a bite of apple

8/3/2019 A bite of Apple

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My bite of the Appleupdated: 9/27/2011 (fall 2011)


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The theme-business With the dropping of Computer from its name, and the introduction of

iPhone, the era of Apple is coming back, at a larger stage. Apple now is a

4-cylinder engine: Mac, iPod, iPhone and iPad lines, and each is a power

house. Each segment is a $10-20 billion business.

As the only vertical integrated PC software and hardware maker, Apple

had lost itself in the WinTel world for more than one decade. iPod saves

and lifts this company, causing so called Halo effect and helped increase

Apples market share in PC from less than 3% to 10% ( in US). However, it

is iPhone that is the real game changer, for Apple as well as for cell phone

and PC industry. iPadis yet another evidence of Apples strength in

innovation and yet another indication that next big thing from Apple could

be around the corner. Apple is the only $200+ billion company(market value) that still grows at

50% rate. Apples unique tracking record of innovating into a new field and

dominating that category defies the rule of too big to grow fast to some

degree.


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The theme-stock

As of 9/27/2011, the market stock price is around

$400, and we believe its fair value is around $500.

Considering its potential growth in next 5 years,

continuous growth from innovation in the long term,

and rich free cash it has accumulated and continueto generate, it is still very cheap with a 15 PE.

AAPL has been a very volatile stock for the last three

years and will continue to be. The combination of its

risk and return offers great opportunity for patientinvestors who buy growth at value price.

Recommendation: BUY Disclaimer: this is an example of stock analysis for educational purposes. The professor is not

endorsing any stock in this class.


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Business Analysis-Macro Economy

The state of our economy (also see separate slides). The state of the overall stock market.(see stock

history)

The impact of slowing economy on AAPL products

Products sold at premium price would suffer

Some purchases will be postponed, but not discarded

Innovative products at its early life cycle will still grow

Financial strength

A strong balance sheet with enough cash is an important

competitive advantage


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Business Analysis-Industry Analysis

See separate slides for smart phone and PC

industry analysis


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Business Analysis-The Products

Overview: Segments, size, market share and

growth. Mac (hardware and software): 14M units ,4% PC share; 30+% growth,

3 times industry average. Down to single digits during recession.Rebounded to 32% growth in 2010.

iPod (also iTune, and accessories): 50M units, 70% US market, negative

growth. Down 7% June09 Q , first decline since introduction. Will

decline at 10% rate

iPhone: 10M + units 2008, 20M 2009, 40M 2010. huge growthpotential, might reach 100M in 2013, and 150M 2015. The King of the

iEmpire.

iPad: 10M first year of introduction, 20M 2011, 50M 2015


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Business Analysis-The Products-iPad

Tablets Demand-why users want it? When

Travel, at home or in class

What

Web

Email

Video (youtube, Netflix, iTune, Hulu)

Ereader, enhanced books, textbooks (interactive features)

Create documents

Other: games, music

More for individual than for business use(?).

Realtor, Spaceship

Conferences


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Business Analysis-The Products-

iPad

Tablets Demand-more on e-textbook

The rising e-textbook tide

Publishers are embracing e-textbook at a very fast

speed. In fact, many text books now have a e-version

E-textbook has very little marginal cost

E-textbooks are not resalable (unlike used books,

publisher and authors always get paid)

E-textbooks offer interactive features for homework

and exams, and many more.

A hardware is needed, cheap and capable. (iPad?)


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iPad

Post iPad launch and the users

Users love their iPads

3.2 Million sold in June Q

Production cannot meet demand


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iPad

Post iPad launch and the tablet industry

The surprise

$500 is a bad surprise for competitors

iPad an extension of phone OS, not Mac OS

Always on, long battery, not Hot!

The Consequence

HP, Microsofts failed first strike

Delayed launch of other tablets

E-reader price war

Current competition (Lenovo, Dell, Android)

Future competition


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Business Analysis-The Products-iPad

How WinPad can win?

