John Goltermann of Obermeyer Asset Management has penned an interesting investment commentary simply titled, "The Apple Conundrum." In it, he shares his viewpoint as a manager that does not own AAPL.
Yes, you read that correctly... there are people out there who do not own AAPL. In a world where the stock is one of the most widely owned by hedge funds, this must be truly shocking news.
Apple a "Trillion Dollar Company"?
We thought it was prudent timing to feature this balanced view on the company. Yesterday, in our "what we're reading" post, we highlighted three articles on AAPL which mostly focused on $1000 price targets and "trillion dollar company" market caps. Contrarians will argue that this could signal at least a short-term top.
The company's future is something hedge fund managers and investors assess frequently given the fact that Apple is, after all, a technology company subject to an ever-changing landscape.
Goltermann's piece cites tech heavyweights Cisco (CSCO) and Microsoft (MSFT) as prime examples of technology companies that became the largest on earth and then saw vast share price declines.
Most, if not practically all hedge fund managers who have purchased AAPL shares are sitting on a hefty unrealized gain. David Einhorn's Greenlight Capital bought AAPL at $248. Today it trades north of $600.
This led us to ponder the true Apple conundrum: when will investors decide to sell? Or from an analytical standpoint: when will risk outweigh reward?
Many portfolio managers have been forced to continually trim their AAPL position sizes simply to manage portfolio weightings. In many cases, AAPL has become such a large percentage of their portfolio due to share price appreciation that they have to do something about it.
But these sales are due to risk management and position sizing rules rather than a change in the investment thesis. So again, the question is: what will cause them to exit AAPL entirely?
The Future Apple Case Study
Recently, we tweeted (follow us on Twitter) that Apple will make a fascinating business school case study one day, not only from an innovation standpoint, but also from a business culture and operational standpoint.
But perhaps the most intriguing case study is that from an investment standpoint. The company has been at the forefront of innovation and secular shifts in technology, but when do expectations become too high?
Sometime in the future, business school students will utilize hindsight bias and point out how 'easy' it was to spot when to get in and out of AAPL shares.
Back during Apple's rough patch, Michael Dell said the company should just shut down and return its cash to shareholders. The company then went on to create entirely new segments of computing.
We'd posture that the Apple conundrum of 'when to sell' could potentially come down to the exact same reason many investors bought in the first place: innovation.
Sure, the company can (and will) continue to sell millions of updated versions of iPhones and iPads. The company's product pipeline is already largely telegraphed with refreshed models usually released each year and redesigned versions every two years. But eventually, investors will wonder, "what's next?"
Apple revolutionized the smartphone and is riding that wave. They created the tablet category and are dominating it. It's rare when one investment offers a deeply entrenched position within a continually rising secular trend. And in this case, that trend is: mobile.
In a slidedeck on the future of mobile, Business Insider illustrates just how dominant AAPL is in that arena. They write that "in a few years, the number of mobile devices (smartphones & tablets) will dwarf the number of PCs ... tablets alone should pass PC sales in 2-3 years."
AAPL: Bulls Versus Bears
Bears will point to the fact that the company has to keep innovating to stay relevant. The late Steve Jobs was responsible for such great innovations that his vision will be hard to replace. Tim Cook, his CEO successor, is a hell of an operator. But he's not necessarily an innovator. That innovation will have to collectively come from Apple's ranks of talented individuals.
Apple created the iPhone, then the iPad, but what's next? There's been a lot of analyst speculation that they'll attack the TV next. But as Greenlight Capital's David Einhorn mentioned recently at the CIMA Conference, the company won't do it unless they can revolutionize it.
Arguing the bull case, Einhorn made a prudent point that the market thinks AAPL is a hardware company, while he believes that it's a growth company that has become a recurring revenue business.
Sell-side research certainly backs that up as well. Piper Jaffray's Gene Munster just put out a research note on AAPL that says "survey work last fall suggested 94% of existing iPhone owners in the US expect their next phone will be an iPhone." That certainly backs up Einhorn's point.
Apple 'Too Difficult?'
