A REAL ISSUE BETWEEN APPLE AND GOOGLE

By Darcy Travlos

Last week, Google Chairman Eric Schmidt received a lot of press as he stepped down from the board of Apple because it highlighted to the investor community that the two companies' businesses were converging. This is true, on the surface, as both now have operating systems for smart phones and computers. However, there is one very stark difference in their strategies - Apple has created a different experience for mobile users while, to date, Google has not. And, as a result, investing in Apple is to invest in a secular growth trend, while investing in Google today is to invest in a business cycle recovery. Let me explain.

Apple's iPhone applications deliver services that users want. Users "opt-in" by downloading applications on their iPhones that they want, and services are delivered by tapping an icon on their iPhone screen. This is a dramatic contrast, particularly on a mobile device, to searching for information or services. Think about it: Using an iPhone app, one can touch an application like OpenTable and make a dinner reservation. The alternative in a mobile environment is to go to your Internet browser on your phone, "Google" restaurants in your area, scroll down (if you can even read the microscopic text) and then call to make a reservation. Search is cumbersome on a mobile device. Delivery of desired information will change user behaviour and expectations.

Therefore, search is becoming a mature business because its future is tied to the desktop or laptop markets. Search is too inconvenient on a mobile device, if users have an alternative to just tap an application. And, today, the desktop and laptop markets are tied to the business cycle and some low-priced growth in emerging markets. It is no longer the secular growth opportunity of the 1980s and 1990s.

But mobility is. Cisco, in its May briefing on mobility, sites that mobile traffic will increase 66x from 2008 to 2013. Apple is driving adoption of smart phones, accounting for 70% of Q1's year-over-year growth in smart-phone unit sales. And, to reiterate, the success of the iPhone is due, in part, to the brilliance of the app store and the convenient delivery of (not search for) the services and information consumers want.

Nice to know, but how does it relate to investment decisions?

Today, Apple and Google have roughly the same market capitalisation, at approximately $145 billion. Both companies have exceeded consensus earnings estimates in the last four quarters, Apple by 14% total over four quarters and Google by 4%. Today, based upon consensus earnings, Apple trades at 24.2x September 2010 estimates, while Google trades at 18.5x December 2010 estimates, with 17% and 14% implied earnings growth rates, respectively.

If we assumed, for example, that both companies were to exceed expectations by the same rate as they have in the past four quarters, the forward P/E multiple for Apple is 21.5x with a 32% growth rate, and Google is 17.7x with a 18.8% growth rate. Both are attractive when adjusted for actual results on the PEG basis, or the P/E multiple one pays for growth, although Apple is more attractive. That is, an investor gets more growth than he has to pay for.

Google is going to benefit from increased advertising as the business cycle recovers. Google has entered the smart-phone market with its Android phones, but this received very little attention on its last conference call, suggesting that investors and the company are still focused on its search and advertising businesses. Again, I believe search is tied to a mature industry, desktop and laptop computers, at least for now.

On the other hand, Apple is going to benefit from increased penetration of smart phones and will begin to change how consumers receive information on a mobile device. Over time, I believe this will change how users want to receive information on the desktop or laptop. With the convenience of having information delivered, versus the inconvenience of searching, user behaviour will change.

And, while Apple is not all about the iPhone, currently the iPhone is ramping up revenues and driving profitability, with the significant added benefit of the "halo effect" - bringing the Apple footprint beyond the installed Mac user base, and driving greater adoption of the Mac computers. The iPhone is driving a secular growth trend toward adoption of mobile devices and delivery of services, and changing how users receive information. At the end of the day, at least this day, Apple and Google appear to have based their futures on different strategies, and Apple is pulling ahead.