This is part 2 or 3 of my illustration of the gross misvaluation of Google (see My Thoughts on Roger McNamee’s View of Google and Mobile Computing). As a reminder to our paying subscribers, on November 2010 we downgraded the stock to Neutral from our Overweight stance while maintaining our valuation. Given the market’s reaction to the stock and the fact that growth was ahead of our expectations, we upgrade the stock back to Overweight territory. The full, unabridged quarterly review is available to all paying subscribers here: Google Q1 2011 results. Below are many of the salient points contained in said download.
Google Q1 results
For the quarter ended March 31, 2011 Google reported gross revenues (before traffic acquisition costs) of $8.58bn, an YoY increase of 26.6% and QoQ increase of 1.6% while net revenues (after traffic acquisition costs) increased 29.1% YoY and by 2.6% sequentially to $6.54bn. The YoY growth in gross and net revenues was the highest at least since 2008 demonstrating a increasingly momentum in the growth of Google’s digital ecosystem. The increase in net revenues (after TAC) was actually stronger than the increase in gross revenues, indicating that Google has not only packed in growth but lowered aggregate top line expenses.
However, despite a strong set of results the stock took a severe beating and was down c8% as the results were short of analyst expectations. The market’s reaction to Google’s numbers clearly reflects the very myopic view of US public markets wherein a stock is dumped if it fails to beat consensus – even when this view clearly overlooks the broader picture.
A few readers have asked me to address Roger McNamara's comments on CNBC, not to mention the drop in Google's share price after earnings. I will split the response into several posts since it is the weekend.
Well, to begin with, I agree with his bullishness on tech and his premise that although it may not increase as a % of GDP in the near term, mobile computing has a lot of growth to run with. As for Google, it has expanded far beyond search and owns the most prominent and fastest growing mobile OS in the world, as well as controlling advertising on said platforms as well as the main video site. It is well positioned. As for the comment about nobody makes money from Android, well those entities that make money from Android disagree. I have outlined this in the first quarter, reference Apple Gears Up To Combat The Margin Compression That Apparently Only It, Google & Reggie Middleton Sees Coming Monday, February 14th, 2011
On January 20th, I posted "Blackberries Lost More Market Share Than We Bearishly Anticipated While RIMM’s Share Price Spikes: Is It Time To Revisit the Bear Thesis?". I turned bearish on RIM last summer and made some money on its dip back then. Shortly afterward, its shares did the QE thing, despite the fact Android started sucking up market share everywhere while simultaneously squeezing margins like orange juice. As excerpted from the aforementioned post:
We have updated our mobile OS and handset manufacturer market share model and will make it available to subscribers as an online app by next week. In the meantime, let’s review some of the findings – vendor by vendor. First up is Research in Motion. This was a profitable short in 2010, with the share price hitting our targets within 100 pennies. Since then, the stock has risen appreciably. Let’s take a look to see if the rise was justified.
Page 5 of our Research in Motion forensic analysis (released in the summer of 2010 - RIMM Forensic Analysis and Valuation – Professional & Institutional or RIMM Forensic Analysis and Valuation – Retail) clearly stated that while we expected RIMM’s handset shipments to rise as a result of a rapidly expanding smartphone market, it will lose considerable market share....
As it turns out, it appears that we were erred slightly to the optimistic side with an 18% market share estimate for 2010. By the end of the 3rd quarter, RIM has fallen to 15.3% according to information calculated from IDC, and its decent has accelerated far faster than even we (the bears) have anticipated – a full 350 basis points for the quarter. This is 6x the decent of last quarter and 7 x the decent of the quarter before that. It is quite safe to assume that they will be materially below this point at year end (the data that we crunch is lagged by a quarter). This market share loss is most assuredly caused by the outsized growth of Android, which I will demonstrate in a minute. Below are charts generated from an updated version of the subscriber document Smartphone Market Model – Blog Download Version:
Two weeks ago, Samsung's VP made tech rag headlines, stating that he felt his company's tablet offerings were not adequate in light of Apple's new iPad 2. He insinuated that Apple had come out with more product than he had expected with a thinner form factor and lower price points. Not many VPs will admit defeat in such a manner. It is now obvious that he wasn't admitting defeat, but simply making astute, empirical and logical observations with which he would us to quickly reposition his product line. This is the product that was to be the 10 inch Samsung Galaxy Tab as of two weeks ago.
