Friday, July 1, 2011

Get AAPL for free - yet another opinionated valuation analysis

These days there's been endless discussion about AAPL valuation, some as usual focused on Apple and its perceived risks, some scolding everyone for even talking about valuation as it's "evidently" irrelevant, and more recently some more focused on market mechanics and manipulation. There's evidence and theory and some data to back almost any combination of reasons, be that pro or con any specific issue. Precisely because of this, most points of view end up being opinion based. I won't even point you to any article as there's been too many and I don't want to bias your research by picking my favorites (check on the list of links at the right for some of them). Or just Google "AAPL valuation" and filter by "last month" with the search tools on Google's left panel.

So here, to add my take to the "AAPL valuation is nuts" opinionated pool, I've chosen to do it without addressing any of the common issues. Yup, you read that right. I won't talk about management uncertainty or competitive forces or the broader economy or sentiment or market manipulation. There's plenty on all of that elsewhere, and usually (if you're good at parsing trolls) insightful and exhaustive discussion through those articles' comment systems.

So what's my take on this then? It's quite simple: I'll just try to predict at which point in time, through the accumulation of earnings, someone who bought AAPL today would be able to get back the full share price, as reflected in Apple's cash position. Call it trading for cash, or book-value valuation, or perhaps a simplified DCF analysis. The point is you'd essentially own AAPL for free from then on. To do that I extended my P&L model a few more years (I usually model 3 years forward on the P&L) and looked at the quarter when cash per share surpassed the current price, assuming the EPS translates directly to cash (if you believe these assumptions render the exercise worthless feel free to stop reading). Simple.

The model spat out a cash per share balance of $333.86 for the quarter ending December 26th, 2015, almost hitting Wednesday's close on the head. That's only four and a half years from now. Given today's extension of the rally to over $343 from the recent low of $310.50, I guess the following quarter ending March 26th, 2016 is now the proper timeframe, with cash per share at $352.79.

I thought I'd do a detailed description of all product lines' evolution throughout those 4-5 years: unit sales, ASPs, gross margins, etc., with lots of charts and hopefully rational justification for the assumptions involved in getting there, both for Apple and the industries in which it competes. But that turned out to be too much for one post (maybe I'll do it in a future post). It also lacked the focus I wanted for this simple argument on valuation. Suffice to say that I'm not modeling any new revolutionary product (not that I don't expect it), nor is it a 5-year projection of the current scorching growth rates, a common criticism made against those of us who've tried to bring attention to the 80% current growth valued at a 15x multiple.

Neither am I assuming an almost catastrophic drop in growth to 16% next year, like the WS consensus implies, although the model does predict that for the current product lines after 5 years. I think my modeling is conservative and this level of earnings accumulation to me seems easily achievable. I'd say I'm 90% confident $350/shr in cash would happen within the next 5 years, if not a year earlier. Obviously you'd have to account for ROI on any acquisitions and/or investments (accounting of which would be impractical) to verify that claim, so it will most likely end up being just a what-if exercise.

So, what I thought I'd focus on for this post is a description of the financial picture for AAPL at that point in time (especially looking forward roughly a year from there) and highlight some comparisons with the current state of events.

Without further ado, here's my revenue, EPS, and cash on hand "estimates" for FY 2015 and 2016, the y/y growth rates, and compared to the estimated FY 2011 figures. I also include a similar valuation as the current one, by applying a multiple of 10x to EPS, plus cash, just for reference because I'm not going to argue against a higher multiple.

Metric        FY 2011  FY 2015  FY 2016  --- CAGR ---
------------  -------  -------  -------  (5yr)  (y/y)
Revenue ($b)   108.36   272.31   313.92  23.7%  15.3%
EPS ($)         27.75    78.92    91.09  26.8%  15.4%
Cash/shr ($)    84.79   310.24   397.03  36.2%  28.0%
Value* ($)     362.26  1099.48  1307.98  29.3%  19.0%

*Value computed as 10x EPS, plus cash.

I'd like to clarify once again, this $1308 is not a 5-year price target for AAPL that I'm putting out. I would expect many things to change this forecast over the next few years. Also, I suspect that if my expectations for the following year or two come through, that the market will pay a higher multiple than 10x excluding cash. What this is, though, is a thought experiment on how soon could one get AAPL "for free" (obviously a figure of speech since Apple isn't currently paying any dividends) if things kept going the way I see them going now, and what if the market paid then the current ridiculously low valuation for the business (forward-looking growth of 15-16%, the conservative scenario I see 5 years down the road for the current product lines, is indeed what WS is expecting for next year).

To illustrate things a bit further, I'll highlight some achievements for the 2015 calendar year:

- 235m iPhones sold (I believe Gartner predicted 1.1 billion smartphones industry-wide).
- 126m iPads sold (compared to 38m in calendar 2011).
- 37m Macs sold (compared to nearly 18m in calendar 2011).
- 347m PCs sold worldwide (excludes servers) giving Mac a 10.7% share.
- More than 850m and 400m cumulative iPhones and iPads sold, respectively.
- More than 800m iOS installed base (about 250m by the end of this year).
- Suppliers get $167b through Apple's COGS (compared to nearly $70b this year).
- Almost $20b in operating expenses (compared to almost $11b this year).
- Nearly a billion shares outstanding (945m by the end of this year).

Of course, the elephant in the room for this exercise is that I'm not modeling anything new from Apple. Yet we all know Apple is right now thinking hard and developing prototypes on the next big thing, whatever it is. Maybe another device, maybe the TV that Munster dreams about, maybe a revolutionary service or something completely out of left field like a brilliant business model shift or investment/acquisition or cost savings or some other new paradigm. I have no idea what the next big thing could be, and thus I can't model any of it. I do know there will be something, maybe it's merely incremental and only requires slight adjustments to my model, or maybe it's an order of magnitude change.

