|Shares Out. (in M):||5,300||P/E||16||20|
|Market Cap (in $M):||630,000||P/FCF||13||12|
|Net Debt (in $M):||-140,000||EBIT||0||0|
|Borrow Cost:||Available 0-15% cost|
Apple is a legacy fast follower technology company with a rapidly declining moat and lack of attractive reinvestment opportunities. Under current lackluster management, the company has transitioned into a high priced retailer whose sky high share of the mobile device global profit pool has nowhere to go but down. Insiders confirm this view with their consistent selling of Apple stock and continuous exit to growing, competing companies. The company’s emotional fan base has translated into an emotional and unsteady investor base. Apple’s optically cheap valuation masks opportunity for a successful short investment as business value deteriorates. Operations are not earning their cost of capital and the company is in slow liquidation. The company’s equity is worth $60 per share, 50% lower than today’s market price.
Link with accompaying charts: https://drive.google.com/file/d/0B5AhopgMAgquZjIzdUJqTUdqaXc/view
Gauged by its current market capitalization, Apple is the most successful company of all time. Founded in 1976 by two college dropouts and a businessman who provided seed capital, the company successfully developed one of the first and most popular personal computers. The company’s computers married internally designed hardware with internally designed software and sold in steadily increasing volumes throughout the 1980s. In the 1990s, Microsoft (operating system) and Intel (CPU) developed a personal computer platform that disintermediated other existing platforms. The Wintel platform divorced software from hardware, commoditizing the majority of hardware manufacturers. This simultaneous industry wide standardization of operating systems created the largest ecosystem for software developers to build new applications into and provided the surest way to monetize their efforts. Apple had a better product from the user’s point of view, but the network effects of the competing larger ecosystem decimated first Commodore’s then Apple’s market share.
Luckily for Apple, one of its founders was a product design genius, whose vision successfully remade the company into the mobile computing industry leader starting with the introduction of its mobile music player (iPod) in 2001 and culminating with the iPhone in 2007. The iPhone offered a combination of voice, data and internet services that were unavailable from competing products, and the product was wildly successful throughout Western markets. Sticking to its roots, the company’s growing suite of mobile computing products bundled internally designed hardware with internally designed software. Because of the company’s small relative size versus existing global manufacturing capacity, Apple was able to outsource all hardware manufacturing and operate a capital light model producing very high returns on capital. While switching costs have historically been very low for consumer tech products, the company designed its products to be interoperable only with one another, preventing the existing or future products (eg tablets, cameras, music players) of competitors from integrating into the Apple ecosystem. Finally, the large ecosystem of apps developed specifically for Apple’s products combined with interlocking devices created large network effects, protecting and growing Apple’s profit pool through 2015.
History Does Not Repeat, But It Rhymes: Research in Motion Analog
Founded in 1984 by two engineering student dropouts in Waterloo, Canada, and later led by an “aggressive, arrogant and sharp tongued” businessman who mortgaged his house to provide the company with capital, RIM was a software company initially focused on wireless data technology, later broadening into mobile communications including email. After licensing its technologies for 12 years to a variety of corporate and government customers, the company married its internally developed software with internally developed hardware, first creating a paging device in 1996, then a mobile phone (the BlackBerry) supporting voice and data service in 1999. Riding the success of its mobile device launch, RIM went public in 1999. The company pursued grass roots, guerilla style marketing tactics, taking products to industry trade shows and winning over potential users by demonstrating the BlackBerry’s dramatically higher feature set versus existing products. The young company was hungrier and scrappier than existing software makers Microsoft and Symbian, and hardware makers Nokia, Motorola and Palm.
For the next decade, the company drove a successful product upgrade cycle every 12 to 24 months, iterating new features that kept the company’s products at the forefront of available technology, and marketed to consumers under ever changing naming (eg BlackBerry Electron, BlackBerry Pearl, BlackBerry Storm, BlackBerry Curve, BlackBerry Torch, BlackBerry 7, BlackBerry 10). Due to controlling its own operating system and restricting what external devices could interact with BlackBerries, the company benefitted from a customer switching costs moat. Later, as many corporations mandated their employees use BlackBerry products alone due to perceived security features, and even subsidized them, RIM benefitted from a mild network effect moat. Revenues grew from $300 million in 2003 to $3 billion in 2007 to $20 billion by 2011.
In 2007, RIM became the most valuable publicly traded company in its home market. The company’s success turned Waterloo into the Silicon Valley of Canada, and created a culture of cultish loyalty to the company. The product became a status symbol and received free marketing from an expanding collection of public celebrities. In 2008, a campaigning President Obama stated “I cannot live without my Blackberry” and that his team concerned about data security would “have to pry it out of my hands.”
In the summer of 2007, Apple launched the iPhone, which proved immediately successful with consumers but failed to notably displace RIM’s market share. RIM management viewed the iPhone as materially deficient and struggled to understand why consumers would want a product that lacked the functionality of the BlackBerry. From Losing The Signal: The Untold Story Behind the Extraordinary Rise and Spectacular Fall of BlackBerry:
‘ “The iPhone’s popularity with consumers was illogical to rivals such as RIM, Nokia and Motorola. The phone’s battery lasted less than eight hours, it operated on an older, slower second-generation network, and, as Mr. Lazaridis predicted, music, video and other downloads strained AT&T’s network. RIM now faced an adversary it didn’t understand. “By all rights the product should have failed, but it did not,” said David Yach, RIM’s chief technology officer.’
Despite this new competitive threat from Apple, whose iPhone market share grew from zero to 18% by the end of 2009, RIM continued to grow and doubled its own share from 11% in 2007 to 21% by 2009.
However, by 2010 the iPhone had easily surpassed the feature and technological advantages of the BlackBerry, and RIM’s market share began to decline. In addition to making a better physical product, Apple was busy forming a multisided network of users, applications and app developers. From Losing the Signal:
“Now RIM was forced to play catch-up. Unlike RIM, Apple had an army of outside developers who had already built consumer apps for its computers and iPods and were primed to do the same for the iPhone. By the time BlackBerry launched its app store in spring 2009, iPhone customers had already downloaded 1 billion apps.”
With the installed base of iPhones growing faster than any other smartphone platform, more software developers were interested in making more apps for this growing ecosystem. Apple made it easy for developers to monetize their efforts while taking a fat 30% cut of the pie. A virtuous circle developed and led to compounding network effects that sucked talent and capital away from the BlackBerry ecosystem and into the iPhone ecosystem.
