This question is important in an analysis of Apple as margins are very
different in software and hardware. Many perceive Apple to have a fairly
large revenue share from OS, iTunes and App Store. In fact combined
these constitute a mere 9 percent of revenue. Normally the more hardware
you sell the lower the margin though at the moment, and particularly
concerning Apple, analysts think the exact opposite. This is a huge
risk!
Thinking into the future
Expectations are high concerning both Apple’s Revenue and EBIT for the next few years Revenue is expected to reach USD 158,230m in 2013. But it is more of a concern that margins are expected to remain above 30 percent - this we have our doubts about!
In table 1 we have listed the competition in Apple’s universe. This ranges from pure software/digital products to mobile handset hardware. Apple operates in the mixed space (i.e somewhere in between) and has at the moment a margin which reflects this mix to an extent as the margin is lower than Google’s and Microsoft’s but immensely higher than Nokia’s and Dell’s on the pure IT hardware side.
Thinking into the future
Expectations are high concerning both Apple’s Revenue and EBIT for the next few years Revenue is expected to reach USD 158,230m in 2013. But it is more of a concern that margins are expected to remain above 30 percent - this we have our doubts about!
In table 1 we have listed the competition in Apple’s universe. This ranges from pure software/digital products to mobile handset hardware. Apple operates in the mixed space (i.e somewhere in between) and has at the moment a margin which reflects this mix to an extent as the margin is lower than Google’s and Microsoft’s but immensely higher than Nokia’s and Dell’s on the pure IT hardware side.
Calculating a weighted EBIT margin on the Hardware companies totals 8.2
percent and for Software/Digital an EBIT margin totals 41.9 percent. On
top of this we have made two extra calculations.
First we know the EBIT margin in Apple is 30.7 percent and we calculate what share of revenue should come from Hardware and Software respectively if this 30.7 percent margin should mimic competitors. The current EBIT margin implies a hardware share of 33 percent with the rest of revenue (67 percent) coming from software (see table 2, left side).
First we know the EBIT margin in Apple is 30.7 percent and we calculate what share of revenue should come from Hardware and Software respectively if this 30.7 percent margin should mimic competitors. The current EBIT margin implies a hardware share of 33 percent with the rest of revenue (67 percent) coming from software (see table 2, left side).
Everything
could potentially be fine but the issue is that Apple is a hardware
company! 91 percent of revenue comes from hardware (9m of 2011) and only
9 percent is from OS, iTunes and App Store! Basically the company is in
danger of a massive margin pressure going forward as the “What-if” EBIT
margin drops to 11.2 percent!, (see table 2, right side)
If this margin becomes a reality over the coming years rest assured that Apple’s current share price would not be USD 385.
Can Apple defy gravity?
Our best guess is – it can’t. Take for example Nokia - at its prime time it was certain that it would be able to sustain a margin in the thirties range, as it was the market leader and had the right products. Nothing is as harsh as reality and after a few “missed boats” Nokia is nothing of what it used to be. Nokia might have thought it had a unique product which would last for decades but now it has an EBIT margin of 2 percent and layoffs are its game at the moment.
Hardware producers have over time showed us that hardware becomes a commodity - high volumes with very low margins. We expect Apple to encounter the same tendency in the coming years unless software becomes the dominating element.
Risks are present
Margin risks are present in Apple and possibly more so now that Steve Jobs is no longer at the helm of the company. These two factors in connection should make investors demand a higher risk premium. Looking ahead, we are inclined to expect Apple to struggle more than we have otherwise been used to.
If this margin becomes a reality over the coming years rest assured that Apple’s current share price would not be USD 385.
Can Apple defy gravity?
Our best guess is – it can’t. Take for example Nokia - at its prime time it was certain that it would be able to sustain a margin in the thirties range, as it was the market leader and had the right products. Nothing is as harsh as reality and after a few “missed boats” Nokia is nothing of what it used to be. Nokia might have thought it had a unique product which would last for decades but now it has an EBIT margin of 2 percent and layoffs are its game at the moment.
Hardware producers have over time showed us that hardware becomes a commodity - high volumes with very low margins. We expect Apple to encounter the same tendency in the coming years unless software becomes the dominating element.
Risks are present
Margin risks are present in Apple and possibly more so now that Steve Jobs is no longer at the helm of the company. These two factors in connection should make investors demand a higher risk premium. Looking ahead, we are inclined to expect Apple to struggle more than we have otherwise been used to.
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