APPLE INC AAPL
August 16, 2016 - 1:10pm EST by
rasputin998
2016 2017
Price: 109.35 EPS 8.24 8.97
Shares Out. (in M): 5,500 P/E 12.84 12.72
Market Cap (in M): 594,000 P/FCF 9.66 8.64
Net Debt (in M): -146,000 EBIT 60,050 61,467
TEV: 448,000 TEV/EBIT 7.46 7.29

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  • Technology
 

Description

 
Investment Thesis Summary
 
Skepticism of Apple remains high on Wall Street despite compelling evidence that the company has i) navigated an
especially difficult phone transition due to extended average phone lives and reduction of carrier subsidies, ii) developed
a meaningful service revenue stream, and, iii) offered substantive new products that are very early in their lifecycle.
Moreover, the company’s ecosystem continues to gain market share across all computing platforms. Apple remains one
of the best managed companies in the world with probably the cleanest financials of any major company, yet the stock
is valued as a passé hardware company at 9x EV/FCF. Once Wall Street regains confidence in Apple’s product roadmap,
appreciates that the ecosystem continues to garner share and is quite defensible, and realizes earnings will grow to the
$12 per share range in a few years, the stock will quickly revalue to a more reasonable multiple and trade at $150+ per
share. Downside is protected by a reasonable but growing dividend, currently a 2.1% yield, and a significant share
repurchase program that has effected an annualized 5.0% decline in share count over the last 3 1/4 years.
 
Company Description
 
Most readers would likely assert that there is little need to provide a detailed company description as part of this
report. As the largest market capitalization company in the world with ubiquitous products that most people have
experienced, Apple needs little introduction. Moreover, from Wall Street’s perspective, the company is simply a mobile
phone provider. Mobile phones are by definition hardware commodities that are replaced ultimately by new innovative
products. Thus, by this line of thinking, it is perfectly rationale to conclude that Apple should trade for a significant
discount to other major leading companies. We believe Apple’s enduring value lies in its superior ecosystem and the
reinforcing and sticky nature of its broad product and services offerings. The Company’s Background from its 10-K
highlights these points. In the next two sections, we provide Apple’s Business Strategy as described in the 10-K, and,
although we do not think it does the company’s vision and positioning justice, it does highlight the contrast between the
conventional “phone hardware manufacturer” view of the company and management’s own view of the Company’s
offerings.
 
From the 10-K:
 
 
"Company Background
 
The Company designs, manufactures and markets mobile communication and media devices, personal computers and
portable digital music players, and sells a variety of related software, services, accessories, networking solutions and
third-party digital content and applications. The Company’s products and services include iPhone, iPad, Mac, iPod, Apple
Watch, Apple TV, a portfolio of consumer and professional software applications, iOS, OS X and watchOS operating
systems, iCloud, Apple Pay and a variety of accessory, service and support offerings. In September 2015, the
Company announced a new Apple TV, tvOS™ operating system and Apple TV App Store, which are expected to be
available by the end of October 2015. The Company sells and delivers digital content and applications through the
iTunes Store, App Store, Mac App Store, iBooks Store™ and Apple Music™ (collectively “Internet Services”). The
Company sells its products worldwide through its retail stores, online stores and direct sales force, as well as through
third-party cellular network carriers, wholesalers, retailers and value-added resellers. In addition, the Company sells a
variety of third-party Apple compatible products, including application software and various accessories through its
 online and retail stores. The Company sells to consumers, small and mid-sized businesses and education, enterprise and
government customers. The Company’s fiscal year is the 52 or 53-week period that ends on the last Saturday of
September. The Company is a California corporation established in 1977.
 
Business Strategy
 
The Company is committed to bringing the best user experience to its customers through its innovative hardware,
software and services. The Company’s business strategy leverages its unique ability to design and develop its own
operating systems, hardware, application software and services to provide its customers products and solutions with
innovative design, superior ease-of-use and seamless integration. As part of its strategy, the Company continues to
expand its platform for the discovery and delivery of digital content and applications through its Internet Services, which
allows customers to discover and download digital content, iOS, Mac and Apple Watch applications, and books through
either a Mac or Windows-based computer or through iPhone, iPad and iPod touch devices (“iOS devices”) and Apple
Watch. The Company also supports a community for the development of third-party software and hardware products
and digital content that complement the Company’s offerings. The Company believes a high-quality buying experience
with knowledgeable salespersons who can convey the value of the Company’s products and services greatly enhances its
ability to attract and retain customers. Therefore, the Company’s strategy also includes building and expanding its own
retail and online stores and its third-party distribution network to effectively reach more customers and provide them
with a high-quality sales and post-sales support experience. The Company believes ongoing investment in research and
development (“R&D”), marketing and advertising is critical to the development and sale of innovative products and
technologies. "
 
 
Investment Analysis
 
Investors have concluded that Apple’s stock and business have peaked. A review of the company’s financials in the next
table supports this thesis. September Fiscal Year numbers highlight that all financial metrics peaked in Apple’s Fiscal
September 2015 year. Yet, in all fairness to the company, all metrics have meaningfully improved since 2012.
 
Year      Revenue           Gross Profit      Operating Income      Net Income              EPS
2012      $156.5B            68.7B                        55.2B                       41.7B                      $6.30
2013        170.9               64.3                           49.0                         37.0                         5.66
2014        182.8               70.5                           52.5                         39.5                         6.40
2015        233.7               93.6                           71.2                         53.5                         9.28
2016*      219.7               84.0                           59.9                         45.7                         8.24
2017**     224.3               87.3                           61.9                         47.1                         8.99
   
 
*Includes street estimates for Q4 2016
 
** street estimates for entire FY 2017
 
(Note: As stated earlier, Apple’s financials are very clean. Unlike most companies, Apple’s historical EPS has represented
a conservative proxy for actual cash generated.)
 
In the world of technology investing, failing to grow, especially on the revenue and gross profit lines, is tantamount to a
death sentence. EPS, a meaningless metric for many technology investors, has held up better than other lines because
share count has declined approximately 18% from 2012 through 2016. Historically, Apple releases a completely
revamped iPhone product in even calendar years (Sep 2010 - iPhone 4, Sep 2012 - iPhone 5, Sep 2014 - iPhone 6, and
Sep 2016 - iPhone 7). In odd years, the company releases only enhanced versions (2011 - iPhone 4S, 2013 - iPhone 5S,
2015 - iPhone 6S). Interesting, surrounding the launch of even-year product redesigns the last two cycles, the stock
price peaked some 100% above prior odd-year cycle lows. However, the iPhone 6 saw a more extended, stock price peak
period that didn’t occur until February 2015 as a result of the late launch and success of the iPhone 6/6+ in Asia.
Expectations that the stock price could move meaningfully to new highs during the upcoming September launch of the iPhone 7 are nonexistent because the supply chain has indicated only modest upgrades for the iPhone 7 and many
observers believe Apple will offer a major redesign in a 10th anniversary product that will launch in September 2017, breaking with
historical cadence. Nevertheless, Apple’s stock has bounced over 20% off the recent cycle low.  A 100% move off the
recent cycle low would represent a $180 stock price.
A review of calendar quarterly numbers highlights the peak business thesis even more profoundly. Importantly, the
tables below also suggest that compares are about to take a pretty compelling positive turn, especially in the March and
June 2017 calendar quarters. The street still believes that the December 2016 quarter will show a modest decline.
 
