A Few Things About Apple’s e-Book Trial You May Have Missed

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

Apple (NASDAQ: AAPL) doesn't become the largest and most valuable tech company in the world by having stupid people in charge. For those who might not think that Tim Cook is as clever, smart or shrewd as the late Steve Jobs, just might want to pay attention to the happenings in the company's e-book price-fixing trial against the U.S. Department of Justice, which is in its second week this week.

Yes, Mr. Cook may not be necessarily the most charismatic guy on the planet, and he certainly does not come across as the marketing genius that Mr. Jobs was, but if there is any doubt about Cook's ability to run Apple, follow along with us to understand how Mr. Cook is no stupid man - in fact, he just might be one of the cleverest in the tech sector—underratedly so; here’s another underrated fact.

Amazon & the five publishers will play an essential role

In this scenario, Tim Cook just might be Sherlock Holmes and Amazon.com (NASDAQ: AMZN) CEO Jeff Bezos is his Professor Moriarty. How does Amazon figure into a case between the Department of Justice and Apple? Now that’s the clever part.

The Department of Justice pinned things on Apple all along when the book publishers suddenly changed their pricing models so Amazon did not automatically have the lowest prices on e-books - the publishers were in control of the prices, not the retailers. What was happening was something that is done in the book-publishing industry a lot. Sometimes retailers get to decide their prices, other times the publishers do.

Well in this trial, the U.S. Department of Justice made the five e-book publishers mentioned in the initial collusion settle their cases, and they the DOJ has been sending each one to the stand to testify against Apple. The five—Simon & Schuster, Hachette, HarperCollins, Macmillan, and Penguin Group—are attempting to paint Cupertino as the one who arranged for this collusion to take place, which sabotaged the pricing and volume advantage that Amazon.com had enjoyed in the e-book space.

It may come down to “the email”

With all of that being said, however, it should be mentioned that the court would also have documentation of Steve Jobs’ infamous email to News Corp. (NASDAQ: NWSA)’s James Murdoch (and HarperCollins, the “HC” in the letter) that contains the following points via AllThingsD:

As I see it, HC has the following choices:

1) Throw in with Apple and see if we can all make a go of this to create a real mainstream ebooks market at $12.99 and $14.99.

 2) Keep going with Amazon at $9.99. You will make a bit more money in the short term, but in the medium term Amazon will tell you they will be paying you 70% of $9.99. They have shareholders too.

3) Hold back your books from Amazon. Without a way for customers to buy your ebooks, they will steal them. This will be the start of piracy and once started there will be no stopping it. Trust me, I’ve seen this happen with my own eyes.

 Maybe I’m missing something, but I don’t see any other alternatives. Do you?

Regards,

Steve

The most damning statement in this email is Jobs’ assertion that Apple and the five publishers (assuming HC is on board) should “create a real mainstream ebooks market at $12.99 and $14.99,” with the word create being of focus here. If the government can prove that Apple’s aim was to artificially create this market, they’re in business, and Cupertino’s role as chief conspirator might get a bit clearer. But that’s not all.

How does Amazon fit in this, really?

What may likely come out at least during cross-examination, could be that this entire case stemmed from an Amazon attorney getting in the ear of the DOJ about e-book publishers changing their pricing models, and the DOJ then asked for thousands of pages of information from Apple compared to very few pages of information from Amazon.

What to watch for should be the highlight of the entire trial, when Apple lawyers cross-examine Amazon to get to the bottom of this entire case as Apple tries to establish the lack of merit in the case in the first place. Put simply, this discrepancy in evidence collection may be a big sticking point that could aid Apple’s outlook, as will shoddy testimonies like this.

Jeff Bezos of Amazon might have been pretty clever in having a hand in this in the first place, but Tim Cook is showing himself to be just as capable as a leader by not taking a settlement and exposing this entire case at trial.

Will Apple ultimately succeed? It is more likely now than it looked a few days ago, but Tim Cook at least knew that the strong move was to fight the case because of how it was established. Will this make the publishing houses look the fool for settling out of court? Possible. But then what?

How should investors play it?

From an investment standpoint, we wouldn’t recommend playing this situation on one side or the other, either via Apple stock, or in Amazon or News Corp. From a valuation standpoint, Apple’s clearly the most attractive—but what’s new—at 10 times forward earnings and a PEG of 0.50.

With more than $100 billion in cash, any outcome in this case won’t dent Apple’s cash hoard significantly, and a loss doesn’t seem set to change how investors are trading Amazon or News Corp either.

Regarding the latter, we’d consider the media giant for its upcoming spinoff of its newspaper and publishing business, particularly for shares of the re-named 21st Century Fox, the higher growth entertainment business that will remain post-split. The publishing division meanwhile will be a cash king, loaded with an estimated $2.6 billion in cash and zilch in debt.

 Amazon, on the other hand, is incessantly called “overvalued” in the financial media, but shallow P/E ratios and growth estimates aside, it appears that the markets are valuing the behemoth for its booming online traffic, which has increased by 55% in two years. If Amazon can increase its conversion rate, which rests near 9-10%, to levels of eBay, which converts 11-12% of its customers to sales, continued revenue gains could drive even more appreciation.

Final thoughts

On the whole, we’ll continue to watch this situation closely, but just like with many things in the investing world, the eBook drama of Apple, Amazon and News Corp is worth watching. There’s a lot more than meets the eye; continue reading about other market strategies at Insider Monkey

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This article is written by David Woodburn and Jake Mann. Insider Monkey's Editor-in-Chief is Meena Krishnamsetty. Meena has a long position in AAPL. The Motley Fool recommends Amazon.com and Apple. The Motley Fool owns shares of Amazon.com and Apple. 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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