Weekly reading – 5th November 2022

What I wrote last week

Apple Earnings

Small but important things


How Google’s Ad Business Funds Disinformation Around the World. A large scale investigation into how Google’s Ads benefit sites that distribute misinformation in non-English speaking countries. I understand that this problem is not easy, but Google is known for engineering prowess and this is an engineering problem. If ads still shows up on sites flagged as misinformers, it’s because someone decides to turn a blind eye on them. “ProPublica also scanned close to 10,000 active articles that fact checkers in the three Balkan countries flagged for false claims since 2019. Just over 60% were earning money with Google. The articles included a range of falsehoods about national politics, the pandemic, vaccines, the war in Ukraine and other topics. Dejan Petar Zlatanovic operates Srbin.info, a Serbian website that publishes pro-Kremlin propaganda copied from Russian state media, election conspiracies about the U.S. and anti-LGBTQ content. Its homepage features a prominent hyperlink directly to the official Kremlin website. Google ads abound there and on article pages. Zlatanovic said in an email that Srbin.info earns between $5,000 and $7,000 per month, with Google ads providing a key portion of the revenue.

The Hype Cycles of Venture Capital. Our society praises monumental wins of venture capitalists passionately and holds those men and women in high regard. But I don’t see the same vigor in criticisms when they fumble millions of capital on new, exciting and…useless ideas. Anyone remember Clubhouse? Or Bird?

Inflation – Stealing From Savers. The headline is that inflation is not going away any time soon and investors will have a hard time to earn sizable returns

After leading $20 billion Figma deal, Adobe’s David Wadhwani is in prime spot to be next CEO. As an Adobe shareholder, I feel good reading this article. Who’s better to succeed the current CEO than the guy championing the subscription business model and having the credentials of leading AppDynamics to be acquired by Cisco.

($) Big Tech’s Dirty Supply Chains Undercut Climate Promises From HQ. “Amazon.com Inc., Microsoft Corp. and Alphabet Inc. have pledged to run their own operations on 100% clean power. But their suppliers — the lesser known companies that make the key components of hit products like the Kindle, the Xbox or Pixel mobiles — remain deeply reliant on fossil fuels. Twelve of the 14 top suppliers get on average 5.4% of their energy from renewable sources or don’t disclose, data from a Greenpeace report released Friday showed. Taiwan’s TSMC is sucking up as much electricity as Sri Lanka’s 21-million population and is expected to use up 12.5% of the island’s annual power consumption by 2025. More than half of Taiwan’s energy is generated from coal and fossil fuels. In South Korea, home to another critical chip-supplier, SK Hynix, the story is similar. The company’s chip factories consume power equivalent to 1.6 million South Korean households and more than 60% of the country’s power comes from burning coal and natural gas.”

JPMorgan Chase wants to disrupt the rent check with its payments platform for landlords and tenants. This is an exciting new product from JP Morgan. It’s so frustrating that tenants have to pay by checks every month because landlords refuse to upgrade their infrastructure. I myself was asked to provide a check as collateral the last two times I tried to book a facility in my apartment building. I abandoned the booking simply because I refused to go to a branch just for a check. For JPMorgan Chase, this can be a strategically great move. At $500 billion in rent payment volume annually, even 0.2% of interchange and/or processing fee can bring in an extra $1 billion in revenue. Landlords that park their rent payments in a Chase account can help the bank get more deposits to fund their more lucrative loan-originating business. Last but not least, even if JPMorgan Chase doesn’t require landlords or tenants to be a customer of the bank, this new platform can serve as a tool to scout new prospects. Think about it this way. If the bank knows the address and rent-paying behavior of a prospect, it can leverage that data to craft a profile and run a marketing campaign toward that profile accordingly. That information is first party, reliably accurate and NOT easy to have.

