Tuesday, February 2, 2016

APPLE & THE NARRATIVE (II)

Here's the second article on Apple and the narrative. Richard Waters: "Apple flitchs the wrong switch", Financial Times, January 29, 2016

Sometimes, giving investors extra insight into a promising new line of business works wonders with Wall Street. But sometimes it does not — as Apple has found to its cost this week. Getting the trick right is of special concern in the technology sector, where established businesses often mature quickly. Having a new story to tell can help investors look beyond a company’s plateauing fortunes. When it comes to using extra financial disclosure to change perceptions, Amazon has become the tech world’s gold standard — somewhat ironically, given its reputation for secrecy. Since it first revealed details last April about Amazon Web Services, its cloud computing sideline, the company’s stock market value has risen by nearly $100bn. Amazon waited until the business was both sizeable and unexpectedly profitable before lifting the lid.

Alphabet, the holding company for Google, has achieved a similar effect with the promise to break out its non-search businesses with its next results on Monday. The purpose here is different: to show off the strength of its core search operation and to demonstrate greater discipline by not shielding the losses of its other activities. But when it comes to Apple, the magic has worn thin. The company’s attempt to draw attention to its services business — which, at $6bn in the latest quarter, produced more in revenue than Amazon Web Services for the first nine months of last year — did nothing to prevent a near-7 per cent slump in the share price on Wednesday. Much comes down to timing. Amazon and Google prepared Wall Street carefully, stoking anticipation for months. Apple, by contrast, dropped its news unexpectedly on a wary investor base. It was hardly surprising that Wall Street chose to see the extra, unexpected disclosure as an attempt to distract attention from what is set to become the first contraction in iPhone sales

The data presentation also seemed halfhearted. Apple executives sought to compare their services business with that of a sizeable, freestanding internet company. But they made little attempt to explain a grab bag of businesses that make up what the company calls its “installed base related revenue” (IBRR). These range from the net revenue on App Store sales to supplying replacement iPhone screens and licensing its brand to accessory makers. But Apple declined to lay out a bigger vision for how the services business was likely to evolve. It also did little to counter perceptions that glitches in areas such as its maps app and iCloud back-up and syncing service showed it had yet to match a pure internet company such as Google in terms of quality and reliability.

In the absence of a clear explanation, investors have therefore chosen to view Apple’s service business in the same light as those from hardware makers such as Xerox: a potentially profitable supplement to the core business, but not something likely to grow into a major revenue source that justifies a premium valuation. Despite the shortcomings, services are likely to remain a high-growth bright spot for Apple, not just in the rest of 2016 but for a considerable period of time. That is partly because of slowing hardware growth. Global smartphone shipments will rise at an average annual rate of around 7 per cent in the medium term, according to research firm IDC. Falling prices will put a lid on overall revenue growth, and economic uncertainty threatens the premium end of the market. With little sign that products such as television set-top boxes and smartwatches will become sizeable new hardware categories in their own right, the attractions of services will loom ever larger.

The gatekeeper status conferred by the App Store is already significant. Apple paid more than $14bn last year to app developers and companies selling content through iTunes, an increase of 36 per cent. If it takes around a 30 per cent commission on these sales, then the App Store and iTunes accounted for more than a third of the money it made last year from selling things to its installed base, and virtually all of the growth. This income source will loom larger as it grows, eclipsing other businesses with less potential. It looks like a promising sign of what could grow into a meaningful source of profits. But the reaction to Apple’s disclosures this week suggests that investors do not believe the company is ready to move decisively beyond its hardware business model.
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