Apple Computer AAPL
April 22, 2003 - 4:55pm EST by
torico780
2003 2004
Price: 13.25 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 4,900 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Apple Computer is the world's only integrated (hardware/software) PC manufacturer. The Company has approximately 5% market share in the global PC market of 145 million yearly units. It offers a series of state of the art PCs and labtops at the leading edge of design, technology, and performance.

Apple announced results last week (4/16/03) which were lackluster. Of note was that the company continues to generate free-cashflow (cash-flow from ops less capex) at the rate of 200 mln per year. More importantly however is that the Company has $4.526 billion in cash and securities on the balance sheet and only 315 mln of debt. This translates into the Company (ex cash) trading at between 3 and 4 times (TEV to free cash-flow). For those of you arguing that were it not for interest income, the Company would generate no free cash-flow, I would agree with you; however you would be looking at the company on a recent historical basis rather than a normalized basis. Additionally, the company’s prospects are not as bad as everyone thinks they are. The products are good. Apple has the best working capital management program in the industry. The 12 and 17 inch labtops are off to a good start. The IPOD is selling at the rate of 78,000 units per quarter and growing and the company has its stable/fanatical customer base which is willing to pay a significant premium, in excess of 25% for similar products, for the Company’s products. Finally, the company’s retail effort is exposing a significant number of consumers to the company’s products and some are responding favorably. Valuing 200 mln of free-cash flow conservatively at 15 times results in a business value of 2.7 bn subtracting the debt. Adding the cash balance of 4.5 bn gives a price per share of 19.70 dollars.

Recent speculation in the press has hinted that Apple is in advanced discussions with Vivendi Universal to acquire the latter’s music business, VUM. This speculation is what caused the company's stock to fall from the $15.5 level to the current $13.25 level and making the stock significantly more attractive.

I believe that there is a very small chance (<5%) that Apple purchases VUM. This is because the acquisition makes very little strategic sense because of a number of reasons: 1) Apple will introduce a system on April 28th, which will allow for the purchase of online music from the five major labels for a per song fee. Why would Apple then purchase one label if they have access to all of them.

2) The music business has little to do with the computer manufacturing business; other than distribution through the internet, there are no synergies.

3) Financially the acquisition would have a bad effect on Apple because clearly its holders see the majority of the Company's value in its cash balance hence the recent price decline due to a cash acquisition scare.

4) Steve Jobs (CEO) is no dummy. Say what you want to say about the guy but he has founded 3 companies: two of them with multibillion dollar market caps (Apple, Pixar) saved another one from bankruptcy (Apple) and sold another one for 500 mln+ (Next) and he is a survivor. Granted his stubbornness boxed him out of the greatest value creation bonanza in the history of the planet and he walked out with only a billion + rather than Gate’s 50 billion, but that is a problem most of us would like to have.

And finally, lets assume that Apple buys VUM for $ 6 bn (a 30% discount to the sales multiple where EMI presently trades) and for simplicity’s sake lets assume Apple pays all in cash and assumes the balance in debt or 1.5 debt + 4.5 cash bn. The combined company would have a TEV of 6.8 bn and free cash-flow on a normalized basis of 700 mln. (VUM had EBITDA of 963 mln during 2002, very little capex and no interest expense) Furthermore, lets assume that this cash-flow stream decreases at the rate of 10% a year every year and we discount the stream at 5%. This cash-flow stream’s value is 4.6 billion; subtracting the debt of this stream gives an implied equity value of 7.5 dollars per share for the combined company. On a probability adjusted basis, Apple’s share price should be 95%* 19.70 plus 5% * 7.5 or 19.1 per share which is 44% higher than where the Co. currently trades.

Catalyst

Press stops speculating on a transaction that makes very little sense.
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    Description

    Apple Computer is the world's only integrated (hardware/software) PC manufacturer. The Company has approximately 5% market share in the global PC market of 145 million yearly units. It offers a series of state of the art PCs and labtops at the leading edge of design, technology, and performance.

