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Apple (AAPL US Equity)

Apple is no longer a growth darling but a value play

Target price: 600 USD Return potential: > 50%

Investment thesis summary Company description Key figures Why the bear case is most likely wrong Apples strong and growing moats Valuation whats in the price today? Peers Multiples Reverse DCF EPV DCF EBIT multiple analysis Conclusions

Apples cash and potential uses Pre-mortem: a summary of risks and negatives Appendix: Analyst consensus and target price revisions, sales

by quarter, product and geography

Klarmanite 2013 www.klarmanite.com

Nobody can know all the facts. Instead, one must rely on shreds of evidence, kernels of truth, and what one suspects to be true but cannot prove. One must also balance ones own perception of the truth with ones best assessment of what others believe. In investing, other peoples perception of reality influences price more than any underlying truth; your own assessment, even if correct, is valueless if it is already reflected in the market price. Seth Klarman

Investment thesis

Apple is quickly becoming unsustainably cheap My chosen valuation methods on average yield a minimum fair value of 557 USD with very (perhaps too) conservative assumptions. With a required margin of safety of 25%, this means the stock is a buy below 418 USD. Hopefully, it will go even lower on the upcoming quarterly numbers.

The bear case for AAPL is poorly constructed and built on a misunderstanding Apple is not the hardware company its made out to be. Samsung has the phone with the hottest specs? It doesnt matter that much. The long term value in AAPL is not predicated upon constantly making the most advanced or best selling phone, but rather lies in the providing the most user/developer friendly digital ecosystem overall. Thats what Apple is building, which not only sustains but increases the substantial economic moats of the company. Apple is the best human-machine interface company in its industry and its position will grow even stronger with time.
Klarmanite 2013 www.klarmanite.com

Investment thesis
The growth case is dead, but the value opportunity is here The transition from hyped-up growth darling to attractive value play will soon have run its full course. The volatility that this adjustment is causing is the reason Apple is currently mispriced analysts are forced to reevaluate their too aggressive growth projections, and consequently the market is temporarily confused.

The time to buy is close at hand. At the current price Apples slow demise is discounted and no growth is priced in, and I believe Apple will prove that this is premature over the next few years (at which point the opportunity to invest in Apple at a discount to intrinsic value will probably be gone).

Cash really is king if used correctly. I think it will be In addition to the low valuation, the company boasts a stellar, cash rich balance sheet with no debt, which reduces investment risk and also makes shareholder friendly actions likely in the near future, whether through increased dividends, preferreds or buybacks (most likely). This should act as a major catalyst for the share price and move it above and beyond my conservative intrinsic value estimate. A reasonable price target appears to be about 600 USD.
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Company profile

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Key figures fundamental ratios

Key Ratios P/E P/E (cash adjusted) EV/EBITDA EV/Free Cash Flow P/S P/BV P/Tang BV P/CF P/FCF ROE ROA ROIC CROIC Current Ratio Total Debt/Equity Ratio Inventory Turnover
Klarmanite 2013 www.klarmanite.com

2011 13.17 12.17 8.86 10.49 3.15 4.46 4.67 10.46 11.35 33.8% 22.3% 41.0% 48.2% 1.61 0.00 70.53

2012 14.63 13.93 9.94 14.03 3.90 5.17 5.36 12.01 14.73 35.3% 23.7% 38.1% 38.2% 1.50 0.00 112.12

TTM 8.89 7.93 5.60 7.16 2.25 2.92 3.02 7.14 8.02 32.8% 21.3% 37.6% 42.3% 1.54 0.00 65.75

Key figures - Quality

Piotroski Score
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 TTM

Piotroski F Scores
Piotroski 1: Net Income Piotroski 2: Operating Cash Flow Piotroski 3: Return on Assets Piotroski 4: Quality of Earnings Piotroski 5: LT Debt vs Assets Piotroski 6: Current Ratio Piotroski 7: Shares Outstanding Piotroski 8: Gross Margin Piotroski 9: Asset Turnover

