Wednesday, March 31, 2010

AAPL: Buy Now (Again!)

In late January I posted an advisory suggesting AAPL was trading at a bargain price. The shares had closed the day before at $192.06, concluding the week Apple released its 1st fiscal quarter results and introduced the Apple iPad. In that post I delved into Apple's elimination of virtually all deferred revenue accounting on the iPhone, the strength of the company's balance sheet and the company's  prospects for strong and continued revenue and earnings growth based on the 1st fiscal quarter's results.
Two months later and at today's closing price of $235 per share, AAPL is no less of a bargain than it was at the end of January. Earlier this month I posted my new 12-month price target for AAPL of $384 per share. As we move closer to Saturday's release of the Apple iPad, that price target becomes all the more reasonable of an expectation.
In a much-referenced report from Morgan Stanley's Katy Huberty, the firm estimates each 1 million iPods sold will add $.25 to Apple's earnings per share. I expect Apple to sell in the area of 8 million iPads this calendar year. If Morgan Stanley's earnings estimate is accurate, the iPad alone could add $2.00 to eps in the remaining nine months of the calendar year. At today's p/e multiple of about 23 times trailing 12-month earnings, that's an additional $46 in share value from the iPad by January 2011. 
Mac sales reportedly remained strong in the March quarter and I expect year-over-year unit sales growth of no less than 35% with only slightly lower revenue growth from Mac sales due to more aggressive pricing on both the iMac and MacBook Pro lines. 
The iPhone, with or without the on-again, off-again rumors concerning Verizon, remains the champion in the smartphone market. For all of the hype surrounding the Droid and the Nexus One, the Android-based smartphone market will continue to the lag the iPhone in app development and easy accessibility of content for the foreseeable future. 
Comparatively, Android-based phones have obsolescence built into the handsets. It's been almost three years since the release of the original iPhone and those first iPhones are running the same OS as a 3GS iPhone purchased today.  The Android handset market is hardware fractured (different phones with different hardware specs) and this is a decided challenge for developers seeking to embrace the platform. The iPhone OS offers developers access to multiple generations of the iPhone and iPod touch as well  as the new Apple iPad. In addition to robust iPad sales, the new device will have a halo effect on the sales of other Apple hardware products and assist in attracting more developers to the iPhone OS platform. The difference between the iPhone OS and the Android OS eco-systems will become more apparent in the months to come now that the initial hype and media attention surrounding the first big wave of Android handsets has faded.  
In the end it's content and its accessibility that sells devices. Hardware specs become a factor when it diminishes or limits access to content people desire. There's a reason publishers are flocking to the iPad and the iPhone OS eco-system. The addressable market is better defined and its growth can be more easily forecast. With content comes customers. Watch for some surprises in the crowds outside Apple retail stores on Saturday. It will be more than the Apple faithful waiting to buy the iPad. These new customers will be a factor in Apple's revenue and earnings performance for the next few fiscal years. 

Colum O'Dwyer And "The Other Mac Blog"

I do a lot of research. Lots of research on Apple and the company's product markets. When I want someone to corroborate or challenge my views on Apple's product paradigm, the integration of hardware and software, and in particular uses of Apple products in the education market, I call a young man named Colum O'Dwyer. Asking Colum a ten second question always involves a ten minute answer. He has an uncanny knack for understanding the way Apple products are designed and the design ethic built into product uses and functionality.
Colum recently began a Web presence called The Other Mac Blog. Being new to the Mac Web he asked if I'd contribute finance-related content for his site. The answer was easy. Writing about Apple and the company's finances is what I do. It's second nature. What makes working with Colum fun is his spirited approach to immersing himself in Apple products and what he discovers about the products and their uses within hours of getting started. 
The other night he planned to do nothing more than watch a bit of TV content so he surfed over to Being the person he is,  he caught a CBS iPad test come across the screen. Within minutes there was a post on his site and he sent screen shots of the find to AppleInsider and At 6:15am the following morning my iPhone is sounding with notifications of text messages from Colum with only the words "check this out" and references to link backs to his story.
I finally had a chance to call him at the end of that day. After my personal briefing from Colum as to why he thinks push notification on the iPhone is underrated and multitasking is an overrated desire among developers, he tells me there were 8,582 page views from reference links on his story about's iPad test. That's Colum and those page views are the result of what happened when this talented and energetic young man sat down to do nothing more than watch some late night TV. He's a natural when it comes to discovering things about Apple and its products. 
Colum has a refreshing enthusiasm for all things Apple and the kind of kinetic energy that makes all this fun (again). I'll be posting on his site on weekends and, knowing Colum, I'll have a few text messages early Saturday morning Pacific Time about all of the unexpected uses he's found for the new Apple iPad. I wonder what he'll discover next?

