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Apple's Scraping the Bottom of the Barrel

Don't buy Apple's (AAPL) stock. And if you own it, sell it. I know the company has a core following that is loyal, even cultlike, but the broader base of believers has been steadily eroding for years.

To wager on this company is to bet that the exodus of users can be staunched and then, implausibly, reversed. It's hard to imagine such a scenario, given Apple's shrinking girth. With less than 5% of the market, the company is no longer an afterthought in PCs -- it's irrelevant.

Here is a breakdown of my analysis of Apple Computer -- the good, the bad and the ugly.

Products: Don't tell me about the dazzling products that Apple introduces from time to time. Because I'll agree with you -- they can be impressive. From the iMacs to the PowerBook to the new iPod portable MP3 player announced this week, it is clear that Apple knows how to design cool products.

  • Pfizer
    Glenn Curtis
    and
    Lissa Morgenthaler
  • American Express
    Glenn Curtis
    and
    Odette Galli
  • Talbots
    Glenn Curtis

    and Tim Arango
  • Hasbro
    Arne Alsin

    and Gary B. Smith
  • Office Depot
    Arne Alsin
    and
    Chris Edmonds

Successful investors don't invest in cool products, though -- they invest in profits. In the past six years, against a backdrop of unparalleled profitability in tech, Apple was profitable in only three of those six years, despite a slew of provocative product introductions.

Business Model: It's safe to say that the business model at Apple is terminally flawed. The PC industry has been completely commoditized. And Apple loses on price because machines based on Microsoft's (MSFT) Windows are much cheaper. Apple also is a big loser compared with Windows based on the availability and breadth of applications.

To survive, Apple has to convince Windows users to migrate to the Mac platform. But since Apple is not competitive on either price or applications, there is no compelling reason for users to switch. The game is effectively over. Dell (DELL), IBM (IBM) and Hewlett Packard (HWP) have a stranglehold on the PC industry that is secure, with Dell's build-to-order model the clear winner over the long term.

Balance Sheet: Fans of Apple stock can hail the financial strength of the company, but this is hardly a reason to buy its shares. Net of all debt (including off-balance sheet liabilities), Apple commands cash or near-cash (such as receivables) of about $7.80 a share. Interest income made up 42% of the profit in the year 2000 and is expected to contribute 50% of the pretax income in 2002.

But why should investors buy into a company with a deteriorating revenue base -- sales are lower at Apple now than they were three, five and even 10 years ago -- just so Steve Jobs can invest capital in short-term instruments that yield 3%? Large cash balances aren't bad if they are accompanied by a value-creating business model that can use the cash for growth, but that's not the case with Apple. It's no wonder then that, assuming the company can meet earnings estimates, the return on shareholder equity in 2002 will be a paltry 3%.

Retail Stores: It's desperation time in Cupertino, Calif., as Apple is going into the retail store business to ensure that its products receive enough attention. This move is fraught with problems, however, because the reason that Apple products are not getting the retailers' attention is because they are not selling well. If Apple machines were moving fast off the shelves, retailers would be happy to provide the shelf space.

And the move into retail takes Apple into an area where it has demonstrated no competence. Now it's going to take on Best Buy (BBY) and Circuit City (CC)? Have the executives at Apple considered the sobering retail experience of Gateway (GTW)?

It's too bad for Apple that the ending to this chapter in the PC story has already been written. The company had the ultimate first-mover advantage many years ago with an array of better products, a vastly superior operating system and even the best commercials!

Apple's story now is fodder for business historians -- don't make it fodder for your portfolio.

Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor specializing in turnaround situations. At time of publication, Alsin and/or ACM was long Circuit City, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to arne@alsincapital.com.

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