In 2012, RIM’s co CEOs departed and a new CEO tried to remake the company, growing into different product areas where the company had limited experience. Culminated by naming Alicia Keys as the company’s creative director, RIM was widely panned as having lost its way. In 2013, an activist shareholder emerged and suggested the company change its product focus, sell parts of itself, and return capital to shareholders. Finally, in 2016, the company changed direction once again and announced its focus on services over hardware. From a September 2016 article in AppleInsider:
“After yet another unprofitable quarter, BlackBerry CEO John Chen has announced that the company will rely on partners for hardware, will no longer design smartphones internally, and will shift to a services-only model to insure the company's survival.”
Challenges Facing Apple
Apple is not Research in Motion… yet. In addition to failing to innovate its primary existing product, RIM also failed to expand into adjacent product areas, while Apple has proven it can adapt. RIM failed to create an ecosystem in which to entrench itself, while Apple has done this superbly. Finally, email network outages in 2009 and 2011 upset existing users and exacerbated RIM’s decline, while the quality of Apple’s products has never been higher.
But there are cracks in the armor. For the first time since its launch, year over year iPhone unit volumes declined in 2016 at the same time unit price declined by the largest annual amount on record. Much more worrisome, however, is the continued market share growth of a competing platform: Android.
For a company’s whose primary moat is the network effects of its ecosystem, a declining user base combined with the accelerating user base of your primary competitor is more than a bump in the road. When competing physical products of equal or better quality sell for prices 70% cheaper, and provide access to equivalent or better apps not exclusive to Apple, network effects erode rapidly.
Closed Ecosystem Does Not Play Well With Others
As of 2017, the largest tech industry players (eg Google, Amazon, Facebook, Microsoft, Netflix) create and develop products and services that interoperate with the products and services of their competitors, allowing for multiple company's ecosystems to grow and flourish at the same time. In varying degrees, these companies share consumer user, preference, buying history, geolocation etc data among each other. Apple is the major exception, as it operates its ecosystem in isolation from others, and attempts to collect a steep tax for any outsider to access its ecosystem. This shortsightedness, understandably viewed by management as protecting their moat, has driven other companies to create competing ecosystems that disintermediate or replace Apple, increasing the value of those ecosystems while decreasing the value of Apple’s.
In addition to a declining user base, time spent by existing Apple consumers on Apple ecosystem apps has also materially declined. Currently 80% of time spent by all mobile users (regardless of operating software) is allocated to Facebook and Google products, two large, well capitalized companies who have and continue to disintermediate Apple’s services and products. Both of these companies have attempted to build their own feature phones and both continue to develop competing ways for the consumer to easily access the internet without the use of a smart phone at all.
The primary example of successfully opening one’s ecosystem is Google acquiring the Android mobile operating system technology and making that software freely available for all smartphone manufacturers, while continuing to advance the technology and provide updates to the existing global user base for free. Google created an industry standard software that it controls without building any hardware.
Other, recent examples of successful network partnerships are Visa opening its platform to new technologies (see PayPal agreement) and Amazon opening its Alexa voice recognition software (to, for example, Google's Nest home monitoring tools). The open system Google fostered encouraged more and more developers to build onto the base platform, thereby increasing the products available on the platform, thereby increasing the users on the platform, thereby increasing the overall value of the platform, at limited additional cost to Google.
Apple’s largest competitors are offering their own substitute products and services as loss leaders to increase and protect their other, more valuables services. Google ($570 billion market cap) and Facebook ($370 billion market cap) are protecting their growing advertising streams, where they control 100% of digital advertising spend. Amazon ($380 billion market cap) is protecting its online marketplace, where 30% of all online retail purchases are made in the US. In addition, all of these companies offer the consumer one of more forms of digital media services (eg music, video, picture sharing, data storage) that compete with services that are core to Apple’s bull thesis. Collectively, these companies have larger scale and firepower and can keep reinvesting in these competing products, while offering them for very cheap or free, over an indefinite time period. As the Android platform continues to scale, Google can also underwrite a materially lower cut of app revenue in its ecosystem over time than the 30% that Apple is dependent upon, further redirecting software developer talent away from Apple’s ecosystem.
Smartphone Declining Relevance
As the scale of computing power dedicated to the cloud continues to grow exponentially, the smartphone is increasingly becoming a "dumb terminal" and not a "pocket computer." Many technologists argue that in the not too distant future, the majority of the compute function that smartphones perform today for consumers and businesses will be replaced by compute processing performed remotely on a server in a datacenter, with the output connected in real time to the mobile terminal via rapidly fast mobile internet service. In this scenario, the incremental buyer of a mobile terminal will not pay $700 for an iPhone, and maybe not even $100. The largest growth market for mobile devices over the next five years is India, followed by China. Based on current economic conditions, the iPhone is prohibitively expensive in India (one phone equates to 25-30% of GDP per capita), confirmed by its existing 2% market share. Subsidized by some combination of the government, carriers, banks, and local internet companies, phones (running on Android, not Apple software) are literally being given away for free (eg the Ringing Bells Freedom smartphone) in India.
Overly Dependent on One Product
Apple’s installed base of phones equals 15-20% of the global market by units, yet it took 103.6% of the smartphone industry's profits (per BMO analysis) during the third quarter of 2016 as Samsung’s industry leading smartphone suffered a very public quality issue. Thus, Apple is dramatically over earning versus its peer group, and mean reversion theory supports this dominance not continuing indefinitely. Longs point to the low relative market share and claim there is much room for this to grow, in addition to volume growth that should come from simply maintaining existing share. I think if the company already earns >100% of the entire market's profit, it cannot materially increase from that level, and has nowhere to go but down. If the company cannot rely on increased smartphone profits to increase its market valuation, its going to need to develop new products and services with correspondingly huge market opportunities. In every current identifiable large consumer or technology vertical (outside of smartphones), Apple has no existing, competitive offering, while all of its peers have successful products growing rapidly.
Apple's success was driven by a product design genius and founder, a once in a generation, Edison type of inventor. That genius has been dead now for several years, and never created a sustainable culture that will allow the company to continue to create and develop new products and services that consumers desire, or attract the best employees that other successful technology companies are simultaneously recruiting. Owner / operators (companies managed by their founder, who still has a large amount of personal capital at risk) tend to perform much better than company's managed by agents. Facebook, Google, Amazon, and Microsoft's founders are all alive, heavily involved in their company's operations, with most of their net worth at risk.