Sunday, March 28, 2010

The iPad: Apple Turns Back The Hands of Time

I remember 1995 and the rollout of the version of Windows that had a reference to that year in its product name. The demand for the then latest version of Windows was huge. Demand was huge less because of the benefits it brought to the computer user who chose to upgrade to Win 95 or who chose to purchase a new PC with it installed and more because of the economic benefits it brought to software makers, component and peripheral makers and Windows PC OEMs. There was a huge economic effort orchestrated by Microsoft to create demand for the OS upgrade and new PCs. It worked.
In one of the biggest blunders in Apple corporate history, Michael Spindler, Apple's CEO at the time, insisted on releasing premium-priced Macs with 680X0 Motorola processors at the expense of the new line of PowerPC Macs that were in strong demand. In my view Windows 95 was not a particularly good upgrade to Windows. But it was "good enough" to sell Windows PCs while the Mac products consumers wanted were in constrained supply. 
It's now fifteen years later and Apple is releasing the Apple iPad beginning Saturday. There are a variety of lessons that could have been learned from the rollout of Windows 95 and it appears Apple has learned the lessons that matter most. It was the "Performa blunder" that eventually led to the return of Steve Jobs to the company and with his return a renaissance for the company.
Among the first steps taken by Steve Jobs and his new management team at Apple in the one of the greatest turnarounds in US corporate history was the abandoning of projects that sapped resources and the elimination of shipping products that deviated from the desired core product competencies of the Mac maker. Apple made things much more simple. Gone were the three-page foldouts of Apple product choices that only confused consumers and gone were products that competed directly with offerings from potential eco-system partners. 
The Apple iPad is coming to market with consumer awareness of a new hardware device not seen since the release of the original Bondi blue iMac in August 1998. The iPad, though a new product line, is building on the success of the Apple iPhone and iPod touch. Unlike the original iPhone which debuted as a new competitor in an existing smartphone market, Apple is defining the tablet market and is pricing the iPad aggressively to thwart early competition. 
The iPad will leverage not only Apple's retail store infrastructure by increasing foot traffic to the retail stores and resulting increase is sales of Apple products, it will also leverage the developer investment in existing iPhone OS apps. Where the iPad will add new dimensions to the Apple product eco-system is through the expansion of that eco-system to include ebook publishers, magazine and newspaper publishers as well as game developers desiring to create product for the iPad's tablet-sized screen. The iPad is to the handheld device market what the home theatre concept was to the marketers of TVs and related products. The Apple iPad provides an immersive experience that can't be rivaled by today's smartphones or netbooks. The revenue streams the iPad will create for app developers and publishers of content for consumer consumption may eventually dwarf the revenue to Apple from iPad hardware device sales. Further, due to the nature of the iTunes sales environment, Apple will be increasing the flow of dollars to its own coffers from distribution fees.
Through the release of the iPad Apple is turning back the hands of time and delivering a product that is not only the foundation for the next generation of computing devices, it's eviscerating the last vestiges of one of Apple's biggest corporate blunders. In the absence of delivering to consumers the products consumers wanted at the time, the OS that was "good enough" by comparison created an economic empire for Microsoft and the company's OS product dependents. Fifteen years later Apple is positioned to create a dominant eco-system that will supplant the Windows PC and its related products and reign for at least the next few years as the driving force in the delivery of apps, games and content to consumers.
Next week I'll post my estimates of iPad unit sales for the balance of Apple's 2010 fiscal year and look at the expanding eco-system supporting and expanding the markets for iPhone OS-equipped digital devices. 

