Wednesday, July 14, 2010

Why It's Time to Short Apple

Apple’s been on an incredible run. The Ipod, then the Iphone, and now the Ipad have taken the company to a whole new level. As a result, it is now the second largest company in the US by market cap after Exxon-Mobil. (As of today, the stock is $252, giving it a market cap of approximately $230 billion).

Unfortunately for longs, I think the company’s fortunes will dip, for the following reasons:

• The Iphone is facing massive competition from Asian manufacturers who will accept a much lower gross margin than Apple. Furthermore, many of these phones, particularly those based on Google’s Android platform, are even better than the Iphone. I happen to own one, and it’s excellent.

• Smart phones will obliterate the Ipod market. Once you have a smart phone, there is absolutely no reason to have an expensive Ipod, especially when people’s music ultimately moves to the cloud. The only reason to have an additional MP3 player is for exercising, but that can be a very small, very cheap MP3 player.

• The Ipad will significantly cannibalize the Macbook market. There are a certain number of people who will always need a full-fledged computer. But there are also a significant number of people (older folks, light users, etc.) whose needs will be fully met by a device such as an Ipad. Those people, especially if they are loyal Apple fans, probably own both a Macbook and an Ipad right now. But when it comes time to purchase a new Macbook in three or four years, they will not do so. Ipads sell for a fraction of full-fledged computers, so the math does not work out well for Apple. Of course , this has implications for Dell and other computer manufacturers, too, but we’re only talking about Apple here.

Apple has proven many times that it is the finest innovator in the world. Unfortunately, as much as they try to protect their markets, others will ultimately be able to provide the same functionality at a much cheaper price. And in Google, Apple has a formidable new competitor in the race to be the world's best innovator. Google’s software is simply elegant, especially the way it integrates internet search functions with GPS navigation.

One day, Apple will invent entire new markets like it did with the Ipod, and its P&L will get another power boost. The problem is that nobody knows when this will happen. The only conservative approach is to assume that this is not coming any time soon – that the company’s short to medium term prospects are reliant on the products in hand. Remember, Apple spent almost the entire decade of the 1990’s in the woods after Microsoft essentially undercut its technology with Windows. It’s easily possible that the same kind of thing could happen over the next several years.