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Taking Back the Market

Is Apple's Insider Selling Market Driven?

Tim Nash - 2002.05.17

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In the wake of Enron, the markets are naturally nervous about insider selling. So the filings by CFO Fred Anderson to sell a further 159,332 shares (after recent sales of 274,000), by VP Nancy Heinen to sell 125,000, by Exec VP Timothy Cook to sell 310,0000 and by board member Sina Tamaddon to sell 250,000 makes investors wonder about the current quarter. Is all the good news out?

With the iMac backlog, the PowerBook upgrades reinforcing the attractions of Apple laptops, and the new eMac helping eMacin education, sales should comfortably exceed 900,000 and may even return to a million. With the corporate sector still looking weak in the US, sales to professionals will reflect this, but Apple is exposed less than the other PC companies.

Apple's education market share should be well up on last quarter's poor showing (under 15%), but US education sales are bound to reflect the shortfalls in state budgets and be considerably down. However the consumer market and increased sales outside the US should outweigh these.

While the outlook for Apple is fairly bright, there are a number of issues about the quality of earnings overhanging the market, some of which will continue to make investors think twice about investing in technology stocks in particular.

With the current treatment of options for executives, these are not charged against company earnings. However, if those options are treated as compensation in future, they will be charged, and Apple's loss last year, for example, would have been much larger. Though given the amount of lobbying money behind preserving the current arrangements, these are likely to stay in place until the government needs to add to the tax base.

Then there is the concealed options position of companies such as Dell. Basically, these companies bet on their share prices rising and, until the dot-com collapse, made lots of money. They bought options so that they could purchase their shares at a given price in the future and sold puts so they agreed to buy an equivalent number of shares at an agreed price on the same date. Profits from this boosted earnings as companies don't need to declare separately any profits from trading in their own shares. Now, however, the costs of covering these positions is eating into their cash reserves - Dell has lost $1.25bn this way and has exposed positions into 2003.

Other companies, such as IBM, have set their pension fund rates of return at a level which boosted profits.

The excesses of Enron have brought off balance sheet debt to the fore. In its better than expected last quarter results, Cisco identified off balance sheet property liabilities. Until the total amount of debt can be easily sorted out by the average analyst - and preferably by the average investor - the risk in owning shares is larger, and therefore fewer investors will want to do so.

Another issue highlighted by Enron is the value of an audited set of accounts to investors, particularly if the auditors are consultants.

There is also is the investigation into the boosting of Initial Public Offerings (IPOs) by such as Merrill Lynch, where analysts worked closely with investment bankers to give positive research notes on stocks they didn't believe in. Although it appears that the SEC and the relevant house committee would prefer this to go away, New York State Attorney General Eliot Spitzer seems determined to follow it up. So the SEC has made a few new rules that might help in the future, but if emails are found at the other major investment banks similar to those at Merrill Lynch, then only experienced investors will be likely to touch IPOs or secondary offerings for some years.

Soon the European Union will bring in regulations so that sales tax is paid on all Internet sales to EU residents. The threat of referral by the Bush administration to the World Trade Organisation is meaningless, as the regulations are designed to bring non-EU companies in line with EU-based companies that already pay the sales tax. While this won't affect Apple, which charges the tax through their local Web sites, it will certainly decrease AOL profits, for example.

Profitable US companies are also registering abroad in havens such as Bermuda to reduce corporate taxes and thereby increasing profits. As Apple has tax credits from previous losses to keep the tax rate down, it is unlikely to gain much from such a move.

Lastly, the expected recovery of the economy keeps on being postponed. Now consensus is for the last half of 2002. First quarter GDP initially looked good. Then, when the government related security expenditure and replacing depleted inventories were factored out, the annual growth rate was seen to be 1.3% - not even enough to stop unemployment from rising. Now that analysis has shown there wasn't a post Clinton depression, if it doesn't recover soon there will be less and less confidence in the Bush administration's handling of the economy.

While the market keeps on reacting to favorable earnings reports from large companies, sentiment stays bearish. Average Price/Earnings of stocks are higher than before previous bull markets - Apple is trading at 40-50 times expected 2002 earnings. So although, with all the hardware announcements and continuing improvement in core software, it is reasonable to expect Apple to outperform the sector, the prospects for the market and the sector are not too bright. LEM

Tim Nash lives with his wife, her website on the area ariege.com, two daughters, a cat, and a dog in the French Pyrenees. He has worked for computer companies for more years than he cares to remember, lapsed for a while after the Apple II, but became a Mac fan when his wife introduced him to the IIsi.

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