Apple's China Problem, Its Tenuous Valuation, And The iPhone 15 — With Walter Piecyk

0:00A leading Apple analyst joins to talk about the company's$200 billion market cap plunge and what's coming up as it reveals the iPhone 15. All that and more coming up right after this. Welcome to Big Technology Podcast Friday edition, where we break down the week's news in our traditional cool-headed and nuanced format. This week, a special episode with a great analyst. We're going to focus entirely on Apple, which was the biggest story in tech and the market this week. It's dropped tremendously in the market. It's gone down$200 billion. I mean, it was at$3 trillion, so it can afford to lose a little bit, you would think.

0:36But the big news is that it has really exceptional weakness in China that's starting to be revealed in a very public way. And some challengers and plenty more to discuss. Joining us today, we have a special guest with us, Walter Pajczek. He's a partner at Light Shed Partners and the GP at Light Shed Ventures. A real bear on Apple. So this is going to be a fun conversation. Welcome to the show. Thanks for having me. So let's start with what's going on with Apple. You know, the stock plunges. Everyone's trying to figure out why. A couple of things bubble up in China. First is that China has banned government employees from using the iPhone.

1:12And then we learned that it might extend beyond that to even state funded companies. So can you take us into what's happening there? I mean, is that really a reason for the stock to fall so much? I mean, I'm not sure that that event in and of itself creates enough of change in numbers for analyst estimates. I don't think you've seen any analysts yet, or I don't think they will next week come out and cut numbers. It's obviously hard to gauge because, OK, you can't use your iPhone in a government agency. It doesn't mean you can't not use it or use it outside that agency, at least yet. But I think that the concern that investors would have is kind of how much does this, what's the slippery slope?

1:52what's the next step that China takes? What's the next step that the U.S. takes in terms of restriction? Remember, the root of this is the banning of Huawei. There's obviously been discussion on the use of TikTok within government agencies in this country. What's interesting is that the Chinese government has a lot of power. I've covered this industry really basically since the mid-90s. And there's times even in China within existing operators, if one telco operator gets too many subscribers and the government would like balance, they have a way of influencing market share shifts in between companies within their own country and then obviously, you know, the shares within the device sellers, whether it's a U.S.

2:38company versus a Chinese company. So I think the bottom line is that's a long way of saying, like, what happened isn't necessarily material in terms of, you know, negatively impacting Apple's earnings. It's not going to cut 15 % or 10 % out of Apple's earnings. It's just highlighting that as things ratchet up between the US and China, you know, there's a lot of potential risk there. And I was spending most of the week trying to figure out who has the leverage here, right? Because Apple has 20 % of its business in China, that's huge percentage, and it has a tremendous amount of manufacturing there, which it's been trying to diversify, but it's really in the early stages.

3:15Then you have China, right people do like the iphone there it's a very popular phone and apple is responsible for millions of jobs so it's not like china is going to say apple get out of the country uh but it's showing the company hey listen you know or you're really showing the u.s like your your big companies and some ways your economy i mean apple's seven percent of the s &p 500 i think 11 of nasdaq right So your company's health depends on our markets. And we have the power to do what we want to them when we want to. So this is obviously a leverage play. It doesn't seem like either there's going to be a big divorce.

3:53But who do you think has the power here? And why do you think anybody would even risk that relationship given how important it is to both? I mean, I think one of the key points of those multiple points that you mentioned was the number of jobs that Apple creates in China. So there's effectively a codependency between the company and the country. So to your point, like as China ratchets up against the U.S. and using Apple in some ways, there might be some limitations in terms of the impact that they can have on their own economy. On the flip side, I've heard some talking heads say, oh, Apple can just snap their fingers and pull manufacturing out of China.

