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January 28, 2014

Sobering Quarter and Guidance for Long-Time Apple Bull

I often think that my best analysis comes from real-time commentary as I listen to the conference calls that accompany the quarterly earnings reports from the companies I follow. In the past, I have offered my twitter comments on Apple (AAPL). Below are my instant message comments sent to a colleague who helps me out with research on my Entermedia hedge fund. Apple is a holding for both Entermedia and Northlake.

The bottom line: this was a sobering set of data for a long-time Apple bull like myself. I still see value in the shares, driven primarily by the incredibly strong balance sheet and financial profile. However, the growth outlook is definitely less than I expected, leaving the company as a product cycle story. The product cycle seems unlikely to kick in until the second half of this year, whereas I had expected it be quite evident in the latest earnings and guidance.

I think the stock is likely dead money until we get some new positive datapoint and given that the latest iPhones and iPads did not do the trick in a seasonally strong period, it is hard to have confidence in the near-term outlook. AAPL shares need some clear and significant positive news to get the stock moving again. AAPL’s calendar of announcements suggests nothing is likely until the next quarter is reported, followed by a June product announcement. I believe the company may have reset the bar low enough that the quarter reported in April could be a positive catalyst. Longer term, the stock is only going to work if revenue and earnings grow consistently. They have not for over a year a now. I think the shares are worth holding after the 7% decline since the earnings were reported, but my bias would be to sell on strength. Previously, I had thought AAPL was a long-term buy.

Real-Time Earnings Conference Call Commentary:

4:36 CT: this AAPL really leaves the stk as a value play. no doubt future expectations too high based on current product lineup. still a ridiculously strong company but minimal growth with mgns to envy. I'd say this justifies the low P-E thesis and the post mkt reaction.

4:40 CT: looking ahead, it's another reset to expectations and with stock down here against a low $40s EPS number and cash, I'd say risk-reward is balanced. it's cheap and model is actually pretty stable, just not growing much. totally new product potential, a large screen phone, further growth in tablets can all be positive catalysts. so plus or minus 10%. blah. meh.

4:41 CT: furthermore I'd add this is the least optimistic call I can remember even when EPS and guidance were similar relatively to past Qs where the stk sold off.

4:43 CT: for example, they are taking pains to explain how one-time issues (or at least what other cos. would call one time) are masking an underlying double digit growth rate. that pretty much says it all.

4:45 CT: only question is whether this reset plus a 10% hit on the stock finally has set things up for renewed positive surprise. I'd say Icahn is gonna push again for buyback and from an "apple is mature" thesis he is right.

4:47 CT: only question is whether this reset plus a 10% hit on the stock finally has set things up for renewed positive surprise. I'd say Icahn is gonna push again for buyback and from an "apple is mature" thesis he is right.

4:53 CT: one positive is that gross margins are looking better than feared. stable in upper 30% range. only one question on this on conference call and considering it has been a primary portion of the bear case that is interesting. I think it supports this concept that it is largely mature cash machine.

4:55 CT: stock won't work unless they use balance sheet for shareholders. CSCO, MSFT, etc. have never done really done that and have never had anywhere near the financial firepower that AAPL has. Arguably no company has ever had this type of financial power.

4:57 CT: Gene Muenster with good question...are you still supporting your prior statements of new product categories coming this year and does that explain the higher expense level discussed earlier on the call. An emphatic YES followed by pause for effect from Tim Cook.

4:49 CT: Muenster follows up with another good question: "so new products come this year, setting up next fiscal year for good growth (remember fiscal year starts 10/1), what would you say to investors who state AAPL is just a product story?" Not much of an answer from Cook besides that he disagrees.

5:02 CT: and that is a wrap. I think the stk can bounce a little but until they announce either (1) new/upgraded products, (2) surprise to upside next Q, or (3) materially larger buyback and/or dividend, AAPL doesn’t have a lot of upside.

5:05 CT: I'll conclude by noting this running commentary is from a stubborn AAPL bull who has owned the stock since early 2005 around $40. that means either I have finally accepted a new reality or AAPL expectations have finally been reset to a level where disappointment is unlikely.

AAPL is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. AAPL is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Posted by Steve Birenberg at January 28, 2014 09:36 AM in AAPL