Rudy Burger
Posted on September 8th, 2011 · Posted in blog

September 7, 2011

With $76B in cash on its balance sheet, Apple Computer (NASDAQ: AAPL) is sitting on a huge war chest with which to make a game-changing move. Apple doesn’t pay dividends or conduct stock buybacks. Now is the time for Apple to think big on the M&A front.

Historically, Apple has tended to buy companies that enable it to improve margins on the same products and services or companies that enhance the Apple user experience. For example, Apple acquired Quebec-based Poly9 software in July 2010 and relocated most of its employees to Cupertino, leading to speculation that Apple was taking mapping software in-house to customize the experience for mobile users. A nice, if modest, step. A variety of smaller acquisitions might fill similar holes in their product and service suites.

In this blog, however, I speculate on larger, strategic moves that Apple might contemplate, instead of smaller “tuck-in” acquisitions that will largely go unnoticed. Apple should be thinking big.

Digital Media Content & Delivery

Current speculation about Apple’s next move has centered around a content delivery acquisition, with potential targets such as Netflix, Disney, Hulu, and even News Corp. Apple is not one of the bidders for Hulu (currently Amazon, Yahoo and Dish Network are bidding on Hulu – with Amazon as the odds-on favorite to win the prize). Apple could certainly afford Netflix ($12B market cap vs Apple’s market cap of $333B). With its 16 million North American subscribers, Netflix (NASDAQ: NFLX) would give Apple instant entry into movie delivery and the growing field of entertainment streaming to consumers. For television, mobile handsets, and many other devices, streaming certainly appears to be the future of entertainment delivery, a field Apple has so far failed to energize with its Apple TV product.

However, buying a digital media content business would complicate Apple’s relationship with other content providers, and content, as opposed to software/hardware, has not been Apple’s sweet spot.

Despite their focus on home entertainment, Apple has never developed a strong position in the games market. Will Apple decide to purchase a games company and launch its own games console?

Not likely. With the increasing shift of games online, Apple can catch a free ride in the gaming sector from the success of Zynga and others, without the need to make acquisitions. And games is a hit-driven business; Apple’s entrée would generate a great deal of buzz, but if the content isn’t on the platform, the failures can be abysmal. Given Apple’s philosophy of closely holding their technology, building a network of games developers would require an investment and commitment of a different order.

Home Automation & Security

Apple has been a pioneer in home networking, so why shouldn’t Apple expand the universe of things that can connect to Apple networks? I’m thinking in particular of Apple extending into the home automation and security market by, for example, acquiring Tyco International (NYSE:TYC, market cap = $18.5B).

Tyco International Ltd. operates in five segments: ADT Worldwide, Flow Control, Fire Protection Services, Electrical and Metal Products, and Safety Products. Apple’s interest would likely lie primarily in only the first of these business segments and the remaining segments could be spun out to another buyer. Tyco Retail Solutions (a subsidiary of Tyco International) provides retail performance and security solutions, including RFID tags for inventory management and theft prevention, which might provide a nice tie-in to future iPhone devices with integrated NFC functionality. Item-level intelligence via RFID ultimately extends URLs to physical objects, a physical divide that Google’s business model has begun to cross.

As an added bonus, Tyco International is headquartered in Schaffhausen, Switzerland, where Apple could spend some of its significant overseas cash.

Mobile Product Components

Component companies that push Apple’s smart phones and tablet computer products further ahead in price/performance will be targets of interest, with improvements in display, battery, and camera technologies on Apple’s radar. For example, according to iSuppli Corp, the bill-of-materials (BOM) cost of Apple’s low-end 16 Gbyte non-3G iPad is estimated to be $259.60, and more than 40% of this BOM cost is dedicated to the display, touch screen, and other user interface components. Meanwhile, the display accounts for half the power consumption of an iPad. Clearly, a smart acquisition could pay rapid rewards in this area.