4:38It doesn't work that way. I mean, it takes a while to get plants up to have them be able to produce iPhones that are high quality. There's a lot of times when you talk about good margins, it's the expertise that Tim Cook, the CEO of Apple, has in managing that supply chain in order to have quality product. You just don't change your manufacturing overnight. So I think there's a very strong codependency between, you know, Apple and China. The thing that is a blind spot, I think, for me and all investors is we're still dealing with governments at a higher level. And there's, you know, this kind of who's going to be the leader in AI and what can be AI, you know, as a technology, how can it be used by the military?

5:24And I think, you know, even if there is this codependency, who knows? Like, am I a political? Do I know enough about politics to know how much China is willing to take on pain if they see a larger, longer term goal in terms of making sure that they have the technologies that they need and that they're not restricted by the U.S. government in terms of AI development or, you know, the use of some of their products in the U.S. by U.S. consumers? Kind of a controversial question. But, you know, the U.S. has been trying to cut off China from and has been cutting off China from basically all the chips that you need to build advanced artificial intelligence, the chips that you need to build fast smartphones.

6:03We're going to talk about that next. And there's been this big campaign against TikTok in the U.S. I mean, obviously, China feels and hears all of this. Do you think the U.S. is overstepping here? I mean, there's there are consequences in some ways to these statements and actions. And there there can be this this maybe like the punch back beginning of the punch back. I mean, I heard again, I heard someone say like, oh, this is all a response to what we did. Like, let's not forget the number of U.S. companies that have social media apps that are restricted in China. So, you know, if you want to go for like a tit for tat in terms of who did what first.

6:38I mean, I think it goes both ways. But again, U.S. companies are getting restricted. Not to get off topic, but let's look at what the FTC is doing when they're looking at the antitrust issues that they have with some of the companies that Lena Khan is going after. And they're not looking at it on the more global basis where let's say you restrict EA or whoever Microsoft is buying versus to the benefit of Sony, which was not a U.S. company. Not EA. Activision. Sorry. Activision. Sorry. brain fart there. Yeah. So, I mean, these things, I think, I think all come to play. So I don't, I wouldn't blame necessarily one side versus another, but as an American citizen, I'm surely aware of the restrictions that U.S.

7:30companies have had in operating in that country. No doubt. I mean, I guess it's clear that the U.S. companies are restricted there, but they have a government that's more willing to take swings that ours is not. So does the U.S. need to pump the brakes a little bit to avoid retribution? Yeah, these are trade issues in large part. They are, I think, wrapped up in a lot of times public safety or free speech or things like that. But at the end of the day, trade is a big part of that. And we do have an election coming up. And there's been a lot of discussion over TikTok and some of these other things.

8:10So what we've seen in the election cycles of our country is not finding that necessarily middle ground, but going one way or the other to dial up the rhetoric and maybe take some actions that will resonate with voters in an upcoming election. So I think that has to be kind of factored in. Whether what they should do or shouldn't do, I mean, you know, than you're asking me to run the public policy. It's always fun. Yeah, I mean, but at some point, if we're at the same time getting back to FTC, trying to restrict our own companies when foreign countries are restricting our US companies in those markets, I would think that there should be maybe some alteration in how we approach that.

8:59It doesn't seem to me that it's going to be a case where China just says no more iPhones in China. I mean, that would be totally drastic and fairly unprecedented, I think, in our globalized but steadily de-globalizing economy. So I guess you can't rule it out completely. It seems unlikely. I mean, with the U.S. just sorry to interrupt you, but the U.S. has banned, you know, infrastructure purchases from, you know, these Chinese companies and has funded the existing infrastructure to be ripped out of existing telco networks. So when you talk about the kind of tit for tat and back and forth, I mean, obviously it's not the same scale as the number of phones that Apple sells in China.

9:42But it's not like technology has not been imports or exports. That's not been discussed as something that is at risk of ban in the past or it certainly is a possibility. Again, I agree with you. Low risk of that, but still can't roll it out altogether. So I think we should definitely talk about like some of these, you know, technology bans. And we'll do that in a second. But the thing I was getting at on this point was that the thing that seems more likely and the thing that surprised me in my research as I was researching, you and I were both on CNBC this week talking about it. I actually think that, you know, I appreciated watching your comments more than I think the things that I said.

