Creduit Suisse analyst Kulbinder Garcha this morning reiterates an Outperform rating on Apple (AAPL) shares and a $500 price target, addressing four pressing concerns he has heard from investors, and suggesting Apple could institute a 5% dividend and still have $100 billion in cash in five years from now.
Concerns Garcha outlines are:
- iPad may not have sufficient demand.
- iPhone’s sales may be reaching saturation
- Stock may be too broadly owned at this point to appreciate.
- CEO Steve Jobs’s health is still a concern.
Nyet, says Garcha, to all that:
- iPad has “the mother of all backlogs,” as Apple COO Tim Cook said on the fiscal Q2 call a few weeks ago.
- Apple may have 50% of a 300 million tablet market “longer term.”
- iPhone will ride the wave of smartphone growth of 50% this year and 32% next year.
- Additional carriers around the world picking up the device.
And as for the shares, they are only 2.6% of the S&P 500′s total value, whereas 5% has traditionally been a “ceiling” to any stock, he writes.
He also notes that, “Apple is unique,” with still low market share in many product categories, allowing for growth. Moreover, not everyone owns Apple shares, he notes, as institutional ownership dropped in Q4. “Even though the breadth of Apple shareholder’s increased, institutional holders were underweight the company.”
As for Jobs, well, “this is a valid concern in the long term,” but he believes the company has a “deep bench” when it comes to management, and its proven “execution” on the business shows the company can add $10 of “extra EPS per year longer term.”
Garcha also addresses some product speculation: the Worldwide Developer Conference Apple will host next month (June 6th to 11th) in San Francisco might extend the use of Apple’s Objective-C development environment to “back-end services,” and that might play into any “cloud” computing offerings Apple makes, such as a streaming music service. That, in turn, might set the stage for a cheaper iPhone, with the capability on the server doing the heavy lifting.
As for a dividend, the bulging cash pile — $66 billion at the end of Q2 — is depressing the stock’s multiple, some would argue. The stock has only a 10% premium to the broader market, by forward P/E, down from 38%, on average, last year and way down from 296% back in 2003.
But that’s not warranted, Garcha argues: he sees some opportunities for M&A, something the company has alluded to in past, but the targets, in his view, are few and small, given Apple’s acquisition history, which included chip makerIntrinsity for $121 million, and PA Semiconductor for $278 million.
The cash could also be used for retail store additions, with the potential to add $19 billion in revenue, but that could probably be funded through the annual cash flow, given how “productive” the retail stores are, at $4,600 in revenue per square foot.
Garcha thinks a dividend will come one day…when growth slows: “Despite our optimism on Apple, there will come a day when the company has saturated its end market potential. We believe at that point the company may seek to make investment in the company attractive through a combination of share repurchase and/or dividends.”
Apple shares today are down $3.53, or 1%, at $336.97.
COMMENTARY: Ray makes some valid points concerning Apple, but Apple is a long way from achieving saturation across its product lines. However, there are some factor's that could negatively impact Apple's earnings:
- Energy costs - This is increasing production, transportation and shipping costs everywhere worldwide, and this can put a squeeze on Apple's costs and negatively impact its earnings.
- Inflation - The U.S. is in the grip of a possible inflationary spiral driven by the Fed's Ben Bernanke and his money printing machine, which he has used to buyback retiring treasury debt. With all that cash in circulation, and the banks not lending most of it, many economists are predicting the return of inflatin. The inflation rate for the 1st quarter 2011 was 3.2%, up a full point from the Feds projection. If you project this over the rest of the year, you're looking at inflation in the double figures. The consumer can only take so much, and they begin cutting back on everything, including Apple products.
- Scarcity of Parts - This is a real concern because a lot of the components that go into the production of the iPad 2 are produced in Japan. The recent Japanese mega-earthquake has severely affected production of those components, not only for Apple, but other consumer electronics producers. The news out of Apple is that they have a huge backlog of the iPad 2, which looks good on paper, but could severely affect iPad 2 sales in 2011.
