Archive for the ‘iOS’ Category

(NOTE: This article was published in Seek Alpha on April 19, 2022, sorry for my delay posting it here!)

SUMMARY:

  • Skillz (SKLZ) announced significant operating changes during their Q4 2021 earnings call, including material cost cutting having to do with ineffective marketing spend.
  • Cost cutting is critical.  But as important is cutting their excessive fee structure (i.e., their “vig”).  Because their problem isn’t getting betting players, but rather keeping them betting.
  • Reducing their dispiriting 50% betting fees to the industry standard 10% won’t affect revenues and could be key to creating sustainable profitability, possibly 1-2 years ahead of guidance.
  • I have a Strong Buy recommendation on SKLZ.
Thesis

Skillz (SKLZ) announced major operating changes in their Q4 2021 earnings call, including material cost cutting having to do with ineffective marketing spend. This cost cutting is critical. One doesn’t need to look past their Q4 2021 P&L results to figure this out.

But even with cost cutting, bears think this situation is unfixable.  That a lot of their revenues were due to “free money” promotions and cutting these will cause revenues to plummet and the company to still crash and burn.  Certainly the current share price reflects this.

But, tactically, the situation has a straightforward fix. Simply reduce the vig — that is, the fees Skillz charges bettors — from their current (and dispiriting) 50% to the industry standard 10%.  Change the vig, change the world.

Bears will counter getting less vig would cause revenues to drop even faster. But they won’t, because when you run the numbers, nothing happens. Well, check that, something important does happen: The revenues become recurring and sustaining.

For my first look at SKLZ, I wrote an overview piece on the company explaining why it was woefully misunderstood and undervalued and tagged it with a “Strong Buy” (and still have that rating). I did so because the company has just too many things going for it to be trading near gross cash levels, including scalable technology, sophisticated infrastructure, a large, established base of paying and non-paying players, a deal with the all-powerful NFL — and now the wildly-popular UFC — partnerships that are sure to attract other top brands, and 3/4 of a billion in gross cash in the bank. But most important for a growth company in this market: An achievable path to profitability.

But it doesn’t have profits right now, which is what the market wants to see. This article examines Skillz’s cost cutting in more detail and its potential effect on profitability, including ways to accelerate profitability 1-2 years ahead of guidance.

Understanding The Other Two Important Numbers In SKLZ’S P&L

Certainly revenues and profits are important numbers in any P&L. But what drives those numbers? And in particular, what drove the gaudy $155 million Skillz spent on Sales & Marketing in Q4 2021?

Two things: $85.6 million on New User Acquisition… and $56.7 million on Engagement Marketing. As the company acknowledged, “Candidly, we spent more than we should have in both user acquisition and engagement marketing in Q4”.

User Acquisition marketing costs in Q4 2021. (Skillz Q4 2021 Investor Day presentation materials.)

Engagement Marketing costs in Q4 2021. (Skillz Q4 2021 earnings press release.)

The company is now committed to cutting User Acquisition and Engagement Marketing costs.  Which is great and needed news.  But the relevant question is why did Skillz feel the need to spend all that money in the first place?

Of course there was great pressure to continue growing its player base.  Like many companies, Skillz was simply offering customer incentives in an effort to kick-start players… the same way it did all through 2021… only accelerated in Q4 in an effort to end the year with a bang.

However, what it really was doing — what it has been doing for a long time now — was trying to make a premium but non-standard fee structure work.  While throwing gobs of money at players did accelerate the top line for many quarters, the “easy money” environment was also distracting from what was happening to the bottom line: Trouncing it. 

Every company needs to incent customers, but after spending nearly half a billion on just marketing in 2021 — compared to less than $400 million for all of 2021 revenue — Skillz now has more than enough proof that its old approach doesn’t work.  Let’s talk about why.

Engagement Marketing That Didn’t Stand A Chance

I’ve always loved the old joke, “The beatings will continue until morale improves!” It kind of reminds me of Skillz pushing “promotional cash” at players and, like the joke, no matter how much promotional cash Skillz doled out, it just wasn’t improving the bottom line.

That’s because it’s not the amount of promotional cash that’s the main issue — that actually did a fine job getting players to open their wallets (as unnecessarily excessive as it was). It’s Skillz’s vig — their commission — that’s chasing away paying players once they start betting. It’s way too high.  Impossibly high.  It’s literally that simple. Change the vig, change the world.

Let’s review: The betting action in a Skillz game — for example, their new NFL 2-Minute Football — is intoxicating… addictive… exactly what you love to see in a legal vice investment. SKLZ is ringing the cash register twice every 60 seconds. Each player wagers a standard $0.60 “entry” fee and Skillz rakes $0.20 every game play. Betting players play on average almost a couple dozen games a day, so the games — and fees — add up fast.

Wow, sounds great if you can get it! But that’s the problem, Skillz isn’t getting it for very long. This is what a Skillz wager looks like to anyone that understands betting — like every NFL and UFC bettor in the world:

Standard bookmaker “vig” vs. Skillz. (The Lone Contrarian’s calculations.)

That graphic says it all, eh? It answers a lot of questions important to the success and/or viability of the business, for example:

Q: Why aren’t players buying in more (i.e., recurring revenue challenges)? 

A: Because it’s impossible to win when the house is taking 5x the standard % rake.

Q: Why was Skillz’s Engagement Marketing “free cash” promotions ineffective in incenting players to buy in again? 

A: Because whether I play with my money or their free cash, I’m going to stop betting once the money’s gone.  Impossible to win.  One and done.

Q: Why does Skillz have so many non-paying active players? 

A: Because players love their games, but not their fee structure… so when they’re done getting hit over the head with a 5x vig, they just continue playing for free. If you are a Skillz player, you know this to be true.

But this is easily fixable: Just change the vig.  That simple.  Change the vig, change the world.

Bears are probably screaming now, if you change the vig from 50% to the standard 10%, revenues will crater!

This is why I believe bears don’t really understand this company. That isn’t the way betting works.  That isn’t the way mobile gaming works.  That isn’t even the way the numbers work. Run the numbers, nothing changes. The revenues stay the same. Well, check that, something important does change, the revenues become recurring. The golden ticket to a sustainable business.

