Strong Buy? Nope, Android Is Roasting Apple

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

After hitting a high of $705.07 back in September, Apple (NASDAQ: AAPL) has fallen significantly and is, at the time of this writing, trading at around $526.31. Check out the following chart.

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AAPL data by YCharts

The drop in Apple can seem like a great buying opportunity. The company has loyal customers, a strong brand, and makes the very popular iPhone and iPad. In addition, Apple has a five year revenue compound annual growth rate (CAGR) of 44.81%, about $121 billion in cash, and a PE ratio of only 11.92. These properties are often the focus of bullish Apple investors. The problem is that many investors dismiss or outright ignore the big threats facing the company.

In September, I wrote a post on Apple’s (relatively) lacking R&D spending and innovation. However, Apple’s immediate biggest problem is Android. Currently, the iPhone is still a cash machine for Apple and developers. In October, App Annie reported that the Apple App Store earned four times the revenue of Google (NASDAQ: GOOG) Play. Similarly, Flurry Analytics estimated that developers of top apps earn only $0.24 on Android for every $1.00 they make on iOS. This is important because more money attracts developers. Apple has a big advantage, but its lead is clearly unsustainable.

The Math Doesn't Lie

As of June 2012, Apple reported a total of 400 million iOS devices sold. As of September 2012, Google reported that a total of 500 million Android devices have been activated. Ignoring iOS and Android devices sold in 2007 or 2008, there is a total of 370 million iOS devices sold since the beginning of 2009. Android only shipped 0.7 million units in 2008. Thus, everything else being equal, for Apple to maintain its 4x lead in app store revenue, the ratio of Android to iOS devices sold has to be 1.35 (i.e. 500/370) or less.

However, iOS is being blown away by Android in units shipped. The iPhone only accounted for 14.9% of worldwide smartphone shipments in Q3 2012. Android dominated with a 75% market share. Apple shipped 26.9 million iPhones and Android shipped in 136 million smartphones. In other words, Android smartphones out shipped the iPhone by a factor of five to one. Taking into account the tablet market, in Q3 2012, iOS and Android shipped in 14 million and 10.2 million tablets, respectively (Strategy Analytics). Also, Apple sold 5.3 million iPods. Combining the numbers, Android is bringing an average of 3.16 devices for every iOS device brought into the market. If the ratio of Android to iOS shipments stays at 3.16, the App Store should maintain a revenue lead of 1.7x over Google Play. That is still really good.

Android Is Taking Over

However, as shown in the following table (Sources: IDC, Gartner for Q4), Android is extending its lead in smartphones at a remarkable rate.

<table> <tbody> <tr> <td>Worldwide Smartphone Shipments (millions of units)</td> <td>3Q12</td> <td>2Q12</td> <td>1Q12</td> <td>4Q11</td> <td>3Q11</td> <td>2Q11</td> <td>1Q11</td> <td>4Q10</td> </tr> <tr> <td>Android</td> <td>136</td> <td>104.8</td> <td>89.9</td> <td>75.9</td> <td>71</td> <td>50.8</td> <td>36.7</td> <td>30.8</td> </tr> <tr> <td>iOS</td> <td>26.9</td> <td>26</td> <td>35.1</td> <td>35.5</td> <td>17.1</td> <td>20.4</td> <td>18.6</td> <td>16</td> </tr> <tr> <td>Android/iOS Smartphone Shipment Ratio</td> <td>5.06</td> <td>4.03</td> <td>2.56</td> <td>2.14</td> <td>4.15</td> <td>2.49</td> <td>1.97</td> <td>1.93</td> </tr> </tbody> </table>

As shown, in Q3 2012, Android and iOS smartphone shipments increased by 91.5% and 57.3% year over year, respectively. Android already had the bigger market share, but it still grew at a much faster rate. The smartphone market is crucial because it dwarfs the tablet or iPod Touch market. The way things are going, Android looks poised to keep extending its shipment lead and, if that lead gets large enough, Google Play will eventually surpass the Apple App Store in revenue. If that happens, developers will favor Android, which would be disastrous for iOS. Android has the advantage because it is a licensable OS. Similar to what happened against Microsoft (NASDAQ: MSFT) in the PC war, Apple is getting beat by overwhelming numbers. The big problem for Apple is that the iPhone generates around 70% of its profits.

Ironically, other platforms might save Apple from Android. Nokia (NYSE: NOK), Microsoft, and Research In Motion (NASDAQ: BBRY) are trying to jump start their mobile device market shares. Nokia looks like it has a successful smartphone with the Lumia 920, which runs on Windows Phone 8. Nokia was able to secure a deal with China Mobile, something that Apple has so far been unable to accomplish. On the other hand, Research In Motion is preparing to launch its new BB10 phones in January. The company reported in its Q3 FY 2013 result, that it still has 79 million subscribers. If Windows or BB10 steal market share away from Android, that would be good news for Apple. However, any market share gained will likely be partly stolen from iOS as well.

Riskier Than What the Finances Show 

Overall, Apple is vulnerable. The company has a large lead in app store revenue, but the increasing big shipment lead Android has gained over iOS will likely reverse this by making an overwhelming majority of devices in the market Android. Also, the competition has clearly caught up to Apple. Apple might seem like a strong buy, but the company is facing major headwinds and is a riskier investment than it appears by just looking at financial statements. There is an illusion that the current lopsided shipment market share is irrelevant. This idea is completely false. Losing market share is almost always never a good sign. Android is roasting Apple and if things keep going the way they are, Apple will be toast.

iamgreatness owns shares of Microsoft. The Motley Fool owns shares of Apple, Google, and Microsoft. Motley Fool newsletter services recommend Apple, Google, and Microsoft. 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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