Netwealth portfolio construction series: Going Global – Don’t I just need Apple shares?

Going Global:Don’t I just need Apple shares?

Presented byTheo Maas & Sam StobartArnhem Investment Management

18 Nov 2016

| Netwealth

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Disclaimer

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This webinar and information has been prepared and issued by Netwealth Investments Limited (Netwealth), ABN 85 090 569 109, AFSL 230975. It contains factual information and general financial product advice only and has been prepared without taking into account the objectives, financial situation or needs of any individual. The information provided is not intended to be a substitute for professional financial product advice and you should determine its appropriateness having regard to you or your client’s particular circumstances. The relevant disclosure document should be obtained from Netwealth and considered before deciding whether to acquire, dispose of, or to continue to hold, an investment in any Netwealth product.

While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), no person, including Netwealth, or any other member of the Netwealth group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information.

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Meet today’s speakers

Theo MaasPortfolio Manager Global SMA Arnhem Investment [email protected]

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Sam StobartHead of DistributionArnhem Investment [email protected]

Agenda

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1. Growth investing and the importance of industries

2. The Apple iPhone food chain

3. Micro industries: The good, the bad and the ugly

4. Arnhem Global SMA’s

5. Q & A

1. Growth investing and the importance of industry

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Growth Investing

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• Where value investors might look for bad news they think will improve, growth investors look for good news they think will get better

• Growth investors focus on the future potential of a company

The argument:

That superior long-term equity performance is driven by above-average, sustainable earnings growth

Growth Investing

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But what about the Industry?

Industry structure and a company’s relative position within that industry are critical determinants of that performance

The Importance of Industry

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Would you want to be involved in the airline industry?

Would you want to be involved in the Retail Industry?

“What industry did you say?”

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“Consumer Discretionary”

• Auto Parts & Equipment, Tires & Rubber, Automobile Manufacturers, Automotive Retail

• Home Furnishings, Homebuilding, Household Appliances, Home Improvement Retail,

• Leisure Products, Apparel, Accessories & Luxury Goods, Footwear, Textiles,

• Casinos & Gaming, Hotels, Resorts & Cruise Lines, Leisure Facilities, Restaurants,

• Advertising, Broadcasting Cable & Satellite, Movies & Entertainment, Publishing,

• Catalogue Retail, Internet Retail, Department Stores, Apparel Retail,

• Computer & Electronics Retail

True diversification is achieved globally


The Information Technology sector is just 1.3% of the S&P/ASX 200 index and limited to Software and Data Processing

But where are IT Services, Hardware, Communications Equipment and Semiconductors?

Information Technology is a broad ranged sector which needs to be dissected to be truly understood

Micro Industries are Arnhem’s preferred basic unit of analysis

1.3%

15.3%

ASX200 World Ex-Aus

IT Benchmark Weights

Source: Bloomberg 31 October 2016

2. The Apple iPhone food chain


The Apple iPhone Food chain


● Apple has had a colourful history to become the largest company in the world with a market cap of US$600bn+

● From the launch of the first iMac in 1998 to the watershed moment of the iPhone launch in 2007, the company has become the bellwether in the technology sector

● Apple has hundreds of suppliers: 346 in China, 290 in Asia ex-China, 85 in The Americas and 45 in EMEA

● Ranging from the design at Apple HQ in Cupertino to the final assembly at Foxconn in Shenzhen

● There are 22 different chips in an iPhone 6 (e.g. Processor, DRAM, Flash, Power Amplifier, LTE Modem, RF Transceiver, Audio, GPS, Gyroscope/Accelerometer)

14Sources: Apple, IHS Suppli, IDC Worldwide , gateway online

3. Micro industries: The good, the bad and the ugly.


iPhone related micro industries


Micro Industry Companies Arnhem View

Semiconductor: Design & IPLimited number of players, no capex required, visibility of revenues. ++

Mobile AppsFast growing, but very competitive. Apple, Google and Facebook gatekeepers. +

Semiconductor EquipmentIndustry structure rapidly improving due to M&A. Lithography market highest conviction. +

Displays Commoditised with high capex intensity. -

SmartphonesIncreasing competition from China, replacement cycles lenghtening. -

Silicon Wafers Limited added value, buyer power strong. -

Silica Sand Highly commoditised industry. --

Semiconductor: Memory Commoditised with high capex intensity. --

Semiconductor: Design & IP


• These industry players are the designers of semiconductors

• Capital light, not involved in fabrication

• Revenue model based on licenses and royalties, related to the number of chips sold that includes the design

• High barriers to entry given patent portfolios and limited talent pool

• Arnhem had exposure through UK based ARM Holdings, which was bought in July at a 45% premium by Japanese Softbank

No current position in our portfolios

In 2015, more than 15 billion ARM-based chips were sold. To date, more than 86bn chips based on an ARM-design were shipped. ARM gets about 4 to 5 pence (GBP) for each chip.

