In Tim Cook's first earnings call as CEO, Apple reported earnings that missed analyst estimates (but not Apple's stated guidance - they always sandbag), a rare event for a company who makes it standard practice to 'delight.'
As you might expect, the stock is trading down today (3.9% = $16.38). So should you look at this minor disappointment as a buying opportunity? Or, see it as an early warning that, relative to their own high bar, Apple's heady growth is slowing?
These four things gave me varying degrees of concern and cause for optimism:
- Apple Retail could be shaky: I have stated it many times before, but it's worth noting again that Apple Retail is the one piece of the company's strategy that I look at as both brilliant and a potential achilles heel. Why? On the brilliant side, the ability to have a controlled environment from which to engage, educate, sell, support and upsell Apple products is something that is both hard to replicate, and the one thing that Google, Microsoft, RIM, Amazon don't have. It's the reason that a tweener 'missionary sell' type of device like iPad can achieve breakout success by virtue of having experts at the ready to explain the solution, and a great environment to play with it. The downside to retail is that it is expensive, stores can lose their cache very quickly if upkeep or service slips, and a retail presence becomes a self-fulfilling prophecy -- It's great when stores are busy, but death if they are not. Hence, every quarter I listen intently to Cook and company talk about retail, what same store numbers look like, and what expansion plans look like. What I heard gave me some cause for pause. In the most recent quarter, aggregate sales at Apple Retail were up only nominally (1% year-over-year) to $3.6B, but the average store itself is generating 9.3% less revenue year-over-year (down to $10.7M from $11.8M). All of the iPhone rumors leading up to the release of iPhone 4S were blamed for a serious drop in iPhone sales at Apple Retail, but the fact remains that 9% is a material drop, compounded with the statement by Cook that of the 40 stores planned in the year ahead, three-quarters will open outside of the US. Taken together, this can be interpreted as Apple Retail is reaching saturation in the US, and as US is the biggest market, that at least gives a basis for concern.
- China emerges as Apple's #2 market: Tim Cook couldn't be more clear in stating that China is Apple's clear #2 country focus, and an enormous opportunity for which the company is applying all of its strategies from the US. The results are staggering. A country that generated 2% of the company's revenue in fiscal year '09 is now generating 12% of the company's revenue in the current fiscal year, and hit a run rate of 16% of the company's revenue in the most recent quarter. They will do $13B of revenue in China for FY '11. Here, Cook was very pointed that he's never before seen so many people rising into the middle class, and that factor catalyzing a massively growing base of aspirants to buy Apple products. One suspects that Apple is way ahead of the competition in China. Just look at their manufacturing relationship with China.
- Pricing overhang avoidance could create margin erosion: One of the questions asked by the analysts was whether the iPhone sales programs that are designed to avoid leaving 'pricing overhang' to get outflanked by Google, et al could create a scenario where in the coming quarters, Apple starts to see margin erosion. Here's how it happens. As Apple starts to broaden their market penetration on a product like iPhone, deals like a FREE iPhone 3GS phone (with new contract) or a $99 iPhone 4 (with new contract) start to drive meaningful unit volumes. This is great for Apple's market share story, but as such units offer materially lower margins than the latest iPhone, it has an adverse impact on operating margins. If you play that strategy into tablet devices, and potentially vertical solution bundles, you see an Apple that has massive revenues, incredible unit volumes, but quite probably eroded margins. That could be good, that could be neutral or that could be bad. Regardless, it's a new piece of narrative for modeling the company.
- iPad could be bigger than the PC: Tim Cook sorta blew my mind in suggesting that he believes that the opportunity for the iPad could be even bigger than the PC. Why? I had two thoughts on this. One is that if you envision a future where there are 10B post-pc devices, it's not hard to construct a scenario where the iPad evolves into a set of form-factors, and a couple billion devices. The graphic up top is by Mary Meeker showing the insane growth of the iPad relative to iPhone and iPod, pretty damn successful products, right? Two is that I take some solace knowing that this type of strategy is very much a core competency of Tim Cook.
Apple is in an amazingly interesting space, but there are certainly minefields to navigate, and this is Tim Cook's first go around in the director's seat. But then again, not really. He's driven these meetings and the underlying operations for a long time.
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