Bulls vs. Bears: Re-analyzing Apple
Apple's (AAPL) "It's only rock and roll" event Wednesday triggered a flurry of fresh reports from analysts who track the stock, including Piper Jaffray's Gene Munster, Caris's Robert Cihra, Needham's Charlie Wolf and RBC's Mike Abramsky. (See AppleInsider for a concise summary of their generally positive remarks.)
But we were particularly taken by the report issued Thursday morning by Brian Marshall, who took over the Apple beat at Broadpoint AmTech when Shaw Wu left for Kaufman Bros.
Borrowing a device Wu liked to use — and one that reflects the way investors talk about Apple on the financial boards — Marshall set it up as a debate between the Apple bulls and the Apple bears:
What the Bulls will point to:
- iPhone ramp is in early innings: With the iPhone now available in 80+ countries (in-line with 81 in March '09, 70 in December '08, 51 in September '08 and 6 in June '08), the global ramp has just begun (recall RIMM has over 400 carriers now). Cumulative shipments of the iPhone since its June '07 inception now total 26.4mil units. [NOTE: Steve Jobs on Wednesday put iPhone sales at 30 million.]
- Best positioned company in technology sector: Apple continues to gain share across its major product lines (MacBook notebooks, Mac desktops, iPod digital music players, iPhone smartphone and the iTunes application). Its business model is becoming stronger over time as well with continued penetration of international markets (the opposite of most of its competitors).
- The Bank of Apple: Apple generated $2.3bil in cash flow from operations in the June '09 quarter and its cash hoard now stands at $31.1bil (or $34 per share) – the single largest in the technology industry. Only Cisco ($29bil cash) has a comparable cash balance to Apple when analyzing the leading technology companies' balance sheets (e.g. Microsoft $21bil, Google $14bil, Hewlett Packard $12bil, Oracle $11bil and Dell $9bil). With AAPL shares currently trading at ~$171, the cash balance represents ~20% of the market capitalization.
What the Bears will point to:
- Margins have peaked: Apple’s gross margin reached 36.9% in June '07 and has since declined to 34.7% in December '08. This trend should continue as pricing pressure will intensify going forward as the company aims to maintain its market share in a declining economic environment. ASPs will simply decrease faster than cost of goods sold (COGS), thus negatively impacting the gross margin.
- iPhone will cannibalize iPod family: The iPhone has successfully integrated the functionality of an iPod into a sleek smartphone and has effectively rendered a significant portion of the iPod product family obsolete. Ever since the June '07 introduction of the iPhone, there has been a marked deceleration of unit sales of iPods on a Y/Y basis. This presents a serious problem as iPods generated 28% of Apple’s total revenue in FY08.
- Stratospheric carrier subsidies unsustainable: It is estimated that Apple receives approximately $450 from AT&T Wireless on the activation of an iPhone 3GS as part of a carrier subsidy program. It is also estimated that Apple receives an average subsidy of ~$300 from its international carrier partners as well. These subsidies are well above average of what other vendors (even RIMM) collect. After the introduction buzz of the iPhone 3GS has worn off and the subsidy agreements expire, the wholesale ASP of the iPhone will likely take a significant step down.
Marshall makes no secret of where he comes down in this debate. Calling Apple "'THE' undisputed growth name in tech," he reiterated his $210 target.
Apple shares, having gained more than 5% in the week before he event, dropped nearly 1% Wednesday to close at $171.14. The stock opened higher Thursday, zig-zagged a bit, and was still up a fraction of a point in midday trading.
Janet said:
"It certainly doesn't matter whether people downloaded 1.8 billion apps — as most of them are free and doesn't contribute to Apple's bottomline."
That is really short-sighted. The apps not only sell the phone but also keep users tied to the iPhone. You can't take them with you to any other handset. This is similar one's music collection keeping one on the iPod or ones software collection keeping them in the Mac or PC camp. Your software creates a critical mass from which most people don't want to switch, even if they think the other device would have advantages. In the case of the iPhone, there is no better device to migrate too, but if the Pre or Android ever actually caught on at all, it would help keep people on the iPhone.
The apps are like a loss leader, they sell the phone regardless if Apple makes the very lucrative 30% or not.
Finally, many 'free' apps have paid versions and serve as free demos. They have to have free apps. The fact that the software is so incredibly inexpensive, compared to rivals 'solutions' will continue to push the iPhone growth rate. It's a good thing, even better than Apple making 30% of all app sales. So far, no one has anything to compete with the app store.
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Uhm, someone tell Marshall his "bear" argument is not up to date. You'd think if this is his latest research note, he'd use the latest figures. Why is Marshall using GMs from December 08, when he has data from March and June of 09? Well, why don't we look at the trend, which he believes should continue downward due to pricing pressure. Well, in June of 09, GM was 36.3%. I think that punched a whole in his weak "bear" argument. Not to mention the fact that when one realizes as Apple recognizes more and more of its deferred iPhone revenue, GMs will increase, as the GM on the iPhone is above 60%. Just do the math. Last quarter's non-GAAP adjustment for deferred iPhone revs showed Gross Margin of $1.005B on $1.405B in sales. That's 71.5%.
I see some false reasoning in some of these arguments.
