Apple is in the news for losing its rank for a time on Wednesday as the most valuable publicly-traded U.S. stock. And now Henry Blodget — who first became famous for the gap between his bullish reports on tech stocks and his bearish emails about them — is touting seven reasons why Apple is a buy.
But I think all those reasons are wrong and the stock has further to fall.
Apple fell $23 a share — dipping below $400 on April 17. According to Bloomberg, one of its audio-chip suppliers, Cirrus Logic, produced too much inventory — which analysts concluded meant that iPhone sales could fall short of analysts’ expectations.
Vernon Essi, Jr., an analyst at Needham & Co., wrote in a research report, “We blame Apple for losing its mobility mojo. This was simply an inventory overbuild for the iPhone 5 relative to Apple’s forecast.”
But this has not stopped Henry Blodget’s Business Insider from arguing that investors should buy Apple shares. According to the SEC, in 2000, Blodget issued a very bullish analyst report while at Merrill Lynch on a company called 24/7. The next day, he wrote an email claiming the company was “a pos [piece of shit].” This helped get him banned from the securities industry.
And now Blodget is touting Apple as a buy – citing seven reasons. Here’s why I think his argument does not hold water.
1. The stock is expensive
Blodget argues that Apple stock is cheap since he claims it trades at a P/E of 9 — less than the market average of 15. Moreover, he argues that if Apple just keeps generating cash at the rate of $40 billion a year, an investor could buy the company today for $390 billion, pocket its $150 billion of cash and just wait six years to get Apple’s business ”free and clear, for nothing.”
But both of these arguments only make sense if the assumptions about Apple’s future financial performance are correct. For example, if you believe that a stock is cheap when its P/E is less than its earnings growth, then Apple is very expensive. That’s because its earnings shrank at a 17% rate in the first quarter of 2013 and are expected to fall nearly 1% for all of 2013. Nor is it clear how these trends will yield $40 billion a year in cash flow.
2. Apple has nothing new in the pipeline
Blodget writes that “excitement should begin to build about the iPhone 5S, the new iPad Mini.” He admits that these products are nothing new. Moreover, based on the bored reaction from my students last fall to the iPhone 5′s announcement, many may shrug should Apple release these “new” versions of old products.
Many will conclude that there is no compelling reason to replace their current iPhones. Or, perhaps they will buy the latest offerings from Samsung and other Android makers.
3. Without Jobs, Apple’s management has lost the ability to innovate
Blodget argues that the team that helped Steve Jobs introduce new products is still at Apple. The absence of innovative products from Apple since Jobs died is compelling proof that his team is not able to take over where he left off. In fact, the fiasco with Apple Maps shows that the team can do harm — rather than merely fail to innovate.
4. A cheaper iPhone marks the end of Apple’s leadership
Blodget argues that a cheaper iPhone is in the works and that’s good for Apple shareholders. But if Apple goes ahead with that cheaper version, its margins will shrink and that will mean further profit declines.
If a company is going to attract capital, it must have a competitive advantage. There are two ways to get that — Differentiation — delivering a better product for which customers pay a price premium or Low Cost Producer — making an adequate product, charging customers the lowest price and profiting by lowering costs below competitors’ levels.
Apple’s competitive advantage used to be Differentiation – it made better products for big existing markets like MP3 players, smart phones, and tablets – that caused Apple’s appeal to investors and customers to soar.
A cheaper iPhone marks a fundamental shift in strategy to Low Cost Producer. And it is highly unlikely that Apple — with its enormous fixed costs including a $5 billion headquarters complex under construction in Cupertino – will be able to lower its costs below competitors’ in order to win as the industry’s low cost producer.
5. Betting on lower expectations is not a good investment strategy
Blodget argues that a terrible earnings outlook for Apple will be good news for Apple investors because it will be easier for Apple to beat diminished expectations. This could be true if Apple comes up with a way to accelerate earnings growth. Meanwhile, Blodget omits offering a price at which investors should buy based on that argument.
6. A new TV or wristwatch won’t revive Apple’s growth
Blodget suggests the possibility that Apple could be working on a ”revolutionary new product like a TV or smartwatch that will suddenly get people jazzed.” Even if Steve Jobs were still running Apple, I would be skeptical that people would pay a huge price premium to replace their existing TVs or buy a watch when they are already carrying a smart phone that tells them the time.
7. Apple is not well-positioned strategically
Blodget argues that Apple is well-positioned strategically. Yet he says that Apple ”has lost its product edge and clung too long to its super-premium pricing strategy.”
He then suggests that Apple should abandon that strategy to become ”both the quality leader AND the price leader.”
Unfortunately for investors, his recommendation would cause Apple’s net income to shrink even further. Under Jobs, Apple was a differentiator – for example, people paid a 44% premium for the iPhone 4s, yielding a 71% gross margin.
Since Apple has lost its ability to do that, Blodget thinks it can now offer the lowest prices in the industry and still make money. That only works if Apple can also lower its costs below those of all its competitors.
If you buy Blodget’s argument on Apple, maybe you can buy the Brooklyn Bridge from him too.