Apple Takes a Bruising as the Cloud Takes Over

Hand-wringing among analysts and investors was the gesture of choice last week after Apple (AAPL) reported that it is no longer growing at record rates. I got the sense that Wall Street both overplayed and underplayed some key issues in the meaning of it all.

First, let’s just stipulate that Apple has a good business selling a lot of hardware for a good price, and makes a boatload of money. Sure, it’s not as big a boat as in the past, but it’s still a huge boat. The company earned about $10.5 billion in the quarter on $50.6 billion in sales. It also sold 51.2 million iPhones, 4 million Mac computers, 10.3 million iPads and an undetermined number of watches, iPods and other stuff.

These are mind-blowing numbers, to be sure, that most companies would kill for. Yet analysts could not have been gloomier. Goldman Sachs, BMO Capital Markets, Deutsche Bank, Nomura and Barclays, among others, all cut price targets and had assessments tantamount to the company’s growth cycle being dead in the water.

Some observers suggested that the only remaining option is to start giving shareholders a piece of its massive $233 billion retained earnings cash hoard. After all, now that the company is no longer growing, it makes no sense to have all that cash on hand. So give it back, they said. Let shareholders invest that money in better businesses.

On one hand, it seems dumb to write off a company executing so well it generates massive quarterly profits. Yet it’s also naïve to assume the growth problem will right itself simply given the passage of time. The problem Apple now faces is vision. When Steve Jobs showed the first iPhone back in 2007, he laid the foundation for one of the best businesses the world has ever seen. He knew it was going to be big and important. While others like Microsoft (MSFT) CEO Steve Ballmer were publicly scoffing at its touch screen and high price, Jobs understood the future of computing was mobile and that customers would pay for that convenience. He saw the big trend most tech insiders missed because they were clinging to past, comfortable business models.

But the next big trend will not be about phones getting smarter. It will be about powerful networks connected to mobile screens. Those networks will know us intimately, collecting vast amounts of volunteered data, such as where we live, the names of our loved ones, favorite shops, what foods and TV shows we like, and our travel plans. Using artificial intelligence, they’ll tell us if our spouse is running late because of terrible traffic on their commute or whether it might be a good idea to pick up a sourdough baguette at the bakery because it’s on sale and just a few minutes away.

These networks are the logical extension of a thin and fat client business model Oracle Systems (ORCL) founder Larry Ellison talked about 20 years ago. He never imagined back then that smartphones would be the fat client. But that time is passing. The devices we carry are overbuilt for the next network-centric computing wave. They need to get thinner so they can be faster; most of the computing will be done on the cloud.

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Apple’s business model does not fit this scenario. It has a comfortable, staid model that involves selling tens of millions of increasingly technology-rich iPhones — charging you more for power you won’t really need. While the rest of the technology world is racing toward the thin network model, Apple is investing very little in that future. A great example is iTunes vs. Spotify. In the old model, which favored Apple, you needed an expensive device with a lot of room to store thousands of songs you bought and owned. In the new model, which disfavors Apple, you need a lightweight device that connects over the network to Spotify, from whom you inexpensively license the right to listen to millions of songs.

Apple CEO Tim Cook is now channeling the worst instincts of Ballmer by using fear, uncertainty and doubt about privacy to cling to his aging business model. In the process, Apple falls further behind competitors and builds inherent weakness into its devices and business. At some point, services that consumers want — like knowing if their spouse is going to be stuck in traffic — simply will not be possible given iPhone privacy restraints. And let’s not forget the slower upgrade cycle required by the network-centric model disadvantages Apple too. For accessing the network, last year’s device is good enough.

In the near term, Wall Street is probably being too pessimistic about Apple’s prospects. It’s going to take some time before the network becomes the center of mobile computing, and Apple is dominating the status quo. But longer term, powerful networks will prevail and push hardware into the background… Thus far Apple has given no indication it will be prepared, and that is why analysts are freaking out.

In the immortal words of Marc Andreessen, ultimately "software eats the world." That is not the world that Apple – which is notoriously terrible at software — is built to thrive in.

From a stock perspective, expect the stock to meander lower, set a long base, and then climb back later in the summer in anticipation of the new iPhone 7. But that may be its last hurrah.

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CARACAS, AY CARAMBA

Venezuela has a bunch of problems. There is no medicine in the hospitals. Food is in short supply. The morgues are overflowing because people are killing each other in the streets. And all these troubles stem from Venezuela’s bigger problem. The country is now so broke it can’t even afford to pay for the currency it needs to print to pay for all of the social services it can’t afford.

Years of overspending by corrupt socialist regimes, coupled with the collapse of oil prices, have left nothing in the coffers. President Nicholas Maduro is printing bank notes at breakneck pace. Last year three dozen Boeing 747 cargo planes arrived in the dead of night filled with nothing but boxes of the new bills. But the new currency only causes more inflation.

This year inflation in Venezuela is expected to reach 720% after cresting at 270% in 2015. When they’re not being robbed or murdered, anxious Venezuelans swarm banks and outdoor markets with backpacks filled with cash, trying to buy goods before prices inevitably rise. It’s so bad that the country’s largest note, the 100 bolivar, will buy you no more than a single loose cigarette from any one of a thousand vendors who are scratching to sell anything they can in the streets of Caracas. It’s a nightmare. The fact that currency-makers are no longer accepting contracts because past orders have gone unpaid is the final slap in the face. If not for the human cost, it would be laughable.

This is the cost of gross mismanagement, and prevents me from recommending the cheap emerging markets.

Best wishes,

Jon Markman

P.S. There’s only one way to say it: Mike Larson blew us away during his briefing yesterday afternoon. This information is so crucial to your financial survival, we’re leaving the recording online for a couple of days. So if you missed this all-important call or want to listen again, be sure to do it NOW!

Click this link to listen in NOW!