Thursday, 19 May 2011 06:19

Is The Evidence For An Apple Margin Collapse Now Incontrovertible?

My many warnings on the impending dethroning of Apple by Google has produced more flak and negative response since any proclamation since my warning about Goldman Sachs in the spring of 2008. Of course, fast foward to the spring of 2011 an you will find Reggie was right on point. I am just as confident, or more, about Apple vs Google, and for the same reasons as I was confident about Goldman Sachs. You see, its not about the quality of the company. Both are strong American companies with strong management, but both are (or at least in the case of one of them, "were") also seen as iconic to such a degree that investors and customers failed to look at the actual numbers, outlook and underlying trends beneath said iconic, "spit-shined-to-perfection-through-marketing" patina. Remember, don't look to BoomBustBlog for what you want to hear, look to us for what you need to hear. With that being said, we have released our valuation numbers for Apple to Subscribers (Pro/institutional level subscribers may contact me directly about the analysis) and the reviews of the latest credible competition to Apple's fastest selling products are now out - the Samsung Galaxy Tab 10.1 (Samsung's reworked answer to the iPad) is now taking pre-orders, and the reviews are very positive.

  • Engadget's Darren MurphIt's quick, nimble, and easy to hold, and it's both thinner and lighter than the heralded iPad 2. There's no question that we prefer the handling of the Tab 10.1 over Apple's alternative, and with the improvements coming with Android 3.1 (and in time, Ice Cream Sandwich), it's going to be mighty hard to overlook this device come June 8th. The 16GB WiFi model will hit for $499 -- exactly in line with the iPad... There's just no other way to say it: the iPad 2 finally has a real competitor. If Samsung could somehow undercut Apple by even $25 here, the choice would be obvious, but it's going to have a whale of a time convincing the masses that a Samsung device is superior to one Designed in California when prices are equal. That said, we'd still recommend the Tab 10.1 over the iPad 2 for heavy Gmail users and all-around fans of Android."

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There are several other reviews around, but Endgadget is, by far, one of the most objective, least unbiased reviewers popularly available. Examples of bias were evident when the reviewer would list how the Samsung pre-release product was faster, shot better pictures, had a better screen, was slimmer, lighter etc., yet in the conclusion states that they prefer the iPad 2 over the Samsung because it is "sexiest", but considers the Samsung the "iPad 2" of Android world. At least from our perspective, this strays from a straightforward comparison, but does exemplify the results of Apple's superior marketing capabilities which should serve it quite well as competition is rapidly ramping up.

As a refresher, here are reviews for the Asus Transformer priced at 80% of the cheapest iPad:

Click for video

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IT Pro Portal

The Asus Eee Pad Transformer has been a very popular tablet - even topping Amazon's best selling tablet list - for two main reasons. Firstly, it provides great value for money; it is both cheaper than the iPad 2 and has a bigger screen with a better display resolution.

Then there's the fact that it has a rather affordable accessory that can convert it into a fully fledged netbook with a 16 hour battery life altogether. The device, which runs on Android 3.0 Honeycomb, is powered by Nvidia's Tegra 2 chip and comes with 1GB RAM as well as 16GB onboard storage. Apart from Wi-Fi, it has USB, HDMI and Bluetooth connectivity.
Read more:

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The release of the Samsung tab 10.1 marks roughly 1% of the Android Honeycomb tablets slated to be released in the next year (4 - Xoom, G-Slate, Iconia Tab, Asus Eee Pad Transformer - out of about 400), and look where we are already. This is going to be a much tougher fight for Apple than even that of the smartphone market, and you see how well Android did in that category as the current market leader in both footprint and growth rate. Literally98% more competition is coming down the pike this year, and products are already widely reviewed as at parity or superior in Apple's chief diversification segment (remember, derives ~70%  of its profits from the iPhone). With that, even the iPhone is supremely challenged by Apple's own parts vendors, Reference :

Apple's biggest suppliers (the most important parts vendors for the products that contributes about 75% of Apple's profits) and the companies that Apples is currently embroiled in global litigation with (no wonder why) also produce similar products, ex. the LG Optimus 3D and the Samsung Galaxy S II.

Speaking of the Samsung Galaxy, this newest refresh is nearly universally thought of to be the best smartphone available, including the Apple iPhone. I haven't found a single review yet that has said otherwise. This is an impressive feat considering how "Apple-centric" the media currently is. Reference this snippet from Endgadget:

For a handset with such a broad range of standout features and specs, the Galaxy S II is remarkably easy to summarize. It's the best Android smartphone yet, but more importantly, it might well be the best smartphone, period. Of course, a 4.3-inch screen size won't suit everyone, no matter how stupendously thin the device that carries it may be, and we also can't say for sure that the Galaxy S II would justify a long-term iOS user foresaking his investment into one ecosystem and making the leap to another. Nonetheless, if you're asking us what smartphone to buy today, unconstrained by such externalities, the Galaxy S II would be the clear choice. Sometimes it's just as simple as that.

