|by Wes George
Apple Explained, Part II: What Ails Apple?
October 16th, 2000
It's times like these that try investors' fortitude. A bear market, no matter how short-lived, is like a burning house with children trapped inside: it tests the character of onlookers. Unfortunately, many in the media have shown only base instincts, shouting, "I told you so!," when in fact few imagined it could get this bad. Apple's fall was caused in large part by market mass psychoses well beyond anyone's control. As I tried to illustrate in Part I of Apple Explained, any endeavor which requires human perception and judgment is always partly hallucinogenic.
Even MacWeek, one of the heavyweights of the Mac media, sunk to naïve invectives to explain Apple's suffering. "I am always amazed by how much Wall Street hates Apple" caterwauls the first line of David Every's wrong-headed editorial. First of all, no matter how much TV talking heads love to anthropomorphize Wall Street, it's still just an emotionless stretch of pavement in downtown Manhattan. Furthermore, Apple trades on the Nasdaq, which (like the Internet) isn't really located anywhere. So before we get locked into an us-versus-them paranoia, we should remember that AAPL's price lies in the hands of ten of millions of investors worldwide of all races, nationalities and political persuasions. No one hates Apple.
If, as an AAPL investor, you still feel singled out for persecution by feckless market forces, it might help to consider the recent fate of Apple's peers. Intel is down by 50% since the beginning of September. Dell scored a 104-week low last week talk about dead money.
In fact, if you look a one-year chart comparing Apple's stock to its peers, AAPL's performance lies in the lower-middle of the pack. Microsoft and Dell have been slightly worse investments, while for the moment Gateway and the ever-ailing Compaq have done better. Perhaps most importantly, far from being hated, Apple's stock has been "Wall Street's" darling all year. AAPL has consistently shown 50 to 100% better returns than any of its competitors in most of the last 52-weeks. AAPL's price is still 100% higher than it was in January of 1998! A 33% return per year was at one time considered excellent, and doubtless it will once again be considered as such.
The truth is that we are at the bottom of a typical October bear market, which, typically, makes mud out of high flying, volatile technology stocks. It's the market's way of flushing the system. There are lots of reasons for the market pessimism this year, as there are every year; what is most important to know is that the secular ten-year bull market trend has not been broken and that few observers expect it to end here.
In part, the regular October flush is the way the markets discount the macro-economic and political fears from the price of stocks overall: once those fears have been well articulated in the price of most stocks, the markets can begin the long and profitable task of re-climbing those walls of worries.
And that, my dear readers, is what I endeavor to do today scale Apple's wall of worry. Let us expose of all of Apple's serious impediments to growth, both as an exercise in due diligence and as an aid in determining just what the risk level is for rational investors tempted to buy AAPL at its currently shocking price-to-earnings ratio of 9.85.
Discounting the Fears
The MHz Wars. Without a doubt, Apple's most serious problem is the company's total dependence on Motorola and IBM to supply PowerPC microprocessor clock-speeds competitive with Intel and AMD. This issue is critical because it's the one dilemma that's completely beyond Cupertino's control short of porting OS X to CISC processors. The original promise of the PowerPC approach was that it would crush, in terms of speed and power efficiencies, the older CISC-based architecture Intel and AMD use. Early on the PowerPC chips were much faster than Intel's offerings, but now they are seriously lagging behind.
Since the dawn of the PC era, Moore's Law has been literally the only force driving the PC upgrade cycle and thus the unit sales numbers for PC vendors. It took Apple's bold ingenuity to realize, years ahead of the competition, that industrial design could also be a driving force in PC sales. Don't underestimate the leap of imagination it took to risk the fate of Apple on a sales imperative that departed from the well-understood desire for faster computers. Nor should we forget that the iMac a computer whose appeal is based entirely on its design factor was Apple's biggest hardware gamble since Lisa!
To this day, the iMac's success is still misunderstood as simply the byproduct of some gimmicky cool or hip fashion. In reality, the iMac is the first PC in history to exhibit an exemplary level of design functionality, a trait we have come to expect from most other durable consumer goods we purchase. In the backwards PC industry, good design can still be safely derided as merely groveling before the latest vogue, even among Mac pundits.
In fact, Apple's design innovations can be viewed as a desperately creative response to the adverse MHz situation presented by a sluggardly Motorola. When Steve Jobs introduced industrial design as a force to drive sales, did he anticipate that the ubiquitous speed-driven upgrade cycle was in jeopardy by Motorola's disinterest in rapid CPU evolution ?
At MACWORLD in July, Apple introduced the first standard dual processor PC in history a clear if unspoken admission that Motorola's tardiness is seriously starting to crimp Apple's high-end business. It would be easy to condemn Motorola and IBM for their incompetent G4 developmental timetables, but it wouldn't be particularly enlightening. What really seems to be going on with G4 development, much to the detriment of Mac sales, is the double whammy.
First, Motorola and IBM sell the bulk of their G4 microprocessors for use in embedded applications, such as cell phones, carburetors, modems, satellites and many other systems. Unlike the PC industry, the demand for embedded microprocessors is not at all driven by MHz concerns. So Apple's need to out-race the Wintel world is placed on back burners at Motorola and IBM. Motorola is only increasing the speed of the PowerPC chip on a timetable dictated by the embedded processor market, not the PC market.
