The Mystery of Ion-X: Long Live Corning!

Apple is using “strengthened ion-x” glass in the new iPhone 6 and 6 plus, and not sapphire. 

When everyone was speculating in recent months that the iPhone 6 would be sapphire, Corning’s stock took a hit since they make the Gorilla Glass used in the current iPhone.

In the Apple announcement on Tuesday, there was no mention of Corning, so their stock has not rebounded. In fact it continues to drift downward.

But I remember at CES that Corning was touting a new ion feature in their latest Gorilla Glass 3.  So today I checked the Corning website and found this text:

CAN YOU EXPLAIN THE ION-EXCHANGE PROCESS?

"Ion exchange is a chemical strengthening process where large ions are “stuffed” into the glass surface, creating a state of compression. Gorilla Glass is specially designed to maximize this behavior. The glass is placed in a hot bath of molten salt at a temperature of approximately 400°C. Smaller sodium ions leave the glass, and larger potassium ions from the salt bath replace them. These larger ions take up more room and are pressed together when the glass cools, producing a layer of compressive stress on the surface of the glass. Gorilla Glass’s special composition enables the potassium ions to diffuse far into the surface, creating high compressive stress deep into the glass. This layer of compression creates a surface that is more resistant to damage from everyday use."

It sure sounds like the same thing. But the analysts seem ignorant, as seem the reporters. At least until someone figures it out for them.

I applaud Apple for avoiding sapphire at this time for the following reasons:

• While sapphire is 25% stronger than Gorilla Glass and more scratch resistant, sapphire also has a tendency to shatter when dropped from just three feet; Gorilla Glass requires three times the force to shatter. 
• Sapphire takes 100 times more energy to produce (according to Corning) – something that Apple cares about with its strong focus on environmental responsibility
• Sapphire costs 10 times as much as Gorilla Glass (according to Corning and MIT), although some of this discrepancy might be addressed in new manufacturing processes deployed in the mega GT Advanced sapphire plant in which Apple invested $578 million
• The new mega plant is just coming online, and relying on that would undoubtedly have caused supply shortages of iPhone 6 – that would have been disastrous for Apple given the lost sales for the holiday quarter
• Corning continues to improve Gorilla Glass and is now on version 3. Each year, their demonstrations at CES are a highlight of that show for me. They will continue to innovate

Long-term, Corning may lose out to sapphire in the next iPhone 7 or iPhone 6s or whatever it’s called. But I have a great deal of respect for Corning’s innovation, and they continually invent new businesses unlike any other company — even perhaps including Apple.  Examples of technologies and businesses that they’ve created include light bulbs (1879), railroad signal lanterns (1912), Pyrex heat-resistant kitchenware (1913), high speed ribbon machine for mass producing bulbs (1926), fiberglass insulation (1932), silicone (1934), world’s largest piece of glass for telescope (1935), CRTs for radios and TVs (1939), continuous melting process for optical and ophthalmic glass (1944), mass-produced TV tubes (1947), Corningware/Corelle® ceramic dinnerware (1952), heat-resistant windows for spacecraft (1961), fusion overflow process for LCDs (1964), fiber optic cable (1979), cellular ceramic substrate fo automotive catalytic converters (1972), active-matrix LCDs (1982), Hubble Telescope glass (1990), Clear-Curve® 90 degree angle optical fiber (2007), Gorilla Glass® for smart phones (2007), and Gen10 process for producing more affordable LCDs (2008). Without Corning’s innovations, we would not have today’s lighting, television and optical communications industries as we know them. In each instance, Corning was responsible for the invention, and in each case they commercialized the innovation so effectively that they became the dominant producer. Corning also created the dominant medical testing company Quest Diagnostics (which was Corning Clinical Labs before it was spun out into a new public company); Quest is now the clear market leader in lab testing. However, Quest was different from the other Corning businesses because it  was created through a roll-up of a series of acquisitions of smaller labs rather than technical innovation. But in any event, I can’t think of any company that combines invention with effective commercialization as much as Corning. Their only weakness is that they are not very good at sustaining businesses in the later stages of the cycle, perhaps because they lose interest in more mature businesses; there are a series of businesses such as Pyrex and Corelle that evolved into money losers, but after divestitures rose to new heights by the acquiring company. But no company excels at everything.

Corning is also resilient. It has managed to bounce back from market disasters, such as the telecom meltdown in 2002 when the world had overbuilt fiber-optics infrastructure and their customers all started to go bankrupt. So I expect that Corning will show resilience and further innovation in glass even if sapphire does eventually replace Gorilla Glass. If you’d like to see the evidence, check out the series of videos that Corning produced a few years ago on “A Day Made of Glass” that Corning released in 2011. The videos are inspiring. 

