Spotify 3Q24 Earnings, Disney 4Q24 Earnings
Hello everyone. Today’s update will take us to streaming land as we circle back to earnings from Spotify and Disney. The two companies reported earnings within the past month.
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Quick Thoughts on Apple's Earnings
Apple reported another weak earnings report. Even though Apple plays the expectations game, I see no reason to spend time hating those involved in creating the game. Apple’s quarterly reports contain a lot of information, most of which is more suitable for tweets and random musings. I will leave all of the growth rates and other metrics to others and instead focus on the big picture.
Apple is still in the beginning of a massive capital investment phase (which has been detailed in 10Q and 10K filings). In the span of four weeks, Apple updated practically its entire product line. Few were expecting such widespread updates. While the iPhone 5 was the worst kept secret, as well as the rumored iPad mini, Apple surprised us with new iPods, new Macs, and a new iPad with Retina display. All of these updates are taking a toll on the company in terms of upfront costs, hurting margins. The first iPhone 5 produced is more expensive than the Xth iPhone 5 produced next year. The same can be said for every updated Apple product.
When thinking of massive capital investment plans, Disney comes to mind. As the U.S. economy was collapsing in 2008, Disney’s management team, which I regard as one of the most talented teams in this global economy, placed the bet that it was the right time to increase capital spend and make needed improvements to its Parks division. The stock market hated the idea (due to the unknown involved), but management stayed the course. Fast forward to 2012, Disney’s Parks margins are only now beginning to increase as guests enjoy the final product. Disney is now able to turn on the earnings faucet and reap the rewards.
I think Apple is following a similar path.
Once Apple perfects the processes required to make all of these new iGadgets, the costs will come down and margins will rise. The iPhone 5 form factor will most likely stay around for the new iPhone in 2013, helping margins. The iPad lineup will probably not see any additional revisions until next fall (when I expect a thinner and lighter iPad with Retina display). Constrained supplies will dissipate and the Apple earnings faucet will be operational once again. Additional implications include the high likelihood of no new Apple products until at least WWDC in June 2013, as well as continued lumpy quarterly earnings. Competition and component availability may also change product plans. In terms of modeling, I think Apple is becoming harder to forecast. I am afraid many independent (and professional) analysts will continue to forecast near-term earnings incorrectly as the number of input assumptions increase. Finally, I have been very public about my concern that product cycles were becoming too planned and orderly (i.e. iPad in March, iPhone in the fall), which artificially impacts demand as customers alter purchasing habits, but all of this is more noise than anything else, and these patterns eventually end.
It doesn’t matter if Apple is a few dollars short of expected 1Q13 earnings or if iPad mini margins are a few 100 basis points lower than normal. Such details change from quarter to quarter. At the end of the day, Apple’s most important goal is making great products. Everything else is mostly noise.
Big M&A Not in Apple's DNA
What will Apple do with its $50 billon cash hoard, which is growing nearly $20 billion annually? On January 6, a Bloomberg article-stating that Apple was shopping around for a new CFO-led some to think that Apple is interested in picking up its M&A pace. In recent months, rumored Apple targets have included Disney ($75 billion), Sony ($40 billion), Netflix ($10 billion), and Twitter ($5 billion).
Steve Jobs, Apple’s CEO, stated on Apple’s most recent earnings call:
[Apple] strongly believe[s] that one or more very strategic opportunities may come along that we’re in a unique position to take advantage of because of our strong cash position. And I think we’ve demonstrated a really strong track record of being very disciplined with the use of our cash. We don’t let it burn a hole in our pocket, we don’t allow it to motivate us to do stupid acquisitions. And so I think that we’d like to continue to keep our powder dry because we do feel that there are one or more strategic opportunities in the future. That’s the biggest reason. And there are other reasons as well that we could go into. But that’s the biggest one.
While Steve sure sounded like Apple is looking at a huge M&A deal, I don’t expect Apple to acquire any large companies (which I label as anything with a $3 billion and higher price tag).