This is how much more Apple Music pays artists than Spotify [Video]. I wonder what non-disclosure agreements these streaming services have with artists. But this is damning to Spotify. If a few more artists come out to back up this revelation, they will be under pressure to increase payout and that would mean higher expenses and less margin. Investors will not like that

Apple CFO talked about the small scale of his Finance team and how efficient they are

Other stuff I find interesting

How the New York City steam system works. The story of steam actually begins in Ancient Rome, where enterprising Romans were already building steam pipe systems for heating buildings and baths. The technology spread to the rest of Europe, but it was in the United States during the late 19th century. Inventors and businessmen turned it into a commercially viable heating option for towns and cities. New York was the first major city in the U.S. to have a steam system and still has the largest one to this day. In fact, if you add up the next five largest steam systems in America, it’s still smaller than New York City’s.

In Greece’s largest port of Piraeus, China is the boss. Europe must be mindful of these investments in key infrastructure by China. If there is opposition to China getting semiconductor technologies from the US, why shouldn’t there be caution when it comes to key infrastructure?

Why Switzerland built a 2-kilometer-long train. I am marveled by the fact that there is a 2km-long train out there. I wouldn’t get on board if the train was operated in many countries, including Vietnam. But since this is the Swiss we are talking about, I’d give it a shot.

The enduring sexism of India’s tech industry. With 1.3 billion people in population and a big portion of that as women, India would be even more competitive if they could foster a culture more liberating and friendly towards women

Vietnam is luring tech giants out of China with flashy infrastructure projects. If our country just provides lands and labor, there will be little transfer of technological, commercial or scientific knowledge. Don’t get me wrong. It’s good to increase the GDP and all that for Vietnam, but I’d prefer us taking a page out of Singapore’s playbook.

($) The Metals for Your EV Are Stuck in a 30-Mile Traffic Jam. This is an eye-opening account on how copper is transferred from mines to ports in Africa. My gosh, what a tough gig it is. The whole continent is hungry for infrastructure investments that will make thousands of lives easier and improve commerce. Rich countries wishing to establish influence should pay attention and act before China does, if they haven’t already


Meta’s Reality Labs is projected to cost as much as the Apollo Program, the very one that landed humans on the Moon

37% of small business owners in the U.S. were unable to pay their rent in full and on time in October

Apple Earnings – The Resilience & Effectiveness Of Apple

Last Thursday, Apple announced its Q4 FY2022 earnings results as follows

  • Revenue: $90.15 bn vs $88.9 bn estimated. Up 8% year over year (YoY)
  • Gross Margin: 42.3% vs 42.1% estimated. Essentially flat YoY
  • iPhone revenue: $42.63 bn vs $43.21 bn estimated. Up 9.7% YoY
  • Mac revenue: $11.51 bn vs $9.36 bn estimated . Up 25.4% YoY
  • iPad revenue: $7.17 bn vs $7.94 bn estimated. Down 13.6% YoY
  • Other Products revenue: $9.65 bn vs $9.17 bn estimated. Up 9.9% YoY
  • Services revenue: $19.19 bn vs $20.1 bn estimated. Up 5% YoY
  • EPS$1.29 vs. $1.27 estimated

On the surface, it looks like a routinely great quarter for Apple, but there are a few points worth calling out.

Apple's revenue growth
Figure 1 – Apple’s revenue growth

First, Apple got hit with a 600 basis point of unfavorable foreign exchange impact due to the strength of the dollar. Had the currency exchange stayed constant, Apple’s revenue growth would likely have been two-digits and could have gone up to as much as 14%. Despite significant foreign exchange headwinds, product margin was 35%, flat compared to Q3 FY2022, and 100 basis point up year over year. This indicates Apple managed to gain efficiency and sell more expensive products. To investors who care about how a company is run, this is a good sign.

Second, the stickiness of iPhone. Since Q4 FY2020, iPhone revenue has increased year over year every quarter. In FY2022, iPhone revenue grew by 7%, on top of the monstrous 39% growth achieved in FY2021. As a billion business worth more than $200 billion, that’s no mean feat. More impressively, the numbers could have been even rosier. According to Tim Cook, the company has been facing and still faces supply chain constraints for the popular iPhone 14, iPhone 14 Pro and iPhone 14 Pro Max. Had Apple had enough parts to meet the demand, they could have added a couple of more billions to their top line. In the time of unprecedented inflation and uncertain macro-economic conditions, this shows how much consumers love their iPhone and considers it more of a necessity than a luxury.