I’ve always thought about buying Corning stock, and the Company may be the next best thing to Apple for sustained innovation and repeatedly re-inventing itself. So I decided today was the day and I pulled the trigger and bought some Corning shares for the first time. I’m not expecting the more than 100 times returns I’ve realized in Apple, Microsoft, Abbott Labs and Nucor, but it could be a long-term winner and this seems to be a good time to buy. We’ll see.

Disclosure: I have owned Apple shares since 1985 and now also own Corning shares.

Is AAPL Running on Fumes, or Poised for More Upside?

This blog has been bullish on AAPL’s stock since my first posting in December 2012. Those who have resonated with that perception (and invested) have fared well, with Apple’s stock up 80% since June 2013. But now that the stock is flirting with the all-time high reached in September 2012, it’s a good time to ask the question, “How much further can AAPL go?”

On a Price-Earnings Ratio basis, AAPL has been trending up since 2011, but so has the general market. AAPL’s current TTM PE is 16.0 versus the S&P 500’s 19.6.  But more telling is the “Cash PE” which backs out Apple’s cash and marketable securities ($164.5 B) from the market cap and adds back long-term debt ($31.0 B).  On that basis, Apple’s PE is only 12.4.

Having a lower PE than the market is logical if the company has lower growth prospects than the market. But what makes Apple still a bargain is that the consensus of analysts is for growth in EPS in the current fiscal year of a bit over 10%, which is only slightly below the 12.5% median earnings growth rate for the S&P 500. So the analysts are either wrong in their growth assessment, or wrong in their price targets. For more on this mismatch, see "Apple’s Cash P/E Ratio is a Bargain Given Analyst Growth Expectations."

Apple clearly is maturing as a company, and there is a limit to growth in the current business lines of iPhones, iPads and computers.  But there are still some areas of high growth:

• Apple’s iTunes/Software/Services businesses grew 22% in 2013 and this segment has gross margins of 95% (on Apple’s 30% take of sales). If iTunes had been listed separately in the current Fortune 500, it would have come in at No. 218, ahead of Texas Instruments, Nordstrom and Marriott. Analysts expect 22% of profit to come from this segment in 2014, and one analyst expects it to grow to 36% by 2020. 
• AppleCare is another 90-95% gross margin business that is experiencing 25% annual growth
• Payment processing could be a huge business for Apple -- potentially rivaling the iPhone business in scale of profits. See "The Next Big Thing for Apple Has Arrived – and Surprise -- It’s not a Gadget." 
• Forays into wearables/fitness and TV are additional avenues for profitable growth

So while Apple’s surging stock price is breathtaking, there is still significant upside – if the markets stay focused on fundamentals and the unrivalled profit-and-cash-generating engine called Apple.

Note: All data were as of July 28, 2014, and based on information from Y-Charts and Yahoo Finance.

Disclosure: I've owned Apple shares since 1985

It’s the Software not the Hardware, Stupid

Here we go again. Analysts and investors worked themselves into a frenzy leading up to Apple’s WorldWide Developers Conference (WWDC) yesterday with visions of iWatches, large screen iPhone 6’s and new AppleTV’s dancing in their heads.

When none of those materialized, they expressed disappointment. Despite the fact that those were very unrealistic expectations for a Developer’s Conference, and Apple hasn’t talked hardware at WWDC in years (since they switched to a September launch cycle for iPhone). At WWDC, the focus is understandably on software, not hardware.

But this leads to the need to debunk a common myth – that Apple’s success hinges on dramatically superior hardware design.

Yes, Apple remains a leader in design, and certainly has not lost its Mojo there.  But even the most avid Apple fan-boy cannot look at any Apple IOS device, compare it to its direct Android competitors and conclude that the Apple’s device looks so much better that the price premium is justified. The same is true for hardware specs. Android phones are comparably stylish and the specs are often superior on many dimensions.

What truly differentiates the Apple customer’s experience are the software and services embedded in the Apple ecosystem, tied together with a far superior UI and user experience all the way from purchase through support and finally in resale value.

User experience:  97% customer satisfaction is unheard of in any business, yet that is what Apple is achieving. The User Experience remains the glue that both retains existing customers and attracts new ones from Android and Windows.

Switchers:  In the last year Apple added 130 million new IOS users who had never purchased anything from Apple before. Half of iPhone purchasers in Apple Stores owned an Android device before. That’s stunning because there are still out there 16 times as many Windows users (1.3 billion) as Mac OSX users (80 million), and 5 times as many Android users (1 billion users with 78.9% OS share in 2013) as IOS users (15.5% OS share in 2013), so there is plenty of growth potential left from future switchers. Apple has outgrown the PC industry now in in all quarters since 2005 but one, and in the most recent year-on-year, grew 12% when the PC industry declined 5%.

