Apple: To Panic or Not to Panic

That is the question my colleague Arik poses for Apple shareholders. He says no, and implies the gloomy mood on Wall Street is overdone. I say it depends on your time horizon. If you’re a short-term trader, times could well get a lot tougher before they get easier. But if you’re a long-term investor—of the sort that most companies much prefer over the day-trading set—you’re in good hands. Despite the stock’s swoon, Jobs is focused on doing the things to make sure Apple maintains its competitive advantages over the long haul.

Why am I bearish on the short-term? Because for the first time in years, there’s no red-hot product to power the company past Wall Street’s expectations. I’m not suggesting Apple will stop growing, but at the moment there’s no magic lever to pull to exploit feverish demand for some new product. Unless Apple gets a major boost from the SDK or whatever second generation iPhone it has in the works, it doesn’t seem as though the iPhone is going to blow away any analysts’ projections. I’m sorry, no matter how cool it is, a $400 phone during a recession is a hard sell. Yes, the Mac product line is in great shape and getting stronger. But Apple is more dependent on sales in the struggling US economy than some rivals, and is a bit player in faster-growing Asian markets such as China. While Apple should continue to gain share globally, these geographic realities will temper Mac sales growth. As for the iPod, I agree the decline in sales growth was inevitable. But it just so happens the comedown has arrived in the middle of the biggest downturn in consumer spending in more than a decade. That’s not good.

What’s more, I don’t see Jobs coming to the rescue of momentum investors with any palliative measures to goose the stock—like issuing a mega-dividend to hand out some of that $18 billion in cash. In a very real sense, Apple is Steve Jobs’ company. And unlike most CEOs—mostly hired guns brought on primarily to serve shareholders—Jobs is motivated primarily by making products. I’ve interviewed him many times, and any question about the stock price usually ends up with some version of “if we make great products, the stock price will take care of itself.” For other executives, I’d say it’s a trite cliché. For Jobs, it’s his guiding principle.

So what could he possibly need with $18 billion in cash? An economist would doubtless say its a misuse of funds. But my hunch is that Jobs figures he's doing just fine by investors, and believes the dough is more valuable in his hands than elsewhere--just in case he needs it someday to make a big acquisition or to corner the market on some new hard-to-get component. As I reported last year, at one point Jobs thought about whether to bid for the 700 megahertz wireless spectrum being aucitoned off. He quickly dismissed the idea--but he'd have had the cash on hand to get in the game had he wanted to.

If Apple's refusal to part with that cash may frustrate investors, Jobs' long-term perspective will likley pay off in the end. For one, it means he’s unlikely to do any of the dumb things CEOs do when times get tough. How many tech companies have started, or got sucked into, a price war in order to maintain their market share or to try to meet analysts’ revenue numbers? How many have stuffed channels to make it appear sales were fine, forcing them to have to slash prices or take big big write-offs to deal with unsold stocks (I think it’s clear now that most of those “missing iPhones” are actually now being used in unlocked mode, rather than gathering dust on shelves somewhere)? These knee-jerk reactions usually only lead to lower margins, which means less ability to fund R&D, greater likelihood of morale-sapping layoffs, and lots of other momentum-stifling downers.

My conclusion, if you haven't guessed, is that Jobs would sacrifice sales growth to maintain his product margins—because profits is what lets Apple pay for its R&D initiatives, its well-paid product designers, and the top-shelf materials uses in its products. He’d much rather frustrate Wall Street for a time, but come out of the recession with his hit-making factory still in top working order.

But what about the recent price cut on the iPod shuffle, one might ask? I admit that when I first saw that low $49 price, I was concerned that Apple was digging into margins to try to prime the sales pump. Turns out it’s probably not the case. David Carey, president of design consulting firm Portelligent, notes that Apple had held its previous price for months, despite plummeting prices for flash memory, which have dropped from $10 a gig a year ago to $3.70 or less today. Given that flash is a major portion of the bill of materials for an iPod shuffle, Carey thinks Apple can easily maintain its historical gross margin on the product at $49. And the 2-gig shuffle will be far more profitable, given that Apple is charging $20 more for a product that has just $3.70 more worth of extra memory.

http://www.businessweek.com/technology/ByteOfTheApple/blog/archives/2008/02/to_panic_or_not.html