Saturday, March 20, 2010

AAPL and Fantastic Share Price Forecasts: Investors Beware

On the various AAPL-related discussion boards it's easy to get lost in talk about fantastic and theoretical pricing models for AAPL. Some compare AAPL's low p/e multiple to company's such as Amazon and attempt to draw conclusions on AAPL's share price upside and future valuations. Investors beware.
Apple has become an amazingly successful enterprise and is currently enjoying revenue and earnings growth at a torrid pace. The decade-long success of the iPod, the successful Intel transition for the Mac, the successful introduction of the iPhone and the anticipated success of the forthcoming Apple iPad make for a highly profitable growth company with leadership positions in each of the company's major product segments. Apple is among the most successful enterprises in US corporate history and there's no reason for the company's rate of growth to subside over the next several quarters. Long-term AAPL investors may continue to be richly rewarded for their investment.
Personally, I'm as bullish as ever on AAPL. I have a 12-month price target of $384 per share and expect the share price to move above $400 per share by the end of fiscal year 2011 (September 2011). This is in contrast to Friday's closing price of $222.25.
AAPL currently trades at a p/e multiple of just under 22 times trailing 12-month earnings. I expect earnings to rise at a 30%+ rate this fiscal year and for revenue to approach $60 billion. At the current rate of revenue and earnings growth it's easy to fall into a valuation trap of forecasting AAPL's share price to rise to fantastic pricing levels based on theoretical models assuming the rates of revenue and earnings growth will continue indefinitely. It's as if the possible doubling or near doubling of Apple's share price over the next twenty four months isn't enough. 
From a long-term investor's standpoint I caution moving the forecast p/e multiple above 25 times trailing 12-month earnings. While it's fun to see how the math works, basing pricing models on theoretical assumptions Apple will sustain the current rates of revenue and earnings growth in perpetuity is a path fraught with peril for investors.
To start the market won't support and sustain a p/e multiple above 25 times trailing earnings for AAPL anytime soon. There's more than enough share price appreciation potential using that multiple as a cap for estimates and forecasts.
Apple is currently growing revenue and earnings at a torrid pace but the pace of growth will eventually moderate (especially as we move twelve fiscal quarters or three years out from today). 
Apple's revenue may move as high as $60 billion this fiscal year. Sustaining revenue growth above 20% annually becomes increasingly challenging as revenue scales higher. Earnings will rise faster than revenue, but there's a practical cap on sustainable revenue growth as realized revenue moves above $60 billion and certainly above $75 billion which may be the reality for FY 2011. 
For the twelve-month period beginning with the start of the June quarter through the end of March 2011, I'm modeling revenue of over $66 billion and eps of about $17.46 per share. Using today's p/e multiple of 22 times trailing 12-month earnings, I forecast a share price of $384 by the end of April 2011. Using a p/e multiple of 25 times trailing 12-month earnings the share price target moves to $436 per share. This illustrates the problem inherent with valuations based on theoretical growth models.