Apple business segments' revenue growth
Figure 2 – Apple business segments’ revenue growth

Next, Services grew 5% YoY and slightly missed analysts’ expectation. Adding the estimated foreign exchange impact of 600 basis points, Services would have grown by 11%, beating the consensus. Since 2018, Services has grown by double digits every year, reaching $78.1 billion in annual revenue in FY2022, up from almost $40 billion in 2018. Compared to previous year, FY2022 posed a lower annual growth, but there are levers that Apple can pull:

  • Apple recently announced price hikes on Apple Music, Apple TV+ & Apple One. The company explained that the price increase for Apple Music is due to more payouts to artists while that for Apple TV+ is fair considering the amount of content that Apple has added since the launch of the streaming service. As the flagship overarching subscription, of course, Apple One will also be more expensive. I think the justification makes sense because if Apple REALLY wanted to increase Services revenue and abuse its power, the company would raise iCloud’s prices. There are alternatives to Apple Music and TV+, but there is nothing to replace iCloud and no Apple user I know doesn’t buy additional storage. In short, this is not a move out of desperation.
  • Apple is loading more ads on the App Store. In their 2022 annual report, the company already cited advertising as one of the main drivers behind Services’ growth. Ads revenue is great and all, but too many ads will harm the user experience. Plus, there is already backlash from developers who saw online gaming ads placed next to their apps. Hence, Apple needs to be careful and considerate about pushing their advertising division
  • Apple Business Essentials. There has been no disclosure from Apple regarding this service, but I suspect it will come to the fold more in the next couple of years

Last but not least, I am really pleased with how Apple manages its costs. The gross margin profile of Products, Services and the whole company have been very stable in the last four years, despite Covid-19, the war in Ukraine, the withdrawal from Russia, the supply chain challenges and other macro-economic events. Operating expenses, including R&D and SG&A, as % of total revenue never exceeded 8% in the last four years. Based on the commentary from the executives, that should be the case for the next twelve months:

When we look at our capex, as you correctly said, I mean, we’ve been fairly stable, and I think our capital intensity is really very good. We have three major buckets in capex for the company. We have certain dedicated tools for the manufacturing facilities. We had some spend around data centers, and we have spent around our office facilities around the world. We obviously monitor all of them. There is nothing unusual that we see for the next 12 months.

When a company reaches a trillion dollar mark in valuation and generates billions of dollars in cash flow every 90 days, there is understandably a risk of being negligent on cost control. Think about yourself. Do you allow yourself more luxuries and impulsive purchases now than you did as a student and when you had lower income? From this perspective, Apple has been a disciplined and prudent steward of shareholder capital. To some extent, I don’t think you can make the same point about other big techs, such as Amazon or Facebook.

Apple's gross margin
Figure 3 – Apple’s gross margin

In short, this quarter’s results were not the most impressive that Apple has ever put out. They were just routinely and boringly good from my perspective and for the reasons I listed above. Even though there is no headline-grabbing debate-fueling stuff such as the investment in Reality Labs by Facebook, I prefer a stable and effective management that keeps their feet on the ground and produces results for shareholders.

Apple’s financials through charts

Apple revealed a stunning quarter last Thursday, surprising analysts and, in my opinion, even themselves. You can listen to the earnings call and read the 10Q here. I am putting the numbers in perspective through the charts below. If you find my work useful and informative, I’ll appreciate a thumb up or a follow. Have a nice weekend!