Let’s quickly look at the math: With a 50% vig (what Skillz has today), a $10 buy-in, and evenly-matched games, a bettor playing the $0.60 “Regular Season” game will win $0.40 half of the time and lose $0.60 half of the time. That’s an average loss of $0.10 every game. So $10 buys you 100 plays, not even a day’s action for some players.  And at the end of those 100 games, the house’s take is $10. Because the vig is so high — and it becomes apparent that it’s impossible to win — players don’t buy in again. But they do keep playing for free.

If we change the vig to 10%, guess what, the house’s take is still $10. The only difference is it takes more games for the house to earn the same amount of money… but — and this is the critical piece to understand — these are games that are going to played anyhow whether they’re betting games or on the free practice field… as evidence by Skillz’s sky-high 84% active-but-non-paying player percentage.  Changing the vig won’t even affect the performance of their network… because Skillz is already serving these games.

50% Vig vs. 10% Vig: The house earns the same either way. (The Lone Contrarian’s calculations.)

I’m sure Skillz was hoping it could charge a premium.  After all, what they’re doing is so new.  And exciting.  But it’s just not working.  Bettors know better.

Skillz seems to have forgotten the basis of what I consider its break-through business concept:  Instead of just making mobile games and struggling — like the zillions of other aspiring game developers — to charge for game play, they tried to solve that problem for the entire industry by creating a development platform that positioned game play as something brand new in gaming: A legal wager. Brilliant! 

But critical to that concept: A bettor wants to win money.  That’s why they’re betting.  But it’s virtually impossible to win against Skillz’s 5x rake in an evenly-matched game. Almost all of the players always lose.  And quickly.  So it can’t be anything else but one and done.  Because betting may not be the smartest thing to do, but even the craziest of bettors figure out when the deck is stacked so completely against them.

So Skillz built a fantastic company with fantastic technology and a fantastic infrastructure, all based on a brilliant idea, and they did all of that and then spent a huge amount of effort and time and cash just getting a player to the money table… only to… what?  Chase them away to the free games because of an impossible 5x rake?

It’s time to share the key insight here: Skillz players want to bet. They just invested a lot of time becoming hot stuff at a Skillz game.  All SKLZ has to do is not stack the deck against them.  Give them a standard vig — one that every bettor is used to — and one that’s been in use since betting was invented, a vig that every bettor thinks they can overcome.  If I don’t feel like the deck is stacked against me, I like to compete (that’s why I’m playing video games in the first place) so I’ll buy-in again… because playing for money is just more fun than playing for fun. Buying in again… and again… and again… is the very definition of healthy recurring revenues (as ironic as that may sound :).

The good news is Skillz can easily change their vig — without affecting revenues — literally overnight.  And the $56.7 million they spent on Q4 Engagement Marketing?  Most of that gets saved overnight, too.

From a revenue point-of-view, there’s another enthusiastically welcomed upside: SKLZ has 3 million active, non-paying players… and many might love to bet again if said deck wasn’t stacked against them. Bringing a big chunk of those 3 million active, non-paying players back into the betting fold would put a JOLT into revenues, eh?

But also MONUMENTALLY important:  Skillz must lower the vig before the mass of NFL bettors enter the picture. The sooner the better.  Because NFL bettors are savvy and won’t stand for paying a 5x rake. The NFL opportunity will otherwise be D.O.A. and Skillz will have snatched defeat from the jaws of victory.

We Don’t Need No Stinkin’ New Customers
Skillz Monthly Active Users exited Q4 2021. (Skillz Q4 2021 earnings press release.)

(* A nod to Mel Brook for a variation of a famous quote from his 70’s classic, Blazing Saddles. : )

Why did SKLZ spend almost $86 million on new customers when it has about 3 million unmonetized players — players who love their games enough to still play actively? They might have also forgotten that the easiest customer to get is an existing customer.

Let’s put this in perspective: If they figure out how to get 1-in-5 to pay the average, they could double revenues. Organically. Sustainably.  As suggested above, changing the vig can do this all by itself (and more). Change the vig, change the world. But there’s more revenue to be found here.

Because while this may sound odd to bettors, there are some people that don’t want to bet… they only want to play free games. So figure out how to make money from their free play.  It’s not like that’s new or anything, much of the mobile gaming industry already relies on monetizing free play. For example:

* How about that time-tested approach, having players watch a rewarded video before a free play? (Maybe give them a 30-day grace period, get ’em hooked, then start showing ads.)

* And that other time-tested approach, paying a cheap monthly subscription so you don’t have to watch ads. This is the subscription generation after all.

* In your multiplayer games, how about selling game skins, Leaderboard animations, dances, badges, and such? That seems to work nicely for free games like Fortnite.

* Even something as trivial as a tip jar can turn out to be a revenue contributor.

But maybe as important: How about creating new kinds of money games… designed to attract non-bettors?

Maybe enter a $1 non-bracketed tournament that happens every hour… where I can play 120 other evenly-matched competitors.  We all play three games and the top 10 averages divvy up $100… spreading it out a little bit just creates more excitement, happiness, and engagement.  Maybe the next 10 participants get Ticketz (Skillz’s virtual currency)… and  — as all gamers know — there are bragging rights for making a Top 20 Leaderboard.  As a player myself, I love those odds for a buck. I just took a break from writing this article, played three games, and kicked butt.

How about a “Daily Subscription Tournament”? Pay $9.99 and your subscription gets you into a month of daily non-bracketed tournaments — that’s just $0.33 a day. Same as above, everyone plays three games, but the top 10 averages divvy up $1,000 and the next 90 participants get Ticketz.  More bragging rights, happiness, and engagement.

Feel free to shorten the $1 Tourney cycle time, or run a different Subscription Tournament for each hour of the day as participation dictates.  By holding these daily tournaments, you just know I’m going to be on the free practice field a lot, so that supports the other monetization techniques discussed above, too.

With over 3 million active, non-paying players, Skillz doesn’t have to look beyond its own registration list to get new paying players. And shouldn’t. If for no other reason, they could have their hands full with new players come this fall when their NFL partnership kicks in. Right now, though, keep cutting most of your $85.6 million User Acquisition spend, it’s not needed. This literally could turn the entire quarter around by itself.

So What Does This All Mean For The Numbers?

Glad you asked. Here’s what 2022 Q4… Q3… or even Q2 could look like:

Back-Of-The-Envelope P&L Projections for SKLZ in some quarter of 2022 based on the actions suggested in this article. (The Lone Contrarian’s projected calculations.)

