Apple - Dropping from its heights

High level summary
Thesis : Slow Grower / Stalwart that is hit heavily by stream of negative news. As apple fell from its heights, I will be grabbing a bite (Mid conviction position) at around USD165-170. There may be strong short selling volume as Wall street hyperventilate over the China - US trade war, Yield curve worries and rumors of poor I phone sales (Probably factual but exaggerated to some extent). I am buying Apple conservatively as it is relatively cheap, but its moat is not considerably wide especially in the fast moving technology /hardware - software industry.

Instead of valuing company as a technology stock, I value apple as a high spec consumer product company (branded goods company) with cyclical cash flow (hardware launches), smoothed by ongoing annuity inflows (growing software business). The power of its brand and design focus, sticky diehard apple fanboys, strong cash flow, good capital allocation decisions  and possibility of innovative / upgraded product launches should make the company a buy at this market correction. A lot of apple's future growth prospects stems from management's conviction to maintain its moat in the saturated smartphone market and launch unprecedented products (Apple Glass at 2020?), and using its brand and hardware sales to grow its software business.

From my scuttlebutt analysis with a local smartphone distributor, embedded Iphone ecosystem consumer and official news channels,

i) the phones covered by the China / Qualcomm ban make up about 10% to 15% of current iPhone sales in China. The ban does not cover the new iPhone XS, iPhone XS Plus or iPhone XR, which were not yet available when Qualcomm filed its lawsuit.

ii) Generally, in terms of consumer habits, Apple fanboys will simply buy the newer Iphones and the profit margin and sales of China sales should take a hit but not too significant. (Nothing to boast about or post in social media about buying older Iphone products). China sales will be affected but not catastrophic to Apple bottom line.

iii) Apple is investing more in client servicing to increase the quality and stickiness of its client experience, in terms of aesthetically pleasing storefronts, as well as strong client support for its hardware and software. Instead of rushing to be at the forefront of technology (low capex and R&D exp) , it is simply entrenching its roots within existing users and attracting new users to onboard. For an expensive product / service, consumers expect a great user experience rather than revolutionary technology (which can be buggy / unreliable)

iv) Apple no longer disclosing sales data may suggest there is plummeting Iphone sales. Or it might be a move to hide its sources / intentions as it develops new products / shift in product orientation. Speculation may be rife but inconclusive.

v) Apple powerful security features has a moat on its own. Fear of corporate and foreign espionage activities as well as data privacy leakage makes Apple a powerful brand people can refer to when things go south. Nonetheless, its security leaks in recent times suggest no company is infallible.

vi) The replacement cost of shifting to android stems from great inconvenience. Apps, music, documents, photos set up as a corporate / family unit makes the entity entrenched and hard to migrate. Apps and music can't shift. From my understanding in subscriptions based business, as long as Apple don't make catastrophic mistakes, and deliver a strong consistent standard of service to Apple users, they will most likely stick on and not downgrade to a perceived lower standard to living.
 

Revenue Breakdown














 I Phone (Lumpy cash flow)
Higher R&D costs and opex to assemble the phone.
Slowing sales volume but expected to supplement growth in Services segment.
Cutting production on Iphone XR suggest it may be hitting consumer resistance to its high price point

Qualcomm ban on older I phone models had introduced a sharp correction on Apple Stock. However, through scuttle-bug analysis from a smartphone distributor, most loyal consumers are buying the newest models anyway and banning older models should not significantly affected the lumpy revenue steam of Apple Hardware sales. Nonetheless, slowing I phone sales is likely one of the key reason why Apple is no longer disclosing its sales numbers. Apple could always redeploy its lower margin older Iphones to other countries through its wide distribution network, and continue selling its higher margin newer Iphones to the affluent in China.

Quote
Qualcomm said in a statement the Fuzhou Intermediate People’s Court in China found Apple infringed two patents held by the chipmaker and ordered an immediate ban on sales of older iPhone models, from the 6S through the X.

The specific iPhone models affected by the preliminary ruling in China are the iPhone 6S, iPhone 6S Plus, iPhone 7, iPhone 7 Plus, iPhone 8, iPhone 8 Plus and iPhone X.

