Why Price Cuts are Actually a Good Thing for Apple

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There are many arguments for why Apple (NASDAQ: AAPL) has struggled so mightily since November.  Poor supply chain management by Chief Executive Tim Cook, the loss of innovation after the passing of former CEO Steve Jobs, and increased competition from the likes of Samsung have all been attributed to Apple’s dramatic decline.  Whatever the reason, it’s certainly been a rough ride.  After briefly trading over $700 per share, the company now exchanges hands for $460—a 35% collapse.

One particularly interesting argument among these is that because the company decided to cut prices on certain products and release lower-priced items, the stock drop is likely to continue.  The theory goes that since margins are everything to a technology firm, lower margins mean lower profits, and a lower stock price to follow.  But is it really that simple?  Or, on the other hand, is there more to the price-cutting story—including a revolutionary catalyst involving China Mobile (NYSE: CHL)--that so many are missing?

Margins are everything, but shouldn’t be

It’s true that Apple is cutting prices on certain products and is likely to release less expensive items in the future.  To illustrate, after releasing its 13-inch ‘Retina’ MacBook Pro four months ago, the company cut its price tag from $1,699 to $1,499.  Investors bearish on Apple might jump to the conclusion that the company simply isn’t as popular with consumers as it once was.  They'll say that Apple now has to resort to cutting prices to keep selling their products, which will only serve to exacerbate the company's problems.

Other tech firms have succumbed to similarly poor fortunes recently.  Investors in Intel (NASDAQ: INTC) rushed for the exits when the company reported its fourth-quarter and full-year results.  Most damning for the company was that Intel’s gross margin contracted almost seven percentage points from last year’s fourth quarter, and the stock dropped 6% on the day of the announcement.  Furthermore, Intel announced it would spend roughly $13 billion on capital expenditures next year, leaving an even less pleasant taste in the mouths of margin-obsessed Wall Street analysts.

Like Intel, the market wasn’t pleased with Apple’s most recent reported results.  Fiscal first-quarter 2013 revenue rose more than 17% over the prior year’s first quarter, but earnings were relatively flat.

Overall, fiscal year 2012 was still a fantastic year for Apple financially. The company’s revenue increased 45% versus 2011. Amazingly, earnings per share have increased at a compound annual growth rate of almost 60% over the last four years.

Don’t miss the bigger picture

It’s true that lower-priced items will hurt Apple’s margins.  What many seem to be missing, however, is that lower-priced items will also result in higher overall sales.  There are millions of consumers who haven’t purchased Apple’s products because they couldn’t afford Apple’s premium prices.

To combat this, Apple is rumored to be releasing a less expensive iPhone this year in China.  This announcement could pave the way for the company’s long-coveted partnership with China Mobile.  China Mobile is a $220 billion giant based in Hong Kong, and provides telecommunications services primarily in Mainland China. The company serves more than 700 million customers, making it the largest telecom carrier in the world.  Unleashing China Mobile’s customer base to Apple would be a huge catalyst.  Lower-priced phones will be a great way to reach customers in under-developed emerging economies such as China. 

To say that Apple has its investors frustrated is an understatement.  The company is currently in the throes of a painful decline from its all-time highs reached last fall.  Not too long ago, financial pundits lauded the company’s vision and innovative magic, and Wall Street analysts routinely one-upped each other with higher and higher price targets.

Fast forward to today, and the company's best days are supposedly behind it, all because of lower margins.  Apple appears to be willing to exchange a few points of gross margin in exchange for millions more loyal customers that lower-priced devices and a partnership with China Mobile can provide.  Profits are what matter, and Apple's profits will keep rising for years to come.  Shareholders have 700 million reasons to be optimistic about the company’s future.

Robert Ciura owns shares of Apple and Intel. The Motley Fool recommends Apple and Intel. The Motley Fool owns shares of Apple, China Mobile, and Intel. 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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