Over the prior four years, insiders have collectively reported $675 million of gross stock sales in 101 reported trades versus just one $470k purchase. Its important to note the culture that exists among Silicon Valley companies re excess stock compensation and frequent insider selling, so its not like Apple stands apart here in a materially negative way. But this just highlights for me that no senior leaders in the company do see or have seen dirt cheap, margin of safety type value in the company’s shares for a long time. Everybody likes the idea of having more money, even people who already have lots of it. So it surprises me that no insiders are willing to commit even a small percentage of their liquid net worth back into the stock if it is such an amazing value.
More alarming than this steady insider selling, the company’s competitors have announced steady poaching of Apple’s top engineering talent over the past two years. Tesla in particular has raided Apple’s nascent car project. Other notable departures include the original Siri team, the former heads of Apple’s online retail business, and the manager who led the company’s recent music service investments.
Capital Allocation and Lack of Reinvestment
While admirably returning capital to shareholders, management's reinvestment of capital has been poor over the last several years. In continuing to focus on its smartphone platform and related ecosystem, Apple has watched peer firms take the lead in every recent tech industry advance: payments, retail, social media, music, cloud, etc. Where the company has delivered or announced new products, consumer demand has been lackluster (watch) or timing has been continually delayed (car). Recent acquisitions in the music space have also been severely criticized by analysts as overvalued and non additive to the company's existing service, such as acquiring Dr Dre's Beats Music for $3 billion when it had just a few hundred thousand users, and eventually shutting down the unit less than 18 months post acquisition.
Over the prior five years, Apple’s return on invested capital has steadily been cut in half as unit sales declined and pricing power eroded. Management has failed to create attractive reinvestment opportunities to offset legacy products, and has instead focused capital spending on gimmicky line extensions and overpriced acquihires. As a result, the company has only produced an incremental $2 billion of profit on an incremental $125 billion of shareholder capital since 2012. If that sounds like coupon clipping a US Treasury Note, that’s because it is: 94% of the company’s capital base at fiscal year end 2016 was cash.
If we assume a required cost of capital of just 8%, then the company has been destroying shareholder value by continuing to operate, given its recent average annual return on incremental invested capital of 7%. The best capital allocation strategy for management to pursue under these circumstances would be to aggressively return capital to shareholders. To remove cash from the invested capital base and calculate ROIC / ROIIC excluding cash, an investor needs to believe management will return cash to shareholders in an extremely aggressive fashion over a short time period and have no future need for that cash to fund reinvestment. Neither of these seem likely in Apple’s case. Despite the increasing stock repurchases and dividends paid over the past few years, the company’s sheer scale presents the greatest challenge regarding accelerated capital returns. An analyst can conclude either 1) management is destroying shareholder value by continuing to operate and not return cash even faster, or 2) management in in the process of liquidating the company.
To management’s credit, they do appear to be following this logic. In their own words, compare management’s “Fiscal 2014 Highlights” with their “Fiscal 2016 Highlights.”
The 2014 commentary contained 447 words, 78 (17%) of which discussed return of shareholder capital, while the 2016 commentary contained 145 words, 82 (57%) of which discussed return of shareholder capital.
Apple is a company in slow liquidation mode, and should be valued that way.
What is the Equity Worth?
Two scenarios are presented below: a base case of gradual decline and a downside case of self disruption. Liquidation value determines worth in the former scenario while a going concern value is assumed for the latter scenario.
In the gradual decline scenario, management attempts to protect its current hardware / software / services bundled offering and maintain its prestige brand image. This scenario is most likely because it presents the least amount of near term pain for management while maintaining a static installed base in anticipation of a future product lottery ticket. Current pricing and volume decline trends continue, but each major product produces an additional, successful refresh cycle, driving a mild volume ramp followed by management taking price. Services revenue growth outpaces product revenue growth as the flattening installed base spends more per user than in the past, and the higher margins inherent to this revenue line bolster overall gross profit margin despite declining company revenues. Management continues to accelerate R&D spend ahead of the refresh cycles, and rewards itself when year over year comps turn positive.
Five years from now, Apple would have an accumulated cash balance of $347 billion assuming no incremental share repurchases. Assuming 10% frictional costs, shareholders would receive $313 billion of the cash in a liquidation. Assuming an acquiror would cut R&D and SG&A spend in half, pay 7x for proforma operating income (or ~4x gross profit) in 2021, pay with cash and assume all working capital, the operations’ cash generating ability would be valued at $171 billion or $145 billion net assuming 15% tax. Adding the net cash to the sale proceeds, and discounting that sum back to today at a 10% discount rate equates to $284 billion, or ~$54 per 5.3 billion shares outstanding. For simplicity, the company’s portfolio of ~15,000 patents are assumed to offset existing debt of $80 billion (assuming they were decoupled from operations and sold to a group of bidders), valuing each patent at greater than $5 million compared to the ~$700k Google paid for each of Motorola Mobility’s 17,000 patents in 2012 (note: based on subsequent events, Google likely paid a much lower implied valuation). Apple’s brand certainly has some independent value, but if the company’s operations enter secular decline, the brand probably would not be disconnected from operations in a sale or liquidation.
In this scenario, there is a $350 billion gap between the company’s realizable equity valuation and its current equity market value, equivalent to approximately one entire Facebook or one entire Amazon.
In the self disruption scenario, management recognizes its existing multi sided network of users / subscribers / developers / apps is more valuable than lumpy hardware revenues. This scenario is less likely because it presents the most amount of near term pain for management and carries a high risk of public failure. The end game for all of Apple’s primary competitors is scale and service based, recurring revenue. Due to the company’s premium hardware product strategy, Apple is severely disadvantaged here, and need’s to grow its installed base as fast as possible just to protect its existing services businesses and their high relative margins from being disintermediated. For enough unit volume to meaningfully grow the company, the company would need to alter its premium pricing strategy and introduce lower margin mobile devices. Its largest opportunities for user base growth are China (10% current share) and India (2% current share), where the price points for competing products are 70% lower than the company’s products.
