Should you add to, or reduce, holdings in the world’s favourite tech stock? Antipodes Partners' Jacob Mitchell has some thoughts.
One-in-10 (11 per cent) Australian SMSFs that own international shares have holdings in Apple. A similar percentage hold Alphabet (Google), with Microsoft and Amazon also among their top holdings, according to recent data from software group Class[1]. (Australian Taxation Office data shows SMSFs collectively held more than $4.3 billion in overseas shares at 30 June 2017, with the US market the favoured destination.)
Investors in Apple have seen their shares jump by more than 58 per cent since the US presidential election. Apple has come to dominate the global handset market (by profits) with the all-conquering iPhone, complemented nicely by Apple’s other products - the “Mac” range, iPads, accessories and a growing services portfolio leveraging its app store. Whilst on most measures Apple has built an extremely attractive model, we’d note the ongoing degradation in its smartphone gross margins in recent years, falling from over 50 per cent in 2011 to less than 40 per cent in the year ended September 2017. The size of Apple’s handset profit pool and need for growth, mean that it must walk a tightrope of innovation-based pricing to sustain both margins and growth.
To this end Apple’s most recent pivot, with the launch of the 10-year anniversary iPhone X, has been to significantly raise prices versus prior generations as they introduce OLED edge-to-edge displays and 3D sensing enabled FaceID. While investors have celebrated the introduction of these features, we have been concerned that Apple’s pricing strategy will test even its most loyal customers, ultimately limiting the appeal of the new devices. Add to this the revelation that Apple have been secretly manipulating the performance of older generation handsets – deliberately slowing the processor, and iPhone owners may feel rightly aggrieved that they are being groomed for future upgrades. Consumer loyalty is hard won, but can be easily lost. Expectation of an iPhone ‘super cycle” in our view look overblown. Apple may well find the market clearing price for recent innovations is much lower, if it is to sustain and indeed grow its valuable installed base. Add to this an increasingly saturated smartphone market with lengthening replacement cycles and our enthusiasm for the world’s most popular technology name is tempered.
Three reasons to avoid crowded technology favourites
Risks of investing in the major US technology stocks include:
1. Regulation: Big technology companies are coming under increased scrutiny by governments around the world because of their size, influence and role in society, particularly around managing sensitive information. This may eventually attract tighter regulation limiting the ability for companies to monetise their users.
2. Fierce competition: Another risk among technology mega-caps is their sheer size means they are increasingly bumping into one another’s domain. Whether it’s Amazon, Netflix and now Apple competing on content streaming or Amazon’s Alexa threatening Google with its voice search capabilities and challenging their core product search ads business, technology titans are bumping heads. Likewise, Google is attacking Apple by launching its own smartphones and Microsoft attacking Amazon’s AWS cloud business with its successful Azure platform. Expect more of this.
3. Market positioning: These high-growth stocks have become excessively crowded trades as investors have paid for growth in a low interest rate environment. If interest rates normalise, they’re vulnerable, and improved global growth could not only brighten the prospects of out-of-favour cyclical stocks, but force long-term global interest rates higher. That sounds like a contradiction – because growth itself has been scarce, attracting premium valuation in securities that have exhibited this characteristic.
Other tech opportunities
On the other hand, changes to the US tax structure could also enliven corporate activity as capital is repatriated back to the US and in so doing unleash a wave of acquisitions that could put unloved ‘‘value’’ technology stocks in play.
Value technology companies include:
- NetApp, a multinational storage and data management company which is traded at 11 times cash flow, cheap ‘‘for a business that isn’t heading for extinction’’. NetApp has an extremely viable standalone future, but equally could sit inside a Cisco and would represent a modest acquisition for them.
- Twitter, the unloved yet influential media platform which changed the way celebrities and politicians exert power. Twitter ultimately belongs inside a Google or even traditional media company that perhaps failed to anticipate the rise of “social” media. Twitter trades at five times revenue compared to Facebook’s multiple of 14 times. Twitter is unique as a modern broadcast platform but has until recently been shunned by the market and potential suitors, with its shares having collapsed from near $70 in 2014 to lows last year near to $14/share.
You have to look at each opportunity individually. We look for companies impacted by short-term uncertainty where the market has lost sight of longer-term business prospects — typically expressed through depressed valuations. Investing with a margin of safety, and multiple ways of winning, we believe yields a sustainable performance with fewer negative surprise over the cycle. Antipodes is also majority owned by its investment staff creating an aligned performance culture.
Jacob Mitchell is chief investment officer at Antipodes Partners – Zenith’s 2017 Fund Manager of the Year.
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