1 1 1 1 0 1 0 0 0

1 1 1 1 0 1 0 0 1

1 1 1 1 0 1 0 1 1

1 1 1 1 0 0 0 0 0

1 1 1 1 0 1 0 1 0

1 1 0 1 0 1 0 1 0

1 1 1 1 0 1 0 1 1

1 1 1 1 0 0 0 0 0

1 1 1 1 0 0 0 1 1

1 1 1 1 0 0 0 1 0

1 1 0 1 0 1 1 0 0

Altman Z Score
Working Capital Total Assets Total Liabilities Retained Earnings EBITDA Market Value of Equity Net Sales Normal Altman Z Score Revised Altman Z Score $ $ $ $ $ $ $ 2003 3,530.0 6,815.0 2,592.0 2,394.0 92.0 8,483.3 6,207.0 4.03 8.07 $ $ $ $ $ $ $ 2004 4,375.0 8,050.0 2,974.0 2,670.0 383.0 14,911.5 8,279.0 5.31 10.23 $ $ $ $ $ $ $ 2005 6,816.0 11,551.0 4,085.0 4,005.0 1,815.0 43,310.2 13,931.0 9.28 17.19 $ $ $ $ $ $ $ 2006 8,038.0 17,205.0 7,221.0 5,607.0 2,818.0 64,182.3 19,315.0 8.01 14.56 $ $ $ $ $ $ $ 2007 12,657.0 25,347.0 10,815.0 9,101.0 5,008.0 141,486.4 24,006.0 10.55 19.51 $ $ $ $ $ $ $ 2008 20,598.0 39,572.0 18,542.0 13,845.0 6,895.0 86,055.0 32,479.0 5.29 10.60 $ $ $ $ $ $ $ 2009 20,049.0 47,501.0 15,861.0 23,353.0 12,066.0 170,244.8 42,905.0 9.38 17.35 $ $ $ $ $ $ $ 2010 20,956.0 75,183.0 27,392.0 37,169.0 18,540.0 267,972.3 65,225.0 8.58 15.37 $ $ $ $ $ $ $ 2011 17,018.0 116,371.0 39,756.0 62,841.0 34,205.0 341,332.2 108,249.0 7.98 13.71 $ $ $ $ $ $ $ 2012 19,111.0 176,064.0 57,854.0 101,289.0 55,763.0 610,567.0 156,508.0 9.20 15.80

Q1 $ 25,469.0 $ 196,088.0 $ 68,742.0 $ 109,567.0 $ 17,672.0 $ 368,158.5 $ 54,512.0 4.73 8.90

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The bear case and why its most likely wrong

The most common bear arguments 1. Apple is a one product hardware company (the iPhone is 50% of revenues and 65% of gross profit), which makes it too risky to touch.

2. The smartphone and tablet competition is intensifying, and Samsung and others are grabbing market share. Once the cool factor dies down, Apple has no competitive advantages. Samsung already makes a more advanced phone. 3. Since Android products have larger market share, software developers will choose Android, and Apple will lose the software war again as they did in the 80s and 90s and become a marginal player in smartphones and tablets. 4. Steve Jobs is dead. Apple as a creative company will die with him.
5. Apple is maturing, and will go the way of Microsoft (and by implication be a terrible investment over say the next ten years). Klarmanite 2013

The bear case and why its most likely wrong

1. The quoted numbers are correct, but is that such a bad thing? You could have said the same thing back in the heydays of the iPod, which the iPhone displaced. This was a deliberate cannibalization tactic from Apple. The smartphone is however, a much more essential tool than the iPod was. Besides, the iPad is also growing in importance as the tablet increasingly replaces the desktop and laptop for non-productive uses. (So strictly speaking, its de facto a two product company). The biggest flaw in the one-product argument is however, that the iPhone/iPad products are just another set of hardware products. They are not, because they are built on a unique, closed OS architecture. This means that the Apple ecosystem (voice, message, music, pictures, tv, desktop) is not accessible without an Apple device. The iOS is Apples real strength, as it is more attractive for software suppliers and also increases customer captivity/stickiness. It is not without reason that David Einhorn calls Apple a misunderstood software company. More on this later. 2. So what if Samsung makes the most advanced phone? It doesnt matter much to most consumers of Apple products. They want the most intuitive and smooth user experience in a nice looking package. This is what Mac has been about too, if you think about it. The addictive part of an Apple device is not primarily its sleek design, it is the elegant user experience that produces the loyal Apple customer. Apples competition is other operating systems (in reality, only Android), not other hardware. Klarmanite 2013