    Apple announced results last week (4/16/03) which were lackluster. Of note was that the company continues to generate free-cashflow (cash-flow from ops less capex) at the rate of 200 mln per year. More importantly however is that the Company has $4.526 billion in cash and securities on the balance sheet and only 315 mln of debt. This translates into the Company (ex cash) trading at between 3 and 4 times (TEV to free cash-flow). For those of you arguing that were it not for interest income, the Company would generate no free cash-flow, I would agree with you; however you would be looking at the company on a recent historical basis rather than a normalized basis. Additionally, the company’s prospects are not as bad as everyone thinks they are. The products are good. Apple has the best working capital management program in the industry. The 12 and 17 inch labtops are off to a good start. The IPOD is selling at the rate of 78,000 units per quarter and growing and the company has its stable/fanatical customer base which is willing to pay a significant premium, in excess of 25% for similar products, for the Company’s products. Finally, the company’s retail effort is exposing a significant number of consumers to the company’s products and some are responding favorably. Valuing 200 mln of free-cash flow conservatively at 15 times results in a business value of 2.7 bn subtracting the debt. Adding the cash balance of 4.5 bn gives a price per share of 19.70 dollars.

    Recent speculation in the press has hinted that Apple is in advanced discussions with Vivendi Universal to acquire the latter’s music business, VUM. This speculation is what caused the company's stock to fall from the $15.5 level to the current $13.25 level and making the stock significantly more attractive.

    I believe that there is a very small chance (<5%) that Apple purchases VUM. This is because the acquisition makes very little strategic sense because of a number of reasons: 1) Apple will introduce a system on April 28th, which will allow for the purchase of online music from the five major labels for a per song fee. Why would Apple then purchase one label if they have access to all of them.

    2) The music business has little to do with the computer manufacturing business; other than distribution through the internet, there are no synergies.

    3) Financially the acquisition would have a bad effect on Apple because clearly its holders see the majority of the Company's value in its cash balance hence the recent price decline due to a cash acquisition scare.

    4) Steve Jobs (CEO) is no dummy. Say what you want to say about the guy but he has founded 3 companies: two of them with multibillion dollar market caps (Apple, Pixar) saved another one from bankruptcy (Apple) and sold another one for 500 mln+ (Next) and he is a survivor. Granted his stubbornness boxed him out of the greatest value creation bonanza in the history of the planet and he walked out with only a billion + rather than Gate’s 50 billion, but that is a problem most of us would like to have.

    And finally, lets assume that Apple buys VUM for $ 6 bn (a 30% discount to the sales multiple where EMI presently trades) and for simplicity’s sake lets assume Apple pays all in cash and assumes the balance in debt or 1.5 debt + 4.5 cash bn. The combined company would have a TEV of 6.8 bn and free cash-flow on a normalized basis of 700 mln. (VUM had EBITDA of 963 mln during 2002, very little capex and no interest expense) Furthermore, lets assume that this cash-flow stream decreases at the rate of 10% a year every year and we discount the stream at 5%. This cash-flow stream’s value is 4.6 billion; subtracting the debt of this stream gives an implied equity value of 7.5 dollars per share for the combined company. On a probability adjusted basis, Apple’s share price should be 95%* 19.70 plus 5% * 7.5 or 19.1 per share which is 44% higher than where the Co. currently trades.

    Catalyst

    Press stops speculating on a transaction that makes very little sense.

    Messages


    SubjectI like apple...
    Entry04/23/2003 01:02 PM
    Memberdoobadoo802
    I think you need to talk about if you think there will be a turnaround in the desktop publishing biz that apple dominates (i think its near 50% market share of the 'desktop publishing' market).

    The recent weakness in the ad world has destroyed apples powermac sales, which is there highest margin product, and historically the main driver of their earnings. I believe there is a lot of pent up demand, and short term it is a negative that macs have a substantially longer useful life than pcs in this industry.

    One thing to note about the ipod, 50% of the sales are to PC users. Its a good product, period.

    The problem with apple is that the market gives the company no respect. In liquidation the firm could be worth $20/share. Aside from the cash, they own their headquarters, the real estate is grossly undervalued on the books, in addition Quicktime and OS X technologies should be worth at least a billion or several dollars/share. They've had trouble really monetizing these assets.

    Another problem they are facing is Motorolla. Motorolla has not been giving attension to the G4, and while the G4 is a good performer and has some unique features that benefit teh platform. Moto has been slow to push the cpu to its true potential. I think its still using the .18 process for example, and no plans to shrink the circuitry. Apple is addressing this with the PowerPC 970 from IBM. This is the technology that is rumored to be incorporated into the g5. In addition, there is nothing technically stopping apple from switching to intel, OS X started out on x86 (open-step), and there is a version at apple headquarters that runs on x86 from what i know.

    About steve, yes he is no moron. I doubt he wants to get in the music biz. He thinks in terms of revolution, he doesn't like the idea of a boring biz on the decline. I hope i'm not wrong.

