
Ha! Just kidding, Apple fans. I know all of you who love Steve Jobs can take a joke as well as the next guy! Nevertheless, anyone who saw the debate on our message boards after Bill Barker and Yi-Hsin Chang Dueled over whether Bill Gates or Steve Jobs were better investments knows to steer clear of personalities. So of course I am not actually going to say anything about Mr. Jobs.
Instead, let's just dive right into the crux of the problem, as I see it: to be a worthwhile long-term investment, Apple needs to expand its market share and revenue base. At this point, it has had only limited success in doing so. If you're going to invest in a PC manufacturer, why choose one with less market share and slower growth than leaders like Dell or Gateway?
Earnings have certainly increased recently, but Apple's financial turnaround is largely a result of cuts in overhead and increased efficiencies. Yes, the iMac is popular, but nevertheless, check out the company's revenue numbers in recent years:
(in millions) 9/1996 9/1997 9/1998 9/1999 Sales $9,833 7,081 5,941 6,134 Year-over-year -11.1% -27.9% -16.1% 3.2%Simply put, those aren't particularly impressive numbers. Sure, there are some product mix changes going on, and the company has better margins and better working capital management, as I'm sure Bill pointed out. I'm not arguing that Apple is going to go bankrupt anytime soon. But better financial management will only get you so far.
Sales growth is important for three reasons. First, as Dale Wettlaufer pointed out in our "PC Companies" Industry Snapshot, sales numbers are crucial in the PC business. Since the average selling prices (ASPs) of PCs is consistently trending down, low or modest growth in unit shipments may nevertheless result in flat or declining revenues. Rapid sales growth is necessary to stay ahead of deflationary prices. Secondly, since the worldwide PC market is growing at a roughly 25% pace, to increase market share Apple has to grow faster than that. And the company needs to increase market share at least a few percent to become anything but a small niche company, and to ensure that software developers continue to write applications for it. And finally, and most obviously, sales growth is necessary to achieve sustainable growth in earnings and cash flow.
I think it's unlikely that Apple can accomplish this over the next few years. While companies like Dell and Gateway roar ahead with their direct sales models, and Compaq continues to sell millions of PCs despite its troubles, Apple may be fighting a losing battle.
First there's the company's problematic fourth quarter (which concluded September 30th), in which it had to guide earnings estimates lower and then posted a 12% drop in revenues and a 7% drop in unit sales compared to the year-earlier period. Certainly much, if not most, of this was due to factors beyond the company's control, such as a shortage in microprocessors from its partner Motorola. And yes, the company did book a lot of backorders.
Nevertheless, Apple shot itself in the foot with its incredibly boneheaded decision to address the shortage partly by canceling early customer orders for its newest and fastest computers, and then offering those same customers slower computers for a higher price. After a firestorm of criticism, much of it from some of their most faithful customers, the company reversed course, but it's amazing that the decision was ever made in the first place. It's not exactly a sign of skillful management. "I've been a loyal Mac person for 20 years, but Windows here I come," stated one customer in a widely quoted sound bite.
Rather than just focusing on one bad quarter, however, let's look at the last four. Here's what we see:
Worldwide sales 12/98 3/99 6/99 9/99 Units sold 944,000 827,000 905,000 772,000 Y/Y Change 48.7% 27.2% 40.5% -7% Market share 3.45% 3.37% 3.54% 2.76%Sources: Apple SEC filings and IDC Corp.
Of course, Apple bulls can point to the two quarters of 40% growth or greater, but Dell clocked in with greater than 50% growth in all four quarters, and IBM grew faster in the first and second quarters as well (keep in mind that these are worldwide numbers). In other words, with industry growth averaging roughly 25%, 40.5% growth is so-so and 27.2% is just enough to maintain market share.
The seasonality of the numbers also indicates Apple's reliance on consumers, where prices and margins are lowest. The iMac may be fun for first-time users, but Apple has yet to make any inroads into the business market, where Dell and IBM have demonstrated significant growth. Apple is even losing its grip on the education market, where it has long trumpeted its dominance.
According to the market research company Dataquest, Dell led in sales to the education market in the second quarter this year with a 21% share, thanks to its 113% growth in that sector. Apple argues that if you include its direct sales to educational institutions, then it remains number one (the two companies are having a bit of a squabble over this). Yet even Apple's preferred numbers only show the company with 22.2% market share, while Compaq is a close second at 19.1%, and Gateway and Dell follow with 17.2% and 15.8%, respectively. With Dell's 113% growth, how long before they catch up?
And without the education or business markets, and only a small share of the consumer market, what's left for Apple? Where will the growth come from? I look forward to seeing Bill's answer to that one.
Next: The Bull Responds