Apple's Business Is Challenged, Carl Icahn Buyback or Not

Investor Carl Icahn continues to pressure Apple , urging management to increase its buyback 150% to $150 billion. With his recent successes, and activist track record, Icahn may be in a better position to influence management than David Einhorn, another hedge fund manager that wanted something similar earlier this year.

But even if Icahn gets his way, it doesn't change Apple's fundamentals. Although its business continues to generate substantial cash, the King of Cupertino is challenged by the rise of numerous low-cost competitors.

Apple holds 10% of all corporate cash
One out of every 10 dollars held by a corporation is owned by Apple, according to Moody's. With nearly $150 billion in the bank, Apple could -- theoretically -- buy Verizon outright and create its own iPhone network. Instead, Apple's management has promised to return much of this capital to shareholders by buying its own stock, as much as $60 billion by the end of 2015.

Since making the announcement in late April, Apple's stock has risen more than 22%. Other factors might be at work, such as the release of the latest iPhone and hopes surrounding new products like an iWatch or television set, but management's willingness to return capital to shareholders -- something that founder Steve Jobs had long resisted -- no doubt helped.

But can that cash generation continue?
While Apple's war chest is certainly impressive, the more pressing question for investors is whether or not the iPhone-maker can continue to generate such substantial amounts of cash going forward.

Last quarter, Apple announced that, for the first nine months of the year, it generated $43.7 billion in cash from operations. That's more than the $41.7 billion that it brought in over the same period of time last year, but only slightly more so. In contrast, that $41.7 billion in 2012 was an enormous jump from the $27.1 billion it took in 2011. Simply put, Apple's rate of cash generation is slowing.

Apple picks margins over market share
That's mostly due to the company's falling margins. Last quarter, Apple's gross margin was just 36.9% -- down substantially from its peak of 47% in the second quarter of 2012. As management admits, many consumers have opted to purchase older iPhones and the iPad Mini, lower margin products than Apple's newer and larger offerings.

Many analysts had expected Apple's margins to continue falling, particularly as the company appeared poised to target emerging markets with a low-cost, low-margin iPhone. Instead, Apple has gone in the other direction, digging in on pricing to offset margin concerns.

The iPhone 5c is still, by most measures, an expensive phone, and given that it's made out of plastic, likely cheaper for Apple to make than the aluminum/glass iPhone 5 (the phone it replaced). Perhaps Apple will try something similar with the iPad Mini this month, when it's expected to announce new models.

Android's threat continues to loom
Meanwhile, Google's Android continues to dominate the globe, accounting for 79% of the smartphones shipped in the second quarter. Android has caught on particularly well in India and China, with the Chinese government going so far as to call its country too dependent on Android.

As Google keeps its mobile operating system open source, Android has found its way onto all manner of handsets, from Samsung's monstrous 6.3-inch Galaxy Mega to the tiny 3.6-inch Casio G'zOne Commando; from Xiaomi's budget Red Rice handset, to the $11,000 Vertu Ti. There's literally any Android phone to satisfy every possible niche.

Android's dominance is now beginning to extend into tablets as well. Although Apple remains the single largest tablet seller, Android tablets finally overtook the iPad in the second quarter, accounting for about 62.6% of the market.

BlackBerry's cautionary tale
With BlackBerry announcing that it would cut 40% of its workforce, the future of the company as a stand-alone handset maker appears unlikely. Largely, its current struggles are due to the failure of its newest operating system, BB10.

Although BB10 may sport an impressive new interface, with a solid keyboard and unique features, it is fundamentally lacking in one aspect: apps. Would-be smartphone buyers have to accept the fact that, should they purchase a new BB10 handset, they won't be able use SnapChat, play Candy Crush, or even watch Netflix.

With such a tiny market share, developers have no incentive to invest time coding for BB10. Instead, they continue to favor the larger platforms of iOS and Android. But will that always be the case? Now down to just over 13% of the smartphone market worldwide, Apple should be concerned about losing developer support.

Money well spent?
Boosting the buyback may be a way for Apple to reward its shareholders in the near-term -- certainly, it's better than just letting that money set there, underutilized But a bigger buyback doesn't change the long-term Apple story.

Android's continued growth presents a challenge to Apple. As BlackBerry has demonstrated in recent months, smartphone platforms cannot succeed without a sizable chunk of the market. I'm not an Apple shareholder, but if I were, I would prefer that $60 billion be used to grow market share, not buyback stock.

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