the apple iPhone, Watch, Airpods, and Macbook

Image source: Apple.

Apple (AAPL 0.86%) is the largest company in the world, and in my opinion, one of the very best. Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B)which is one of The Motley Fool's favorite businesses, also owns about $28 billion worth of Apple shares. This interview with top technology analyst Gene Munster focuses on Apple's mastery as a technology powerhouse that blends hardware, software, and services like no other. In this interview, we also discuss why Gene -- one of the most sought-after Apple analysts in the world -- decided to leave Wall Street to start a venture capital firm, and what technological innovations he and his partners are investing in.

John Rotonti: You spent 21 years as an analyst at Piper Jaffray and are regarded as one of the top technology analysts in the world. Why did you decide to pursue another career as a co-founder of Loup Ventures?

Gene Munster: [Co-founders] Andrew [Murphy], Doug [Clinton], and I spent 10 years working together researching major tech stocks and reporting on new advancements. We saw the large tech companies spending significant money advancing AI [artificial intelligence], AR [augmented reality], VR [virtual reality], robotics, and frontier tech in general. Instead of observing the next major technology shift as analysts, we wanted to participate by actively investing, and not just write about it.

JR: What is Loup Ventures? What type of research do you publish and what types of businesses and technologies do you invest in?

GM: Loup Ventures is a research-driven venture capital firm. The company is rooted in our passion for research and curiosity. We publish research on all facets of frontier technologies -- things that will fundamentally change the way we live and work. Our research includes work on publicly traded companies including Apple, Amazon (NASDAQ: AMZN)Facebook (NASDAQ: FB)Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL)Nvidia (NASDAQ: NVDA), and Tesla (NASDAQ: TSLA), but also smaller stocks such as Lumentum (NASDAQ: LITE)II-VI (NASDAQ: IIVI)Finisar (NASDAQ: FNSR), and iRobot (NASDAQ: IRBT). All companies relevant to our core investment themes in AI/robotics/XR [extended reality].

We've also spent a lot of time on finding derivative and sub-themes within our core focus themes; things that might be more under the radar. Two sub-themes we're big on include the "empathy economy" and braintech.

The companies we invest in fall broadly into autonomy (AI/ML [machine learning]/robotics/AV [autonomous vehicles]) and experience (AR/VR/braintech). We're stage-agnostic, although most of our investments are earlier-stage, since our fund is only $25 million. Some example of our investments in the empathy economy include Enjoy and Spruce Labs. Neurable is an example in braintech.

JR: How did you, Doug Clinton, and Andrew Murphy come up with the name Loup?

GM: The meaning of Loup is twofold. First, "loup" is "wolf" in French. We identify with wolves, being based in the north, fiercely competitive, and operating in a pack. Second, our research keeps readers in the "Loup."   

JR: On Apple's first-quarter fiscal 2018 earnings call, CEO Tim Cook said that Apple has "set the standard for the next decade of smartphones." Do you think the iPhone will be the primary gateway into the Apple ecosystem of software and services in five or 10 years? Or do you think a wearable will replace the iPhone as Apple's leading device? Does it even matter to the long-term thesis?

GM: The view of phone or wearable matters depending on your horizon. Over the next three to five years, wearables won't have a major impact on Apple's business, but beyond that, wearables will likely begin to replace phones. Maybe in 10 years or even more, we could see more than half of phones replaced by wearables. Hardware companies that don't have a wearable offering will be left behind. We believe the entry wearable for Apple will be tethered to the iPhone initially, similar to the iWatch's first iteration.

JR: How important are the Apple Watch, AirPods, or other future wearables to the Apple Story?

GM: AR and AI technology in wearables will let us connect more naturally and will eventually replace smartphones in a screen-less future. We believe AirPods are a more important piece than the watch because interacting with devices through AirPods is seamless and natural, whereas holding up a watch to your face to talk to Siri or on the phone is clumsy. Also, the ear is a better approach to track health and activity compared to the wrist. For the time being, Apple's watch is still an important part of moving away from smartphones, and it lays the groundwork for more natural wearables like AirPods or AR glasses of the future.

JR: The Amazon Echo seems to have a very large lead as a home speaker (and virtual assistant). It also seems that these home automation devices could signify the next big change in consumer habits -- how we interact with our technology to listen to music, control home appliances, and buy stuff online. How is the Apple HomePod doing, and can it gain meaningful market share?