This scenario assumes management first cuts the iPhone price in half in 2018, with only a tepid response in volume. Now all in on its radical strategy shift, management further cuts price down to a level commensurate with competing smartphones, and volume growth surges to 425 million units by 2021, giving the iPhone a market share (21%) equivalent to Samsung’s in 2015. More importantly, service revenue expands 50% faster than overall unit volume ($41 billion incremental growth, or the creation of five Netflixes), and a full third (up from 11% in 2016) of the company’s revenues are now generated by recurring services. Gross margins for the company’s hardware products decline into the mid 20s, but the expanded services revenue stream more than offsets this compression.
This scenario assumes a perfect threading of the needle: competitors stand still, product quality remains high, existing users do not defect from the brand, additional manufacturing capacity is easily accessible at favorable prices, and gross margins actually increase. Despite this hail mary success, operating income would still be 45% lower in 2021 than it was in 2016.
Valuing 2021 operating income of $31 billion at 15x, the company’s operations would be valued at $467 billion. Adding accumulated cash of $345 billion to the operations’ value and discounting that sum back to today at 10% equates to $503 billion of enterprise value. Deducting $80 billion of existing debt provides a current equity value of $425 billion in this scenario, or ~$80 per share.
In this scenario, there is a $200 billion gap between the company’s realizable equity valuation and its current equity market value, equivalent to approximately five entire Tesla’s.
I think I am being very generous with the margin assumptions here, especially given the experience of Nokia and Blackberry. A critique could be made regarding R&D spend continuing to grow in such large absolute terms, but I am not sure what choice Apple management has. Note: competitor R&D as a percentage of revenue for 2016 was as follows: Facebook 27%, Google 16%, Microsoft 14%, Amazon 12%.
Management doing something large and inorganic with its existing cash hoard is the biggest risk to the short thesis. Because of its long history and culture of only developing products internally, I think the likelihood of this event is low. Further, due to sheer scale, its hard to determine what acquisitions the company could make that would be both available for sale and accretive to existing operations.
o Due to their similar focus on product quality and brand image, as well delivering media digitally and controlling content, an acquisition of Disney could make a lot of sense. Disney wants to create a Netflix competitor by the time its contract runs out with Netflix in a few years (hence its investment in MLBAM last year, the entity which operates the back end for HBO Go). Disney also owns a high quality portfolio of media content that it has proven it can successfully reinvest into, even at larger and larger scale. Disney needs an operating platform to reach consumers over the internet; Apple has it.
o Similar commentary for Disney, but instead: Netflix. While debatable if Netflix’s current content spending is creating value for its shareholders, it certainly has a need for a large amount of cash and believes it can keep reinvesting it at a high return. Netflix needs cash; Apple has it.
While iPhone unit trends look set to continue declining, especially as Samsung returns to the marketplace humbled and hungry, Apple could introduce another successful iPhone upgrade cycle in the US, providing the company more time to develop line extensions for other products and services, or create new products with markets big enough to impact the company’s current $630 billion market cap.
Even in decline, the company should continue to deliver large amounts of free cash flow and return cash to shareholders. At its current valuation, management is likely destroying value by repurchasing shares, but will likely continue to do so and provide support to the current stock price. If management announced plans to pay an immediate >$100 billion return of capital dividend and did so with minimal tax impact to shareholders, I would need to re underwrite my views on the company’s capital base and capital allocation.
|Entry||01/23/2017 09:11 PM|
I was looking forward to seeing the "other side" argument, but look at your models - you have sales collapsing (fine) but then your R&D is going from $10b to $20b+ while sales are collapsing? What are they are investing that money in? SG&A is a similar story. I must be missing something.
|Entry||01/24/2017 10:11 AM|
I have been on this board before with this-but will reiterate. It makes little sense for Apple not to buy Netflix. The biggest way to scale Netflix and increase its widening lead in global television is to invest more in a broader set of content rights. Sports rights for example, eventually. Apple could do this. Apple could also potentially figure out a way to bundle Netflix with hardware in a growth market like India, which could be a key differentiator.
There is an argument that the acquisition would not make sense because Netflix loses value if it is exclusive to Apple products/ecosystem-and Apple does not capture value if its makes Netflix available everywhere. But Apple does not need to make Netflix exclusive to build value in Netflix over the long-term if it increases the content budget and grows the global subscriber base, both of which it could do. Apple could also market Netflix through its retail distribution to encourage sales of Apple products or optimize features for Apple products, with reducing Netflix's ubiquity. If Apple ever decided to make a television set, optimizing Netflix for that set would be a powerful selling point. This is happening in the smarttv market now.
There are few other ways for Apple to build/acquire $11B in recurring subscription cash flow, growing over 20% per year, with a global brand, in an enormous addressable market, with an opportunity to bundle the service, drive future hardware sales, and scale its high-margin, high-multiple services revenue stream. It would also be an economic and efficient way for Apple to build a very valuable library of owned IP--that could have application for VR/AR down the road.
It makes no sense for Apple to make a few shows to bundle with Apple music, as has been reported is the strategy. That will make little difference for the business-and actually risks damage to Apple's brand if the shows are not done well.
Acquiring Netflix would instantly make Apple the dominant company in global film and television. That is an evergreen market around the world. It can create huge intangible value in the Apple brand. It may be financially dilutive--but so were Instagram and Whatsapp. The long-term strategic rationale is solid. And the financial dilution does not account for the possibility that Apple could bundle/market Netflix to drive consumer product sales, particularly in emerging markets.
If Google or Facebook acquired Netflix, it would seriously diminish the probability that Apple will ever have a real presence in the consumer entertainment market. That would be a dangerous opportunity cost, based on the bundling possibilities of content/services down the road. (A Disney acquisition makes a lot less sense-capital intensity in the parks; no OTT business; a lot more expensive for many assets that are mature-to-declining (i.e. domestic cable networks).
|Subject||Re: Re: Netflix Acquisition|
|Entry||01/24/2017 02:57 PM|
1-It makes sense for any company that wants global scale in streaming video to buy Netflix because the library, data, brand awareness, and market penetration in Latin American and major strategic English speaking markets cannot be replicated and the market for streaming video is large and growing. Many companies will want to participate (see John Malone at LGF investor day speaking about the Netflix business model-
2-Amazon and Netflix are not substitutes if they have different content and they each have enough scale to create and license exclusive content. People like choice and variety in content and will get both to suit different moods and preferences. People generally want more good content, not less. Netflix has advantages internationally as it is the leading consumer brand for streaming and has almost 50mm subscribers and has been in Canada, LatAm and English speaking parts of Europe for almost five years. Also, Amazon is creating some complexity in its domestic prime video product that probably does not help it take market share. Long-term, Amazon does have some weapons i.e. Alexa / strapping a camera on a drone so a person can watch their package fly to their house. But both should do well if they can create content people want to watch.
