Technology: Apple, Inc. (NYSE: AAPL)

Krause Fund Research Fall 2010
Technology
Recommendation: BUY
Analysts Alex Christ, Krause Fund Analyst alex-christ@uiowa.edu Baylee Rosonke, Krause Fund Analyst baylee-rosonke@uiowa.edu Jostten Sackitey, Krause Fund Analyst jostten-sackitey@uiowa.edu
Apple, Inc. (NYSE: AAPL)

November 14, 2010 Current Price $308.03 Target Price $350-370
Bite Into This Worm-Free Apple
Apple has continued to ride the momentum of the iPhone, which is now its largest revenue generator. We expect sales to increase 22% to 48.7 million units this year as demand continues to expand both domestically and abroad. The iPad showed strong initial performance with sales of 4.19 million units in the first nine months of 2010. We expect sales to increase exponentially in 2011 with 26 million projected units sold. Apples strong financial position, including approximately $50 billion in cash and securities and an additional $11.3 billion in cash and marketable securities projected for 2011, ensures Apples financial stability. Due to increased competition in its product markets and expensive production costs of the iPhone and iPad, Apples gross margins will contract slightly in 2011 to 38% from 39% in 2010. Additionally, we expect gross margins to deteriorate slightly in the coming years as competition intensifies in Apples major product areas. While Apple is hugely successful at selling iPhones and iPads, these products are cannibalizing sales for the iPod product line. We expect moderate decreases in units sold of about 7% per year for the iPod until 2013.
Company Overview
Apple, Inc. (AAPL) is a global designer, marketer, and manufacturer of computer and consumer electronic devices. The firm is headquartered in Cupertino, California, and was originally known as Apple Computer due to its focus on the Macintosh (Mac) personal computer. Since the early 2000s, a successful revamp of the Mac product line and development of new products, such as the iPod and iPhone, have transformed the company into the worlds largest technology firm. Apple, Inc. is also the second largest company listed on the S&P 500, with a market capitalization of $282 billion. In January 2010, Apple released the highly anticipated iPad and sold approximately five million units in the first nine months.
Stock Performance Highlights

52 week High 52 week Low Beta Value Average Daily Volume $321.30 $188.68 1.08 19.08M
Share Highlights
Market Capitalization Shares Outstanding Book Value per share EPS (ttm) P/E Ratio (ttm) Share Performance (ttm) $282.56B 917.31M $52.55 $15.41 19.99 +50.66%
One Year Stock Performance

60% 50% 40% 30% 20% 10% 0% 10% 20% Jul10 Aug10 Sep10 Mar10 May10 Feb10 Nov09 Dec09 Apr10 Oct10 Jun10 Jan10
Company Performance Highlights