1- For the bulls:
You cannot argue, "Well, the REAl earnings if you were to count all iPhone revenue (non-GAAP) is $X much more than the reported," and then in the next breath turn and say they have $31B in the bank. Some of that money in the bank is the deferred revenue. You cannot eat your cake and save it too.
2- Bears:
A- iPhone is cannibalizing the iPods. So what? Wow cannibalizing at a higher profit margin. Awwwwwww – I cry all the way to the bank.
B- "After the intro buzz has worn off…" While I agree that the subsidies may decline somewhat in the future. After the initial buzz has worn off… there will be a new model! And a new one after that, and… The nay-sayers always seem to assume that the current device is the last thing Apple will ever come up with. It is, of course, inevitable that Apple earnings will plateau (assuming they do not start making everything on the planet), but I think this is several years away at very least.
Seems to me there are a couple kinds of related analysis to consider:
1. pure financial performance. Apple doesn't have to hit home runs all the time, it just has to continue to grow. Frankly that's the model for Microsoft – sustained growth but without necessarily leading technology.
2. technical performance. can Apple continue its delivery of new/improved items that lead/capture markets?
3. sales performance. Within the related markets (computers, music players, phones), can Apple continue to maintain its sales and profit margins.
Apple is creating a new category, mobile computing, that merges the functionality of cell phones, blackberries, cameras, camcorders, music players, GPS devices, dictating machines, game consoles, radios, and who knows what else. The iPhone is one prong of their attack. The other prong is the iPod which is being transformed from a music player to a mobile computing device: first the iPod touch and now the $149 iPod Nano. Some customers get everything in an iPhone. Others keep their old cell phone and use an iPod for everything else. The single function music player market is dying and Apple is just protecting its share of that market as it converts its installed base to the mobile computing concept. They are running alone toward a goal post that no one else seems to know exists. (Long on AAPL)
@PED,
That's why I used the word "approx".
But the fact is that Apple gave a number out and it is a "material" number that can move markets.
Nobody cares about an extra million songs here and there with their keynote presentations — a million songs at 99 cents each with a 10-15% margin is $150K.
It certainly doesn't matter whether people downloaded 1.8 billion apps — as most of them are free and doesn't contribute to Apple's bottomline.
@WhenThinkinhItHelpsToWalkInAStraightLine,
Up to June 30, 2009 — Apple sold a cumulative total of 26.38 million iphones.
So it means that from July 1, 2009 to Sept 9, 2009 — Apple sold approx 3.62 million iphones.
Both Munster and Abramsky are re-affirming their belief that Apple will sell 7 million and 7.2 million iphones respectively in the current quarter — which basically means that they think Apple can somehow sell another 3.5 million iphones in the next 3 weeks.
ex ped: You can't take that 30 million figure too literally; Apple always rounds these numbers for its presentations.
Good report.
In your estimation (research, etc.) why does Apple not declare a dividend, It seems to me that without giving a dividend aapl will always be in the roller-coaster cycles.
In this article dated 9/10 shaw wus successor analyst says that 26.4 million iphones have been sold to date. Yet, yesterday, on September 9, (9/9) Steve Jobs Told the whole world that 30 million iphones have been sod to date?
Perhaps editorial clarification is in order.
WhenThinkinhItHelpsToWalkInAStraightLine
ex ped: Done.
Apple will conquer PC, smartphone, MP3 player market with Mac, iphone and ipod. The world just can't resist it.
Imagine we are all driving only BMWs.. The ultimate driving machine. Isn't that cool?
Great article.
As a bull I point to something else: unparalleled track record. We all know about the innovation, but compare one financial aspect: since 2002, when Apple was listed as #325 on the fortune 500 list, it has marched forward (stalling in 2004) to 2009 where it stood at #71. That's impressive because of its relative steadiness, not an unsustainable zoom up the list.
As to bears, margins peaked as economy peaked. Restoration will take new products people just gotta have. Got a better candidate than apple in that department?
Iphone cannibalize ipod: lets hope so! Ipod will be cannibalized by someone, better Apple than the competition.
Carrier subsidies waning: probably, but may be balanced by exploding market that will drive costs down, further innovation that keeps prices high. Hard to see how this one aspect, if true, would pull stock price down as cash continues to mount amid much other good news.
–Greg Bates, Monroe ME
@Brian,
You are reading my comments out of context.
A few people (including PED) are arguing that historically Steve Jobs announces a big round number — like 2 billion songs downloaded or 1.8 billion apps downloaded — and for sure those have been rounded off (either up or down).
By the time, Steve Jobs went on stage and announced 1.8 billion apps downloaded landmark — in actuality, they might already have gone over that number by another 5 million apps.
I am arguing that those aren't "material" numbers that affects apple share price and thus they can be largely rounded up or down either way (WITHOUT the SEC coming after Apple).
iPhone sales figures are a material number that affects apple share price — so Apple is going to be somewhat careful with their rounding off.
Do I think that the actual cumulative iphone sales on the day of the keynote could be something like 30.2, 30.3, 30.4 million iphones — sure, that's highly likely. Do I think that it's 32 or 33 million iphones? No — otherwise, Munster would be raising his iphone estimates for the quarter.
If you read Appleinsider's summary of Munster's comments — he agrees with the 3.62 million iphone number for this quarter so far, but he is also sticking to his guns of 7 million iphones for the whole quarter. It means that Munster really believe that Apple will sell another 3.4 million iphones in the next 3 weeks.