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How Billionth iPhone Sale May Not Be That Great for Apple

As Apple (NASDAQ: AAPL)reported its financial results for the third quarter of its fiscal 2016, it was also celebrating hitting a key milestone with its flagship iPhone. Its sales topped one billion this month.

While it celebrated that monumental news, the market was digesting something that was unheard of when it comes to Apple – a downgrade. The reason for the downgrade explains many of the concerns some market players are increasingly griping about more.

Before we get into the reasons behind that downgrade, let’s start with the good news first. That news stems from Apple’s earnings report that it released and discussed this week.

Apple posted quarterly revenue of $42.4 billion and quarterly net income of $7.8 billion. That equated to $1.42 per share. These results compare to revenue of $49.6 billion and net income of $10.7 billion, or $1.85 per share in the same quarter of fiscal 2015.

Its gross margin weakened a bit to 38% from 39.7% in the second quarter of fiscal 2015. Of note are Apple’s international sales, which accounted for 63% of the quarter’s revenue.

Apple’s services business segment grew 19% year over year. Its revenue from its app store also grew. In fact, it was the highest it has ever been.

 · Shareholder value

Apple has been notorious for sitting on piles of cash, as it raked in even more of it from record sales of its iPhone and iPad. Shareholders grew increasingly frustrated with that. In what could be seen as the extension of an olive branch, Apple began paying shareholders dividends in 2012. That put to an end a drought of Apple dividend payouts that reached back to 1995.

Apple has also stepped up its share buyback program over the past few years. However, not all are positive on these repurchases. Earlier this year, Fortune said the company had wasted billions of dollars in buying back its stock.

Fortune found that Apple had paid a 21% premium over the value investors were paying for its stock when it was trading around $95. It closed Wednesday, the day of Apple’s third quarter release, around $104.

BGC Partners, the firm that downgraded Apple, found that Apple’s share repurchases over the last six quarters have all occurred at higher average prices than where the stock is currently trading. The stock has lost approximately $235 billion in value while repurchasing $117 billion is shares, according to BGC.

No matter, Apple’s CFO told investors this week that the company returned more than $13 billion to investors through share repurchases and dividends.

Furthermore, he said the company has completed almost $177 billion of its $250 billion capital return program.

Apple provided the following guidance for its fiscal 2016 fourth quarter:
• revenue between $45.5 billion and $47.5 billion
• gross margin between 37.5% and 38%
• operating expenses between $6.05 billion and $6.15 billion

The $.57 dividend declared by the company is payable on August 11.

 · The downgrade

BGC downgraded Apple ahead of its earnings report release. The firm cut its rating to “sell” from “hold.” It also cut its price target to $85 from $110.
The reason for the downgrade stemmed concerns that the upcoming iPhone 7 won’t sale as well as the current iPhone SE model in the market now.

The whole “cool factor” thing that propelled iPhone sales in the past may not be “cool” to investors anymore. Yes, it’s great that the new generation phone may have new features that outshine previous models. However, it won’t have those infamous subsidies that made the previous phones attractive, AND affordable.

You may recall the wireless carriers constantly promoting free phones, or heavily discounted phones to attract customers to sign lengthy contracts with them. That practice began to go by the wayside as consumers began to opt for pay-as-you go plans. Many wireless carriers did away with the subsidies, and the like. This meant customers have had to absorb the full price of the phone.

In the minds of many consumers, it is ridiculous and economically foolish, to
shell out $600 on a new phone every few years.

So while Apple pats itself on the back for selling one billion of the phones, it is highly unlikely that it will reach that number within the same time frame in the future.

To BGC’s point, I too believe that Apple must step up its acquisitions. Its buy of a karaoke company of sorts drew laughs among market players this week. That announcement came on the heels of Soft Bank’s revealing that it is acquiring ARM Holdings for $32 billion.
This should have been a company Apple should have gone after to buy.

According to BGC’s note:
Apple acquiring ARM could make so much sense, it’s a high margin business with future growth, plus there is a national security interest benefit. It positions Apple for the growing IoT (Internet of Things) market. So disappointing! Perhaps management was focused on how to remove headphone jacks.

Clearly, all is not loss for Apple. Its resilience is fascinating. Just look at its high revenues despite the drop in its iPhone sales.

The key for the company stock moving forward does not just hinge on iPhone sales. The company must move big in acquiring something Big. While share buybacks generate some investor satisfaction, the programs don’t cause a stock to move higher.

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