The bear case and why it is most likely wrong:

the iPhone was a gamechanger for AAPL. It has now sold over 250 million units

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The bear case and why its most likely wrong

3. Another iOS advantage its much more attractive for app developers
The personal computer wars of the past was won by MSFT instead of Apple primarily because more attractive software was available for the Windows system. Today, iOS actually offers more apps (850k vs 700k for Android), and iOS has a large and growing installed base. But so has Android, the bears argue, their base is even larger than Apples. Yes, but unlike Android, iOS has a homogenized architecture, making it attractive for developers (develop something for one Apple product and it is workable on all devices with little customization necessary. Android is not identical across devices, making development more customized by definition, and also more expensive. iOS customers also tend to spend much more money when using their devices. Since Android is an open OS , piracy and malware is also more common (mobile cybercrime was up 80% y-o-y according to Symantec). A larger base is worthless if your efforts are pirated, and/or your customers arentt spending any money. As a result of all this, iOS has so far been the first choice for developers of apps. There are also other iOs advantages, which can be read up on here:
http://www.knowyourmobile.com/products/18584/android-vs-ios-developers-perspective-big-two http://seekingalpha.com/article/1105381-the-network-effect-why-apple-s-ios-will-win-the-platform-warover-google-s-android?source=feed
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Its iOS vs Android the other players are marginal

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The bear case and why its most likely wrong

Device market share is misleading look at the underlying economics

Despite the aforementioned points, the stock market is looking at market share by device and concluding that Apple is losing the war as Samsung et al sell more smartphones and tablets than Apple. This is wrong, in my opinion.
Instead, we must look at the economics of the respective market shares, and if we do, we find that the iOS crowd is a more active, profitable bunch: iOS users accounted for an overwhelming majority of the shopping traffic of smartphone and tablet users in 2012 (see next slide).

iOS users also have a higher level of in-App purchases and use their devices more (web traffic measurements).

This is also an effect of being in the premium segment, but the numbers do seem to indicate that the Apple user experince is more satisfying and engaging: the fact that iOS users spend more time and money on/through their devices indicates that Apple makes the most user friendly and addictive consumer products in the market place.
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iOS users are more engaged and more profitable

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iOS users are more profitable

Platform market share handheld devices

Total operating profit mobile industry

% market share

% total industry profits

13.1 34.3 iOS Android Other 52.6 37

-8 iOS Android 71 Other

Sources: Comstat, Canaccord

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The bear case and why its most likely wrong

4. Steve Jobs is dead a brief management discussion

Yes. Hard to argue on that one. He is quite dead. And I would have greatly preferred it if he was still living. However, I dont think that means the end of apple as a creative, customer satisfaction focused company, even though Jobs was undoubtedly a creative genius. It should be noted that he was also a tyrannical leader, and that his management practices were far from recipes for success.
In fact, I think Tim Cook is likely an underestimated leader, and that Apple will continue to thrive even in Jobs absence. Cook is known for sharing Jobs passion for customer satisfaction and has said and done nothing to indicate that Apple fall into the trap of sacrificing quality or margins for market share, quite the opposite. The same can be said for Jony Ives, the uniquely talented head of Apples design team (not dead, not leaving). Apple obviously employs more than one brilliant individual, and Jobs spirit of innovation has fostered a corporate culture that will probably die hard. With the exception of Scott Forstall, the major players from the jobs era are still employed at Apple, and very well taken care of compensation-wise. The team that made AAPL what it is today is still mostly intact.
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The bear case and why its most likely wrong