    --
    doob

    SubjectThe ad market/desktop publishi
    Entry04/23/2003 04:42 PM
    Membertorico780
    I beleive that the ad market will turn around and like tech has somewhat stabilized. The problem is the timing and my guess on this matter is as good as anyone elses.

    I had not even thought about their real estate value nor the value of their software on a standalone basis. From my perspective, and I have followed this company seriously for about a year, this company is a little free-cashflow machine which was able to generate 200 mln in free cash-flow in the toughest environment in tech ever seen (almost). Furthermore, the company's position is defendable as has been demonstrated. The competition has thrown everthing at Apple and with fewer resources than everyone Apple still produces better products in terms of design, user friendliness, operating performance etc than the competition and I know because I use Windows.

    Your point on the chip is well taken. MOT is not paying a lot of attention to the chip and it is a superior chip to Intel's product. The worst case scenario would have to be to adapt to Intel, before that however, IBM would probably support the Power PC line and has already announced the Power PC 5 chip so this concerns me a little less.

    Ipods are awesome. More than 50% of the sales of ipods are to Windows users and again, Apple has come out with a superior product to that of the competition and both the 12 inch and 17 inch labtobs are firsts in the industry that are selling well in their first quarter. The price point is a little high, but the product appears to be worth it. Essentially, the 17 inch is a portable desktop.

    Finally if you read the articles on the Apple music service/software that is expected to be announced by Apple on April 2008 it has the full support of the Recording Industry of America and if the Company has somehow made it attractive on a risk(lawsuit) reward (get the music)basis to sign up for the service then the possibility for the Apple is significant.

    SubjectCorrection
    Entry04/23/2003 04:56 PM
    Membertorico780
    I said April 2008 in the last message which was supposed to be April 28 2003

    SubjectProcessors etc...
    Entry04/24/2003 05:17 PM
    Memberdoobadoo802
    We agree, the processor situation is rapidly being address.

    About the potential V deal, which if pursued would be more like a V disease for apple. Apple has a history of floating insane rumors to grab media attention. Before the ipod, people were rumoring that a new apple pda was coming out. I have no doubt this is the same thing.

    But what about the buyback? With $12 cash, apple can buy its shares for $1.50! They have a huge program in place that has not been used. I'd be very worried if it wasn't being used right now. Why are they hording the cash? While an acquisistion is unlikely, certainly a pr about shares repurchased would be a boon of confidence that they are not looking to buy something else.

    --
    doob

    Subjectwhy I exited Apple
    Entry04/24/2003 06:43 PM
    Memberrobert511
    I recently closed out my bullish position in Apple. What concerned me was how carefully worded their press release was. As I recall, it said Apple has not made an offer to buy Vivendi Music. It did not say that there were no plans to buy it in the near future. To me, this was Sherlock Holmes' dog that did not bark. I perceived the risk factor as far higher than the 5% you gave it. I was concerned that the cash was burning a hole in Jobs' pocket.
    Still, all should become clear in the next couple of weeks. I hope you are correct

    Subject12.50 put
    Entry04/24/2003 10:31 PM
    Memberdoobadoo802
    The may 12.50 put is really cheap. I didn't mind trading off a bit of return for the insurance against a jobs blunder... I think thats how you have to trade it, when the outcome is binary like this. I think people are underestimating the risk of a devastating apple acquisition in terms of the put, and overestimating it in terms of the stock...

    I'd sleep doubly better if i had some evidence of a big buyback. C'mon Stevo, a buck twenty-five for AAPL is better than 5x ebitda for a sunsetting biz....I hope he 'gets it,' and this is just a pr stunt!

    --
    doob

    SubjectTEV / FCF, real estate, cost s
    Entry04/24/2003 11:13 PM
    Memberkevin155
    Are you subtracting net cash from TEV, yet including interest expense in your FCF calculation? If so, I think you are miscalculating the TEV / FCF multiple of 3-4x.

    I agree that the company looks cheap because of its cash per share, but I would say it looks cheap on a TEV / sales or other "potential" basis, but not on a multiple of current cash flow. As you pointed out, the company today does not generate FCF without interest income (especially as it continues to pour money in its unproven retail strategy). In addition, this company has spent $200-$400m (after tax) per year in the last three years on stock option grants. Despite their non-cash nature, I view options grants as a real expense (and FASB likely will too some time soon) and the company is probably getting a tax benefit from them which also gooses reported cash flow.

    Also, I'm not sure how much credit I'd give for their real estate because 1) Silicon Valley currently has high 20s% office vacancies and 2) if they were to sell their real estate, they would presumably have to pay incremental lease expense to house their people and operations.