Match features

Price

OS: Win 7 mobile OS, system always on, no starting

time Battery

Form-weight, thickness

Apps

Differentiate MS Office, Flash

Connections with other devices, print

Different forms (7, 5, 11..)


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iPad

iPad Strength

Apps

Price-$499 Battery-10 hours

iPhone OS: easy to start, always on, low consumption of power

Fast, no virus, no pop ups, no frozen screen

Weakness

No openness (store files, play video and music from other sources)

No Flash

No real keyboard

No MS office


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iPad

iPad sales, profitability and stock value added

Commands 30-50% share of tablet market

6 million units for fisical 2010 (twice the units of

all kindles sold so far), 20 mil 2012.

Gross Margin: 35%

iPad standalone stock value: $45 B, or $48/share

Sales=$600*20M=$12b Operating Profit: 12*35%=$4.2b Net Profit:

4.2*70%=$3b

Assuming PE=15 3*15=$45b market capitalization


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Business Analysis-The Products-iPhone

Quick survey

satisfaction

Smart phone ownership and satisfaction

iPhone ownership and satisfaction

Other smart phones satisfaction

Plan to buy

Buy iPhone Buy other smart phones

Why like iPhone?

Why not?


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Strength Non-defendable

All-in-one pocket device Full screen Touch (vs. keyboard, tracking ball), (Win vs. Dos), important

for applications (calculator, etc..) Ease of use An evolving phone: your phone gets better without hardware

upgrade Defendable

The brand (innovative, cool, high quality, premium brand) Multi-touch:

Critical for small screen device, great for internet Protected with patent, challenged by Palm Pre, and more challengers to come. Just sued HTC, and

Google could be next

App store iTune Ecosystem: (medium file manager and on-line store)


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Weakness

Real issue A closed system

The exclusive carrier: smart decision or not?

The data fee: an opportunity for a no-data fee competitor?

Non-issue The battery: not enough for a heavy duty day

The keyboard: Need hepatic feedback?

The device price

The features: what should be included and what shouldnot?

Weakness from your user experience


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Business Analysis-The Products-iPhone The iPhone-competition

Competition: Is the Storm coming? Is it time for Dream?

New Entry:

Traditional phone makers

Smart phone only makers

New comers

PC guys: Dell, HP, Lenovo, Acer

Create and continue dominance like iPod? Or fade away like Mac before

Possible outcomes of smart phone industry

Co-existence of several major brands, hardware and platforms

A dominant player (winner takes all)

A universal operating platform ( Google, WinMobile)

Projection of smart phone industry market share in 5 years


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The iPhone: sustainable competitive advantage

Strategic Strength

Strength

Software and applications: smart phones will be software centered

Hardware: a fashion statement

PC expertise: the phone feature is less important, and the computer featuresare the differentiator

The App store and iTune

The brand

The customer loyalty: the highest among competitors, always

The focus and economy of scale


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Strategy It is the software!

Old game (hardware) vs. Apple (Software)

I dont see new form factor in the near future

Using App Store to distinguish from competitors

Get iPhone/iTouch to mass market

Making development tools easy to use

More App, less in-house software

Using iTune content to distinguish ..


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Business Analysis-The Products-the Mac

StrengthSoftware

Relatively free from most viruses

Fast speedMost applications are free

Hardware

Design driven (first all-in-one design)

First to see the desktop to laptop trend

Strong brand in US, especially college( Hollywood?)


