Apple – Reinventing the whale

    Over the last several months, the market capitalization of Apple shares has increased by approximately the entire GDP of Malaysia. This hype was because of its supposed new Apple 3.0 strategy - a media services company that would not be affected by the vagaries of the smartphone market. However, in the coming weeks we will find out whether this could be sustained or this turned out to be the biggest short opportunity of the year.

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    Credits: ZDnet

    On 02 January 2019, after the close of business, Apple shocked the investing world when it announced  that it was expecting a worse than forecast results for its December year end quarter. During Apple’s  November 2018  earnings call, the company  had forecast sales of between $89 – $93 billion, or $91 billion as its midpoint, which is frequently used by traders to determine whether or not the company “beat” or “missed” revenue expectations. The midpoint represented a 3% increase in the preceding year’s sales for that quarter.

    It later announced on 02 Jan 19  that it revised its sales estimates downwards to $84 billion, $5 billion below lowest estimate of $89 billion and $7 billion below its midpoint estimate. Percentage wise, this was -5.6% below its lowest estimate and -7.7% below its midpoint sales estimate. Its shares shed $15 that day, closing at $142. On paper, that represented a loss of about 10% or $72 billion.

    In his letter to shareholders, Apple CEO Tim Cook blamed the decline in sales due to the following factors – (1) slowdown in demand in China, (2) earlier shipments of its top selling premium smartphones that placed the sales in the preceding quarter and (3) the strong US dollar.

    Subsequently, on its earning call on Jan 29 2019, Apple gave guidance that the sales for the Jan – Mar ‘19 quarter would come in between $55 billion – $59 billion, with a midpoint of $57 billion. At $57 billion, sales would be -6.7% below its previous year’s sales for the same quarter of $61.1 billion. At the lower end of $55 billion for the quarter ended in Mar ‘19, this would be -10% below its sales for the quarter ended in Mar ‘18. Gross margin was estimated at 37 – 38%.

    However, Apple shareholders who did not sell on that fateful day in January were actually rewarded because Apple shares gained a whopping $48, or about  $229 billion in market value over the next several weeks. It closed trading on Friday at the price of $190. To give you some perspective, in 3 months Apple increased its market capitalisation by an amount equivalent to the entire market capitalisation of Citigroup and Caterpillar combined. The current market capitalisation of Apple is $896 billion.

    Part of this reason was that Apple engaged in a massive media blitz to promote an important corporate event that took place last Monday on March 25, 2019.  Many investors were wondering what was it that Apple was going to announce and decided to buy the shares to avoid the Fear Of Missing Out (FOMO) , in case it was something truly special that would send the shares to the stratosphere. Some speculated that it will be a massive new media service, a new product or something that will dazzle the imagination. Few dared to bet against Apple for fear that Apple bull investors will be so taken up by this new service that the stock will zoom ahead to over  $200.

    Oprah Winfrey will create original content for Apple new service – tv+. But her endorsement did not manage to save Weight Watchers, a stock of about $1.5 billion market cap. Will she be able to save Apple?

    So the event last Monday came and went. There was Steven Spielberg and more importantly, there was Oprah Winfrey.  This was the reaction by one CNBC reporter:

      • Apple has been talking up the importance of services to its business on earnings calls for the last two years.
      • Monday is supposed to be the big coming-out party for new services that would drive this strategy, but Apple does not announce pricing for many of them, including video.
      • The entire event feels rushed and incomplete.

    Monday’s event was supposed to be the big coming-out party for this services vision.

    But if Apple v.3 is going to change the way investors value Apple, they’ll need more answers than Cook gave Monday. Apple was so sparse on key details around its video and news services that it felt like Apple had rushed the event or was waiting on a critical deal that never came through.

    Apple introduced Apple TV+, its subscription video service for original programs, and showcased a handful of series starring Jennifer Aniston, Kumail Nanjiani and Oprah Winfrey.”

    See link here:

    Pause.

    In one word : underwhelming.

    The only logical reaction to such a letdown would be to hit the sell button. Aggressively and repeatedly.  On that day, Apple shares did tumble about $7 to $186, but it regained to $188. This was done on a volume of 50 million shares. However after that day, when you would expect to see a more violent reaction, Apple shares were extremely stable and over the week it was very clear to everybody in the market that Apple had a major support at $188. By support,  it means that if the price went below $188, then there will be huge buy orders to bring the price back above $188. By Friday this support level moved up slightly to $188.6.