    I agree that the company has great products and fanatical loyalty, but the question is can this proprietary model which has higher gross margins offset entirely by higher R&D SG&A expense compete effectively with Dell? In other words, can this company ever get to a "normalized" level of profits given its relative cost disadvantage?

    Also, I get feeling that this company is being run for the benefit of satisfiying Steve Job's whims and not for shareholders given: 1) hoarding cash for God knows what (Vivdendi or another value-destroying acquisition?) 2) lack of share repurchases/dividends 3) egregious compensation for Jobs (e.g. a $90m airplane given to him by the company in 12/99 and 5m shares of restricted stock in 3/03).

    Subject12.50 puts
    Entry04/25/2003 08:06 AM
    Memberrobert511
    Actually, I had shorted those puts last summer and bought them back earlier this month when I started feeling uncertain about Apple's future. The floor on the stock gets much lower if they trade much of their cash for a music company.

    SubjectRe 12.50
    Entry04/25/2003 12:03 PM
    Memberdoobadoo802
    I think thats why i own them along witht the shares...

    SubjectJobs compensation
    Entry04/25/2003 12:14 PM
    Memberquentin720
    Have you focused on Jobs' option restructuring in March? It was truly outrageous. To refresh your memory, Jobs held options on 27.5 million shares (20mm struck at $43.59 and 7.5mm struck at $18.30). It was bad enough that Jobs had options on all those shares, but at least the exercise price for most of them was $43.59. If Jobs got rich, then at least the shareholders did well. He turned that on its head by cashing out the options at their Black-Scholes valuation and taking restricted stock. Jobs does well regardless of how the stock does.

    And how about the plane? It is not enough to give Jobs a G4? AAPL has to pay the taxes on it as well?

    The agency costs at AAPL are just too high for me

    SubjectShareholder Value
    Entry04/25/2003 01:52 PM
    Membermark227
    I've owned this stock in the past and I believe you are correct in many respects about the values and the products. Unfortunately as others have posted, there is a huge issue here of management's complete disregard for shareholder value, i.e. lack of productive use of cash. More importantly, Apple has simply not been profitable for a long time after proper adjustment for employee options. Regardless of the accounting treatment, they are a real expense. Slowly, but surely the corporate assets are being siphoned off to Jobs & Co. Take a look at the trend of shares outstanding and where they're going. Perhaps you can make decent money trading this stock, but long-term it's hard to win with a declining business and shareholder unfriendly management.

    SubjectUniversal
    Entry04/25/2003 05:28 PM
    Memberdoggy835
    I doubt AAPL will buy Universal Music in its entirety. But it wouldn't surprise me to see them take a 20% stake for $1B or some such nonsense.

    SubjectEducation market
    Entry04/27/2003 10:41 AM
    Memberchavez811
    What % of apple's sales come from the education market? My concern here is that most governments are cutting back on their budget, and similarly, spending on computer will be curtailed. In this type of environment, Windows PCs offer more cost effective products.

    SubjectJobs/Education
    Entry04/28/2003 08:22 AM
    Membertorico780
    Jobs is getting paid too much and the board here is clearly a bunch of cronies because they essentially let him exchnage his WAY out of the money puts for shares at the current price which is complete BS. The funny thing here is that the shareholders have not said anything and neither does the press really. Every article on "most overpaid CEO's" should have Jobs on the front cover. The Apple is ripe for a little shareholder activism; pardon the pun.

    Education represents 22 to 23% of revenues and it is hurting because of higher state budged deficits.


    SubjectBeaten to the Punch
    Entry04/28/2003 01:14 PM
    Membermickeys797
    Nice write-up. I was working on writing up Apple as well but have been too busy with other work to get it done. I agree with your analysis. I believe Apple is very cheap at these levels.

    One thing no one has mentioned yet is Apple's ability to position themselves as the leader in the emerging computer based home entertainment center market. I believe this will be a key strategy for Apple. They are announcing today an online music distribution business and they are already working on a Tivo/Replay like system as well. These two pieces along with their superior ease of use and design will allow them to get Apple products into people's home in their tv/media rooms, even if the homes are Windows users.

    I think 2003 will be a turning year for Apple and I expect a $25 stock price within 12 months.

    SubjectTo me, there does not seem to
    Entry04/29/2003 05:35 PM
    Memberdacsom795
    To me, there does not seem to be a lot to get excited about. Your downside is limited to the cash on the books and if they crank out a blockbuster product at some point in the future you have some upside. The most likely scenario is that it trades in a narrow range for a long time.