 
Period                 Revenue         Gross Profit      Operating Income     Net Income        EPS
Q2 2014, Mar      45.6                17.9                          13.6                         10.2                 1.68
Q2 2015               58.0               23.6                            18.3                         13.6                 2.35
Q2 2016               50.6               19.9                            14.0                         10.6                 1.91
Q2 2017*             54.5               21.3                             14.9                         11.4                 2.16
 
 
Period                 Revenue         Gross Profit      Operating Income      Net Income        EPS
Q3 2014, June     37.4                14.7                           10.3                          7.7                  1.28
Q3 2015               49.6                19.7                            14.1                        10.7                 1.85
Q3 2016               42.3                16.1                            10.1                          7.8                  1.42
Q3 2017*             47.0                 18.1                           11.6                          9.0                  1.73
 
 
Period                 Revenue         Gross Profit      Operating Income       Net Income       EPS
Q4 2014, Sep       42.1              16.0                            11.2                         8.5                   1.42
Q4 2015                51.5              20.5                             14.6                        11.1                  1.96
Q4 2016*              46.7              17.7                             11.6                         8.9                   1.64
Q4 2017*              50.2              19.3                             12.8                         9.8                   1.90
 
Period                 Revenue         Gross Profit      Operating Income       Net Income        EPS
Q1 2015, Dec 14    74.6              29.7                            24.2                        18.0                 3.06
Q1 2016                  75.9              30.4                             24.2                        18.4                 3.28
Q1 2017*                 73.5              28.7                            22.5                        16.7                 3.12
Q1 2018*                 78.3              30.9                            24.5                        18.1                 3.51
 
Secular vs. Cyclical Mobile Phone Market
 
It is easy to conclude that Apple’s mobile phone sales have secularly peaked as the iPad appears to have done, yet the
product redesign cadence begs the question, is the current slowdown product cycle driven? Since Apple continues to
add new users and the average upgrade period continues to extend (currently almost three years), mathematically a
strong case could be made that the next product refresh could see a record number of Apple mobile phone sales. In
light of the growth in services and other products, a return to just prior even-year cycle sales would clearly drive
earnings to record levels. Finally, a convergence of new technology and the 10th anniversary of the iPhone may even
provide the opportunity for a super phone cycle. Many supply chain companies have been reporting that a large North
American OEM (of course Apple ) has initiated orders for significant numbers of OLED (Organic Light Emitting Diode)
displays, yet these orders cannot deliver product in time for the 2016 iPhone 7 launch. Most observers believe OLED
provides the opportunity for Apple to radically change the performance and form factor of the iPhone. If this occurred
in a 10th anniversary version, mobile phones could catapult to a record 250 million plus units.
 
Transition to a More Sustainable Business model
 
The prevailing wisdom regarding Apple is that the company lives and dies by the iPhone. Dollar sales of iPhones as a
percentage of total sales increased from 55.7% in fiscal 2014 to 66.3% in fiscal 2015, so this appears supported by the
data.But the 2015 percentage should represent the high-water mark, as services and other products will grow at a
much faster rate than iPhones going forward.  In fact, if one thinks about the value of the iPhone franchise as a
percentage of market cap, which is how an equity purchaser should do it, the iPhone impact is significantly muted,
which in my view argues for a much higher PE multiple.
 
I expect Apple to generate $223 Billion in revenue in FY 2017. The composition of this number is as follows:
 
iPhone: $140 B
iPad: 20 B
Mac: 20 B
Services: 28 B
Other: 15 B
 
I don’t believe it is a stretch at all to value the revenue of services and other products (which would include future
products) at 2x the multiple of the mature hardware revenue of the three main products. The company has stated that
Services has higher than corporate average margins, and most observers believe services should grow 15-20% annually
for the next several years. Other Products revenue will grow meaningfully as well, given the significant increase in R&D
spending the last several years and the impending ramp of Apple Watch (more on that later). With these conservative
assumptions, iPhone already represents just 45% of the company’s market value, iPad and Mac 6.5% each, Services 18%,
Other 10%, and cash 14%.
 
This admittedly somewhat convoluted exercise highlights that Apple’s value is not driven as much as perceived by the
iPhone. In fact, the iPhone’s success stems from the value of Apple’s ecosystem, not the other way around. This
includes the premier apps and software development platform, superior design and hardware manufacturing, better
retail distribution and customer service, and more tightly integrated usage among different devices, in addition to the
most robust and secure architecture and operating system. It is the broad-based benefits of this system that keep
customers so loyal.
 
The large, billion-unit installed base that builds on this ecosystem will drive remarkable amounts of revenue and
opportunity going forward. Pokemon Go highlights this.  Apple receives 30% of software and content purchases made
within an App on an Apple device.  Some analysts expect Apple to receive $3 billion in revenue from Pokemon Go alone
in the next 18 months.  In 2015, the App Store generated around $6 billion for Apple on some $20 billion in gross
revenues.  This gross number is up from an estimated $10 billion in 2013 and $15 billion in 2014.  As a standalone
company, Wall Street would value this business at well over $100 billion.  I would much rather own this revenue stream
than the capital intensive Amazon Web Services or Netflix.  Moreover, Google is believed to happily pay Apple
approximately $1 billion per year to be the default search option on Apple devices.  In addition, Google pays a
percentage of search revenue that could represent at least another $1 billion per year.  Finally, Apple reported that Non-
GAAP installed base related purchases grew 29% y/y to $10.3 billion in the June quarter.  This accelerating growth rate is
up from 27% in Q2, 24% in Q1, and 23% for all of FY’15.  These revenue streams are already included in the estimated
$28 billion of services revenue for 2017, yet they highlight the likely durability and growth prospects of Apple’s Services
revenue.
 
Of course, these opportunities vanish if users switch away from Apple hardware, but the use cases for Apple’s
ecosystem only appear to be getting more compelling.  The optimal authentication of a user has allowed Apple to
negotiate receiving a reported .15% of every transaction completed with Apple Pay.  The convenient double-click use of
Apple Pay on Apple Watch ushers in a much easier way of executing a transaction.  Apple CarPlay is hailed by many car
OEMs as an important differentiating feature.  We think it is just a matter of time that this hardware/software/trusted
partner ecosystem brings about the ability to use your phone/watch/or future Apple devices for keys, payments, remote
controls, among countless other features.
 
That brings us to the much-disparaged Watch, which is held up as a monument to Apple’s perceived inability to innovate. This is a
product that sold an estimated 12-13 million units and generated an estimated $6 billion in revenue in its first year.
More importantly, user satisfaction levels remain higher than any Apple product, despite the Watch not being
waterproof and lacking GPS and LTE cellular phone capabilities.  We believe this is because the Watch, in addition to be
comfortable and stylish, offers many conveniences and useful applications. This product will likely ultimately become an
individual’s health sensor, remote control and access device, payments vehicle, in addition to providing a convenient
way to monitor messages, calendar events, stock quotes, among countless other activities. The second generation
Watch is almost certain to add $15 billion to $20 billion in FY 2017, approaching numbers generated by the iPad and Mac.
 