3-Amazon does have a funding advantage in so far as the retail business can finance the heavy upfront cash investment in content. But Netflix has a data advantage and scale advantage on a per sub basis which allows it to amortize the investment more efficiently (I am assuming that Amazon Prime does not have 100mm video subscribers) High upfront cash investment is required in content to fund original programming. Your willingness to underwrite depends on the value that you judge is created by investing in original television programming for global distribution. To date, that investment has provided good economics for Netflix because it is growing the subscriber base, reducing churn, building library value, creating the largest global database of consumer entertainment preferences, and shifting consumer behavior away from linear television. The quality and variety of the content has improved meaningfully in a short time, which makes the product better. Netflix just won the Golden Globe for best drama and it has only been making original content for about 5 years. That quality should continue to improve because the platform will attract the best storytellers as it scales because it offers the biggest budgets, least censorship or friction (no ads) and largst audience.
4-I think Netflix's biggest advantage might be that it can invest aggressively to build content franchises, brand awarenes, and create asset value in the form of data and IP. The legacy media companies are severely disadvantaged by their capital return mandates and lack of technological capabilities now that the distribution has changed from linear to the internet.
|Subject||Re: Re: Re: Netflix Acquisition|
|Entry||01/24/2017 03:58 PM|
Hey guys, you seem to have gotten lost. Let me help you out:
|Subject||Declining user base|
|Entry||01/24/2017 09:16 PM|
Thx for an interesting write-up.
A question: You state that the AAPL user base is declining several times in the write-up. Is it? What is the data you base this claim on? Or are you talking about relative share decline here (different story entirely) or is this a development you think will happen? As far as I can tell, there is little data to support that claim as fact today.
|Subject||Re: Declining user base|
|Entry||01/24/2017 11:14 PM|
Hopefully it provided a useful, variant view on a name with 37 sellside buy ratings.
Overall installed base continues to increase but at a declining rate, while Android installed base is increasing at an accelerated rate (the more impt point). Have seen installed base estimates at various points in time but generally conflicting data. Combined with last years' share decline and expected share decline this year, the overall installed base is at or nearing tipping point of initial decline (that is my argument, assuming 2-3 year avg life of product).
|Subject||Re: Re: Re: Declining user base|
|Entry||01/25/2017 11:07 AM|
You are arguing for a self disruption (not M&A, ie inorganic), which is the downside scenario I present. In this scenario, Apple creates 5 Netflixes from scratch and is rewarded by the market with a fulsome valuation.
Microsoft began their business model transition 3 years ago on a revenue base that was 1/3 the size of Apple's, recurring in nature, and was largely immune to the whims of consumers.
Apple is a victim of their own amazing success and the associated scale it produced. A thesis predicated on the hope of a new CEO and radical change in company strategy is more likely to produce material downside than upside, in my experience. I get that the company's valuation deserves an option value component (due to historical innovation and cash balance); I just cannot create a scenario where that option ends up being worth $200 - $300 billion over the next few years.
|Subject||Re: Re: Declining user base|
|Entry||01/26/2017 12:52 PM|
Based on Kantar stats recently it seems AAPL is losing ground in China and gaining ground in the US in terms of market share. Europe seems to be mostly positive except for Germany. All in all AAPL seems to be doing ok. So I think it's too early to say we are at some sort of tipping point in terms of its user base. Not saying it can't happen, but it's not a fact as of today.
|Entry||02/06/2017 09:35 AM|
At the risk of getting my head bitten off, as I know this stock has stoked angry passions in the past, I wondered if anybody was interested in getting the discussion going again? Two weeks on from the writeup, stock is of course volatile on earnings, but here we are retesting the highs (along with the broader indices, to be fair). When I actually look at the numbers, I would say what they are reporting is actually validating the bear case posted on other Apple discussions on VIC in the past. China is still obviously not going well for them as a whole (though they seem to be blaming most of it on non-mainland markets). iPhone revenues were +5.3% on the quarter, but you have an extra week of sales in the quarter reported, so knock off maybe 8% for that and you get to -2.7% reported, factor in the currency headwind and you are probably about flat? LTM iPhone volumes still ~15m below the peak; channel checks being cited in the press today in Taiwan indicate the company will do 225m-235m iPhones this year, strong growth YoY but still not above the peak levels at the midpoint, which was one of the bear points discussed on one of the threads on here. Analyst made the point on the call that the company pointed to installed base up double digit, possibly validating the point several people have made on lengthening upgrade cycles given the divisional numbers reported. Gross margins at the group level -100bps YoY; Services division, which is higher GM than the group average per the company, was +22% YoY which by my rough maths probably puts iPhone GM -200bps YoY? Basically most of the fundamental bear case around the business (not the stock) articulated on here seems to be about right, but the stock is doing fine. Simply too cheap? Cash gets repatriated to the US courtesy of The Donald and they buy their way back to growth? Or the case around peak iPhone sales being behind us is just plain wrong and we’re only in the early innings of the smartphone growth story, as per Tim Cook’s view?
|Subject||Re: Comments on CNBC from Chamath|
|Entry||02/16/2017 11:37 AM|
Do you think that is fair? Seems like the phone is more like a consumer staple with pricing power. More like Frito-Lay than Hermes. Luxury goods companies rarely address such a large market. The app store platform does not seem to have a luxury good analog.
|Subject||Re: Re: Comments on CNBC from Chamath|
|Entry||02/16/2017 12:38 PM|
"more like Frito-Lay than Hermes" ...in good fun, WinBrun
|Subject||Apple buying Disney|
|Entry||04/13/2017 03:52 PM|
No suprise to anyone on the board, but I think it makes much more sense for Apple to buy Netflix than Disney:
1) Disney's films are tied up in pay-1 deals around the world, often for several years--they are exclusive to Netflix in the U.S. Those films would not be available for an Apple OTT product for years in some cases.
2) Producing expensive content for an owned OTT service without a lot of subscribers is not an efficient way to monetize the content without a large existing subscriber base. In fact, it may actually supress the value of the underlying IP relative to getting the IP in front of a large global audience. Disney has built tremendous value in secondary Marvel characters through Netflix's global distribution and subscription platforom, which allowed for grittier storytelling. Keeping those shows on an owned service with a much smaller audience does not build library value.
