AGILEVC My idle thoughts on tech startups

February 28, 2013

hungaryYesterday was Apple’s shareholder meeting and as many of you know, there’s obviously been healthy debate about what they should do with the ~$137 billion in cash they’re sitting on.  I had read somewhere that Apple’s cash pile was equivalent to Hungary’s GDP so I tweeted out the suggestion that perhaps an activist shareholder should push an acquisition of Hungary rather than thinking small (e.g. increasing dividends or issuing preferred stock).

Hungary probably wouldn’t sell their sovereignty and entire economy for 1x sales, but Apple has no debt so they could probably lever the deal and borrow money on top of $137 billion in equity.  For some reason the notion of Apple hiking the taxes of Hungary to fund a dividend recap just amuses me…

But in all seriousness, what should Apple do with a massive and growing pile of cash?  The three obvious buckets are of course to invest heavily in new products (the Apple TV or iWatch or whatever), return cash to shareholders (via dividends, buybacks, new class of preferred shares, etc), or acquire stuff.  Besides Hungary, what M&A strategies actually make sense?

FWIW Apple isn’t Cisco or Oracle.  Apple’s an incredible organization because of its long history of internal innovation rather than excellence in acquiring, integrating, and growing other businesses.  Over the long arc of time (by tech standards) Apple has done very few acquisitions >$100M and has never done a billion+ dollar deal.  Buying NeXT provided the foundation of what is now the desktop Mac OS plus brought Steve Jobs back to the Apple fold.  More recently acquiring Quattro Wireless created the iAds mobile ad network and Siri was of course a technology acquired from SRI.  Less auspiciously Apple bought a Swedish mapping technology company (C3) to form the basis of Apple Maps.  Lastly Apple has bought several component companies (chip companies Intrinsity and P.A. Semi, flash memory company Anobit, and security hardware – Authentec) to be integrated in various iStuff.

Apple is fundamentally great at creating innovative new platforms that consumers love because they’re easy to use and rationalize digital fragmentation.  They weren’t the first in PCs, MP3 players, smartphones, or even tablets yet Apple revolutionized each of those categories.  Apple doesn’t really make money by selling software or even digital content, but they seamlessly integrate software and content to support a high margin hardware business.

But Apple’s DNA is about quantum leaps, not incremental ones.  So if they were to become an acquisitive company, I’d argue they have to be as big & bold in buying as they are in product innovation.  The three main vectors Apple might pursue are:

1) Buy Content – Content is strategically important to Apple’s platforms, but in the grand scheme of Apple it’s a pretty meaningless part of their business.  If you add up all the content, software, and services (e.g. iCloud subscriptions) it’s about 6% of Apple’s revenue.  To put that in perspective, all the chargers and other accessory stuff amounts to about 50% of the revenue Apple generates from content + software + services.

Some people think Apple should buy Netflix.  On paper it makes sense… ~$10B market cap, deals with lots of content owners, a nascent library of Netflix developed content, and a happy/loyal consumer base.  But it makes less sense to me… consumers love Netflix because they can get it on all kinds of hardware devices (TVs from many makers, game consoles, tablets, etc) and content owners deal with Netflix because they don’t want iTunes to dominate digital video as it has digital music.  Apple could buy Disney instead (~$98B mkt cap) and own a vast library of content and the “infrastructure” to develop more (ABC/ESPN, movie studios, etc).  They’d probably divest the theme park business but the rest of Disney would give Apple an incredible platform to rethink video @ home in an on demand world.  It would also transform the company by making meaningful profits on content in addition to hardware.  Time Warner (~$50B mkt cap) would be the other logical choice in this vector.

2) Buy Pipes – Many have thought that communications infrastructure would become “dumb pipes” and the content and/or hardware companies would win home “infotainment”.  Pipes companies are still pretty valuable it turns out and on demand video hasn’t really eroded that… you still need cable or fiber to your home to watch Netflix, and it’s not like total revenue to the “cable” companies (Comcast, Time Warner Cable, Verizon Fios, AT&T Uverse) has really declined.  Plus building out a telecom network to the home is pretty hard and costly… there’s a reason Google Fiber is available in precisely 1 of the top 100 US cities.  The satellite TV guys (DirecTV, Dish Network) have good pay TV businesses and nationwide coverage but lack a true broadband internet offering so they wouldn’t be a fit.

Owning pipes and the content deals that go with them could strategically aid Apple in a couple ways.  First the reason the iPhone was such a profitable success for Apple was because they got to double dip… consumers paid Apple and wireless carriers paid Apple (in the form of subsidies) for each device.  No matter how awesome an Apple TV might be, it’s difficult to envision a similar scenario where cable companies subsidized the cost.  By the time the iPhone came out there were 3-4 wireless carriers with national scale so it made sense for AT&T to do an exclusive with Apple, but cable still tends to be a local duopoly or even monopoly so less incentive to try to shift consumer share.

But if Apple owned one of the big cable companies they could essentially boost the profitability of TVs by internally subsidizing with monthly subscription revenue.  They’d also instantly get access to a huge swath of TV and movie content out there.  Plus if they bought Comcast ($106B mkt cap) it’s essentially a twofer of #1 (content production) and #2 (pipes) now that Comcast has fully acquired NBC Universal.

3) Vertically Integrate - Apple could also vertically integrate in more radical ways.  I don’t mean buying Hon Hai (aka Foxconn) to control vast labor and production of Apple’s hardware.  I mean component suppliers like Marvell ($5B mkt cap) or STMicroelectronics ($7B mkt cap) for chips, or Sharp ($3B mkt cap) or Toshiba for LCD displays, etc.  Companies like Samsung and LG also supply Apple with displays, but since they compete in end-user devices trying to buy either of them probably wouldn’t make sense.  The display components are super low margin so Apple is unlikely to do that, but the semi companies conceivably could be a better fit.  But at the end of the day vertically integrating wouldn’t really transform Apple’s business in the way #1 or #2 would.

4) Buy A Social Platform - Really Facebook ($63B mkt cap) is the only one that makes sense to me from a strategic standpoint.  Twitter doesn’t really give the same depth of strategic synergy and and Apple is a consumer company rather than business-centric so that rules out LinkedIn.  But even though Apple could offer Facebook shareholders a 100% premium over the current stock price, obviously this one is never going to happen given Mark Zuckerberg’s voting control of the company.

My bet is that Apple does none of these things of course.  Maybe Hungary is starting to look more plausible…

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