Mobile – I/O Fund

I grew critical of Apple earlier this year when it became clear the company would decline in revenue year-over-year, yet investors and analysts alike continued to pump the stock. With yesterday’s earnings report, we have further confirmation that Apple is not a growth company anymore although it continues to trade at growth valuations.

While many celebrated yesterday’s earnings report, there were notable signs of erosion. To start, Apple has lost $5 billion in revenue year-over-year, from $265 billion to $260 billion. This is despite having the “best fourth quarter ever,” according to Tim Cook. The truth is that the EPS was higher due to buybacks.

My analysis in MarketWatch published prior to earnings, pointed out that the iPhone was exposed to macro smartphone saturation. Those numbers showed a deeper decline than overall revenue with a $22 billion decline reported year-over-year.

Although Apple has ceased reporting smartphone unit sales, the numbers reveal there are fewer smartphone units being sold. Moving forward, with the recent release of the iPhone, Apple will contend with a lower average sales price. This is bound to affect smartphone device revenue moving forward, which declined at a rate of 15% year-over-year.

Overview of Mobile Saturation:

The smartphone market contracted to 1.462 billion units in 2017 and to 1.420 billion units last year. While almost 1.5 billion smartphones sales a year globally is substantial, the law of saturation drives down prices. I wrote about the price effects of mobile saturation in March, prior to Apple lowering prices for the first time with the iPhone 11.

China represents about one-third of smartphone penetration compared with the U.S., at one-12th. Pricing wars are evident in Asia, where China’s Huawei has grabbed market share to become the world’s fastest-growing smartphone seller. The company has seen a 66-fold increase from 3 million units sold in 2010.

Samsung may be the true bellwether for mobile, as the company is in first position for total smartphones shipped and is the world’s largest manufacturer of memory chips. In the first quarter, the company reported a 60% drop in operating profits, followed by a 56% decline in the second quarter. Analysts expect another decrease in the third quarter. Smartphone units have been making lower highs and lower lows over the past two years.

Samsung’s disappointing performance hints at the ties between smartphone sales and consumer confidence as China’s confidence index is languishing at a two-year low.

Notably, IDC forecasts the pricing wars will continue with 5G handsets in Asia, as low-cost models are expected to hit the market next year. In the U.S., Latin America and Japan, the average selling price (ASP) of a 5G handset will be around $1,000, while it will be $600 in China.

Don’t Believe the Earnings Beat:

The fiscal Q4 earnings beat is at odds with overall performance. Although profit topped expectations, this is the first time since Tim Cook took over in 2011 that Apple declined in profit in all four quarters of a fiscal year.

The media touts the services revenue as the answer to the iPhone decline. As we saw this year, double digit declines on the segment responsible for $165 billion in revenue (iPhone) is not easily staved off by a revenue segment posting $40 billion per year (services).

If one did not look closer at the numbers, it would easy to think services was a major growth segment. We see the growth was at 18%, which is below the 20% traditional benchmark that defines growth. As of now, this doesn’t appear to be the answer to the gaping iPhone decline. This is proven by the annual decline in overall revenue.

Wearables growth of 55% to $24 billion in revenue is decent. However, again, the iPhone decline was steep enough at $22 billion to wipe out the entire Wearables category.

I had pointed out in a Fox Business News interview prior to earnings that its unlikely lightning strikes twice with the iPhone as it’s not only one of Apple’s best growth drivers historically, but it’s also one of the best growth drivers we’ve seen across the tech industry. This is evident in last year’s smartphone revenue of $165 billion, which I also pointed out will be Apple’s peak year in mobile.

Note: although I provide an entry price for Apple on Fox Business News, this is something Knox Ridley specializes in and covers as a contributing analyst to our premium site Tech Insider Research. You can catch his detailed technical analysis published on Seeking Alpha next week.Knox Ridley specializes in and covers as a contributing analyst to our premium site Tech Insider Research. You can catch his detailed technical analysis published on Seeking Alpha next week.

Here is a snapshot of Apple’s performance over the past year. If the stock ticker was not attached to the graph, it would be hard to guess this is the world’s most valuable company.

As most investors know, Apple has plenty of cash. It produces about $50 billion-$60 billion a year in free cash flow and has over $100 billion in cumulative reserves to fund new projects. While analysts are optimistic about many new pivots, these will weigh on margins. This is especially true for Apple TV+, which comes with a high content bill and low subscription revenue, as the OTT streaming service will be bundled for free or priced at $5.

Keep in mind, Apple’s cash reserves are seeing the effects of the buybacks, and Alphabet has now surpassed Apple in cash reserves. Apple has $102 billion compared to Alphabet’s $117 billion. This is due to Apple spending $122 billion on stock buybacks since the beginning of 2018. Alphabet is growing, as well, at a rate of 20% year-over-year.

Analysts who are raising Apple’s price target based on fiscal 2020 cite Apple TV+ revenue as a primary reason with little discussion of the forecast for Apple’s main growth driver. Apple TV+, which will compete with Amazon Prime Video, Netflix and other TV-streaming services, is more likely to cause bottom-line losses in the short term as Verizon is offering the subscription for free while requiring costly original content from headliners such as Oprah. (She doesn’t come cheap.)

In my opinion, these new price targets seem more like an attempt to cover current positions, as the majority of institutions are holding this stock at lower entry points.