Another underappreciated expansion of the Apple ecosystem is into the enterprise and businesses.  Just as PCs replaced
dumb terminals in most retail establishments, the iPad is clearly displacing PCs in this function.  Furthermore, Macs
continue to gain share in personal and business computing.  These trends highlight enduring value of Apple’s superior
ecosystem and the reinforcing and sticky nature of its broad product and services offerings.
 
Finally, we have not begun to appreciate the advantages derived by such a robust, familiar, trusted ecosystem
and the products that could be spawned.  In the world of augmented and virtual reality, ubiquitous displays, machine 
learning, and advanced voice recognition, one is unlikely to predict the winning form factor.  Nevertheless, a
compelling case can be made that Apple has the winning ecosystem to deliver it.
 
Financials and Valuation
 
Apple’s last quarter (its June Q3 June FY 17 quarter) provided strong proof that Apple’s business remains defensible and
durable.  Despite reducing channel inventory by in excess of $1 billion and facing customers holding out for the new
version of the iPhone and Watch, the company earned $1.42 per share.  Thus a distressed, conservative forward
earnings projection still leaves one comfortably in the $8.00 per share range. In light of the positive contribution from
services revenue and upgrade dynamic detailed above, $9.00 per share of earnings for FY 2017 appears eminently
attainable. When factoring in Apple’s substantive balance sheet (over $26 per share of net cash or $15 per share,
assuming full tax on repatriation), Apple should trade for a more reasonable 12x earnings plus fully repatriated cash, or
$123, today.
 
Apple’s stock has demonstrated that, like most technology equities, it will trade based on the perception of forward
earnings. When trying to determine a target price for Apple one year out, an investor should determine earnings for
the company’s fiscal year September 2018. There are many comprehensive, sound models published by Wall Street
analysts. Most have Apple earning approximately $10 per share in FY 2018. In light of Apple’s recent
underperformance, these models are likely conservative.  We have made the case that the ecosystem and large
installed base will drive stronger than expected revenue.  The nice thing about an investment in Apple is that you do not
need to have upside surprises to drive the stock higher.  Most analysts’ models project modest iPhone growth off the
very weak 2016 numbers, declining iPad and Mac sales, slowing services growth rates, and very modest revenue from
new products.  Moreover, most project flattish gross margins and significant increases in operating expenses (especially
R&D).  Nevertheless, EPS reaches over $10 and FCF per share will be close to $12. The excess FCF reflects Apple’s conservative
accounting for taxes, stock-based compensation, and accruals.
 
Apple’s balance sheet, of course, is fortress-like, but one of the key questions in analyzing the stock is how much credit
for the net cash of $26 per share do we give the company? This question is more theoretical than practical, as it will never
be returned in a single transaction such as a special dividend, even if there was a repatriation tax-holiday.
However, I think Apple’s approach to this cash is clear. Over time, it will likely be worked down, but more importantly,
the balance sheet allows the company to utilize all FCF for shareholders in an optimal manner.  Recently, the company’s
board of directors made it clear that buybacks are the top priority followed by a modestly growing dividend. In
addition, the company remains in a position to complete strategic M&A. Our view is that Apple is correct not to pursue a
large, say over $15 billion, strategic acquisition.  Those arguing for such a transaction do not appreciate the strategic
nature of Apple’s position.
 
So what is the proper valuation for Apple?  Despite strongly believing that Apple’s services business is developing into
a franchise that is worth a meaningful part of the company’s enterprise value, we do not think a sum-of-the-parts
valuation is appropriate.  Clearly services require the hardware to maintain its dominance for the installed base to grow.
Also, existing and new products exploiting its ecosystem will drive improved margins and earnings, so it is not only about
services growth.  Apple is correct when it says it is uniquely positioned to leverage the combination of hardware, software,
and services to provide a superior customer experience. Some combination of hardware and services in conjunction with its
scale; brand; design, manufacturing, and marketing capabilities; customer service; distribution network; and balance sheet
should allow Apple to continue to grow earnings. When the market’s fear of declining earnings abates, the stock must
revalue to closer to a market multiple. We are gaining visibility into that scenario with the pending iPhone 7/10th
anniversary launches, expanding services offerings, and growing revenue from new products, especially the watch, and
continuing stock repurchases.
 
Conclusion
  
Apple clearly remains one of the best companies in the world. Its products are loved by a remarkably diverse
demographic. Its cash flow generation is unparalleled. The narrative that the company is a passé hardware company
with imminent risk of perpetual decline doesn’t stand up to reasonable analysis. This view is in the process of being
quickly debunked. As the company’s stock is institutionally under owned, the stock should quickly rerate to a 13-14
EV/FCF ratio ($150 range), especially when one considers the quality of the cash flows and alternative investment
opportunities.
 
 
 
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Better than expected product launches this fall and next year, steady growth in services and other products, clarity on the stickiness of the ecosystem and all that implies, combined with "earnings yield" value accretion to shareholders from buybacks and dividends will eventually force a revaluation of the shares.

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    Description

     
    Investment Thesis Summary
     
    Skepticism of Apple remains high on Wall Street despite compelling evidence that the company has i) navigated an
    especially difficult phone transition due to extended average phone lives and reduction of carrier subsidies, ii) developed
    a meaningful service revenue stream, and, iii) offered substantive new products that are very early in their lifecycle.
    Moreover, the company’s ecosystem continues to gain market share across all computing platforms. Apple remains one
    of the best managed companies in the world with probably the cleanest financials of any major company, yet the stock
    is valued as a passé hardware company at 9x EV/FCF. Once Wall Street regains confidence in Apple’s product roadmap,
    appreciates that the ecosystem continues to garner share and is quite defensible, and realizes earnings will grow to the
    $12 per share range in a few years, the stock will quickly revalue to a more reasonable multiple and trade at $150+ per
    share. Downside is protected by a reasonable but growing dividend, currently a 2.1% yield, and a significant share
    repurchase program that has effected an annualized 5.0% decline in share count over the last 3 1/4 years.
     
    Company Description
     
    Most readers would likely assert that there is little need to provide a detailed company description as part of this
    report. As the largest market capitalization company in the world with ubiquitous products that most people have
    experienced, Apple needs little introduction. Moreover, from Wall Street’s perspective, the company is simply a mobile
    phone provider. Mobile phones are by definition hardware commodities that are replaced ultimately by new innovative
    products. Thus, by this line of thinking, it is perfectly rationale to conclude that Apple should trade for a significant
    discount to other major leading companies. We believe Apple’s enduring value lies in its superior ecosystem and the
    reinforcing and sticky nature of its broad product and services offerings. The Company’s Background from its 10-K
    highlights these points. In the next two sections, we provide Apple’s Business Strategy as described in the 10-K, and,
    although we do not think it does the company’s vision and positioning justice, it does highlight the contrast between the
    conventional “phone hardware manufacturer” view of the company and management’s own view of the Company’s
    offerings.
     