    Its pretty clear that they have no intention of buying or making a stake in Vivendi Music.

    SubjectiTunes Music Store Sells over
    Entry05/05/2003 09:57 AM
    Membermickeys797
    This is a huge success and the stock is up on the news. I have used the service and agree that they really did get it right.

    They also announced that they sold over 110,000 of the new iPods in the last week.

    Great news which I believe marks the beginning of the turnaround for Apple! The stock should continue to trend higher from the current level.

    Subject1 million songs sold in the fi
    Entry05/05/2003 10:15 AM
    Membertorico780
    Not too shabby. I'd hate to have to put a valuation on this thing if it becomes the legal Napster.

    SubjectiTunes for PC
    Entry05/05/2003 03:56 PM
    Memberdoobadoo802
    Word is apple is working on iTunes for PC. They are currently hiring several PC software engineers for an "iTunes for PC" project.

    Could be huge...

    --
    doob

    SubjectRegarding the Merrill Reiterat
    Entry05/06/2003 11:38 AM
    Membertorico780
    I spoke to the guy last week. He would not know value if there was a stack of 100s 10 inches thick laying in front of him!!

    Subjectcongrats - looks like you bott
    Entry05/06/2003 02:19 PM
    Memberkevin155
    take the money and run or are you holding?

    SubjectI thought the stock was worth
    Entry05/06/2003 02:52 PM
    Membertorico780
    I don't know how to value music yet. Total back of the envelope though:

    4 mln songs per month at 30 cents with an 80% margin gives gross profit of 11 mln yearly. Take out tax gives you 8 mln. Apply ridiculous internet multiple and multiply by windows market share and you get whatever you want to get!!!!!!

    Aint the market grand!!!!!

    SubjectPC
    Entry05/06/2003 03:07 PM
    Memberdoobadoo802
    Apple 5% of market. Wait till the pc version comes out in 6 months.

    --
    doob

    SubjectPC II
    Entry05/06/2003 03:09 PM
    Memberdoobadoo802
    oops posted too quickly...

    Forget about what apple makes on the music for apple customers. The big market is the pc users. Look at the ipod sales over the past week (see apple pr). Now imagine how many pc users with pc version of itunes (which is integrated with ipod) will buy an ipod!

    Margins on ipod is most likely 30% or so...

    --
    doob

    SubjectMargins on IPOD are small
    Entry05/06/2003 03:56 PM
    Membertorico780
    Margins on song sales are huge.Its all incremental

    SubjectTarget Price?
    Entry05/06/2003 06:45 PM
    Membermickeys797
    Torico,

    You mentioned in your write-up a target price of $19. Is that still your target?

    My initial target is $18.60 and above that it would be around $25, but to get there we would need to see a turnaround in the computer market as a whole and a pickup in sales of Macs.

    What do you think and where do you recommend selling?

    SubjectTarget Price
    Entry05/07/2003 11:06 AM
    Membertorico780
    As I said. Target was 19.70 ~ 20 (to make it simple)

    As stated I don't know how to value music yet. Couple of problems with the music valuation. 1) Its created a surge in IPOD demand thereby giving the Co some growth 2) Its opened a gateway for Apple to become an online music distributor. This second avenue could be worth a lot. I have just always sucked at understanding the valuations that the market gives to internet companies.

    A pickup in PC demand gives me a price target of 23-25 and you can value music however you like.


    Subjectvery nice timing
    Entry05/07/2003 04:27 PM
    Memberrobert511
    Your timing was as good as mine was bad! Congratulations.

    SubjectThanks
    Entry05/07/2003 04:43 PM
    Membertorico780
    VIC did not agree with you.

    SubjectI think a sell around here might make some sense
    Entry12/07/2010 05:12 PM
    Membertorico780
     

    SubjectRIP Steven Jobs
    Entry10/05/2011 10:07 PM
    Membertorico780
     

    SubjectRE: RE: RIP Steven Jobs
    Entry10/06/2011 11:27 AM
    Memberopco
    Torico, I sincerely hope you held onto this stock the whole time and are now retired and sipping a vodka soda somewhere in the Carribean. 

    SubjectPretty Funny in Retrospect
    Entry10/07/2011 10:31 AM
    Membercasper719
    I read today that Cook has 1 million shares that vest between 2016 and 2021. But thats nothing compared to the "worst compensation package of all time"!
     
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