Also Read: Apple’s Stock Price is at Inflection Point

EPS not as Relevant Due to Buybacks

Many Apple proponents will use the stock as an income stock, yet the company trades at growth valuations. The buybacks Apple is doing on a consistent basis is alarming for a tech company, who should be innovating with cash reserves rather than propping up the stock price to beat earnings per share.

In the most recent quarter, Apple disclosed it had spent $17.9 billion to buy back 92.6 million shares during the fiscal fourth quarter. During the three prior quarters in the fiscal year, Apple had spent $49.2 billion. There is $78.9 billion remaining in its stock buyback program. The reduced share count this year has helped Apple beat earnings per share of $2.91 with $3.03 reported with fewer outstanding shares as a result of the buyback.

Apple has bought a total of 2 billion shares over the past six years, which brings the shares outstanding to their lowest level since 1999, according to Charlie Bilello, who is also a Seeking Alpha contributor.

Conclusion:

Apple will be particularly exposed to lower consumer confidence when this occurs. Mobile saturation is already showing its effects with a $22 billion loss in iPhone revenue year-over-year. In fact, the saturation of the iPhone could prove to be one of Apple’s biggest challenges to date, as the company attempts to make many pivots, all of which will add noise to the big picture that mobile’s golden days are behind it. This will not be resolved by a single quarter’s earnings “beat,” nor will it be absorbed by services revenue until at least 2023.

If your investment thesis is to focus on primarily cash reserves and cash flow, while ignoring growth and the leverage of buybacks to boost EPS, then Apple is likely in your portfolio. As a tech analyst, who look towards future growth for the highest gains, this is a company where I am personally on the sidelines and is not a company I can recommend long-term.

A version of this analysis appeared in MarketWatch on October 29th, 2019. It has been updated and lengthened post-earnings.A version of this analysis appeared in MarketWatch on October 29th, 2019. It has been updated and lengthened post-earnings.MarketWatch on October 29th, 2019. It has been updated and lengthened post-earnings.

Why do Hackers Attack Mobile Devices and Applications?

In order to understand threats, we must understand what hackers are trying to achieve. Hackers will mount different kinds of attacks to achieve different kinds of goals. And so, defending against hackers in the context of application security may involve defending against many different kinds of attacks on your mobile device.

Hackers might be interested in bypassing business logic. For example, they might want to bypass controls that let them cheat at a video game or violate the terms of a software license. Of more serious concern is the potential for hackers to bypass controls in safety critical systems. It is not inconceivable that lives could be at risk if a hacker were able to hack a medical device, connected car or some component of critical infrastructure, such as a wind farm, a coal or nuclear power plant, a power grid, or a water treatment facility.

According to a recent study, automobiles today run systems that have more than 100 million lines of code. Those applications often contain valuable intellectual property, which hackers would rather steal than develop. For example, they might be a competitor or a nation state with inferior technology attempting to improve their own products in order to compete more effectively.

Hackers might also be interested in obtaining valuable pieces of data that are managed within the application, such as music or video, financial data, or privacy sensitive health data.

While data can be protected with cryptography, this only shifts the problem from protecting the data directly to protecting the cryptographic keys. Cryptographic keys are not only used to protect data. They can also be used to create a secure identity for a device.

A device may need such a key to authenticate to a cloud service. If a hacker were able to obtain this secret, they might be able to masquerade as that device or as the owner of the device. Cryptographic keys are also used to establish secure communications. For example, HTTPS is a familiar protocol that uses SSL/TLS to secure communication to websites. If a hacker were able to obtain these keys, they could snoop on or alter supposedly secure communications.

For all of these reasons, hackers are highly motivated to steal cryptographic keys embedded in or controlled by an application.

Sometimes hackers aren’t interested in the application itself, but using the application as a digital stepping stone to try to achieve some other goal. Hackers are often interested in obtaining root access on the device the application is running on, so they can install malware or use the device as a launch pad to attack something else.

Consider the 2016 Mirai botnet that infected web enabled cameras and installed a piece of malware that launched the largest distributed denial of service attack in history against the dynamic domain name service Dyn, causing wide spread internet outages. Those 100,000 cameras were able to launch 1.2 terabytes per second of data at a major piece of the global internet infrastructure. Here the goal of the attacker was not to compromise the webcam directly, but rather to bring down the web services of many companies whose DNS was controlled by Dyn.

Hacking Mobile Devices: Reverse Engineering and Tampering

Hackers employ two fundamental techniques when attacking: reverse engineering and tampering. If the hacker is trying to bypass business logic, they have to find where in the application the business logic resides. That requires reverse engineering. Then they typically must tamper with the application to bypass that logic.

If the hacker is trying to steal intellectual property, sensitive data or cryptographic keys from an application, they have to know where to look in the application. Unless those secrets are obvious, hackers need to reverse engineer the application to find them.

If the hacker is trying to create a stepping stone attack, they often use the workflow shown in Figure 1:

First, they find some vulnerability in the application, which again requires reverse engineering;

Then, they craft an exploit that takes advantage of that vulnerability;

Finally, they attack by launching the exploit to the application.

In a remote attack like the popular SQL injection attack, this may involve sending the message to the application over the internet. But if they have physical access to the device, which with mobile and IoT based systems can be as easy as a trip to the store, then they can directly tamper with the device.

Category: Mobile

Apple is Not a Growth Company Anymore