    From the 10-K:
     
     
    "Company Background
     
    The Company designs, manufactures and markets mobile communication and media devices, personal computers and
    portable digital music players, and sells a variety of related software, services, accessories, networking solutions and
    third-party digital content and applications. The Company’s products and services include iPhone, iPad, Mac, iPod, Apple
    Watch, Apple TV, a portfolio of consumer and professional software applications, iOS, OS X and watchOS operating
    systems, iCloud, Apple Pay and a variety of accessory, service and support offerings. In September 2015, the
    Company announced a new Apple TV, tvOS™ operating system and Apple TV App Store, which are expected to be
    available by the end of October 2015. The Company sells and delivers digital content and applications through the
    iTunes Store, App Store, Mac App Store, iBooks Store™ and Apple Music™ (collectively “Internet Services”). The
    Company sells its products worldwide through its retail stores, online stores and direct sales force, as well as through
    third-party cellular network carriers, wholesalers, retailers and value-added resellers. In addition, the Company sells a
    variety of third-party Apple compatible products, including application software and various accessories through its
     online and retail stores. The Company sells to consumers, small and mid-sized businesses and education, enterprise and
    government customers. The Company’s fiscal year is the 52 or 53-week period that ends on the last Saturday of
    September. The Company is a California corporation established in 1977.
     
    Business Strategy
     
    The Company is committed to bringing the best user experience to its customers through its innovative hardware,
    software and services. The Company’s business strategy leverages its unique ability to design and develop its own
    operating systems, hardware, application software and services to provide its customers products and solutions with
    innovative design, superior ease-of-use and seamless integration. As part of its strategy, the Company continues to
    expand its platform for the discovery and delivery of digital content and applications through its Internet Services, which
    allows customers to discover and download digital content, iOS, Mac and Apple Watch applications, and books through
    either a Mac or Windows-based computer or through iPhone, iPad and iPod touch devices (“iOS devices”) and Apple
    Watch. The Company also supports a community for the development of third-party software and hardware products
    and digital content that complement the Company’s offerings. The Company believes a high-quality buying experience
    with knowledgeable salespersons who can convey the value of the Company’s products and services greatly enhances its
    ability to attract and retain customers. Therefore, the Company’s strategy also includes building and expanding its own
    retail and online stores and its third-party distribution network to effectively reach more customers and provide them
    with a high-quality sales and post-sales support experience. The Company believes ongoing investment in research and
    development (“R&D”), marketing and advertising is critical to the development and sale of innovative products and
    technologies. "
     
     
    Investment Analysis
     
    Investors have concluded that Apple’s stock and business have peaked. A review of the company’s financials in the next
    table supports this thesis. September Fiscal Year numbers highlight that all financial metrics peaked in Apple’s Fiscal
    September 2015 year. Yet, in all fairness to the company, all metrics have meaningfully improved since 2012.
     
    Year      Revenue           Gross Profit      Operating Income      Net Income              EPS
    2012      $156.5B            68.7B                        55.2B                       41.7B                      $6.30
    2013        170.9               64.3                           49.0                         37.0                         5.66
    2014        182.8               70.5                           52.5                         39.5                         6.40
    2015        233.7               93.6                           71.2                         53.5                         9.28
    2016*      219.7               84.0                           59.9                         45.7                         8.24
    2017**     224.3               87.3                           61.9                         47.1                         8.99
       
     
    *Includes street estimates for Q4 2016
     
    ** street estimates for entire FY 2017
     
    (Note: As stated earlier, Apple’s financials are very clean. Unlike most companies, Apple’s historical EPS has represented
    a conservative proxy for actual cash generated.)
     
    In the world of technology investing, failing to grow, especially on the revenue and gross profit lines, is tantamount to a
    death sentence. EPS, a meaningless metric for many technology investors, has held up better than other lines because
    share count has declined approximately 18% from 2012 through 2016. Historically, Apple releases a completely
    revamped iPhone product in even calendar years (Sep 2010 - iPhone 4, Sep 2012 - iPhone 5, Sep 2014 - iPhone 6, and
    Sep 2016 - iPhone 7). In odd years, the company releases only enhanced versions (2011 - iPhone 4S, 2013 - iPhone 5S,
    2015 - iPhone 6S). Interesting, surrounding the launch of even-year product redesigns the last two cycles, the stock
    price peaked some 100% above prior odd-year cycle lows. However, the iPhone 6 saw a more extended, stock price peak
    period that didn’t occur until February 2015 as a result of the late launch and success of the iPhone 6/6+ in Asia.
    Expectations that the stock price could move meaningfully to new highs during the upcoming September launch of the iPhone 7 are nonexistent because the supply chain has indicated only modest upgrades for the iPhone 7 and many
    observers believe Apple will offer a major redesign in a 10th anniversary product that will launch in September 2017, breaking with
    historical cadence. Nevertheless, Apple’s stock has bounced over 20% off the recent cycle low.  A 100% move off the
    recent cycle low would represent a $180 stock price.
    A review of calendar quarterly numbers highlights the peak business thesis even more profoundly. Importantly, the
    tables below also suggest that compares are about to take a pretty compelling positive turn, especially in the March and
    June 2017 calendar quarters. The street still believes that the December 2016 quarter will show a modest decline.
     
     
    Period                 Revenue         Gross Profit      Operating Income     Net Income        EPS
    Q2 2014, Mar      45.6                17.9                          13.6                         10.2                 1.68
    Q2 2015               58.0               23.6                            18.3                         13.6                 2.35
    Q2 2016               50.6               19.9                            14.0                         10.6                 1.91
    Q2 2017*             54.5               21.3                             14.9                         11.4                 2.16
     
     
    Period                 Revenue         Gross Profit      Operating Income      Net Income        EPS
    Q3 2014, June     37.4                14.7                           10.3                          7.7                  1.28
    Q3 2015               49.6                19.7                            14.1                        10.7                 1.85
    Q3 2016               42.3                16.1                            10.1                          7.8                  1.42
    Q3 2017*             47.0                 18.1                           11.6                          9.0                  1.73
     
     
    Period                 Revenue         Gross Profit      Operating Income       Net Income       EPS
    Q4 2014, Sep       42.1              16.0                            11.2                         8.5                   1.42
    Q4 2015                51.5              20.5                             14.6                        11.1                  1.96
    Q4 2016*              46.7              17.7                             11.6                         8.9                   1.64
    Q4 2017*              50.2              19.3                             12.8                         9.8                   1.90
     
    Period                 Revenue         Gross Profit      Operating Income       Net Income        EPS
    Q1 2015, Dec 14    74.6              29.7                            24.2                        18.0                 3.06
    Q1 2016                  75.9              30.4                             24.2                        18.4                 3.28
    Q1 2017*                 73.5              28.7                            22.5                        16.7                 3.12
    Q1 2018*                 78.3              30.9                            24.5                        18.1                 3.51
     
    Secular vs. Cyclical Mobile Phone Market
     
    It is easy to conclude that Apple’s mobile phone sales have secularly peaked as the iPad appears to have done, yet the
    product redesign cadence begs the question, is the current slowdown product cycle driven? Since Apple continues to
    add new users and the average upgrade period continues to extend (currently almost three years), mathematically a
    strong case could be made that the next product refresh could see a record number of Apple mobile phone sales. In
    light of the growth in services and other products, a return to just prior even-year cycle sales would clearly drive
    earnings to record levels. Finally, a convergence of new technology and the 10th anniversary of the iPhone may even
    provide the opportunity for a super phone cycle. Many supply chain companies have been reporting that a large North
    American OEM (of course Apple ) has initiated orders for significant numbers of OLED (Organic Light Emitting Diode)
    displays, yet these orders cannot deliver product in time for the 2016 iPhone 7 launch. Most observers believe OLED
    provides the opportunity for Apple to radically change the performance and form factor of the iPhone. If this occurred
    in a 10th anniversary version, mobile phones could catapult to a record 250 million plus units.
     
