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This is a long one, so you might wish to get a cup of coca and settle in before you start.

As it happens this is my 500th post. It took me almost 3 years to get to 500, and at the rate things are going TMF will be bankrupt before I hit 1k, so I'll make this as long as possible;-)

Plato's thinking is not that unconventional. In fact it's the type of 1.5 dimensional thinking that is taught in most MBA programs. If you were to present to a group of third year MBA candidates case studies in AAPL and DELL, the latter would be instantly recognized and appreciated. This recognition would center on the concept of “market share”, a concept that gets thrown around a whole lot in boardrooms and chat rooms alike.

Market share is a concept tailor made for easy conception. It very easily translates into graphs and charts and makes for nice metaphors. Contrary to popular belief, MBA candidates are, like the population the come from, equally divided between the above and below average (or as I like to call 'em “possessors of above average stupidity”) and so it is no surprise that the tendency of corporate boardrooms is to focus exclusively on market share, such as it is defined, as a sole criterion for success.

That's what makes Plato's analysis so banal, a perfect summation BTW for whoever said it. It is pat and licks depth and is not to far from the great many analysts out there who keep comfortably to what they know.

Market share is not, however, a criterion to be viewed in a vacuum. If you doubt this, simply ask yourself what Ford's market share is, then reconcile that with their bottom line.

The reason I am focusing on market share here is that, as I read Plato's analysis, this is his primary thesis for the unsuitability of AAPL as an investment. If I may summarize – “Apple computer has a limited niche market of fanatic users that is not growing or is growing slowly. This fact is evidenced by AAPL's shrinking revenue base and sketchy profit record and is the result of making a proprietary, premium priced product in a market dominated by cheaper, more functional PCs.”

By all means, Plato, if this misrepresents your take, correct me. But this is the essence from what I've taken from your posts.

As far as that goes, market share is the meta concept that dominates the entire thread – AAPL is loosing market share and thus profitability.

As I said, this is not an unconventional view. Nearly every magazine article I read about AAPL, including the largely glowing Time piece, dismissively inserts some comment or two that AAPL's market share is “sliding” or “crumbling” and most stock analysis points to this as well, citing market analysis that “shows” AAPL getting crushed by an onslaught of cheaper PCs like a squirrel at a Glasgow soccer game.
So allow me to point to a few things that refute this entire argument.

The first and most important thing to realize is that the term “market share” must be taken in context of the market to which you are referring. When you talk PC sales are you talking about desktops? Workstations? Servers? Portables? Retail market? Direct sales market? US? Worldwide? AAPL doesn't even compete in many of those markets, and market share analysis can be manipulated depending on what markets you choose to include or exclude. So my first point is that I think most conventional methods for determining market share in the PC (inclusive) sector are misleading and unreliable.

But, more importantly, market share analysis is, as it relates to AAPL, largely irrelevant anyway.

Let's take a hypothetical example. Let's say that in 2001, AAPL sold 5 out of every 100 computers sold, giving them a 5% market share, while another all-powerful company sold the other 95. Then in 2002, for some reason, AAPL only sells 4 out of every 100, with Michae- er, I mean the CEO of this hypothetical company, selling the other 96.

So, AAPL goes from 5% to 4% market share, right?

Now, which is the better investment?

The answer, of coarse, is “it depends”. Because in this case we know that every new computer AAPL sells means profit in hand while the same many not be true for the other company. What if the total market for PCs grew from year to year by, say 50%? Even though AAPL only sold 4 out of 100 sales did increase, right? Each of those new sales was profitable, right? So, AAPL's market share decreased but their suitability as an investment was not tied to market share but rather their ability to sell computers at a profit.

This example is but one of many I could use to illustrate my point that market share is not all-important. And, quite frankly, if you grock AAPL, their products, and their size as compared to competitors (MSFT and DELL chief among them) you'll quickly see that AAPL is not in a position to make market share principally important. AAPL is uniquely suited amongst the box makers because it is small enough to be able to increase profitability in a cutthroat and increasingly stodgy industry with only relatively small increases in boxes sold.

Look at Wal-Mart – the king of market share retailing. Their entire business plan revolves around capturing market share, and they're very good at it. Does Wal-Mart's ability to sell more kitchen gadgets than anyone say anything about Williams Sonoma? Does their ability to sell more clothes than anyone affect Brooks Brothers, or Victoria's Secret, or Eagle Outfitters, or Abercrombie & Fitch or scores of other niche retailers?

You see market share is a grand thing, but it's obvious that the examples I've mentioned cannot hope to compete with Wal-Mart at their own game. Thus they turn to the task of creating a separate market for their products, one that circumvents Wal-Mart's hegemony at selling lots and lots of crap really cheap. Each of these companies, as an investment, is not dependant on the concept of market share in the way it is being used by Plato, nor is the concept of “the clothing market” applicable to those companies that sell various types of apparel.

Lest I be accused of trading in generalities and straw men, let me show you what I am trying to say with real numbers. If market share is a pointless yardstick by which to grade AAPL what should we use?