5. Apple will stagnate and go the way of Microsoft As Apple is becoming a more mature company, it will naturally be more concerned with protecting its franchise, aggressively protecting its intellectual property and perhaps sacrifice risk-taking and innovation to some degree. This is natural, and not necessarily negative. If Apple goes the way of Microsoft, it will become less of an innovator and more of a cash cow. Does this have to be a negative? No. As value investors, we should primarily be concerned with the price we pay for an existing franchise and the durability of that franchise and not focus too much on the growth potential. (Going back to my earlier point of the true nature of Apple as a company, I believe this is in fact a durable franchise and not a soon-to-be obsolete hardware producer).Microsoft is often cited as an awful investment since 2000. But that is only true from the perspective of a shareholder that bought in at peak valuations (MSFT traded at an EV/EBITDA multiple of 50 at peak levels). The problem for a person buying MSFT in 1999 was not that the company stopped growing. EPS actually grew by a CAGR of 8% between 1999 2013 and shareholder equity doubled. The problem was the initial price paid for that future growth. As I will show in the valuation section, Apples valuation is not at all elevated, but rather Klarmanite 2013 low, and literally no growth is priced in.

Apples strong moats

Apple has several important economic moats that protect the franchise and help reduce investment risk. Very few companies in the world have moats in all these categories. The nature of several of Apples moats is also such that they grow in strength over time, an added benefit. These moats are central to my investment thesis and in my opinion confirm that Apple is not merely a hardware company. Switching costs: Apples ecosystem creates customer captivity Major hassle to move music, pictures, documents etc sticky customers
Network effects: Apples services increase in value as more people use them Direct network effects: iMessage, Facetime, Game Center Two-sided network effects: the App store (developers consumers) Intra-personal network effects (devices communicate: AirPlay, Apple TV, iCloud) Cost advantages Economies of scale Intangible assets Brand value Intellectual property (patents, code etc) Klarmanite 2013

Apples strong moats

Apples moats are reflected in its numbers:

Fiscal year ROE ROA ROIC CROIC 2006 19.9% 11.6% 277.5% 250.5% 2007 24.1% 13.8% 464.9% 677.3% 32.2% 2008 23.0% 12.2% 444.4% 848.2% 28.2% 2009 26.0% 17.3% 63.9% 71.4% 36.3% 2010 29.3% 18.6% 48.2% 57.1% 34.2% 2011 33.8% 22.3% 41.0% 48.2% 37.7% 2012 35.3% 23.7% 38.1% 38.2% 39.0% TTM 32.8% 21.3% 37.6% 42.3% 35.2%

GPA (Gross Profitability to Assets) 32.5%

High margins
Gross Margin Operating Margin Net Margin 29.0% 12.7% 10.3% 34.0% 18.4% 14.6% 34.3% 19.3% 14.9% 40.1% 27.4% 19.2% 39.4% 28.2% 21.5% 40.5% 31.2% 23.9% 43.9% 35.3% 26.7% 41.9% 33.5% 25.3%

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Valuation: whats in the price today?

In order to establish what the market thinks of Apples future, lets start with a ratio analysis: If we assume that my hypothesis on the companys moats is more or less accurate, should Apple be trading at: a cash adj. P/E of 8? 8 x FCF? 5,6 x EV/EBITDA?
Fundamental Ratios
P/E P/E (cash adjusted) EV/EBITDA EV/Free Cash Flow P/S P/BV P/Tang BV P/CF P/FCF 2011 13.17 12.17 8.86 10.49 3.15 4.46 4.67 10.46 11.35 2012 14.63 13.93 9.94 14.03 3.90 5.17 5.36 12.01 14.73 TTM 8.89 7.93 5.60 7.16 2.25 2.92 3.02 7.14 8.02

I think thats way too cheap. Thats the sort of valuation you give to a business in serious decline. And as Ive said, I think thats the wrong diagnosis here.