Endgadget is not the only reviewer to go head over heals over Android super-powered phones. Check it out, courtesy of

    1. Dan Sung of Pocket-Lint rates the phone with 4.5 out of 5 stars and calls it a “cracking experience” and like Engadget, “better than any other Android smartphone.” Very minor complaints included the 1080p DLNA streaming, which was noted could be better, plus minor quibbles with the camera lens but overall the conclusion is that “no one buying this superphone will have anything to complain about.
    2. Chris Davies over on Slash Gear. Guess what, Davies also says, “this could well be the best Android smartphone on the market today” and noted that iPhone users that were shown the Galaxy S II said they could have their heads turned by it. There were minor criticisms, such as the keyboard, but these were said to “pale in comparison to the Samsung’s strengths.” In conclusion Davies says “we’re running out of reasons not to buy the Galaxy S II.”
    3. Electric Pig by Ben Sillis, who gave the phone a staggering 5 out of 5 star rating and says “Samsung has triumphed again with theSamsung Galaxy S 2.” There are some quibbles about software in this review but not enough to get in the way of it being a “surefire contender for phone of the year,” and again the superb display gets a special mention.

Be aware that Samsung builds the chips for Apple's iPad and iPhones, is embroiled in a 4 or 5 country IP lawsuit with Apple, and also happens to build their own proprietary chip for the phone above and most likely the chips for their new (thinner, faster, lighter and possibly less expensive) tablets as well. It appears as if the stuff they build for their own Apple-competing products are cheaper and faster than what they produce for Apple. This puts Apple in a bind as they not only compete directly and sue Samsung, but will have a problem as they cannot quickly jump to another vendor that can produce the volume and tech that Samsung does. What happens when your biggest and most valuable vendor becomes your biggest biggest competitor and you start suing them? What happens when they produce superior tech for their own competing products? Well, we're about to find out. We may also find out what happens when your second largest and most valuable supplier does the same, for LG is going full steam ahead with high end Android tablets and phones as well, supplying equal or superior screens for their devices as well.

This also begs the question, "What happens when the market tightens up on either the supply or the demand side?" I anticipated this several months ago when I penned, "Steve Jobs Calls End Of the PC, We Call The End Of The Fat Margin Tablet – Including The Pretty iPad, With Proof!". Well, in the news (due largely to the issues that Japan has faced), "Component shortage to hit tablet makers". When things get scarce, whose products and enduser customers do you think LG and Samsung will cater to first? Their own or Apples?

Last year, pundits and analysts were supremely bullish on Apple's tablet prospects. Unfortunately, they were comparing early products running cell phone software offered at non-competitive prices to Apple's dedicated tablets and established sourcing channel. We, at Boombustblog warned against said optimism - or more accurately against such pessimism in regards to Androd's prospects (Steve Jobs Calls End Of the PC, We Call The End Of The Fat Margin Tablet – Including The Pretty iPad, With Proof! and The Tablet Pricing Wars Have Commenced, Targeting Apple’s iPad 2 Which Is Not Even For Sale Yet). One of the main reasons was that the very few companies that have the capacity and pricing power to offer Apple the tech that it needs to produce the iPad/iPhone are the same companies that are ramping up design and production for Android devices. It is highly unlikely they can do it for Apple at a cost of X% and not do it for themselves at a cost of X-5%. We appear to have been proven correct on this point.

Obliterating the thesis that Apple has superior pricing power, Samsung has come out with a competing tablet with a better screen, that is lighter and thinner than the iPad 2, running superior cameras - all for the same same price point (see reviews above). Asus, the inventor of the netbook category which prompted Apple to reinvent the tablet computer in the first place) has come out with a tablet featuring a better screen, a different (and in our opinion, as well as others) superior add-on form factor (keyboard dock) that enables production of content as well as mere consumption of content, and comparable performance for a full 20% less than Apple's entry level product! Reference New Taiwanese Tablets Show What So Few Have Suspected: Apple’s iPad 2 Is An Expensive Toy!