Same Back-Of-The-Envelope P&L Projections as above but without interest expense. (The Lone Contrarian’s projected calculations.)

Assumptions:

* Baseline revenues are Q4 2021’s RAEM (Revenue After Engagement Marketing) and to be conservative I assume no increase (vs. Skillz guidance of “above 30%” growth). Recall that this metric is essentially “net revenues,” i.e., doesn’t include any promotional money in the tally.

Reducing the vig means getting to invite past betting players to wager again. I’m assuming 1-in-5 will try their betting hand again… remember, these are players that want to bet again. So that doubles revenues to $104 million.

I am not, however, including any other recurring buy-ins, digital advertising revenues, newly created cash games, or any revenues from the NFL partnership. Note: I am not including these because the goal was to see the effect of cost-cutting activity on profitability.  Clearly, though, I feel strongly that all of these efforts can drive additional, significant revenues.

* I’m using costs from the December 2021 quarter as a baseline.

* Revenues are decreasing from Q4 2021 but we’ll still keep Cost of Revenues at Q4 2021 level.

* Baseline costs include a 10-15% increase in employee compensation, New User Acquisition cut by 80% (and, per company comments, Aarki to save 30% on the remaining 20% that is being spent), and Engagement Marketing cut by 80% (and Aarki again to save 30% on that remaining 20%, too).

* The company recently registered almost 16 million additional shares.

* I added $7.7 million per quarter for their Dec 2021 $300 million financing that carries a 10.25% interest rate.

* For this back-of-the-envelope exercise, I’m not including any “Change in fair value of common stock warrant liabilities”, “Other income (expense), net”, or “(Benefit) provision for income taxes”.

What’s It All Mean?

Profits!

OK, to be clear, it’s back-of-the-envelope and just $0.003 per share for whatever quarter they decide to change their vig, which isn’t even rounding error to a penny. But given that the average Wall Street analyst is predicting a loss of about -$0.15 per share per quarterany profit should quiet those that believe the company is going to run out of cash soon.

As important: Without their big interest payment, they have a profit per share of $0.02.

Fun to think what adding more recurring revenue (especially from the 3 million active but currently non-paying players), digital ad revenue, revenue from newly created cash games, and NFL revenue (!) can do to SKLZ’s top line.  Jumps by leaps and bounds, as does its bottom line.  But that is for a future article. 

But it all starts with reducing the vig. Change the vig, change SKLZ’s world.  In this case, the results could be moving up profitability guidance 1-2 years.

I like the Skillz exec team and for all I know they’re way ahead of me with all of this. Or have figured out an even better cost-cutting and monetization approach. But what I wanted to illustrate in this article is with just a few easy levers pulled, we can already see a dramatic difference to SKLZ’s bottom line in a short period of time.  It’s why I continue to think this company is woefully misunderstood and undervalued.

I think every American was heartened at the speed that the U.S., and the free world, levied sanctions on the totalitarian regime of Russia.

A few weeks ago, many said we couldn’t turn off Russia’s access to Swift, that would be the equivalent of an economic nuclear strike.

Then BAM! The EU said, “we’re doing this NOW, please join us.”

Many said we couldn’t stop buying Russian oil, because that would hurt the world, including the EU, way too much.

Then BAM! We stopped buying Russian oil.

Just a few weeks ago, who would have thought so many company would join the battle? Google. Facebook. Twitter. Visa. MasterCard. American Express. PayPal. Nike. Adidas. McDonald’s. Starbucks. Coke. Pepsi. Hundreds and hundreds more… all flipping the middle finger to Putin. In fact, if you haven’t stop doing business with Russia yet, something is wrong with you.

China’s reaction to all of this? Silence in the beginning. A lot of folks say that’s just their way, “to observe.”

I think it’s something different. That they originally thought what Putin thought: “No way the U.S. and the EU can ever get their stuff together to act in concert… and certainly whatever they do won’t have teeth.”

But both Putin and China were oh so wrong. The outpouring of support for Ukraine? STUNNING. BLINDING.

UNANIMOUS.

So China went from quiet cockiness to silent terror… now knowing that the free world has a NEW weapon against oppressors: We’ll just turn you off.

It couldn’t have happened 20 years ago… maybe not even 10… but now the world is really so interconnected, that it really is possible to, say, strangle Russia-the-dictatorship-that-oppresses-people to economic death.

With all this momentum, China realized it had to do something.

Of course they didn’t do what would have been truly helpful to peace… and that is whisper in Putin’s ear, “wtf, it didn’t work, stop acting like a madman!”

Instead it’s s-l-o-w-l-y been rolling out support for Russia over the last week or so. Essentially “reminding” everyone we need to de-escalate because it will further mess up global supply chains and such.

Boy, did Xi miscalculate on that one, too.

Talk turned today of “secondary sanctions” against China. If they’re still doing business with a murderous dictator that wants to take away others’ freedom, then maybe we’ll just turn China off, too.

My reaction?

YES! LET’S DO THAT! NOW!!

Then I got to thinking, why wouldn’t we do this? China is mostly a one-way relationship: They economically abuse us. And every time we ask them to play fair, they cry about it.

Then I got to thinking some more: Which American companies would get hurt by this?

And then it hit me: Apple. The world’s most valuable company. The company that derives 19% of its revenue from China. The company that makes almost HALF of their iPhones in China.

This would be an economic disaster of epic proportions for Apple stock.

And since virtually EVERY person on the planet either has money directly in Apple… or their mutual fund does… or their 401K does… or their bank does where they save their money… and so on…

… hurting Apple stock is akin to hurting every person on the planet.

I kid you not.

Remember the dotcom crash? It started (imho) because Microsoft and Intel, the two companies that used to financially represent everyone in the world, missed earnings numbers and sent shock waves through the financial markets. A history-making crash.

So it’s happened before.

We survived… but remember it was awfully rough for a while… and Microsoft stock price, literally, flat-lined for about the next decade.

If sanctions move to China — whether it’s for their support of Russia — or they start moving on Taiwan — I know every American will feel the way I do: YES! LET’S DO THAT! F*ck China. You sell to your oppressed people… and we’ll sell to the FREE world.