10:20But as I was researching, one of the things that I found so fascinating was that, A, well, let's just get into it. there's a faster Huawei phone called the Mate 60 that's just come out, which is just like basically taking a dramatic step forward in terms of connectivity in China. And it's not only the faster specs. I mean, it sold out in like two days right away. But it's not only the faster specs that people are interested in. It's this matter of national pride. And the US banned Huawei from using the Android operating system. And that effectively, between that and the restrictions on connectivity, the adoption within China, I think, tanked.

11:02And the iPhone was the beneficiary of that. Now, with this faster phone, the thought is that Huawei can start to make up some of that market share. And with a product that has somewhat close to parity to the iPhone in China, this is the thing that surprised me, is that it's now becoming a matter of national pride in China where people are like, I am a, I believe in the government. I believe in our country. I'm a Huawei user. And this, what this government thing signals is that, you know, if you are a true supporter of the Chinese communist party, you're not touching that iPhone. You're going to get this Huawei Mate 60 and roll with that.

11:40And when it becomes this sort of a move, a movement phone versus a specs phone, that's where you could end up seeing the iPhone really lose some share there. I think that's 100 % true. It's just there's different elements of it. A, you could already have that sense of pride. That may already exist. B, the government can impact it through how they communicate with the citizenry there. And the third thing is just outright impacting it. Meaning, again, talking about this, there's a word for it. I forget what it is. But there's a need for balance. So let's say you had AT &T, T-Mobile, and let's say Sprint still existed.

12:19and they were a really weak third competitor. And the government said to the other two guys, you cannot sign up new customers for the next six months because we want Sprint to be able to sign up new customers. Those are the types of actions that have been taken historically in that country in order to restore balance, in this case, to the number of subscribers for an existing operator. So when I see that historically have happened, then I think that they can take even more formal steps to help, in this case, what you would, you know, In operator land, we call this the national champion. Let's say Huawei is the national champion.

12:53To help the national champion really just restrict and go to the operators and say, which are government-owned, and say, just don't sell the iPhone or maybe subsidize Huawei and don't subsidize iPhones, where it's not like an outright ban of they can't import them or keep them in the country, but obviously influence those numbers. So certainly, again, that's clearly a risk. So briefly, what's your prediction of where this goes from here? I mean, again, this is like trying to put on politics hats. And I just think like this risk always existed, right? This is, let's get back to the root of why we have a sell rating.

13:32I mean, if you look at the multiple of it, multiples should be a function of growth and risk. And you have no growth, right, already. And now you have, and let's say the expectation for growth overall for the company is low single digits for next year. and this is a risk of it. So this is the risk. As risk gets dialed up, meaning that this could lead to less phone sales, you should pay a lower multiple, period. So the way you would theoretically approach something like this, you just say, okay, there's a 10 % probability that handsets are down a million in this quarter, and then it gets resolved.

14:12There's a 20 % chance that something more dramatic happens. And then you're effectively weighting the risk of those different scenarios in order to come up with a average earnings number. And then you put a multiple on it. So when I look at this all together, we've already done that. And this is why my revenue estimate is $17 billion below consensus for next year. Our earnings are below consensus. And ultimately, if whether this is something that impacts revenue, some of the regulatory risks in terms of what they're charging in their app store or some of the restrictions that they'll have on search, all these things come to play in terms of what numbers the company is going to generate.

14:58Walt Pysik is here. He is a partner at LightShed Partners and a GP at LightShed Ventures. We're talking a lot about the policy side in the first half. In the second half, we're going to talk a little bit more about Apple's business. Walt is actually the most bearish analyst on Apple in the entire analyst community. So kind of interesting to dig into that a little bit more. And then we'll also preview the iPhone 15 and maybe touch on one or two more topics before we head out. Back right after this. Did you know your credit card points and miles can lose value to inflation? Credit card companies often reduce the redemption value of your points and miles.