ROA ROE Revenue 5-Year Historical Revenue Growth 18.64% 29.32% $65.22B 238%
Financial Ratios
Current Ratio 2.01
Figure 1: Blue: AAPL; Red: S&P 500 source: Yahoo! Finance
Important disclosures appear on the last page of this report.
Investment Thesis
Based on our valuation analysis, we believe Apple, Inc. is currently undervalued, at a current price of $308.03. Our BUY investment recommendation is based on Apples current industry momentum and future growth outlook, driven by new iPhone and iPad product launches. Additionally, Apples financial position, diversified product offerings, and brand name value have allowed it to quickly become a dominate competitor within the consumer electronics market. We have instituted a target price range of $350 to $370 dollars based on our valuation models, which represents a 13.7% to 20% premium on the current market price. Apple, Inc. is currently undervalued; strong product momentum and growth rates will allow the stock to appreciate in the nearterm. Apple has remained profitable throughout the recent economic downturn. We believe that Apple will continue its trend of releasing innovative consumer products, which will enable Apple to outperform its competitors over the next 12 to 24 months.
growth will remain subdued over the next year, with GDP likely to grow a meager 2.7% in 2011. We also took into account the rebuilding of corporate inventories and the weakness in consumer consumption, which traditionally represents 70% of GDP. However, as the economy continues to gain traction, we expect GDP to continue to grow in 2012, likely exceeding 3.25% as the general economy and consumption experience improves.
U.S. Real GDP Growth
6.0 4.0 2.0 0.0 2.0 4.0 6.0 8.0 2006 2007 2008 2009 2010 2011 Q1 Q1 Q1 Q1 Q1 Q1
Figure 2: Real GDP Growth 2006-2011
Economic Outlook
Overall Economic Outlook: The United States economy remains unsettled as it continues to recover from the economic recession, but there are clear signs that the economy will begin to expand steadily, albeit slowly, over the next 12 to 18 months. The National Bureau of Economic Research concluded that the worst recession since the Great Depression officially came to an end in June 2009 after 18 months, during which the S&P 500 lost nearly 60% of its value1. However, over the last five quarters, the economy has shown mixed signals regarding its ability to recover. A strong economic outlook at the beginning of the year was quickly undermined by the expiration of the homebuyers tax credit and completion of inventory rebuilds by corporations, highlighting the inability of the economy to find a solid foothold for expansion. Recently, improvements in leading indicators and the Federal Reserves $600 billion package of economic stimulus suggest that the economy will slowly begin to improve. We forecast small, but positive gains over the next year. Our positive economic forecast strongly affects Apples operations. We believe there is only positive economic upside to the firm in the next 12 months. Despite current high unemployment and declining consumer spending, Apple grew net sales 52% in 2010, up from 14% in 2009. This high growth comes in periods where consumer sentiment was low, indicating Apple has a strong brand image and loyal customer base within the consumer electronics sector. We believe that the recovering consumer will contribute to even greater near-term growth for AAPL. GDP: The Gross Domestic Product (GDP) is a broad measure of the overall health and performance of the American economy. For the third quarter of 2010, real annualized GDP rose slightly to 2.0% from the second quarters meager 1.7%. We expect that Technology companies, including Apple, are heavily dependent on overall market indicators, such as GDP growth due to consumer sentiment exposure. Technology companies rely on the strength of consumer and business sectors to fuel revenue demand and growth. Our modest GDP forecast indicates that growth and demand in the technology sector will improve, but not at a high rate. Additionally, the GDPs of other major countries are another important consideration for Apple. The United Kingdom grew at an annualized rate of 2.8% as of the third quarter of 2010. Germany saw similar moderate growth of 2.2%. Both rates are above the growth seen in recent years, but like the United States, this is still below what is necessary to push Europe into an economic expansion. The economies of India and China have experienced strong growth, with India growing 8.8% and China growing 9.6% over the last quarter. Technology companies, such as Apple, are exposed to international economic health because a large portion of revenues originates from out of the United States. Additionally, outside markets are a key source of potential growth. Consumer Confidence: Consumer confidence remains low, but has shown steady improvement over the last few months. We anticipate consumer confidence to continue improving slowly throughout the near term. The University of Michigans Consumer Sentiment Survey rose to 69.3 in November, the highest level since June 2010. Despite this increase, consumer sentiment is still below the 70.0 level , which would represent the end of recessionary pressures. The Conference Board Consumer Confidence survey echoes this thesis, with an October measure of 50.2 that is slightly above September numbers. Both surveys indicate that the economy is sending relatively mixed signals to the consumer. The weak housing market and high rate of unemployment are
GDPGrowth(%)
currently keeping confidence low. One positive sign in the Conference Boards survey was a rise in the expectations portion of the indicator. This rise in expectations served as the major upward driver of the October gain in consumer sentiment. We expect the Consumer Sentiment Survey to show modest gains over the next 12 months, with the index reaching 78-80 by the end of 2011. Consumer confidence traditionally trails other economic indicators and is heavily based on improvements in other sectors of the economy. This indicator should improve as the economy trends towards expansion and quantitative easing generates economic growth. Consumer confidence can have a large impact in the technology sector. The technology sector is often seen as a bellwether to the economy because it is driven by business and consumer demand.2 An increase in consumer confidence will correlate with higher consumer spending, so the technology sector, especially consumer products based companies such as Apple, will benefit.
Consumer Sentiment 2007 - 2011
as the iPhone and Mac, the uptake in spending in this sector is important going forward. Cash on Hand: The cash companies maintain on their balance sheets is a strong indicator of the business climate. Cash hording represents a weak future outlook as firms create a buffer against week demand and operations. Conversely, a decrease in cash represents a positive economic outlook as businesses spend and are comfortable with lower cash balances. The recession increased the cash on hand of firms to the highest levels as a percentage of assets in nearly 50 years, with $1.84 trillion held globally by non-financial companies at the end of the first quarter of 2010. Technology companies represent a large portion of this cash balance, with $207 billion held at the beginning of this year. We expect technology firms to decrease cash balances by 15% over the next year as the economy improves. The acquisitions market will primarily drive this spending, as companies begin taking advantage of large cash balances. Acquisitions are the primary way technology companies spend their large cash balances. This trend is already visible with large acquisitions such as Intels $7.8 billion purchase of McAfee during the middle of 2010.6 At the time of purchase, Intel had $20 billion in cash reserves. We expect companies with large cash balances, such as AAPL, to look towards acquisitions over the coming months in order to drive growth. Unemployment: The unemployment outlook in the United States is bleak, and we expect only minor improvements in unemployment over the next 12 months. As of October, the unemployment rate stands at 9.6%, and we believe the rate will likely reach 10% before economic stimulus begins to cut down this number near the end of 2011. The labor market is a fundamental weakness in the economy, as illustrated by its lack of improvement in the beginning of 2010, when the U.S. experienced overall economic gains. However, there have been some positive signs, with October 2010 seeing non-farm payrolls increase by 151,000, a number cited as the minimum number of jobs created monthly needed in order to spur overall employment gains.4 Another indicator the labor market is gaining traction is initial jobless claims. The most recent number for weekly initial jobless claims is 435,000 jobs; this is the lowest four-week moving average of the year. We expect the unemployment rate will decline to 9.4% by the end of 2011. This improvement will be driven by improvements in the business sector, as the economy recovers from the recession.
100.0 90.0 80.0 70.0 60.0 50.0 Jan07 Jan08 Jan09 Jan10 Jan11 Jul07 Jul08 Jul09 Jul10 Jul11
Figure 3: University of Michigan Consumer Sentiment Survey Consumer Spending: The United States is likely to experience weak consumption throughout 2011, as it has over the last 12 months. While both personal income and consumption are up 3% over the last year, recent monthly changes remain flat, with income actually declining 0.1% in October and consumption increasing a modest 0.2%.3 The weak trend indicates consumers do not have the ability to drive the economy forward due to high unemployment and stagnant wages for those who are employed. We expect personal income and expenditures to both remain modest, at monthly growth of less than 0.5% for 2011, as the economy recovers. The recovery is currently being buoyed by government spending, which must trickle through the business sector before the consumer will see strong general improvements. While this result appears likely, it will take time for the impact to be felt by the consumer. Consumer spending and income is important for technology firms such as Apple. Increases in both metrics indicate an increase in the ability and willingness of consumers to buy. A recent bright sector in consumer spending was an increase in durable goods consumption, which increased 0.7% in October. Since many of Apples consumer goods are durable goods, such
Unemployment Rates 2007 - 2011
11.0 10.0 9.0 8.0 7.0 6.0 5.0 4.0 Jun-07 Oct-07 Feb-08 Jun-08 Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11
Unemployment (%)
earnings to support debt, and they need a low amount of capital to run their operations, compared to other industries. Instead, debt is used primarily as a tool for merger and acquisition financing. Recently, large mature technology companies have found low interest rates to be a cheap source of capital, with Microsoft and EBay each using three-year bonds at a record corporate rate of 0.875%. We do not believe that Apple will seek to finance any operating or M&A with debt in the foreseeable future, but the firm would likely command yields similar to MSFT due to its high cash flows and stable operations.
Industry Overview
Originally known as Apple Computer, Apple Inc. has evolved from a computer manufacturer to a digital electronics manufacturer. Apple competes on an international level with many well-funded, strong brand name competitors in each of its product segments. AAPLs major product markets include the personal computer market, the mobile smartphone market and the digital music player market. Personal Computer Market: The personal computer market can broadly be divided into desktops, laptops, and tablet computers. Apples Mac line competes within all three market segments. As of the 3Q2010, the five largest computer hardware manufacturers made up 80% of the market5. Major computer manufacturing companies are provided in Figure 5 below.
3Q 2010 PC Unit Market Share Leaders
Figure 4: Unemployment Rate (%)
Similar to consumer confidence and spending, the unemployment rate is important for technology firms because the consumer sector drives firm revenues, specifically for consumer products. The technology sector was able to weather the recent recession well, despite its dependence on the consumer and there will be only upside to a strengthening American consumer. A strengthened consumer will translate to higher spending on technology products and a stronger overall outlook for the sector. Interest Rates: Interest rates directly impact corporate growth by determining the cost of borrowing capital. The Federal Funds Rate, a fundamental driver of bank interest rates, has remained steady at 0-0.25% since the financial crisis. We expect the Federal Funds Rate to remain at this level over the next 12 months due to fears that an increase in the rate might stymie an economic recovery. On November 2nd, the Federal Reserve announced a quantitative easing commitment of $600 billion to aide economic growth. This commitment will have the same effect as lowering the Fed Funds Rate, which supports our hypothesis that the Federal Reserve does not intend to raise rates in the near term. Given the announcement, we do not believe that the Federal Reserves outlook on the economy will become optimistic enough to raise the Fed Funds Rate in the near-term; after 2011, the FOMC may choose to raise the rate marginally. A second driver of interest rates and corporate debt financing is U.S. Treasury yields. November 2010 auctions of the 10-year Treasuries yielded 2.63%, which is near the all-time low, while market yields on 10-year Treasuries have spiked to 2.83% recently due to the Federal Reserves quantitative easing. As the economy continues to recover, we expect Treasury rates to decline slightly over the next few months due to the influx of money from the Federal Reserve. Rates should begin to rise slowly during 2011 as the recovery progresses, with an upside to the U.S. 10-year Treasury in the range of 3.10% by 2011. Looking farther, we are optimistic that the 10-year Treasury could reach levels of 3.75% in the latter half of 2012 as the economy speeds up. Interest rates do not have a strong impact on the technology sector because these firms tend to prefer the use of equity financing. Technology firms do not typically have the stable
HP Dell Acer Apple Toshiba Others Figure 5: Market Share of 3Q Computer Shipments Desktop Computers From 2005 to 2010, the U.S. computer manufacturing industry managed 0.9% annual growth. During that time, computer prices have fallen 11.6% annually and imports now represent 80% of U.S. domestic computer demand. We anticipate Apples annual revenue for desktops to decline by approximately 6% each year through 2015.6 This expectation is slightly more optimistic than IBISWorlds expectation of 7% annual declines through 2015 for the entire industry. Leading this revenue decline is falling computer prices and saturation of the desktop computer market. From 2005 to 2010 U.S. personal computer penetration has increased from 67% to 77%, and we expect this figure to continue to rise as computers become more affordable. Computer manufacturers, such as AAPL, anticipated the commoditization of PCs and diversified product offerings accordingly. The price decline in PCs has boosted demand for
the computer-related goods and services many technology companies, including Apple, provide. Laptop Computers The portable computer segment has recently grown, despite an overall decline in the computer manufacturing industry. Desktop computers accounted for 44.2% of computer manufacturing revenue in 2007 but in 2010 are expected to account for only 36.4% of the revenue. Portable computers are anticipated to constitute 46.7% of personal computer industry revenue in 2010, despite declining prices.6 Apples series of MacBooks enables Apple to continually take advantage of the growing demand for laptop computers. Tablet Computers The tablet computer market is a young but high growth segment of the personal computer market. Apple recently launched the iPad tablet computer and sold three million units in 80 days. According to Strategy Analytics Apples iPad currently has 95% of tablet computer market share. Apple sold 4.19 million iPads, a 26% increase from the previous periods sales of 4.4 million units.7 Apples current market domination may soon be adversely affected by increased competition. Many competitors including RIM, Hewlett-Packard, Co., Motorola, Inc. and Samsung Electronics Co. are venturing into the tablet computer market.7 Tablet computers are able to occupy the space between smartphones and laptops. Despite increased competition, we anticipate Apples continued market domination due to its compatible applications via the iTunes Store and highly valued user experience. Apple may suffer from increased cannibalization as the iPad increases in popularity. Consumers may choose to purchase the iPad in place of a MacBook or iPod. Supply Trends A recent trend in the computer market is the development of high performance computers with low prices; this is primarily driven by input costs for components such as CPUs and memory. Computer manufacturers have recently shifted towards solid state hard drives (SSD), which offer many advantages over traditional disk drives. Prices for this new technology have been high, limiting the affordability of many new computers, but in mid-2010, the price of NAND-type SSD memory dropped below $1 per gigabyte.8 This level was seen as a benchmark for driving down prices for computers. In the future we predict high levels of capacity for SSD computers and steady price declines. Cloud Computing: Cloud computing and increased investment in servers is another promising trend within the computer manufacturing industry. Cloud computing is a model in which software and computing power is available over the Internet. In 2010, servers are expected to be 16.9% of computer manufacturing revenue. Major players include Google Docs, Office Live Workspace and Google Wave. The iWork.com document sharing service is Apples response to the increased importance of cloud computing.9 Apple has one major competitive advantage over Google and Microsoft. Google Docs, Office Live Workspace and Google wave are read on mobile devices including the iPhone, iPod and iPad10. Consumers are able to read documents on Apples mobile devices, but are unable to edit documents. The iWork.com service should increase in popularity as it is
utilized by current Apple customers for both reading and editing purposes. Mobile Smartphone Market: Apple Inc. is a well positioned competitor within the mobile phone market. Apple, Inc. specifically competes within the smartphone sector, with its iPhone. By the end of 2010, there will be an estimated 5 billion active mobile phone contracts in the world, covering approximately 75% of the worlds population.11 Despite the high level of penetration in the world, most of these contracts are for cheaper, less sophisticated feature phones. The smartphone market is a small, rapidly growing subset of the overall mobile phone market, which is defined as phones that are able to run third-party application software and that have a wide range of capabilities. We anticipate smartphones will likely grow in mass market popularity as faster 3G and 4G services become widely available. Smartphone category revenues for 2010 are expected to reach 16.6 billion, twice the sales in 2007, when Apple Inc. first launched the Apple iPhone.11 Mac and Windows operating systems clearly dominate the PC market, yet there are many competitive cell phone operating systems. Consumers can choose between Apples iOS, RIMs BlackBerry OS, Googles Android, Microsofts Windows Mobile, Nokias Symbian OS and many others.11 In the past, many operating systems could compete due to the reliance on pre-installed applications. This trend has shifted, in part due to Apples successful Apple iPhone App Store. As consumers begin using phones with peripherals, consolidation is likely.
Market Share of Smartphone Platforms
50.00% 40.00% 30.00% 20.00% 10.00% 0.00% 9/1/2009 12/1/2009 2/1/2010 Figure 6: Installed Base Smartphone Platform Share 5 Leading Brands Within the U.S. RIM, Apple and Microsoft are currently the leaders in platform market share.11 RIM will likely continue to be a major force, despite consolidation, due to its businessfriendly approach and popularity as a company-purchased phone. Google and Microsoft are also well-funded players that may continue playing major roles in the smartphone market. Apples iOS is also positioned well, due to its strong customer following. Even as consolidation ensues, Apple will likely continue to be a smartphone market leader. Digital Music Player Market: Apple, Inc. is also a major player in the mature digital music player industry with its line of iPods. We anticipate steady declines within Apples iPod product line. One major reason for RIM Apple Microsoft Google Palm
the declining market is the smartphone trend. In the future, a music player will likely become a feature instead of a standalone product. Apples other products including the iPhone and iPad will likely cannibalize iPod sales. A decline in iPod sales is already apparent in Apples most recent financials; in 2010, iPod sales declined 7.06%. 12 Apple Inc. can potentially stay competitive by continually lowering prices and increasing function. The major competitors within the digital music player market are depicted in Figure 7. In addition to selling the iPod device, Apple maintains the iTunes music store as a place to buy music, video, and thirdparty applications for the iPod (and also the iPhone and iPad). In part due to the widespread adoption of the iPod in the United States, iTunes represented 26.7% of music sold in the United States in 2009.13
MP3 Player Market Share 07-08
iPod (Apple) 54% Sony 11% SanDisk 8% Samsung 6% Creative Zen 5% Zune (Microsoft) 3% Other Brands 23%
The Retail segment operates Apple-owned stores in Canada, the U.S., Japan, the UK, and Italy. Though the Americas constitute the largest segment for net sales, the Asia-Pacific segment net sales grew most rapidly. In 2010, Asia-Pacific net sales increased 160% and Japan sales increased 75%.14 Most of the growth in Asia-Pacific sales was due to increased availability and sales of the iPhone. Growth in the Japan segment was also due to increased iPhone sales as well as strong iPad demand and the strength of the Japanese yen.14 We believe much of the demand for Apples products will continue to be generated outside of the Americas. Specifically, much of the growth we projected in iPhone sales is a function of increased global availability. Financial Summary: Apple Inc.s 2010 net sales increased 52% due in large part to the introduction of the iPad as well as the high growth Apples iPhone. In 2009, Apple net sales grew 14.44% after a 2008 increase of 56.17%.14 Apples continued success is attributable to product innovation. Apples products generally experience a period of high growth followed by decreased growth as market penetration and competition rises. Apple sustains normal growth in many of its product lines through continual (often yearly) upgrades.
Apple Historical Net Sales
Net Sales (millions)
60,000 50,000 40,000 30,000 20,000 10,000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Figure 7: Digital Music Player Market Share 07-08
Company Analysis
Apple, Inc. is an international corporation founded in 1976 that designs, manufacturers and markets a range of electronic devices including personal computers, mobile phones, and portable digital music players. Headquartered in Cupertino, California, the firm known originally as Apple Computers has expanded over the last decade to include wellknown products such as the Macintosh (Mac) computer, the iPod, the iPhone, and the iPad. Apple also produces a wide range of software to fits its proprietary Mac OS X operating system. Operating Segments: Apple, Inc operates through five reportable geographic segments: Americas (North and South), Europe (and Africa), Japan, Retail, and Asia-Pacific. Figure 8 below depicts 2010 Apple net sales by operating segment.
2010 Apple Net Sales
Americas 37.5% Europe 28.7% Japan 6.1% Asia-Pacific 12.7% Retail 15%
Year Figure 9: Apple Net Sales 2000 2010 (millions) Mac Mac net sales showed impressive growth in 2010 with an increase of 26%. This growth was driven by unit sales growth, which increased 31% from 2009. Increased unit sales were accompanied by decreased pricing, following the overall computer manufacturing trend of price declines as technology improves. In 2010, net sales per unit decreased 4%. Mac portable computer net sales increased 18% from 2009. 14 MacBook Pro was updated in April of 2010 and strong demand for the new MacBook Pro was a key factor in Mac portable computer sales growth. We anticipate Mac products will continue to provide a stable stream of revenue throughout 2018. However, due to the maturity of the personal computer market, we expect growth to remain at stable levels. iPhone The iPhone was first introduced in January of 2007. The iPhone was Apples first and only venture into the cellular phone market. iPhone features include a mobile phone, an iPod, and a portable electronic device with internet capabilities. Apples iPhone is aimed at high-income customers with an interest in music playing capabilities. In 2010, net sales of the iPhone were $25.2 billion compared to 2009 sales of $12.1 billion. 14
Figure 8: 2010 Apple Net Sales by Operating Segment
Increases in iPhone sales are attributable to continued growth from existing carriers, expanded distribution and strong demand for the recently released iPhone 4.15 As of September 2010, Apple distributed its iPhone in 89 countries and is dependent on 166 carriers. We project the iPhone will continue being a major source of revenue, with forecasted growth of 22% in 2011 and 25% 2012. This increase in growth will be due to expansion to the Verizon cellular market in the United States, increased demand due to gradual price declines, demand for the latest iPhone in combination with yearly product updates and the traditional two-year cell phone contract, and increase demand for the iPhone abroad. iPad In April 2010, Apples iPad was released in the U.S. and has since been released in a number of countries. The iPad is a tablet computer that is able to fill the demand for a web-enabled device larger than a smartphone and smaller than a traditional laptop. As of September 25, 2010, Apple distributed its iPad in 26 countries. Apple distributes the iPad directly from Apple retail stores, indirectly through cellular network carriers and through some third-party resellers.14 The iPads current sales figures represent demand from early adopters during the first nine months of its release. We expect continued growth for the iPad as availability increases and economic health in the U.S. recovers. Additionally, the tablet computer market is relatively young, so iPad growth will be driven as the consumer continues to adopt this type of computer. iPod The iPod was released in 2003 as Apples entrant into the digital music player market. The device was the catalyst for the rebirth of the AAPL brand after having suffered in the 1990s. Sales quickly took off and the iPod was Apples largest revenue source until 2009 when it was eclipsed by the iPhone. As of mid2010, the iPod has captured a 76% share of the digital music player market. Looking forward, however, iPod sales will likely suffer as consumers choose to purchase iPhones or iPads instead of iPods. In 2010, iPod sales increased, though at a miniscule 2%. There was a clear shift in 2010 from basic iPod units to the most recent addition to the iPod product line, the iPod touch. This shift is visible through the increase in net sales per iPod unit, which, in 2010, grew 10%.14 We anticipate the percentage of Apples net sales attributable to the iPod will likely fall throughout the next ten years.
2010 2009 Apple Product Mix
Apples revenue breakdown in Figure 10 illustrates Apples diversified products. One of Apples main competitive advantages is its ability to continually innovate and produce popular products. Apples varied product mix minimizes the risk Apple faces in each particular market. Apple is able to hedge U.S. computer manufacturing industry risk by entering into new markets. This strategy has proved valuable in the recent economic environment. Strategy: Innovation and seamless integration is at the core of Apples strategy. Apples innovation is supported by high levels of investment in research and development. In 2010, Apples R&D expenditure reached $1,782 million up from $1,333 million in 2009. 14 Apple aims to design and develop its own operating system, hardware, software and services. Apples products are aimed at businesses, consumers, educators, students and government agencies. Apple is continually improving its personal computers and other electronics (e.g. iPhone). Apple is also looking to exploit the trend of combining mobile communications, personal computers and consumer 12 electronics. Apple Input Supply: Most of the components used in the manufacturing of Apples products are available from a wide variety of sources. Apple, is however susceptible to the risk of inadequate supply of certain components used in Apples many electronic devices. Components such as microprocessors, enclosures, certain liquid crystal displays (LCDs), and certain optical drives are 14 currently obtained through limited sources. A supply shortage is unlikely, but possible going forward. Apple may need to seek out additional input supply. Apple Product Demand and Distribution: The demand for Apples computers and other electronic devices is driven in part by technological changes. Rapid advances in technology spur consumers and businesses to replace computers every three to five years.16 Moores Law suggests the number of transistors per integrated service doubles every two years.17 Despite this general rule, business demand has been stagnant, due to the weak economic climate. We anticipate business purchases grow as investment in new computer systems will track improved business profits. Consumer sentiment also drives demand for Apple products. Consumer purchases have recently accounted for a large portion of computer manufacturing revenue. Consumer sales are expected to constitute 19.7% of 2010 computer manufacturing revenue, yet consumer sale profit margins are low. Computer manufactures are looking to business and government customers to increase profit margins. Generally, business and government customers yield profit margins of 6% - 9%, the high margins are due to IT bundling and the purchasing of more profitable server systems.6 Together the average overall net profit margin of a computer manufacturer is 3.5%. Apples net profit margin is much higher, around 28% in 2010 due to its unique product mix and cost cutting measures.14
100% 80% 60% 40% 20% 0% 2010 2009
Software,service andothersales Peripheralsand otherhardware iPad iPhone Othermusic iPod
Figure 10: 2010- 2009 Product Mix as a Proportion of Net Sales

