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Apple Needs to Execute, No Longer Innovate

Posted on Wednesday, Jan 23rd 2008

Yesterday, Apple released its earnings for its first quarter of fiscal 2008 that ended December 29, 2007. Revenue was $9.6 billion, up 35% y-o-y and 54% sequentially driven by the strong sales of Macs, iPhones, and iPods. Net income was $1.58 billion, or $1.76 per diluted share, up 58% y-o-y. Gross margin was 34.7%, up from 31.2% last year. Its cash balance increased by over $3 billion in the quarter and now rests at over $18.4 billion. Read my earlier post on what I think it might do with it.

In the quarter, Apple shipped 2.32 million Macs, a y-o-y growth of 44%. Mac products and services accounted for 47% of the revenue in the quarter. Its OS Leopard, released on October 26th, has already raked in revenue of $170 million during the quarter.

Music products and services represented 50% of revenue in the quarter. Apple sold over 22.1 million iPods (up 5% y-o-y) and over 2.3 million iPhones during the quarter. The total iPhone count has now moved to 4 million since the launch. Total revenue from sales of iPhone, iPhone accessories, and payments from carriers was $241 million in the quarter. It is not just the iPhone that is doing well. Even the iPhone inspired smartphone HTC Touch did well with sales of 2 million.

The iPhone launched successfully in the U.K., Germany, and France. Apple will roll out the iPhone in some more European countries and Asia in 2008. It looks all set to achieve its 2008 goal of 10 million. Apple’s international business grew 46% y-o-y, which is a good sign with the slowdown of the US economy. Its domestic business also did well with 27% y-o-y growth.

However, Wall Street is bent out of shape. Apple’s shares went down by 11% or $17 to $138.49 in after-hours trading yesterday. One reason is that its revenue target of $6.8 billion or 29% growth y-o-y is much below the analyst consensus of $6.99 billion. Another is the flat domestic sales of iPods. Plus there are concerns that with the US economy slowing down, consumers might not go for its high-end gadgets.

Whatever the reasons might be, I think it is a good time to buy the stock. It is currently trading around $129 after hitting 52-week high of $202.96 on December 27.

Why? Multiple reasons.

1. The iPod franchise is still spectacular, maintaining over 70% market share, and is basically becoming a multi-billion dollar, highly profitable cash cow.

2. Apple is turning its attention to the Mac business, with good results, and a large, high growth market opportunity awaits it.

3. Similarly, the iPhone is also in a large, high growth smartphone market, where Apple has rapidly risen to the #2 market share position behind Rim.

I am delighted that Steve Jobs did not pull yet another “new thing” at MacWorld this year. Instead, Apple is focusing on the businesses that are already in gear.

For Apple, today, execution is the name of the game, not innovation. And Apple stock is a long term buy and hold over the next 3 years.

Apple Inc. (AAPL)

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I agree that Apple needs to execute. They’ve been doing a stand up job no maker what the stock market does. I do understand your concern that Apple strengthen its’ current businesses before going and looking for new ones. They’ll never stop innovating, that’s what makes it Apple. I imagine that you’re hoping that they continue to innovate within their current business segments.

I wonder how you feel about Apple growing and innovating in one particular area – selling to business. Don’t you think that Apple can do a lot of internal organic growth with the $18B in cash on its’ balance sheets?

Last month you mentioned the possible acquisition of Dell. It would be a game changer. After digesting Dell, Apple would change the market share game permanently in one swoop – which is probably what you’re suggesting. There would be much press coverage and the IB fees involved would be out of this world.

But does it make sense to purchase all of Dell, only to have to shut down many divisions? Even though Dell was worth 50% more 2 years ago, it was still valued at $45B this morning, and trading up all day. Apple has little need to continue producing low-end boxes that contribute nothing to earnings.

Apple and Google are the desirable companies to work for in Silicon Valley. With so many struggling hardware and software companies, some folks likely worry about the long-term prospects of their current employer and/or of their jobs. All Apple need do is hang a Hiring Talented and Experienced Account Reps sign. Apple would get quite a number of interested individuals and possibly teams, especially if they can show they are truly committed to the Business market. Purchasing Dell would show commitment, but doing so is so costly. Surely, there must be some other way to curry favor among their future hires – experienced account reps.

With $18B in cold cash couldn’t Apple buy into the channel? There must some way to acquire and/or set up an infrastructure to sell to and service business clients. Smaller, more strategic acquisitions together with internal growth of call centers, distribution centers, and service organization makes more sense. Combined with raiding the staff of other business software and hardware vendors, Apple could create a formidable organization for a fraction of the almost $50B required to acquire Dell, with none of the baggage either.

Spending so much in such an acquisition would have its’ benefits but seems not the most efficient use of funds. Consider that much of Dell’s market share is low-cost, low-profit sales. Dell had net income of $2.5B per year in the most recent quarterly report (3Q08). Apple has over $1.5B in net earnings and over $3B in cash flow in the Dec’07 quarter alone. Cash flow figures give us some visibility on apple’s actual performance; now that Apple hides so much of their revenue and earnings (iPhone, AppleTV) in 24 month installments.