What do you get when you add...
The world's most prolific mobile OS with the largest market share and greatest growth rate
The world's greatest advertising company
The world's largest cloud computing company
The world's largest online retailer???
A hell of a lot of competition for everyone else in the mobile computing space. Amazon app store: Launchpad for mobile dominance! Amazon is opening it's Android app store Tuesday (today). It will run as a subset of Google's Android Marketplace and will be heavily monitored and moderated by reviewers, very much like the Amazon store is - which will set it apart from Google Marketplace and be similar Amazon's running of the FAO Schwatz and ToysRus websites.
The tech media has multiple reports of Amazon focusing on competitively lower prices for apps to gain a competitive edge.
Bloomberg has Warren Buffet saying:
"Warren Buffett said he’ll probably prolong his aversion to electronics makers such as Apple Inc. (AAPL) because their business prospects are harder to predict than companies such as Coca-Cola Co. (KO)
“We held very few in the past and we’re likely to hold very few in the future,” the billionaire chairman of Berkshire Hathaway Inc. (BRK/A) said in Daegu, South Korea, today, referring to electronics makers. Coca-Cola, based in Atlanta, is “very easy for me to come to a conclusion as to what it will look like economically in five or 10 years, and it’s not easy for me to come to a conclusion about Apple,” he said".
He's absolutely right. Not only does Warren not know what lies in store for Apple's future, nobody else does either. Combine that with the fact that everyone is acting like they do know what lies in store for Apple's future - with the majority preaching abject and unfettered success if not domination, spells opportunity.
See my post from earlier this morning - How the “I Love Apple, There Is No Other Fever” Adds To The Attractiveness Of An Ever So Unpopular Apple Short and More On Realistic Views of Apple and the Undervaluation of Google.
I have decided to post a recent email exchange to illustrate the psychological component of a potential Apple short. As all who follow me know, I believe that the amount and quality of competition that Apple is and will be facing in the near future will curtail its hyperbolic growth and/or margins, essentially invalidating the lofty price targets that have been assigned to it by the well followed sell side analysts. There is also a market psychology side to this as well. Apple has, by far and wide, the greatest amount of reverence I have ever seen bestowed upon a corporate entity. Its employees, products, and stock are literally worshiped and zealously, if not aggressively defended. This nearly blind devotion can and does tend to cause one to take a blind eye to shifts in market dynamics, fundamentals, competitive forces and adverse macro economic trends. In a nutshell, emotions take over where the brain should be leading. At ~$340, a near doubling, the greatest competitive forces the company has ever had, the removal of first place in market growth rate (mobile) as well as displacement in market share, a myriad of global macro-economic disasters, abject worship by Wall Street's sell side analysts (who tend to lose more than they win, yet drag many a retail investor down with them) and the fact that it is one of the world's most largely held stocks - albeit held by many who overlook the obvious - Apple makes an appetizing short if the entry can be timed and hedged correctly. Think about it. Here you have an opportunity where a company MAY be slowed down considerably hitting potential macro, competitive and logistical headwinds in a potentially stiff macro environment, with an all time high triple digit share price (good for options traders) and there is literally close to ZERO competition for the short because EVERYBODY is long and convinced Apple is not a fruit but bread-like manna from heaven. When everyone is crowding to one side of a boat, it is wisest to make your way over to the opposite side.
On that note, here is an email exchange that I recently had with a polite yet zealous Apple fan that follows my blog.
In continuing with what appears to be one of the very, very few voice that look at the mobile computing wars from an empirical perspective I will update readers on the price action in Apple and why I feel that the market may be getting wise to what BoomBustBloggers have known since last year. I want to make it clear that this is in no way to be considered investment advice or a recommendation. It is simply a reflection of my thoughts and ruminations on the mobile computer space and the relative prospects of the front leaders therein. On March 16th, I posted Shorting Apple and Why Software Developers Can Make More Money On Android wherein I discussed the suitability of shorting(putting) Apple stock with tight stops. This, or course was in direct contradiction to the recommendation of Goldman Sachs who has a $430 target on the company. See Taking The Challenge To Goldman Sach’s Apple Proclamation One Step Further and Is It Now Common Knowledge That Goldman’s Investment Advice Sucks!