Prices are another key determinant of electronic device demand. Recently, falling prices have boosted computer sales. In 2007, average prices for desktops and portables decreased by approximately 1.3%, followed by 2008 declines of 4.3% and 2009 declines of 14%.6 Low prices have shifted manufacturing from the U.S. to other, lower cost foreign manufactures. This is not a major concern for Apple, due to its contract manufacturing strategy. Apple can take advantage of cheaper foreign manufacturing costs by producing products outside of the U.S., closer to input suppliers. Apple then distributes its products throughout the world utilizing Apple owned retail stores, online stores, direct sales forces, third-party network carriers, wholesalers, and independent retailers.14
Future Prospects
Strengths: Strong Liquidity & Operating Margin Apples strong liquidity will continue to provide stability in a tumultuous market environment and is one of its strongest financial qualities. In 2010, Apple generated $18,595 million in net cash from operations, an 83% increase from 2009 net cash from operations of $10,159 million. This allows Apple to have a balance of $51 billion in cash and short-term marketable securities, which represents 67.8% of its total assets.14 Apples 2010 current ratio is 2.01, which also suggests a strong shortterm financial position and the full capability of meeting shortterm liabilities.18 Looking forward, we expect Apple to continue to add to these liquidity reserves as it steadily generates high free cash flows from operations. Apples continued revenue growth and strong operating margins illustrate Apples ability to compete in a highly competitive technological environment. In 2010, Apples revenue reached $65.225 billion, a 52% increase from 2009 revenue of $42,905 billion. Apples operating margin continues to remain high in 2010 at 28.19%.14 This high margin reflects an optimal pricing strategy and proficient cost controls including Apples preference for contract manufacturing. .Diversified Products & Brand Image Apples strong brand name is one of its most valuable assets. Apples brand was recently valued at $83.2 billion in a 2010 report by Millward Brown. Figure 11 illustrates one of Apples major competitive advantages, its brand name.19 The Apple, Inc. brand name is currently ranked above Microsoft, one of Apples direct competitors. Apples high brand value represents the importance of loyalty for Apple customers. Figure 11: 2010 Top 10 Most Valuable Global Brands One of Apples major strengths is its diversified product offerings. Apples product mix includes personal computers, mobile phones and music players. In addition to these wellknown products, Apple offers software products such as Apple iOS, iWork and Safari.20 Apples many product lines, serve as a hedge to market instability. Apples varied product mix is a major strength and ensures Apples stability in a rapidly changing market landscape. Weaknesses: Lack of Mobile Phone Variants & Network Dependence Apples only presence within the mobile phone segment is the iPhone. Though the iPhone has been a huge success, other specific mobile phone companies will continue to launch new products. Apple will be relegated to a specific niche, the highend music phone. The success of Apples iPhone is also heavily dependent on external cellular network providers. Apple has limited network carriers and currently relies exclusively on AT&T within the United States. Apple relies on O2 in the UK, Orange in France and T-mobile in Germany. 20 Due to the limited number of network carriers, network failure could negatively affect iPhone sales. It has recently been substantiated by Fortune that the iPhone will be coming to Verizon in early 2011.15 The increased network distribution will help to mitigate potential issues due to lack of network carriers. Apples minimal network distribution is another weakness. Apples App Store is the singular distributor of applications for iPhones, iPods, and iPads. Apples competitors have much larger third-party distribution networks.11 Lack of distribution may negatively affect future growth. Legal Claims There are currently many claims alleged against Apple. For instance, Eolas Technologies filed an infringement lawsuit in October of 2009 involving two Eolas patents. 20 With Apples large presence, there are many relentless lawsuits that may potentially damage Apples highly valued brand. Opportunities: Retail and Innovation
In 2010, 15% of Apples revenue was attributable to its retail segment.14 We believe Apple should further explore retail. Opening more stores will attract new customers and provide existing customers more convenient services. Retail stores entail heavy investment in early years, but with average store revenue in 2009 and 2010 averaging around $26 million we believe opening more stores in high traffic areas will continue to generate revenue for apple. Apple also continues to invest in research and development. Most recently, Apple launched the iPad, a tablet personal computer. Apple also continually creates updated versions of each its products. Apples recent iPhone 4 release enabled iPhone net sales to grow 95%.14 Apples continual focus on innovation and product development ensures Apple is well positioned in a highly competitive technology market. Threats: Digital Theft and Potential Price Wars Apple is susceptible to the risk of unauthorized use of digital content, such as the digital content provided through iTunes. Users could potentially copy and share content, as it is difficult to monitor and protect unlawful uses.20 This theft may lead to lower iTunes sales for Apple. Apple is facing an increasingly competitive landscape. Price declines in Apples Mac product lines are already visible, as unit sales increased and sales per unit decreased in 2010. The iPad may also face pricing competition as competitors enter the market. The BlackBerry PlayBook, for example, is expected to enter the market at a price under $500.7 This increased competition may lead to an eroding gross margin. We forecast Apples profit margin will likely decline from 36% in 2010 to 35.75% in 2018.
Key Assumptions: Revenue Decomposition We decomposed AAPLs revenue by product line unit sales and price per unit. Overall, we project that Apples revenue will continue at a growth rate greater than 20% in FY2011, as it continues to dominate current markets. However, due to AAPLs relative size, we believe it will soon begin to reach a mature level of growth. At the end of the explicit forecast period, Apples overall net sales growth slows to 4.37%. Beyond 2018, we anticipate Apple will grow at a rate comparable to U.S. nominal GDP growth, 4%. We forecasted slight price declines for many of Apples products due to increased competition. We do not anticipate huge price declines, due to AAPLs niche market focus. Due to Apples brand value and image, it is unlikely prices will fall drastically, despite increased competition. We forecast desktop prices to decline 2% per year throughout the forecasted time horizon. For portable computers, we forecasted yearly price declines of 2% to 3%. The largest price decline we projected is for the iPod. We anticipate AAPLs other products to steal some of iPods sales in future years and thus we implemented 5% declines in iPod prices per forecasted year. We do not foresee iPad price declines due to the iPads recent launch and current lack of competitors. The most important driver of Apples future value is revenue. In the last fiscal year, Apple saw a 93% increase in iPhone net sales, which has been AAPLs strongest selling product over the last two years. We project unit sales of the iPhone to remain strong into the future with 22% growth in FY2011. After 2012, we anticipate iPhone sales will begin to slowly decline as penetration rises. We reach a projected yearly growth in iPhone net sales of 11%, as the explicit forecast ends in FY2018. While the number of iPhones sold becomes high during our explicit period, we believe that this number is justified due to the iPhones growth prospects in the United States and abroad. With 270 million projected smartphone unit sales in 2010, Apples sales of 40 million iPhone units represents approximately 15% of the market. We believe that the smart phone market will increase drastically over our explicit period, and that Apple will see their market share decline slightly in the future due to increased competition. Thus, due to the increased future market and competition, we believe that our iPhone growth projections are conservative and fairly represent Apples potential compared to the overall smatphone market.21 Accordingly, due to cannibalization we project iPod unit sales will decrease yearly. We forecasted iPod sales will decline 7% in FY2011 and will continue to decline at a rate of 13% in FY2018. Gross Margin Another assumption of high importance is our gross margin projections for Apple. The firm is currently operating very efficiently due to its ability to charge premium prices across all of its product lines. AAPLs current gross margin has recently experienced increases and remained hovering around 40% in FY2010. However, similar to our revenue analysis, we believe that this gross margin will start to decline and return closer to historical levels. In the final year of our forecasted time horizon, we forecast AAPLs gross margin as 35.75%. More generally, we expect Apple, as a lean company, to adapt most of its other accounts as necessary to accommodate revenue growth.
Valuation Analysis
Our Apple, Inc. valuation analysis involved multiple techniques. These techniques include the discounted cash flow (DCF) model, the economic profit (EP) model, the fundamental P/E model, the relative valuation P/E ratio and the P/E to growth ratio (PEG). The DCF and EP models both calculated current target prices of $366.73. This suggests a premium of 19.0% over the current price. The PEG ratio returned a value of $298.05. The relative P/E analysis was calculated using earnings estimates for companies comparable in size and industry performance. Our relative P/E returned a value of $355.21 and our fundamental P/E technique resulted in a low value of $167.46. We feel a major component of Apples future growth is intangible momentum and brand loyalty that will result in strong growth for the iPhone and iPad; these intangibles are best reflected in the forward-looking discounted cash flow and economic profit models. Given the importance of momentum effects, we are comfortable with the price range produced by the DCF model and the EP model. The DCF and EP models allow for future projections based on brand value and momentum. Based primarily on these models, we recommend investors buy AAPL in order to take advantage of future revenue growth fueled by momentum.