Dell is probably the single largest payer of fees to Microsoft, or close to it. Trying to change that overnight would incur that wrath of the very customers that the Dell acquisition would justify. Alternatively, keeping the Microsoft payment spigot on is not at all strategic for Apple either. Customers would move to Apple more willingly if it were their own decision to do so. Forcing so many customers to make the move en masse to Apple, would create opportunities for HP and others, who would not share in the cost of the Dell acquisition.

So creating the infrastructure to sell to business will take a lot of work. It certainly wouldn’t be easy. But it is both possible and much cheaper than buying Dell. This way Apple could focus their effort on the most profitable segments of the market and cherry-pick the best products to offer and the best customer types to pursue.

Plus growing into the business market through internal organic growth is more consistent with your concern that Apple not over-extend itself. Apple can continue to serve the business market by working up from small to mid sized businesses served out of the Apple Stores. Apple can grow this organization and handle increasingly larger businesses profitably. Apple already has experience with some quite large education contracts. let’s see what they can do with purchasing Dell.

Realtosh Sunday, January 27, 2008 at 8:54 PM PT

I totally agree that Apple needs to innovate within the segments they’re already in, and that they need to penetrate the business market.

Building channels take very long, and in the business market, they have a big DNA problem. That’s why I suggested buying Dell.

Sramana Mitra Monday, January 28, 2008 at 10:47 AM PT

Do you still think building a business channel is worth north of $50 Billion? Is there any way to do it short of acquiring Dell, maybe cheaper?

I hear your concern that building the channels takes a long time. As you’ve said recently, Apple has enough on their plate right now. The thought of Apple being distracted from current businesses digesting Dell; such an endeavor could negatively impact revenues and earnings.

My concern is that it may not be the best use of capital. It may be more profitable, even if not game changing, to build the channel with smaller acquisitions. If return on equity is better by building out the channel, than wouldn’t that be the better way even if less grandiose?

Plus I’m also concerned about corporate integration. The corporate cultures of the companies couldn’t be more different. Would integrating these 2 polar organizations be easier than building out the channel with smaller easier to digest acquisitions?

Apple would basically be taking the sales & service divisions of Dell plus some distribution infrastructure and getting rid of most of the rest. Apple wouldn’t want to continue producing Dell gear.

But I get it; buying Dell would make a statement and open many doors to Apple gear. I can see how they would transition all OS/software to OS X within the year. Their software developers would be working overtime for at least that long figuring out how to transition server installations to OS X Server easily. Wow, all those IT guys having to retrain in OS X. The client side would be a bit easier; OS X would substitute for Windows clients quite nicely and easily. Plus not having to pay the Microsoft licensing fees would make the Apple (Dell) gear cheaper without Windows on it. I could see a many customers opting for OS X only, since it would come on the box for free. They would pay extra for the Windows license only if absolutely necessary. I get it. I see the synergy.

But, is there a better cheaper alternative? Most importantly, is it worth $50B? Would the additional marginal profits from the business built upon the Dell acquisition justify spending $50 Billion dollars?

Realtosh Monday, January 28, 2008 at 12:13 PM PT

I think, winning the PC Marketshare business will be very worthwhile for Apple, and Dell can help them get there.

Sramana Mitra Monday, January 28, 2008 at 3:47 PM PT

You’ve created an interesting question by positing the Dell acquisition. That we’re even discussing it as a real option shows how much has changed in the last 10 years.

Will the additional market share be profitable?

Should Apple go for the hardware business or software business?

Is it too late to ever be able to supplant Microsoft and Windows as the default installation? OS X has carved for itself a nice position as the premium OS alternative to the default Windows. Apple is experiencing phenomenal growth in Mac units, revenue and earnings. At this point, there is still much room for growth. At what point will the additional market share no longer be worthwhile?

Will there ever be a future for anyone else in the OS business (after Microsoft) without the hardware revenue? Right now the OS business works for Apple only because of the hardware revenue.

You can answer here or post a new blog. I’d like to hear more from you on this. These questions have implications throughout the computer technology industry.

Realtosh Monday, January 28, 2008 at 7:56 PM PT

Okay, I will tell you what I would do if I were Steve Jobs.

I would go for the market share. High-end, Low-end, everything.

The MAC OS and computers are so much better than the rest in the market, I would just do everything I possibly can to “swamp” the market with “better” products.

I would use some older technology and relaunch them in the low-end. Capture emerging markets that way.

And, I would buy Dell, and “swamp” the business PC/laptop market. I would probably leave the server market alone, but that’s all.

Consumers and Prosumers should all be mine!

Sramana Mitra Tuesday, January 29, 2008 at 4:18 PM PT

Compelling vision.
In that case, I agree a Dell acqisition would speed things along.

Realtosh Wednesday, January 30, 2008 at 4:07 PM PT