Apple had about $124 billion in Q1 FY2022. If we look at the last four quarters, it generated $94 billion a quarter, higher than most Fortune 500 companies did in 2021

Services has got a lot of attention due to its explosive growth, but Product and iPhone in particular are still the main revenue drivers

Both Product and Services’ gross margins have been increasing in the last 2 years. Services’ margin is an astonishing 72%

Wearables is now Apple’s 3rd biggest business

Wearables and Services have grown every quarter YoY since 2018

Apple is back in China

Japan, Apple’s smallest geographic segment, has an astounding operating margin of 47%

Apple’s users are increasingly engaged within the ecosystem

Direct channels have made up 1/3 of Apple’s business in the last three years

Disclaimer: I own Apple stocks in my portfolio

Apple – a 4th quarter unlike others and a year impacted by Covid

A different Q4 than others

Apple recorded around $64.7 billion in revenue, a tad higher than they did in the same period last year, and gross margin of 38.2%, 50 basis points higher than Q4 FY2019. Operating income came in at $14.8 billion due to an increase in Operating Expenses. While the increase in revenue is modest, the underlying story between this quarter and Q4 FY 2019 is very different. First of all, we are still in the middle of the pandemic which forces changes in consumer behavior. Students or office workers may spend more on hardware to aid remote working or learning. Consumers may increase consumption of digital content and services more while in isolation for a long time. Secondly, Covid-19 also forced Apple to close some of its stores; which might have adversely impacted sales. Thirdly, Apple didn’t have a new iPhone like it did with iPhone 11 last year; which is a significant element to keep in mind while comparing the two fourth quarters. About 2 weeks of sale for a highly anticipated like a new iPhone is a big deal. Apple executives gave some color on it:

 While COVID-19 and social distancing measures impacted store operations in a significant manner, demand for iPhone remained very strong. In fact, through mid-September, customer demand for our current product lineup grew double digits and was well above our expectations – Luca Maestri

If you look at China and look at last quarters — I’ll talk about both last quarter and this quarter a bit. Last quarter, what we saw was our non-iPhone business was up strong double digit for the full quarter. And then if you look at iPhone and you look at it in 2 parts: one, pre-mid-September, which is pre the point at which the previous year we would have launched iPhones, that, that period of time, which was the bulk of the quarter, iPhone was growing from a customer demand point of view. And of course, the — not shipping new iPhones for the last 2 weeks of September makes that number in the aggregate a negative.  – Tim Cook

Source: Apple Q4 FY 2020 Earning Call

While I understand the story here; folks didn’t want to buy a new phone in the last two weeks of September until after iPhone 12 came out, I wonder why both Tim and Luca kept emphasizing the growth of iPhone in terms of demand, not sale. Perhaps, I am being too paranoid, but I wonder if that specific call-out implied there is a difference in demand and sale or, in other words, there is a supply constraint.

Because of the reasons given above, it’s not easy to draw a conclusion on the two fourth quarters. It’s unclear how much the factors canceled out one another, but I have a feeling that not having a new iPhone for 2 weeks is the larger force at play here. Hence, I think it’s positive for Apple to exceed the sale last year without an iPhone. But what made up the absence of the new iPhones and a bit more?

Even though iPhone sale dropped by 21% in Q4 FY2020, non-iPhone sale grew by 30% with an excellent performance from Mac, which reached an all time high revenue of $9 billion and 29% growth, and iPad, which grew by 46% YoY. According to Apple, Mac grew by double digits in every geographic segment and notched all-time revenue records in Americas and Asia Pacific. Meanwhile, iPad had the best September quarter in 8 years in spite of supply restrictions and also saw double digits from every segment like Mac. Additionally, Services had a nice quarter as well with $14.5 billion, up 16% from the same period last year with all time records in App Store, cloud services, Music, advertising, payment services and AppleCare.

Source: Apple

In terms of geographic segments, all segments, except China, grew year over year. The absence of a new iPhone, like Tim Cook said, impacted sales in China more than other regions as last year, iPhone made up a higher percentage of sales in China than in other regions. Another reason, according to Tim as well, is a drawdown from the channel side. However, Apple is very bullish on the prospect of iPhone 12 in China because of 5G’s popularity and the fact that Apple is arguably the only major phone manufacturer without a 5G-enabled phone.

