Walmart Discounting Apple Products: Gloom or Boom?

This past Friday, Walmart announced on its Facebook page that it was rolling back its iPhone and iPad pricing for a limited time. Within minutes, the announcement flew around tech blog circles, quickly reaching mainstream publications such as ABC and CNN.  

The discussion soon took a new direction as bloggers began to wonder if Walmart’s discounted pricing actually meant Apple was imploding; unable to sell supply due to lackluster demand.  One blogger summed up that attitude well, writing: 

"Apple has finally thrown in the towel on pretending there is a supply shortage and admitted there is simply not enough demand at the given price point, by proceeding to sell the margin flagship iPhone 5 at a third off the original price, at the bargain basement commodity expert Wal-Mart of all places….And just like that, the “niche premium” magic of the once uber-cool gizmo is gone, not to mention AAPL’s profit margins, very much as the stock price has been sensing over the past two months…”

The blog known as Reuters added additional fuel and mystery to the Apple bear argument, in their usual naive style:

"Apple has focused on high-priced, premium gadgets for many years and has strictly enforced its prices with retailers and other distributors. However, a Wal-Mart spokeswoman said on Friday that the discounts were arranged with Apple.

'We worked together with them on this,' the spokeswoman, Sarah Spencer, said. 'They are a great partner.'

Why is Walmart Discounting Apple Products? 

Third-party retailer discounts are nothing new.  Best Buy and RadioShack routinely sell entry-level iPhone 5 units for less than $199 (Best Buy is currently selling the 16 GB iPhone 5 for $149.99).  Apple’s wholesale pricing and margins remain intact as these third-party retailers eat the discount (ignoring differences between wholesale and retail prices). Similar campaigns are seen with iTunes gift card promotions, where retailers offer free iTunes gift cards when purchasing Apple products. Best Buy is also well known for promotions similar to “Buy $100 of iTunes gift cards for $75”  - where Best Buy (not Apple) is responsible for the discount.

Diving into Walmart’s latest iPhone and iPad price discount campaign sheds additional light.

1) The promotion is only valid in-store. For brick and mortar retailers, store traffic and same-store sales metrics are important. One of Walmart’s ultimate goals in discounting iPhones and iPads is having customers travel to a Walmart and make their way through the store before finally reaching the iPhones and iPads (conveniently not located near the store entrance). Walmart feels confident that it will be able to sell additional items to these customers, similar to placing milk and eggs at the back of a supermarket so that a customer has to walk through the entire store just to buy a few essentials. In addition, many consumers will narrow their holiday shopping destinations to a few stores over the next week and Walmart wouldn’t mind making that exclusive list - using discounted iPhones and iPads as the carrot for getting people into the stores.

2) The promotion is only good while supplies last.  Many consumers have flocked to Walmart’s Facebook wall to point out that quite a few Walmart locations don’t have iPhones or iPads in stock. Walmart receives good press coverage from discounting popular items, while not losing much money as product supply limits sales; sneaky, but efficient.

3) Brand awareness. By advertising discounted iPhones and iPads, Walmart is using the promotion as a marketing campaign to strengthen consumer’s association between Walmart and Apple. Many consumers don’t think of Walmart as the first place to visit for iPhones and iPads. I can only imagine how many people now have Walmart at the top of their destination list in search of that perfect Apple gift for the holidays. 

What about that little gem from Reuters indicating Apple was working with Walmart on this discount?  On the surface, it sounds somewhat damning for Apple, but in reality, it doesn’t mean much; only that Apple is okay with Walmart eating iPhone and iPad price discounts. Sounds like an iPhone and iPad boom to me. 

Thoughts on Apple's 6.4% Stock Drop

Everyone wants to create a story for why Apple’s stock dropped more than 6% today. While daily stock fluctuations are hardly worth mentioning, a 6% drop on seemingly no news does stand out as an outlier. 

I have difficulty believing that a stock moves up or down on a specific news item because I am unable to verify why everyone is selling (and buying) a particular stock. Those selling shares at 9:30 AM may have a completely different motive compared to those selling at 3:59 PM. The same philosophy applies for a stock on the rise.  

As Apple’s stock collapsed throughout the day, news sites were fumbling over each other trying to guess what could possibly cause Apple shares to fall.  Several reasons floated around the web included:

1) A DigiTimes Article. I assume this article talked about all iPhone production coming to a halt, because I have a hard time thinking of any other topic that can cut $30 billion of Apple market cap in a few hours.

2) Tax Selling.  This one just won’t die.  Are investors selling their Apple shares today (25% off the high) only to avoid paying 5% more taxes on dividends and maybe 5-10% more for long-term capital gains?

