Apple deflates stock price
Were recent profit warnings designed to end financial expectations? Apple can't deliver?
Analysis Apple's Q4 profit warning, issued on Monday, has nothing to do with meeting the demands of customers but everything to do with controlling the expectations of Wall Street. It's not at all about Motorola's ability (or otherwise) to keep Apple's factories stocked with PowerPC 7400 (aka G4) CPUs. Instead, it's all about reining in a runaway stock price before what's expected of the company outstrips what it can deliver. So what does Apple's statement actually say? Well, not very much, actually. Essentially, when the company announces its results for the current and fourth fiscal quarter, which is about to end, it reckons earnings will be between $75 million and $85 million. It also says that's lower than last quarter's revenue, which you may recall came to $114 million (before being bumped up by the sale of $89 million worth of ARM shares). And the reason? Motorola didn't ship Apple enough G4 processors. Sounds simple, but such is the fall in earnings that it warrants a closer look -- having your profit fall by up to 41 per cent year on year (Q4 1998 saw earnings of $106 million) seems rather more serious than a limited supply of processors. So what about the flow of G4s into Apple? There has been talk of trouble at Motorola with the G4 ever since last June when rumours surfaced that the chip was way off schedule. Subsequent events have shown that that wasn't the case after all, but that doesn't mean everything at Motorola has been running smoothly either. New CPUs -- and the G4 is significantly different from the G3 -- take time to design, time to debug and time to produce. If the company is to be believed, Motorola has been ramping up production of G4s for the last couple of months. That doesn't mean its been punching out any more chips, rather that the number of defective parts which have to be dumped have been falling as bugs in the production process have been dealt with. These days chips are produced for a range of clock speeds, if they fail to run at, say, 500MHz, they're tested at 450MHz and, if necessary, are sent down the line until they're certified to run at a clock speed within the range, don't work at all or do work, but a slower speed than the vendor can get away with. In the early days of a CPU's life, that process tends to favour lower clock speed chips. There's nothing surprising there -- that's how all processors start out. The point is, Motorola knows that, Apple knows that and Apple should arguably have tailored its own shipment plans accordingly. In fact it has, which is why the 450MHz machine wasn't set to appear until the end of the month, and the 500MHz G4 sometime in October. When your release schedule is so spaced out, a few weeks here or there shouldn't make much difference, and indeed they arguably haven't. The fact is, even with a good supply of CPUs, computer companies can't always get machines out on time. The blue'n'white G3 may have shipped on time, for example, but a heck of a lot of people had to wait some time for their machines as the initial batch of orders were fulfilled. It's no different this time, and the proof is that for all the complaints against Motorola, Apple hasn't rejigged any of its 450MHz and 500MHz release dates. So what's really going on here. First, the profit fall. Revenues and earnings traditionally tail off in the summer months, which is why CFO Fred Anderson has always stressed the very positive expectations the company has for the December quarter (Q1 2000) and downplayed Q4. And he did so not only in Monday's profit warning but months ago when Q2's numbers were published. A fall of 41 per cent year on year sounds a great deal, but Apple did exceptionally well last year because it launched the iMac. iMac sales are continuing reasonably well, but the trend is downward, largely because the novelty has begun to wear off but also because there has been no recent kick to the line to give sales some extra momentum, much as the release of the multi-coloured casings did back in January and February, and the 333MHz speed hike did a few months later. Now, hopefully, the combination of the iBook, a revitalised iMac and ramped-up Power Mac G4 will indeed allow Anderson's predictions for the fourth quarter. But that's why he made them, and why the profit warning was, to a degree anticipated much earlier and dutifully sidelined in favour of better results in the next quarter. Any gaps in the processor supply line will have made matters worse, but they won't have changed the broad financial outlook for the quarter. So why make the warning? Well, the blame lies not with Motorola but with Apple itself, though to be fair, most other computer companies would have done the same. The announcement of the iBook, followed closely by the launch of the G4 and all the rumours of the upcoming iMac 2 have driven Apple's share price way up. At the beginning of the year Apple stock sold for around $35, this month it peaked at over $80 -- that's the highest price Apple stock has ever achieved. Now that's great if you're an Apple investor, but not too hot if your Apple itself. Even in its heyday, when it was solid, successful and its future wasn't in question, Apple was trading at the $40 mark. It would have been hard to sustain the expectations inherent in a share price double that one even then, but now when Apple can still feel the heat from the massive losses it recorded while under Gil Amelio? No, Apple really doesn't need that kind of pressure. Hence the 'deflationary' tactic of driving down the share price by issuing a profit warning. Apple's statement has so far knocked around $11 off the share price, getting it down towards the $60 mark, which is probably a reasonable indication of what the company is really worth. Company executives are legally bound to maximise the value of their shareholders' investments, and if that means limiting it in the short term to prevent much, much worse figures in the medium to long term, so be it. What 'much, much worse figures'? The ones that will come if the Street loses confidence in a high, overvalued stock. If Apple runs into real trouble -- and a slower-than-expected supply of brand new processors isn't real trouble -- it could well lose the backing of Wall Street. Apple -- and AAPL owners -- had enough of that in 1997. ®