Apple Gets Whacked

Shares of Apple (NASDAQ: AAPL  ) are down in the Jan. 2 session following a downgrade from Wells Fargo. While the voice of one analyst isn't enough to have a material long-term impact on the stock, it is important to take a look at the concerns raised and to see if they are material to the long-term investment thesis. So, is Wells Fargo making mountain out of a mole-hill, or are their concerns legitimate?

It's the margin question – again
The long and the short of it is that Wells downgraded Apple from "outperform" (i.e. buy) to "market perform" (i.e. neutral that really means "sell"). What's interesting is that the firm's bullish thesis had originally been predicated on gross margin expansion as a result of what Apple is doing with the iPhone 5c and 5s. While Wells is still bullish on the short-term stabilization/expansion, the firm is cautious about the long-term sustainability of "large" subsidies that allow for Apple's robust iPhone gross margins.

Should this be a concern?
There are really two schools of thought here. The first – and the one that's typically bearish for Apple – is that the carriers really have all of the power here. This is an interesting point of view because, at the end of the day, smartphones are valuable precisely due to the fact that they offer Internet access just about anywhere – something enabled by the carriers. The idea here is that people will want to buy smartphones anyway, putting the carriers in the position of power.

The other school of thought is that the iPhone is a premium product that drives smartphone subscriptions, increased data usage, and so on. While this is probably a more dubious argument (since, again, the smartphone revolution is a very powerful secular trend), there's no denying that customers love their iPhones and if a carrier were to make it difficult for customers to use iPhones, another carrier may end up offering the subsidies in a bid to attract customers.

Apple seems safe – for now
The bottom line here is that Apple is probably safe for as long as Apple's brand remains aspirational and powerful. However, it's tough to ignore the threat that Samsung (NASDAQOTH: SSNLF  ) , Apple's chief competitor, brings to the table with its wide array of Android devices. From the lowest-of-the-low end, free-with-contract phones to devices like the Galaxy Note 3 that command a premium to Apple's devices in their base configurations, Samsung has become a truly viable alternative to Apple.

What would make Apple a much easier investment would be to see it continue to expand its high end, premium iPhone lineup in order to capture further share of the high end market. If Apple's "larger" iPhone 6 can drive Samsung further into the lower end of the handset market and capture more share of the high end, then Apple's premium brand and its pricing power will remain intact, keeping the balance of power between Apple and the carriers roughly where it is today – and Apple's margins stable. 

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Comments from our Foolish Readers

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  • Report this Comment On January 02, 2014, at 9:30 PM, riwaterman wrote:

    "What would make Apple a much easier investment would be to see it continue to expand its high end, premium iPhone lineup in order to capture further share of the high end market."

    Have you heard of China Mobile? They will be expanding Apple's high end market considerably. In addition, Apple's lower cost models will also protect Apple's great margins. But suppose (and I doubt it will happen) Apple's margins dropped by 10%, their margins would still be the envy of all phone makers including Samsung.

    " it's tough to ignore the threat that Samsung ... brings to the table ..." Have you been paying attention? Samsung is in crisis mode and their earning are dropping and their stock price is dropping too! What threat.

    Also check out usage by the smartphones presented by Chitika.com. from WallSt cheat sheet: "Newly released data from online ad network firm Chitika showed that Apple (NASDAQ:AAPL) emerged as the biggest overall winner in the North American smartphone and tablet markets after the holiday season. (in an accompanying graph), Apple was the ONLY smartphone company to gain usage share among all of the major device makers."

    Oh and by the way, TODAY Cantor Fitzgerald‘s Brian White reiterates a Buy rating, and a $777 price target, writing that after a “challenging 2013,” the stock is the firm’s “top large-cap pick” for the year, which he thinks will be “a year of innovation.”

    “Our research suggests Apple has been working hard to excite investors in 2014 with new product innovations,” writes White, predicting that based on recent “checks” in Asia, “Apple will ride the holiday momentum into 2014.”

    Why didn't you report on that reiteration??? Too positive news for Apple for your taste perhaps.

    Finally Cramer also noted on CNBC that Wells Fargo got it wrong, Apple is a BUY!!!

  • Report this Comment On January 03, 2014, at 12:55 AM, Johnsoftie10 wrote:

    Don't kid yourself there are many more alternative to Apples Iphone. Go and educate yourselves and look at the capabillities of the smartphones in Asia. The hedge funds love to "PUMP and DUMP". After January watch the retreat on AAPL. It has little to no innovation! AAPL rose only because of the pumping by the Fed. Reserve who love to distort mkts look at stocks doubling and tripling in value. One has to be an idiot to listen to Jim Cramer. He "pumps stock" that he has bought at much lower prices".

  • Report this Comment On January 03, 2014, at 7:58 AM, Cintos wrote:

    In the last few months, the largest carrier in China and the largest carrier in Japan have bowed to consumer demands and are selling the Apple smartphones.

    Carriers have been resistant to the Apple model because they loose control of the upgrade process and loose control of the configuration options - both good development for the consumer. Android helps them perpetuate the 2-year obsolescence model because Android software upgrades are nearly impossible to obtain. Less than 2% of Android phones are on the latest version, whereas almost 80% of iPhones in use are on iOS7.

    Consumer demand was responsible for Verizion finally offering the iPhone - they had dug their heels in, hoping that the Android phones would succeed and make the iTunes store irrelevant.

    Consumers, not "Analysts" will determine Apple's future trajectory.

  • Report this Comment On January 03, 2014, at 8:43 AM, fauxscot wrote:

    Post hoc ergo propter hoc?

    Not really.

    Slow trading day. Market down. Apple down. Yawn.

    Earnings 1/23/2014.

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