According to our 2011 to 2018 projections, we anticipate Apple will continue operating strongly. AAPLs total asset base will increase significantly due to a large accumulating cash base. We have not included assumptions for future shareholder payouts and acquisitions, due to uncertainty. Because acquisitions are the primary way technology companies spend accumulated cash, Apple will have an inflated cash balance. Additionally, due to its strong market position and efficient operations, Apple acts similar to a cash-cow such as Microsoft in its ability to generate free cash flows year after year. Apples ability is in part due to a lack of manufacturing facilities and low inventory holdings, which it is able to maintain by outsourcing production for all of its products. This lean quality allows AAPL to avoid large capital expenditures and use of short-term cash in working capital. Additionally, these potential acquisitions are not modeled within our valuations. We believe that acquisitions will occur due to the Apples high cash balance, so there is potential value that is not represented within our report models. Discounted Cash Flow and Economic Profit Models: The discounted cash flow (DCF) and economic profit (EP) models project the value of Apple common stock to be $366.73. The DCF/EP model is one of the primary factors influencing our buy recommendation because we believe that the premium placed on the stock by this model highlights the strong intrinsic qualities of the firm that cannot be highlighted in the other models. The price suggested by this model is an 19.0% premium over the current stock price, which we believe is driven by the strong top-line revenue growth that Apple will see over the coming years and its ability to maintain a relatively high gross margin. The forward-looking nature of the DCF/EP models allow for the momentum of current high revenue products to factor into the future financial performance of the stock. In calculating our DCF/EP models, we made a few important assumptions about the firm. First, when Apple reaches a steady state in 2012, our models assumed a continuing value (CV) growth rate of 4%. A CV of 4% was chosen because a mature Apple will grow at a rate that closely tracks U.S. nominal GDP growth, which is historically 3 to 4.5%. Our continuing value return on equity (ROE) is predicted to be 78%, which represents the high growth nature of the technology sector. Relative P/E and PEG Ratios: We calculated the implied valuation for Apple stock using the Relative P/E and PEG Ratio valuation against six peer companies. The six peer companies were chosen based on similar characteristics, primarily companies within the technology sector with a large market capitalization, high growth, and a strong brand name. Google was chosen due to its strong brand name, large market capitalization, and because it is an Apple competitor within the internet and mobile phone industries. Sony and SAP were chosen because they are both large technology conglomerates; Sony within consumer electronics and SAP within database systems. Dolby Laboratories was chosen because of its strong brand name and dominance within the audio technology sector, which mirrors Apples dominance within the digital music sector. We chose Cisco Systems because Cisco is another large company of high brand value within the technology sector. Finally, Microsoft was chosen because it is closet in size to Apple (via market
capitalization) and competes directly with Apple in many of Apples core businesses. After calculating the peer P/E ratios, the implied value of Apple common stock is $355.21 and $343.46 using 2011E and 2012E P/E values respectively. This is slightly lower than our DCF/EP model. We believe that these values are fair relative to the current share price of $308, and they indicate the potential upside for the stock. However, we also believe that this relative P/E valuation is not able to incorporate intrinsic Apple information that is driving the firm growth, such as current product momentum. Second, the peer PEG ratios imply a value for Apple common stock of $298.08 and $288.42 using 2011E and 2012E data respectively. These values are lower than the current share price and significantly lower than the DCF/EP and relative P/E projections. The PEG ratio is not a strong metric to calculate the value of Apple because Apple is currently operating differently than its peer companies. It is the largest technology company yet is experiencing a period of very high growth. Due to these factors, the PEG ratio does not accurately represent Apples value since none of its peers are experiencing a similar situation. Additionally, the PEG ratio calculation traditionally allocates lower values to firms with low growth rates. Apples five-year growth rate is lower than its peers, although it is still generating strong earnings for its consumers, so we do not believe that the PEG ratio is justified due to Apples large and unique operations compared to its peers. Fundamental P/E: Another model we utilized, the Fundamental P/E valuation, is based on the projected internal P/E ratio for Apple in 2018, discounted back to present value. According to our model, Apples share price is valued at $167.46, which is low. We believe that this theoretical number is skewed because it does not take into account current firm trends. Instead, the Fundamental P/E takes into account the more conservative longterm growth estimates. The Krause Fund is a long fund with a time horizon of six months to one or two years. Due to the Krause funds relatively short-term investment horizon, we believe the DCF, EP and PEG ratio valuations are more appropriate because these models are able to take into account current market trends and firm momentum. The values produced in our DCF, EP and PEG ratio valuations fall in line with the target prices calculated by other investment professionals. The Fundamental P/E valuation model was used as a proxy to the dividend discount model because Apple does not currently pay dividends on its common stock. According to this model, Apples share price is valued at $167.46, which is considerably lower than the price target that we have established. However, we do not believe that this method accurately represents the true value of Apple. As a technology firm, Apple has consistently remained with the philosophy of giving shareholder value through stock appreciation by reinvesting free cash flows into the business or acquiring other companies as a use for its cash instead of paying it out to the shareholders in the form of dividends. The Fundamental P/E model does not represent a realistic scenario for the firm due to the fact that potential dividends are unlikely in the near-term and unpredictable overall. Additionally, our Fundamental P/E model assumes that
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the firm would begin paying a dividend out to shareholders in 2018 (the end of the explicit period). The length of time between the current period and the potential payout also contributes to the low share price due to time value of money assumptions and our cost of equity assumptions. Thus, Apples dividend policy and future outlook prevent this model from being a realistic interpretation of firm value for the shareholders. Weighted Average Cost of Capital: Cost of Equity We calculated Apples cost of equity using the Capital Asset Pricing Model (CAPM). The risk-free rate we employed in calculating the cost of equity is 4.01%, which is the current auction yield on the 30-year U.S. Treasury security. This is an appropriate security because it matches our long-term investment horizon. We also implemented a market risk premium of 5.11%, based on forward-looking estimates of future market returns. This value is appropriate because, similar to the implemented Treasury yield, the premium represents a forwardlooking value that best corresponds with our investment horizon. The final component of CAPM is the beta. We selected a beta of 1.076 which is the average of Apples weekly betas measured at two, five, and seven year intervals. This beta is mid-range compared to historical weekly betas during this time-frame; accordingly, we believe that it is a strong approximation of the firms future performance, since it approaches the market beta of 1.0. Using these CAPM assumptions, we calculated the cost of equity to be 9.51%. Cost of Debt The cost of debt has been assumed to be 3.605%, which was calculated based on the yield to maturities on recently issued bonds within Apples peer group. Apple has not had debt outstanding for the last five years, so it is not rated by a credit rating firm. However, if Apple did raise debt, it would likely find itself on the higher end of the investment grade ratings due to its strong financial position and high stable cash flows. To calculate the cost of debt, comparable companies of AAA/AA rated technology firms and other conglomerates where chosen who had issued 10-year debt since July 2010. Issuers of 10-year debt were chosen because this matches our relative equity investment horizon assumed for other parts of the WACC calculation22. The companies chosen for the relative analysis were Microsoft, Target, Ebay, Berkshire Hathaway, and Johnson & Johnson. The average of the 10-year debt yields for these five companies is 3.34%, which we will imply as a possible cost of debt for Apple if it were to issue similar bonds. However, we raised the value to 3.605% by including a recently issued 30year note of Microsoft. We believe that this is appropriate because MSFT is Apples most comparable peer company in terms of size and because the cost of debt is relatively low right now due to the current economic climate. With a marginal tax rate of 35%, this gives Apple an after-tax cost of debt of 2.34%. Target Capital Structure As a cash-generating technology firm, Apple has been able to operate with a lean capital structure for most of its existence. There has been no outstanding debt for the last five years, and the present value of the minimum lease payments is currently valued at $1.6 billion, which is small compared to the firms total equity of $47.7 billion. Additionally due to the firm strong operations and ability to generate cash flows, we do not expect
the firm to deviate from this capital structure in the future by raising debt financing. Thus, the target capital structure for the firm will remain the current all-equity capital structure with a small portion of operating leases. Weighted Average Cost of Capital (WACC) Based on our assumption for the firms cost of debt, cost of equity, and capital structure, we have estimated Apples WACC to be 9.46%. Since the capital structure is forecasted to remain constant, this is the WACC that we have used throughout the forecast period for our DCF/EP analysis.
Sensitivity Analysis
Since our models include many assumptions, it is important to test the sensitivity of our final target price to our key assumptions. This analysis enables us to determine a comfortable range, taking into account assumption variability, for Apples target stock price. Beta: We analyzed daily, weekly, and monthly beta figures for AAPL at two, five, and seven year intervals. The maximum average beta measured weekly against the S&P 500 was 1.103 and the minimum beta for the same time period was 1.038. Beta figures can be easily manipulated using different time horizons and frequencies. We chose the mean beta of 1.076, though a larger confidence interval would range from 1.05 to 1.09. Our sensitivity analysis illustrates that even if the model utilized a higher beta of 1.09, the current stock value remains comparatively low. At a beta of 1.09 the target price for Apple is 362.43, a 17.7% premium. Market Risk Premium: Our model utilizes a forward-looking market risk premium of 5.11%. We believe the risk premium is likely to stay high, given poor consumer sentiment and recent dismal GDP growth. If we used a lower risk premium, more similar to past geometric averages, such as 4.80%, the price would increase to $388.35. Due to the current economic climate, this price is likely too high. Cost of Debt: Apple does not currently have debt outstanding. Our models cost of debt assumption is based on recently issued debt from comparable companies. Due to the imprecise nature of this comparison, it is important to understand the impact Apples cost of debt on final target price. Our model utilizes a 3.605% cost of debt. It is yet to be seen if Apple is able to raise debt financing more or less cheaply than comparable companies. A cost of debt assumption of 4.5% leads to a target price of $366.46 and an assumption of 2% leads to a price of $367.25. Despite the uncertainty surrounding our models cost of debt, it does not materially impact our current price. CV Growth Rate: Calculating the continuing value (CV) is an important component of our valuation models because CV accounts for a large percentage of our final valuation and stock price.