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16:49Each week, I'll sit down with some of the most interesting, provocative, and influential people who are shaping our right now. Big interview conversations are fun. I want a shark that... That eats the internet. That turns it all off. Unfiltered and unafraid. So in a lot of ways, I try to be an antidote to the unimaginable faucet of reactionary content that you see online, to the best of my ability. Every week, we're going to offer you the ultimate luxury of our times, meaning and context. True or false, you, Brian Johnson, the man sitting across from me, one day, at some point, as of yet undefined in the future, you will die.

17:30False. Tell me more. Listen to The Big Interview right now in the same place you find Wired's Uncanny Valley podcast. Subscribe or follow wherever you get your podcasts. And we're back on Big Technology Podcast with Walt Pysik. Walt, are you proud of the label, the most bearish analyst on Apple and Wall Street? I'm really not. And I mean, I've covered this thing for, I don't know, 15, 16 years. And I've had a buy rating on it more than a sell rating. So I'm not like, I know there's some people that kind of dig in their heels on certain companies. I certainly was that way with Sprint before it got bought by T-Mobile.

18:08But in this case, like, you know, it's nothing against the company, the management team, the products. It's just, look, we just look at, we do what the, we, we, I'm very model focused. And what the numbers tell us is the consensus is too high and the valuation is too high. And our input on this, unlike many of my peers, is from the operators, which is the demand side. And they're telling us what's happening. And I'm seeing it in the reported numbers, what's happening with the replacement cycle, meaning how long people hold on to their phones. And I had this very similar situation back in, I think it was 2012, where we had downgraded the stock.

18:46In that case, it was from just a buy to a neutral. We hadn't gone to sell at that time. and early on you know the stock didn't work out and i was on you know on cnbc you have egg on your face blah blah blah and then and then the misses started happening and um and the stock the stock was impacted so look i don't know if i'm going to be right or wrong but i just look at the numbers right driven and by the way our peers are you know do a great job and they do something i don't do which is they go to asia and they figure out what the supply is the risk on that though is you know I can think of certain analysts, they come out and they say, oh, Asia is telling us that they're going to make this number of phones.

19:21And then two weeks later, they get revised down because Apple goes to them and says, yeah, you know, we're not selling as many phones. So we're reducing the production. So that's a supply based supply side based analysis. And ours is more focused on the demand side. Let's go ahead. Sorry. You've had you brought up two things that I want to touch on and then we can get back to to this. But the first is valuation. Right. And the second is the upgrade cycle. So first valuation. Okay. I look at it pretty simply, which is that I see the numbers, right? Apple's up 40 % this year. It was, it hit all time highs above$3 trillion and stayed there for a while, even as its revenue contracted for three straight quarters.

20:02And it looks like it's going to do that again this quarter. I mean, how does a company end up having such a high valuation, right? So it's not just the number, but it's multiple, right? Which is like the forward looking price to earnings ratio was above 30, which is just not does never had that in its history before. And again, if its revenue is going down, sales are going down for it to soar in this way, just seems completely counterintuitive. So let's touch on that first and then get to this slowing upgrade cycle. What do you think? Sure. First of all, I don't believe in the that the market is efficient every single day.

20:41Over time, the market is efficient in terms of growth and valuation. So sometimes you just have more buyers than sellers. People are buying for defensive reasons. There's shifts into certain types of companies. Maybe there's a hope for growth. I mean, earnings estimates have come down. So these things happen from time to time. And look, maybe I'm going to be wrong. And they're going to outperform even consensus. And the stock is reflecting better growth in 2024, which the upcoming quarters will determine that. But it just kind of is what it is until it isn't. Everyone's like, oh, it doesn't go down.