If that happens, I’m not sure Apple wouldn’t get caught in an awfully bloody crossfire.

This is not a Reuters headline you want to wake up to… being put on a Chinese “unreliable entity list.”

Looks like we’re heading for a showdown between everyone’s favorite American president and everyone’s favorite Chinese Communist Party.

And, unfortunately, Apple (AAPL) may be caught in the middle.

Ouch.

Well, that’s not a good headline.  More evidence that, in the short term, AAPL may have too much of a premium built in.

Here’s the link to ZeroHedge’s take on the new IDC global smartphone report.

Apple reporting earnings yesterday.

They beat significantly lowered expectations on top & bottom line.

How excited were analysts?  Not very.  Only a few upgraded price targets (a bearish sign), and then only by small amounts (also a bearish sign).

AAPL tried to rally… but couldn’t make it over $300… and fell back for a loss on the day.

There’s a reason why 80% of analysts CUT price targets going into earnings… because the virus has really bashed Apple. 

Here is the perspective:

Apple’s guidance for this quarter was a revenue range of $63b to $67b.

From Apple’s conference call yesterday, Tim Cook said:

Based on Apple’s performance during the first five weeks of the quarter, we were confident we were headed toward a record second quarter. At the very high end of our expectations.

That means they were on track for $67b.  But actually it probably means they were on track for $68b to $70b… since Apple is notorious for sandbagging guidance.

But, with the virus, they only logged $58b in revenues.  (Still a huge number, btw.)

Assuming even revenue distribution through the quarter, the $67b would have been about $22.3b per month… so theoretically the $58b was $22.3b + $22.3b + $13.4b, since the bulk of the virus problems hit in March.

So… if we take $13.4b as what they did in March… and assume an “uptick” for April (as Cook called it in the earnings call)… and assume things don’t really open up in U.S. or Europe until June… and assume a “normal” June… we could guess revenues might be $14b + $14b + $22.3b or about $50b…

… that’s if everything opens up in June and things go back to the “happy go lucky!” good times of Janurary.

Hello?  Are any of the Apple fanboys bidding up AAPL listening?  That’s still a big-ass revenue contraction… like 30% below a ballpark of what their pre-virus performance might have been… when the stock was hitting an all-time high of $327.85.

So why is AAPL currently trading just 10% below that now?

Because the reality of the next 1-2 quarters hasn’t sunk in for Apple investors yet.

Seems to me my simple, back-of-the-envelope hack calculations suggest AAPL should be down another 20%… or <$240.

And that’s not even including what happens if we see a second wave of infections… or if the market, which shot up in April, naturally cycles down 5-10% in May.

My 2 cents.

I’m a contrarian. It’s my observation that when everyone thinks one thing, the real, outsized opportunity is the other.

But what happens when everyone thinks one thing… but the market is thinking quite another?

Take AAPL. From a low of around $212 a month ago, it’s powered its way to almost $290. More impressively, just about 12% from its all-time high.

Heck, if you went way out on a limb, you could probably say that’s even within a normal trading range.  “Has the whole world stopped?  We didn’t notice!”

But all through this romp upwards, most Apple analysts have been decidedly negative.

Out of about 30 analyst moves in the last two months, a whopping 80% of them were downgrades.

To put this in context, Intel analysts were split 50/50 between upgrades and downgrades going into their earnings last Thursday.  So, relatively speaking, 80/20 to the negative side is a big spread.

 

 

As important, some of the AAPL downgrades were double downgrades… that is, a second price-target cut within just a few weeks.

So what’s the contrarian play here? Go against analysts and buy?  Or go against the market and short?

I think you go against the market. That’s the bigger “everyone” in this case.

Going against the market also seems, well, more rational to me.  I love Apple but I think the current market enthusiasm seems excessive given our uncertain environment:  Uncertain when lock-downs will end… uncertain that people will want to congregate at Apple Stores when they do… uncertain when we’ll see a vaccine… uncertain that a 2nd, or even 3rd, inflection wave may hit… and so on.

This uncertain environment is awesome for a select number of businesses… say Amazon and Netflix… but could be less kind to a (mostly) consumer hardware company like Apple.  Not that I’m not saying people can live without their iPhones — they can’t — but I am saying they may be less quick to buy $1,000 upgrades.

No doubt, what makes going against Apple scary is it’s one of a handful of companies that has the business levers to manage its way around a crisis like this.  And they are notorious for pulling rabbits-out-of-hats.

Still, a V-shaped recovery?  THE ENTIRE WORLD HAS SHUT DOWN.  Does a (mostly) consumer hardware company merit trading anywhere near an all-time high?  Does the market merit trading anywhere near an all-time high?  Somewhere in this equation there has to be some p-a-i-n.

I’m not the first person to say there’s a good chance we’ll see another downdraft.  So if Apple does surprise to the upside, AAPL could still take a tumble along with the rest of the market.  Nice to have a backup scenario in this situation.

P.S. A couple of other quick AAPL trading comments:

  • While Apple has done a terrific job moving into services, these are still only about 20% of company’s revenues. Meaning, Apple is still mostly a hardware company.
  • Intel, also a hardware company, has had a similar run-up as AAPL. Last Thursday INTC blew away their numbers, benefitting from the Coronavirus “work at home” situation. Apparently, with mobile being such a huge focus the last few years, home desktop machines have been ignored and needed updating.
  • In contrast, you don’t need to upgrade your iPhone to work at home.
  • One last data point: Even though Intel blew out numbers, INTC finished flat for the day.

Apple announced earnings today… they beat on top and bottom lines… and even though iPhone unit sales missed by a tad, average sales price crushed expectations.

Sounds good, right?

Not so fast.  Apple is DOWN almost 6.5% in the after market.

Yikes!

Turns out guidance came in a bit light.

And, Apple said it was going to stop reporting on unit sales, which — supposedly — signals to analysts less volume going forward.

Here’s what I think:

WHAT IS EVERYONE CRAZY?!

Apple just reported 40% earnings growth.  That’s right — 40%.  That’s spectacular for any company… but a company Apple’s size?  That’s p-h-e-n-o-m-e-n-a-l.

To put valuation in perspective:  Usually your P/E matches your earnings growth.  So if you are growing at 10%, you have a 10 P/E.  So if you’ve grown earnings by 40%, you should have a P/E of 40.