Secondly, a force of nature commonly called survival of the fittest is powering the drive for speed at Intel and AMD. Whereas IBM and Motorola are fitful collaborators on G4 development, Intel and AMD are engaged in fierce, hand-to-hand, mortal combat for market share. The only thing that drives Pentium and Athlon sales is speed, speed, and more speed. The blood thirsty competition between AMD and Intel has pushed them to exceed Moore's law (for the moment) in the MHz Wars, while IBM and Motorola lounge in their peaceful gardens of content, well behind Moore's formula.
Fortunately, all is not lost. Both Motorola and IBM are sensitive to their own self-interest in keeping the PowerPC processor viable in the PC market. Lately Motorola has been making noises that suggest a 1 GHz G4 called "Apollo" is in the works. A recent C-NET article recent quipped, "Motorola said Tuesday it would boost its G4 processor to 1 GHz and beyond, although it is unclear when or if Apple Computer will adopt the faster chips." Huh? Of course Apple will adopt gigahertz G4s when they arrive in sufficient quantities! Motorola's PowerPC road map even shows plans for G5 and G6 processors with speeds of 2GHZ plus.
In conclusion, while the lure of high-MHz machines is on hiatus as a force encouraging Mac users to upgrade, it will return with a vengeance sometime in late 2001. This alone makes AAPL an incredible bargain at today's much depressed price.
New Product Strategies
The second biggest threat to Apple is a faltering new product strategy. As I pointed out last week, Mr. Cube has an identity problem. It's a gorgeous machine that requires sophistication and discretionary income to appreciate, but Apple seems to want it to fill the Performa's old shoes as a midrange box between the low-end iMac and the hopelessly high-end dual Power Macs.
Even worse, as iMacs, sans a speed-driven upgrade cycle, reach some sort of sales saturation point, the industrial design polymath of the Cube is the only new basket Apple has to carry its eggs, and that basket is cracked. The Cube conundrum appears likely to be a drag on Apple's bottom line for the rest of the year or until the company finds solutions to the technical, marketing and identity issues that surround this most elegant of all PCs. All of the bad news on the Cube is not out yet, so it represents a force working to keep AAPL's price from rising too far too fast.
As anyone who follows my ramblings knows I was hugely disappointed with Apple's tepid Internet strategy announced last January and with Apple's lack of interest in producing a so-called Internet device. Later, Phil Schiller and Steve Jobs convinced me that the world was not ready for pure Internet devices this year especially of the wireless variety and that the iMac is already the world's first desktop Internet device.
Nevertheless, every other computer hardware company is bringing to market an Internet device. My own informal poll reveals that the most universally desired Mac product at the moment would be some sort of supercharged Newton with an unearthly form factor derived from the iBook's design. I know a dozen people who would snap 'em up tomorrow if such things were available. My gut instinct tells me some type of mini-iBook-like device must be in the skunk works at Apple.
Apple should be dreaming big. Apple should leverage its consumer-friendly brand name to offer a countertop, maintenance-free Internet device running a narrow-purpose, crash-proof OS X-lite for under $500. The major selling point would be that the thing is so God-awfully beautiful that everyone would covet one. The targeted audience would be newbies, Wintel users, and anyone who just wants to surf the Internet with no PC hassles. In fact, the targeted audience would for the first time ever transcend the platforms war, making it potentially the largest market Apple has ever entered. New users from the Wintel world wouldn't have to "convert" to the Mac OS religion but would merely become users of a radically simple Net access device that just happened to have a big Apple on the side. In theory, Apple should own this emerging market, which appears to be tailor-made for Apple's strengths. Cupertino has shown the ability to succeed in the exact areas where its PC brethren have been the weakest: simplicity, elegance, innovation, and clever advertising.
Both a wireless mini-iBook device and a no-crash countertop Internet station are the only new hardware categories Apple is likely to produce in 2001 or 2002. If either was to be available this Christmas season, AAPL would probably be $20 per share more expensive today than it is. So what's holding these products up? It couldn't be Apple's lack of vision or maybe, in part, it is.
The primary reason that Apple has yet to unveil an Internet device is probably that Cupertino wants them shipped with carbonized applications so the devices are optimized from the bottom up for Mac OS X. The second reason could be a lack of vision.
That's a wrap for today, folks
Stay tuned for Part 3 (tentatively scheduled for Wednesday), the conclusion of Apple Explained, to be posted on Wednesday morning where we'll examine Apple's much reduced R&D budget, how Apple's multiple sales initiatives step on each other's toes and what Mac OS X means to investors and the company's long-term future.
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Wes George writes about the financial side of being a Mac nut. Wes has followed Apple's finances for the last 7 years and comes to The Mac Observer every Monday to tell all about his opinions. He is, in his own words, "inordinately fond of money." If you would like to write Wes, make it nice. Someday you might own a company that has something to do with Apple, and Wes will probably still be writing for The Mac Observer...... On the other hand, Mr. George is known to love a rousing, hair-raising debate, so send him your worst!
Disclaimer: This column is for informational and entertainment purposes. While Mr. George may be sage indeed, his writings can not be construed as a solicitation to buy, nor an offering to sell any particular stock. As with any trading in the financial markets, you must use your own judgment to make the best trades that you can. Neither The Mac Observer nor Wes George may be held accountable for trading advice.