Saturday, January 30, 2010

AAPL: On Sale Now

Beginning in the 1st fiscal quarter of 2010 (the three-month period ended in December 2009), Apple changed its accounting for the iPhone through the elimination of deferred revenue accounting on handset sales. 
This change in accounting method not only created a $3.815 billion increase in the company's previously reported cumulative retained earnings (increase determined by comparing the September 26, 2009 retained earnings line in Apple's 4th fiscal quarter balance sheet released in October 2009 versus the same date's balance sheet released in Apple's 1st fiscal quarter report released in January 2010), it also increased the reported revenue and earnings in Apple's first fiscal quarter and presumably future quarters in this fiscal year as iPhone unit sales continue to grow relative to prior-year periods and virtually all iPhone revenue is reported in the fiscal quarter in which the handsets are sold.
The increase in cumulative retained earnings came about through the elimination of deferred asset and liabilities on the balance sheet directly related to the previously deferred revenue for the popular iPhone.  The difference between the assets and liabilities extinguished in the accounting change was booked as earnings and is now reflected in the retained earnings line on the balance sheet. In other words, through September 2009, Apple earned $3.815 billion more than had previously been reported under the old accounting rules. For value investors and those who make investment choices based on the strength of a company's balance sheet, overnight Apple became much more attractive following adoption of the new accounting rules for iPhone revenue recognition.
A more compelling and popularly watched metric for finding value is the p/e or price-earnings multiple of the company. Under the deferred revenue model for iPhone accounting Apple's share price as a multiple of earnings per share hovered at or above 30 times trailing twelve month earnings. The elimination of deferred revenue has Apple now trading at a p/e multiple of about 18 times trailing 12-month earnings, based on Friday's closing price of $192.06.
In determining the new trailing 12-month p/e ratio or multiple I added Apple's previously "adjusted" net earnings for the fiscal quarters 2, 3 and 4 from FY '09 and the recently reported earnings for fiscal quarter 1 of FY '10 and divided the sum by the number of reported fully diluted shares as of 12/26/09 or the end of the most recent quarter. This 12-month earnings per share number was divided into Friday's closing price and yielded a trailing 12-month p/e of just under 18 times trailing 12-month earnings.
In the fiscal quarter ended 12/26/09, Apple grew revenue by 32% versus the prior-year period and earnings following revisions for the accounting change by nearly 47%. Apple is currently trading at a p/e multiple reflecting only 40% of the most recent quarter's earnings growth. Try and find a better value among large cap stocks.

At a p/e multiple of 18 times trailing 12-month earnings long-term investors may find Friday's closing price as an excellent entry point. 

Monday, January 4, 2010

AAPL @ $300 Per Share Explained

I've had a number of questions on the Apple Finance Board concerning my $300 per share 12-month price target for AAPL. I published the target in October and expect on or before the end of October 2010 for AAPL to surpass that price.

Below is a simplification of my reasoning and why $300 per share is moderate price target and not an aggressive target as some might think. 

AAPL currently trades at a trailing 12-month price-earnings multiple of over 34 times GAAP earnings. That's as of today's closing price of $214.01. This p/e multiple might give some investors reason to pause and consider Apple's rate of continuing growth and the prospect for further share price appreciation. While Apple continues to grow, maintaining a p/e multiple of over 34 times trailing earnings would be a challenge because future revenue and earnings growth would be expected to moderate to a more sustainable long-term pace.

But the current p/e multiple is based on GAAP earnings which includes deferred revenue recognition on iPhone unit sales. Using Apple's non-GAAP numbers as published in the quarterly earnings releases indicates a much different earnings outcome. For the fiscal year ended in September and including all iPhone revenue in the quarters in which the sales were made, Apple's net profit was about $8.750 billion, not the $5.72 billion with iPhone revenue and earnings deferred. Using the end of fiscal year count of fully diluted shares, Apple's earnings per share works out to $9.56, not the $6.25 reported under GAAP. 

Using the non-GAAP or "adjusted" earnings of $9.56 per share, AAPL currently trades at a multiple of about 22.39 times trailing 12-month earnings and below the current pace of organic "adjusted" revenue and earnings growth. This p/e multiple is about one-third lower than the p/e based on GAAP results.

By the end of this fiscal year Apple must adopt a different revenue recognition model for the iPhone based on the changes in accounting rules the company actively advocated to have adopted. Following adoption of the news rules virtually all iPhone revenue will be reported under GAAP in the quarters in which the revenue activity occurred. To make historical comparisons accurate, I expect Apple to restate financial reports for the past three years, increasing reported revenue and earnings in line with the company's "adjusted" or previously non-GAAP results for those years.

I've published preliminary FY 2010 revenue estimates that suggest Apple could grow "adjusted" revenue by 40% over FY 2009 based in large part on a doubling or more than doubling of iPhone unit sales. For the sake of discussion, we'll assume "adjusted" earnings this fiscal year grow at a rate of 35% pending the change in accounting method for the iPhone. Applying 35% eps growth to last fiscal year's $9.56 yields an eps for the year of about $12.91 per share. Applying a moderate p/e multiple of 25 (less than the rate of trailing revenue and earnings growth) would price the shares at about $323. Using today's modest p/e multiple of 22.39 on "adjusted" earnings would value the shares at $289.

