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Reggie Middleton

Reggie Middleton

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How Google is Looking to Cut Apple's Margin and How the Sell Side of Wall Street Will Enable It

Posted: 08/12/10 04:21 PM ET

The Apple Forensic Analysis and Valuation is nearly complete and will be available to subscribes in a few days. In the meantime I will discuss a few salient points and logic that went into the design of the model. As I have said several time in the recent past, Apple is very similar to gold in its elicitation of passion and emotional responses from both those that own it and those that invest in it. I am sure this article will prove proof-positive of such as Apple fanboys and haters jump all over the comment columns. The fact of the matter is, whether concerning Apple or gold, allowing your emotions, passions likes and dislikes to cloud the empirical process of analysis is a sure fire path to losing money – sure fire!

The Front Runners for Supremacy in the Mobile Computing and Telecomm Paradigm Shift

On that note, let me remind all that There Is Another Paradigm Shift Coming in Technology and Media: Apple, Microsoft and Google Know its Winner Takes All. Computing and personal technology services are turning portable, thin client, and to the cloud. The stakes are high in this one, for the winner will most likely end up being the next Microsoft. No matter how maligned Microsoft may be in the new millenium, no other tech company makes (or has made) as much money as Gates, Ballmer, crew. It’s an enviable problem to have. I have narrowed down the likely front runners for this position to be none other than:

I follow the comment sections of many prominent, and some not so prominent but nonetheless excellent blogs and new media sites, and misconcpetion seems to reign above many others, and that is that Google will not make any money with Android other than (now sparse) mobile ad revenue. This is a total misunderstanding of the Google/Android Strategy. For those who cannot see the forest due to all of the tree bark getting in your way, I urge you to review Android Now Outselling iOS? Explaining the Game of Chess That Google Plays in the Smart Phone Space:

Many commenters are lamenting on the fact that Google is not making money on Android sales since the OS is given away for close to free while Apple is making $250 per handset sold. Those who are looking at it from this perspective are missing the forest due to that big fat tree that is in their way! Yes, Apple is making a killing on its iPhone sales, and it would be difficult to attempt to catch them with a fat margined product. They have managed to produce both margin and volume and have wrapped it up with extreme customer loyalty. What the armchair pundits are missing is the power of reach. Google is developing massive reach, and developing it ridiculously quickly. A byproduct of this reach is the commoditization of the smart phone platform which will probably cut the fat margined business model off at its knees. That is not to say that Apple will be cut off at the knees, but they will have to alter their business model for the competitor-less margin that they enjoyed for the last three years will no longer be a given. It also means that anyone else reaching for the crown (including Apple) will have to spend more upfront to gain less per unit sold. This actually benefits Google, for they are not in the hardware race, yet they benefit from each and every handset, tablet, desktop and automotive unit sold. Google is trying to become the new Microsoft!

In the meantime, Google ramps up the potential to push software as a cloud service, downloadable software and interactive, activity/context sensitive rich media ads and services to hundreds of millions of new users. This opens up a phenomenal opportunity for Google, and it appears as if many are missing the point because Google (wisely) decided not monetize it immediately, but to let it gestate and grow. Do you remember 15 years ago when many felt the same about search and the fact that Google wasn’t making any money providing search (pre-advertising)?

How Google is Looking to Cut Apple’s Margin and How the Sell Side of Wall Street Will Enable This Without Sheeple Investor’s Having a Clue

No, Google is not in the mobile space for search ads, it’s looking to become the next Microsoft with Android as the next Windows. It is thinking big, simultaneously going after both the consumer and the enterprise space with cloud-based software and services – and advertising!

In the meantime, sheeple-like investors are being hoodwinked by quarter after quarter of Apple blow out earnings. Don’t get me wrong. I feel and fully acknowledge that Apple is executing on all 8 cylinders of a 6 cylinder engine, but it still has its real world limitations. Apple will start to bump up against these limitation over the next 4 quarters, and the signs of this bump are already apparent. Of course, the signs are being handily masked by the games that Apple management and the sell side analysts of Wall Street play, with the “Sheeple” retail and the lazier component of the institutional investors being put out to take the eventual bullet.