I would submit that Revenues are the prime measure by which we should judge AAPL's ability to increase “market share”. Here are the past 4 years, which most accurately illustrates the state of the company since the return of Steve:

1998….. $5.941B
1999….. $6.134B (+3.2%)
2000….. $7.983B (+30.1%)
2001….. $5.363B (-33%)

The trend here is pretty unmistakable, good sales growth for many quarters and then, <wheeeeeee>, it pulls a Thelma and Louise.

I submit that early, strong sales growth is prima facia evidence of AAPL's increasing “market share”, i.e. their ability to expand their user base. But the critics would, most likely, maintain that the revenue surge was merely the result of old users upgrading and thus show little or no growth in the installed number of Mac users at all. Which is it?

This question only leads us to the real question, which is paramount to AAPL investors, and is the question that the misuse of market share attempts to answer.

Does the drop in AAPL's revenues signal a natural limit, a glass ceiling if you will, to AAPL's ability to grow in light of its niche status within the overall market? Or is it something more transitional – a function of the economy perhaps?

This question is paramount, because in order to justify AAPL as an investment, we need to see Rev numbers grow again at rate that increases shareholder value.

Notice that, nowhere in that question is a comparison between AAPL and Dell (or anybody else), as market share necessitates, relevant. In other words Revenue growth for AAPL is what is important, not the ratio of computers it sells compared to Dell.

This is especially true because AAPL is highly profitable. We all know AAPL has Gross margins of 30%, but look at the trend of operating income as a % of net sales:

1998….. 4%
1999….. 6%
2000….. 7%
2001….. –6%

Again the trend is unmistakable until the 2001 FY as AAPL is able to spread load its development costs across a larger number of units and increase cash flow and profitability. So, as we increase net sales to pre-2001 levels, net profitability will similarly increase.

I believe that the disastrous 2001 FY was largely the result of two factors – the Cube fiasco and the recession. I wrote a post highlighting the disservice the Cube did to our income statement a while back, but I'm too lazy to go find it. Suffice to say, all other things being equal, 2001 would most likely have been a profitable year without the Cube to drag it down. Throw in the recession and Sep 11 and its no surprise how that the dip in that otherwise upward sloping revenue line occurred.

Already in the Q1 AAPL shows $1.375B in Rev with an estimated $1.5B in 2Q. $1.5B is more than adequate, especially since 2Q is usually AAPL's slowest coming, as it does, just after X-Mas but before the back to school computer rush. In 2000, the peak of the .com excess, AAPL saw $1.945B in Q2.

This brings us back to our central question, whether AAPL is a growing company or a company that is forever limited to declining or marginally growing sales.

Plato says,

Let's have everyone who thinks they understand Apple's financials and operations make a prediction on earnings/revenues and stock price movements when the next quarter's numbers are due.

I'll put myself on a limb here and predict the AAPL will exceed $6B in revenue for FY 2002 as we climb out of the recession. In fact, I'll go where so few angels fear to tread and specifically say $6.2B, which will beat 1999's numbers. (I won't predict stock price here, 'cuz that's not my bag, baby.)

Fred Anderson has already stated that he's setting the goal of $8-9B over the next couple of years, and I believe this is eminently achievable. Though I don't know for certain, I'm pretty sure AAPL never exceeded $10B, or if they did it was only for a short while. So you can see how a projected Rev increase that puts us North of $10B stacks up historically.

A reasonable projection on my part looks like this:

1998….. $5.941B
1999….. $6.134B
2000….. $7.983B
2001….. $5.363B
2002….. $6.200B Est (+15.6%)
2003….. $7.5 – $8.0B Est (+20 – 29%)
2004….. ca. $8.62 – $9.2B Est (+15%)

OK – to be honest anything beyond 2003 is really a SWAG, but my entire position in AAPL is predicated on my estimates for 2002 – 2003 having merit. These projections assume a gradual economic recovery and continued success overseas and are based on several factors weighing in our favor:

1) The anecdotal success of the Apple stores. In addition to bringing in a great deal of foot traffic, a reported 40% of purchases at he store are made by non-Mac users. For those of you who had problems with the iPod being Mac only, can you now see where that strategy might have had merit? Look at the avalanche of industry praise for the iPod, along with the attention focused on the new iMac. Neither one of these products might be enough to induce purchases, but the two of them, combined with other proprietary tools like iMove, etc, create a complete, viable, and wholly unique product. Perhaps the exclusivity of the iPod was part of the stores' pull to new users. Tough to say, but the stores are definitely impacting AAPL's reach, even CompUSA is improving the retail experience for Apple users, and one can't help but see the cause and effect there. Again, this all points to the conclusion that AAPL is expanding its user base, despite what the market share parrots are saying, and leaves open a great deal of room for progress. Of the 27 stores open last year, many of them weren't open until November and some of them weren't open until after the big post turkey day shopping frenzy. Having the stores open for the full CY will give them every opportunity to exert their influence.