THE APPLE' CASH HOARD
There is good and bad news when it comes to Apple's liquidity. Apple is presently sitting on roughly $66 billion in cash, cash-equivalent and marketable securities. That's impressive, and the most of any Fortune 500 company. $29 billion is in cash and short-term marketable securities (mostly treasury securities and commercial paper). Apple also holds $36 billion in long-term securities. Treasury securities and corporate securities make up $12 billion and $18 billion of the long-term securities respectively. However, with all these riches, Apple is generating hardly any return on that cash, cash-equivalent and marketable securities. According to Seeking Alpha, at the end of December 31, 2010, the return was only $0.22 per share, absolutely abysmal. Apple stock ended the year at $322 per share, so the return is not even worth calculating.
Are these pathetic returns cause for concern? You bet it is. Had Apple invested its cash hoard wisely in the S&P 500, instead of long-term marketable securities, their returns over the last twelve months would be 17.06%. If they had invested in the DOW, their returns would've been 18.16%. This is an over-simplification, of course, because it assumes Apple would not touch those investments and re-invested any dividends.
THE HEDGE FUND EFFECT
Here's something else that may raise some eybrows. 195 hedge funds currently hold Apple stock, representing over 4% of all Apple shares issued and outstanding. That's the most stock held for a single company by hedge funds. If these hedge funds catch a cold sniffle, and begin losing faith in Apple stock, this could cause a stampede to cashin those shares, creating chaos in the market. Here's what Forbes' John Navin says,
"195 hedge funds own this stock. Come on now. Do you think there’s much room for error here? If a difficulty arises, and it will eventually, do you suppose that all of those hedge fund managers will politely agree to get out one-at-a-time in a calm and orderly manner? When was the last time you heard “polite” and “hedge fund” in the same sentence?"
I think Mr. Navin makes a very valid and scary point. Here's the list of hedge funds holding Apple shares through February 2011:
We are already starting to see some of the major hedge funds gradually moving away from Apple stock.
What should you do? We think you should get a second opinion before making any decisions. Here are what other prominent hedge fund managers were doing:
- George Soros - Soros Fund Management: George Soros reduced his Apple (AAPL) holdings by 93K shares at the end of March. He bought 210 K call options, which were offset by a 280 K position in Apple put options. Soros is getting bearish about Apple.
- Stephen Mandel – Lone Pine Capital: Mandel had 1.7 Million shares of Apple at the end of December. He sold about 9% of these, as Apple went up during the first quarter. He had $542 Million in Apple at the end of March, vs. $553 Million at the end of December.
- Phill Gross and Robert Atchison – Adage Capital: Reduced number of shares by 5%. Adage had $503 Million in Apple at the end of March.
- Chase Coleman – Tiger Global Management: Increased Apple holdings by 25%. Coleman had $493 Million in Apple at the end of March.
- Lee Ainslee – Maverick Capital: Increased Apple holdings by 3%. Maverick had $416 Million in Apple at the end of March.
- John Griffin – Blue Ridge Capital: Reduced Apple holdings by 13%. Griffin had $340 Million in Apple most recently, vs. $364 Million at the end of December.
- David Einhorn – Greenlight Capital: Unchanged. Einhorn had $292 Million in Apple at the end of March.
- Eric Mindich – Eton Park Capital: Increased Apple call options by 67%. Mindich had $174 Million in Apple calls at the end of March.
- Barry Rosenstein – JANA Partners: Reduced Apple holdings by 19%. Rosenstein had $83 Million in Apple at the end of March.
- Dan Loeb – Third Point: Increased Apple holdings by 25%. Loeb had $70 Million in Apple most recently.
- David Tepper – Appaloosa: David Tepper initiated a brand new $70 Million position in Apple.
- Alan Fournier – Pennant Capital: Increased Apple holdings by 51%. Fournier had $64 Million in Apple at the end of March.
- Julian Robertson – Tiger Management: Reduced Apple holdings by 34%. Robertson had $28 Million in Apple at the end of March.
- Leon Cooperman – Omega Advisors: Increased holdings by 88%. Cooperman had $28 Million in Apple most recently.
