Apple Inc. (NASDAQ:AAPL) stock has gone nowhere in 2016, and that’s after falling nearly 30% from early July 2015 to late January of this year … and while there are many theories for AAPL stock’s stall, there is only one good reason.
Apple is being transformed from a company focused strictly on devices to one that competes in the cloud against Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL), Microsoft Corporation (NASDAQ:MSFT), Facebook Inc (NASDAQ:FB) and Amazon.com, Inc. (NASDAQ:AMZN).
AAPL took the decision to catch up in cloud infrastructure over a year ago, and is spending $15 billion in capital this year mostly on a network of scaled cloud data centers to serve its app store and iCloud operations. This comes after spending over $11 billion last year.
Even for a company of Apple’s size and financial strength, this is serious money. AAPL had no debt at the end of its 2012 fiscal year, but now one-quarter of its assets are subject to debt. Its cash flow from investment came in at negative $56 billion for 2015 and it nearly matched that in just the first two quarters of 2016.
What it is getting for all that cash is independence from rivals and the capability to deliver scaled media, software and backup services to a multibillion customer base. But the benefits from that will not appear in the value of AAPL stock for some time, and there is some risk involved. Apple has long held out the possibility of service revenue improving its financial position. Now that revenue has to be there.
This is why reports of Apple buying Tidal or any other media service start to make sense. AAPL is going to need an enormous amount of traffic to fill these servers. Heck, even a purchase of Nintendo Co., Ltd (ADR) (OTCMKTS NTDOY) — worth about $40 billion following the launch of Pokemon Go — starts to make sense in that context.
Ready For The Great Game
Augmented reality games like Pokemon Go show the promise of the new approach. A host of games and other services, based on placing digital objects in real-world contexts, are going to follow, make no mistake.
These apps are going to require enormous cloud capacity to run, and those who have that capacity will have a huge advantage.
But Apple shareholders have a right to be concerned. A company seen as a slam-dunk producer of wildly profitable devices is going to be taking the much smaller profit margins of a service provider, and there is no turning back. The move makes perfect sense from a strategic standpoint. But from a financial standpoint it carries risk, and it is transforming Apple’s balance sheet in frightening ways.
My view is that Apple will find a way to profit — that it is doing the right thing — but that its margins will never get back to where they once were. Mass-market service margins are not like mass-market product margins.
You can buy AAPL stock today for the 2.3% yield and the hope that its price-to-earnings ratio of 11 — reminiscent of International Business Machines Corp. (NYSE:IBM) — might rise a bit. And for what it’s worth, I’m holding on to what I have.
But until the new strategy is proven, realize you’re accepting a new kind of risk — and also realize that a buy in AAPL is not a buy in a growth stock anymore.
Dana Blankenhorn is a financial journalist who dabbles in fiction, his latest being The Reluctant Detective Travels in Time. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing, he was long AAPL, AMZN, GOOGL and MSFT.