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Is Apple on the Operating Table?

Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

"The best thing that happens to us is when a great company gets into temporary trouble...We want to buy them when they're on the operating table." - Warren Buffett.

Is Apple (NASDAQ: AAPL) on the operating table? Good question. Anyone who's read Michael Woolf's recent piece in USA Today entitled "The Age of Apple May Be Over" could be easily forgiven for thinking that the Cupertino juggernaut had already died under the knife. Quote: 

The age of Apple should, reasonably, be a fleeting one. And this, in its way, is good news. Innovation happens in the technology business and new markets open when the mighty fall — often not until the mighty fall.

A short run on top is long enough. 

Here's what we know: In October, Apple showed up at the ER complaining of chest pain. It could be indigestion, panic disorder, a bleeding ulcer, or a heart attack: In short, anything.

While we're waiting on the lab results to come back, let's take an inventory of the risks associated with the patient's medical history, age, diet, exercise regimen and work-life balance by taking a close look at the Strengths, Weaknesses, Opportunities, and Threats. Fear is in the air. Now may be the time to get greedy.   

Strengths

Cash hoard: Somewhere over the Atlantic ocean, there's a fire-breathing dragon named Scourge who devours sheep and little village children by day and guards Apple's mountain of gold by night. Apple's treasure trove increased by $50 billion in 2012, for a total of $121.251 billion in cash and marketable securities, most of it managed by Apple subsidiary Braeburn Capital.

Ecosystem: It's an undisputed fact of human nature that the fear of loss is more powerful than the hope for gain. For tens of millions of consumers, Apple's proprietary ecosystem represents more than a catalog of apps, a trusted name, or a familiar operating system: It represents a significant investment. Apple's customers are locked in by their previous purchases of everything from apps to accessories. The switching costs are enormous.

Case in point: Remember the consumer backlash over Apple's switch from its traditional 30-pin dock connector to the smaller 8-pin Lightning connector? That was just a cable.

“In business, I look for economic castles protected by unbreachable 'moats'.” -Warren Buffett, 1995 Letter to Berkshire Hathaway shareholders.

Brand name: Apple currently ranks #1 on BrandZ's annual list of the Top 100 Most Valuable brands. How much goodwill (i.e. durable competitor advantage) does that little silver apple buy?

About $182.951 Billion – roughly the value of GE, Facebook, Wal-Mart, VISA, and Amazon put together, and more than McDonald's and Coca-Cola combined.

That's a lot of Thank You cards.

"Businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic goodwill." – Warren Buffett

Job's Legacy: Tim Cook inherited the most popular and recognizable name in technology, a phenomena that can be quantified in terms of what it buys: high margins, customer devotion, free advertising, longer product cycles and R&D without the kind of time pressure that Apple's competitors operate under.

Weaknesses

Exchange Rates: One of the problems with being a multinational corporation is the exchange rate. Apple has been getting hammered lately by the surprising resiliency of the U.S. dollar.

Rising Component Prices: Sourcing core components through “frenemies” has its costs. Rival Samsung recently hit Apple with a 20% across-the-board markup on it's processors. Apple will have to shell out the extra money on 200 million ARM A6 and A6x in 2013 alone.

Competitors Get a Free Ride: Apple requires technological disruption in order to preserve its hefty profit margins. Apple's R&D department is tasked with the lofty goal of “inventing the future.” It's a win-win scenario for competitors like Google ): If Apple succeeds, Google's designers can quickly reverse-engineer the product and determine which iterative improvements to make while evading Apple's patents. If Apple fails, Google gets a public relations coup.

Opportunities

Improving Supply Chain: Foxconn appears to have resolved its worker difficulties for the moment. The iPhone 5S design, rumored to be in beta, addresses the problem of scratches to the iPhone 5's aluminum casing.

China Mobile: The biggest phone company on the planet has yet to release the iPhone into the world's largest cell phone market. With 655 million subscribers, China Mobile has the power to cement Apple's dominance in the smart phone market.

Education: Education is a potential windfall for Apple. The U.S. government will spend $644.9 billion (about $11,655 per student) on K-12 education alone in 2013. Apple currently has the largest education sales force in the world.

Threats

Cannibalization:  Barclays estimated iPad Mini sales at more than 5 million units in Q4, while Canaccord Genuity forecast sales of 9.25 million units. Both analysts have a target price on Apple of around $800.

How could that be? It's simply a matter of assumptions: Barclays is assuming that the iPad Mini won't significantly cannibalize the iPad 4. Canaccord Genuity is assuming that it will, and with good reason: Apple's celebrated ecosystem means that consumers will be more likely to downgrade from an iPad to an iPad Mini than switch from an iPad to a Kindle Fire HD or a Nexus 10. 

Margin Compression: iPad mini margins are below the corporate average. Introducing a new successful line of products just as other products start to fade is an Apple tradition. iPod sales fell off dramatically in 2010 as the iPhone started to achieve critical mass. Without a new product like iTV, Apple's newest product is the iPad. The problem is that Apple makes twice as much profit selling iPhones than it does iPads.

Orchestrated Irrelevance 2007-2011: iPod sales (gold) iPhone (blue), iPad (green).

Foolish Roundup

Wall St. analysts were caught with their pants down when Apple's Q3 earnings blew past guidance and overcompensated by drastically raising their Q4 projections, despite conservative Q4 guidance from Cupertino. When iPhone 5 weekend sales failed to match these inflated projections, these same analysts were caught off guard again and desperately looking to Mr. Market for some direction. 

Enter: Apple Maps.

What hasn't changed are the fundamentals. Apple is still Apple: The strongest name in tech with the most popular brand on the face of the planet trading at under an 8x P/E ratio (less net cash). 

That's the kind of Christmas gift that keeps on giving. 


FatalX has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Google. Motley Fool newsletter services recommend Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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