Mobile Apps


• High growth industry, with low barriers to entry

• Competition from traditional players (console and PC games), but new start-ups emerge every day

• Gatekeepers Apple (App Store) and Google (Google Play) take 30% of the revenues generated

• Need to get to scale and repeatable content (franchises like Candy Crush or Angry Birds)

We have a position in Activision Blizzard. Through the acquisition of King Digital it is now one of the biggest players in mobile apps.

In 2015 US consumers played (and watched others play) Activision game content for 42bn hours. That is similar to Netflix, but around 4x the national viewership of all major sports combined.

Semiconductor Equipment


• Highly specialised market dominated by a handful of players globally. ‘Moore’s Law’ is in their hands

• Cyclical growth industry dependent on capex budget in the chip industry

• Very high barriers to entry, given the unique nature of most technologies

We have a position in ASML, the market leader in lithography which is the most critical step in making a chip

ASML’s Lithography machines are highly complex and very expensive. The current generation sells for around 25m EUR. The new generation (EUV or Extreme Ultra Violet) will sell for 100m EUR each.

Displays


• High volume market with very high capex intensity. Economies of scale determine your competitive position as customers like Apple and Samsung demand tens of millions of units at the lowest price

• Hard to differentiate as technology cycles are relatively long (LCD, LED, OLED)

• Market is dominated by Asian players (Samsung, LG, Sony)

• Characterised by low margin & low ROI


The “new new” thing in smartphone displays will be flexible OLED (Organic Light-emitting Diode) screens, which do not need any backlight (great contrast, saves battery life) and will be wafer thin and bendable in any shape.

Smartphones


• The smart phone industry is dominated by two platforms: IOS (Apple) and Android (Samsung, HTC, LG, Xiaomi, Huawei). IOS is losing share against Android. Windows, Blackberry and Symbian (Nokia) have all disappeared.

• Replacement cycles are lengthening (from less than 2 years to 2 – 3 years), due to lack of innovation

• Competition from Chinese vendors (Huawei, Xiaomi) is intensifying


The new Xiaomi Mi Mix phone showcases how far the Chinese manufacturers have come. With a 6.4-inch ‘edge-to-edge’, 16 megapixel camera and designed by Philippe Starck, it sells for half the price of an iPhone or an exploding Samsung.

Silica Sand


• The most commoditised micro industry in the whole food chain (it literally is sand). While you can’t make silica sand in your kitchen, it’s not rocket science and hence typically part of a building material company

• Shares the same problem with the silicon wafer industry in terms of customer concentration, hence is a price taker not setter

• It is one of the cheapest input costs in making a chip, so most wafer manufacturers are not worried who supplies them


Sand is the building block for silicon to create chips. You do need pure sand, called silica sand and the process involves heating it to 2,000 degrees Celsius before transforming it to silicon.

Silicon Wafers


• Hopelessly commoditised industry with just a handful of dominant (mainly Asian) players. Economies of scale rule.

• Differentiation is very difficult; the product specifications vary little and technological innovation (such as going from 8 to 12-inch wafers) happens once every 15-20 years.

• Customer base (the big chip players like Intel and TSMC) is very concentrated and does not help bargaining power


Once you have pulled a cylinder shaped ingot from silicon, you can slice thin discs or wafers from it. The thinner the better with the most common diameters being 4, 8 and 12-inch.

Semiconductor: Memory


• The worst of two worlds: highly commoditised and very capital intensive. Due to this, the industry is very cyclical. The industry is dominated by a handful of players (Samsung, Micron, Hynix).

• Two dominating products: DRAM and NAND Flash. Both essential parts of any PC, notebook or smartphone.

• While demand for data capacity is growing rapidly, price/GB is coming down just as rapidly.

• High barriers to entry (capital intensity is very high).


Samsung’s latest chip-making plant (fab) will be located south of Seoul and ready in 2H17 and will be specialising in NAND Flash. The budget for this fab is USD$14.7bn (the GDP of Jamaica).