- David Gerstenhaber – Argonaut Capital: Reduced holdings by 67%. Gerstenhaber had $3 Million in Apple at the end of March.
- Ray Dalio – Bridgewater Associates: Reduced holdings by 48%. Dalio had peanuts in Apple.
- Andreas Halvorsen – Viking Global: Sold out. Halverson had 260 thousand shares of Apple at the end of December. He seems to be the most bearish hedge fund manager in this group.
Overall these hedge funds had 9.5 Million Apple shares (excluding Soros’ put options) at the end of March. They had 9.3 Million shares at the end of December.
ACQUISITION PREDICTIONS
So what's the cure for Apple's stock? That's the $64 million dollar question, but buying back their own shares is not a very good option, since it will only minimally increases their earnings per share, and even then there is no guarantee it would drive up their stock price.
There are a lot of different rumors, and I have spread a few of my own, that Apple is hoarding all that cash to make a major acquisition. In my opinion, it doesn't make much sense to acquire small fry. They need a catch a big fish, make a major acquisition. I am guessing that the acquisition will be a fit with Steve Jobs' Digital Hub Strategy.
Steve recognized upon his return to Apple in 1996, that he had to do something radical and gamechanging in order turnaround Apple from the abyss. He also believed that Apple could not survive solely as a computer company. What Steve saw coming was the evolution of a Digital Lifestyle driven by two powerful forces:
- The Internet - A gradual movement away from print towards online digital content.
- Mobile Consumer Electronics Devices - Including portable music players, laptop computers, digital camera's and smartphones.
The Digital Lifestyle gave birth to the Digital Hub Strategy--Jobs' grand vision to reposition Apple as a consumer electronics company, and re-invent the computer as a platform that could be used to record, exchange and store digital content, in any format, so that it could be available on any mobile device. In a blog update dated October 28, 2011, I wrote about how the Digital Hub Strategy had transformed Apple into one of the world's
The Digital Hub Strategy has proven to be an overwhelming success--the iPod, iMac, iPhone, iPad and iTunes now dominate in their market segments. That's a string of major product successes that may never be broken. I don't believe that Steve Jobs will deviate from his original grand vision. Having said this, I am surprised that Apple has not made that major acquisition, but I believe that Apple is buying time until it finds the right opportunity to add another spoke to the Digital Hub Strategy. In fact, I felt so confident that Apple would pull off a major acquisition, I wrote about this in a blog post dated October 20, 2010. I won't disclose what I predicted, but let you read my post and let me know what you think.
CONCLUSION
Sometimes I wonder if too much is made over a company's earnings-per-share (EPS) and price-earnings-multiple (PE) or ratio, key metrics for valuing publicly-traded companies. Apple has experienced quite an impressive increase in value since its low of $241.62 on August 26, 2010. Apple stock peaked at $363 per share on February 16, 2011, and has been on a roller coaster ride since, continually dropping in value only to rise again and about 10 points under its peak in February.
This should not be happening to a company like Apple, because it has everything going for it:
- Management Team - Steve Jobs has grand vision and he has arguably one of the most seasoned management teams in high-tech.
- Great Products - Steve Jobs is one of the greatest "product pickers" of all time--with product successes that would be the envy of any company, including the iPod, iPhone, iPad, iTunes, iMac and iBook.
- Strong Business Fundamentals - Apple's balance sheet numbers, revenues, gross profits and earnings are the envy of any consumer electronics company. It's gross profit margins are the highest of any consumer electronics company. You already know about its monumental $66 billion cash hoard. Apple's market capitualization is presently $309.6 billion, second only to Exxon Mobil Corporation on the Dow Jones Industrials. Apple is now worth more than IBM, Sony Corporation, Intel, Google, GE and Microsoft.
Apple is the victim of its own success. Investor expectations are so high that they border on delirium. If you have been riding the Apple success wave, you may feel that the thrill of riding the wave is gone, so maybe now is a good time to get out and recognize some of that appreciation in value.