3) To scale a global OTT product, Apple would need a lot of content---more than just Disney content---in order to efficiently aggregate a lot of content--a service needs a large installed base of subscribers, data, and direct relationships. Netflix has those assets and Disney does not. The international market is going to likely provide most of the growth---Netflix is dominant internationally.
4) If Apple bought Netflix, overnight it would become the most dominant media and content distribution business in the world with tremendous buying power. As a content creator, Disney would likely have to sell to the Apple/Netflix entity in order to build maximum value in the IP and get the best return on its content investmets. Disney does not have the capabilities or scale to build a Netflix rival. Disney also could suffer a bit because its desire to remain a wholesome family brand likely would deter it from creating an OTT product with edgy scripted programming. Without that programming, the addressable market is smaller.
I guess the Apple shareholders like that the Disney deal would be financially accretive upfront. But over the long-term, Netflix would put Apple in a stronger position to grow its service revenue by becoming the world's leading global internet television service. It would be positioned to accelerate Netflix to 1B global subscribers, invest in a deep library of owned intellectual property that would serve as a hedge against changes in hardware preferences or platforms, and would make Apple a more culturally influential and relevant company.
|Subject||Re: Re: Apple buying Disney|
|Entry||04/18/2017 08:54 AM|
Thank you. I heard Eddy Cue at the re/code conference suggest that Apple's goal in television is to move culture. I find that to be a bit self-indulgent. I think the goal should be to provide great entertainment at a reasonable price for a lot of people. In the process of doing that, perhaps certain shows will have a cultural impact. I believe that Netflix's documentary initiative has the potential to become one of the most culturally impactful genres of programming that has emerged in a long time. These documentaries are contemporary high-value investigative journalism of a quality and character that does not exist in print, cable, or social media. These documentarians are our Woodward and Bernsteins. This content could build great intangible value in the Apple brand over time, as it is doing for Netflix, thereby adding a level of depth and meaning to Apple products in a way that competitors cannot easily copy.
Reed Hastings and Ted Sarandos are two of the best executives in corporate america. Ted could run any of the major media companies. He has tremendous taste combined with customer empathy and a populist sensibility for entertainnment. Reed is a brilliant corporate strategist and technologist. This type of talent is rare; if Apple were serious about building long-term advantages in video, it would get these two on board.
|Entry||06/21/2017 03:11 PM|
This is pretty good. Its not clear how making a few shows will make a difference for a Company Apple's size. Its not really clear how spending $2B, which would be a big ramp, will make a difference. Netflix is spending $7B. Amazon is spending 4-$5B. HBO is spending $2B. If Apple spends $2B--and ends up with three hit shows and a few decent shows, and a few flops, what does that do for the business? Maybe they just want to create goodwill around the brand and sell more products.
Over the next ten years, I believe the return that apple could get investing its cash to grow the Netflix content library and subscription value, which would produce owned IP that can be monetized globally across many businesses, a lot of data, potentially sports rights, and sticky direct relationships with a global consumer base built on an emotional connection developed through storytelling, is going to be a lot better than buying back its stock.
|Entry||06/21/2017 03:31 PM|
Agree 100%. I read that editorial this morning and thought "how much more cover does this management team need to go forward w a NFLX acquisition?" But maybe it struck a nerve highlighting AAPL's lack of management depth and succession planning... In addition to recurring revenue, global scale, owned IP, and ~great management, the analytics and targeting NFLX has created could potentially add a lot of value to the remainder of AAPL's media businesses.
|Subject||Re: Re: WSJ-OP--Apple/Netflix|
|Entry||06/21/2017 03:37 PM|
Great points. I feel like there is a possibility that Eddy Cue is the wrench in this happening. As Ahab931 noted, Reed Hastings is not going to report to Eddy Cue. And Eddy Cue has been there for a long time. And Eddy Cue seems to revel in the glamour. But it would be so good for Apple's business and Apple stock (I am a shareholder) if they put Reed in charge of software and services with an eye toward making him CEO. He is the rare type of leader that can create tens of billions of market value.
|Subject||Re: Re: WSJ-OP--Apple/Netflix|
|Entry||06/21/2017 05:41 PM|
they don't have to do anything. But I think it could be great for both.
Netflix is a software company. It is consumer entertainment software. There are about 1700 employees on the tech side of the business, including data scientists and engineers. If it is easy to replicate 100mm global subscribers, Netflix has too many employees. If it is not easy, Apple needs more employees.
Netflix provides a recurring subscription based service for one of the most fundamental behaviors in households around the world-watching television. Apple is trying to grow its high-margin, recurring services business. Netflix would do that. Netflix's operating margins at scale are likely to be over 40%. Apple could take the margins higher by building pricing power in the subscription through content investment. Apple is unlikely to build a business internally with this margin structure.
The combined business would be positioned to replace a large percentage of linear television viewing over the next ten years. It could take a lot of the value in the linear television ecosystem. As Apple built the netflix offering, there would be less reason to get cable. That is a gigantic durable lucrative market. It is way more efficient to implement this strategy on top of Netflix's 50mm U.S. subscribers and brand awareness as the leader in streaming.
There would be no second place in streaming on a global basis with Apple's global device distribution, financial resources, and retail presence combined with Netflix's content library, data, and global penetration, including dominant market share in Latin America and all major english speaking markets. Apple could increase the variety and depth of Netflix's content library---seeking to drive penetration into 100mm U.S. homes. It could unlock a lot of pricing power in the Netflix subscription---which creates high-margin revenue. It could get sports rights. It could make tons of family movies that could give it a library of owned IP that could aspire to rival Disney. It could time new device introductions with the launch of new Netflix shows, creating insane global marketing events around the world that no one could replicate. It could leverage the direct digital relationships with Netflix's 100mm subscribers to create in-home AR/VR experiencee. It could piggyback on Netflix to integrate Siri into homes around the world through television viewing in order to compete with Alexa.
Apple can invest in content. It is just unlikely to do anything for the business that is meaningful. If they make a few shows--what does that do for the economics? Why would they risk Google buying it, effectively closing the door on them entering the business at scale.