But that’s not the case for AAPL.  Apple has a trailing 20 P/E… or, even more amazing, just a forward 14 P/E.  Which means there is a case to be made that AAPL is undervalued… it could be trading 100% higher… or even 200% higher in some circles.

Further, with a company like Apple — that is, consistent… steady… predictable — is light guidance really an issue?  Especially given that Apple usually gives lighter guidance… and has been doing so since the days Steve ran the company?

I think not sharing iPhone unit totals is the real issue… and it’s not with investors… but with analysts that are tasked to create projection models.

Fair enough, it will make their job harder.

But, seriously, Apple is consistent… steady… predictable… AND growing earnings at 40%… and, btw, growing revenues at a whopping 20%, too… their job is already pretty straightforward.

So here’s what I also think:  AAPL may initially go lower… but at some point the investment community is going to say, “It’s the #1 product in the world, produced by the #1 brand in the world.  40% earnings growth means they continue to knock the cover off the ball.  Most of the macro economic indicators are still intact.  Uhm, are we daft?!”

That’s when the momentum will shift… and we’ll see AAPL move higher.

And, despite what will seem like a stock-crushing open, I think it could happen sometime tomorrow.

UPDATE:  Well, uhm, maybe next week.  :)

Apple (AAPL) reports after the bell today.

Everyone expects a miss.  Lots of people have already significantly cut iPhone and rev estimates.  The stock has already fallen about 10% (correction territory) in just the last two weeks… so a lot of negativity is already priced in.

On the other hand, what’s NOT priced in are two biggies:

(1)  Apple is going to talk about what it’s going to do with its MASSIVE repatriated cash horde.

I think this is going to be stunning… since I believe it may be the LARGEST cash repatriation EVER for a corporation.

All kinds of stock-positive things will be discussed… like significantly raising the dividend… or massively increasing buy backs… and so on.

So this will be a positive.

(2)  The market is so totally fixated on iPhone that it sometimes forgets that Apple has other massive businesses, too… like services… like Mac… like iPad… and so on.  And like the rest of tech this quarter, I think those will surprise to the upside as well.

So, my thoughts are these:

The bad news about iPhone is already mostly priced in, which I think minimizes or eliminates the downside.

The good news about repatriated cash usage and all the other Apple businesses are NOT priced in.

So I tend to think they’ll be more of an upside surprise than not.  Which is counter to the way everyone’s going into this earnings call.  As a contrarian, that’s scary but what I like as an investor.

A report out from Drexel Hamilton this morning about AAPL… his rationale sounds familar!

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Drexel Hamilton analyst Brian White (formerly at Cantor Fitzgerald) initiates coverage on Apple (NASDAQ: AAPL) with a Buy rating and a price target of $200.00 (Street High)

White highlighted:

  • The sharp correction in Apple’s stock this summer represents an attractive entry point as we believe fears surrounding China are overblown, concerns around difficult iPhone comparisons are short-sighted and the appreciation for the implications of this transformational super cycle is surprisingly muted.
  • Trading at just 8.2x our CY:16 EPS projection (ex-cash) and well below the 14.7x for the S&P 500 Index, Apple remains one of the most undervalued technology stocks in the world.
  • In our view, Apple’s successful transition to a larger form factor iPhone with the iPhone 6/6 Plus is the start of a sustainable upgrade cycle that has already catapulted the company to the #1 position in China’s smartphone market for the first time ever during 1Q:15 and we estimate the company will gain share in the global smartphone market in 2015.
  • Despite a slowing economic backdrop, our recent trip to China further supports our view that Apple fever is alive and well across the country. For example, we believe Apple is planning a bigger push into Tier 3-5 cities (80-90% of China’s households) across Mainland China over the next 12-24 months and the country’s 4G network is only 12% penetrated.
  • We expect the next big iPhone market that could open up for Apple is India and we view the country at a similar stage as China was for Apple in 2010. With a population of 1.25 billion, India is similar in size to China’s 1.36 billion and enjoys a wireless subscriber base of 980.8 million users as of the end of June (source: Telecom Regulatory Authority of India).
  • For the first time in five years, Apple entered into a new product category this year with the launch of Apple Watch in April, marking company’s initial push into the wearable technology market. We believe Apple Watch will be a major hit this holiday season.
  • In our view, Apple is innovating like never before with entry into the first new product category in five years with Apple Watch, the launch of new services such as Apple Pay, an expanded effort in the TV market with the all-new Apple TV and investment in big, new industries such as the auto market that we believe could eventually lead to an “Apple Car”.

Readers know I think Apple unleashing 11 million programmers onto TV is going to turn TV as we know it on its head… similar to what Apple did to the cell phone industry.

But I was stunned how surprised — excited — I was to see the new Apple TV Remote.

Why?

Because Apple just figured out how to unlock using the next generation of TV.

The last time they did that was with the gesture interface in the tablet category (iPad).

The time before they did that with the gesture interface in the cell category (iPhone).

And the time before that with the “thumb” interface in the digital “MP3” music player category (iPod).

So, the new Apple TV remote is a big deal.

While there is no doubt that Apple’s iOS development platform — and the legions of loyal Apple programmers creating zillions of phenomenal, mind-blowing, and ultimately incredibly useful apps — is the heart & soul behind Apple’s device success…

… in each case there had to be a simple, elegant interface to be able to use all of that goodness.

Today TV remotes absolutely suck.

Do I really need to prove that?  Just look at what’s sitting next to your TV.  Probably at least three remotes… all necessary at various points… and all with dozens of buttons that are impossible to use during nighttime viewing.

That is, unless you get one of the many universal remotes… which I swear are all harder to use than flying a small airplane.

It’s like using a PC… when all you really want is a Mac.

So from what I can tell from the announcement yesterday, Apple — once again — cracked the code on a huge new market.

They didn’t do it with some weird, “Minority Report” in-the-air, be-careful-if-you-sneeze-because-you’ll-change-channels interface.

They did it the Apple way:  Simple.  Elegant.  Useful.

As Tim Cook said, “The future of TV… is apps”… which is true…

… but what’s going to unlock that future is the new interface Apple just created, the new Apple TV Remote.

No one is really talking about what could potentially be MIND BLOWING at tomorrow’s big Apple announcement.

Sure, lots of talk about the next rev of iPhones.  And bigger iPads.  But Apple TV is relegated to back-of-the-bus stuff.