If you compare Apple's revenues, earnings and earnings per share over the previous five quarters, the numbers look like this:
- Qtr Ending 3/26/11 - Revenues: $24,667 billion - Earnings: $5.987 billion - EPS: $640
- Qtr Ending 12/25/10 - Revenues: $26,741 billion - Earnings: $6.004 billion - EPS: $6.43
- Qtr Ending 9/25/10 - Revenues: $20,343 billion - Earnings: $4.308 billion - EPS: $4.64
- Qtr Ending 6/26/10 - Revenues: $15,700 billion - Earnings: $3,253 billion - EPS: $3.51
- Qtr Ending 3/27/10 - Revenues: $13,499 billion - Earnings: $3,074 billion - EPS: $3.33
Those are pretty staggering numbers. Of the top computer companies in the DJI30, only IBM comes close in terms of revenues, but its EPS is about a third of Apple's. Google is the only company that can match Apple's EPS, but in the quarter ended March 31, 2011, its EPS came in at $5.51. Apple's was $6.40.
Can any publicly-traded large cap company beat Apple in term of share appreciation? Here are Apple's share prices since May 16, 2006:
- May 19, 2006 - $64.51
- May 18, 2007 - $110.02
- May 16, 2008 - $187.62
- May 15, 2009 - $122.42 (This is during the height of the Great Recession and after the financial meltdown of September 8, 2008. If you don't know of any stock that didn't drop in value during this time span let me know)
- May 19, 2010 - $222.25
- May 18, 2011 - $339.87
Since May 19, 2006, Apple stock has appreciated in value by 397.49%. That's pretty darn good, wouldn't you say? Google is the only company not in the DJI30 with a price per share higher than Apple's. Google's stock ended the day at $529.81 per share. However, Since May 19, 2006, Google's stock price has only increased by 41.61%. Not a single DJI30 company beat Apple's stock appreciation rate. Nobody even came close. Every stock has up-and-down movements, and Apple is no different, but I challenge you to show me another publicly-traded, large cap company in the high-tech sector that has out-performed Apple.
A former Morgan Stanley trader told me just today that Apple stock is over-priced. I look at this quite differently--stockholder's have chosen to reward Apple for its unmatched meteoric performance. They love and have so much confidence in the future of Apple that they have elected to give Apple a premium of 5.15 times its book value per share. You will find very few stocks in the DJI30 that even comes close to Apple's premium over book value per share.
Let's look at at the book value per share (BVPS) for some of the tech stocks in the DJI30 using their book value per share for the quarter ending March 31, 2011 and today's closing price per share:
- Apple - BVPS: $66.73 - Share price: $339.87 - Premium: 5.15
- Google - BVPS: $151.94 - Share price: $529.81 - Premium: 3.48
- Microsoft - BVPS: $6.36 - Share price: $24.69 - Premium: 3.88
- IBM - BVPS: $18.68 - Share price: $170.44 - Premium: 9.12
- HP - BVPS: $18.97 - Share price: $36.49 - Premium: 1.92
- Cisco - BVPS: $8.54 (April 30, 2011) - Share price: $16.65 - Premium: 1.95
I would be more worried about IBM's premium over its book value per share, than I would Apple.
Even more ominous is the premium over book value per share that many of today's hottest internet stocks are getting. Let's look a few using their book value per share for the most recent quarter ended March 31, 2011 and today's closing or estimated price per share:
- SINA Corp - BVPS: $20.28 - Share price: $111.40 - Premium: 5.49
- Sohu.com - BVPS: $27.37 - Share price: $84.38 - Premium: 3.08
- Baidu.com Inc - BVPS: $5.64 - Share price: $131.84 - Premium: 23.37
- LinkedIn (Post-IPO) - BVPS: $3.38 - Share price: $43.50 - Premium: 12.86
- Facebook (Post-IPO) - BVPS: $1.60 - Share price: $28.00 - Premium: 17.5
As you can readily see, some of the premiums being paid for many internet companies, including the top social networks in the U.S. and China, are outright scary. Most of them are running 3 to 4.5 times that of Apple. Who's fooling who?