Riddle me this – If Apple can consistently beat the estimates of your favorite analysts quarter after quarter, after quarter – for 11 quarters straight, shouldn’t you fire said analysts for incompetency in lieu of celebrating Apple’s ability to surprise? After all, it is no longer a surprise after the 11th consecutive occurrence, is it? I would be surprised if my readers were surprised by an Apple surprise. Seriously! Apple management consistently lowballs guidance to such an extent that it can easily manage, no – actually create outperformance. This has has a very positive effect on their valuation. Of course, I do not blame Apple management for this, of they are charged with maximizing shareholder return. The analytical community and the (sheeple) investors which they serve is another matter though. Subscribers can download the data that shows the blatant game being played between Apple and the Sell Side here: File Icon Apple Earnings Guidance Analysis. Those who need to subscribe can do so here.

Below, I drilled down on the date and used a percentage difference view to illustrate the improvement in P/E stemming from the earnings beats.

In our analysis of Apple, we are using real world assumptions of future performance derived from backing in to the low balling this company is prone to. If you look at its history carefully you can gauge what management is comfortable with, hence what they may be capable of on the margin. Using these more realistic numbers, it is much more likely Apple will deliver a miss in the upcoming quarters in its battle with the Android! The following is the reason why.

Apple is growing like a weed and at expanding margins, but those margins are most likely at (or close to) their peak and will probably drop rather quickly since The Apple “beats” analyzed above include margins, and the company has consistently beat on margin. Keep in mind that Apple has very strong competition in their most lucrative space where they literally had none before. The competition is already outselling them and offering more technical flexibility and diversity. Thus, when (and that is an emphatic when, not an “if”) margins “continues to drift downward, the sheeple will be clueless and probably pile deeper into Apple stock because they will probably still be “beating” at every earnings announcement. The NPD Group, a provider of current consumer POS analysis is the latest in an increasing list of consultancies that show Android taking the number one spot in the Smartphone market (both in terms of sales growth and installations.

The NPD Group: Motorola, HTC drive Android to Smartphone OS lead in the U.S.

Android now installed in one of every three smartphones sold at retail. BlackBerry OS share drops 9 points to 28 percent.

PORT WASHINGTON, NEW YORK, August 4, 2010 - Riding the wave of new handset introductions and wide carrier distribution in the second quarter (Q2), the Android smartphone operating system (OS) continued its upward climb in the U.S. consumer mobile phone market, according to The NPD Group, a leading market research company. For the first time since the fourth quarter (Q4) of 2007, RIM fell to second position, as Android took the lead among operating systems in handsets sold to U.S. consumers. NPD’s latest wireless market research reveals that Android accounted for 33 percent of all smartphones purchased in Q2, ahead of RIM (28 percent) and Apple (22 percent).

“For the second consecutive quarter, Android handsets have shown strong but slowing sell-through market share gains among U.S. consumers,” said Ross Rubin, executive director of industry analysis for NPD. “While the Google-developed OS took market share from RIM, Apple’s iOS saw a small gain this quarter on the strength of the iPhone 4 launch.”

Based on U.S. consumer purchases of mobile phones in Q2, the top 5 Android smartphones were as follows:

  1. Motorola Droid
  2. HTC Droid Incredible
  3. HTC EVO 4G
  4. HTC Hero
  5. HTC Droid Eris

“Blackberry 6 will soon offer features that have been popular in recently launched Android handsets, such as support for capacitive touchscreens and a WebKit-based browser. However, the Blackberry Torch lacks the large screen allure that has characterized the best selling Android devices at its price point, including the Droid Incredible and EVO 4G,” Rubin said.