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AAPL trades at a massive discount to comparables

Comparables analysis P/E Forward P/E PEG P/S P/B P/Cash P/Free Cash Flow Dividend Yield Payout Ratio

aapl 9.04 8.16 0.44 2.27 2.94 9.40 8.55 2.66 % 11.98 %

orcl 15.13 11.10 1.42 4.12 3.54 4.59 13.55 0.74 % 16.26 %

csco 11.83 9.80 1.43 2.32 1.98 2.37 13.07 3.30 % 33.14 %

ibm 12.95 10.20 1.23 2.02 11.00 17.39 0.00 1.81 % 17.39 %

msft 15.89 10.04 1.86 3.39 3.36 3.46 12.68 2.98 % 45.44 %

goog 23.82 15.00 1.53 4.95 3.51 5.29 20.87 0.00 % 0.00 %

qcom 19.39 13.15 1.31 5.42 3.14 8.36 32.37 2.17 % 28.78 %

On a cash adjusted basis, AAPLs earnings yield is 15,8%...does that seem a little high to anyone else? The average comp trades at an EY of 8,8%.
For AAPL to be valued in-line with comparable listed companies on a cash-adjusted basis, the price would have to be 69% higher 660 USD.
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Valuation: whats in the price today? Negative growth.

Taking this a step further: If AAPL is judged by the market to be in terminal decline that would mean the market is pricing in very little in terms of future growth. By reverse-engineering a DCF, one can check the implicit growth in AAPLs stock price today. At the point where the DCF value equals todays stock price, one will have found the market price implied growth inputs. Using last years FCF as our starting point, a 10% discount rate, a forecast period growth rate of 1% and a terminal growth rate of 0%, the DCF outputs todays stock priceso the market is currently saying that AAPL will never see positive growth again. This sounds unlikely to me at this point. At some point, it must inevitably occur, but I cannot see why that would be the case today because saturation is not that high yet in AAPLs target markets, which should still see several years of decent growth.
Sensitivity Matrix: Growth vs Discount Rate 8% 449 505 570 645 732 Discount Rates 9% 10 % 421 396 472 442 531 496 599 558 677 628
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Growth Rates

-1 % 1% 3% 5% 7%

11 % 373 416 465 521 585

12 % 353 392 437 488 547

Earnings Power Value (EPV) aka no growth valuation: Confirms reverse DCF valuation
EPV Valuation Section Values for Normalized Income TTM Free Cash Flow Avg Normalized Income Med Normalized Income Avg Adj. Income 5 yrs TTM Adjusted Income Data: EPV Cost of Capital Normalized Adjusted Income Average Maintenance Capex Interest Bearing Debt 1% of sales Cash & Equiv Cash - Debt Shares $ $ $ $ $ 46,300.0 24,461.5 23,195.4 20,756.2 45,171.6 EPV > Net Repro Value = Moat exists EPV = Net Repro Value = No Moat EPV < Net Repro Value = Value Destroyer
$450 $400 $350 $300 $250 $200 $150 $100 $50 $0

An EPV measures the earnings power value of the company with no growth. The EPV estimate roughly confirms my conclusions from DCF valuation:

$ $ $ $ $ $

10.0% 31,977.0 (3,128.4) 1,646.9 39,820.0 38,173.1 939.06

Book Value

Net Repro Value


no growth is priced in today.

Calculation: EPV
Cost of Capital Rates 8% 9% EPV 399,712 355,300 Per Share 426 378 + Cash - Debt 437,885 393,473 Per Share 466 419

10 %
11 % 12 %

290,700 266,475

310 284

328,873 304,648

350 324

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IDC: smartphone market forecast 2012-2016

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A quick look at the smartphone market and growth rates: The smartdevice is the fastest adapted new technology in history
The rate of iOS and Android device adoption has surpassed that of any consumer technology in history. Compared to recent technologies, smart device adoption is being adopted 10X faster than that of the 80s PC revolution, 2X faster than that of 90s Internet Boom and 3X faster than that of recent social network adoption. Five years into the smart device growth curve, expansion of this new technology is rapidly expanding beyond early adopter markets such as such as North America and Western Europe, creating a true worldwide addressable market. Overall, Flurry estimates that there were over 640 million iOS and Android devices in use during the month of July 2012. Peter Farago, Flurry Analytics
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Global Apple iPhone sales trend

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Whats the ultimate size of the market for smartphones/tablets?

