Astrology, P1 sightings, Convertibles, Debt Rating and, Yes, the AppleTrader goes to MacWorld
May 31st, 1999

A full moon shone in last Sunday’s sky, with Mars and Jupiter in opposition. The Summer Solstice will soon follow on June 21st. Significantly, that’s the same date in 1995 AAPL made its last high peak before beginning two-and-a-half dreary years of decline. In a fabulous astrological conjunction, Apple is poised to challenge that old solstice high set four years ago to the day.

I say this not because I believe in astrology--although the ancient art might be more accurate at predicting price movements than the average stock analyst--but because all the relevant indicators seem to have touched bottom for AAPL. The general market sentiment, currently negative on the PC sector as a whole, favors Apple as investors struggle to find value in an over priced market with considerable downside potential. After all, how many good deals remain on the NASDAQ? Not many, if PE ratios and book values still matter, and I think they do, even in this new Aquarian age of the Internet tulip market.

The most important news last week for AAPL investors was the first palpable evidence that the iBook (a.k.a. MacMate, P1 or whatever) is on its way. AsiaBizTech reported that Alpha Top, a Taiwanese electronics manufacturer, had won the bid to build the secret consumer portable that we all hope will debut at MacWorld in July.

Since the return of Steve Jobs, Apple has been very tight with its state secrets—so tight there has been speculation that the iBook isn’t on schedule. This rumor now appears to be unfounded. No outsiders know what the iBook really looks like, but that doesn’t stop eager but graphically talented Mac fanatics around the world from creating fantasy machine visions.

From the same AsiaBizTech article one can glean further signs of the iMac’s ongoing success. How long does it take for a fad to be upgraded to a trend and then be promoted to a full-scale subculture? I don’t know, but it looks like the iMac zeitgeist is still gaining mindshare, and production continues to ramp up. Apple is pushing the pedal to the metal on production since no one knows how long the iMac monopoly will last before Wintel rip-offs begin to appear. Even Michael Dell has been quoted as saying that the iMac is a "wake up call for the PC industry."

Convertible notes

June 1st is the earliest date on which Apple can convert its outstanding 6% debenture notes. These notes were issued back in the dark days of Gil Amelio to help float the company while Gil tried to unload Apple’s bloated inventory. Apple has opted for this early call of the debt because they are doing so well. It’s a no-brainer to retire this expensive crutch as soon as possible. Since these notes are convertible to shares of Apple stock at the cheap bargain price of about $29, most of the $661 million in debenture notes will be converted into 22.6 million shares of Apple stock.

Eric Yang provides a thorough exposition of the whole process at his website, AAPL Investors, if you’re interested in the details. The bottom line according to Eric is: "The conversion of 6% notes on June 1, 1999 will increase Apple's income and improve its balance sheet by eliminating most of its long-term debt. The move will also make it more likely for Apple to implement a share repurchase program in the future. While the note conversion this week may introduce some short-term trading volatility, in the long term it will benefit Apple and its investors."

The elimination of about two thirds of Apple’s long-term debt will increase shareholder equity by $653 million to over $2.8 billion boosting Apple’s book value which is already the best in the PC industry! This essentially makes AAPL bargain-basement-fire-sale cheap, an anomaly in the high-tech sector. Don’t expect it to stay that way for long.

An interesting aside to this convertible note issue is that it may be the source of the massive short interest that has plagued Apple for the last year. Thirteen percent of Apple’s outstanding shares are in short interest. That’s ridiculously high for a company with rapid, sustained growth and a PE barely in the teens. According to Eric, many of the note holders are conservative, risk-adverse institutions who probably shorted AAPL when the stock price rose above the $29 conversion price. Mr. Yang notes, "This strategy not only locks in existing profit but can actually deliver even more profit if shares of Apple stock drops back down below the $29.205 conversion price. Furthermore, the convertible notes holder continues to earn 6% interest on the notes." This would explain why short covering never seems to catch fire as it should when AAPL soars to new highs.

Once the notes are converted this week we could see a substantial drop in the short interest that has hovered over Apple like voracious vultures. The many investors who check the short interest numbers of an equity in order to gauge the sentiment of possibly more knowledgeable players will no longer be frightened away by the short interest reports which have often placed Apple in the top five most shorted companies on the NASDAQ.