Under-the-hood improvements: Innovations such as the announced switch from Open GL to Metal are unlikely to get much mention in the press or in analyst reports, but with a benefit of 10x improvement in speed that will allow an iPad to compete now with console games, it is hugely important. This order of magnitude improvement will drive expanded sales of devices (and games) as well as future customer satisfaction. Imagine what will happen when Apple finally opens up a new supercharged AppleTV (with faster A8 (?) processor and Metal instead of Open GL) to third party apps and gaming in the home. Another example is the switch from Objective-C to Swift Programming Language, as well as the biggest improvement yet for Apple’s SDK, open beta testing program, extensions/widgets and inter-App communication, and other such innovations. When you consider the Apple Store carries 1.2 million app titles and has delivered 75 billion app downloads, nurturing the 9 million registered third party developers in its ecosystem with the tools to make even better apps is hugely important in maintaining Apple’s edge in the tasks their devices can perform.

New Integrated Ecosystems: While not unexpected, the HomeKit and HealthKit unifying development tools and corresponding Home and Health apps for IOS and OSX solve real unmet needs and give further reason for more people to switch to Apple devices and retain the current users. These both have far reaching benefits, although IMHO the Health initiative has more potential to “change the world” as it evolves beyond a neat collection of info across apps into a dashboard -- to adding real value through integration with health care providers such as the Mayo Clinic that can notice a problem before you do. HealthKit is far more important than iWatch in accomplishing this. So this new software is a very big deal for Apple.

Payment processing: As I mentioned in this blog in September 2013 (before much was being said on the subject), Apple has the potential to create one of the biggest businesses in the world (rivaling iPhone) by combining TouchID, 800 million accounts with credit cards attached, iBeacon, and 800 million IOS devices in the wild to quickly create a convenient payment processing system that can revolutionize retailing and solve a $190 billion per year problem of credit card fraud. For more on this, see my blog archive.  None of this was mentioned at WWDC, but that’s because Apple does not need the Developer Community to implement this. But in January 2014, Tim Cook said they were very interested in payment processing and my prediction is we will see an announcement of something emerging in this area either later this year or in 2015. Unlike many of the improvements that are free “glue” to cement the ecosystem (but do not contribute revenue directly), this initiative can be a major source of revenue and profit – so analysts and investors should be paying close attention to it as it develops.

Continuity Integration across devices: The Continuity Features such as Handoff syncing work across devices, Airdrop between IOS and Mac, Instant Hotspot and SMS/phone calls on all your devices were described that further give users reasons to own both IOS devices and Macs to get the full benefit are crucial for exploiting the halo effect and switch (or stay) in the Mac OSX environment as well as own iPhones and/or iPads. Family sharing is another feature that will help push the non-Apple devices out of your family’s life.

So bottom line, there was much to celebrate in the announcements at WWDC, and Apple planted many seeds that will bear fruit in terms of improvements that lead to future device sales -- both attracting new converts and well as delighting and retaining those who already have Apple devices. The future looks bright for Apple.

Disclosure: I've owned Apple shares since 1985

Apple’s Cash P/E Ratio is a Bargain Given Analyst Growth Expectations

At some point in the not-too-distant future, the stock market will realize that Apple’s valuation is overly discounted.  Yes, Apple's earnings are not likely to grow at the percentages seen a few years ago (although Apple’s growth remains strong in some areas of software and services where gross margins exceed 80%). However, expectations for lower growth are much more than appropriately discounted into the current stock price. Here’s why.

Basic Investing 101 says that a company’s Price/Earnings (PE) ratio should be a reflection of its anticipated future growth rate. The forward PE of the S&P 500 is 15.9.  So companies expected to grow earnings at a rate faster than the market should have higher PEs and those that have lower expectations should trade at lower multiples.

Apple is currently trading at a forward PE of 11.4, but adjusting for its cash hoard, the forward PE is 7.5.  Does Apple deserve to trade at a PE less than half of the market PE? Well, only if the market truly believed that Apple's growth rate in earnings would be less than half of the market growth rate.

Let’s take a look at the 33 largest market cap stocks in the US. Unfortunately for efficient market enthusiasts out there, analyst expectations for growth of Apple earnings at 19.6% are at the top of this peer group (#4 of 33). So the explanation of “low growth” for Apple’s low PE is irrational, at least relative to the general market.  Here are the specifics:

Apple bashers would say that the largest cap companies are not the right comparison because size makes these companies a lower growth peer group -- it's hard to grow faster from a large base of revenue. Again, this is not true – projected growth for these largest cap stocks averages 11.3% vs. 9.6% for the S&P 500.

The PEG ratio factors together these two measures of 1) valuation multiple and 2) growth expectations, with lower PEG numbers representing better value.  Again, Apple with a PEG ratio of 0.63 is the best value among the 33 largest cap companies:

So if the market is correct in expecting Apple will grow at 19.6% vs the S&P 500 at 9.6%, then Apple’s PE should be more than twice the S&P 500, not half the S&P 500 PE.

Go figure. Seems irrational to me.

Note: All stock prices and analyst projections were as of March 1, 2014, and based on information from Yahoo Finance.

Disclosure: I've owned Apple shares since 1985