21:20By the way, there was also a time when there was a lot of discussion of, hey, this thing should be valued like a SaaS or like a services company like Netflix, which I also found amusing because Netflix's PE multiple was actually lower than Apple's. And let's just focus on that for one second. Netflix spent two decades building what they have today in terms of investing in content, investing in technology, which is massive, investing in customer acquisition. And they're undoubtedly the biggest in this one segment of what Apple does. And they're a$30 billion company, right? Apple's services business alone is$80 billion.

22:03And by the way, it grew less than 10 % in the last three quarters. So it's not like you're getting hyper growth in this segment. So to say like, let's take a business that's 20 % of your total, growing at 10%. So you're adding what, two percentage points of growth? And you're going to re-rate the entire company to say this is a service business? A, that's I think faulty logic. And B, even if you did that, you're not even getting a higher multiple because the multiple is already as high as some of these other recurring revenue businesses like Netflix. Exactly. I mean, 52 % of the revenue is still from iPhones.

22:40So, yeah. And by the way, like iPhone 100 % is a recurring revenue business in the sense that those customers come back to you, right? So I get that. Like there's, you know, where Apple is today in terms of their customer loyalty, you know, you can argue that that's a very, you know, a predictable business. But the point is it's not growing. And then you've got two other segments that are effectively in decline. So, you know, what is that? What is where do you end up with? You end up with no growth. Is the rest of the economy at risk a little bit because we have sorry, the rest of the market at risk a little bit because so much of the it seems like Apple's just kind of been pulling it up year after year.

23:24And it just I mentioned the first half, but it makes up so much. Like if you're a passive investor, you hold ETFs like you have like the S &P 500 or NASDAQ funds like you're your seven to 10 or even more percent of your portfolio is just going to be Apple. So, I mean, your prediction is that this stock is going to fall dramatically. What does that say for the rest of the market? I mean, look, we all own index funds and mutual funds. So it's probably one of my biggest personal holdings, not because I own it personally. I don't. Just because it's within an index fund. But it's not a call on the market.

24:03And frankly, last quarter when the stock sold off after they reported, the market was up. And I think a lot of times, you know, leadership, you know, meaning the top five or ten stocks in the market are always the primary driver or frequently the primary driver. And sometimes those things change. So maybe if Apple has a drawdown, which it has had in the past, maybe not when its weighting was as great, then maybe one of the other large-cap tech names like Amazon or Facebook is going to do that much better in terms of how the overall markets can perform. And money will just shift there. So I think just things change.

24:42Like, you know, leadership has always been big and there's been different leaders 10 or 20 years ago that no one thought would ever fall off. And they did. Okay. And so let's talk. And by the way, just to be clear, our call is not that like this is the end of Apple. Apple is doomed. All I'm saying is. It's going to be a pretty expensive. I mean, it's still a very valuable company even if it hits your. It's a great company, right? But where should it be valued? And where should consensus be? So maybe when they miss and the stock comes down and our numbers are in line with consensus, maybe our numbers are going to be better than consensus, and then it can return to decent performance.

25:22Maybe all of this R &D that they've been investing in over the years, I mean, just look at that R &D number. I think it's like$30 billion a year now. It continues to grow as a percentage of revenue. Maybe that will deliver some innovative products. I know there's always been this speculation about cars and TVs, and now you actually have a product that they're going to launch in the first quarter with the VR, the AR VR. Yeah. So maybe one of these things will return a great company. I just don't think that this is the right price to invest in it. And so let's pick up on one last thing, which is before we move to iPhone 15, which is the upgrades, right?

25:58So you say you speak to the operators, right? So these are the companies that know who's upgrading, how often this happens. I mean, they're like, if you're going to look for someone to know this almost as well as Apple does, it's them. And the sense that I get from hearing you speak about it is that people are just holding onto their phones for years and years and years, longer than they ever have. Is that sort of what you're seeing? And I mean, this sort of like segues naturally into what's going to happen with the iPhone 15. But just from the operator side, is that what you're hearing from them?