Kulbinder Garcha, a Credit Suisse IT hardware analyst, said in a report recently that only about 24 percent of the people in

the world who could potentially afford a smartphone have one. Current estimates of the size of the smartphone market fail to properly account for so-called white-label phones that don't carry big brand names, he said. By analyzing the total cost of owning a smartphone, including a data plan, Garcha estimates the number of people potentially in the market for a device could rise to just shy of 5 billion by 2017. Right now, only 1.2 billion people worldwide have one. "You've got to have a 6,000 US dollar income level," Garcha said. "There are about 4.95 billion people in the world that have that income level, and so we think that's the addressable market for smartphones long term." https://emagazine.credit-suisse.com/app/article/index.cfm?fuseaction=OpenArticle&aoid=387842&coid=264&lang=EN

Fast growing market: According to Apple, the size of the annual smartphone market will double by 2016, to 1,4 Bn units sold per year (meaning AAPL will sell 20% * 1,4 Bn = 210 phones per year by 2016). The tablet market will grow even faster, and reach 375m units per year
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The iPhone market

If AAPL is right, and the global smartphone market grows to 1,4 bn units per year in 2016 and we assume they keep at least 15% market share from 2013 to 2016 (they had 18% in 2012), then iPhone sales should look roughly like this, assuming a smooth sales growth trajectory:

Smartphone market iPhones Sales growth rate Market share Total market N/A

2011 72.3

2012 125 72.9 %

2013 128 2.2 % 15.00 % 852

2014 150 17.2 % 15.00 % 1005

2015 178 18.8 % 15.00 % 1186

2016 210 18.0 % 15.00 % 1400

15.32 % 472

17.31 % 722

Note that judging by the quarterly sales rate at AAPL, they are doing better than this (37m in the latest quarter (FQ2 2013) estimate for 2013, a run rate of 148m iPhones sold this year.

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According to Apple, iPhone sales CAGR between now and 2016E would then be: 125*(1,14^4 =210). 14%. This is well below IDCs forecast of 19% CAGR, but still high. This realization is of course a huge disappointment if you have modelled in a 25% growth ratebut as I will show, this is actually more than enough to justify saying that AAPL is probably undervalued. And AAPL does have more products than the iPhone to lean on going forward, notably iPad sales, increased revenues from other services as its installed base grows as well as any growth from new products they may launch.

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Valuation and fair value estimates

If we assume the following: Margins stay more or less in-line with historical numbers A 10% discount rate* A 3% growth rate in FCF over a forecast period of 10 years A 10 yr terminal growth rate of 2%

The discounted value of Apples future cash flows is roughly 510 USD.
I think its unlikely that AAPL will grow slower than this or see negative growth, rather it seems to me that the biggest risk is on the upside. People talk about margin pressure becoming a problem. I dont see it yet in the numbers, and company strategy has historically never been to sacrifice margins for market share for example. The matrix on the next page shows the growth/discount rate sensitivity, and illustrates the upside potential should growth rates surprise positively.

* Strictly speaking, the calculated WACC for AAPL is 9,6%, but I dont trust WACCs and usually stick with a 10% discount rate

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Discount rate / growth sensitivity matrix

Sensitivity Matrix: Growth vs Discount Rate 8% 461 521 589 668 760 Discount Rates 9% 10 % 432 405 485 454 547 510 619 575 701 649 11 % 382 426 477 536 603 12 % 360 401 447 501 562

Growth Rates

-1 % 1% 3% 5% 7%

Even at -1% growth, the DCF value is above todays price of 390 USD

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EBIT multiple valuation

EBIT Multiple Valuation

Normalized revenue projection Projected normalized Op margin Operating Income (EBIT) est Valuation Multiple

116,250.0 25 % 34,875.0 11

155,000.0 30 % 46,500.0 11

193,750.0 35 % 67,812.5 11

Value estimate operating segment

Plus cash and marketable secs Less total debt Less off balance sheet obl Fair value of equity estimate Shares outstanding