Company Culture. It is an understatement to say that Apple’s corporate culture is unique. Apple managers have roles that are not typical in other companies, with more time spent on actual product development and brainstorming. Apple managers rarely just manage. Former IBM executive Mark Papermaster reportedly left Apple only a few months on the job as SVP Devices Hardware Engineering due to cultural incompatibility. On top of that, Apple had spent months trying to fill the SVP Hardware position before settling on Papermaster. It is tough for Apple to fill its top ranks due to its unique culture. If Apple were to acquire a company with a large workforce, it would be tricky to assimilate these new Apple workers to the culture that has led to so much success. Conflicting company culture is one of the biggest reasons for failed M&A and that rings even truer in Silicon Valley.
Company Structure. As I discussed in a previous AAPL Orchard post, Apple’s structure allows decision makers to come in contact with everything that is shipped to the consumer (Macs, iPhones, iPads, etc) and more importantly everyone who is in charge of the product (designers, engineers, marketers, etc.). Ideas are not bounced off of committees. Finished products are not required to get a certain number of approvals. I know of few, if any, large companies with a similar structure. For Apple to acquire and assimilate a company with a management structure reminiscent of a Egyptian pyramid, more than luck and hard work would be needed.
No Prior History for Large M&A[1]. Apple has never acquired a large company. Apple’s largest acquisition was NeXT in 1997 for $404 million ($540 million inflation adjusted). Recent acquisitions P.A. Semi and Quattro Wireless were $278 million and $275 million, respectively.
What is the right kind of M&A for Apple?
Peter Oppenheimer, Apple CFO, on Apple’s F1Q10 earnings conference call was pretty clear:
[Apple] occasionally acquire[s] small companies from time to time for their technology and talent. That is why we do it.
Tim Cook, Apple COO, shed more light on Apple’s M&A strategy at an investor conference in 2010.
[Apple has] always been about making the best product, not having the highest market share or the highest revenue, and so acquiring a company so our revenue gets larger isn’t something that drives us.
I think Tim Cook’s quote is important. Apple is focused on making the best products, not growing it’s earnings. Steve Jobs knows great products drives great earnings and Apple will never follow any other rule, or its continued success will be in jeopardy.
As an example, would Apple acquire Twitter? Would Twitter help make Apple’s current product lineup better? I don’t think so. (I am not even considering Twitter’s financials and possible sale price)
So what will Apple do with it’s cash?
1) Acquire talent to plug any holes in Apple’s current team and resources. I suspect some software team acquisitions may be in the offering as distinguishing software will become even more important for Apple to set itself apart from the competition. Buying smaller teams of outside talent makes company assimilation, from both a culture and company structure viewpoint, easier to accomplish. A small group of acquired software engineers can be quickly lumped within the iTunes or iOS team without much disruption.
2) Long-term agreements (aka “strategic opportunities”) for product components. In 2009, Apple paid an up-front cost of $500 million to enter into a long-term agreement with Toshiba for NAND flash chips. Recent rumors include Apple partnering with Sharp and Toshiba to build LCD factories with a price tag over $1 billion. Apple faces supply constraints whenever a new product is released and I expect Apple to pour billions into its infrastructure, forming new partnerships to guarantee that components are available, and at a good price, when needed. Finally, Apple needs additional investments, such as the $1 billion data center in North Carolina, to support and grow its current product lineup.
3) I don’t expect Apple to buyback its stock or issue stock dividends in the near term.
All of these investments and cash outlays won’t end up costing anywhere near $50 billion, but since when was having a lot of cash that bad of a thing?
[1] Some will say it is for this reason that Apple is interested in a more experienced CFO. I would respond that Apple’s storied history is a result of no large M&A. For Apple to change course now, especially considering how its team is performing, would be shocking to me and serve as a worrying indicator that something is awry in Cupertino. I am not ruling out large partnerships or agreements with certain companies that are not in a position to be acquired (Facebook, AT&T, Comcast etc.), but these are a whole other ball game compared to an acquisition.