    Transition to a More Sustainable Business model
     
    The prevailing wisdom regarding Apple is that the company lives and dies by the iPhone. Dollar sales of iPhones as a
    percentage of total sales increased from 55.7% in fiscal 2014 to 66.3% in fiscal 2015, so this appears supported by the
    data.But the 2015 percentage should represent the high-water mark, as services and other products will grow at a
    much faster rate than iPhones going forward.  In fact, if one thinks about the value of the iPhone franchise as a
    percentage of market cap, which is how an equity purchaser should do it, the iPhone impact is significantly muted,
    which in my view argues for a much higher PE multiple.
     
    I expect Apple to generate $223 Billion in revenue in FY 2017. The composition of this number is as follows:
     
    iPhone: $140 B
    iPad: 20 B
    Mac: 20 B
    Services: 28 B
    Other: 15 B
     
    I don’t believe it is a stretch at all to value the revenue of services and other products (which would include future
    products) at 2x the multiple of the mature hardware revenue of the three main products. The company has stated that
    Services has higher than corporate average margins, and most observers believe services should grow 15-20% annually
    for the next several years. Other Products revenue will grow meaningfully as well, given the significant increase in R&D
    spending the last several years and the impending ramp of Apple Watch (more on that later). With these conservative
    assumptions, iPhone already represents just 45% of the company’s market value, iPad and Mac 6.5% each, Services 18%,
    Other 10%, and cash 14%.
     
    This admittedly somewhat convoluted exercise highlights that Apple’s value is not driven as much as perceived by the
    iPhone. In fact, the iPhone’s success stems from the value of Apple’s ecosystem, not the other way around. This
    includes the premier apps and software development platform, superior design and hardware manufacturing, better
    retail distribution and customer service, and more tightly integrated usage among different devices, in addition to the
    most robust and secure architecture and operating system. It is the broad-based benefits of this system that keep
    customers so loyal.
     
    The large, billion-unit installed base that builds on this ecosystem will drive remarkable amounts of revenue and
    opportunity going forward. Pokemon Go highlights this.  Apple receives 30% of software and content purchases made
    within an App on an Apple device.  Some analysts expect Apple to receive $3 billion in revenue from Pokemon Go alone
    in the next 18 months.  In 2015, the App Store generated around $6 billion for Apple on some $20 billion in gross
    revenues.  This gross number is up from an estimated $10 billion in 2013 and $15 billion in 2014.  As a standalone
    company, Wall Street would value this business at well over $100 billion.  I would much rather own this revenue stream
    than the capital intensive Amazon Web Services or Netflix.  Moreover, Google is believed to happily pay Apple
    approximately $1 billion per year to be the default search option on Apple devices.  In addition, Google pays a
    percentage of search revenue that could represent at least another $1 billion per year.  Finally, Apple reported that Non-
    GAAP installed base related purchases grew 29% y/y to $10.3 billion in the June quarter.  This accelerating growth rate is
    up from 27% in Q2, 24% in Q1, and 23% for all of FY’15.  These revenue streams are already included in the estimated
    $28 billion of services revenue for 2017, yet they highlight the likely durability and growth prospects of Apple’s Services
    revenue.
     
    Of course, these opportunities vanish if users switch away from Apple hardware, but the use cases for Apple’s
    ecosystem only appear to be getting more compelling.  The optimal authentication of a user has allowed Apple to
    negotiate receiving a reported .15% of every transaction completed with Apple Pay.  The convenient double-click use of
    Apple Pay on Apple Watch ushers in a much easier way of executing a transaction.  Apple CarPlay is hailed by many car
    OEMs as an important differentiating feature.  We think it is just a matter of time that this hardware/software/trusted
    partner ecosystem brings about the ability to use your phone/watch/or future Apple devices for keys, payments, remote
    controls, among countless other features.
     
    That brings us to the much-disparaged Watch, which is held up as a monument to Apple’s perceived inability to innovate. This is a
    product that sold an estimated 12-13 million units and generated an estimated $6 billion in revenue in its first year.
    More importantly, user satisfaction levels remain higher than any Apple product, despite the Watch not being
    waterproof and lacking GPS and LTE cellular phone capabilities.  We believe this is because the Watch, in addition to be
    comfortable and stylish, offers many conveniences and useful applications. This product will likely ultimately become an
    individual’s health sensor, remote control and access device, payments vehicle, in addition to providing a convenient
    way to monitor messages, calendar events, stock quotes, among countless other activities. The second generation
    Watch is almost certain to add $15 billion to $20 billion in FY 2017, approaching numbers generated by the iPad and Mac.
     
    Another underappreciated expansion of the Apple ecosystem is into the enterprise and businesses.  Just as PCs replaced
    dumb terminals in most retail establishments, the iPad is clearly displacing PCs in this function.  Furthermore, Macs
    continue to gain share in personal and business computing.  These trends highlight enduring value of Apple’s superior
    ecosystem and the reinforcing and sticky nature of its broad product and services offerings.
     
    Finally, we have not begun to appreciate the advantages derived by such a robust, familiar, trusted ecosystem
    and the products that could be spawned.  In the world of augmented and virtual reality, ubiquitous displays, machine 
    learning, and advanced voice recognition, one is unlikely to predict the winning form factor.  Nevertheless, a
    compelling case can be made that Apple has the winning ecosystem to deliver it.
     
    Financials and Valuation
     
    Apple’s last quarter (its June Q3 June FY 17 quarter) provided strong proof that Apple’s business remains defensible and
    durable.  Despite reducing channel inventory by in excess of $1 billion and facing customers holding out for the new
    version of the iPhone and Watch, the company earned $1.42 per share.  Thus a distressed, conservative forward
    earnings projection still leaves one comfortably in the $8.00 per share range. In light of the positive contribution from
    services revenue and upgrade dynamic detailed above, $9.00 per share of earnings for FY 2017 appears eminently
    attainable. When factoring in Apple’s substantive balance sheet (over $26 per share of net cash or $15 per share,
    assuming full tax on repatriation), Apple should trade for a more reasonable 12x earnings plus fully repatriated cash, or
    $123, today.
     