Why?  Because everyone had been expecting either (1) an actual Apple TV set, or (2) that whole “skinny” bundle cord-cutting thing… so they’re all somewhat disappointed.

But I think — rather, I’m hoping — everyone has it wrong.

And that is that Apple has created a product that will let Apple do to the TV experience that they did to the cell phone experience… and that is completely redefine what we expect from TV.

How will they do this?  By announcing “iOS TV”… essentially unleashing their 11 million or so iOS programmers on TV.

That would change the face of TV as we know it.

It’s been a really long time coming (here and here).  But, in about 24 hours, we could be saying once again, “Do you want to do this with your TV set?  Yep, there’s an app for that!”

People are weirded out because the iPhone “lost” its marketshare leadership position in China.  (Here.)

But are high-end products really supposed to be marketshare leaders?

I think not.

There’s not a business school prof or business textbook in the world that thinks so, either.

What investors should be focusing on is not that Apple “lost” their #1 marketshare ranking…

… but rather how utterly amazing it is that the high-end supplier in the market is anywhere close to the #1 ranking…

… especially during their OFF-CYCLE!

Now that speaks to the phenomenal momentum Apple has in China.

I can’t understand why AAPL recently touched $110 and isn’t instead cruisin’ up to the $140’s by now.

I mean, I intellectually understand why people might be worried about China…

…. but not really…

… the China stock market “crash” happened so fast I can’t believe anyone actually noticed.  Even with the crash, the market is still up about a third year-over-year, so most investors (as opposed to traders) are still holding on to nice gains.  But to further minimize any effect on the Chinese consumer, 90% of Chinese households don’t even own stock.

On the other hand, there are some pretty irresistible AAPL drivers right now, including:

  •  AAPL has a consensus P/E of 12.7 vs. 17.7 for the S&P… however, Apple is increasing EPS a whopping 45% vs. a paltry 7.9% for the S&P… hardly seems fair, eh?
  • AAPL has upgraded only 27% of their existing iPhone installed base… which gives them a lot of room for continued organic growth
  • AAPL still has very large external targets, though… for example, India… and a bunch of unhappy Android users
  • Oh, yeah, AAPL has other billion dollar products, too
  • AAPL may be set to release iOS TV… which could do to the TV biz what the iPhone did to the cell biz… which is, of course, completely turn a huge, massive industry on its ear
  • AAPL has more money in the bank than, well, everyone

.

All of which is why — with full disclosure! — I’m back on the AAPL bandwagon.  <smile>

One of the raps on AAPL is that everyone and their mother owns it… as in, there’s no one left to buy it… and if that is the case, how does the stock go up?

One way to evaluate ownership is to see how much hedge funds own.  Presumably, these are the world’s smartest investors.  Definitely, a lot of money is consolidated into a relatively few hands and their purchases tend to move the stock price needle (so to speak).

From the latest data, hedge funds collectively own 5.8% of all publicly traded companies.

But, together, they only own about 2.9% of AAPL… 50% underweight the market.

That makes sense.  Money people rang the cash register after the terrific 2014 run.  After all, they don’t get bonuses unless they book profit.

But even that 2.9% figure is skewed.  Turns out a big chunk of hedge fund ownership is held by Carl Icahn… which means that net Icahn, most hedge funds own even less of Apple…

… which means there are definitely still impactful potential buyers for Apple on the sidelines.

And why would they buy?

Lots of good business reasons… but probably the biggest is the ole’ swinging pendulum… like a moth to a flame, they’re all looking how “cheap” AAPL is… how exciting the upcoming iPhone upgrade cycle will be… maybe the introduction of a real, live iOS TV (i.e., my daughter spending a lot of money on TV apps like she does on iPhone apps)… and they won’t be able to resist… they’ll start piling into AAPL… again.

People say that people are waiting until the new year to sell AAPL… which makes some sense in that capital gains can be deferred by a year… but a few things trouble me about this conventional wisdom.

First, your average AAPL investor is in it for the long haul… so selling, regardless of the timing, is generally something they don’t consider.

Next, we had three big dips in December… the flash crash… a big one a few weeks ago (with AAPL trading down to 106)… and the one we just finished the 2014 with (to 110).  Telling, of course, that each successive dip was shallower (as a percentage) than the previous dip.

So here’s what I think is happening:  Big funds cashed out of AAPL in December… so they could lock in profits… so they could lock in their bonuses.

And here’s what I think is going to happen:  While there might actually be some minor tax-planned selling in January, I believe those same funds that sold AAPL in December (to lock in bonuses) won’t be able to stay away from the anticipation of blow out earnings for AAPL in January.

So, look for AAPL to rise in January.

P.S.  Hope next year is the very best 2015 ever for everyone!

Misleading headlines happen all the time.

The big headline this morning from the Wall Street Journal:

Larger Apple iPad to Be Delayed

That’s what everyone picked up.  You might think, “wow, Apple’s really blowing it… yet another problem!”

If you read the article, though… or even just the subhead below the headline:

Apple Suppliers Concentrating on Meeting Demand for New iPhones

… you’ll find the real reason for a potential delay:  Because they’re swamped just trying to fill iPhone demand.

That’s a tremendous problem to have… unfortunately you’d never pick that up from the headline.

 

UPDATE:  Someone finally got it right!  From the BusinessInsider:

Apple Delays Plan To Make A Giant iPad So It Can Pump Out More iPhones

See the difference?  One suggests something negative… the other gets to the heart of the story — that overwhelming demand for the iPhone is causing Apple to juggle manufacturing — something that is clearly positive in the big picture.

 

What has always amazed me is how quickly — even viciously — sentiment can change.

Yesterday… even this morning… AAPL just felt… stuck.

Truth is, AAPL has been treading water for about three months now.

Certainly it’s had its share of outstanding news… but in the battle of bulls vs. bears, the bears were able to make the most out of some pretty flimsy stuff over the last month… iPhone’s bending (a grand total of 9 out of 10,000,000)… iOS 8 growing pains (pretty standard for any major new OS)… China getting delayed (until next week, not 2015 as they were suggesting)… downgrades that weren’t downgrades (someone lowered their target price above the current AAPL share price and still called it a downgrade?)… and so on.

I have to admit that yesterday, as the market was tanking, things felt a bit bleak.