On top of this, the market can go through many tribulations in the next five years so assuming things will be the same as now is at best naive. Broader economic risks are real, and retail investors (be that on their own or through their pension funds) are as turned off by market shenanigans as ever.

In any case, keep all that in mind and again don't take these as my real forecasts for 2015, but as a baseline. Hope you find good use of them, and please feel free to question them and knock them up or down in comments below.

Update: Above I've said I wouldn't link to any of the articles talking about AAPL valuation. However, a commenter below has pointed out a forum (one which I don't frequent) thread by Nicolae Mihalache (one of the 10 or so independent analysts participating in PED's smackdowns), in which he tries a similar analysis as the one here. He did one here with realistic estimates, and again here with WS analysts expectations. What impressed me after a quick look of his "realistic" table is how relatively close we are in our projections. Perhaps after 5 years I'm a year behind Nicu's, but this is remarkably close for these types of projections. Thanks for the link anon.


Dennis Hildebrand said...

Well done Daniel...........

Very interesting, I enjoyed your prognostication. I think a lot of us think about what those numbers will look like 4-5 years out. I think that your terminology of establishing a baseline fits. Dennis

Anonymous said...

Awesome work as always. I'm guessing your 2015 assumptions jibe with horace's.

Have you seen Nicu? I've noticed him doing something similar as you here...

Relentlessfocus said...

Thanks for this analysis, really useful.

JavaJack said...

Wonderful "What if". Thank you as always for your fascinating analysis.


Al said...

The fact is Apple is going to revolutionize manufacturing again. They will be able to produce their products for less money than the competition through the use of revolutionary materials like Liquidmetal (one example) while maintaining much higher profit margins. They will slowly choke out Sony and Samsung in the television market and hopefully destroy Netflix and Facebook once their installed user base is higher by preloading default Apple software that keeps all the proprietary data in house. Apple may even start an Apple Search app that users can rely on instead of Google.

The next five years should be very interesting. I live in San Francisco but if my investments pan out, I may just relocate to Cupertino. :)

Chandra said...

Daneil: To get to 272.31B by 2015, I think you are probably using 600+ as the ASP of each of the 235Million iPhones. That is overly optimistic. There are not that many high ARPU subscribers out there for carriers to subsidize such a high cost phone. Apple has to go lower, significantly lower ASP to reach that level of sales.

Nicu said...

Thanks for linking my post on Traderhood. It is not visible anymore, but it was the sequel to another take on the valuation : "What AAPL price and analyst predictions would imply for Apple's future"

It's a kind of inverse engineering of the "brain" / assumptions of hedge funds (and most investors), even if they are not aware of it.

Daniel Tello said...

Chandra, ASPs for 2015:

iPhone: $560
iPad: $537
Mac: $1280

Could be optimistic, but Apple's pricing power commands respect.

Nicu, thanks for the link and great analysis.

Chandra said...

Daniel: About that $560 ASP, what are your assumptions about the mix of the 235M sold in 2015? The current model or a mix of the current model plus lower cost prepaid phones?

Big Daddy Kane said...


Thanks for this, good to read you again. Wondering when we eager readers might expect your 3Q breakdown? Also wondering if you'd spell out what effects the iPhone 5 Septemberish release might have on 3Q and 4Q?


Roy in San Jose said...

Cool. I had to be away from computers and networks for a few days, so couldn't respond sooner.

This was a much needed commentary that hopefully provides a larger framework for Apple's continued growth, beyond the next quarter, so fund managers can stop thinking the wheels are about to come off Apple's growth.

I don't have the tools or resources to make credible quantitative projections of Apple's business mix over the next five years, but qualitatively speaking, I would speculate on three things:

One, some kind of a low-end phone. This may not necessarily help gross margin %, but it is necessary for market share, I believe;

Two, a bigger push into the corporate desktop. The Mac could reach for a much higher penetration than 10-11%. Why not 20% or even 50% some day? I don't know if anyone tracks how many legacy Windows apps are being retired each year, but surely, that has been one powerful reason for enterprise buyers to stay with Windows. But that base should be steadily eroding. Apple may have reached an important inflection point here, with more and more IT departments willing to support Macs, iPhones and iPads. Once that dam bursts, Apple could quickly surge to a 20-25% market share in the enterprise desktop (non server).

Three, as you said, something(s) new... iTV, iCamera, iVirtualReality, digital video distribution, ...

People need to realize that Apple's revenues in a few years will be bigger than the GDP of Greece, which puts both the Greece problem and AAPL valuation in a proper perspective!

chandra said...

Reflecting on Daniel's approach here further: Normally DCF analysis only focuses on the future earnings growth without any consideration for past successes/performance. But here, since Apple is accumulating cash, the past successes are reflected there. The amazing thing is, they do not need to spend money to maintain this above average growth, which again accelerates the growth in cash position.Is this something unique to Apple?

Anonymous said...

Very interesting read, thanks! I"m wondering, what am I missing, at 15% growth, how does EPS go to over $78 in 2015? thanks

Daniel Tello said...

Thanks anon. I think you're reading the right-most column, with a heading "(y/y)". This represents the last year growth in the period, i.e. FY2016 vs. FY2015. Notice the next to last column with a "5yr" heading is also under the "CAGR" (Compound Annual Growth Rate) together with the last column. This next to last showing 26.8% is the average growth in the 5 years from FY2011 to FY2016, and it would give EPS of $91 in FY2016 if we start at $27.75 (but this starting point has already moved, see my latest post). As you mention, the $78.92 is the EPS estimate for FY2015, which is 4 years—not 5—from 2011, and the CAGR for those 4 years would be about 30%.