On the subscription side, Apple reported 585 million paid subscriptions in total, a sequential increase of 35 million from the previous quarter. For the last 3 years, that has been a sequential increase from one quarter to another. At this rate, it won’t be an issue for the Cupertino-based company to reach its goal of 600 million subscriptions by the end of the calendar year 2020. With the introduction of Apple One on Thursday and the imminent advent of Apple Fitness+, it’ll be interesting to see how they will impact the subscription base. There is no doubt that it will go up, but how fast it will reach the 1 billion mark remains to be seen. My guess is 3-4 years, at the earliest.

Source: Disclosures from Apple

How did Apple perform after a year full of challenges?

Apple spent at least half of the last fiscal year in the middle of a once-in-a-lifetime pandemic that brought both headwinds and tailwinds. On one hand, there was more demand for iPad & Mac to enable remote working as well as for possibly Apple TV+, Games and Music. On the other, there were supply constraints and forced store closings. Given all the ramifications of Covid-19 and the absence of a new flagship iPhone, Apple still managed to pull in $274 billion in revenue in FY2020, up 6% from last year. Gross margin increased by 50 basis points to 38.2%, due to a bigger percentage of revenue from Services. Operating margin dropped slightly by 40 basis points to 24.14% because of higher expenses. Next year, my expectation is that gross margin will decrease marginally while operating margin will remain flat because 1/ the new iPhone 12s will be available for order; which will bring a lower gross margin than Services and 2/ the new subscription bundles should also adversely impact gross margin.

Looking at Apple’s segment breakdown, iPhone sale unsurprisingly decreased by 3% YoY while non-Phone sale (Mac, iPad and Wearables) rose by 16%. Individually, Mac grew by 11%, a substantial step-up from 2% YoY growth last year, while iPad grew also by 11% and Wearables by 25%. Apple gave a bit more color on the performance:

  • Mac sale increased due to primarily higher sale of Mac Book Pro
  • iPad sale grew due to “higher net sales of 10-inch versions of iPad, iPad Air and iPad Pro”
  • Wearables sale grew “due primarily to higher net sales of AirPods and Apple Watch”. Because this segment also includes Apple TV, Homepod, iPod touch, Beats products and Accessories (like keyboard, Magic Mouse or cables), this disclosure means that last year wasn’t particularly a good year for Apple TV and Homepod. It’ll be interesting to see how the new Homepod Mini will perform in the future.

The changes in Services really caught my attention. Services brought in almost $54 billion in FY2020, up 16% YoY, “due primarily to higher net sales from the App Store, advertising and cloud services”. The color given by Apple this year differed a bit from last year’s when the increase in Services sale came mainly from App Store, Licensing and Apple Care. The difference, I suspect, came more from the impact of Covid-19 which forced some store closings and hurt AppleCare, than from an increase in demand for iCloud. When comparing the language Apple used to describe their Services segment, two points stood out for me

Services’ main components– Advertising
– AppleCare
– Cloud Services (iCloud)
– Digital Content
– Payment Services (Apple Pay, Apple Card)
– Advertising
– Apple Care
– iCloud
– Digital Content
– Other services (Apple Arcade, Apple News+, Apple Pay, Apple Card)
– Digital Content and Services (which doesn’t include any language on licensing)
– iCloud
– Apple Care
– Apple Pay
How Apple broke down Services in their Business segment included in Annual Reports in 2018, 2019 and 2020
  • Advertising, which may include the deal with Google, was called out more prominently in 2019 and 2020. Perhaps, it’s because the payment from Google is substantial enough for it to have its own section
  • The new Payment Services now has its own section which I suspect will be the case moving forward. Tim Cook already said it’s an area of great interest to Apple, though they haven’t made public any more updates on either Apple Pay or Apple Card for a while

From the geographic segment perspective, 2020 was a good year for Americas, Asia Pacific and Europe as those segment booked all-time records while Japan stayed largely flat for the past three years and China had the lowest revenue since at least 2015. In fact, China’s revenue as % of total revenue came down from 20% in 2018 to less than 15% in 2020 while Europe was responsible for one fourth of Apple’s total revenue, up from 23% in 2018. With the new 5G-enabled iPhone 12 that suits Chinese consumers well, this segment’s revenue may likely increase considerably in the upcoming fiscal year.