    For example, on 27 Mar ‘19 (last Wednesday), the Dow Jones and the Nasdaq sold aggressively during the morning session, with the Nasday down 90 points at one time. Big tech companies like Microsoft sold down consistent with a volatile session but Apple stock did not budge below the $188 barrier for a long time. When it finally broke below $188, the joy of the short sellers was short lived as the shares pulled back almost immediately i.e within an hour.

    When we look at the short sales, it becomes clearer. Short sellers profit when the share price goes down. On Monday to Wednesday, the average short sale volume was about 9.7 million shares. On Thursday to Friday, it dropped to 4.5 million shares.

    The reason I think is due to this major $188 support level. What this means is that there is a “big” buy order at $188 per share, big enough to absorb millions shares worth billions of dollars. The order is probably at least $10 to $15 billion in size, which could support about a volume of 70 million shares. Even worse for the short seller is that if the initial support is breached, a new buying order  could be triggered that will push the price back up. Only a  mad person would dare pick a fight against a stock backed by such strong support levels.

     This reminds me of the case of the London Whale, a JP Morgan credit trader in the UK who traded aggressively and made others afraid to bet against him. In the case of the London whale it worked for some time, until it didn’t and JP Morgan ended up with a $6.2 billion loss. Actually JP Morgan was lucky,  if things went sour the bank could have gone underwater.

    So who could this be?

    It is probably not Warren Buffet, one of the largest shareholders in Apple because he had deemed the price at about $171 to be its fair value. And Buffet did mention that Berkshire has  no interest in increasing its stake in Apple.

    Well, the biggest suspect should probably be Apple itself. Apple is notorious for using its vast cash reserves to buy back its shares. Let’s give an idea how big it could be.

    In the quarter ended Dec 31, 2019 Apple repurchased $8.9 billion of its stock. If you think that is a big number, consider that in its Annual Report issued a quarter earlier, Apple could still repurchase $70.9 billion of its stock under its buyback program. This means that Apple entered the Jan to Mar 19 quarter with enough “ammunition” to repurchase $62 billion of its stock. And in case if you were wondering, yes – Apple has net  cash (that means cash minus debt) of $130 billion. So it could easily put in a buy order of lets say $20 to $30 billion at a certain price point and still have room to spare.

    However, there is a catch to this and it goes back to the 3 reasons cited in Tim Cook’s letter to shareholders on 02nd Jan 2019, warning them of worse than expected results.

    (1) Slowdown in demand in China,

    (2) Earlier shipments of its top selling premium smartphones that placed the sales in the preceding quarter and

    (3) The strong US dollar.

    Unfortunately for Apple, factor (1) and factor (2) has gone worse over the quarter.

    Slowdown in demand in China

    The slowdown in demand in China is not only due to saturation of smartphones but Chinese consumers actively deciding to support Huawei in retaliation to perceived US injustice towards the Huawei CFO.  This means that American brands like Apple would be punished severely as it will be considered “bad manners” to be seen with an Apple iPhone in a society known for its nationalistic views.

    Earlier shipments of its top selling premium smartphone

    This is also bad for Apple as its premium iPhone, the iPhone X would now be considered 2 quarters “old” and not as new as the latest releases from Huawei and Samsung.

     

    To that, we may even add to other factors

    Slowdown of demand in Europe and Slowdown in demand in the United States.

    In the US, consumer confidence took a hit in February and the overall imports decreased in Jan. This is not good for Apple, as even though Apple is a US firm, the iPhone is actually manufactured in China, which means that it will count towards imports to the US.

    This perhaps makes the entire rationale for the rushed Mar 25 event more logical. Apple may have known that it could post worse than expected financial results for the Jan – Mar ‘19 quarter due to the slowdown in iPhone sales. The only way was to try to get the market to think that Apple was now a services company or a media company or a media – services company so that it won’t get punished by the stock market. It also put in a massive support level at $188 to discourage short sellers from entering into positions.

    Well all of this is conjecture right now, but we will see over the next several days. If Apple does not come out with any statement next week, then it is safe to assume that sales was between the estimates made, or in the worst case only slightly off. If not, then we may see this:-

    Apple shares could tumble by 20% if sales are below $52 billion. Our estimate is sales of about $51 billion and gross margin at about 33%.
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