Doug Kass Claims The Apple Might Be Spoiled

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

In a recent appearance on CNBC, famed hedge fund manager, Doug Kass, made the assertion that Apple (NASDAQ: AAPL) has lost its edge, and went on to explain his theory behind the recent 10% pullback in the stock. To summarize, he stated that:

1. Apple became vulnerable for profit taking- being up 70% for the year; it became a target for mutual fund managers wishing to lock in profits.

2. Due to supply chain issues, they will have massive delivery problems for all the pre-ordered iPhones.

3. They are trying to protect their franchise from Samsung/ Google's (NASDAQ: GOOG) Motorola and Android operating system and other competitors rather than to continue to innovate and create cutting edge products.

4. Kass questioned whether first mover advantage could be protected?

5. In a different venue (not CNBC) he claimed the lightweight of the iPhone 5 made it seem like a toy.

I'm going to address each of these issues one by one.

The weight of the phone- On this point I am going to completely disagree with him. I have never imagined that a lighter phone could be considered a detriment. I don't think that Kass's view on technology here matches the population as a whole. It's like a dinosaur complaining that the plants he is consuming are too small, even as they give him more nourishment.

Supply chain issues- There are always going to be challenges in business. Apple has done a remarkable job in building quality products with their Chinese manufacturers. We are all aware of the problems at the Foxconn factory as reported by the New York Times, and the recent shortage of workers for Chinese factories. Apple, for the sake of its own reputation, might opt to increase the benefits and the pay of Chinese workers, but I do suspect that these challenges will be resolved in short order.

As of right now, the iPhone 5 is sold out around the world. Demand is overwhelming supply. Predictions are 32 to 40 million iPhone 5s will be sold. Many end users understand this, and will patiently wait for their phone to arrive so long as the delay is not too long. This is a challenge that most companies dream of having.

Selling by institutional investors- any stock that has had the run which Apple has had is due for a pullback. Look at any overall winning stock chart in history and see if you don't find a 10% pullback. The question is- are they selling for profit taking, or more fundamental reasons?

First mover advantage- is the iPhone 5 that much better than the Samsung Galaxy? Success breeds imitation, and the outsized profits and margins which Apple has earned naturally attracts competition. While there are many slavishly devoted Apple fans, the only way for Apple to keep growing, in the face of new competitors eager to yank away some of their profits, is to up the ante and create even more revolutionary new products- like the iPad, and like the iPhone when they originally came out.

Many investors will say, "Apple has been doing this for years." Yes, they have, but myself and other pundits have said it before, "How much of that was related to having Steve Jobs at the helm?" Without cutting edge products that continue to raise the bar, Apple's margins, and hence profitability, will be slashed, along with it, the price of its stock.

Protecting the franchise- part of Apple's reputation comes from the outstanding service found at its company owned stores. In a cost cutting effort, the company recently fired some of its Apple Store employees, leading to a noted (around various tech blogs) decline in the customer experience. You don't get to reap excessively high margins, and provide lackluster service for long.

According to Kass, "Apple is now selling less or equal products for more money." I asked whether the Samsung Galaxy approached the level of the iPhone. The fact is, opinions around the world differ on which phone is superior. In the past, the iPhone was always the clear-cut choice for numero uno.

The iPhone 5 must get a number of old users to upgrade? If the upgrade cycle has been lengthened, Apple will be hurt severely.

Mapgate and Purple Haze

It has been reported recently that users taking photos with the iPhone 5 were seeing a purple reflection in their pictures. Hardware wise, in the past, Apple has quickly reconciled display problems of the iPad. It was there, and quickly disappeared. I don't anticipate this being a big issue.

However, with Apple Maps, (that were often incorrect on positioning, and sometimes displayed nonexistent destinations) it is my opinion that Apple made a major misstep. Apple's brand has forever (defined in terms of the short life cycle of technology) been associated with absolutely superior products. By continuing Steve Job's war against Google and Android, trying to replace Google Maps with their own software, when it obviously wasn't even close to ready, the big question for me becomes, is this a canary in the coal mine?

Under Jobs, the software was seamless, nearly perfect. When the original iPhone and iPad came out, my friends were all amazed of the revolutionary nature of the technology and software. How easy it was to use, how natural. This is part of the reason that the public is willing to pay through the nose for their products. If Apple were to have one or two more "Mapgates," this positive association will certainly be weakened, if not lost.

Competition enhanced: Google and Android are offering Apple serious competition. Google has a different motive giving away the software to OEM's for free, to get you into the Google ecosystem, and it has been working. When the iPhone came out, its software was top of the line. Android has caught up.

Bottom line: To create a revolutionary new product every time is not easy. Apple has done so in the past, which has enabled their current high margins. For the stock price to grow, Apple must continue in this vein. As an investor, you have to decide on the likelihood of this. For me, if another canary starts to sing, I'm going to be selling. In the meantime, I'm going to stay tuned for what I anticipate to be another record quarter of profitability for the company. Hey, being pre-sold out worldwide can't hurt. 

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margiecfl 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.If you have questions about this post or the Fool’s blog network, click here for information.

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