I'm moderating my p/e forecasts to what I consider a sustainable pace of growth for the next three to five years. Should the share price move above 25 times trailing 12-month earnings one may be buying into a bubble rather than investing for sustainable growth.
While Amazon currently trades at a p/e multiple of 63 and Google at a more modest yet higher p/e multiple than Apple of 27, the comparisons of these two companies to Apple are not wholly analogous. Maintaining a realistic p/e multiple and price target for AAPL requires more than a cursory comparison to other companies offering products that overlap some of Apple's product markets. In contrast, HP, the world's largest PC maker currently trades at a p/e multiple of just under 16 and IBM, the granddaddy of tech companies, trades at a p/e of just under 13 times trailing 12-month earnings. Though Apple is growing faster than HP and IBM, Apple's long-term challenges of managing success and managing growth are more akin to HP and IBM than to the challenges at Amazon or Google. 
Working in favor of a continued strong pace of growth at Apple over the next twelve quarters include the expansion of the retail store presence into new markets overseas, market share growth opportunities for the Macintosh line particularly in the EU states, continued growth in iPhone unit sales in both the domestic and international markets,  an expected successful launch of the Apple iPad and growth in revenue from iTunes store sales and growth in revenue from services such as MobileMe and AppleCare. Apple will continue to grow revenue and earnings at an attractive pace. Growth rates, however, will moderate as we move three to five years out from today. 
Contrasting fantastic price valuations based on theoretical revenue and earnings growth models, Apple's management has offered clues about the management ethic and the approach to sustaining and managing the company's continuing success. According to Tim Cook, Apple's COO, the company isn't interested in being the biggest player in each of its major product markets. Rather, the company is interesting and making the best products in each of the company's major markets. Apple is rewarded in this approach through high gross margins and a loyal base of product users.
Apple's illustrious, storied and at times tragic corporate history evidences one important reality: Consumers are willing to buy Apple products they consider innovative, easy-to-use and well designed for their intended purposes. Consumers are not willing to buy Apple products due to the brand name alone. Apple must innovate to maintain high gross margins and maintain strong revenue and earnings growth. Necessarily the focus on innovation, design and user satisfaction places a reasonable restraint on boom cycle growth at the expense of long-term rewards.
Apple warrants a p/e multiple higher than HP and IBM. But a valuation model that pushes the price above 25 times trailing 12-month earnings should be viewed with caution. At today's multiple of about 22 times trailing 12-month earnings long-term investors should continue to be richly rewarded for their investment. All but the most impatient investor would consider the doubling or near-doubling of the share price over the next two years sufficient. 
As I said earlier, I'm more bullish than ever on AAPL. But for fantastic valuation models that push the p/e multiple above 25 times trailing 12-month earnings, investors beware. My valuation models are based on a p/e of 22 times trailing 12-month earnings. It's a pace of earnings growth I consider sustainable over the next three to five years. 

