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Monday, 21 March 2011 11:17

How the “I Love Apple, There Is No Other Fever” Adds To The Attractiveness Of An Ever So Unpopular Apple Short

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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.

Reggie,

I'll try to be short and to the point. I have tremendous respect and admiration for the work you do in analysing the financial markets and actors. I read every post you write. I also think your analysis of Apple and its market situation is correct.

However, I just wish you'd come across somewhat less jubilant about seeing Apple trounced by the Android stampede.

Why? Simply because Apple is not a despicable vampire squid like the banks you also seem to want to see go down in flames. Apple is a crucial catalyst for extremely valuable change. Without Apple, it's questionable whether Windows or any other ubiquitous user friendly interface standard would have emerged. Without Apple, we would still be using Nokia "smartphones" in Europe and Blackberries in the US. Without Apple, the operators would still control the small and highly fragmented market for useless smartphone applications. Without Apple, a tablet would still be an impopular niche device running a crippled version of Windows. (I won't even get into how even HTML arguably evolved from Apple's HyperCard UI principles).

Simply put: without Apple, the personal computing industry would lose a major chunk of visionary leadership, so why make it sound like its demise is both inevitable and desirable?

Sorry if I have read something into your writings that's not there, but that's how it has come across.

Thanks and keep up the unique and outstanding work you do!

The following is my reply...

I don't want to see Apple go down in flames, and the banks either. My only issue with Apple is not with Apple at all. I dislike the undue favoritism that Apple gets in the media. That is not Apple's fault though, it's their job to engender such. Apple, just like the banks, are inanimate corporations. They are not good, nor bad. They are just businesses. It appears that many who follow Apple fail to realize this.

The interface that you refer to was borrowed by both Microsoft and Apple from the Xerox PARC. Apple is not any more responsible for it than is Microsoft. You are right that Apple is an important catalyst for change, but so is any company that successfully introduces a disruptive product or service.

It is good when a company introduces creative destruction and it is good you both recognize it and appreciate it in Apple, but there appears to be a significant amount of bias in your tone (and forgive me if I'm incorrect). Google's Android launch is even more disruptive than Apple's iPhone and iPad, and has issued in materially more innovation in a much shorter time frame than all of Apple's products. Within a year, we have the introduction of multiple core chips, real 3D interfaces and screens, Li-Po batteries, extensive use of cloud computing for both the enterprise and the consumer, as well as some of the most unique business model applications seen in the industry. Despite all of this, you seem to be coming to the defense of Apple but not the support of Google. To be absolutely honest, this "undue" loyalty to Apple (both its products and its stock) make its stock a very desirable target to short because it is almost universally held, the potential weaknesses in its business model and markets are seemingly ignored by the vast majority of its investors and it faces the most competition it has even had in its existence against the most capable companies it has ever faced. In the face of all of this, nearly everybody (the financial community, press, and consumers) literally turn a blind eye to practically all of it. - Trading at $350, and not necessarily very cheap - it is a short made in heaven for anyone who can see the opportunity for what it is.

And this is the reader's rely...

Thanks for the quick response, Reggie.

I do have to admit that I'm biased in favor of Apple. Having used and touted their products since the original Mac – often in extreme headwinds from Wintel centric IT departments – breeds a very specific kind of minority loyalty. As a branding guy, I also admire their superior design management, from the smallest product box to the largest flagship retail store.

It also doesn't hurt that I held Apple stock since $9 because I believed in them despite being called "beleagured", "rotten" and "marginalized" by the press. (Journalists weren't always so fawning. In fact, I honestly believe that without the internet and a few faithful Apple fansites, the company would have gone under during the dark years in the mid nineties). Anyway, I sold my stocks way back at $230, so I'm not defending the current price. As I said, I think you're right on with the margin compression analysis.

(By the way, Apple did borrow significant UI functionality from the Xerox Star, a word processor I have personally used. However, they also added important features, like drag and droppable UI objects. It apparently took the skills of a Steve Jobs to turn it into a successful commercial product because neither Xerox nor anybody else did. And don't even get me started on how incompetently Microsoft handled the exact same information that Apple had access to. I was forced to use all the early Windows monstrosities during the time when Microsoft was trying to catch up. It wasn't until Windows 95 appeared, nine years later, that they had anything even remotely comparable to the Mac. Believe me. That time period, when Mac users cursed their incapable PCs at work, was when the cult of Mac was born.)

Anyway, I'm a happy Google user too, just far less emotionally attached. So let's just agree that both Google and Apple are very competent at what they do and that the world is better off thanks to their products. Ultimately we consumers are the winners if they keep competing for our business. Heck, I don't even mind an underdog like Microsoft in the fray. Competition is good.

Take care,...

Take note of the "emotionally attached" comment. I must commend this reader, for although he is (both admittedely and apparently strongly) emotionally attached to Appe (something I don't personally understand, but see often) he was able to make a logic-based decision to sell of the stock. Kudos! It may seem to some that he sold off early since Apple is now trading in the mid $300s, but no one can consistently time the markets perfectly and he used his head and locked in a spectacular gain (cost basis of $9, sold off at $230). Personally, I would have sold off to my cost basis or locked in gains with puts and/or calls, but he did an excellent job nonetheless. The lack of emotional attachment to Google would probably allow him to make even more empirical decisions regarding that company. It is my opinion that Apple is treading on dangerous ground right now. It is a fine, innovative company with slick product design and an uber sense of understanding its retail customer, but it also reaps the margin benefits of consumer ignorance in relation to the competitive advantages of the competition. Granted, that's the competition's fault and not Apple's. Apple now faces a new caliber of competitor in Google and its Android platform/open OS/revenue share model and now its a whole new ballgame.

From my most recent post on Shorting Apple...

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…