Maybe that’s what they mean by “capitulation”?

Because… just a few hours later… AAPL now feels like it’s ready to e-x-p-l-o-d-e.

Here’s what is different:

(1)  Carl Icahn announced that he’s going to start being an activist pain-in-the-ass again.  Wall Street bulls love when he does that… and no one seems to do it better than Carl these days.

(2)  Apple — for the first time ever — is one of the top 5 suppliers of PC products.  Not bad for an after-thought business.

(3)  While the PC numbers aren’t the major earnings driver at Apple, I think a few analysts may take the time to raise overall estimates yet again… and this time include the somewhat overlooked fact that iPhone 6 demand in China is through the roof.

(4)  There’s a big announcement October 16th… most people think it’s to refresh the iPad and laptop line-up… but some news sources are saying that we’re about to get… Apple TV… !  Anyone that reads my blog know I think this is the next major, major, major revenue driver for Apple.

(5)  All of this drives (frenzies?) into AAPL earnings on Monday, October 20th… which is about as big an event as there is on Wall Street.

I always believe things swing too far in any one direction.  The last three weeks have been downers for the major markets.  Given the Fed comments today, I think we’ll see things swing in the other direction for a bit… which, adding that to the five points above, means I think AAPL is going to go on a mini tear.

 

 UPDATE:  Oppenheimer looks to be the first firm out-of-the-gate to raise AAPL estimates… and up price target to $115.

Could It Be… Apple TV?

Posted: October 8, 2014 in Apple, Apple TV, Business, Farros, iOS, Royal

Could it be… Apple TV?

From Investor’s Business Daily:

Long-rumored Apple TV app store could be reality soon

I’ve written about this for a while (here and here)…

… like AAPL did to the entire cellular phone industry, I’ve been eagerly awaiting when APPL turns the even-more-massive broadcast world on its head.

Maybe sooner than later?

 

There’s a great maxim in investing:  Buy the rumor and sell the news.

It means that things go up in anticipation… but when the news is released, reality usually puts the hype in perspective.

It will be interesting to see “if it’s different this time” (so to speak)… that is, if AAPL keeps rising after the expected September 9th iPhone 6 introduction.

I think it will.

Because Apple isn’t making just one introduction this year… they have more queued up… the iWatch… a payment system… and — hopefully before it’s too late — iOS TV.

Even the iPhone 6 could be a multiple shot… since everyone in the world will be speculating how many zillions they sold in the first 30 seconds of introduction… over the first weekend… by the end of the year… etc.

Guess we’ll know the answer soon enough.

Disclaimer:  I continue to be on an AAPL bandwagon… sorry in advance!

Just read a Motley Fool piece entitled, “Samsung’s CFO Said Something That Might Concern Apple Shareholders.

The article suggests that if Samsung is having mobile problems (particularly in emerging markets), maybe Apple could be, too?  That’s certainly a reasonable suggestion.

But, what the article doesn’t even contemplate is this:  Maybe Apple is gaining marketshare?

Wasn’t AAPL’s last quarter bolstered by some smart discounting in the emerging markets?  Maybe that good trend is continuing?

But from the bigger picture point-of-view:  Does anyone really think the mobile business is slowing down?

Like clothes and food and water, mobile is the one thing that everyone on the entire face of the planet really, truly might have to buy… and given the changing nature of technology, apparently buy over and over again.

Except, unlike clothes and food and water, which you can buy from literally about a zillion companies… it feels like you can only buy mobile from two places right now:  Apple and Samsung.

(Take a step back for a moment… that’s a pretty freakin’ amazing statement to make… no wonder Apple is the world’s most valuable company.)

So… when the CFO of Samsung says their quarter isn’t “look[ing] too good,” I kinda read that differently than Sam at The Motley Fool.  What this suggests to me is that AAPL’s upcoming quarter might not be as “throw away” as a lot of people think.  I believe AAPL has meandered downwards over the last few weeks exactly because of this type of erroneous thinking.

If Apple, indeed, pulls another rabbit out of its hat (like it did last quarter), that could set up another potential earnings pop… unless, of course, AAPL starts climbing in anticipation of that beforehand.

Either way, I think we’re higher by 5-10% after quarterly earnings than we are now ($91.98), especially after touching the $80’s last week.

We’ll see.

At the risk of becoming, “All Apple All The Time”… I will share with you the approach Daniel Sparks over at The Motley Fool just took evaluating AAPL:

As I attempted to make the doom-and-gloom case for Apple stock at $91.28, I kept running into walls.

So he threw it out to readers to chime in… here’s what I had to say:

 

I love the approach of this article, thank you.

I’m most worried about upcoming earnings.  Even though recent inventory checks seem bullish for the quarter, common sense tells me that people really may be waiting for the iPhone 6 (I am)… that’s gotta hurt on some level.

On a macro level, I’m worried about a war breaking out… or oil spiking to $140… or some such… which, of course, would spook the entire market.

I also worry that AAPL could shoot itself in the foot and make a dud product… Newton, anyone?  Specifically Apple could underpower the iPhone 6 relative to Android devices… they seem to do that… and at some point that will catch up with them.  I also think Apple made a user interface mistake taking away the “button” controls in iOS7… used to be easy to know what to tap… now it’s a bit more guesswork… the point is that Apple isn’t infallible and we may see things get more complex, not less… which could hurt adoption.

Finally, I worry about contrarian things… everybody really is jumping on the bandwagon… you know it’s bad when even an author has to resort to a bear challenge!

 

With all of that said, I can easily see — actually do see — the counters to all of these.

Fewer iPhone 5’s sold could just as easily mean even more iPhone 6’s will be sold.  In that contrarian way, a net positive.

When war breaks out, that reduces uncertainty… and generally speaking people look for a “flight to quality.”  Another net positive.  (Though, if oil misbehaves, that’s an entirely different story… that’s one to watch for the entire market.)

And Apple has already shown people a lot of iOS 8… and we know from the history of Apple laptops, Apple will figure out that smokin’ fast hardware will count in mobile, too.