If Apple had no interest in this space, I would not be saying this. But they are buying films (music documentaries), hiring television executives (Sony) and making shows. why dabble?
|Subject||Re: Re: Re: WSJ-OP--Apple/Netflix|
|Entry||06/21/2017 05:50 PM|
you lost me at 'netflix's operating margins at scale will be greater than 40%'...NFLX already has saturated North America and is well on the way to doing so in most of the developed world, if the current subscriber footprint is not at least a good measure of 'scale' then what is? they will not (or cannot) slow content spending one iota given competiton...and OPM is 10% today, a cool 30pts from your target.
no horse in your appl/nflx argument but am intrigued how or why you think 'at scale' looks meaningfully different to nflx today. i assume you think 'at scale' they can double/triple/etc prices while content costs eventually subside...despite everyone else and their mother producing oodles more of content at inflated prices netflix helped create.
|Subject||Re: Re: Re: Re: WSJ-OP--Apple/Netflix|
|Entry||06/21/2017 06:23 PM|
1) why do you think the market is saturated in U.S/developed. 5G + more screens + cheaper connectivity + more connectivity +more content + better----should keep the streaming market growing for some time. Netflix has 100mm subs today. the breakdown may look something like this: 50mm U.S. + 15mm Latin America + 5MM UK/Ireland + 5mm Canada + 2.5MM Australia + 5MM Nordics + 1.5mm France===84MM. that leaves out a lot of the world, including big developed world markets in Western Europe, and some big television markets in Eastern Europe (Poland/Turkey). I think they will get to 60mm U.S. by 2019---and Lat Am will grow probably at over 10% for the next few years. If that is roughly right, they are still pretty small. really no one knows how big the streaming market will be--but it is probably early to call it. I don't see why domestically it would not be bigger than the U.S. Pay-television given more screens, more connectivity, cheaper price. 100mm should be the floor.
2) As I have said on other boards, I think the competitive dynamic is not going to play out the way you frame it. People are going to have multiple services if the services have different content. The market can support a few--and I don't think they are going to all have to invest irrationally in content to maintain a subcriber base, particularly as the home entertainment infrastructure for internet television gets better and cheaper. I don't think people are going to only watch Netflix or only watch Amazon. That would almost be kind of strange, particularly as the variety and quality of original programming increases. And I don't think people, particularly older people, are going to churn at high rates once they have watched a few shows that they like
3) HBO had 40% margins. Cable networks at maturity have 40% margins.
It would be irrational for Netflix to operate at less than 40%, unless it can drive much higherverall contribution profit through volume given comparable margin structures in the industry. Otherwise Netflix should copy HBO's business, wholesale the content, and license internationally.
I also think they have a lot of pricing power because for many people Netflix is a full or partial substitute for cable. Difficult to find many products where people sub $80-$100 service for a ten dollar one--and are happier for it.
|Subject||Re: Re: Re: Re: Re: WSJ-OP--Apple/Netflix|
|Entry||06/23/2017 08:43 AM|
sorry for the slow response. point taken re your view of the US market; i disagree fundamentally (i dont think more screens = more subscribers, necessarily, and I would be unwilling to underwrite more than 1x US households, even in a full penetration scenario) but we can leave that point as the thing i had real contention with is your assessment of NFLX's business potential.
my point on margins is simply this - how exactly is Netflix going to scale the profitability you envisage? as you mentioned HBO had 40% margins - on a much smaller subscriber base than NFLX has already (and has had for some time). Same goes for the cable networks. Since NFLX's footprint is so much bigger (both in terms of subscribers as well as geographically) and yet so much less profitable, either I need to hear a convincing argument how/why they are massively going to increase prices, and/or cut costs. The reason they can't copy HBO's model is the same reason they can't earn 40% margins, incidentally - because they are spending way too much on content (both in absolute and relative terms).
clearly - since you think there will be multiple services in existence, and the market can support a few - then it sounds like you are not underwriting massive price increases (unless you really think this is the most bullet-proof business and demand for NFLX is largely inelastic to price). Or, perhaps they are going to stop spending on content at some point - but all signs point to this not happening (indeed the more they spend, the more competitors spend, forcing them to continue spending).
If you could articulate a decent thesis on how NFLX could stop investing in content at some point (having built a substantial content library that was deemed evergreen and thus a huge moat to stop competition), then I would be happy to change my mind. but i don't think you can make a blanket statement like 'nflx at scale would have 40%+ margins' without more evidence than a hope that content spend comes down at some point - especially not when that co's avowed plan is to go in the completely opposite direction.
|Subject||Re: Re: Re: Re: Re: Re: WSJ-OP--Apple/Netflix|
|Entry||06/23/2017 12:01 PM|
I appreciate your response. But I would put this more simply; Apple has the resources and scale to make Netflix a global content creation and distribution monopoly for a long time. nothing about it would be me too. It would be completely differentiated and dominant. Apple would get access to unbelievable talent, including Reed Hastings, which is like getting Lebron James. It would meaningfully scale the recurring services revenue in Apple's business above any level the company is likely to achieve by building. It would create a large amount of sustainable market value for Apple. On a company of Apple's size and revenue base, those are rare deals to find and should be seized.
Look at Google and YouTube, which is not a perfect analogy by any means--but Google paid like $1.6B for YouTube in 2006-and now some people believe it could be worth $100B and is probably just getting going. It has diversified Google's business, benefitted from Google's resources, improved Google's competitive positon in video advertising, and positioned Google to take advantage of many new opportunities in content creation and distribution at a global scale. It is building Google's relationship with young kids, tomorrow's customers. It has made Google less reliant on its dominant core search business. Apple has a similar opportunity with Netflix. Yes, the price is way higher. But Netflix has 100mm subscribers and internet video is still in its infancy.
You may be right about Apple's prior strategies. Maybe culturally or philosophically it is not a fit. But I feel like the history of tech would suggest that a company with deep exposure to the hardware business, that is dependent on one product for the majority of its profits and strategic depth, and that increasingly relies on one somewhat fragile market (china) for growth, is taking more risk by not doing something bold than it would be doing it, even if the bold move is a departure from the past behavior.
|Subject||Re: Re: Re: Re: Re: Re: WSJ-OP--Apple/Netflix|
|Entry||06/23/2017 04:21 PM|
I guess I disagree with your characterization of the market. I don't think Netflix is spending more because competitors are spending more. I think they are spending more because it is a good investment. The spending creates long-term library assets, builds global brand awareness, shifts viewing from linear television, and helps aggregate more data. Also--looking at the absolute content budget is not useful without considering the return that spending generates in terms of viewing per dollar spent, engagement and enjoyment, which will have an impact of lifetime value. My feeling is that Netflix is getting more effiicient in its spending by shifting to original programming and getter better at personalization. Both of those capabilities are very supportive of higher long-term margins. Personalization especially because knowing what people like allows Netflix to be very efficient in spending, which effectively allows it to completely revalue content based on what people actually want to watch given a certain context. That is a tremendous advantage versus peers without data or without a great personalization model and can probably be the biggest single driver of long-term margin expansion.
