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Should Apple Get a Wide Moat Rating?

Pat Dorsey, CFA

Pat Dorsey: Hi, I'm Pat Dorsey, the director of equity research at Morningstar. As you know, we rate all of the companies we cover at Morningstar with wide, narrow, or no economic moat. We've had Apple for a long time in the narrow-moat bucket for a large number of reasons.

Associate director for technology Toan Tran, who covers Apple, recently said, "Hey, maybe this is a wide-moat business." So I thought we'd open that up for discussion. Thanks for joining me, Toan.

Toan Tran: Thanks for having me, Pat.

Dorsey: People have asked me this for a long time, as if it's self evident that of course Apple is wide-moat, my goodness me. For a long time you've had some reservations about that, but there's a catalyst recently that made you think, well, maybe it's time to upgrade it.

Tran: Yeah, there has been a catalyst and that was the release of the iPad. Thinking about Apple as a wide moat. It's been percolating in my mind for a while. We have Apple at positive moat trends. What Apple is doing, is that they are building a dominant mobile platform. Basically, they're recreating Windows in the mobile space with the iPhone.

What happens there is that as this installed base of iPhones and iPod Touches, and now the iPad grows, it becomes really attractive for developers to come and write programs for those devices, because there's lots of users and, most importantly, you can make money selling apps to these users.

Dorsey: It's a classic network effect.

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Tran: Yes, absolutely. It's the classic network effect. So as more developers come to the ecosystem and write more apps, that attracts more users, which grows the installed base, thus attracting more developers. You get that virtuous cycle going. Once it gets going, once it reaches a certain critical mass, it's pretty much unstoppable.

Dorsey: Arguably, iPhone has been at critical mass for a while now, right? We could have made this argument a year ago, a year-and-a-half ago. What was it about the recent launch of the iPad to make you think, hmm, maybe things have actually taken a step change to a new level.

Tran: The iPhone, of course, has done tremendously well. Steve Jobs disclosed yesterday they sold over 50 million units a day, and the iPod Touch they've sold 35 million. So, 85 million units, that's a big market.

I think the change with the iPad is that this could really be a game-changer in terms of changing the way people interact with computers. I can see many years down the road where the iPad is the default way that people do things with computers.

Dorsey: ... Whereas the iPod Touch and the iPhone are, because of their small form factor, necessarily going to be limited to certain uses.

Tran: Yes, absolutely. Given the size of the screen, there's just some things you physically can't do. The iPad though, with its much larger screen, changes the equation. I could see where this is the primary computer or computing device for a good portion of the consumer market.

Apple, I think, has pretty big ambitions. They think with the iPad they can really start to take on and displace Windows in the consumer market.

Dorsey: There are a couple of recent trends that are helping that along, right? The advent of cloud computing. We've got more and more processor power, information being stored remotely as opposed to having it on your physical device that you're holding in your hand, as well as the netbook trend. It seems like people might just buy an iPad instead of a netbook.

Tran: Yeah, absolutely. Both things help Apple out. Cloud computing, like you said, moves more computing power away from the user, so you don't really need a big, heavyweight device anymore.

I think the demand for netbooks that we've seen just illustrates people want a simple device that they can use to do the things they want: get on the Internet, do email, chat, watch videos, listen to music. They really don't want a big, complicated Windows PC where they have to worry about what virus do I have this week.

Dorsey: The little dig right there. But of course there is a fly in the ointment to the wide-moat argument, and he happens to have a black turtleneck.

Tran: And Levi's jeans.

Dorsey: Yes.

Tran: I think the thing that's keeping us from going to wide moat with Apple at this point, is that so much of Apple's value is tied up in Steve Jobs. The most important thing about Steve Jobs is the moral authority or the moral sway he holds within Apple.

Steve Jobs is a legend in Silicon Valley for what he has accomplished, and rightly so, I think. He's the co-founder of Apple. There's really no one else in the company that can get everyone on the bus moving in the same direction. I think that's a really important point, and without Steve Jobs, Apple will probably lose some of this edge.

Dorsey: You've drawn an interesting analogy with Apple's most hated foe, Microsoft, when Gates left in the mid '90s.

Tran: Yeah, I think Microsoft--probably a combination of certain things with the antitrust ruling. Bill Gates started disengaging from Microsoft in the late '90s. Microsoft still has a great business in Windows, but they really lost their edge. They lost their killer instinct in terms of a sense of direction, a sense of purpose, and really being able to move the company into new directions.

Dorsey: Yeah, not having their founder there to really basically get everyone on the bus no matter what color the bus is, no matter what direction it's going on, seems to matter a lot for tech companies, especially when they're so tied to a key visionary like either Gates or Jobs.

Tran: Yeah, absolutely.

Dorsey: At this point, basically, I think the way you put it was,if Jobs were to kick the bus tomorrow, I wouldn't be making this argument.

Tran: Yeah, I think that that's fair to say. I would say,though, Apple is probably the widest of narrow moats. They are at the cusp, I think.

Dorsey: All right, thanks very much, Toan.

Tran: Thank you, Pat.

Dorsey: I'm Pat Dorsey and thanks for watching.