Q: Shares of Apple took a beating recently because of iPhone sales, and shares in your fund dropped on the day of their earnings announcement because of your investment in Apple. What are your thoughts on the future of Apple as a company, and as an investment for your vehicle?
A: We continue to support a reasonably large position in the company. We’re running our smallest absolute position in Apple, because we have been saying quite vocally that the smartphone market is fully penetrated – probably 80% global penetration now. That makes it very difficult for Apple to grow, given that two-thirds of its profits come from the iPhone. What we saw in the last quarter shouldn’t have been any shock to anybody, really, particularly as we’re coming towards the end of the iPhone 6/6S cycle.
Here’s the bull case: this company has the best, most recognized brand on earth, with 500 million affluent customers, and those customers are just waiting to buy something else from it. The challenge for Apple is to come out with a device that will drive an upgrade of the installed base, and there’s a question mark there: we don’t know if they can or if they can’t.
I think what’s critical, and why I retain the size position that I have, is that frankly there’s not very much downside absolute risk. The company’s earnings are plateauing. They may even come down a bit. But the valuation is less than half of the valuation applied to Coca-Cola, a business that doesn’t grow either but has a great brand and great recurring revenues. Over time, if Apple can demonstrate that it has longevity, it has a very loyal affluent customer base, and the multiple can rerate quite materially.
Q: You’re confident that the iPhone 7 will deliver something cool that people will like, and that the Apple share is good value?
A: The iPhone 6 was an unusually strong upgrade, because they introduced new form factors: bigger phones. There was a whole bunch of people that upgraded at that point. That’s going to be a very difficult upgrade cycle to replicate with the iPhone 7. You can’t keep increasing the size of a phone indefinitely. You have to add new features and new software, and maybe there’s fast-charging potential, dual cameras, noise cancelling… There’s always something you can add. But I don’t think we’re anticipating anything like the 6 upgrade. We just think it should be better than a 6S upgrade.
The reason you retain a position in the stock here is that, when you back out the cash, the stock is trading at a single digit P/E – not far off half the S&P multiple, for frankly one of the best brand businesses in the world. It’s out of respect for the company and its brand and its customer base that we’ve retained the position size that we have, because the immediate growth profile of the company is moribund. We’re sort of making an exception for this stock because it’s an exceptional business.