Two recent events related to Apple Inc. (NASDAQ:AAPL) caught my attention over the previous weekend.
Berkshire Hathway’s large investment in Apple of $1 billion last week made headlines all over the world. It was indeed an iconic moment as Warren Buffett has religiously avoided technology stocks throughout his illustrious career. What could this be attributed to and, more importantly, did this portend a shift in favor of technology investments? At a time when the NASDAQ is near its all time highs ?
Tim Cook, the CEO of the most valuable company on earth, lands up in India soon thereafter, for the first time ever ! So late in the game when India is no longer an emerging story ? Compare this with Bill Gates, John Chambers, Michael Dell and Scott McNealy…. all of whom visited India in the early part of 2000’s. I still remember the energy and enthusiasm which was prevalent in their closed-door meetings with business leaders in Bangalore and the huge interest demonstrated on both sides in learning from each other……these visits resulted in significant investments into India couple of years down the line from these companies.
Is the timing of these two seemingly unrelated events merely a coincidence ? Or is there a larger picture lurking behind the canvas ?
To understand this I first attempted to analyze Warren Buffett’s surprising change in approach towards investing in technology stocks. Firstly, by his own admission, he does not understand technology and does not own stock even in his best friend’s iconic company, Microsoft Corporation (NASDAQ:MSFT). It is highly unlikely that at this stage in his career he would have developed an in-depth understanding of technology to make such a large investment. Secondly, he had also once said that though creative destruction is great for capitalism, it is not so for the certainty of investment outcomes, thus, industries prone to disruptive technologies did not figure in his investment philosophy. Apple is clearly in this category of companies prone to a high risk of disruption. iPhone contributes about 65% of Apple’s profitability and is in its 8th year. Compare this with the current state of the irrelevance of the erstwhile companies dominant in this space over the last decade: Nokia, Blackberry, Motorola, Sony Ericsson, etc and the drift should be clear. Thirdly, if we are to analyze the pattern of investments of Berkshire, the underlying theme has conventionally been one of consistency and predictability of cash flows. Businesses related to public utilities, energy, foods and drinks, retail, etc. After all, utility companies are natural monopolies (as demand for electricity will always be around with no alternative to cables running into our homes) as will the need for food products….with changing food habits being a huge entry barrier for competitors of his investee companies like Heinz, Coca Cola or See’s Candies !
Apple just does not fit into this hypothesis! Unless Buffett is giving a message that Apple is not the high growth stock it used to be and is now to be deemed in the same category as a boring utility/FMCG stock with stable cash flows. His investment forte. Something he did with IBM, his only technology investment in 2011 after its metamorphosis into a services organisation. By the way, returns from that investment is still in negative territory after 5 years.
This leads me to Tim Cook’s visit to India, significant, given that Apple consistently ignored India from its inception. Apple’s difficulties in the walled garden China are well known and is now reflected in its poor results just announced in April, post which the stock tanked by 30% from its peak of $133 to sub $90 level. No CEO can ignore such a catastrophic fall in its market cap in the global markets. It is quite obvious that India is perhaps the only market with the potential to alleviate Apple’s growth concerns in this situation. And, being a neglected market, the benefits of low hanging fruits are too tempting as a quick fix solution for any American CEO. Hence “humbly approaching India” with visits to Siddhivinayak Temple and Shah Rukh Khan ! A far cry from his public statement in 2012 that ‘India had less potential than other markets’. As if such gimmicks would endear him to the powers that be for special incentives or garner affinity of the masses !!