Apple: A great company, not a great stock


• Apple’s profitability is very (70%+) dependent on the iPhone

• The smartphone industry is very competitive with high returns attracting new entrants (China)

• Smartphone replacement cycles are lengthening (2 years +) due to lack of innovation

• New products (Watch, Car) or Services (iCloud) are not material enough to compensate

• The big pile of cash (US$250bn) will not be used productively (tax repatriation, lack of M&A)

• With Revenue/EPS going backwards (10% in FY2016), AAPL has ‘value trap’ written all over it

4. Arnhem’s Global SMAs


Arnhem’s SMA Solutions


Arnhem Global SMA’s; Arnhem Australia+ and Arnhem Global Growth, are designed specifically to deliver true equities diversification to Australian investor portfolios

Global EquitiesGrowth

Australian EquitiesFranked income

Global Equities

Growth

Arnhem Australia+Balanced Exposure

Arnhem Global Growth

Complementary Exposure

Income and growth portfolio designed for pre-retiree, transition to retirement and pension investors who need to balance income requirements with longer term capital growth demands.

The Australian equity component targets a 4% gross yield.

Growth portfolio designed for investors with an existing direct Australian equity portfolio.

Provides capital growth potential with genuine equities diversification.

Arnhem Global SMA Characteristics


Arnhem Global SMA portfolios are high conviction, low turnover and hold 15 – 30 high quality stocks.

The portfolios provide genuine equities diversification by investing in high growth industries and companies not available in Australia.

0% 2% 4% 6% 8% 10% 12% 14%

ASX200

MSCI World ExAus

Arnhem Australia +


3 Year expected EPS growth

Source: Bloomberg, as at 31 October 2016

Performance


Arnhem Australia+

Performance (Gross) 1 Month 3 Months 1 Year YTD 2016Inception 1.1.2015

Arnhem Australia+ -2.61% -3.69% 0.25% -0.52% 10.42%

S&P/ASX 200 Acc. -2.15% -3.20% 6.11% 4.00% 6.67%

Outperformance -0.46% -0.48% -5.86% -4.53% 3.75%


Performance (Gross) 1 Month 3 Months 1 Year YTD 2016Inception 1.1.2015

Arnhem Global Growth -1.77% -4.14% -6.68% -3.05% 15.34%MSCI World ex-Australia(Net AUD) -1.22% -1.58% -5.28% -0.94% 10.27%

Outperformance -0.55% -2.56% -1.40% -2.11% 5.07%

Source: Arnhem. Gross performance with dividends reinvested as at 31 October 2016. The respective model performance has been calculated using the 1 January 2015 Model portfolio positions. Any model portfolio that commenced on a date other than the one specified may hold different positions and will experience different returns which may be better or worse than the Arnhem model referenced above

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Performance since inception


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Performance since inception

Arnhem Australia+

5. Q & A


Disclaimer


This presentation may not be copied or distributed or passed on, directly or indirectly, to any person without the express consent of Arnhem Investment Management Pty Limited ABN 17 129 606 775, AFSL 332484 (Arnhem). This presentation is produced for general information only and shall not constitute an offer to sell or any type of solicitation or form the basis of or be relied upon in connection with any contract or commitment whatsoever or be taken as investment advice. You should seek your own professional advice in relation to investments in the funds presented.

In New Zealand, Arnhem is an exempt provider under the Financial Advisers Act 2008 that is permitted to provide financial adviser services to wholesale clients as overseas financial advisers as it does not have places of business, and does not provide any financial adviser services to retail clients. In New Zealand this document is only being provided to institutional investors whose principal business is in the investment of money or persons who, in the course of, and for the purpose of their business habitually invest money, or are wealthy and experienced in investing money or are experienced in the industry or business to which the securities relate, or are otherwise not members of the public for the purposes of the Securities Act 1978.

The information contained in this presentation has been compiled to furnish you with an opportunity to examine and evaluate the funds mentioned. Arnhem has not considered the specific investment objectives, financial position or needs of any specific recipient. While great care has been taken to ensure that the information is accurate, Arnhem, to the extent permitted by law, disclaims all responsibility and liability for any omission, error, or inaccuracy in the information or any action taken in reliance on the information and also for any inaccuracy in the information contained in the presentation which has been provided by third parties. Past performance is not necessarily indicative of future performance.

Thank youDisclaimer

This webinar and information has been prepared and issued by Netwealth Investments Limited (Netwealth), ABN 85 090 569 109, AFSL 230975. It contains factual information and general financial product advice only and has been prepared without taking into account the objectives, financial situation or needs of any individual. The information provided is not intended to be a substitute for professional financial product advice and you should determine its appropriateness having regard to you or your client’s particular circumstances. The relevant disclosure document should be obtained from Netwealth and considered before deciding whether to acquire, dispose of, or to continue to hold, an investment in any Netwealth product.

While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), no person, including Netwealth, or any other member of the Netwealth group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information.

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Netwealth portfolio construction series: Going Global – Don’t I just need Apple shares?