In terms of operating margin, Japan led the way consistently at 43% while Americas, the biggest market for Apple, lagged behind other segments. China’s operating segment has been steadily improving and has now the second highest operating margin, behind only Japan. Because Apple didn’t give any explanation on the difference in operating margin across segments, I suspect that the reason why Americas’ is low is because of introductory offers from services such as Apple TV+, Apple Card, including sign-up bonuses, investment in content and installment plans for purchases with Apple Card, which is available to only consumers in America.

From a market distribution standpoint, Apple has been steadily increasing its direct share, growing it from 28% in 2017 to 34% of total revenue in 2020. I would imagine that a direct sale through its stores and website carry a higher gross margin than through a 3rd-party supplier. However, given that Apple didn’t particularly offer enough information and that Apple has 0% interest payment plan in America for customers with Apple Card through its stores and website, it’s challenging to gauge the specific impact of this transition. Nonetheless, because America’s operating margin and the company’s stayed largely flat, the more emphasis on direct channels may mean more in terms of customer relationships than in margin.

All in all, here are my take-aways from looking at Apple’s latest 10Q and 10K

  • Non-iPhone businesses have a bright outlook. Mac and iPad booked a strong 4th quarter, are well-liked and with a high probability, will continue to enjoy the tailwind of remote working trend. Wearables will continue to grow. I love my Apple Watch and Airpods Pro and anyone I know who bought these products says the same thing. The fact that Wearables is now the size of a Fortune 130 company after only 5 years on the market is incredible. The thing with Apple is that they tend to have a knack for offering incremental improvements that work well for consumers while keeping the prices largely on the same level. Because of that, I have confidence that Wearables will continue to grow in the near future.
  • iPhone is no longer responsible for half of Apple’s revenue like it used to in the past. Regardless, it’s still a popular phone. Just look at how people follow closely every announcement, from hardware to software, and how folks share their homescreen designs with iOS14, something that Android has had for a long time. Because I live in the US where 5G infrastructure isn’t really well built, it’s hard to see how iPhone 12 will sell. Personally, I wouldn’t buy iPhone 12. There is not enough motivation to upgrade from 11 to 12. Even Apple executives were pretty guarded when it came to giving colors on the new phones. On the other hand, iPhone 12 may become a hit in China, especially with the 5G infrastructure they have over there.
  • Services is now bigger than Mac and iPad combined and grew at a clip of 16% in the last two years. The key drivers of that growth look set to remain strong in the near future: 1/ Apple Care, which rides along with Apple’s popular products, 2/ App Store & iCloud and 3/ Advertising which seems to be made up largely of the deal with Google. Even though that deal is under scrutiny, it’s unclear whether Apple will lose that lucrative advertising money. Even if it does, there will be other browsers ready to jump in, albeit at a lower value. The breadth of Apple’s services keeps growing with Apple One and Apple Fitness+, and presence in more geographical markets. Hence, I expect Services to keep growing at 15-16% a year in the next two years.

Disclaimer: I own Apple stocks in my personal portfolio.