Sunday, March 14, 2010

Defining The Apple iPad's Market

In reading comments around the Web it's clear the Apple iPad is as misunderstood as it is already successful. The Apple iPad isn't designed to compete with laptops. It is designed to compete economically with netbooks. 
Microsoft and the Windows PC OEMs are challenged by commodity-grade pricing on netbooks and shrinking hardware margins. Although netbooks are creating unit sales gains for the PC industry, they are not producing sufficient margins to satisfy Microsoft's goals for Windows licensing revenue growth and, because of low retail prices, are not satisfying the gross margin desires of the hardware OEMs.
The Apple iPad has already cut the underpinnings of the market for the Kindle DX. No doubt Amazon will retool the product, add functionality and most likely adjust pricing, the market for the Kindle DX is essentially gone. 
The iPad is aggressively priced based on its specs. Just ask the executives at Acer. That company has chosen not to pursue entry into the tablet market following the release of the Apple iPad. Without the prospects of continuing revenue for the device through app and content sales, attempting to compete with Apple in the tablet market doesn't make economic sense for the company. This from the fastest growing PC maker on the planet and a leader in netbook sales. 
While Microsoft and some Windows PC OEMs are now touting tablets as the next market for product sales, monetizing that market following the original hardware sale is a problematic issue.
Witness the dramatic falloff in market share for Windows Mobile smartphones following the ascent of the iPhone, aggressive pricing by RIM on the Blackberry line and the release of Android OS-based phones. The much-hyped Windows Phone that will appear late in the year will not be compatible with existing Windows Mobile apps. Microsoft is starting over in developing an eco-system to support the Windows Phone.
The Apple iPad is about economics, not hardware. Deliver all the Windows-based tablets that are being mentioned around the Web and without a means to monetize the products following the original hardware sale they will deliver nothing to the manufacturers in terms of revenue growth and rising margins. Slap Windows 7 on a tablet and all one gets is a product to compete with other Windows 7 hardware devices and nothing to expand the eco-system for developers.
There's nothing in the market now that will compete effectively with the Apple iPad and the Windows PC OEMs will not be able to deliver a competing product anytime this year. It's not about the hardware. It's about economics and the ability to monetize products after original sale. 
Based on reported pre-order volume, the Apple iPad is already achieving sales success.  For now the Windows PC OEMs don't have an answer and slapping Windows 7 on a tablet is about as underwhelming as it sounds. It will deliver nothing in terms of aggregate revenue and earnings growth for the OEMs and at best only trade revenue between product lines. More products without a net gain in sales. 
The Apple iPad is designed to compete economically with netbooks while building demand for apps and other content available through iTunes. With iPhone OS-equipped devices already approaching 100 million unit sales, the iPad will enhance the appeal of iPhone OS devices and most likely create a halo effect for sales of other Apple products. 
The Apple iPad isn't designed to compete with laptops. It's designed to economically compete with netbooks and deliver avenues for monetization of the devices following the original sale. This is about economics, not hardware. For Windows PC OEMs looking at the tablet market, without a robust channel for app and content sales tablets represent nothing but a zero-sum game. 

Saturday, March 6, 2010

AAPL Twelve-Month Price Target: $384 Per Share

Establishing a 12-month price target for AAPL is as much an art as it is a science. Over the past four fiscal years (from October 2005 to September 2009) Apple has averaged an annual rise in revenue of 32.9% and an average gain in eps of 56.5%. These would be astounding numbers for anyone who hasn't been following the company on a daily basis over this four-year period.
Apple (Ticker Symbol: AAPL) closed on Friday at $218.95, an all-time closing high. During Friday's session the shares traded as high as $219.70 on volume of more than 32 million shares. No doubt the nearly 4% rise in share price and above-average demand for shares was due in part to an announcement of the release date in the US of the Wi-Fi version of the Apple iPad. At the current market cap Apple is among a small number of enterprises trading on a US exchange with values near or above $200 billion. No matter the distance the share price has already travelled, further gains in value are ahead.
In Apple's first fiscal quarter of 2010 the company realized about a 32% gain in revenue and about a 47% gain in eps. Clearly the pace of growth in revenue and earnings hasn't slowed. For the fiscal year ending in September, I expect revenue between $57 billion and $61 billion and eps ranging between $13.75 and $14.25 per share. The revenue and earnings performance support my 12-month price target issued last October of $300 per share. 
There are several variables that will impact Apple's revenue and earnings performance over the next twelve to fifteen months. These variables include but are not limited to the successful launch of the Apple iPad, non-exclusive carrier relationships for the iPhone in the United States (including Verizon), the positive impact of additional Apple retail store locations and rising Mac market share particularly in markets outside the United States. In the most recent quarter international sales accounted for 58% of Apple's revenue. 
In developing this price target I relied heavily on statistical trends and the likelihood of continuing strong gross margin ratios due to the positive impact of the Apple iPhone and iPad as well as increasing contributions to revenue from iTunes store sales. 
For the 12 month-period ending in March 2011, I forecast revenue of $66 billion and eps of $17.45. Based on a trailing p/e multiple of 22 times earnings (similar to today's multiple) I've established a 12-month price target of $384 per share by the end of April 2011. 
The price target takes into account the time needed for the financial markets to receive and respond to Apple's March 2011 quarterly results.