The market and consumers shrug off the iPhone 4's antenna problems as Apple rolls to record profits
When Apple (AAPL) Chief Executive Officer Steve Jobs announced he was giving away $30 plastic cases to dissatisfied iPhone 4 owners on July 16, Wall Street breathed a sigh of relief. There would be no expensive recall of the more than 3 million reception-challenged devices that had been sold since the iPhone 4's debut on June 24.
Then came Apple's blowout second-quarter results announced on July 20, when the company reported profits of $3.25 billion on $15.7 billion in sales. Analysts were expecting $2.9 billion in earnings on sales of $14.7 billion, according to data compiled by Bloomberg. Judging from the two- to three-week waiting lists to buy an iPhone 4, "Antenna-gate," as Jobs calls it, has not caused Apple-entranced consumers to lose faith. "Let me be very clear on this," Chief Operating Officer Tim Cook said during Apple's earnings call with analysts. "We are selling every unit we can make."
Mac sales also set an all-time record, and the three-month-old iPad sold so briskly that it is already bringing in more revenue than the still-growing iPod business. "For many people in this economy, Apple is what makes them happy," says Kaufman Brothers senior analyst Shaw Wu. "Its products make their lives easier and provide some entertainment, at a time when people don't feel good about a lot of other things in their lives. It sounds silly, but it's not that far from the truth."
Apple's run is far from over, says hedge fund investor David Einhorn of Greenlight Capital, who has been buying shares. "While growth over the next few years will certainly be slower than it has been over the last few years," he wrote in a July 16 letter to investors, "AAPL does not appear to have fully penetrated its market opportunities."
Of course, it doesn't have those markets to itself. At a time when Apple is racing to ramp up its production capacity, rivals are massing with products of their own. While Google (GOOG) recently discontinued its Nexus One phone, mobile phones based on its Android software, such as Motorola's (MOT) Droid X and HTC's Evo, are selling well. Microsoft (MSFT) is about to launch revamped mobile-phone software. Analysts say Hewlett-Packard (HPQ) is working on an iPad-like tablet based on technology from newly acquired Palm.
Jobs says a primary reason for Apple's success is that it doesn't specialize in software like Microsoft or Google, or hardware like HP or Samsung. It does both, enabling it to make minute trade-offs to improve products—say, to get a bit more battery life. It brings the same obsessiveness to its dealings with suppliers and distributors that it does to industrial design. While Apple, like most tech companies, outsources the assembly of its products, it demands to know details down to the source of raw materials, says the CEO of one supplier. It's a cost-effective way of ensuring quality control, says the executive. (Apple spokesman Steve Dowling declined to comment for this story.)
Apple's partners tend to do what they can to keep Cupertino happy: No other tech company can give a supplier or manufacturer the same combination of volume and growth. This gives Apple huge leverage. Mike Fawkes, a venture capitalist who used to be HP's global supply-chain head, says Taiwanese contract manufacturer Hon Hai Precision Industry most likely accepts minimal margins on the millions of iPhones and iPads it makes, yet gladly takes Apple's business for the volume and the cachet such an account brings. (Hon Hai spokesman Edmund Ding declined to comment.)
Then there's customer service. Most companies outsource the cost of hand-holding as much as possible. Apple invests in it, hiring legions of store reps, known as "geniuses," who work at the company's 293 stores. It can afford such investments—the company has $24 billion in cash, and analysts expect it to churn out $10 billion to $15 billion in cash a year from operations.
The one thing Apple can't afford is a real, lasting blow to its stellar reputation. Antenna-gate was not that. Hundreds of people lined up outside for hours when Apple opened a new store in Shanghai on July 10. On the analyst call, COO Cook said U.S. schools, struggling with plummeting budgets, still managed to spend a record amount on Macs. He added that 50 percent of Fortune 100 companies are currently providing the iPad to employees or testing the tablet computer out.
David Eiswert, who manages T. Rowe Price's (TROW) $271 million Global Technology Fund, says he's less concerned with future product mishaps than with Apple's ability to capitalize whenever the stock market doubts the company's hold on the consumer psyche. He says he has urged Apple to institute an automatic stock buyback program that would be triggered whenever the share price drops. Should there be another Antenna-gate-type screwup, "Everyone would freak out," he says. "And Apple would be able to pick up another 5 percent of the shares at the lower prices." Eiswert says it would be a simple way to improve earnings per share. As if Apple needed any more help.
The bottom line: The antenna problems with Apple's iPhone 4 show no signs of dampening consumer demand for the device.