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The continuing value growth of 4% used in our calculation is representative of nominal GDP growth. Apple is a stable company that has performed well during the recent economic downturn. If we felt Apple will continue to outperform the general market, a CV growth rate of 5% may be appropriate. A CV growth rate of 5% increases Apples target stock price to $415.65. We believe this assumption is overly optimistic. As Apple continues to mature, its revenue streams will likely be in line with the overall economy. iPhone Sales Growth: We anticipate iPhone unit sales will grow 11% in FY2018. This is a decline from projected 2012 unit sales growth of 22%. A more optimistic assumption would be iPhone unit sales growth of 15%, leading to a target price of $372. This results in a premium over the current stock price of approximately 20%. Due to increased competition in the smartphone market, we believe iPhone sales unit growth of 15% in 2018 is likely too high. Cost of Goods Sold: Also, the lean cost of gold sold percentage can have a big impact on future performance. If Apple reverts to its historical cost of goods sold percentage quickly or goes higher than historically due to competition, the stock price will change. Our assumption for cost of goods sold as of FY2018 is 64% of net sales, an increase from 60.62% in 2010. We anticipate Apples growth margin will decline as competition increases. If a cost of goods sold percentage closer to the 2010 level was implemented, such as 63%, Apples target prices rises to $381.78. Conversely, if competition increases dramatically Apples cost of goods sold could increase to 65% of net sales, leading to a target price of $357.71. Despite the major decline in the target price, the value is still above the current price of $308.03, and thus we are confident in our buy investment recommendation. iPad Sales Growth: iPad product sales are an important source of revenue for Apple going forward. The iPad is a newly launched product and as such sales figures are difficult to project. Our model implements moderate sales growth figures of 3% in the final year of our explicit forecast. Increasing growth from 3% to 5% raises Apples target price to $367.90. We believe Apple is unlikely to experience iPad sales growth lower than 2%. Research and Development: Research and development is one of Apples largest costs. Apple has continually invested in product innovation, but even small changes in research and development spending can impact target prices materially. Research and development is forecasted as 3% of net sales in FY2018. This represents a slight increase from 2010 levels of 2.73%. If research and development drastically increase to 4.5% due to increased competition, Apples target price would fall to $342.85. Important Disclaimer: This report was created by students enrolled in the Security Analysis (6F:112) class at the University of Iowa. The report was originally created to offer an internal investment
recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students skills, knowledge and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report.
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http://finance.yahoo.com/news/US-consumer-confidence-dropapf-4165827227.html?x=0 Dismal Scientist. (2010, October 28). Real GDP Retrieved from https://www.dismal.com Dismal Scientist. (2010, October 28). Real GDP Retrieved from https://www.dismal.com http://www.cultofmac.com/apple-cracks-10-pc-market-sharefor-first-time-in-decades/63273 Thormahlen, C. (2010, November). Shut down: With consumer profits falling, manufacturers look to business for a boost. Retrieved from http://www.ibisworld.com.proxy.lib.uiowa.edu/industryus/defaul t.aspx?indid=740 Yang, J., & Miller, H. (2010, November 10). RIM Climbs to Highest Since June on Plan for Tablet Under $500. Retrieved from http://www.bloomberg.com/news/2010-11-10/rim-to-selltablet-computer-in-north-america-in-first-quarter.html Mearian, L. (2010 August 19). NANd flash memory pricing to plummet to $1 per GB. Retrieved from http://www.networkworld.com/news/2010/081910-nand-flashmemory-pricing-to.html Morgenstern, D. (2009, January). Cloud Computing: Apple vs. Microsoft. Retrieved from http://www.zdnet.com/blog/apple/cloud-computing-apple-vsmicrosoft/2730
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Toor, A. (2010, November 1). iPhone Coming to Verizon in Early 2011, Says Fortune. Retrieved from http://www.switched.com/2010/11/01/iphone-verizon-early2011-fortune/ Smith, T. W. (2010, October 28). Computers: Hardware. Retrieved from http://www.netadvantage.standardandpoors.com.proxy.lib.uiowa .edu/NASApp/NetAdvantage/showPublication.do?dataPosition= 0&SPID=22934 Intel. Moores Law: Made Real by Intel Innovations. Retrieved from http://www.intel.com/technology/mooreslaw/ Mergent. (2010, November 10). Apple Inc. Retrieved from http://www.mergentonline.com.proxy.lib.uiowa.edu/companydet ail.php?compnumber=12161&pagetype=synopsis Millward Brown Optimor. (2010, April 28). BrandZ Top 100 worth over $2 trillion, a 40 percent growth over five years, strong brands outperformed the stock market and proved resilient in recession. Retrieved from http://www.millwardbrown.com/Sites/mbOptimor/Ideas/BrandZ Top100/BrandZTop100.aspx Global Data. (2010, October). Apple Inc. Financial and Strategic Analysis. Retrieved from http://research.thomsonib.com.proxy.lib.uiowa.edu/gaportal/ga.a sp
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Figure 1: Dismal Scientist. (2010, October 28). Real GDP Retrieved from https://www.dismal.com Figure 2: Dismal Scientist. (2010, October 28). Real GDP Retrieved from https://www.dismal.com Figure 3: Dismal Scientist. (2010, October 28). University of Michigan Retrieved from https://www.dismal.com Figure 4: Dismal Scientist. (2010, October 28). Unemployment Retrieved from https://www.dismal.com Figure 5: Thormahlen, C. (2010, November). Shut down: With consumer profits falling, manufacturers look to business for a boost. Retrieved from http://www.ibisworld.com.proxy.lib.uiowa.edu/industryus/defaul t.aspx?indid=740 Figure 6: Mintel. (2010, June). US Mobile Phones. Retrieved from http://academic.mintel.com.proxy.lib.uiowa.edu/sinatra/oxygen_ academic/search_results/show&/display/id=482692
Mintel. (2010, June). US Mobile Phones. Retrieved from http://academic.mintel.com.proxy.lib.uiowa.edu/sinatra/oxygen_ academic/search_results/show&/display/id=482692 Mintel. (2009, June). US Portable Technology. Retrieved from http://academic.mintel.com.proxy.lib.uiowa.edu/sinatra/oxygen_ academic/search_results/show&/display/id=393594
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Figure 7: Mintel. (2009, June). US Portable Technology. Retrieved from http://academic.mintel.com.proxy.lib.uiowa.edu/sinatra/oxygen_ academic/search_results/show&/display/id=393594 Figure 8: Apple, Inc. (2010, October 25). Apple Inc. 10-K. Retrieved from https://www.apple.com/investor/ Figure 9: Apple, Inc. (2010, October 25). Apple Inc. 10-K. Retrieved from https://www.apple.com/investor/ Figure 10: Thormahlen, C. (2010, November). Shut down: With consumer profits falling, manufacturers look to business for a boost. Retrieved from http://www.ibisworld.com.proxy.lib.uiowa.edu/industryus/defaul t.aspx?indid=740 Figure 11: Millward Brown Optimor. (2010, April 28). BrandZ Top 100 worth over $2 trillion, a 40 percent growth over five years, strong brands outperformed the stock market and proved resilient in recession. Retrieved from http://www.millwardbrown.com/Sites/mbOptimor/Ideas/BrandZ Top100/BrandZTop100.aspx
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Apple Inc.
Key Assumptions of Valuation Model Ticker Symbol Current Share Price Marginal Tax Rate Normal Cash WACC Cost of Equity Cost of Debt AAPL 308.03 35% 15.00% 9.46% 9.51% 2.34% 2011E 29% 62.0% 10% 0% 3% 6.90% 3.53% 0% 12.00% 9.00% 3% 1% 1143% 5% 5% 7% 4% 2% 25% 49% 60% 15% 3% 7% 38% 2012E 30% 62.0% 10% 0% 3% 6.90% 3.53% 0% 13.00% 9.00% 3% 1% 1143% 5% 5% 7% 4% 2% 25% 49% 35% 15% 3% 7% 37% 2013E 31% 62.0% 10% 0% 3% 6.90% 3.53% 0% 14.00% 9.00% 3% 1% 1143% 5% 5% 7% 4% 2% 25% 49% 30% 15% 3% 7% 34% 2014E 32% 62.5% 10% 0% 3% 6.90% 3.53% 0% 15.00% 9.00% 3% 1% 1143% 5% 5% 7% 4% 2% 25% 49% 22% 15% 3% 7% 33% 2015E 33% 63.0% 10% 0% 3% 6.90% 3.53% 0% 16.00% 9.00% 3% 1% 1143% 5% 5% 7% 4% 2% 25% 49% 20% 15% 3% 7% 32% 2016E 34% 63.3% 10% 0% 3% 6.90% 3.53% 0% 17.00% 9.00% 3% 1% 1143% 5% 5% 7% 4% 2% 25% 49% 16% 15% 3% 7% 32% 2017E 35% 63.7% 10% 0% 3% 6.90% 3.53% 0% 18.00% 9.00% 3% 1% 1143% 5% 5% 7% 4% 2% 25% 49% 16% 15% 3% 7% 32% 2018E 35% 64.3% 10% 0% 3% 6.90% 3.53% 0% 19.00% 9.00% 3% 1% 1143% 5% 5% 7% 4% 2% 25% 49% 16% 15% 3% 7% 32%
Effective Tax Rate COGS ex D&A Depreciation Amortization of Intangibles Amortization of Goodwill Research & Development Selling, General & Administrative Interest Income Other Income (Expense) ST Marketable Securities Accounts Receivable, net Allowance for Bad Debt Inventory Accounts Payable Lease Asset Lease Liability Accrued Expense ST Deferred Revenue LT Deferred Revenue Deferred Tax Asset Deferred Tax Liability Capital Expenditures Depreciation Other Assets Other Current Assets LT Marketable Securities
Apple Inc.
Revenue Decomposition Fiscal Years Ending September 30th 2008A Unit Sales by Product: Macintosh Desktops % Growth Macintosh Portables % Growth iPods % Growth iPhone % Growth iPad % Growth Price per Unit Sold Macintosh Desktops % Growth Macintosh Portables % Growth iPods % Growth iPhone % Growth iPad % Growth Net Sales Per Product Macintosh Desktops % Growth Macintosh Portables % Growth iPods % Growth iPhone % Growth Other Music Products % Growth Peripherals and Other Hardware % Growth Software, services, and other % Growth iPad % Growth 3,712,000 36.77% 6,003,000 38.41% 54,828,000 6.19% 11,627,000 737.08% NM 0.00% 2009A 3,182,000 -14.28% 7,214,000 20.17% 54,132,000 -1.27% 20,731,000 78.30% NM 0.00% 2010A 4,627,000 45.41% 9,035,000 25.24% 50,312,000 -7.06% 39,989,000 92.89% 7,458,000 0% 2011E 5,274,780 14% 11,022,700 22% 46,790,160 -7% 48,786,580 22% 26,103,000 250% 2012E 5,907,754 12% 12,676,105 15% 43,514,849 -7% 60,983,225 25% 32,628,750 25% 2013E 6,498,529 10% 14,577,521 15% 40,468,809 -7% 72,570,038 19% 36,870,488 13% 2014E 6,823,455 5% 16,326,823 12% 36,421,928 -10% 83,818,394 16% 39,820,127 8% 2015E 7,096,394 4% 17,959,506 10% 32,415,516 -11% 95,552,969 14% 41,811,133 5% 2016E 7,309,285 3% 19,396,266 8% 28,525,654 -12% 109,885,914 15% 43,483,578 4% 2017E 7,528,564 3% 20,947,967 8% 25,102,576 -12% 125,269,942 14% 44,353,250 2% 2018E 7,754,421 3% 22,204,845 6% 21,839,241 -13% 139,049,636 11% 45,683,847 3%
1,515 2.25% 1,455 0.23% 167 3.78% 580 555% NM 0%
1,359 -10.28% 1,322 -9.13% 149 -10.47% 629 8% NM 0%
1,340 -1.38% 1,248 -5.56% 164 10.03% 630 0% 663 0%
1313 -2% 1223 -2% 156 -5% 630 0% 663 0%
1287 -2% 1199 -2% 148 -5% 598 -5% 663 0%
1261 -2% 1175 -2% 141 -5% 600 -5% 663 0%
1236 -2% 1140 -3% 134 -5% 600 -5% 663 0%
1211 -2% 1105 -3% 127 -5% 600 -4% 663 0%
1187 -2% 1072 -3% 121 -5% 576 -4% 663 0%
1163 -2% 1040 -3% 115 -5% 553 -4% 663 0%
1140 -2% 1009 -3% 109 -5% 531 -4% 663 0%
5,622,000,000 39.85% 8,732,000,000 38.74% 9,153,000,000 10.21% 6,742,000,000 5381.30% 3,340,000,000 33.81% 1,694,000,000 34.44% 2,208,000,000 46.42% NM 0.00%
4,324,000,000 -23.09% 9,535,000,000 9.20% 8,091,000,000 -11.60% 13,033,000,000 93.31% 4,036,000,000 20.84% 1,475,000,000 -12.93% 2,411,000,000 9.19% NM 0.00%