2) In addition to new users being drawn in with the iPod and the new iMac, existing users have every reason to upgrade. Older iMacs are not just slower or bulkier than their newer counterparts, but many of them lack some of the things that allow users to use them as a “digital hub” like Firewire, CD/RW, DVD/RW, and built in Airport slots and antennas. Since so much of AAPL's great new software and hardware take advantage of these technologies in innovative ways, I expect that the number of old iMac users upgrading to new ones will be high. Steve has said as much several times, that he intends to “milk” existing users by continually innovating new products that force people to upgrade to remain bleeding edge.

3) In addition to existing iMac users, there a number of 1st generation PC users that are also ready to upgrade and Apple products are bound to be attractive to them. This is probably best known around here as the “Herring Theory”. Again, evidence, some of it anecdotal, some of it derived through market research and CPU sales numbers, shows that AAPL is managing to sell computers to a growing user base, and many of these people are, IMO, former Mac users who switched during the dark days before the return of Steve or people who bought computers to take advantage of the Internet and are now ready to take advantage of all the applications that are network centered – i.e. the Digital Freakin' Hub.

4) The continued drive towards higher bandwidth applications. I'll leave more detailed example of what I mean her for later since this post is already too long. But, suffice to say that Broadband will do for the sector and the market something very similar to what the Internet did for them.

5) AAPL's continued ability to create must have products. I'll admit to fishing in murky waters here, since I am as much in the dark as anyone as to what, exactly, AAPL is bringing to market in the future. But the company made a good decision not to slash R&D when the economic downturn came, and we can see that reflected in both the iPod and the iMac. Of AAPL's major product launches last year, OSX, iMac, iPod, iBook, TiPB, and the Cube, only the Cube was a wash and 4 were home-runs (the iMac being a projected home run based on initial orders). That's a pretty good record and one that augurs well for the next year. Las year AAPL released at least one new product (including silent upgrades – Silent but deadlies?) every 2 months or so.

All of this- the growing revenue numbers, increasing user base, etc- is useless of coarse, unless AAPL can expedite that growth to the bottom line. Here's where AAPL's potential really shines.

One of the oft repeated themes of Plato's analysis is that, as a small, niche player, AAPL spends too much on SG&A as well as R&D to allow AAPL to be profitable with such a low market share (but by now you should be adequately convinced that this proposition is flawed on its face).

Nonetheless, the idea that AAPL has lost control of its R&D budget or its SG&A budget isn't accurate. From FY98 – 00 both SG&A and R&D expenditures as a % of sales remained almost constant at 15 and 5% respectively.

Only in the disastrous FY01 did they rise and affect AAPL's profitability as a percentage of sales. In fact SG&A actually decreased sequentially from 00 to 01 despite AAPL's retail initiative.

The % increase in SG&A and R&D expenditures were one of the main reasons why AAPL's net margins were low in 2001, a point Plato loves to exhort ad nausea. But, of coarse, that fails to address how a similar reduction in these expenditures as a % of net sales will return AAPL to industry leading net profitability and its impressive ROE of 22%+.

In other words, increasing sales mean rising net margins.

From CY98-01, when AAPL increased shareholder equity from $4.88 to $11.34 per share, the stock price AAPL's stock price rose, approximately, by the same 3-1ish ratio. If you look at AAPL's historical ROE under Steve, then project future revenue Growth, you can get a sense of AAPL's potential profitability, and a reasonable trading range for the stock given those parameters.


Let me summarize for those of you who've held on this long.

1) AAPL's “market share” is irrelevant. Even granting that you could accurately, and impartially define what market you are talking about, AAPL's success does not rest on capturing or growing market share in the manner of Dell or Wal-mart. It is not a market share company. This is not to say such an occurrence would be unwelcome, only that the focus on how big AAPL's piece of the pie is, relative to the other pieces of pie out there, ignores the fundamental question of how quickly AAPL's piece is growing relative to itself.

Market share is irrelevant. Revenue growth is not.

Mmmmmmm. Pie. Aaarggghhhh….

2. Regardless of market share computations, AAPL has, since the return of Steve, grown it's user base sufficiently to generate increasing revenues and earnings with the exception of FY 2001. Given that, one need only assume AAPL can grow its future revenue stream sufficiently to justify it as an investment.

3. I believe that AAPL's products, along with its retailing strategy are in a good position to continue increasing revenues, so that 2001 will appear the aberration, a function of a wilting economy and a badly launched product (as a complete aside, given 20/20 hindsight, I have to question the thought process that even designed the Cube. The Cube's greatest attribute was its form factor, that combined with a LCD gave someone a lot of desk space. But this is also clearly a major selling point of the new iMac. So, really the Cube was just a reshaped iMac with no real “market” of its own. Assuming Steve had already committed to the iMac II form, you have to wonder what the market justification was for introducing the Cube ahead of it. Just wonderin'.)

4. AAPL, has managed its costs beautifully, IMO, and still remains a profit-generating machine. As AAPL experiences revenue growth, the result of upgrading and new users buying great new products, AAPL stands to throw off a huge amount of cash from operations and thus see a corresponding rise in its.

These 4 fundamental are at the core of why I see AAPL as a worthwhile investment, especially at prices in the teens as we saw last year. There are also a few things I'm probably forgetting, but the day grows long and I have a pint calling me from the officer's club.

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