103,000 0 0 486,625 939

103,000 0 0 614,500 939

103,000 0 0 848,938 939

Fair value per share Multiple & scenario sensitivity

9 x EBIT 10 x EBIT 11 x EBIT

518.2 Bearish
444 481.1 518.2

654.4 Base
555.4 604.9 654.4

904.1 Bullish
759 831.9 904.1

At 10 x EBIT (+ cash debt) AAPL is worth 605 USD. Peers trade at an avg / median multiple of 11,4 / 9,4 while AAPL is currently trading at 5,8 x last years EBIT. Way too low!
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Conclusions Heads: I win, tails: I dont lose much

DCF value: EBIT value: Average: 510 605 557,5

Requiring a 25% margin of safety, this implies a buy below price of 418 USD. Given the conservative assumptions that went into this analysis, this estimate of fair value is likely on the very conservative side, and I have no problem seeing AAPL above 600 or even 700 USD again in a slighty more bullish scenario (a 15 x multiple on last years EPS yields a 662 USD stock price, e.g). I dont like relative valuation methods, but as mentioned earlier, if AAPL were to trade in line with comps, it should be at over 660 USD.

All in all, I think it is reasonable to expect AAPL to trade at 600 USD (target).
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The downside scenario First of all, the downside should be limited given todays low expectations, the substantial moats of the company and its rock solid balance sheet which invites shareholder friendly activities like increasing the dividend or buying back stock. Lets say the bears are right and margins compress from 25% to 19% on a 2012 revenue base (implying no growth). If investors value the company at just 10 x this margin-compressed EPS despite AAPLs brand value, cash position and capital return programme, the result is a share price of 297 USD, which is 24% below the current price of 390.

All in all, the realistic upside is at least 50%, while the downside is 24%.

Conclusion: AAPL should be bought at todays prices and below. With a 600 USD target, the return potential in terms of capital gains alone is > 50%.
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Apples cash and its potential uses

AAPLs distributable cash: Assuming full repatriation taxes are paid on foreign cash holdings, AAPL currently has about 104 Billion USD in cash. Subtracting e.g. 14 Bn, which should be more than enough to run the business and invest in new products given its prolific cash flow, one is left with about 90 Bn in distributable cash. AAPL could pay a special dividend: This is the equivalent of a dividend of 89,5 USD per share AAPL could buy back stock on a massive scale About 24% of the current stock outstanding at todays price Update: AAPL announced an increase in buybacks of 50 Bn by 2015 on April 23rd

AAPL could crush any competitor, buy almost anyone, and enter any market it wishes (though thankfully, this would be out of character).
I think the most likely scenario is a big stock tender offer, or large buybacks over time. A company that buys back large amounts of stock at a large discount to intrinsic value is actively creating value for shareholders. This should help realize some of the dormant value in AAPL stock right now.

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Apple offshore cash & securities, total cash and investments

Source: zerohedge.com
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Pre-mortem risks and negatives

Q: If your hypothesis doesnt play out like you think: what caused this to happen? A: One of the following seems most likely: This is an analysis based on a central postulate: that Apple is not merely a hardware company. If this turns out to be incorrect, my investment thesis does not hold. (What Donald Rumsfeld might refer to as a known unknown in his vastly underestimated and much abused quote as Defense Secretary) New disruptive technology renders AAPL technology obsolete (a so far unknown unknown) Major product launch fiasco (would take more than one) destroys value Android becomes the preferred developer platform (as we have seen, this is unlikely, as iOS offers far better economics and less piracy and malware problems) Margin pressure and brand value loss if AAPL chooses to compete in lower-end markets (no indication of this happening anytime soon). Loss of key employees / upper management (yes, I know, Steve is dead)

Long-term and severe macroeconomic pressures which favor AAPLs low-end competitors and marginalizes iOS as an operating system
Dumb-ass acquisition spree on a massive scale wastes cash and erodes market confidence
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Appendix: analyst consensus and target price adjustments

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Appendix: Sales trends

Source: zerohedge.com

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Sales trends by product

Source: zerohedge.com

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Sales trends by geography

Source: zerohedge.com

Klarmanite 2013 www.klarmanite.com

Margin trends

Source: zerohedge.com

Klarmanite 2013 www.klarmanite.com


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