I followed up the next day with Note For The Few Realistic Apple Bears…
Shortly thereafter the trade was stopped out with a roughly 31% gain. I have put a similar position back in this morning. Let's take a look at the divergent price action between the two mobile computing war front runners.
Apple has had the expected effervescent launch to its iPad 2 last week, which was tarred some in Asia by the trifecta calamity Japan's earthquake, resultant tsunami, and consequent nuclear reactor near meltdowns - still going on. The problems Apple face go farther than a mere temporary (or not so) hampering of the Japanese market to the new iPad 2. Apple is relying on the iPad 2 to diversify its current ~65-70%+ concentration of profits in its highly successful iPhone product line. Any disruption in the selling of iPad 2s gives Google's Android tablet products more room to expand and capture market share. From CNBC:
The iPad 2 battery, which IHS iSuppli said is "unusually thin", is manufactured by Apple Japan, an Apple subsidiary, and likely requires advanced manufacturing technologies that reside in the country.
"Logistical disruptions may mean that Apple could have difficulties obtaining this battery, and it may not be able to secure supply from an external, non-Japanese source," the report said.
Production at many Japanese manufacturing facilities has come to a halt following Friday's 9.0 earthquake and subsequent tsunami, which has left more than 5,600 people dead and destroyed swaths of the country.
Toshiba, which is one of the companies that produces the NAND flash memory used in the iPad 2 according to IHS iSuppli's research, briefly shut down a flash memory manufacturing facility in Japan and warned it could face hurdles distributing its products.
Suppliers of other components whose factories weren't damaged are likely to be affected by logistical issues, such as difficulties procuring raw materials and shipping finished products, the report said.
Apple launched the iPad 2 in the United States last week to strong demand, with many stores selling out of the device and analysts estimating that the company sold 1 million units during the debut weekend.
The current wait time for an iPad ordered online is 4-5 weeks.
Within 4-5 weeks, Samsung should be launching its 10 inc Tab product which arguably the most competent threat to Apple's iPad 2 to date, and only the 2nd of over 3 dozen tablet-specialized "Honeycomb" devices to ship in the next quarter or two. From As The Tablet Margin Crunching Parade Marches On, Consumers Benefit From The Cheapest Prices Of The Best Products:
Even without the launch of these higher end specialized products, Android 2.x tablets are already flooding the retail markets. Here is a page from Sear's website after typing in the term "tablet"... Click to enlarge.
These are not just the junk tablets often pushed over from the wholesale Chinese shops either. Included for $300 and change is the Viewsonic 10" tablet which can dual boot Windows 7 and Android, and its cousin the pure Android 10" tablet. With a software upgrade to versions 2.2 to 3.0, this tablet mirrors the much more expensive Motorola Xoom and Samsung Tab and can run neck and neck if not beat the iPad 2 at nearly all function - yet it is priced less than the current iPad 1. Yes, all available from Sears. Remember my admonitions concerning margin compression - these prices are, and will continue, to drop like rocks.
- The Tablet Pricing Wars Have Commenced, Targeting Apple’s iPad 2 Which Is Not Even For Sale Yet…
- Steve Jobs Calls End Of the PC, We Call The End Of The Fat Margin Tablet – Including The Pretty iPad, With Proof!
So, as the iPad 2 enjoys one to one and a half month delays, these Android tablets will continue to sell and occupy mindshare that probably would have gone to Apple. If Apple does not succeed in diversifying its profit base farther, it will be left vulnerable. The Japanese incident is a perfect example. The two popular mobile products that are grown (ever so slightly) market share are very vulnerable to happenstance disruptions. Google actually benefits from this by building a very diversified base of vendors from every hardware corner imaginable, many of which may not be as effected as Apple who has sole sourced certain components. In the meantime Google Is Said to Test Mobile-Payment System With VeriFone - Bloomberg. If Google is successful in cornering this market, it simply adds to the ubiquity of Android as it will surely be built into the OS. Do remember how quickly Android has risen from near zero to pole position in terms of market share.