In his commentary, Goltermann characterizes the company as 'too difficult' for a myriad of reasons. The crux of his argument is that while he and his colleagues use and love Apple's products, the technological landscape shifts so frequently that it's hard to jump on and off the trend train safely.
He writes (emphasis ours), "Apple now comprises 4.4% of the S&P 500 index and, all by itself, is larger than the entire utilities industry. With 932 million shares outstanding, every dollar move in Apple's share price represents nearly $1 billion in net new capital flowing to its shares."
That's a lot of money flowing into AAPL. And as Aswath Damodaran, Professor of Finance at NYU's Stern School of Business points out, the company's recent dividend announcement has attracted a whole new set of investors: dividend aficionados. This, of course, comes in addition to the pre-existing momentum traders/investors who piled on over the past six months. The latter is one of the reasons he actually recently sold his longstanding AAPL position.
He mentions that he hopes he is wrong by selling too early and that the company's shares continue to skyrocket higher. But if you think about it, selling early is often a problem investors are faced with.
As detailed in the latest issue of our premium Hedge Fund Wisdom newsletter, John Griffin's hedge fund Blue Ridge Capital sold 70% of its longstanding AAPL position in the fourth quarter of 2011. Since then, AAPL is up an additional 54%. While they still held a small position, that's obviously a sizable gain left on the table. But that's the difficult choice investors have to make.
Technology Trends Create & Destroy Value
A few years ago, we posted a technology trends presentation by Coatue Management, Philippe Laffont's tech-oriented hedge fund. They identified AAPL as a potential beneficiary of the rising smartphone trend. Since then, AAPL has gone on to further entrench themselves in mobile by defining a new computing category (tablets) and then dominating every competitor.
At the end of 2011, Coatue disclosed in their 13F filing with the SEC that Apple (AAPL) was their top holding, a position that represented over 18% of their reported 13F assets (i.e. a percentage of their long US equity positions).
While this number is by no means a percentage of their overall assets under management, they still had almost $518 million in capital allocated to AAPL shares at the end of the year. Since then, AAPL's price appreciation means that their stake is now potentially worth over $798 million (assuming they haven't sold any shares, which is probably unlikely).
The point of highlighting Coatue's massive stake is to showcase the benefits of finding a secular winner and jumping on the wave. Surfing it is the easy part. As mentioned earlier, it's the exit that's much more difficult.
One of the slides in Coatue's presentation showcases the various trends seen in technology over the past fifty years. They highlight how IBM (IBM) dominated the mainframe era, Microsoft (MSFT) dominated the personal computing era, Cisco (CSCO) dominated the networking era, and how Google (GOOG)/Apple (AAPL) have dominated the internet/mobile era.
(click to enlarge)Just as Goltermann compares AAPL to Microsoft (MSFT), Erik Swarts over at Market Anthropology does the same by posting up an interesting series of charts contrasting parabolic price action between MSFT at its peak to the current AAPL action.
Over the past 20 years, AAPL has now generated over a 4000% gain. Shares of MSFT at their peak yielded around a 2500% gain. He highlights now that "Apple has pulled up next to Microsoft's market cap high from 2000 of roughly $586 billion."
(click to enlarge)However, Swarts also shrewdly notes that, "both previous successors to the title of World's Largest Market Cap (that went parabolic) certainly did not go bust, but maintained a leadership position within their respective industries. Their valuations simply matured and lost the enormous momentum drive that propelled them to unsustainable growth trajectories."
The Apple Conundrum
Years from now, it will certainly be interesting to see who was able to successfully time the entrance and exit from the secular trend of mobile, and specifically, shares of AAPL. But in the mean time, investors are watching a live case study on investing unfold before their eyes in the form of the Apple conundrum:
Can Apple keep innovating?
Is the secular tide strong enough to carry Apple's boat on its own?
When will growth expectations become unsustainable?
When to sell?
Embedded below is John Goltermann's 'The Apple Conundrum.' Be sure to read his entire commentary as it was the inspiration for this lengthy post.
What's your take on the Apple conundrum? Let us know in the comments section below.