iPhone sale slowed down, iPad and Services impressed

Highlights from the press release and earning call

  • iPhone sale down by 17% YoY. Mac had a great quarter with a YoY increase of 21%. Mac had a 5% revenue decline compared to last year
  • Half of the Mac customers during the quarter were new to Mac and the active installed base of Macs reached a new all-time high
  • 75% of the Watch customers never owned a Watch before
  • Apple Pay transaction volume more than doubled year-over-year and on track to reach 10 billion transactions this calendar year. Apple Pay is now available in 30 markets and will be live in 40 markets by the end of the year. New York’s MTA system will begin their rollout in early summer.
  • 390 million paid subscriptions at the end of March, an increase of 30 million in the last quarter alone.
  • “As we mentioned in January, we’ve been working on an initiative to make it simple to trade in our — trade in a phone in our store, finance the purchase over time and get help transferring data from the old phone to the new phone. As part of this initiative, we rolled out new trade-in and financing programs in the U.S., China, the U.K., Spain, Italy and Australia. The results had been striking. Across our stores, we had an all-time record response to our trade-in programs and with more than 4 times the trade-in volume of our March quarter a year ago.”
  • All-time services revenue records in four of our five geographic segments. Services accounted for 20% of March quarter revenue and about one-third of gross profit dollars.
  • “In fact, the number of paid third-party subscriptions increased by over 40% compared to last year in each of our geographic segments. And across all third-party subscription apps, the largest accounted for only 0.3% of our total Services revenue.”
  • Wearables business grew close to 50%
  • Total cash, plus marketable securities: $225 billion. Total Debt: $113 billion
  • App Store search ad business: up around 70% over the previous year and expanding into new geographies
  • An additional $75 billion for share repurchases is authorized

Note: In the following chart, Other Products refers to Wearables, Home and Accessories . I tried to update the historical figures as much as possible, but there might be some discrepancies to the latest ones.

Revenue in Q2 2019 is down by 5% YoY

iPhones and Mac disappoint while the other segments impress year over year

iPhone and Mac’s makeup of Apple’s total revenue continued to decline. Services and Wearables/Home/Accessories become increasingly more significant

Revenue from Greater China as % of the total revenue continues to slide while Americas’ share went up this quarter

Both Gross and Net Margin decline year over year

Q2 201439.32%22.40%3.12%6.42%
Q2 201540.78%23.39%3.31%5.96%
Q2 201639.40%20.80%4.97%6.77%
Q2 201738.93%20.85%5.25%7.03%
Q2 201838.31%22.61%5.53%6.79%
Q2 201937.61%19.93%6.81%7.68%

Dividend growth decreased compared to last year

My thoughts

Though revenue went down compared to last year, it’s not that bad in my opinion. It is almost on the same level as Q2 2015 when iPhones made up 70% of the total revenue. Services, iPad and Wearables seem to be able to make up, at least for now, some of the lost revenue from iPhones. The continued drop of Gross Margin is concerning and so is the almost 3% decline in net margin.

As customers prefer keeping and using their phones longer and Apple is losing ground in China, a major market for the iPhones, I think the iPhone share in the revenue pie will become smaller while Services will be more important to the company’s health. Tim Cook wasted no time on emphasizing that this is the best quarter for Services as it made up 20% of the total revenue and 1/3 of the total gross profit. Much time was spent on a whole range of services. I look forward to seeing the remaining two quarters of the year and the first of the next year after many services announced last month debut.

I actually prefer the trade-in initiative to lowering the prices as the initiative will likely not dilute the brand value as much as price cuts, especially for a luxury brand such as Apple. It’s promising to see the response to the new trade-in program.

While it’s interesting to see a significant growth in the App Store search ad, I am concerned about what it would do the image of a privacy-focused brand such as Apple. Ads and privacy don’t actually go hand-in-hand.

Disclaimer: I owned Apple stocks. This post is a practice exercise and stems from my curiosity. It’s not intended to be investment advice or anything of the sort. I am not that good lol.





Apple’s strategic switch

Disclaimer: I do own a few Apple stocks, but it’s nothing major and this post is just to share my observation of Apple. As a fan of business strategy, I have been a fan of the company and interested in how it performs amid the concerns after the letter to shareholders on 2nd January 2019.