In 7 quarters, Android went from last place to first place - WORLDWIDE! Expect the same to happen in the tablet space where competition is even worse and the Android camp has a much larger stable of much more capable competitors ready to jump out of the gate as the iPad has only one year head start as compared to the iPhone's 3 year head start. Does the market see this? At the money, front month puts jumped 41% while Apple fell faster and farther than Google during the market rout, and gained less, slower during the government pump up.
I am slowly gathering puts on Apple again, with tight trailings, of course. Apple's situation may not become apparent immediately, but it is definitely in more of a competitive bind than many are letting on. I have been clamoring that Apple's margins will get chopped by Android's commoditizng the smartphone space - both on the lower and and the higher end. See Apple on the Margin and my on air proclamation just hours before Apple released earnings and declared - surprise, surprise - a drop in margins. Go to 3:40 in the video... [iframe http://plus.cnbc.com/rssvideosearch/action/player/id/1618325359/code/cnbcplayershare 400 380]
- The Potential Equity Investments Most Likely To Prosper From the Google/Apple/Microsoft Mobile Computing Battle
- The Nokia/Microsoft Alliance & Android’s Commoditization Of The Mobile Computing Platform…
- Apple Gears Up To Combat The Margin Compression That Apparently Only It, Google & Reggie Middleton Sees Coming
- Will Google Win The Mobile Computing War? Let’s Walk Through Where They Stand Now & How To Value Them
- Sony Bites The Bullet & Joins The Android Camp, Adding Its Entire Suite of PSOne Games To The Android Platform
- If You Need More Proof Of Apple’s Inability To Keep Up With Google’s Android & Over 100 Other Android Hardware Vendors…
Subscribers are reminded to review the Apple iPhone Profit Margin Scenario Analysis Model as well as review the Apple Earnings Guidance Analysis document that details how Apple’s management expertly manages sell side earnings expectations, and consequently their share price. Non-subscription readers should reference How Google is Looking to Cut Apple’s Margin and How the Sell Side of Wall Street Will Enable This Without Sheeple Investor’s Having a Clue and then compare and contrast to Will Google Win The Mobile Computing War? Let’s Walk Through Where They Stand Now & How To Value Them.
Regarding the post that I made this morning, Shorting Apple and Why Software Developers Can Make More Money On Android - the Apple bear position has indemnified and paid for itself with a 66% return on OTM puts in front of a trailing stop. The rest is gravy from here and if Apple pops back up I'll simply wait for it to get too close to that Goldman Sachs recommendation and have at it again.
I have finally started dabbling with Apple shorts and puts. My OTM S&P put positions were profitably stopped out due to trailings yesterday when the market recovered some of its losses. I have decided to use Apple in the place of the S&P puts for the time being. Medium to long term, the trade is more evident and obvious to anyone who is objective and follows BoomBustBlog. It is significantly more risky shorter term. Alas, there are marginal gains already, and once they accrue to the point of indemnifying my trailing stop, I will add more. After I finish the current leg of my global real estate research to be disseminated to institutions, I will offer tidbits of the modeling (I have already offered subscribers significant info on why I think Apple is a risky long play). From a contrarian standpoint, it may be safe to go short with tight stops, after all although Apple Gears Up To Combat The Margin Compression That Apparently Only It, Google & Reggie Middleton Sees Coming, we still have those guys over at West Street... 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? I have taken The Challenge To Goldman Sach’s Apple Proclamation One Step Farther, Apple’s Closed System Risks Failure! Listen, everyone, regardless of what investment positions or tech products you may have in your stable, needs to ask themselves the appropriate "What if's". I have spurred the conversation with "Will Google Win The Mobile Computing War? Let’s Walk Through Where They Stand Now & How To Value Them"
Remember, I may not always be right, but it does pay to look at the track record... Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best? More attention should be paid to the little guy, after all by now it is Now Common Knowledge That Goldman’s Investment Advice Sucks! Didn't you get the memo? I'm sure many traders have spurned Apple due to the Japanese market being cut off right at the launch of the iPad 2, but the issues go deeper than that. I will cover it in depth at a later date, though.