GM: We see Google Home as the long-term smart speaker unit share winner with 50% unit share in 2023, Echo with 35% and HomePod with 12%. Google's lead in AI is behind this market-share prediction. HomePod is the best-sounding smart speaker and has the best listening skills, but its first version finished behind Google Home and Echo in query performance of the speakers we've tested. We expect HomePod to quickly catch up to Amazon and likely lag Google. One reason why HomePod version 1.0 query performance lagged was because HomePod technology does not support navigation, calendar, email, calling, or Google search. To be competitive with existing smart speakers, HomePod will expand its domains.

JR: What excites you the most about the Apple story? That the iPhone has become a utility in the daily lives of many people and the corresponding pricing power of the iPhone? Its services revenue, which is higher-margin, recurring, and growing faster that the company as a whole? That Apple has the largest augmented reality platform in the world and AR will likely be how consumers interact with devices in the future? That Apple Pay is gaining traction? Its enormous free cash flow generation and balance sheet? All of the above? Something else entirely?

GM: The most exciting part of the Apple story over the next 10 years is the company's commitment to build the premier device to experience the world.  Apple is the window for more than a billion users into the internet, apps, location, friends, learning, and creativity. We think this will evolve from a smartphone-first approach to an AR-first approach. Second, we're excited about the potential in auto, likely an operating system. Self-driving cars will be a massive shift in how humans get around, and Apple could have a play here. I want to be measured in my optimism around Apple and auto. For a long time, I predicted Apple would come out with a TV and it never happened -- a painful learning for me that just because Apple is working on something does not mean that it will see the light of day.

JR: Apple has about $160 billion in net cash. What should it do with all that cash?

GM: They probably should have bought Tesla, or at least tried to, several years ago, but that ship has long since sailed. Maybe some other emerging small automaker or autonomy platform could make sense. Investments in content would also make sense. They spend significantly less, still, than Netflix (NASDAQ: NFLX) and Amazon on original content, and we expect that to change over the next few years. Micro content like GIFs and Vines is sort of an interesting space that could fit well with their messaging platform efforts. What they most likely are going to do with the cash is what they have been doing — repatriating it to shareholders by slightly increasing the dividend and buying back shares.

JR: Can you think of another business that combines hardware, software, and services in a way similar to Apple, but obviously on a smaller scale?

GM: Peloton comes to mind. Amazon has done it with Echo and Kindle. 

JR: Here's a fun one: Do you think Apple would be more likely to acquire Netflix, PayPal (NASDAQ: PYPL), or Square (NYSE: SQ)?

GM: Netflix makes the most sense, but all would be long shots.

JR: Will Apple be the first sustainable $1 trillion market cap company?

GM: We don't have price targets at Loup Ventures. What I can say is Apple is positioned for 5% revenue growth for the next few years, they've got a potential tailwind with this data privacy issue because of how well they handle user data, and they're the company that's closest to the $1 trillion mark. I'll leave the answer to the question in the hands of investors.

JR: Finally, just one on Facebook. It is being scrutinized because of (1) news that Russia used Facebook to meddle in the 2016 U.S. presidential election, (2) the proliferation of fake news and violent content, and (3) prominent investors warning that social media is addictive and questioning its utility to society. Facebook is now under renewed scrutiny because it was reported that Cambridge Analytica collected data on 50 million Facebook users without consent. Following the Cambridge incident, Facebook is being investigated by the FTC. What are your views of Facebook's business going forward?

Facebook isn't going away. Unwinding the value of a network of 2 billion users would probably take many, many years. MySpace floated around for a while even after Facebook took over social, and they had less than a tenth of the users that Facebook does now. That said, users are definitely upset that FB abused their trust, and we wouldn't be surprised if we see some small influence on engagement over the next few quarters. People have short memories, and Facebook seems to be doing as much as it can to do a better job protecting data and giving consumers control of their data, even though most users are not willing to take the necessary steps to truly manage that data.

The bigger threat is probably some sort of government regulation, at least from a headline standpoint. The steps the company is already taking might circumvent a lot of the business impact from any regulation. And in this scenario, the whole consumer internet industry will take a hit, not just Facebook.