Moody upgrade

Because of the early call on those old debenture notes and the success of the iMac, Moody's Investors Service raised the ratings on Apple’s $300 million 6.5% senior unsecured notes due in 2004 from B2 to B1. The article goes on to admonish Apple not to spend its cash reserves on a stock repurchasing plan. Moody is a business debt rating service, oddly they seem intent on dispensing unsolicited strategic advice to Apple’s management in their report.

Moody acknowledges that Apple has increased sales 34% since the introduction of the iMac (August 1998) and has reported the highest gross margins in the industry at 26.8%. They even predict that Apple could increase its margins in the future should the company succeed in penetrating the enterprise market! That’s an absurd idea since it’s the fierce competition in the enterprise market that is currently crushing the PC manufactures’ gross margins and leading to a down turn in the fortunes of the computer hardware sector. A more logical argument would be that Apple’s immunity from shrinking margins stems largely from its lack of enterprise market exposure.

As for the downside, Moody points out that "Apple's cash horde, while substantial, would be of only modest comfort when contrasted with the combined resources of Microsoft, Intel, and the Wintel consortium. Despite the iMac's success in the retail consumer market, the company's share of the overall personal computer market, estimated at under 4%, remains modest."

That’s a pretty harsh way of looking at it. Fortunately, Apple’s future growth doesn’t depend on the Wintel consortium’s blessings. In fact, as the only viable consumer alternative to the vast Wintel Empire, Apple may benefit disproportionately as the 40% of homes without computers join the wired world of the Internet over the next few years.

Moody reveals its lack of deep Apple knowledge with this observation, "Any marked departure from the fabled Mac OS would be scrutinized closely and risk acceptance, not only by the broader personal computer market, but also by the ardent loyalists who have supported the existing operating system." Moody is worried that the NeXT OS and Unix foundations of OSX might not be a big hit with the Mac faithful. Such a preposterous conjecture calls into question the rest of their sage analysis of Apple.

Don’t Listen to Analysts

Speaking of poor analysis, I can’t help but get upset by what passes as ‘stock analysis’ these days. From a recent Reuters’ article, "Buy ratings made up two-thirds of a total 26,692 U.S. analyst recommendations at the end of March, according to data from the research firm First Call Corp. The 208 sell recommendations accounted for less than 1 percent of the total. The rest were ‘holds,’ which investors have learned to view as ‘sells’."

The lesson to learn here is that if you are investing in individual stocks you must do your own homework. Never buy or sell because an analyst raises or lowers a rating unless your independent research confirms his or her thinking on the matter. BTW, I’m not an analyst, just a lowly online trader trying to learn proper punctuation. But don’t take my advice either. Advice is just a disguised form of nostalgia.

Mr. Gap Fills A Gap

Millard Drexler, president and chief executive of Gap Inc., joined the newly expanded Apple Board of Directors last week. This is really bullish news for anyone familiar with the dismal state of Apple’s retail presence at CompUSA and in Europe. The Mac retail market has been looking up recently with Sears coming onboard and CompUSA’s sincere effort to reverse their horrible image. Still, the retail picture is the weakest link in Apple’s business model.

Let’s hope that Drexler’s marketing savvy will help resolve the complex web of issues that hinder Apple’s retail sales. I also hope that he can bring some new insight to the cognitive dissonance that arises from the contrast between Apple’s Think Different ad campaign, targeting the genius-snob market, and the mass market appeal of the iMac, the computer every teenager in America wants. Apple successfully winnowed down its product line to a small well-focused group. It’s now time that Apple to consolidate its advertising message to a single well-focused voice that can unambiguously define Apple’s image.

Apple Trader Goes to MacWorld

I am honored to speak at MacWorld on the topic of ‘Stock Market Investing with your Macintosh’, Session 42 in the MacWorld Expo User Conference on July 22 at 3:30pm. I hope to see you there as I reveal the arcane science of online trading with a special emphasis on the software tools that are available for the Mac platform. Of course, in this business the learning curve never stops and I look forward to this opportunity to exchange ideas and compare notes with other online investors in that never ending search for the perfect balance between risk and reward.

Your comments are welcomed.