Friday 4 December 2015

Is it the beginning of the end for Apple's strong run?

The domestic Chinese market has been in meltdown over the last few weeks. First, the government moved to curb volatility by clamping down on short selling.Then, China surprised investors by weakening its currency by almost 2% after a weekend of poor trade data and prompting a sell-off in global equities at the end of the month.As a technology manager, what happens in China – and its implications for the wider economy and Asian consumer – is obviously a concern. We have around 5% of our portfolio in China, albeit in Hong Kong listed shares rather than in the A-share market. 
The Chinese economy is undoubtedly slowing and, while we do not believe there will be a recession, there is pressure on certain sectors. Some companies selling into China's economy will be vulnerable. For example, sales in the auto industry, where competition is increasing, have been disappointing. A number of industrial companies, such as Otis Elevators, have shown real weakness too. There is also pressure on luxury goods because of the crackdown on corruption.But the slowdown may well be beneficial for other sectors, like internet companies, where we have a number of holdings. These companies are still seeing strong revenues because pricing is generally better on the internet and there are still lots of great deals at a time when consumers are becoming more price sensitive. There are fears it could be the beginning of the end for Apple's outperformance too. Most recently, Apple fell into bear market territory for the first time in several years this month. But Apple shares also saw a significant dip when the group announced its results in mid-July.On the face of it, this is slightly baffling. Its results were still well within its guidance. Certainly, the company missed projections for revenue forecasts and its iPhone sales were not as strong, but it is still predicting £1bn in sales for the Apple Watch. Part of the problem is that Apple has been exceeding expectations for so long, an expectation that it will beat them all is now baked into the share price. One analyst suggested Apple shareholders had become 'spoilt' by the company constantly beating estimates. We believe it probably is the end of Apple's outperformance.While there is good new user conversion within the US, outside the US, it is mostly a replacement cycle. In China, for example, Apple has been successful at getting the high end of the market, but we are sceptical about the extent to which it will make inroads further down the value chain. It has strong competitors in Xiaomi, a privately owned Chinese electronics company, and others.Meanwhile, elsewhere in the tech sphere, Microsoft recently wrote down $7.6bn in connection with its Nokia deal as the reprioritisation of the business continues. This is more than the $7.2bn it paid for the phone group in the first place and confirms the view that this was one of the worst deals in corporate history. The premise on which the deal was done was fundamentally flawed and the consultants who dreamt it up were guilty of some woolly thinking.Certainly, Nokia was the number two player in the phone business, but their analysis neglected to note that Apple makes 90% of the profits in the mobile phone business. The second largest player makes no money at all. This meant Microsoft spent its giant cash pile on a business that, in effect, has no return.

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