The challenges Apple will have to overcome as a result of not being meaningfully present in this market are huge. The ecosystem for iPhones is under development and the sales of the product, so far, is largely due to the ‘status symbol’ paranoia of the upscale market, kitty party going Indian buyer. Spotify, for example, does not exist in India; neither does a customer centric service offering where a faulty product is simply replaced across the counter in Apple stores. Accessories are terribly overpriced leading to a flourishing grey market. Indians by nature are cost conscious though there is a segment, regrettably, which will go to absurd lengths to outdo his or her neighbour, but that is not a large number. Though “Apple’s U-Turn from arrogance to servility” was reported in qz.com post his visit, I did not quite hear anything substantive from Cook which reflected a climb down from his high pedestal necessary to meaningfully break into the Indian market…..notwithstanding some breathless and starry-eyed anchors on popular TV channels swooning at the imminent opening of hundreds of Apple stores in India with their full range of products. For example, the fact that iPhones are more expensive than in the US due to higher taxes here, but with far less functionality due to lack of ecosystems, is a serious challenge surmountable only, in part, by pricing initiatives specific for India till these issues are resolved. However, he insisted that the quality and “value” being highly superior, pricing will remain at international levels and Apple will not participate in the Rs. 12k Smartphone market. Yet, Apple aspires to increase its share of India business from less than 1% of its total revenue. Secondly he, rather contemptuously, proposes to sell refurbished phones in India to reduce the price points and the permission for which has been rightly refused by the Government. His latest request for a waiver from conditionalities of local sourcing for single brand retail, ostensibly for being a “high technology” company, was rightly refused by the FIFB whilst clearing its proposal to participate in the Indian market on a level playing field. Mind you, this request was made without any commitment to setting up a manufacturing capacity in India and would have resulted in large scale “dumping” of used phones in the US into our markets. Remember PL 484 of the mid-sixties when the US dumped spoilt wheat in the name of aid into India! Simply shocking to apply this ancient thinking to contemporary India !
This entire approach of what is right for the US is right for the world, and premium pricing based on “perceived value” rather than what the market can bear, is fundamentally flawed and is the same mistake many MNCs made in the 90s and early 2000s including marquee companies like Digital Equipment (DEC), Lucent and GE, all three companies I had the good fortune to be associated with or observe very closely. GE learnt from it and survived, Digital and Lucent did not. I still remember the arrogance of Dick Poulsen, Chairman of EMEA and the General International Area and member of the core team of Ken Olsen, the legendary founder Chairman of DEC, when I made a presentation to the Board on why Digital’s cost plus pricing model cannot survive in the post liberalization environment in India in 1993, and needs to migrate to a revenue minus pricing model to match the advent of low-cost PCs unleashed by IBM, Compaq etc in the emerging open architecture world. His arrogant answer, which rattles me till today, was “these are playthings and not ‘real’, high technology products for serious enterprise applications which a petty finance manager should not attempt to understand“. We could not convince him that the age of superminicomputers was seriously threatened by the advent of powerful 32 bit systems and that the opportunity to cash in with DEC’s revolutionary Alpha 64 bit RISC processor with attractive pricing for this huge market was limited. He did not agree, and we all know how Intel, and clones like AMD, reacted in a few years time with its x86 chips at extremely attractive price-performance points. Lucent pretty much did the same folly by ignoring repeated pleas from the local management not to exit the high potential GSM business in India in 2002 due to competitive pricing pressures from rivals like Ericson and Huawei. They did, and opted for CDMA instead purely due to its ability to price it higher; Lucent does not exist today.
Even 2-3 decades later in a vastly interconnected world, Tim Cook very much echoes this same philosophy of intransigence many American managers are infamous for. Both Digital and Lucent (legendary Bell Labs was part of Lucent after the trifurcation of AT&T) had awesome research and innovation capability, believed in proprietary operating systems to extract exorbitant prices from its cult following and had huge cash flows. Apple too is strikingly similar at this moment in all these respects. Apple is also perhaps making the same mistake with respect to its arrogance, ignoring large markets like India and trying to play the game without learning from either the past experiences of other MNCs or seeking inputs from its local management team.
Perhaps Warren Buffett has seen through this and believes Apple will not risk a change in its business model and, given its high innovation capability and strong franchise, will still continue to grow safely at FMCG rates in the secured confines of its existing markets. How it will prevent an erosion of value due to the risk of disruptive technologies is not clear. Maybe this will be his second technology investment after IBM which will test the patience of his investors.
Disclaimer: The opinions mentioned above are solely of Author. The article was originally published by the author here.