7,603,906,303 8,197,010,994 8,434,724,313 8,596,671,020 8,677,479,728 8,759,048,037 8,841,383,089 6,201,000,000 6,927,757,200 43.41% 11.72% 9.76% 7.80% 2.90% 1.92% 0.94% 0.94% 0.94% 11,278,000,000 13,483,976,800 15,196,441,854 17,126,389,969 18,606,110,062 19,852,719,437 20,797,708,882 21,787,679,824 22,402,092,396 18.28% 19.56% 12.70% 12.70% 8.64% 6.70% 4.76% 4.76% 2.82% 6,458,454,797 5,706,044,813 4,878,668,315 4,124,914,060 3,448,428,154 2,882,885,937 2,382,705,227 8,274,000,000 7,310,079,000 2.26% -11.65% -11.65% -11.65% -14.50% -15.45% -16.40% -16.40% -17.35% 25,179,000,000 30,718,380,000 36,478,076,250 43,542,022,650 50,291,036,161 57,331,781,223 63,294,286,470 69,269,267,113 73,813,331,036 93.19% 22.00% 18.75% 19.36% 15.50% 14.00% 10.40% 9.44% 6.56% 6,728,997,600 7,536,477,312 7,988,665,951 8,388,099,248 8,723,623,218 9,072,568,147 9,435,470,873 4,958,000,000 5,800,860,000 17.00% 16.00% 12.00% 6.00% 5.00% 4.00% 4.00% 4.00% 22.84% 3,038,450,000 3,646,140,000 4,083,676,800 4,492,044,480 4,716,646,704 4,952,479,039 5,200,102,991 1,814,000,000 2,430,760,000 34.00% 25.00% 20.00% 12.00% 10.00% 5.00% 5.00% 5.00% 22.98% 2,573,000,000 2,745,885,110 2,930,386,722 3,135,513,793 3,386,354,896 3,657,263,288 3,949,844,351 4,265,831,899 4,607,098,451 6.72% 6.72% 7.00% 8.00% 8.00% 8.00% 8.00% 8.00% 6.72% 4,948,000,000 17,318,000,000 21,647,500,000 24,461,675,000 26,418,609,000 27,739,539,450 28,849,121,028 29,426,103,449 30,308,886,552 250.00% 25.00% 13.00% 8.00% 5.00% 4.00% 2.00% 3.00% 0.00%
Net Sales % Growth
37,491 56.17%
42,905 14.44%
65,225 52.02%
86,736 32.98%
100,082 15.39%
113,351 13.26%
124,088 9.47%
134,183 8.14%
142,457 6.17%
150,416 5.59%
156,991 4.37%
Apple Inc.
Income Statement Fiscal Years Ending September 30th Values in Millions 2008A Net Sales Cost of Sales Gross Margin Depreciation and Amortization Research and Development Selling, general, and administrative Total Operating Expenses Operating Income Other Income and Expense Income before provision for income tax Provision for income taxes Net Income Earnings per share: Basic Shares used in calculating earnings per share Basic 37,491 24,294 13,197 496 1,109 3,265 4,870 8,327 620 8,947 2,828 6,119 2009A 42,905 25,683 17,222 734 1,333 3,415 5,482 11,740 326 12,066 3,831 8,235 2010A 65,225 39,541 25,684 1,027 1,782 4,490 7,299 18,385 155 18,540 4,527 14,013 2011E 86,736 53,776 32,960 1,119 2,602 5,985 9,706 23,253 903 24,157 7,005 17,151 2012E 100,082 62,051 38,031 1,767 3,002 6,906 11,675 26,356 1,191 27,547 8,264 19,283 2013E 113,351 70,278 43,073 2,372 3,401 7,821 13,593 29,480 1,669 31,149 9,656 21,493 2014E 124,088 77,555 46,533 3,072 3,723 8,562 15,357 31,176 2,212 33,389 10,684 22,704 2015E 134,183 84,535 49,648 3,740 4,025 9,259 17,024 32,624 2,721 35,345 11,664 23,681 2016E 142,457 90,104 52,353 4,481 4,274 9,830 18,584 33,769 3,293 37,062 12,601 24,461 2017E 150,416 95,815 54,601 5,193 4,512 10,379 20,084 34,517 3,864 38,381 13,433 24,948 2018E 156,991 100,867 56,124 6,019 4,710 10,832 21,561 34,563 4,445 39,009 13,653 25,356
6.941
9.222
15.408
18.702
20.853
23.053
24.352
25.400
26.236
26.758
27.196
881,592
893,016
909,461
917,084
924,707
932,329
932,329
932,329
932,329
932,329
932,329
Apple Inc.
Balance Sheet Fiscal Years Ending September 30th Values in Millions 2008A ASSETS: Current assets: Cash and cash equivalents Short-term marketable securities Accounts receivable, less allowances Inventories Deferred tax assets Other current assets Total current assets Long-term marketable securities Property, plant and equipment, net Goodwill Other non-current equity and debt investments Acquired intangible assets, net Other assets Total assets LIABILITIES AND SHAREHOLDERS EQUITY: Current liabilities: Accounts payable Accrued expenses Deferred revenue Current portion of long-term debt Total current liabilities Deferred revenue non-current Deferred Tax Liabilities Other non-current liabilities Total other non-current liabilities Total liabilities Shareholders equity: Series A non-voting nonconvertible stock Common Stock Retained earnings Accumulated other comprehensive income/(loss) Total shareholders equity Total liabilities and shareholders equity 2009A 2010A 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E
11,875 10,236 2,422 509 1,044 3,920 30,006 2,379 2,455 207 285 839 36,171
5,263 18,201 3,361 455 1,135 3,140 31,555 10,528 2,954 206 247 2,011 47,501
11,261 14,359 5,510 1,051 1,636 7,861 41,678 25,391 4,768 741 342 2,263 75,183
17,687 16,082 7,572 862 1,751 6,197 50,151 28,570 8,023 741 308 2,748 90,540
29,163 18,173 8,737 994 2,066 7,150 66,283 33,500 10,338 741 277 3,171 114,310
42,029 20,717 9,896 1,126 2,414 8,098 84,280 38,865 12,682 741 249 3,591 140,409
53,361 23,824 10,833 1,233 2,671 8,865 100,787 46,335 14,104 741 224 3,931 166,122
65,758 27,636 11,714 1,333 2,916 9,587 118,944 53,159 15,343 741 202 4,251 192,640
77,255 32,335 12,437 1,415 3,150 10,178 136,769 61,645 15,640 741 182 4,513 219,490
87,926 38,155 13,131 1,494 3,358 10,746 154,811 70,237 15,985 741 164 4,765 246,703
97,211 45,404 13,705 1,559 3,413 11,216 172,509 78,945 16,386 741 147 4,973 273,701
5,520 4,224 1,617 11,361 768 999 746 1,745 13,874
5,601 3,852 2,053 11,506 853 2,216 1,286 3,502 15,861
12,015 5,723 2,984 20,722 1,139 4,300 1,231 5,531 27,392
9,847 6,071 3,036 18,954 1,301 3,422 1,231 4,653 24,909
11,362 7,006 3,503 21,871 1,501 4,037 1,231 5,268 28,640
12,869 7,935 3,967 24,771 1,700 4,717 1,231 5,948 32,419
14,088 8,686 4,343 27,117 1,861 5,220 1,231 6,451 35,429
15,234 9,393 4,696 29,323 2,013 5,698 1,231 6,929 38,265
16,173 9,972 4,986 31,131 2,137 6,156 1,231 7,387 40,655
17,077 10,529 5,265 32,870 2,256 6,562 1,231 7,793 42,920
17,823 10,989 5,495 34,307 2,355 6,670 1,231 7,901 44,563
7,177 15,129 (9) 22,297 36,171
8,210 23,353 77 31,640 47,501
10,668 37,169 (46) 47,791 75,183
11,358 54,320 (46) 65,632 90,540
12,113 73,603 (46) 85,670 114,310
12,940 95,096 (46) 107,989 140,409
12,940 117,800 (46) 130,694 166,122
12,940 141,481 (46) 154,375 192,640
12,940 165,942 (46) 178,835 219,490
12,940 190,889 (46) 203,783 246,703
12,940 216,245 (46) 229,139 273,701
Apple Inc.
Forecasted Statement of Cash Flows Fiscal Years Ending September 30th Values in Millions 2011E Cash Flows from Operating Activities: Net Income Adjustments to reconcile: Depreciation and Amortization Allowance for Doubtful Accounts Changes in Working Capital: Accounts Receivable Inventories Deferred Tax Asset Other Current Assets Accounts Payable Accrued Expenses Deferred Revenue Other LT Liabilities Deferred Revenue Non-Current Net Cash by Operating Activities Cash Flows from Investing Activities: Short-Term Investments Capital Expenditures Long-Term Investment Securities Other LT Assets Net Cash by Investing Activities Cash Flows from Financing Activities: Proceeds from Issuance of Common Stock Repurchases of Common Stock Net Cash by Financing Activities Net Increase (Decrease) in Cash Cash, Beginning of Year Cash, End of Year 17,151 1,119 179 2012E 19,283 1,767 36 2013E 21,493 2,372 36 2014E 22,704 3,072 29 2015E 23,681 3,740 27 2016E 24,461 4,481 22 2017E 24,948 5,193 21 2018E 25,356 6,019 18
(2,241) 189 (115) 1,664 (2,168) 348 52 (878) 162 15,464
(1,201) (133) (315) (954) 1,515 934 467 615 200 22,215
(1,194) (132) (348) (948) 1,506 929 464 680 199 25,057
(966) (107) (257) (767) 1,219 752 376 502 161 26,718
(909) (100) (245) (721) 1,146 707 353 479 151 28,309
(745) (82) (234) (591) 939 579 290 458 124 29,702
(716) (79) (208) (569) 904 557 279 407 119 30,855
(592) (65) (55) (470) 746 460 230 107 99 31,853
(1,723) (4,340) (3,179) (485) (9,727)
(2,091) (4,051) (4,930) (423) (11,495)
(2,544) (4,688) (5,365) (420) (13,018)
(3,108) (4,469) (7,469) (340) (15,386)
(3,812) (4,956) (6,824) (320) (15,912)
(4,698) (4,758) (8,486) (262) (18,204)
(5,820) (5,519) (8,592) (252) (20,184)
(7,249) (6,403) (8,708) (208) (22,568)
690 690 6,426 11,261 17,687
755 755 11,476 17,687 29,163
827 827 12,866 29,163 42,029
11,332 42,029 53,361
12,397 53,361 65,758
11,498 65,758 77,255
10,671 77,255 87,926
9,285 87,926 97,211
Apple Inc.
Common Size Income Statement Fiscal Years Ending September 30th 2008A Net Sales Cost of Sales Gross Margin Depreciation and Amortization Research and Development Selling, general, and administrative Total Operating Expenses Operating Income Other Income and Expense Income before provision for income tax Provision for income taxes Net Income 100.00% 64.80% 35.20% 1.32% 2.96% 8.71% 12.99% 22.21% 1.65% 23.86% 7.54% 16.32% 2009A 100.00% 59.86% 40.14% 1.71% 3.11% 7.96% 12.78% 27.36% 0.76% 28.12% 8.93% 19.19% 2010A 100.00% 60.62% 39.38% 1.57% 2.73% 6.88% 11.19% 28.19% 0.24% 28.42% 6.94% 21.48% 2011E 100.00% 62.00% 38.00% 1.29% 3.00% 6.90% 11.19% 26.81% 1.04% 27.85% 8.08% 19.77% 2012E 100.00% 62.00% 38.00% 1.77% 3.00% 6.90% 11.67% 26.33% 1.19% 27.52% 8.26% 19.27% 2013E 100.00% 62.00% 38.00% 2.09% 3.00% 6.90% 11.99% 26.01% 1.47% 27.48% 8.52% 18.96% 2014E 100.00% 62.50% 37.50% 2.48% 3.00% 6.90% 12.38% 25.12% 1.78% 26.91% 8.61% 18.30% 2015E 100.00% 63.00% 37.00% 2.79% 3.00% 6.90% 12.69% 24.31% 2.03% 26.34% 8.69% 17.65% 2016E 100.00% 63.25% 36.75% 3.15% 3.00% 6.90% 13.05% 23.70% 2.31% 26.02% 8.85% 17.17% 2017E 100.00% 63.70% 36.30% 3.45% 3.00% 6.90% 13.35% 22.95% 2.57% 25.52% 8.93% 16.59% 2018E 100.00% 64.25% 35.75% 3.83% 3.00% 6.90% 13.73% 22.02% 2.83% 24.85% 8.70% 16.15%
Apple Inc.
Common Size Balance Sheet Fiscal Years Ending September 30th 2008A ASSETS: Current assets: Cash and cash equivalents Short-term marketable securities Accounts receivable, gross Allowance for doubtful accounts Accounts receivable, less allowances Inventories Deferred tax assets Other current assets Total current assets Long-term marketable securities Property, plant and equipment, net Goodwill Other non-current equity and debt investments Acquired intangible assets, net Other assets Total assets LIABILITIES AND SHAREHOLDERS EQUITY: Current liabilities: Accounts payable Accrued expenses Deferred revenue Current portion of long-term debt Total current liabilities Deferred revenue non-curren Deferred Tax Liabilities Other non-current liabilities Total other non-current liabilities Long-term Debt Total liabilities Shareholders equity: Series A non-voting nonconvertible stock Common Stock Retained earnings Accumulated other comprehensive income/(loss Total shareholders equity Total liabilities and shareholders equity 2009A 2010A 2011E 2012E 2013E 2014E 2015E 2016E 2017E
31.67% 27.30% 6.59% 0.13% 6.46% 1.36% 2.78% 10.46% 80.04% 6.35% 6.55% 0.55% 0.00% 0.76% 2.24% 96.48%
12.27% 42.42% 7.95% 0.12% 7.83% 1.06% 2.65% 7.32% 73.55% 24.54% 6.88% 0.48% 0.00% 0.58% 4.69% 110.71%
17.26% 22.01% 8.53% 0.08% 8.45% 1.61% 2.51% 12.05% 63.90% 38.93% 7.31% 1.14% 0.00% 0.52% 3.47% 115.27%
20.39% 18.54% 9.00% 0.27% 8.73% 0.99% 2.02% 7.14% 57.82% 32.94% 9.25% 0.85% 0.00% 0.35% 3.17% 104.39%
29.14% 18.16% 9.00% 0.27% 8.73% 0.99% 2.06% 7.14% 66.23% 33.47% 10.33% 0.74% 0.00% 0.28% 3.17% 114.22%
37.08% 18.28% 9.00% 0.27% 8.73% 0.99% 2.13% 7.14% 74.35% 34.29% 11.19% 0.65% 0.00% 0.22% 3.17% 123.87%
43.00% 19.20% 9.00% 0.27% 8.73% 0.99% 2.15% 7.14% 81.22% 37.34% 11.37% 0.60% 0.00% 0.18% 3.17% 133.87%
49.01% 20.60% 9.00% 0.27% 8.73% 0.99% 2.17% 7.14% 88.64% 39.62% 11.43% 0.55% 0.00% 0.15% 3.17% 143.56%
54.23% 22.70% 9.00% 0.27% 8.73% 0.99% 2.21% 7.14% 96.01% 43.27% 10.98% 0.52% 0.00% 0.13% 3.17% 154.07%
58.46% 25.37% 9.00% 0.27% 8.73% 0.99% 2.23% 7.14% 102.92% 46.70% 10.63% 0.49% 0.00% 0.11% 3.17% 164.01%
0.00% 14.72% 11.27% 4.31% 0.00% 30.30% 2.05% 2.66% 1.99% 4.65% 0.00% 37.01%
0.00% 13.05% 8.98% 4.78% 0.00% 26.82% 1.99% 5.16% 3.00% 8.16% 0.00% 36.97%
0.00% 18.42% 8.77% 4.57% 0.00% 31.77% 1.75% 6.59% 1.89% 8.48% 0.00% 42.00%
0.00% 11.35% 7.00% 3.50% 0.00% 21.85% 1.50% 3.95% 1.42% 5.36% 0.00% 28.72%
0.00% 11.35% 7.00% 3.50% 0.00% 21.85% 1.50% 4.03% 1.23% 5.26% 0.00% 28.62%
0.00% 11.35% 7.00% 3.50% 0.00% 21.85% 1.50% 4.16% 1.09% 5.25% 0.00% 28.60%
0.00% 11.35% 7.00% 3.50% 0.00% 21.85% 1.50% 4.21% 0.99% 5.20% 0.00% 28.55%
0.00% 11.35% 7.00% 3.50% 0.00% 21.85% 1.50% 4.25% 0.92% 5.16% 0.00% 28.52%
0.00% 11.35% 7.00% 3.50% 0.00% 21.85% 1.50% 4.32% 0.86% 5.19% 0.00% 28.54%
0.00% 11.35% 7.00% 3.50% 0.00% 21.85% 1.50% 4.36% 0.82% 5.18% 0.00% 28.53%
0.00% 19.14% 40.35% -0.02% 59.47% 96.48%
0.00% 19.14% 54.43% 0.18% 73.74% 110.71%
0.00% 16.36% 56.99% -0.07% 73.27% 115.27%
