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Monday, March 4, 2013

perverse perspective

I love the markets, but sometimes they are really stupid.

Last year the market perceived Google incorrectly.  The big boys very blatantly ignored Google's potential. With the false assumption of the Facebook and the "walled garden" threat Google's trailing multiple unfairly reached levels seen during recessions and financial shocks (between 15-16).

Throughout the year, I was very critical of the low valuation, but also of Google's strategy. I wrote much about what I thought they needed to do to become a true player in the mobile space. The posts include:

- Google+MMI need to improve (A few months later we saw the improvement: GOOG is ready for MMI. Q4 2012 showed MMI is no longer a margin issue, for now. More on that below.)

- Google's Opportunity

- Google needs to Wake Up

Looking back, Google has taken those steps, and added a thoughtful approach to design. Google's transition has been reminiscent of another brilliant company. So much so, I feel Google was/is busy executing a flattering strategy: mimicking Apple.

While Google was dealing with a contracting multiple in 2012, Apple on the other hand, had a multiple that held up fairly well during the 2012 market down turn.

In today's market, the sentiment has shifted. The market is now rewarding Google with a premium multiple, while giving Apple a severely discounted multiple.  Apple's multiple is so low, the last time the modern version of Apple witnessed such a low multiple was during the great recession back in 2009.

Whats more, the last 3-4 years as Apple was growing its top line by +40% annually, (and at times +85% of the bottom line) its trailing multiple systematically contracted. The market never, NEVER, truly projected Apple's growth in the last 3 year.  Until recently, the multiple leveled off to around 14, with its highs and lows being 12 and 16, respectively.

So as Apple grew as a company, its stock valuation shrunk. But that is not currently happening with Google.  Google is the third largest US company with a $260B market capitalization, and trades with a trailing multiple that has expanded near 25.

Between 2009 and 2010, Apple was a company producing around $50B in revenue, it was growing its top line and bottom line by 40% and 85%, respectively. Its market capitalization was between $100 and 200B yet its trailing multiple was contracting, and did not see north of 22.

Naturally, I think to myself, WTF?!? And I have been thinking and writing about the "WTF" for the last two months. The market is writing off the leader in the evolution of computing (AAPL), and embracing a stock whose company is following the lead.

There are plenty of arguments circulating as to why this phenomena is taking place.  The reason range from the most obvious to the not-so-well-thought-out.

1. The obvious being an expected contraction in earnings from Apple, and an earnings growth for Google.

2. Not-so-well-thought-out being Web-Services theory. (Apple is perceived to have none, while Google has plenty.)

Are the above reasons valid?


Google will continue to benefit through advertisements, and even more so over the next quarter or two as the company has muddied the water w/respect to where their ad generation is coming from. With their unification of mobile and desktop investors will gain less transparency of performance. (Google is basically becoming a black-box.)  But their market share in mobile search and desktop search is already at peak levels. Any growth coming from search will be from sector growth.  Given mobile will cannibalize desktop, this push-pull action does not merit a premium 25 multiple for the 3rd largest US corporation in the US.

Apple has given the road map for hand-set profits. Samsung also showed Google what its missing from the handset game. Google definitely can gain revenue from the handset space.  The only question to this is whether or not Google can sell a premium device at a profitable price.  So far Google has only sold hardware at cost, and it has not shared details of device sales to get an accurate portrait of demand.  Also, Apple has shown its premium hardware can be manufactured at a better price Samsung's premium hardware. (Galaxy 3 $283, iPhone 5 $199)

Will Google allow for margins to shrink or sell hardware at decent margin (a margin level to justify a premium multiple)?

Will Google truly transition into a true hardware company? If they want to be at Apple's level, they will have to take some serious risks with manufacturing, distribution and supply-chain management.  Risks that maybe a bit bumpy to execute.  Like billions in upfront cash and equipment purchases.

(As far as the "carrier-cutting-off-subsidy" threat, I simply point to Vodafone Spain. It removed subsidized smartphones, and lost 639,000 subs in one quarter.  Premium phones do a great job to have users obtain a higher monthly data charge.  Unless carriers want to be charged with 'collusion', or a carrier wants to lose share, the subsidies will be removed. Basically, I do not think this is going to happen.  This should benefit both Google and Apple.)

Apple should continue to benefit from increase adoption of their products, but as the iPhone's growths eases from its exponential rise, it should see a similar growth to the general smartphone market adoption. (With the exception of areas like China, India and emerging markets.) Apple has always focused on China, and the proof is in the revenue. (Some $24B in revenue from China.)  But Apple is now focusing the iPhone on the rest of the emerging markets, and that should allow for higher adoption. IMO, the true driver of growth for Apple is the iPad line and its continued growth in services.

Web Services:

The web is the premise of Google's core business, so its obvious that they excel here. But just because Apple does not compete with the type of Web-services Google offers, Apple's services are more than just 'pretty good".   Pundits and chatter focus on one or two ancillary items, like the initial poor Maps experience or poor iAd performance.  But the fact is that Apple's services saw a revenue of $12.890 Billion for 2012.  In December 2012 its 3month ending net sales was $3,687B vs a 2011 3month ending of $3,020B. A 22% increase. This is a tremendous re-occuring and growing revenue/earnings stream that acts as a moat to the iPhone/iPad/Mac hardware.

Because of the current perspective, Google is in a trading scenario where the "trend is your friend".

Apple is in a perversely negative cycle that will not allow it to breach its 10SMA on the weekly.

I certainly do not want to be hating on Google just because it is seeing positive sentiment. I am a fan and a bull of the company, just not of the stock when its at such a high multiple with such a high market capitalization.  But just like I defended Google when the market was shitting on it, Apple too does not deserve the perverse perspective it is currently seeing.

A few potential catalysts for AAPL:

1. The fruits of the Oct 2011 reorganization. Will we see enough positive changes to iOS user interface that will get the people excited. (But not mess with the famous ease of use.)

2. Improvements to Passport to include mobile payments

3. Apple TV SDK (allowing for 3rd party app of Apple TV). Or maybe a deal with a few cable/internet providers that would have Apple TV as their interface instead of the current cable box.

4. Announcement of the iTV (actual television). 

5. China Mobile deal. (Although the China 3G sales numbers suggest this really not needed right now).

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