3) China Mobile Approves a Nokia Phone.  So Apple loses $30 billion of market cap in a few hours because China Mobile announces it will sell a Windows Phone made by Nokia?  Really?

4) Samsung is Crushing Apple. Let me guess. Teens are ditching their iPhones and iPads and switching to Samsung phones because they are just that cool. Surely that would cause Apple to lose $30 billion of market cap in a few hours. 

5) Some rumor about retail margin requirements being increased for only one stock; Apple.  At first glance, this one at least sounds somewhat plausible, until one realizes most individual investors highly levered with margin already faced tough times a few weeks ago when the stock crashed to $505.  Even if this rumor was true, individual investors would be unable to account for $30 billion of Apple value vanishing in a day. 

6) Apple Maps. If all else fails, blame Apple Maps (ok…maybe I was the one to tweet this one as an excuse for Apple’s drop).

All of these possible explanations for today’s stock drop are nothing more than attempts of adding context to mystery; creating a story out of the unknown. Unfortunately, many are missing the big picture. 

There are very few news items that are even capable of moving Apple’s stock price by 6% in a day (the worst daily decline in years). Such a move is typically left for monumental events such as a CEO departure or natural disaster impacting production or distribution, and even then those events would often be met with a rush of buyers willing to support the stock.

Is there anything we know for sure about today’s price action? Yes.  

For every trade, the marketplace needs a buyer and seller. A stock price is the equilibrium where a buyer and seller are willing to exchange a share. Today, sellers were outnumbering buyers at $569 (Apple’s stock price at 9:31 AM), so the marketplace had to lower the price until sellers and buyers were in equilibrium. At 3:59 PM, the equilibrium for Apple’s shares was down to $538.  Selling pressure remained elevated for most of the day, and as the share price declined further, additional selling pressure came in, forcing the shares to fall even more. Apple shares haven’t seen this type of price action in years (the typical retracement was only around 15%, which would take a few weeks to occur). Buyers would typical come in and support the stock (the Flash Crash of 2010 stands out as another notable exception). 

The next question is what caused all of this selling? Unfortunately, we are forced to think of possible reasons for the selling to create a story because we hate the unknown.  I could end this post right here and call it a day, but what’s the fun in that? Sometimes even I need a story or two. 

I’m skeptical that any rumored (or even factual) news story was capable of causing the world’s most valuable company to drop 6% in a few hours. Instead, I think the intense selling pressure was caused by several mid-sized hedge funds forced to sell Apple positions because their computer models were programmed to sell Apple. In an effort to remove emotion from trading, some funds program models to buy and sell stock given certain market conditions (most likely momentum characteristics). By removing the human from the equation, one is unable to avoid selling a stock on no news (in many ways, for the model to be successful, all decisions have to be followed).  I think a rather large fund (or a few) were forced to liquidate or reduce their Apple positions simply because the stock was in collapse mode. Add in differing degrees of leverage (money borrowing) and you can see how things can snowball out of control very quickly. I also believe a similar thing happened last month when Apple shares fell 8% in only two days. The harder Apple fell, the faster the models said sell.  Meanwhile, buyers were simply unable to outnumber the sellers, causing the equilibrium price to remain under pressure. Of course, I’m sure there were plenty of retail investors selling Apple shares for completely different reasons, which supports my skepticism for labeling specific news items as stock price drivers.

Looking at the long-term, Apple is facing several headwinds that may give buyers pause. I have a difficult time modeling much in the way of EPS growth in 2013 given tough year-over-year margin comparisons. In addition, recent Apple management changes have not been tested in the marketplace.  I’m sure one can also come up with a few other things that would elicit fear about Apple’s future, but at a certain price and after a set amount of time, these fears are fully realized and digested by the market. I suppose one can also come up with good scenarios for Apple, but what’s the fun in that? When Apple’s stock plunges on heavy volume, skepticism should take hold, helping to usher in clear thoughts. Short-term stock trading is a fool’s game and I would love to be proven wrong. 

Anti-Apple Militia's Shifting Tactics; Attacking Apple's Cool Factor

A few years ago, I coined the phrase “anti-Apple militia” to describe the disjointed and incoherent group of SAI commenters that were not happy with Apple’s growing success. As Apple’s increasing dominance became clearer, the anti-Apple militia would desperately think of a new plan of attack,  often shifting themes within weeks. Some of my favorites were:

1) iPhone 3GS will flop because it looks just like iPhone 3G.

2) Palm Pre will crush the iPhone.

3) People don’t want a curated Apple App Store.

4) Android will crush Apple in the U.S.

5) iPad will flop because it’s just an oversized iPhone.