And to think that just a few months ago it was believed by most that Apple could undercut these competitors in pricing. Actually, Apple may be able to compete in a price war with the high volume, low margin, south east Asian kings of the tech manufacturing world, but in order to do so, those industry leading fat margins simply have to go. This has been the crux of our thesis from the beginning, and the evidence that supports it gets stronger and stronger every day. Again, reference Steve Jobs Calls End Of the PC, We Call The End Of The Fat Margin Tablet – Including The Pretty iPad, With Proof! and The Tablet Pricing Wars Have Commenced, Targeting Apple’s iPad 2 Which Is Not Even For Sale Yet

As explained in the last article on this topic, Apple is not lacking for demand in tablets but is truly lacking for supply. The Japanese Tsunami/nuclear disaster has curtailed supply and Apple is also forced to fight (literally, as in through global law suits) with it's major suppliers for its most profitable products as direct competitors in the tablet and smartphone space. Thus, whatever remaining supply that Apple previously negotiated as the sole large volume buyer is now hotly contested by nearly every large computer and media device manufacturer in the world. We called this occurrence last summer, and it is now becoming apparent as Apple strains to retain costs (ie save margins) while simultaneously swapping inferior components. As excerpted from New Taiwanese Tablets Show What So Few Have Suspected: Apple’s iPad 2 Is An Expensive Toy!

Not only is competition expected to put significant pressure on prospective demand, it is driving costs up as well. The following is excerpted from the subscriber document File Icon Apple - Competition and Cost Structure.

While Apple's battle with Samsung has made the most headlines in the pop media, it's there competition with LG Electronics that is really hurting them from a line item perspective. As practically every new Honeycomb tablet (except for the first, the Mororala Xoom) features a superior screen at a comparable (or in the case of the Asus Transformer, much lower price), the cost of said components are not only the largest line item cost for Apple, but the largest expense increase over generation as well. Apple will be very hard pressed to find a vendor who can supply in the volume and quality that LG Display can (giving them ample pricing power), and if it were to shop around it will probably have to solicit... Samsung, it's largest competitor in the tablet/smartphone space, via Android.

In the meantime, as an answer to all of those professional analysts and market researchers who failed to see what BoomBustBlog made quite clear early in 2010 (see the Mobile Computing Wars series in its entirety), Google’s Android Market Share Explodes As It Expands Its Reach To Cars, Toys, Home Automation, Music & Movies – All In The Cloud:

Amazingly enough, despite Apple's stellar performance ad launch on Verzon's network,, Google's Android still managed to pull ahead significantly in market share.

These are the numbers pr-Verizon - Even With Apple’s Successful Launch On Verizon, Google Continues To Increase It’s Lead In The Smarthphone Space Friday, May 6th, 2011

65.8 million people in the U.S. owned smartphones during the three months ending in January 2011, up 8 percent from the preceding three-month period. Google Android captured the #1 ranking among smartphone platforms for the first time in January with 31.2 percent market share. RIM ranked second with 30.4 percent market share, followed by Apple with 24.7 percent. Microsoft (8.0 percent) and Palm (3.2 percent) rounded out the top five.

Top Smartphone Platforms
3 Month Avg. Ending Jan. 2011 vs. 3 Month Avg. Ending Oct. 2010

Total U.S. Smartphone Subscribers Ages 13+

Source: comScore MobiLens
Share (%) of Smartphone Subscribers
Oct-10 Jan-11 Point Change
Total Smartphone Subscribers 100.0% 100.0% N/A
Google (via Android)
23.5% 31.2% 7.7
RIM 35.8% 30.4% -5.4
Apple 24.6% 24.7% 0.1
Microsoft 9.7% 8.0% -1.7
Palm 3.9% 3.2% -0.7

With all of the evidence introduced above, our original thesis is stronger than ever. We never called for the fall of Apple, but definitely did call for the fall of Apple's margins - which is, as we see it, a given. With the extreme emotional sentiment directed at Apple, this proposed margin fall may very well be faced with outsized reaction from the market - you know, as if the impossible has actually occurred.

Apple valuation

Yes, we are more optimistic on Apples' earnings than the sell side (reference page 16 in subscription document File Icon Apple - Competition and Cost Structure) Look to my writings from last summer to determine the common sense reasons why: :

No, Google is not in the mobile space for search ads, it's looking to become the next Microsoft with Android as the next Windows. It is thinking big, simultaneously going after both the consumer and the enterprise space with cloud-based software and services - and advertising!

In the meantime, sheeple-like investors are being hoodwinked by quarter after quarter of Apple blow out earnings. Don't get me wrong. I feel and fully acknowledge that Apple is executing on all 8 cylinders of a 6 cylinder engine, but it still has its real world limitations. Apple will start to bump up against these limitation over the next 4 quarters, and the signs of this bump are already apparent. Of course, the signs are being handily masked by the games that Apple management and the sell side analysts of Wall Street play, with the "Sheeple" retail and the lazier component of the institutional investors being put out to take the eventual bullet.

