Connoisseur of the untold stories on Wall Street, skewed toward activist hedge funds

Billionaire Warren Buffett Would Buy Apple (AAPL)?

Added on by Lee Ho Fook.
warren buffett.jpg

Be sure to check out our detailed stock analysis (click here). It's no secret that Warren Buffett loves strong consumer brands that generate plenty of cash. He's the ultimate value investor. Well then, why hasn't he bought Apple (NASDAQ:AAPL) stock? It's perhaps his unwillingness to go along with the crowd or to follow the likes of some of his fellow billionaires. Buffett has famously said in the past that he doesn't understand technology and he doesn't want to backtrack. He did just buy H.J. Heinz and I doubt he fully understands how ketchup gets made or the manufacturing process. Apple is a similar company to Heinz, making a product that gets manufactured and sold, except it is a tech product rather than a consumable product.

Strong consumer brand with product loyalty

I argue that Apple isn't a technology company in the conventional sense, but more of a consumer products company. As anyone knows from going to an Apple store or seeing a new Apple product launch, there is no loyalty like Apple loyalty. Customers line up for hours to get the latest Apple products. That is why the company can achieve a 33% operating margin. Customers pay the premium for Apple products because they cannot live without their iPhones or iPads. Owning Apple products is such an integral part of the loyal user's daily life that switching to another brand is not an option. Plus the fact that there isn't a company that offers the same range of products as Apple.

Compare the products of Apple,with the likes of Google (NASDAQ: GOOG). Would Buffett ever consider buying this tech company that utilizes search algorithms? Probably not. Unlike Google, Apple gets 70% of its revenue from two stable products, its iPhone (50%) and iPad (20%); however, Google is one of Apple's chief competitors in the smartphone industry. But I'm thinking that Apple will be able to continue to steal market share from Google in the mobile sector as Apple continues to focus on its key product, the iPhone, Google's true motives for its Android OS and Motorola phones lie in its plans to extend beyond desktop searches into mobile searches. As a result, I think Google is more motivated to be a mobile search and mobile ad leader regardless of its actual OS or hardware market shares. eMarketer projects that Google will be the fastest growing mobile ad platform over the medium term, capturing 22% of the market by 2014, where Facebook will be second with 17% of the market, Yahoo!third at 8% (see if Google is heading to $1,000).

Compelling valuation

The current valuation of Apple appears very attractive, even if you classify it as a mega-cap stock with limited future growth (see more about Apple's new industry). Nonetheless, Apple is a company that has a forward P/E of 8.69 and $137 billion in cash. Given Apple's current market cap, its cash position represents 33% of its entire market valuation, with the company generating some $13 billion in cash per quarter. In looking at Buffett and Berkshire Hathaway's five largest holdings -- Coca-ColaIBM (NYSE: IBM)Wells FargoAmerican Express, and Proctor & Gamble -- all have higher P/Es than Apple.

Buffett bought IBM

Buffett's first foray into technology was his large purchase of IBM, his third largest position representing over 17% of his public securities portfolio. Buffett also added a small VeriSign, another tech company, position during the fourth quarter. One of the main things that Buffett likes about IBM is its aggressive stock buyback plan. IBM last year added $5 billion to its stock buyback plan, bringing the total buyback to $11.7 billion. Apple last year announced a $10 billion share buyback plan. It's still less than IBM's and IBM has a fraction of the cash on hand as Apple.

Maybe Buffett wants to see more cash returned to shareholders? He's not alone, as that is what most money managers are looking for. Most recently David Einhorn of Greenlight Capital sued Apple wanting them to issue preferred stock to unlock shareholder value and free up some of its cash hoard (see Einhorn's iPref presentation). Does Apple really need $137 billion in cash?

Buffett loves to buy when no one else is

It's pretty safe to assume that the fast money has been dumping Apple stock. Apple fell from grace with hedge funds during the fourth quarter, losing its top spot as the most-owned company. Many of the momentum players feel that the company cannot continue to grow as it did in the past. They have sold their long positions or shorted the stock (see hedge fund activity). This is the time when Buffett likes to buy best. He loves to come in when something is out of favor and been beaten down. The high for the stock last year was $705. Many traders thought $1000 was the next stop and have gotten burned in this downturn. At around $440, Apple is over $260 off its all-time high in a few short months. This could be a solid time for Buffett to buy (see what Buffett is buying). Here are some of the major hedge funds that have been selling off their stake since the fourth quarter.

  • Billionaire Leon Cooperman and Omega Advisors sold off 100% of his stake.
  • Bain Capital's Brookside Capital also sold off 100% of its shares, where during the third quarter Apple was 7% of its portfolio.
  • Billionaire Dan Loeb and Third Point sold of 100% of its stake, which was 9.3% of its third quarter portfolio.
  • Billionaire Stephen Mandel and Lone Pine Capital sold 100% of their shares, which had been 3.2% of Lone Pine's third quarter portfolio.

What's next for Apple?

As far as the current situation goes, Apple is one of the leaders in the market with its iPhone, but I still see room to grow. The company is in a heated battle with Google for mobile phone dominance, with Google's Android operating system currently leading the way.

Mobile operating system market share (2012 fourth quarter, source: Gartner)
1.  Android 70%
2.  iOS 21%
3.  Blackberry 4%

However, I am less concerned with Google's dominant position, as it allows more room for Apple to grow and capture market share. What's more is that although Apple is still battling Android over mobile OS, Apple also has a dominant position in the hardware game, whereas Google is well behind. Apple is third with respect to mobile hardware market share, where Google's Motorola is ninth with 2%. 

Mobile Phone Market Share (2012 fourth quarter, source: Gartner)
1.  Samsung 23%
2.  Nokia 18%
3.  Apple 9%

Apple does have a lot going for it in 2013. The company will release a new iPhone and there's the potential deal with China Mobile, the world's largest mobile phone carrier. Chine Mobile's market share in China is falling and now is the time for them to do a deal with Apple. There's also the potential iWatch and the market is clamoring for iTV from Apple. Apple fans want Apple to revolutionize the television the same way they did with the mobile phone. If Apple does that, Buffett won't be the only one wishing he bought Apple at these levels!