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Business Analysis-The Products-the Mac

WeaknessSoftware

Win compatibility, pose long term

threatLack of applications

High price

Less brand recognition outside US,especially developing countries

Penetration in business not successful


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Financial Forecasting

Top-down product driven approach

Sales

Revenue driver

Market share: (Too big to grow)

Units

Average Selling Price (declining ASP)


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2008 Sales Sept 2008: Mac 10M, iPod 54M; iPhone 10M

Market share: 3.4%PC, 45%MP3, 1%Mobile,7%Smart

ASP:

Some Software sales are more related to the total installed

base than new sales, like an operating system upgrading

iTune revenue is more related with the installed base of iPod

iPhone, new accounting rule


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Profits and margins: from top line to bottom line

Gross margin

Competition will force price cut and reduced margin

Component cost declines over time

Mac, iPod: historical average

iPhone:

Operating margin

Economy of scale. Fixed cost is fixed, average cost down, Net

income increase faster than sales and profit margin graduallyimproves

Profit margin

Interest

Tax


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EPS

EPS=Net Income/Number of shares outstanding

Number of shares: SEO, normal Dilution, option

grants


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Stock Valuation

PE approach

Forward PE

Five year super growth P/E model

Simple and useful

Financial forecasting beyond five years is of little value

Five year super growth: growth will eventually slow down

due to competition and rule of big numbers

Assuming industry average P/E in five years


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Stock Valuation

Sensitivity Analysis

Future=uncertainty

Output depends on inputs and model

Map possible inputs and output (price)


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Stock Valution

Free Cash Flow(FCF) model

Consider FCF as the theoretical dividend that can

be paid

It works like a two stage dividend growth model


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The moat Definition of moat:

Long term sustainable competitive advantage

Wide: The company still owns the market if it stands still

for five years

Narrow: The company can stay ahead of its competition ifit keeps moving faster than competitors

None: The company can be outpaced by competition any

time

Components of moat: Switching cost, network effect,scale of economy, brand, intangible assets

Google, Facebook, MSFT,NFLX,Railroad, Utility


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The moat: Apple-Narrow but growing

The brand commands premium, and enjoys

loyalty

Q: who is willing to pay premium for those brands

AAPL, Dell, SONY, Tiffany

The innovation is not a one-time wonder

Apple II, Mac OS, iPod, iPhone, iTune, App store


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The moat: Apple-Narrow but

growing

Is there a switching cost?

In class survey: will you switch?

iOS: Users do not want to switch OS. There is a

time cost of learning

Apps: they cost money, contain personal

data(1password, notes, iBook) and wont work on

other OS. Content: music/video purchased from iTunes with

protections.


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The moat: Apple-Narrow but growing

Network effect: The value to individual users increasesas more users use the product/service.

the more users of iOS, the more developers, the

more Apps and the more users. It is a good cycle,like a rolling snow ball.

Facetime, Game center

The gravity of mobile OS will concentrate on iOS

and Android. Together, they may take 50%-75% of

smart phone and tablet market


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The risk

Steve Jobs: The priced in expectation is that he will stay active as CEO for a

least 5 more years(60 years old) and probably less than 10 years (65). If he

stops working for health reasons, AAPL might lose $25b to $50b value

instantly. Any speculation of his health will also cause the stock price

fluctuate in a large range

Competition: AAPL is not Microsoft at any fronts it competes.

Enemies:

Enemy number 1: Google. Competes with AAPL on mobile OS, Tablets, internet TV,

and possibly music.

Enemy number 2: Microsoft

Smart phone family: NOK, MOT, HTC, Samsung, RIMM Price and margin pressure


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The risk

Disruptive technology: like Cloud computing does to

Microsoft, Smart phone does to Nokia.

Double Recession: we should still see growth, but slowed

down.

Regulation: not a big concern as Soft or Intc, but a growing

concern

Quality issue, product failure

Antenna gate for iPhone4.

Explosive iPod in Japan

White iPhone delay

Lawsuit: patent lawsuit banned it from delivering smart

phones.


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Bulls vs. Bears

The Bear

Too big: AAPL has a market cap higher than Soft, and the only

direction from top is going down.

Valuation: Current valuation is still high, compared with Soft

and Intc.

Android: Competition like Android is catching up

Margin: Margin might collapse because of competition

Growth: Growth will slow down. Rule of big numbers.

Double dip


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Investing Strategy

Ladder Approach

Buy at 20% discount

Overweight at 30% dis

Leap call option at 40% dis

Short term call options at 50% discount


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a bite of apple

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