    Apple’s stock has demonstrated that, like most technology equities, it will trade based on the perception of forward
    earnings. When trying to determine a target price for Apple one year out, an investor should determine earnings for
    the company’s fiscal year September 2018. There are many comprehensive, sound models published by Wall Street
    analysts. Most have Apple earning approximately $10 per share in FY 2018. In light of Apple’s recent
    underperformance, these models are likely conservative.  We have made the case that the ecosystem and large
    installed base will drive stronger than expected revenue.  The nice thing about an investment in Apple is that you do not
    need to have upside surprises to drive the stock higher.  Most analysts’ models project modest iPhone growth off the
    very weak 2016 numbers, declining iPad and Mac sales, slowing services growth rates, and very modest revenue from
    new products.  Moreover, most project flattish gross margins and significant increases in operating expenses (especially
    R&D).  Nevertheless, EPS reaches over $10 and FCF per share will be close to $12. The excess FCF reflects Apple’s conservative
    accounting for taxes, stock-based compensation, and accruals.
     
    Apple’s balance sheet, of course, is fortress-like, but one of the key questions in analyzing the stock is how much credit
    for the net cash of $26 per share do we give the company? This question is more theoretical than practical, as it will never
    be returned in a single transaction such as a special dividend, even if there was a repatriation tax-holiday.
    However, I think Apple’s approach to this cash is clear. Over time, it will likely be worked down, but more importantly,
    the balance sheet allows the company to utilize all FCF for shareholders in an optimal manner.  Recently, the company’s
    board of directors made it clear that buybacks are the top priority followed by a modestly growing dividend. In
    addition, the company remains in a position to complete strategic M&A. Our view is that Apple is correct not to pursue a
    large, say over $15 billion, strategic acquisition.  Those arguing for such a transaction do not appreciate the strategic
    nature of Apple’s position.
     
    So what is the proper valuation for Apple?  Despite strongly believing that Apple’s services business is developing into
    a franchise that is worth a meaningful part of the company’s enterprise value, we do not think a sum-of-the-parts
    valuation is appropriate.  Clearly services require the hardware to maintain its dominance for the installed base to grow.
    Also, existing and new products exploiting its ecosystem will drive improved margins and earnings, so it is not only about
    services growth.  Apple is correct when it says it is uniquely positioned to leverage the combination of hardware, software,
    and services to provide a superior customer experience. Some combination of hardware and services in conjunction with its
    scale; brand; design, manufacturing, and marketing capabilities; customer service; distribution network; and balance sheet
    should allow Apple to continue to grow earnings. When the market’s fear of declining earnings abates, the stock must
    revalue to closer to a market multiple. We are gaining visibility into that scenario with the pending iPhone 7/10th
    anniversary launches, expanding services offerings, and growing revenue from new products, especially the watch, and
    continuing stock repurchases.
     
    Conclusion
      
    Apple clearly remains one of the best companies in the world. Its products are loved by a remarkably diverse
    demographic. Its cash flow generation is unparalleled. The narrative that the company is a passé hardware company
    with imminent risk of perpetual decline doesn’t stand up to reasonable analysis. This view is in the process of being
    quickly debunked. As the company’s stock is institutionally under owned, the stock should quickly rerate to a 13-14
    EV/FCF ratio ($150 range), especially when one considers the quality of the cash flows and alternative investment
    opportunities.
     
     
     
    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise do not hold a material investment in the issuer's securities.

    Catalyst

    Better than expected product launches this fall and next year, steady growth in services and other products, clarity on the stickiness of the ecosystem and all that implies, combined with "earnings yield" value accretion to shareholders from buybacks and dividends will eventually force a revaluation of the shares.

    Messages


    SubjectService Revenue Growth
    Entry08/16/2016 09:12 PM
    MemberGCA

    "most observers believe services should grow 15-20% annually for the next several years"

    Assuming that you believe this as well, what would you say is the bigggest driver behind this service revenue growth?

    Thanks


    SubjectRe: Strawman
    Entry08/17/2016 03:30 AM
    MemberBarong

    Agree with Condor. The current state of AAPL is analyzed through and through. For the record, I'm a huge AAPL fan and a believer in the company long term, but I reluctantly put this in the too hard pile recently. 

    The most interesting question for an investor of course concerns Apple's future: can AAPL continue to create blockbuster products and increase the monetization of its ecosystem so much that it compensates for the falling iPhone sales? I don't know (the only rational answer), but I don't think that these favorable scenarios are priced in today. As such, a rerating may occur after launch of said blockbuster products or evidence of said monetization - but before that, I doubt we'll see one. And I'm not quite seeing how AAPL can compensate for the falling iPhone sales over the next few years. 

    In the meantime, AAPL's stock could just as easily rerate down as up IMO. One can fairly easily think up depressing revenue growth scenarios for a few years at least. I don't understand people who seem hell bent on shorting AAPL when there are plenty of easier marks out there. But nor do I understand the need to be long AAPL at 108 USD. It's not that cheap either (my DCF value is 113 USD). You'll probably make some money over the long term, but it's not a sure thing and there should be easier things to do out there. --> Too hard pile.

     

    Example of a scenario that would depress AAPL's stock price for longer. This is what I use as revenue input in my DCF (which as stated before returns 113 USD).

     

    Unit sales(m) 2016 2017 2018 2019 2020 CAGR
    iPhone 210 189 180 180 180 -4 %
    iPad 45 41 36 36 36 -5 %
    Mac 22 20 18 16 14 -10 %
    Sum 277 249 234 232 230 -4 %

     

    Unit ASP 2016 2017 2018 2019 2020 CAGR
    iPhone             630             595             565             565             565 -3 %
    iPad             450             428             406             406             406 -3 %
    Mac          1,240          1,203          1,167          1,132          1,098 -3 %

     

    Revenue by product 2016e 2017 2018 2019 2020 CAGR
    iPhone        132,300         112,455     101,491     101,491     101,491 -6 %
    iPad          20,250           17,314        14,803        14,803        14,803 -8 %
    Mac          27,280           23,815        20,791        18,150        15,845 -13 %
    Services          24,224           29,069        34,883        41,859        50,231 20 %
    Other products             3,000             3,450          3,968          4,563          5,247 15 %
    Total        207,054         186,103     175,935     180,866     187,617 -2 %

     


    SubjectRe: Re: Strawman
    Entry08/17/2016 03:48 AM
    MemberBarong

    (I should add that I'm pretty sure all these figures will prove horribly wrong.)


    Subject2 cents
    Entry08/17/2016 04:03 AM
    Memberrhubarb

    Put me in the "this is probably unsustainable" camp.  But Apple is a tough short because there is some chance they do something pretty epic.  They have the cash, the talent, the culture.  Meanwhile the multiple is fairly low and their capital return is surprisingly excellent.  All things considered, it doesn't seem that mispriced.  


    SubjectXiaomi - comparable phones 5 times cheaper
    Entry08/17/2016 06:43 AM
    MemberLeo11

    IMHO bulls underestimate the threat from Xiaomi and the impact it will have on volume and ASP of iPhones.

    It took the company only few years to become No.3 smarphone manufacturer globally and the largest in China. And the reason for that is simple - it sells high quality phones cheaply. I mean really high quality phones not some plastic phone immitations.