Model selection and promotions continue to play a role in the race for carrier dominance. According to NPD’s Mobile Phone Track, Verizon Wireless has maintained its lead among top carriers for the last three quarters comprising a third (33 percent) of the units sold in the U.S. mobile phone market in Q2, followed by AT&T (25 percent), Sprint (12 percent), and T-Mobile (11 percent). In Q2 Verizon Wireless continued their buy-one-get-one (BOGO) offers on all smartphones, including both RIM and Android models.

In spite of an overall decline in the number of mobile phones purchased year over year, the ongoing popularity of both messaging phones and smartphones, which are generally more costly than standard feature phones, resulted in slightly higher prices for all mobile phones in Q2. The average selling price for all mobile phones reached $90, which is a 3 percent increase since Q2 last year. Smartphone unit prices, by comparison, averaged $143 in Q2 2010, which is a 9 percent decrease over the previous year.

Data Note: The information in this press release is from Mobile Phone Track – NPD’s consumer tracking of U.S. consumers, aged 18 and older, who reported purchasing a mobile phone. NPD does not track corporate/enterprise mobile phone purchases.

Now, Apple will not sit on its laurels while Android eats its lunch, but their are only three realistic ways in which Apple can compete.

  1. They can compete on price, which they now have the scale and volume to do, but is the antithesis of the “Premium Apple Brand” that they have worked so hard (and quite successfully so, may I add) to create over the last few years. More importantly, it will materially (and potentially drastically) impact margins.
  2. They can compete on features and technology. This will be very difficult to accomplish due to the sheer extent of competition they are facing. Apple will effectively have to out engineer Samsung, Motorola, HTC and about 70 other manufacturers on the hardware side and simultaneously outrun Google’s Android and its army of hundreds of thousands open source contributors on the software side.  This is highly unlikely. Doable but improbable. More importantly, it will materially (and potentially drastically) impact margins.
  3. They can license their OS along with minimum hardware specs to third parties. This seems to be the most logical step to the possibility of longer term dominance, but also apparently flies in the face of both the company’s culture and the company’s history. More importantly, it will materially (and potentially drastically) impact margins. If you remember, this is how Apple lost the PC wars, by refusing to license the OS as the PC became commoditized and prices fell through the floor. Microsoft benefited immensely from this occurrence for it did not make hardware, but it did benefit from every piece of hardware sold. Does this sound even remotely familiar (hint: Google cloud services) to anyone???

So, what is the recurring theme in all of these decision branches? Let me help out those who are still not getting it: More importantly, it will materially (and potentially drastically) impact margins. So, as Apple’s margins dwindle due to competition from the Android, they will consistently beat expectations since the sell side analyst community continues to play this non-sense game. As for those who don’t believe it can happen so quickly, take a look at Apple’s margins for the last quarter…

For more on this topic, visit Apple on the Margin!

More on the Creatively Destructive Pace of Technology Innovation and the Paradigm Shift known as the Smartphone Wars!

  1. There Is Another Paradigm Shift Coming in Technology and Media: Apple, Microsoft and Google Know its Winner Takes All
  2. The Mobile Computing and Content Wars: Part 2, the Google Response to the Paradigm Shift
  3. An Introduction to How Apple Apple Will Compete With the Google/Android Onslaught
  4. This article should drive the point home: 
  5. A First in the Mainstream Media: Apple’s Flagship Product Loses In a Comparison Review to HTC’s Google-Powered Phone
  6. After Getting a Glimpse of the New Windows Phone 7 Functionality, RIMM is Looking More Like a Short Play
  7. Android is gaining preference as the long-term choice of application developers
  8. A Glimpse of the BoomBustBlog Internal Discussion Concerning the Fate of Apple
  9. Math and the Pace of Smart Phone Innovation May Take a Byte Out of Apple’s (Short-lived?) Dominance
  10. Apple on the Margin
  11. RIM Smart Phone Market Share, RIP?
  12. Motorola, the Company That INVENTED the Cellphone is Trying to Uninvent the iPad With Android
  13. Android Now Outselling iOS? Explaining the Game of Chess That Google Plays in the Smart Phone Space

 

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