0.00% 13.09% 62.63% -0.05% 75.67% 104.39%
0.00% 12.10% 73.54% -0.05% 85.60% 114.22%
0.00% 11.42% 83.89% -0.04% 95.27% 123.87%
0.00% 10.43% 94.93% -0.04% 105.32% 133.87%
0.00% 9.64% 105.44% -0.03% 115.05% 143.56%
0.00% 9.08% 116.49% -0.03% 125.54% 154.07%
0.00% 8.60% 126.91% -0.03% 135.48% 164.01%
Apple Inc.
Value Driver Estimation Fiscal Years Ending September 30th Values in Millions 2008A NOPLAT: Net Sales Cost of Goods Sold Ex D&A Depreciation Amortization of Non-Goodwill Intangibles R&D Expenses SG&A Expenses EBITA Less: Adjusted Taxes Income Tax Provision - Tax on Interest Income +/- Tax on Other Income (Expense) +/- Gains on Non-Current Investments Adjusted Taxes Plus: Change in Deferred Taxes NOPLAT Invested Capital: Operating Assets: Normal Cash Accounts Receivable Inventory Other Current Assets Total Operating Current Assets Operating Liabilities: Accounts Payable Accrued Expenses Deferred Revenue Total Operating Current Liabilities Net PP&E Other LT Operating Assets Operating Leases Acquired Intangible Assets, net Total Other LT Assets Other LT Operating Liabilities Deferred Revenue Non-Current Other Non-Current Liabilities Total Other LT Liabilities Invested Capital Return on Invested Capital: NOPLAT Beginning Invested Capital ROIC Free Cash Flows: NOPLAT Change in Invested Capital FCF Economic Profit: Beginning Invested Capital ROIC WACC EP 37,491 24,294 450 46 1,109 3,265 8,327 2009A 42,905 25,683 681 53 1,333 3,415 11,740 2010A 65,225 39,541 958 69 1,782 4,490 18,385 2011E 86,736 53,776 1,085 34 2,602 5,985 23,253 2012E 100,082 62,051 1,736 31 3,002 6,906 26,356 2013E 113,351 70,278 2,344 28 3,401 7,821 29,480 2014E 124,088 77,555 3,047 25 3,723 8,562 31,176 2015E 134,183 84,535 3,717 22 4,025 9,259 32,624 2016E 142,457 90,104 4,461 20 4,274 9,830 33,769 2017E 150,416 95,815 5,174 18 4,512 10,379 34,517 2018E 156,991 100,867 6,002 16 4,710 10,832 34,563
2,828 -229 11.55 0 2,611 118 5,834
3,831 -142 28.35 0 3,717 1126 9,149
4,527 -109 54.6 0 4,473 1583 15,495
7,005 -316 0 0 6,689 -993 15,571
8,264 -417 0 0 7,847 300 18,809
9,656 -584 0 0 9,072 332 20,740
10,684 -774 0 0 9,910 245 21,512
11,664 -952 0 0 10,711 234 22,146
12,601 -1152 0 0 11,448 224 22,544
13,433 -1352 0 0 12,081 199 22,635
13,653 -1556 0 0 12,097 52 22,519
5624 2,422 509 3,920 12475
5263 3,361 455 3,140 12219
9784 5,510 1,051 7,861 24206
13010 7,572 862 6,197 27641
15012 8,737 994 7,150 31894
17003 9,896 1,126 8,098 36122
18613 10,833 1,233 8,865 39544
20127 11,714 1,333 9,587 42761
21369 12,437 1,415 10,178 45398
22562 13,131 1,494 10,746 47934
23549 13,705 1,559 11,216 50029
5,520 4,224 2,385 12,129 2,455
5,601 3,852 2,906 12,359 2,954
12,015 5,723 4,123 21,861 4,768
9,847 6,071 4,337 20,255 8,023
11,362 7,006 5,004 23,372 10,338
12,869 7,935 5,668 26,471 12,682
14,088 8,686 6,204 28,978 14,104
15,234 9,393 6,709 31,336 15,343
16,173 9,972 7,123 33,268 15,640
17,077 10,529 7,521 35,126 15,985
17,823 10,989 7,850 36,662 16,386
1,376 285 839
1,523 247 2,011
1,884 342 2,263
2,006 308 2,748
2,585 277 3,171
3,170 249 3,591
3,526 224 3,931
3,836 202 4,251
3,910 182 4,513
3,996 164 4,765
4,096 147 4,973
768 746 1,514 2,126
853 1,286 2,139 2,686
1,139 1,231 2,370 7,006
1,301 1,231 2,532 15,624
1,501 1,231 2,732 19,298
1,700 1,231 2,931 22,993
1,861 1,231 3,092 25,508
2,013 1,231 3,244 27,776
2,137 1,231 3,368 28,915
2,256 1,231 3,487 30,071
2,355 1,231 3,586 31,141
5,834 1,503 388%
9,149 2,126 430%
15,495 2,686 577%
15,571 7,006 222%
18,809 15,624 120%
20,740 19,298 107%
21,512 22,993 94%
22,146 25,508 87%
22,544 27,776 81%
22,635 28,915 78%
22,519 30,071 75%
5,834 623 5,211
9,149 560 8,589
15,495 4,320 11,176
15,571 8,619 6,952
18,809 3,674 15,135
20,740 3,695 17,045
21,512 2,515 18,996
22,146 2,267 19,879
22,544 1,140 21,404
22,635 1,155 21,479
22,519 1,070 21,449
1,503 388% 9% 5,692
2,126 430% 9% 8,948
2,686 577% 9% 15,241
7,006 222% 9% 14,908
15,624 120% 9% 17,331
19,298 107% 9% 18,915
22,993 94% 9% 19,337
25,508 87% 9% 19,733
27,776 81% 9% 19,917
28,915 78% 9% 19,900
30,071 75% 9% 19,674
Apple Inc.
Weighted Average Cost of Capital (WACC) Estimation Beta Calculation Years 2 5 7 Maximum Minimum Mean Median Capital Asset Pricing Model (CAPM) Risk-Free Rate Beta Market Risk Premium Cost of Equity Cost of Debt Cost of Debt Marginal Tax Rate Cost of Debt (After-Tax) Daily 0.919 1.002 1.045 1.045 0.919 0.989 1.002 Weekly Monthly 1.103 1.075 1.038 1.44 1.088 1.475 1.103 1.475 1.038 1.075 1.076 1.330 1.088 1.44 Implied Cost of Debt Comparable Issues Company Rating Term MSFT AAA 10-Year TGT A 10-year EBAY A 10-year BRK AA+ 10-year JNJ AAA 10-year Average
Yield 3.200 3.3606 3.5568 3.610 2.970 3.34
4.01% 1.076 5.11% 9.51%
3.605% 35.00% 2.34%
Weighted Average Cost of Capital (WACC) Cost of Debt (after-tax) Cost of Equity Target Debt/Capitalization Target Equity/Capitalization WACC Target Capital Structure Market Value of Equity PV of Operating Leases Total Capitalization Debt/Capital
2.34% 9.51% 0.70% 99.30% 9.46%
267,905 1,884 269,788 0.70%
Apple Inc.
Discounted Cash Flow (DCF) and Economic Profit (EP) Model Valuation Fiscal Years Ending September 30th Values in Millions Assumptions: CV growth CV ROIC WACC Cost of Equity 4.0% 78% 9.46% 9.51% 2011E DCF Model Free Cash Flows (FCF) Continuing Value (CV) Total Free Cash Flows PV of FCF Value of Operating Assets Less: Operating Leases ESOP Plus: Excess Cash Long-Term Investments Short-Term Investments Equity Value Shares Outstanding Intrinsic Share Price Fraction of Fiscal Year Elapsed Current Stock Price Current Market Price Premium for Intrinsic Value EP Model ROIC Beginning Invested Capital WACC Economic Profit (EP) Continuing Value (CV) Total Economic Profit PV of Economic Profit Beginning Invested Capital Value of Operating Assets Less: Operating Leases ESOP Plus: Excess Cash Long-Term Investments Short-Term Investments Equity Value Shares Outstanding Intrinsic Share Price Fraction of Fiscal Year Elapsed Current Stock Price Current Market Price Premium 2012E 2013E 2014E 2015E 2016E 2017E 2018E
6,952 $ $ 6,952 6,352 289,673 $
15,135 15,135 12,632 $
17,045 17,045 12,997 $
18,996 18,996 13,233 $
19,879 19,879 12,652 $
21,404 21,404 12,445 $
21,479 391,474 412,953 219,361
21,449 $ 21,449
1,884 5,004
$ $ $ $ $ $ $
1,477 25,391 14,359 324,012 893.02 362.83 0.12 366.73 308.03 17.79%
$ $
222% 7,006 9.46% 14,908 $ 14,908 13,620 7,006 289,673 $
120% 15,624 9.46% 17,331 $ 17,331 14,465 $
107% 19,298 9.46% 18,915 $ 18,915 14,423 $
94% 22,993 9.46% 19,337 $ 19,337 13,471 $
87% 25,508 9.46% 19,733 $ 19,733 12,559 $
81% 27,776 9.46% 19,917 $ $ 19,917 $ 11,580
78% 28,915 9.46% 19,900 $ 361,403 381,303 202,548
75% 30,071 9.46% 19,674
1,884 5,004
1,477 25,391 14,359 324,012 893.02 362.83 0.12 366.73 308.03 17.79%
$ $ $ $
Apple Inc.
Relative P/E Analysis Ticker GOOG CSCO DLB SNE SAP MSFT Company Google Cisco Systems Dolby Laboratories Sony Corporation SAP Microsoft Price 617.58 23.75 65.60 47.47 50.29 27.07 EPS 2011E $25.54 $1.39 $2.69 $2.40 $2.90 $2.42 EPS 2012E $29.65 $1.60 $3.10 $2.75 $3.42 $2.70 Average $20.85 P/E 11 24.2 17.1 24.4 19.8 17.3 11.2 19.0 16.5 P/E 12 20.83 14.84 21.16 17.26 14.70 10.02 16.5 14.8 Est. 5yr Gr. 19.60 11.50 17.20 17.20 12.80 11.10 PEG 11 1.23 1.49 1.42 1.15 1.35 1.01 1.3 1.3 PEG 12 1.06 1.29 1.23 1.00 1.15 0.90 1.1 1.2
$ $ $ $ $ $
AAPL
Apple, Inc.
308.03
$18.70
12.5
Implied Value: Relative P/E (EPS11) Relative P/E (EPS12) PEG Ratio (EPS11) PEG Ratio (EPS12)
$ $ $ $
355.21 343.46 298.05 288.42
Apple Inc.
Fundamental P/E Valuation Model Fiscal Years Ending September 25 Assumptions CV growth CV ROIC WACC Cost of Equity ROE 2011E EPS Key Assumptions CV growth CV ROE Cost of Equity Future Cash Flows P/E Multiple EPS(next period) Future Stock Price $ 18.70 $ 4.00% 78.28% 9.46% 9.51% 11.07% 2012E 20.85 $ 2013E 23.05 $ 2014E 24.35 $ 2015E 25.40 $ 2016E 26.24 $ 2017E 26.76 $ 2018E 27.20
$ $ $
11.59 27.20 315.25
Intrinsic Value
167.46
Apple Inc.
Sensitivity Analysis Beta 1.076 319.72 332.97 348.43 366.73 388.72 415.65 449.37
CV Growth Rate
366.73 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5%
1.04 327.66 341.85 358.51 378.32 402.28 431.84 469.23
1.05 325.41 339.33 355.65 375.02 398.41 427.20 463.52
1.06 323.20 336.85 352.83 371.78 394.62 422.68 457.97
1.08 318.87 332.01 347.35 365.49 387.28 413.93 447.28
1.09 316.75 329.64 344.68 362.43 383.72 409.70 442.13
1.1 314.66 327.32 342.05 359.43 380.23 405.57 437.12
Cost of Goods Sold 2018
366.73 62.5% 63.0% 63.5% 64.3% 64.5% 65.0% 65.5%
5% 379.35 373.49 367.62 358.82 355.89 350.03 344.16
7% 382.17 376.25 370.33 361.46 358.50 352.59 346.67
iPhone Growth Rate 2018 9% 11% 13% 384.98 387.79 390.61 379.01 381.78 384.54 373.05 375.76 378.47 364.10 366.73 369.37 361.11 363.72 366.33 355.15 357.71 360.26 349.18 351.69 354.20
15% 393.42 387.30 381.18 372.00 368.94 362.82 356.70
17% 396.24 390.07 383.90 374.64 371.55 365.38 359.21
$ Research and Development 2018
366.73 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50%
0.00% 388.76 380.83 372.91 364.98 357.06 349.14 341.21
1.00% 389.38 381.44 373.50 365.57 357.63 349.69 341.76
iPad Growth Rate 2018 2.00% 3.00% 4.00% 390.00 390.61 391.23 382.05 382.65 383.26 374.10 374.69 375.29 366.15 366.73 367.32 358.20 358.77 359.34 350.25 350.81 351.37 342.31 342.85 343.40
5.00% 391.85 383.87 375.88 367.90 359.91 351.93 343.95
6.00% 392.47 384.47 376.48 368.48 360.49 352.49 344.50
Market Risk Premium
366.73 4.80% 4.90% 5.00% 5.11% 5.20% 5.30% 5.40%
2.00% 388.94 381.64 374.64 367.25 361.43 355.21 349.21
2.50% 388.75 381.46 374.46 367.08 361.27 355.06 349.07
Cost of Debt 3.00% 3.61% 388.57 388.35 381.28 381.08 374.29 374.10 366.92 366.73 361.12 360.94 354.91 354.73 348.92 348.76
4.00% 388.21 380.95 373.97 366.61 360.82 354.62 348.65
4.50% 388.05 380.79 373.82 366.46 360.68 354.49 348.52
5.00% 387.88 380.63 373.67 366.32 360.54 354.35 348.39
Apple Inc.
Operating and Capital Lease Obligations Capital Leases 0 0 0 0 0 0 0 0 0 Operating Leases 266 267 260 244 226 826 2089 205 1884
Years Ended April 30, 2011 2012 2013 2014 2015 Thereafter Total Minimum Payments Less: Interest PV of Minimum Payments
Capitalization of Operating Leases Pre-Tax Cost of Debt Number Years Implied by Year 6 Payment Lease Commitment 266 267 260 244 226 275 2.34% 3 PV Lease Payment 259.9 254.9 242.5 222.4 201.3 702.5 1883.6
Year 1 2 3 4 5 6 & beyond PV of Minimum Payments Year 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 Capitalized Operating Leases $1,884 $1,523 $1,376 $1,128 $914 $689 $497 $493 $384 $355 $218
Apple Inc.
VALUATION OF OPTIONS GRANTED IN ESOP
Ticker Symbol Current Stock Price Risk Free Rate Current Dividend Yield Annualized St. Dev. of Stock Returns
AAPL 308.03 4.01% 0.00% 50.10%
Range of Outstanding Options Range 1 Total
Average Number Exercise of Shares Price 21,725,000 90.46 21,725,000 $ 90.46
Average Remaining Life (yrs) 2.85 $ 2.85 $
B-S Value Option of Options Price Granted 230.35 $ 5,004,445,169 230.35 $ 5,004
Apple Inc.
Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding Number of Options Outstanding (shares): Average Time to Maturity (years): Expected Annual Number of Options Exercised: Current Average Strike Price: Cost of Equity: Current Stock Price: $ $ 21,725,000 2.85 7,622,807 90.46 9.51% 308.03 2010A 7,622,807 90.46 $ 690 0 308.03 $ 893,016 7,623 900,639 2011E 7,622,807 90.46 $ 690 0 308.03 $ 909,461 7,623 917,084 2012E 7,622,807 99.06 $ 755 0 337.32 $ 917,084 7,623 924,707 2013E 7,622,807 108.48 827 0 369.39 924,707 7,623 932,329
Increase in Shares Outstanding: Average Strike Price: Increase in Common Stock Account: Change in Treasury Stock Expected Price of Repurchased Shares: Number of Shares Repurchased: Shares Outstanding (beginning of the year) Plus: Shares Issued Through ESOP Less: Shares Repurchased in Treasury Shares Outstanding (end of the year)
Assume that shares outstanding increases due to ESOP only until 2012 since the average time to maturity for the options is 3 fiscal years.