    As an anecdotal example I bought myself Redmi 3 ($125) - great slim metal design, long battery life and has all the features the average user of the latest iPhones and Galaxy phones needs. And the phone also works smoothly. Good reviews indicate other users have the same oppinion.

    Currently Xiaomi phones are still almost unknown neither in US nor Europe, but that is likely to change over the next few years.

    There will always be some ultra loyal users who will continue paying any price just to be part of Apple ecosystem, but for majority the obvious question will be - why buy iPhone for $600 if I can get almost the same for $125?


    SubjectQuestion for Condor/Others on the Cash
    Entry08/17/2016 09:27 AM
    MemberWinBrun

    I am curious how the Apple bulls feel about the cash position and the potential for Apple to deploy it for a big acquisition.

    I am a Netflix bull-so take this with a grain of salt. But Apple is in a position to buy Netflix-and then double the content budget to create a global television service that would be a viable competitor to the big bundle in the U.S over time. That can be a very large business-even for Apple. This would be a much more powerful way to enter the market than repurposing linear networks for a new streaming service.

    I have heard the argument that Apple won't do this because 1) it is a product company; 2) Netlfix is available on all devices and Apple wants to sell Apple devices; 3) Apple does not need to buy Netflix because it can fund its entry into content/streaming without buying anything. I am not persuaded by any of these arguments.

    1) Apple is becoming more of a service company-subscription video is probably the highest margin and biggest service revenue stream.Increasing the service revenue would be great for the multple.  

    2) having a service revenue stream that earns money outside of the Apple ecosystem is a hedge against Android/low-cost hardware competitors-----Comcast bought NBCU even though it was not exclusive to Comcast's cable system----John Malone has hedged content and distribution.  

    3) It would be more efficient for Apple to buy Netflix than try to enter the market from scratch because of the 80mm subscribers, existing content library, and brand awareness outside of the U.S.  

    I don't think that there is much integration risk. Netflix can operate independently. Apple can provide more capital. 

    Apple is in the great position of having enough cash and free cash flow that it could not only buy a great business-but also scale that business in a way that dramatically improves the economics. There are few businesses that benefit from incremental scale more than content.

     

     

     


    SubjectStrawman defined
    Entry08/17/2016 01:13 PM
    Memberrasputin998

    I will provide a more detailed response to the specific pushback in another post, but wanted to start with some broader thoughts:

    1.  Condor, you accuse me of setting up a strawman argument.  My understanding is that means I am arguing against an easy to rebut view that few people actually hold.  In other words, my suggestion that there is a conventional view that Apple is just another phone OEM with a life cycle that will generally follow the path (albeit from a much larger scale) of its predecessors is not actually held by many investors.   Yet it seems to me that Biffins, Barong and Leo implicitly do hold this view by modelling revenues having reached an all-time peak in fiscal 2015.  I actually think it's more than a little ironic that the first thing Biffins and Barong do is state their agreement with you, and then proceed to promulgate the very argument that you brand as a strawman.  I have seen similar views from other astute investors in many places on this site and others.

    2.  I don't think the fact that the company is well-covered (and of course we never argued that it wasn't) says much about what the prevailing view actually is or about the quality of the investment idea.  Can anyone really know what investors generally believe without an exhaustive, well-executed survey?  What we can say is that stock investing is similar to a pari mutuel system where price distills the prevailing beliefs of market participants and, in our view, a TEV/EBIT of less than 7.5 suggests they don't expect much going forward. 

    3.  Barong, I appreciate your disclaimer that you're pretty sure your projections will be horribly wrong.  If units and ASPs decline at anything close to what you have modelled, our thesis is incorrect and Apple will be a poor investment from the current price.  Everyone is entitiled to project as they see fit and I don't want to get into the weeds too much here since we are very far apart in our views, but as an example, Other Product Revenues approached $10bb over the last 4 quarters and you are projecting that they will be under $3.5bb in 2017.  Your model strikes us overall as very, very pessimistic.  The fact that your DCF actually generates a value that is higher than today's market price off of these assumptions suggests to us that this one actually shouldn't be in the too hard pile.   

    4.  Biffins, our point on the larger installed base and the longer refresh cycle is simply that a true full refresh cycle should generate higher unit sales.  We are assuming that a longer refresh cycle will translate into a higher percentage of the the installed base participating in the refresh.  Since mathematically unit sales will equal the participant percentage times the size of the installed base, we expect sales to be higher on the next full refresh since both of the factors in the equation are higher.  You may disagree with that participant percentage assumption but I wanted to try to clarify our meaning since you said you read the sentence several times without understanding it.

    5.  I fully agree with Condor's final sentence that the most effective long statement on Apple is that it provides an excellent earnings yield with a decent capital return and it is a high quality compounder at a good price.  Our intention was to support exactly that view throughout the writeup but maybe we weren't as direct as we should have been.  A good part of the discussion was about the durability and opportunity set of the franchise, but that is what makes it a high quality compounder in our view. 


    SubjectRe: Re: Xiaomi - comparable phones 5 times cheaper
    Entry08/17/2016 01:14 PM
    Memberwolfowl

    Huawei has caught up. 

     

    中国智能手机Q2最新出货量排名!华为OV前三


    SubjectMore detailed response
    Entry08/17/2016 01:49 PM
    Memberrasputin998

    I think it is a paradox that the analyst community so strongly supports Apple, while my sense is that the stock is very underowned institutionally.  I think the sentiment by those that control investment dollars is on balance negative toward Apple's stock.  I've been monitoring the holdings of larger institutions and most large cap mutual funds and large hedge funds are meaningfully underweight the stock versus their benchmarks.  

     

    GCA - the drive of the services revenue is the growing installed base and ever broadening range of offerings.  I don't that people appreciate the services revenue stream.  Despite the $28 Billion in estimated FY 17 revenue from this business, it is rarely analyzed in detail in most research reports.  The PE will start to rerate when the market understands that this is basically a 30% toll on all in-app software and content as well as many services purchased.  (If the service itself is from the software, the charge applies.  Thus, Uber doesn't pay it but Match.com does.)  How can there not be continued growth in purchases of software, content, and services through apps with the installed base and product line continuing to expand?  This will dampen the cycle impact of the phone and cause gross margins to improve over time.  This services stream will likely grow to $50 billion in less than four years. Finally, I think it is important to note that Apple provides real value in exchange for this toll.  The company provides development tools, infrastructure, billing as well as a distribution and marketing pipeline to a ready installed base of a billion units of higher-end consumers.    