This is an oversimplification of the justification for my $300 price target first published in October. I will provide a revised 12-month price target following the release of 1st fiscal quarter results later this month. 

Saturday, January 2, 2010

The Apple Tablet And Why It Will Succeed

One of my favorite stopping points on the Web is Philip Elmer-DeWitt's Apple 2.0 column. I appreciate Philip's prolific updates and the gamut of topics he covers. 

A few of his recent columns have covered the forthcoming Apple tablet device. Inevitably, due to the exposure his columns receive, many of the comments from readers tend to fall into one of two camps - comments from those who love Apple products and comments from those who hate Apple and Apple products. Discussions about the much-rumored Apple tablet is the latest frontline in the ongoing verbal skirmish between the partisans. 

In discussing this much-rumored device those who insist it will somehow fail even before it's released see only a hardware device. Most expect it to be an outsized iPod touch. These naysayers claim it will be too expensive and will fail because of the price. Those who are supportive of this yet to be announced product claim it will succeed citing the success of the iPhone and the iPod touch as evidence of Apple's uncanny success with hardware devices.

Although I believe this product will succeed, my view is based neither on its price (unknown) nor because of the iPhone's success. While the success of the iPhone and iPod touch suggest Apple can (and will) deliver successful products in the future, my view is based on the belief content drives hardware sales. I've mentioned this axiom before.

I believe the forthcoming Apple tablet (in addition to what's expected to be a superb product design) is coming to market to drive sales of apps and commercial content. The iPhone, iPod touch and the forthcoming tablet are essentially constant content sales devices. From music to movies, to games, to apps to newspapers to magazines, the tablet, similar to the iPhone and iPod touch will build the iTunes Store economy. 

What's unique about a tablet-sized device is that is it a better venue for the consumption  of visual content such as movies, TV shows, sporting events designed for a larger screen and magazines transitioning from a traditional print format. 

Recalling Marshall McLuhan's legendary statement "the medium is the message," an outsized iPod touch will profoundly change the manner in which the message is delivered and received. In other words,  the tablet is a movie screen to the iPhone's TV-sized screen. The tablet device will inebriate the senses. Viewing or interacting with commercial content and apps on an iPhone or iPod touch takes work. No matter the proportional ratios, the imagination plays a role in viewing content or even playing games on the devices. We tend to imagine a field beyond that which is offered on these handheld devices. The Apple tablet will provide for more content to be viewed or consumed on a much larger screen presence, changing the way we view and enjoy what's offered.

Those who suggest the product will fail may be looking at the Apple tablet as a hardware device, not as a visual portal designed to enrich the user experience. The experience will sell the device, not a review of the hardware specs.

Effectively positioned, the tablet will help further define the market for the iPhone and the iPod touch. Ironic as it sounds, the tablet will assist in expanding the market for both of those devices. For example, anyone who has ventured to a movie theatre to see a much-anticipated new movie on the big screen tends to enjoy it no less when viewed again on a TV or laptop. The initial experience at the theatre is rekindled when viewed again, even if the visual field of the device is smaller. As a companion product the tablet will expand the market for iPhone OS-equipped devices.

As this new product debuts we will see an expansion of apps and commercial content to support it. It will drive iTunes Store sales of commercial content and new games and apps specifically designed for its screen dimensions. It's an expansion of the product paradigm, not a product to be viewed outside its relationship in the product paradigm no matter the size of the screen.

Friday, January 1, 2010

AAPL Fiscal Year 2010 Revenue - Simply Staggering

In reviewing Apple's fiscal year results for the 12-month period ended in September and working with the non-GAAP "adjusted" numbers which reflect all iPhone revenue in the quarters in which the units were sold rather than Apple's reported GAAP results that defer revenue recognition on iPhone sales over the anticipated two-year economic life of each unit I arrive, at the following results:

Fiscal Year 2009 revenue of $42.85 billion (based on Apple's published statements)

Net income of $8.75 billion

EPS of about $9.56 based on 915 million fully diluted shares outstanding at the end of the year

These results are no doubt impressive. During the fiscal year Apple shipped 20.731 million iPhone units, 10.393 million Macs and 55.007 million iPods including the popular iPod touch.

Using non-GAAP "adjusted" numbers as the basis for a FY 2010 revenue forecast and factoring in a 110% growth in iPhone unit sales for the fiscal year as some have suggested, I arrive at 43.5 million units sold and "adjusted" revenue of over $26 billion for iPhone-related revenue activity. Estimating 20% Mac unit sales growth at a constant FY 2009 ASP (average selling price), 5% growth in iPod unit sales at a similar constant ASP and 10% growth in Other/Non-iPhone revenue, I arrive at a total "adjusted" revenue forecast for the fiscal year of about $60 billion in revenue, an increase over FY '09 of over $17 billion or 40% increase in revenue for the fiscal year. 

Obviously iPhone revenue is the catalyst for explosive growth in FY 2010 and I will adjust my projections following the first fiscal quarter's results and the announcement of the new Apple tablet at end of January. 

Following formal announcement of the new device, projections of Mac unit sales growth will need to be revised and rising sales of the iPod touch will impact iPod revenue in the fiscal year. This preliminary revenue projection is a rough estimate based on current revenue trends.