But Apple stores contacted by AFP in Beijing, Shanghai and Fuzhou said they were still selling those older models - confirming a company statement that all remain available. "If the ban is ultimately imposed, there will be no Apple products under 6,500 yuan (US$940) in China," noted Wang Xi, a senior market analyst at research firm IDC.

A patent in the U.S. is not a patent in China, unless someone registers a patent in China
Unquote

Ipad - No close competition
Mac -Perfectly competitive market
Possible emerging products - Apple Glass, hearing equipment, watches, wearable equipment. 




Services (smooth cash flow)
App Store.
Able to pocket profit from every app download and payment made through the app store.
Music, TV shows, movies, podcasts,
Low expenses and high margins. Low Capex and Opex
20%-30% Growth rate in its service business.

Apple care. Hardware sales will contribute to the growth of the software ecosystem.
Apple pay.


Technology Acquisitions
Shazam - Music ID app
Siri - Voice recognition
Beats - Premium priced Headset known for high profit Margins and prices.

Financials



Cheap from a P/E, FCFE, liquid securities / cash hoard  and P/CF perspective.

Cash flow can easily cover short term debt, although its long term debt is worrying.

Enormous Cash Flow and Cash hoard and low PE making it an asset play. Huge warchest to deploy its capital on promising situations.

Earnings power of Apple should not decline rapidly in the short run due to its prominent branding. 

Berkshire Hathaway did due diligence on the company and believe it is undervalued.

Low Capex considering it is a technology company. Instead of rushing to be at the forefront of technology, Apple is using its brand to sell Veblen goods, whereby its premium branding allows it to increase price, profit margin  and sales volume simultaneously.

Good capital allocation decision. Not diwosifying, but very focused on choosing suitable acquisitions. Conducting share buyback and raising dividend when it has excess cash.

Porter 5 forces

• Bargaining power of suppliers.
  Hardware products (Samsung components, Qualcomm chips) suggest that company is adequately diversified with regards to its components sourcing for its products. When Qualcomm increases prices, Apple is free to walk away to another supplier. 
  Regarding software, I am not at a competent level to judge the prowess of its software and app components.

• Bargaining power of customers.
  Yes. With the huge influx of China smartphone brands, with hardware specs that is identical or even better than expensive Apple products,  consumers have plenty of choices. Nonetheless, the stickiness of its brand mostly emerges when new product are launched and the social media hype reignites.
  
  Per my scuttlebutt analysis with Iphone users, people whom are young and eager to impress, with a higher marginal propensity to spend / consume, will choose a premium brand over a cheaper one. As they get deeply entrenched into the ecosystem, it will be harder to pull out.

• Threat of new entrants.
   Considerable. Oppo is a classic example. By poaching engineers from Samsung and Apple, they are able to manufacture a plagiarized phone with the best part of both companies (I phone aesthetics, Android versatility and home button) , with commendable specifications at a much lower price point.
  
  Smartphone markets are very saturated and undergoing commoditization. Although the brand of Apple might hold up in the short run, it is important to develop unprecedented / highly improved alternative products and services to survive the onslaught of capitalism. Under Tim Cook, there has been attempts to move into that direction, but the legacy of Steve Jobs and Iphone has overshadowed the new products so far.
  
  Threat of substitute products or services.
  Ditto to the previous point. Every new product will have countless PHD and engineers reverse engineering the other's products and selling it at a lower cost.
  
  Competitive Rivalry
  Ditto to the previous point.

Sources
http://www.annualreports.com/HostedData/AnnualReports/PDF/NASDAQ_AAPL_2017.pdf

https://www.reuters.com/article/us-qualcomm-apple/china-court-bans-sales-of-older-iphone-models-in-apple-qualcomm-global-battle-idUSKBN1O91LD Bullish Reviews
https://www.channelnewsasia.com/news/asia/apple-phones-still-sold-in-china-despite-ban-11021578
https://www.youtube.com/watch?v=4aPC5F8GU6k&t=191s
https://www.youtube.com/watch?v=_3MqIHEpoBs
https://www.youtube.com/watch?v=9AILOPs6gwM
https://www.youtube.com/watch?v=wZc4PbKbof4