     

    I also don't believe that it is appreciated that the installed base continues to grow meaningfully, by some 100 million phones per year, despite the declining number of unit sales reported by Apple because of refurbished phones being resold.  I probably should have flushed this detail out more.  My overarching point is that it is really hard to get the final sales number much below 200 million units for long.  I don't believe that the average life of a phone will extend much past three years.  But even if it extended to four years, it would still only be a few years before Apple's sales are well above 200 million units again.  I also don't find it necessary to hazard a guess on future iPhone sales.  I do however believe that expectations are quite low for the iPhone 7.  Moreover, if the 7 underwhelms, the 10th anniversary product would likely drive a super upgrade cycle that could lead to December 17 demand of 90 million units or more.  This is based on the premise that Apple’s user loyalty remains high and the installed base continues to grow some 15% per year.  Asian purchasers of 6+ and 6S+ phones clearly caused a spike in sales, as noted, but those users are now part of the growing installed base.  Separately, I do not buy the view that Apple has stopped innovating.  They understand that they need to make the overall experience more robust and convenient, which is more software and services driven.  The necessary enhanced hardware features will be offered, but always slower than the critics demand.  In my view, Apple Watch, CarPlay, Pay and Music are strong first generation products that support my thesis.  No one responded to my observations about the Watch, but it is hard for me to imagine that the company doesn't sell 20-25 million units with the next version.  Of course, if the Watch flops and services slow, my thesis is broken.  The thesis is not broken if Apple only sells 70 million units versus 75 million units (about a $4 billion decline in revenue) in the upcoming December quarter; as long as the installed base keeps growing, this will only lead to a stronger cycle in the future.  Services could grow 30% y/y ($1.8 Billion) and the Watch sells 5 million additional units y/y ($2.5 billion) in the December 2016 quarter to offset such an iPhone decline; margins would improve and EPS would still grow since share count will be 6% lower.  My premise is that over the next twelve months, Apple's model will be deemed much less cyclical while EPS starts to return to growth, and investors will realize it is just a matter of time before iPhones grow again.  As I pointed out in my original piece, the March and June compares start getting really easy.  Anyone that thinks EPS is going to $8 sometime in the near future has not thought through the services, Watch, installed base, and share count reduction.  Finally, I project that iPhone sales will return to over 250 million sometime in the next three years because of the much larger installed base.  If that does not happen, it is likely because other Apple products are cannibalizing the iPhone.        

     

    I concede that it would be hard for the stock to rerate if the hardware cycle impacts earnings in the future as it did in FY 2014 and FY 2016, but the company does not need to beat and raise to effect a rerating.  If the company hits published numbers and people appreciate that trough earnings are in and the quality of earnings has improved (more services and more diverse products), the rerating will occur.  This will be helped along by the company's continued aggressive stock repurchase program.  The next 15-20 % reduction in share count will be far more impactful to the stock price.  

     


    SubjectRe: Strawman defined
    Entry08/18/2016 12:47 AM
    MemberBarong

    Thanks. Obviously too low on the other products line. Not entirely sure what I was thinking there, not entirely sure it will matter though. Anyway - you make some good points. 


    Subjectrepatriated cash
    Entry08/18/2016 05:55 AM
    Membermack885

     

    One Obvious reason to own AAPL today, as in right now, is the probablility of repatriation occuring within the next 18 months.  This catalyst was clearly stated by Tim Cook last week.  We believe this alone would lead to a significant multiple expansion from todays levels.  

    How long are you willing to keep unrepatriated income overseas?

    Honestly, I believe the legislature and the administration will agree that it’s in the best interest of the country and the economy to have tax reform. So I don’t think I have to make that decision. I’m optimistic that it will take place next year.


    SubjectRe: Re: More detailed response
    Entry08/18/2016 01:18 PM
    Memberrasputin998

    Condor - 

     

    Thank you, I did understand your criticism.  I agree that this write-up contains nothing new about the company that hasn't been discussed elsewhere.  However, just because an argument has been made and is known by people following the stock doesn't mean that it has been discounted in the share price.  As is clear from the responses on this board, many know the view but simply don't agree with it.  So, yes, you are right that we are just taking a side.  Again, this doesn't mean that we have set up a straw man to knock down or that it isn't contrarian, as in fact it seems that a great many well-informed market participants hold the opposing view.   

     

    The next part of your criticism I think boils down to "why now?" for re-rating the stock.  The catalyst section of the write-up lists better than expected product launches this fall and next year, steady growth in services and other products, clarity on the stickiness of the ecosystem and all that implies, combined with "earnings yield" value accretion to shareholders from buybacks and dividends.  

     

    Maybe it's due to a flaw in our approach, but we've been doing this a long time, and experience has taught us that the catalyst we expect to have the greatest impact on the share price rarely does, and frequently it's something out of left field or seemingly nothing at all that suddenly changes perception.  Often, re-ratings seems to occur during inflection points when there is clear visibility that the second derivative of revenues and EPS is turning positive again, as we believe we are on the verge of for Apple now.  In our view, right now we can see the bottom of the phone refresh cycle just as the higher growth, more predictable, low capex "Services" piece, along with the "Other Products" segment, are becoming truly meaningful parts of the business.  The market will therefore soon be able to confidently project a smoother revenue stream going forward.  

     

    Once this is clear, we simply don't think a recognizable asset like Apple's stock, which is almost large enough to be an asset class in itself, can sit around at below 7.5 times EBIT in a world where the bonds of technically insolvent countries trade at negative yields, the entire US treasury yield curve is well below the inflation rate, and bubbles seem to the norm in most asset classes.  

     

    Maybe your point that Apple is sitting near the top end of its 5 year historical P/E range actually means that we're breaking out on this measure and the re-rating is in fact underway.   Who knows?     


    SubjectRe: Re: Re: Strawman
    Entry08/18/2016 01:21 PM
    MemberSpocksBrainX

    "I think you are taking my comments a bit too literally and a bit out of context."

    True - I was just making a very small point.  This guy (you) already got it:

    Finally, re: multiple/valuation, on P/E, AAPL has traded between 8x and 15x forward year EPS for the last 5 years, averaging 11x. Currently, they trade above 12x. I find it hard to argue that they should be re-rating higher - they are closer to the high-end of their valuation over the last few years, years that included some unbelievable earnings growth for a company that size. I certainly think AAPL in 2014 - when they traded at 13-15x is better than AAPL today. More importantly, without a catalyst other than hitting current consensus numbers, what makes them re-rate? Unless - again - you think the market thinks consensus is too high, which I highly doubt.  

    So you already made the case that it could re-rate (though in my defense I quoted your other paragraph directly!).  The thing is, I think that if people were convinced this company's earnings were going to be stable, it could easily trade for 20x.  Everything else does.  Look at Tootsie Roll...and look at MSFT which traded for a lower multiple for years as investors were convinced they were done and you can come up with a long list of examples.  We don't want to make the mistake of thinking 8x or 10x or whatever times means anything other than an abritrary marker (esp. in a world of 1.5% 10 yr UST).   In the end, I was only make a wee small point - things happen, things we often can't see.    That's it.  

    P.S.  This stock ALREADY rerated - you know, when the EPS report came out.  I'd call a 20% move in a few weeks a re-rate...

     


    SubjectRe: Re: Agreed with Condor
    Entry09/06/2016 08:49 PM
    MemberBiffins

    Biffins

    How long do you expect the upgrade cycle to extend out to and why?  Any data here or just your opinion?

     

    I believe this is the data you were asking for.  My contention is that "Over 3 years" tab will keep growing at the expense of the other categories. This leads to declining sales as product cycle extends. Also if they break from tradition and call this Iphone 6 SE or something instead of Iphone 7, implying the likely iterative changes and no design changes, I believe sales could be even more disappointing. 

    https://si.wsj.net/public/resources/images/BT-AK850B_UPGRA_16U_20160905164510.jpg