Two recent social network IPO's, Renren, the "Facebook of China", and FriendFinder, a social dating service, were disasterous affairs. If this is a barometer of what investor's in the public market really think of social networks, then this should be a real cause for concern. LinkedIn has its IPO on Thursday, May 19, and its PE multiple is outrageous given its performance.
Here are a few things for you to ponder when it comes to internet companies:
- None of the above internet companies make anything. Apple makes great products--lots of them. They are sold throughout the world. Apple's combined revenues and earnings exceed the combined totals for the above internet companies. What does Facebook make? NOTHING. They connect people with other people so they can collaborate. How much is that really worth?
- Internet stocks are historically difficult to value because their valuation is based mostly on hype, euphoria and greed and future potential. There seems to be an infatuation with bigness or the number of users for these internet companies. Facebook does not hesitate to remind us that they have 600 million users. This is their biggest selling point when pitching advertisers. I call this the "Facebook Halo Effect".
- There is no real attempt to use quantitative valuation methods that discount future earnings to take into account risk and uncertainty. Valuations are based solely on future potential and not much else.
- Revenues per user for major internet companies (both public and private) hover at $4.50 and less per user, the lowest among technology companies.
- The majority of internet companies use an ad-supported revenue model. The ad-supported revenue model of social networks like Facebook, LinkedIn, SOHU, Baidu and others is deeply flawed. It was a quick-and-dirty attempt by social networks to monetize their user base, and not much has really changed since Friendster started charging for advertising back in 2005. According to WebTrends, social media clickthrough rates are abysmal--the lowest of any media. Social media is essentially worthless for generating revenues. Social media ROI's are almost impossible to measure, because their are so many different metrics being used.
- The ad-supported revenue model of social networks, particularly Facebook, have already reached a critical inflection point. According to my Inflection Point Theory, the total number of users and advertising revenues are finite. Social networks are robbing market share from each other. It's a zero sum game. There is no real differentiation among social networks. Growth in users for the majority of social networks is no longer exponential, and has reached the saturation point in many geographical markets. Growth rates in the number of users and ad revenues will slow down, and both will eventually peak. The only solution is for social networks is to ad additinoal revenue streams--games, apps, check-ins and daily deals are becoming typical among social networks.
I would like to use this simple analogy when it comes to Apple.
The magical "Apple Tree" has been producing an over-abundance of delicious fruit year-after-year. The tree branches are literally overflowing with fruit. A few crop pickers are eager to pick the low hanging fruit so that the Apple Tree can grow even more fruit.
Steve Jobs' sick leave announcement on January 18, 2011 caused only a temporary drop in Apple's stock price. It has since regained all of that loss and then some.
If there is a downside to all of this, there are two of them:
- Hedge funds now hold 4% of Apple's shares. Since the start of 2o11 some of those hedge funds have cashed in some of those shares, but there hasn't been any wholesale exit. In many respects, Apple has almost become a valuable commodity like gold, something worth holding on to. The general thinking is that Apple is a good stock worth holding. All the stock analysts say the same thing. In fact, a few hedge fund manager's have bought more Apple shares.
- The iPad is still top dog among tablets by a wide margin, and I don't see anything changing. Apple also leads in apps by a huge margin, insuring that Apple maintains its lead in the iPhone and iPad. A serious shortage of parts and components for the iPad 2 is only going to temporarily slowdown sales. Eventually the parts will be produced and Apple's iPad 2 backlog will start to decline.
I would like to ad a caveat to the above downsides. Apple has no control over hedge fund investments or a shortage of parts and components. Could these issues have a negative impact on Apple's stock price? Yes, but don't count on it having a huge impact on Apple's share price.
In short, what is wrong with Apple's stock? NOTHING. The company is doing just about everything right and clicking on all cylinders. In January several stock analysts predicted that Apple's stock would eventually hit $400-to-$450 per share. I still believe this will happen. A major acquisition will take care of that quite nicely. Stay tuned.
Courtesy of an article by Tiernan Ray dated May 16, 2011 appearing in Barron's and an article dated March 15, 2011 appearing in Seeking Alpha and an article dated April 25, 2011 appearing in The Register and an article dated May 17, 2011 appearing in The Sax Angle
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