Riddle me this - If Apple can consistently beat the estimates of your favorite analysts quarter after quarter, after quarter - for 11 quarters straight, shouldn't you fire said analysts for incompetency in lieu of celebrating Apple's ability to surprise? After all, it is no longer a surprise after the 11th consecutive occurrence, is it? I would be surprised if my readers were surprised by an Apple surprise. Seriously! Apple management consistently lowballs guidance to such an extent that it can easily manage, no - actually create outperformance. This has has a very positive effect on their valuation. Of course, I do not blame Apple management for this, of they are charged with maximizing shareholder return. The analytical community and the (sheeple) investors which they serve is another matter though. Subscribers can download the data that shows the blatant game being played between Apple and the Sell Side here: File Icon Apple Earnings Guidance Analysis. Those who need to subscribe can do so here.

Below, I drilled down on the date and used a percentage difference view to illustrate the improvement in P/E stemming from the earnings beats.

In our analysis of Apple, we are using real world assumptions of future performance derived from backing in to the low balling this company is prone to. If you look at its history carefully you can gauge what management is comfortable with, hence what they may be capable of on the margin. Using these more realistic numbers, it is much more likely Apple will deliver a miss in the upcoming quarters in its battle with the Android! The following is the reason why...

Of course, our valuation flies in the face of that of Goldman's: Goldman’s $430 Target, Screaming Buy On Apple At Its All Time High Is In Direct Contravention To Reggie Middleton’s Logic – Who’s Right? Well, Who Has Been More Right In The Past? Tuesday, December 14th, 2010a and Reggie Middleton Takes The Challenge To Goldman Sach’s Apple Proclamation One Step Farther, Apple’s Closed System Risks Failure! Wednesday, December 15th, 2010

Before anybody decides to jump on the Goldman bandwagon, it may be worthwhile to ascertain who was has been the most accurate over time. After all, we often query "Is It Now Common Knowledge That Goldman’s Investment Advice Sucks???" It has been asked in the past...Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?

If you recall this time last year, no one thought Research in Motion would take such a precipitous fall at the cyberorganic hands of Android either - at least no one other than subscribers of BoomBustBlog: Blackberries Getting Blacked Out, Imitate Amateur Base Jumpers Sans Parachute! Friday, April 29th, 2011

Next up in the technology space: Google valuation adjustments in our proprietary valuation model for professional/institutional subscribers re: Chromium/Android (see Google Valuation Model (pro and institutional)) and how Chrome netbooks and Android tabets (ex. the Transformer) can (and probably will) curtail Apple's move into the enterprise in next article.

Related reading:

  1. Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google
  2. The Google forensic report (63 pg Google Forensic Valuation, to plug in your own assumptions see Google Valuation Model (pro and institutional)
Last modified on Thursday, 19 May 2011 10:22


  • Comment Link Ted K Saturday, 04 June 2011 23:56 posted by Ted K

    Reggie, great stuff as usual, both from a technology perspective and in thinking about valuations. It seems you would be short almost all tech companies right now, with the possible exception of Samsung. Are there any tech companies you like as equity investments now??? (I mean ones you would go LONG on). Also GS has been beaten down quite a bit. Is it fair value around 135??? I'm guessing you will direct me to subscription, if so fair enough, but I have to wrangle as much free stuff out of you as I can Reggie, you understand eh???

  • Comment Link irieblue Saturday, 21 May 2011 13:52 posted by irieblue

    Reggie, I am concerned your Apple bias is causing you to miss some key points .
    (1) iPad revenue includes high margin items like the smart cover, chargers/docks. The competition has none of these
    (2) Apple sells the bulk of iPads in their stores and online store and don't have to give up as much money to the retailers like best buy etc.
    (3) Selling a competing product even with better specs for the same price as the iPad is not competing with the iPad given the factors above.

    Apple is able to get much better pricing on components that any single competing vendor.

  • Comment Link Jay Thursday, 19 May 2011 18:24 posted by Jay

    I suffer from eyestrain with every one of these screens. When is an easier to view display going to come out?

  • Comment Link Reggie Middleton Thursday, 19 May 2011 12:41 posted by Reggie Middleton

    That's really up to personal preference. Utility does to the Asus, aesthetics and size goes to the Samsung, IMHO.

  • Comment Link anon989 Thursday, 19 May 2011 11:00 posted by anon989

    So which tablet should we purchase -- Asus Transformer or Samsung Galaxy Tab?

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