6) No one is buying iPhone 4 because of Antennagate.

7) No one is buying iPhone 4S because it looks like an iPhone 4. 

8) No one is buying iPhone 5 because of Maps.

Recently, I’ve seen the anti-Apple militia shift tactics and instead of attacking a specific iPhone or iPad feature, the detractors are going after the intangible; Apple’s popularity and coolness. Many anti-Apple comments are falling under the same genres, including:

"My daughter says all of her classmates are switching to Samsung and Windows phones. iPhones just aren’t cool anymore.” 

"Has anyone gone to an Apple store lately? They are empty and the only people I see are older folks. Meanwhile, Microsoft stores are packed with kids. So crowded."

"I was at the market yesterday, and some kid came up to me and couldn’t stop asking about my kick-ass Samsung phone. Youth just aren’t interested in the Phone anymore."

I think one of the main catalysts for this new attack campaign was Samsung’s ads that mocked people waiting in-line for the iPhone 5, including the scene of a son holding a spot in line for his parents. Samsung is going after one of Apple’s largest competitive advantages: it’s coolness. I look at these shifting attack tactics as desperation.  If using the battlefield analogy, Samsung and the anti-Apple militia are firing all remaining ammunition in the general direction of the enemy hoping something will stop the advance.

In reality:

1) Kids can’t get enough of iPhones and iPads (literally - parents are often not willing to buy new iPhones for their children until at least 8-9th grade).

2) College students continue to embrace Apple products at an alarming rate. 

3) Apple stores are more packed now than ever, with some complaining about how loud the stores have become.  Will the anti-Apple militia soon proclaim “no one goes to Apple stores because they’re too loud”?

4) Despite much broader product roll-outs, including massive pre-order allotments, people are still lining up for new Apple products.

Apple competitors see the writing on the wall. Not only is Apple continuing to broaden its reach across the world, including advances into enterprise and education, but it’s coolness factor is actually expanding.  As for the surveys and guesstimates showing Apple’s market share is getting trounced in China and markets where Apple has a weaker presence;  a true battle is one where both sides are present.

Quick Thoughts on Apple's Earnings

Apple reported another weak earnings report. Even though Apple plays the expectations game, I see no reason to spend time hating those involved in creating the game. Apple’s quarterly reports contain a lot of information, most of which is more suitable for tweets and random musings. I will leave all of the growth rates and other metrics to others and instead focus on the big picture.

Apple is still in the beginning of a massive capital investment phase (which has been detailed in 10Q and 10K filings).  In the span of four weeks, Apple updated practically its entire product line.  Few were expecting such widespread updates. While the iPhone 5 was the worst kept secret, as well as the rumored iPad mini, Apple surprised us with new iPods, new Macs, and a new iPad with Retina display.  All of these updates are taking a toll on the company in terms of upfront costs, hurting margins. The first iPhone 5 produced is more expensive than the Xth iPhone 5 produced next year. The same can be said for every updated Apple product. 

When thinking of massive capital investment plans, Disney comes to mind. As the U.S. economy was collapsing in 2008, Disney’s management team, which I regard as one of the most talented teams in this global economy, placed the bet that it was the right time to increase capital spend and make needed improvements to its Parks division. The stock market hated the idea (due to the unknown involved), but management stayed the course. Fast forward to 2012, Disney’s Parks margins are only now beginning to increase as guests enjoy the final product. Disney is now able to turn on the earnings faucet and reap the rewards. 

I think Apple is following a similar path. 

Once Apple perfects the processes required to make all of these new iGadgets, the costs will come down and margins will rise. The iPhone 5 form factor will most likely stay around for the new iPhone in 2013, helping margins. The iPad lineup will probably not see any additional revisions until next fall (when I expect a thinner and lighter iPad with Retina display). Constrained supplies will dissipate and the Apple earnings faucet will be operational once again. Additional implications include the high likelihood of no new Apple products until at least WWDC in June 2013, as well as continued lumpy quarterly earnings. Competition and component availability may also change product plans. In terms of modeling, I think Apple is becoming harder to forecast. I am afraid many independent (and professional) analysts will continue to forecast near-term earnings incorrectly as the number of input assumptions increase. Finally, I have been very public about my concern that product cycles were becoming too planned and orderly (i.e. iPad in March, iPhone in the fall), which artificially impacts demand as customers alter purchasing habits, but all of this is more noise than anything else, and these patterns eventually end.  

It doesn’t matter if Apple is a few dollars short of expected 1Q13 earnings or if iPad mini margins are a few 100 basis points lower than normal. Such details change from quarter to quarter. At the end of the day, Apple’s most important goal is making great products. Everything else is mostly noise.