Forget new Apple products—THIS is the issue

Let me start off by saying that I am a HUGE fan of Apple products. In my household, we have 3 big iMacs, 3 MacAirs, countless iPods, 4 iPhones, 4 iPads and 3 AppleTVs. Notice I did not say an Apple Watch. I also look forward to buying the new 12.9" iPad when it comes out. I love to relax by watching mindless comedies and the bigger screen would be great. Having said all of the above, I am not a big fan of Apple's stock currently.

Tune in to CNBC's "Closing Bell" on Tues., Jan. 26 at 4:45pm ET. Dan Niles will be on talking about Apple's latest earnings report.

In 2010, Apple revenue grew 81 percent from a year earlier, but then it went downhill: Revenue growth of just 68 percent in 2011, 29 percent in 2012 and 6 percent in 2013. The biggest reason for the slowdown in revenue growth was other smartphone vendors, particularly Samsung, were launching larger phones, which Apple refused to do. Memo to Cupertino: Bigger is better.

A customer uses his iPad outside an Apple store in Shanghai.
Peter Parks | AFP | Getty Images
A customer uses his iPad outside an Apple store in Shanghai.

When Apple released the new larger iPhones last year, my wife and I both finally upgraded. For all of us with friends who owned a 6" Samsung phone, it was a long time in the wilderness feeling like second-class citizens. And, it was the best line-up of new products since they added a second camera to the phone back in 2010 on the iPhone4.

In 2014, revenue growth finally started to pick up — to 15 percent. This was the first time revenue accelerated on a yearly basis since 2010.

Unfortunately, we do not see the new iPhones or other Apple products just released on Wednesday as having compelling enough features to drive revenue growth up year-over-year during the holiday season. The product releases on Sept. 9 were mostly evolutionary in nature with no must-have features. Rose gold is unfortunately not my color and I do not think 3D touch will get it done. We do like the MLB baseball app on the AppleTV but are waiting for the tennis version as the US Open coverage could really use some help this week.

The most exciting announcement wasn't the products but Apple's new iPhone-leasing program. This should encourage consumers to upgrade more frequently and thereby help shorten the replacement cycle for phones which had been lengthening over the last few years. It will also enable Apple to "own" the customer by selling them an unlocked phone that they can switch between the carriers, essentially commoditizing the wireless-service providers. However, this will cause friction with their carrier partners who want to own the customer and sell them commoditized phones. It would not surprise us if this was a baby step towards Apple launching their own MVNO phone service a couple of years in the future depending on their experience. We see the ability of Apple to monetize the 800 million credit cards on file through services as the next great evolution of the company over the next decade. Their current music offering is just the tip of this iceberg.

The biggest issue for Apple in the near term, however, is China. Though China only accounted for 27 percent of Apple revenue in the June quarter, it accounted for 58 percent of the revenue growth year-over-year. To be clear, of the $12.2-billion increase in revenue from the June quarter of 2014 to the June quarter of 2015, Apple revenues from China increased by $7 billion.

Why is this an issue? The Shanghai Composite Index rose 152 percent year-over-year to its recent peak of 5166 on June 12. Since then, China's stock market has now declined by 37 percent from the peak to its close on September 9th. Did some of that 152 percent gain in the stock market help drive the 112 percent year-over-year increase in Apple's China revenues in the June quarter? If I was up 152 percent, you better believe I would have a few new electronic toys sitting in my house that I did not have time to use but I just had to have! It would be hard to believe there was not some "wealth effect" in China as well. A new iPhone is not something you need to have if you are feeling poorer.

So is there any evidence that the conditions in China are having an impact on consumer spending? On August 24, Tim Cook, in a Tweet to CNBC's Jim Cramer, said that "we have continued to experience strong growth for our business in China through July and August." I hope he does not regret saying that. Two weeks later on Sept. 8, Alibaba, the leading e-commerce platform in China, lowered their expectations for gross market value growth by 5 percent relative to their guidance less than a month ago. A lot can change in two weeks except the desire of my children to want to play video games instead of cleaning their rooms. Baba saw macro factors negatively affecting consumer psychology in China, which drove lower average order values. We would note that Apple already missed Street expectations of 51 million to 52 million iPhone shipments globally in the June quarter when they shipped 47.5 million. (We were positioned to benefit on their April earnings release from a stock decline and we did.) We believe the stress on the global consumer, not just China, is even greater in the current quarter.

For us, investing is all about risk versus reward. Maybe shorter upgrade cycle driven by their new leasing program counteracts the risk from China and the stock continues to outperform the S&P. Having said that, Apple's revenues from China are 27% versus the S&P at about 2%. In our view, the downside risk is currently not worth the reward. When Apple finally does launch their own over-the-top TV service sometime next year, I will be there with a long position in the stock, sitting on my couch with my ginger beer and ready to view more mindless content but until then I am worried about the guy in Beijing viewing his brokerage statement.

Commentary by Dan Niles, founding partner of AlphaOne Capital Partners and senior portfolio manager of the AlphaOne Satori Fund. Previously, he was a managing director at Neuberger Berman, a subsidiary of Lehman Brothers.

Disclosure: AlphaOne and Dan Niles currently have a position(s) on Apple stock which benefits from a price decline.

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