Yesterday, Apple announced their Q1 earnings. A few notable points from their announcement and earning call:

  • Apple no longer reports units sold across their business segments
  • Overall, Apple recorded $84.3 billion, down 5% year over year
  • Products gross margin was 34.3% and Services gross margin was 62.8%.
  • iPhone revenue dropped by 15% year over year
  • Services revenue in Q1 was $10.9 billion, a 19% YoY increase. Service revenue grew from $8 billion in calendar 2010 to $41 billion in calendar 2018, allegedly on pace to reach $50 billion in 2020
  • Mac revenue was up 9% while iPad revenue was up 17%
  • Wearables, home and accessories revenue grew by 33% to $1.8 billion
  • There are 50 million paid Apple Music subscribers, up from 40 million reported in June 2018
  • Apple reported a base of 900 million installed iPhones, out of 1.4 billion active devices in total from Apple
  • There are 360 million paid subscriptions across Services portfolio, an increase of 120 million versus a year ago.
  • This quarter saw 1.8 billion transactions through Apple Pay, twice the volume recorded in the same quarter a year ago
  • In Germany, there are more Apple Pay activations in one week than for Android in one year
  • “Revenue from cloud services continues to grow rapidly with year-over-year revenue up over 40% in the December quarter. And readership of Apple News set a new record with over 85 million monthly active users in the three countries where we’ve launched the United States, the U.K., and Australia”.
  • Ending Q1 2019, Apple cash stands at $244 billion while net cash is at $130 billion

I am a big believer in the notion that business models need to be adapted to the changes in the business environment. No business model could be effective while staying still over the years, especially in the fast-changing world that we live in today. Apple should be no exception and from the numbers reported, it seems to me that they are making changes.  

For years, the bulk of Apple’s business has come from hardware which is differentiated by its exclusive software, especially in the case of iPhone. iPhone revenue has made up approximately 60% of Apple’s turnover. However, the luxury smartphone market has reached the maturation point. iPhone unit sale growth has been either minimal or flat for quarters. Greater China market, which makes up 20% of their iPhone revenue, has boasted challenges to Apple, particularly in 2018. Their iOS isn’t as appealing to Chinese users as it is to users in other parts of the world while competitors such as Huawei and Xiaomi offer alternatives with more or less same features at a lower price. The macroeconomic conditions in China and the trade war aren’t helpful either.

The growth in iPhone revenue has come largely from the price hike which lengthens the upgrade cycle and puts a limit on how much Apple can reach out to potential users. Not everyone can afford those pricey phones. Lowering the prices isn’t the solution. Firstly, Apple is a luxury brand. Lowering prices may leave significant damages to its brand power. Secondly, cheaper phones will require substantial changes to its operations, including supply chain, distribution and Sales & Marketing.

All the signs point to the fact that too much dependence on iPhone is no longer sustainable for Apple moving forward. Enter Services.

Services has been a bright spot amid concerns over iPhone revenue for the past 2 or 3 years, growing at a 20% annual clip. Put that in perspective, their Services revenue this quarter alone is $10.9 billion, almost equal to Netflix’s revenue in 3 quarters in 2018 while Facebook Q3 revenue was about $13 billion. Instead of making money from devices, Apple is betting on users keeping devices longer and paying consistently and more for services. And why not? If the users tend to hold on to devices longer, it makes sense to generate more money from their activities. Plus, margin from Services is substantially higher than that of Products.

And they have been doing a good job. Apple Pay transactions reached 1.8 billion this quarter, 100% YoY increase. Revenue from cloud went up by 40%. The number of paid subscriptions grew by 50% year over year and Apple Music has added 10 million users, reaching the 50 million mark and achieving a 25% growth, since June 2018.

As of June 2017, developers earned $70 billion from App store since its launch in 2008. As of January 2019, the figure went up to $120 billion. Moreover, we are about to see their investment in original content as their streaming service is reportedly going to be live this April.

In summary, Apple seems to be heading to the right direction strategically in my opinion, given the changes in the environment they are operating in. I think the following guidance in the next few quarters will continuously be lower than analyst expectations as the reduction in iPhone revenue may not be sufficiently offset by the growth in Services yet. There is a chance that Apple won’t have the same revenue level as they had at the peak of iPhone-dominated era.

Nonetheless, I think the company is far from the demise alleged by some after a letter to shareholders on 2nd January 2019. They generated $84 billion in revenue and almost $20 billion in net income in 90 days! Instead, the change to be a Services company may be better for the company’s health.