Apple’s large price drop
and the Google’s large price jump
occurred within days of each other. They highlight how challenging tech valuation
and pricing can be in a normal trading context let alone in an M&A setting.
I find it useful to distinguish the different stages of tech firms to
understand the economic dynamics. My scheme is as follows:
1)
Seed: idea stage with no established business model
or revenues; private market valuation set by handful of optimists of
questionable reliability.
2)
Early: established business model and revenues -profits
hopefully to follow e.g. Square; price based on relative value compared to
“peers”.
3)
Mature: great returns/profits but growth
leveling off e.g. Apple and Google; key drivers are growth and returns.
4)
Old: declining returns with limited if any
growth e.g. Hewlett Packard and IBM; focus on shareholder distributions and breakup
asset values.
Recently, Apple and Google experienced large stock price
swings. GOOGLE increased by 16%+ or $65B on July 17 while Apple fell 7% or $60B
four days later. Ralph
correctly notes stock prices are based on expectations not actual results.
Expectations are frequently based on
extrapolations-sometimes sophisticated, but still extrapolations based on
beliefs not facts. Once a new signal (which could be information or noise) is
received, investors revise their prior beliefs regarding future operating
performance-Bayesian
updating or learning. Tech firms are inherently volatile given short product
life cycles and their uncertain operating environment. Relatively small changes
in expected growth rates can have a huge valuation impact.
Apple, although it had a great quarter, gave revenue
guidance that shook investor growth expectations. Specifically, concerns over
iPhone, iPad, iWatch and the next “big thing” caused investors to markdown
growth estimates. It is still a great firm but was priced too high based on new
growth estimates. This raises another issue-will Apple’s management try regain
its growth “mojo” through expensive unfocused new product R&D and
acquisitions? Remember they have a huge $200B+ cash pile and could do lots of
damage. Hopefully activists like Icahn will keep pressuring them to return more
cash to shareholders. Interesting to see how their management reacts. The
record of aging tech firms refusing to age gracefully like HP is not a happy
one.
Google benefited from a “twofer”. They had a better than
expected second quarter. They also provided information on improving growth
prospects for mobile ads. Equally important, their new CFO provided comforting
words on expense and capital discipline. The problem with maturing tech is the
discipline to manage the transition from high growth to more modest growth.
Managing the transition has an important impact on expectations. Whether Google’s
management can deliver on these raised expectations remains to be seen. If they
disappoint then expect a subsequent large downward pricing adjustment.
My take is mature tech firms are fraught with agency cost
issues which make them difficult to value. They will try to fight the
transition to slower growth and try to manufacture growth through undisciplined
capital allocation at the expense of returns and value. New management teams
unburdened by legacy culture will be needed to avoid Microsoft-Nokia type
M&A misadventures.
J
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