More to the point:  AAPL has been in the penalty box for so long that the stock really has been depressed for years… if you normalize the terrific gains over the last year with the disappointing performance over the last few years, the chart kind of suggests Apple ends up where it should be… with the trajectory still aiming high and to the right.  Given I’m a big believer in the pendulum swinging too far in any direction, I don’t think we’re at “enough” yet… because even a mediocre iPhone 6 upgrade cycle will be staggering… and if you throw on an iWatch (personal health/info development platform), iTV (entertainment development platform), and maybe a massively-connected payment system and such…

… it’s just hard to see — given that Apple is one of the top brands and cash machines in the entire world — AAPL *crawling* into simple p/e parity with the rest of S&P as being crazy.

Just p/e parity alone represents about a 24% increase in stock price… or up to just under $115 a share.  For a company that arguably is the most relevant in its growing space, does $115 feel so far from where we are?  Not really.

Imagine what AAPL can be worth if actually gets a multiple it deserves… ?

Arg, I’m not sure I was very helpful to the bear case, sorry!

I haven’t been a fan of the iWatch.  Well, I mean, it’s not bad… I just didn’t see how it was going to move the needle.

Until now.

I had an epiphany.

It’s not a “watch”… duh… but a wearable computer… duh again.

My epiphany, though, was about why I would need a wearable computer:  Because I’m currently wearing pants without pockets… which is forcing me to actually carry my smart phone in my hand with me… and place it vulnerably on a table in a public place… to keep it in earshot because I need to hear an upcoming meeting reminder alert.

Bingo.

A wearable computer.  No more carrying in hand.  No more carrying bulgingly in a back pocket.  No more fishing it out of a purse.

Now I get it.  <smile>

A picture from the keynote at the World Wide Developers Conference… this doesn’t look like any iPhone Apple currently sells… and I haven’t seen a single report commenting on this new chassis… which was followed by a screen of a real iPhone 5S a few moments later.

Where are all the conspiracy theorists when you need them?! <smile>

WWDC

Hard not to get excited by all the Apple activity.  Very cool that one of the very oldest tech companies is still one of the most relevant.

Problem has been that Apple has been in the penalty box for the last few years… people have been waiting and waiting and waiting for the “next big thing.”

It’s Apple’s fault.  They’ve certainly teased the market… Tim Cook hasn’t been shy about saying how excited he is about R&D quarter after quarter after quarter.

Somehow it now feels a bit different.  Other key execs are now very publicly making rather bold statements:

Later this year, we’ve got the best product pipeline that I’ve seen in my 25 years at Apple.”  

— Eddy Cue, Apple’s senior vice president of internet software and service, at a tech conference on Wednesday

I’m not crazy that he qualified the statement with “Later this year”… something almost everyone reporting on the statement seemed to gloss over.  But I still think it’s a significant statement… and significant that there is finally some kind of timeframe associated with whatever the heck they’ve been working on for the last four years since the introduction of their last great product the iPad.

What might he mean?

The easy guess is the iPhone 6.  That upgrade cycle — probably the biggest in smart phone history — could easily take Apple to $700.

“Pipeline” is usually plural, though, meaning we should see other announcements before year’s end.

Tons of rehashed speculation about these — a payment system (big), better iCloud (bigger), and an iWatch (not so big) — but my personal favorite is that Apple really, truly, finally releases an iOS development platform for “Everything Not Mobile”… also being referred to today as the “Internet of Things.”  i.e., your family big screen TV — decidedly not a mobile device — will be the center of your home’s universe, including, of course, completely reinventing the home entertainment experience.  (Here and here.  And you thought Apple was only building a cool-looking TV. <smile>)

That kind of pipeline could make AAPL skip all the way up to $833.

Normally I would say a 200 point jump from today’s closing of 633 is unrealistic in any kind of short or medium-term timeframe.

But, here’s the thing about any big stock split — like the very one they’re doing next week that will most likely take the stock to $90 — $90 to $119 doesn’t seem like such a big moveon the contrary, that seems rather normal for a company on the move…

… which is why I think AAPL will surprise everyone, even the most hardcore fanboys out there… and especially those folks that like the number “33.” <g>

 

P.S.  My $833 number isn’t just simple psychology… there’s math behind it, too.

Measured by P/E, Apple has famously been trading at about a third discount to the average S&P stock for a couple years now — even below its own perennial average — that penalty box mentioned above.

Which I have to say is weird.  Even at its low point, Apple continued to be the strongest brand — and one of the most phenomenal cash-generating machines — in the world.  Surely that merits at least “average”?  Average gets AAPL into the 800’s.

But maybe more important, because of its massively spectacular run between 2004 and 2012 — something like a 50x return (!) — everyone on the planet ended up owning AAPL for a long time.

Two things were apparent:  (1) If everyone already owned Apple, no one was left to buy Apple… as in bid up the price.  And (2) people were naturally itching to take profits.

Given those factors, you only need a spark to send a stock in the opposite direction.  That spark — JOLT — came as Android proved to be a real competitor… and when Apple’s “next big thing” always seemed to be “next quarter”… quarter after quarter after quarter.

The confluence of all of those things meant that people had enough and bailed… resulting in an almost 50% decline in stock price… a thorough thrashing in 2012 and 2013.

Which gets me to my point:  There are now lots of buyers on the sidelines… and the stock will doubtlessly run as everyone ventures back in.  The fact that the stock will be “cheaper” after the split means even the little guy will feel like they can participate, too.

Indeed, momentum is a powerful force… both in nature and on Wall Street.

Which leads me to an investment philosophy I have that applies to this situation:  The pendulum always swings too far.  As I believe Apple stock will in this situation, too.

I now completely, totally get why Apple shareholders are frustrated with Apple.

Almost one year ago I wrote, “So Now I Get Apple’s Next Revenue Driver… It Will Be Amazing.”  It was then that I figured out Apple TV wasn’t going to be “just another pretty TV”…

…but an iOS development platform that will allow throngs of smart and eager programmers to reinvent TV in the same way as the iPhone reinvented — turned on its head — the entire cell phone industry.

can’t wait for Apple to unleash the iOS programming masses on the TV business.

And I mean that literally… what the hell is Apple waiting for??

A year ago they had already been working on it for years.  They already have the development platform (iOS)… they already have the throngs of smart and eager programmers…

… every day delayed is another day Google/Android is getting its stuff together… as evidenced by the banging Apple has taken in iPhone marketshare over the last two years.

Apple, this is your next big thing.  It’s frustrating — actually, unbelievable — that you may actually squander this golden opportunity.