| In our continuing series entitled "Another Sign," we have one of the biggest signs yet that Apple is a healthy company. Moody's announced that it has raised the rating on Apple Computer, Inc.'s US$300 million 6.5% senior unsecured notes, due 2004, and to (P)B1 from (P)B2 on the remaining US$200 million available under the company's 1993 shelf registration for senior unsecured debt.
This debt does not include the $661 million worth of 6% convertible subordinated notes. Apple announced last month that they would be called for redemption on June 1, 1999. According to Moody's (We have commentary on this in The Mac Observer Spin at the end of this long article):
The company's senior implied rating was raised to B1. The upgrade reflects the continued strengthening of Apple's balance sheet and market share, aided by the initial success of the iMac, the company's entry into the lower-priced personal computer market, introduced in August, 1998, and the momentum of a greatly expanded software applications development effort for the Macintosh platform.
Although the ratings are constrained by uncertainties over the company's long term financial planning and business strategy, the ratings outlook is revised to positive based on our belief that Apple will preserve a substantial portion of the cash and short term investments it has amassed while, in the near term, sustaining the sales momentum achieved with the rollout of the G3 PowerPC generation of products.
The upgrade takes into account Apple's return to year-over-year revenue growth, as exhibited by sales increases of 8.4% and 8.9% recorded in FY1999Q1 and FY1999Q2, respectively; the company's modest debt leverage of .6 times cash flow for the LTM ended March 27, 1999, reflecting the conversion of the 6% convertibles; and cash and short-term investments that have grown to more than $2.9 billion at the end of March, 1999, up from a low of $600 million three years earlier.
The company's gross margin has steadily improved to 26.8% for the LTM, a measure that exceeds the leading Wintel-based personal computer vendors. Management has continued to reduce the company's expense structure, and has made extraordinary strides toward approaching industry-leading working capital metrics.
More significant, Macintosh CPU unit sales were up 34.5% over the three quarters since the iMac rollout, stanching the deterioration in the company's market share.
The iMac, with its innovative chassis design and unconventional rainbow colors, has received critical acclaim for its styling as well as the performance of the G3 PowerPC RISC microprocessor manufactured by Motorola. However, the ratings also recognize the intense price competition among personal computers today, particularly among the burgeoning sub-$1,000 models, a market that could present difficulties for the premium priced $1,199 iMacs.
Although the company continues to benefit from the intense fervor of its installed base of users, its Macintosh operating system faces a formidable challenge in holding its position against the ubiquitous Windows operating system marketed by Microsoft through such OEM vendors as Compaq, Dell, Gateway, Hewlett-Packard, Acer and IBM.
Apple's management has made considerable progress in streamlining the company's distribution channels, dramatically reducing inventory through a greater reliance on more standardized parts and the outsourcing of system assembly, and improving upon receivables processing.
The company's adept management of its supply chain could be attributed to a simplification of its product line from 15 models to three, with a very broad range of feature configurations. A fourth model, a professional class notebook computer, is on the way. Nevertheless, continued success may be reliant on a significant enhancement to the Macintosh operating system if the company is to leverage its latest round of desktop and mobile product introductions beyond its installed base of retail consumer and professional buyers.
At the same time, any marked departure from the fabled Mac OS would be scrutinized closely and risk acceptance, not only by the broader personal computer market, but also by the ardent loyalists who have supported the existing operating system.
This marks the second time in recent months that Moody's has increased a rating for Apple.
The report issued by Moody's also explained why the rating was not higher. In particular, the report says that while Apple's cash supply is great, it doesn't matter much in the face of the combined might of the Wintel Empire as well as some other issues that could impact Apple negatively in the future. According to Moody's:
Apple's cash horde, while substantial, would be of only modest comfort when contrasted with the combined resources of Microsoft, Intel, and the Wintel consortium. Despite the iMac's success in the retail consumer market, the company's share of the overall personal computer market, estimated at under 4%, remains modest.
Apple's strategy of focusing on its traditional strongholds of education, government and scientific institutional users as well as professional publishing and graphic design all but abandons the corporate market, where frequent upgrade cycles and high volume shipments could enable the company to further extend its margins. Furthermore, it is unclear how the company will fare in the consumer segment when confronted by a panoply of application specific handheld devices as the era of pervasive computing arrives.
The ratings are additionally influenced by some uncertainty relating to Apple's use of its estimable cash and short term investments, over $2.2 billion of which were funded over the past three years from inventory and receivables adjustments. The company's cash management policy is evolving, but the magnitude of available cash could lead the company to succumb to pressure from its shareholders, and engage in activities that would be inimical to bondholder protection.
Moody's is concerned over the degree to which cash may be applied toward a possible stock repurchase program for the purpose of buttressing the price of the common stock, recently trading at about $42-44 per share, or of averting shareholder dilution stemming from the exercise of common stock options.
We believe that the company must exercise considerable discretion in drawing from its fulsome cash position, establishing a minimal liquidity threshold to respond to unexpected and sharply graduated research and development funding requirements.
This issue is accentuated by management's tendency to be circumspect regarding its technological roadmap. Nevertheless, our concerns are mitigated by the role of the Board of Directors' Audit and Finance Committee, chaired by former IBM and Chrysler CFO Jerome B. York, in setting financial parameters for the company. The positive outlook reflects Moody's expectation that Apple will limit its balance sheet leverage, having restored its capitalization to the conservative profile befitting of a technology concern; and that the company will be able to sustain its recent momentum and begin to augment its niche market.
The Mac Observer Spin: Wow, this is big news. Moody's has gone to great lengths to demonstrate they believe in Apple's recovery. They even acknowledge the fervent support of Mac fanatics and question the effect that a decrease in that support could have on the company's future. According to Moody's:
At the same time, any marked departure from the fabled Mac OS would be scrutinized closely and risk acceptance, not only by the broader personal computer market, but also by the ardent loyalists who have supported the existing operating system.
That is a very interesting comment to come out of a financial report. The Mac world is indeed very different from the rest of the computing world.
This is part of our "Another Sign" series because this is the strongest statement of support to come from Wall Street to date. This is clearly an obvious sign that Apple is in fact a healthy company with a bright future. Something that Observers have known for months on end and Wall Street has just begun to recently catch on to.
Congratulations to Apple!
Apple
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