Another idea that has been rumored for a while is for Apple to buy ARM Holdings plc (LSE: ARM, Market Cap = $12B). ARM licenses the semiconductor processor cores that run inside many of today’s mobile products. Just about every Apple and Android-based mobile product on the market uses ARM technology. If Apple purchased ARM, the entire mobile space would tumble into chao. Yet, since ARM has plenty of competitors, it’s unclear whether the anti-trust regulators in Europe and the US would block such an acquisition.

Human Computer Interface

Apple’s products have always been characterized by their simple and elegant user interface. Next-generation user interfaces are likely to make more use of spoken language instructions (voice) and gesture interface. However, I think Apple is more likely to continue to license speech recognition technology from Nuance Communications, Inc. (NasdaqGS:NUAN, Market Cap = $5.3B) than to try and buy it or another provider.

Gesture recognition has started to hit the mainstream market via gaming consoles, such as the wildly popular XBOX Kinect and its dedicated 3D camera. Although gesture recognition has not yet come to mainstream laptop and mobile products, adding another $1 web cam to the top bezel of a laptop would enable the laptop to capture 3D visual data and thus process the user’s hand gestures and facial expressions. I would expect Apple to pioneer gesture recognition technology to add additional Apple magic their products. In fact, the multi-touch technology that ships with all Apple laptop’s and mobile products is an early form of gesture recognition technology. Visual gesture recognition would be an interesting addition to Apple’s rumored entry into the TV market next year.

There are no large public companies that dominate the nascent gesture recognition market at this stage. GestureTek was founded in 1986 in Sunnyvale, California, and was an early pioneer in gesture recognition technology. Qualcomm acquired certain IP assets from GestureTek earlier this year.

Social Media

Social Media continues to be red-hot from an investment and IPO perspective, and Apple has no real contenders in the space. The closest Apple has come to a Social Media offering is Ping, a social media extension to iTunes.
I would expect to see Apple to continue on this organic growth path of building social networks around their customers’ media and to keep back from the social media arena. As suggested by a number of industry pundits, Apple has a pretty well-known disdain for social media. With a loyal army of fans, Apple probably doesn’t feel compelled to reach out; their devices connect them with their customers.

Telephony Operator

Apple’s magic is created by seamlessly integrating software, hardware, and service; you turn on your iPhone or iPad and gracefully step between applications, unaware of the multivariate bridges being crossed beneath – until you lose your signal.

Thus far, in the rapidly evolving mobile and digital streaming arenas, the carriers have held back innovation in their networks for fear of cannibalizing their business. AT&T’s initial unlimited data plan is now being replaced with a tiered usage plan, as they try to scrape revenue from their permanently online user community.

To see the stifling effect the carriers have had on innovation, you need look no further than the lack of unified communication (integrated email, voicemail, sms, chat, etc.) provided by today’s operators. You can be sure that it isn’t Apple holding back this type of innovation on their devices.

There are only two US-based targets that offer both a nationwide cellular infrastructure and broadband to the home: AT&T (market cap of $164B) and Verizon (market cap $94B). Acquiring either one of these companies would be a massive game-changer for Apple and the entire mobile products industry.

The explosion of the iPhone and iPad underscores a recurring theme: software drives sales. Apple has created the elegant platforms and now has the resources to push deeper into the stack, so that innovation continues to reach the user’s fingertips. In acquiring a major carrier, Apple would gain the capability to shape all layers of the user experience, driving innovation from the application layer all the way down to the infrastructure. And Apple’s die-hard user community would switch to the Apple-owned carrier to maximize the experience. For Apple’s competitors, it would be nearly impossible to catch up.

It needs to be said that the challenges associated with an acquisition of this sort would be formidable. The cultural challenges alone of this type of merger would be profound; both Verizon and AT&T are both heavily unionized. Yet, Google purchased Motorola Mobility.

In the next few months, Apple will be positioning itself with its new CEO for its next phase of growth. Mobile remains at the top of the priorities, of course, but with so much in flux in the industry, from hardware into software, there are few strategic moves for a company Apple’s size. Realistically, Apple now has the cash to step into a new arena altogether. Given the thunder and lightning that has accompanied Apple over the past few years, wherever they next make landfall will be in for big change.