Random Thoughts on AAPL

I have never attempted to post on this blog about why I am long AAPL because this company has been the most talked about story in the business world over the last year and I thought I couldn't possibly add more to the internet discussion. Well, today I am going to break this rule.

Doing this helps me to check my thesis why I think AAPL is such a good buy at this moment in time. If the story doesn't make sense to me, then I ditch the stock. AAPL just consistently exceeds my expectations.

I am not sure that anything that I discuss is "original" considering that I have probably read thousands of posts and articles about the company over the last year, but I will try to briefly paraphrase what I have retained with regards to the "big picture" about this company's success and why I think that 2008 will be even better. Hopefully, a condensed version (like this) will provide us all some prospective about AAPL and I apologize in advance for not crediting any authors below that may have put some orginal thoughts of reasoning about AAPL into my little brain over the last year.

First, some history. I have had a fondness with this company for the last 22 years. I bought a Mac in 1985 to help finish college. I simply loved it. It was so much better than it's competition and took programming to a whole new level. It was an engineering achievement. The mainframe world was ending (at least temporarily) and the "green screens" where being replaced with a compact and very sleek computer with a simple, easy-to-use interface.

Apple was taking off. They had a killer platform, but they had the wrong market. They focused on the educational and creative market while not really competing effectively in the business market. I ended up having to leave my Mac after college to learn the world of DOS and Windows because that is what the business world expected.

Apple suffered because they picked the wrong market and Microsoft (software and OS) and Dell (hardware) overcame Apple's original engineering advantages by mass producing their products at price points that Apple couldn't compete with. Trying to find another niche, Apple bombed with the Newton. Not because handhelds weren't going to be popular, but because the Newton did not really have a killer application that folks HAD to have. It did a lot of stuff well, but didn't compete with the Palm (at the time) that did a few things very well. Simplicity won and the Newton's fanfare ended quickly. Apple tried to do everything and the Newton ended up being too big, running too slow, with too little power.

With the iPod, however, it all came together. They offered a gadget that does one core job well - it plays music. They developed a slick looking interface inside a tightly engineered package. They combined the four things that they learned over the years: 1) simplicity - make it useful, 2) Have a killer platform or application, 3) engineer a product that is better than anything that currently exists, and 4) market this to a wider market and appeal to a broader base.

They accomplished all four of these themes by also creating iTunes to be integrated with the iPod. This on-line music and video store made it simple for iPod users to purchase, download, and play music and video. Apple convinced music labels to sell content on iTunes using FairPlay and avoided the DRM (digital rights management) controvery that has been holding back music downloading since Napster. Rather than clamping down music in an impossible effort to prevent all theft, Apple suggested that the labels profit by providing honest customers a superior product to buy. The combination of the iPod with iTunes, while MicroSoft failed to understand the market, gave Apple a huge lead and a huge core user base before another player tried to compete.

The iPhone and the iTouch is just an extension of these basic concepts. Develop a brand and awesome marketing with simplicity, wide market acceptance, and engineering advantages while using a killer application as the base. The iPhone is bringing mobile computing and the internet to millions of people because it's combining key mass-market adopted technologies such as digital music, email, instant messaging and the cell phone in an impressive way that no one has done before.

They have positioned themselves to have an outstanding Christmas season that should roll right into a huge 2008. They have also done this by leveraging their brand and popularity back to their roots - building Macs. The "coolness" factor is causing consumers to take another look at the Mac, a technology and a platform that Apple continued to develop, allowing AAPL to increase its PC market share in a very tough and competitive industry.

The iPod continues to exceed expectations. Loyal customers are buying them like computers (every couple of years) to get the upgrades (I have two iPods). AAPL's iTunes store has now taken over as the "preferred" place to buy music and video and is now one of the largest music distributors with on-line downloads growing while CD purchases are declining.

The iPhone is also being released in other countries as we speak. Their strong margins on the iPhone continues to astound the critics as they negotiate revenue sharing agreements with mobile phone service providers.

I expect applications to be developed for the iPhone that will be downloaded and purchased on iTunes. I expect iTunes and the convergence of technologies on the iPhone to lead to an effective iTV. I already play my music through my soundsystem using my iPod (who needs CD's or a CD player?). Why can't I get all my TV content through iTunes? Well, I probably will in the future.

The iPhone turns a profit at the point of sale. But it also makes money off the service providers and drives consumers back to iTunes for music and other content now that they have internet on their iPhone. When applications are made for the iPhone, AAPL will also generate revenue through revenue sharing agreements with these developers.

Critics keep looking for an "iPod killer", but the reality is that all of Apple's products are linked, one built upon another. Why would anyone mix and match?

So how can AAPL slip up? Is this is a sure thing? Well, Alexis W. Cabot, an investor based in Rome identified the following red flags and roadblocks for Apple (http://www.macobserver.com/forums/viewtopic.php?p=377733#377733). I have paraphrased them below:

1. Steve Jobs continued leadership of the company is still essential. We all know how his idea of what works and what doesn’t permeates the decision thinking process at Apple, but Apple must learn to do without him, otherwise it will not be a great company. General Electric has done a great job at creating internal leaders that are excellent managers and have kept the company at the top of corporate America for a century. Apple must have it’s own management creation process in place.
2. Corporate hubris. Signs that the company starts believing it can do no wrong and that customers will buy anything they produce will be when the company has peaked. Apple went through this phase in the late 1980’s and we all know how that ended. Apple’s insistence on revenue sharing with the networks just to sell a Jesus Phone would be nice for us shareholders, but there is a wider world out there that has laws against such restrictions on trade. I hope that Apple/Steve Jobs doesn’t shoot itself in the foot if it insists too much on these revenue sharing deals.
3. Inability to build lasting partnerships. As Steve Jobs himself said at "All Things Digital" that Apple has to learn how to make better partnerships. Never has Apple needed more content and networking partners than before. It needs to work with music and movie companies, with it’s own set of histrionics, and then with the highly regulated and staid cell-phone networks.
4. Souring US relations with China and the rest of the world. A trade war between the incumbent superpower and the aspiring one are likely to derail Apple’s (and most of corporate America) growth. It will be more expensive to outsource and then sell to China, which has one of the most rapidly growing and homogeneous middle classes of the world. Given the poor job the US has done in managing its international relations, this is a growing possibility.

AAPL is on-sale now. Ask your broker and do your own due diligence.