I don't think the industry structure is going to be as radical as you suggest, requiring a bullet-proof business that can push through massive price increases. Internet networks will grow. People will have a few. At scale, the networks will adjust spending to satisfy the subscriber base and earn good returns, just as happened in the linear industry structure, which was at 40% operating margins at maturity. Read about what Ted Turner was spending in the late 1970s early 1980s to grow his networks ahead of profits--it makes Netflix look inexpensive. Getting to scale creates very good margins in the content distribution business. But it requires a lot of investment. If you don't believe that the global internet television market is going to be very big, or that people will continue to pay to t.v. in the home, or that a new technology is going to displace the internet as the underlying distribution mechanism or entertainment medium, then what Netflix is doing is not going to be good.
HBO does not have a smaller subscriber base. It was doing 40% margins with 30mm U.S. subscribers and about 90mm outside the U.S. HBO was supporting economics from 120mm global subs with about $1B in original content spending (and $1B or so in output deals, mainly in Latin America and U.S.). The model that allowed HBO to achieve these margins was getting enough scale in the U.S. to create original content that it could own--and then licensing this content around the world, through a variety of deals, including a channels business in Latin America or the Home of HBO business at Sky in the UK. HBO was spending way less per sub and getting higher margins.
Netflix should do about $2.3B in contribution profit in the U.S. this year. The tier 1 markets (markets opened from 2010-2013) were collectively doing about $500mm in contribution profit in 2016. Say the business in 2017 will do about $3B in contribution profit from the profitable markets. If the HBO model is structurally more profitable, Netflix could exit all the unprofitable international markets by sub-licensing content or cutting off spending, reduce the variable G&A/marketing and tech and dev associated with those markets, and move to creating and licensing their original programming around the world at high incremental margin the same way HBO does. In fact, the licensing business is going to get better over the next few years because there are is more competition (which will benefit companies like Showtime and Starz). But there would nothing preventing Netflix from doing that if that is a better business unless they are irrational or stubborn.
|Subject||Is now the time to sell?|
|Entry||01/27/2018 12:13 AM|
Is now the time to sell?
Any thoughts on AAPL now that the iphone 8 / X "supercycle" is peaking? Clearly demand for the X is muted and fewer than expected people want to pay $1k+ for a mildly incremental phone.
Sure I get that ASPs and margins could easily surprise to the upside here. But a ton of reports are talking about the production cuts into Q1. I don't think great margins will save them from narrative that 2019-2010 could be over the hill for them
The stock has peaked and fallen around each major product launch. The stock has rallied a lot and trades at a historically high multiple again (relative to the last 8 year range where it goes between 10 and 15x P/E)
HomePod? Too little, too late
Cash repatriation / lower taxes? The stock won't get rewarded for capital return. They have to buy a recurring rev biz like Netflix or Twitter or Snap that could excite investors. So far that seems very unlikely and not in their DNA. They wanted to invest in WDC instead! NAND is still a very cyclical commodity industry and about to go into a downturn....
Services is interesting, but too small to change the consumer product cyclical narrative
|Subject||Re: Is now the time to sell?|
|Entry||01/30/2018 06:22 PM|
I don’t know if this is the time to sell, but just some thoughts as an Apple user and observer of technology.
The momentum from the iPhone is starting to wane. Pretty much every adult alive has a smartphone now. I have a X and it’s a sweet phone, but it feels like I have an iPhone because I’m trapped in the ecosystem, not because the product blows my mind. I see a lot more iOS bugs than I used to and encounter situations where I think “really this is how they wanted it to work?”. The iPhone lineup is a confusing mess. Of course, iPhone is so gigantic and moaty that Apple might be able to ride the slipstream forever (see Windows or Office), but are they the company that brings us the next billion user platform? Probably not. It’s not an open-ended growth story anymore, but maybe that’s okay if it’s not priced like one.
|Subject||Any thoughts on the massive inventory build?|
|Entry||05/02/2018 03:38 PM|
So Apple's inventory grew 150% YoY on 3% unit volume in iPhone. Inventory was up 77% sequentially going in to a quarter that iPhone units are typically down 20% sequentially. Apple claimed a pre-buy on "components" which given TSMC's revenue guide down (and partially blaming Apple) would indicate the "components" are core processors. They talked about a 1.8 million unit drop in channel inventory of iPhone but the inventory growth adds to 4-6 million units depending on whether you think it is finished goods or inventory. Is there any reason this makes sense?
|Subject||Re: Re: Any thoughts on the massive inventory build?|
|Entry||05/02/2018 10:10 PM|
Not sure why they'd pre-buy memory when they said they thought both DRAM and NAND were peaking on the call. Seems counter intuitive to buy a whole bunch of something when you think the price is going down. The reason I figured it was cores is because TSMC reduced their forward revenue guidance from 10-15% to 10% and placed part of the blame on Apple even though Apple is moving to their 7 nm technology in 2H CY. As for other components Catcher, Goertek, Luxshare, Win and AMS all suffered this Q and blamed Apple. Face ID goes in all three models and a bigger OLED add in capacitors and I'm not sure how you get to $3 billion. That's why I asked.
|Subject||Re: Re: Thoughts?|
|Entry||08/02/2018 01:14 PM|
Agree with Condor. At the current price you're getting a 6% levered FCF yield with FCF likely to grow in the 4-6% range for the next several years, resulting in a 10-12% annual return. Not bad, but not great either (this assumes no change in the multiple).
|Subject||Re: Re: Re: Thoughts?|
|Entry||08/02/2018 03:39 PM|
its the biggest mutual fund underweight by a wide margin. q was fine and ASP's (one of the keys to the bear case) was better than expected. as you point out expected return is ok - not great. kinda all you need to know to know that there are going to be a fair amount of buyers for it.
|Subject||Re: Any thoughts on the massive inventory build?|
|Entry||08/02/2018 03:41 PM|
every hardware company and contract manufacturer is building inventory because of the component issues. i think with aapl, you have to also look at channel inventory, which came down last q to the low end of their normal range.