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Krause Fund Research Fall 2010

Apple, Inc. (NYSE: AAPL)

Stock Performance Highlights

One Year Stock Performance

Company Performance Highlights

Figure 1: Blue: AAPL; Red: S&P 500 source: Yahoo! Finance

Important disclosures appear on the last page of this report.

Figure 2: Real GDP Growth 2006-2011

Important disclosures appear on the last page of this report.

Important disclosures appear on the last page of this report.

Unemployment Rates 2007 - 2011

Figure 4: Unemployment Rate (%)

Important disclosures appear on the last page of this report.

Important disclosures appear on the last page of this report.

Net Sales (millions)

Figure 7: Digital Music Player Market Share 07-08

Figure 8: 2010 Apple Net Sales by Operating Segment

Important disclosures appear on the last page of this report.

100% 80% 60% 40% 20% 0% 2010 2009

Software,service andothersales Peripheralsand otherhardware iPad iPhone Othermusic iPod

Figure 10: 2010- 2009 Product Mix as a Proportion of Net Sales

Important disclosures appear on the last page of this report.

Important disclosures appear on the last page of this report.

Important disclosures appear on the last page of this report.

Important disclosures appear on the last page of this report.

http://www.unwiredview.com/2010/09/07/idc-raises-2010smartphone-shipment-forecast-to-270-million/ Factset Research. (2010, October 28).

Important disclosures appear on the last page of this report.

Important disclosures appear on the last page of this report.

1,515 2.25% 1,455 0.23% 167 3.78% 580 555% NM 0%

1,359 -10.28% 1,322 -9.13% 149 -10.47% 629 8% NM 0%

1,340 -1.38% 1,248 -5.56% 164 10.03% 630 0% 663 0%

1313 -2% 1223 -2% 156 -5% 630 0% 663 0%

1287 -2% 1199 -2% 148 -5% 598 -5% 663 0%

1261 -2% 1175 -2% 141 -5% 600 -5% 663 0%

1236 -2% 1140 -3% 134 -5% 600 -5% 663 0%

1211 -2% 1105 -3% 127 -5% 600 -4% 663 0%

1187 -2% 1072 -3% 121 -5% 576 -4% 663 0%

1163 -2% 1040 -3% 115 -5% 553 -4% 663 0%

1140 -2% 1009 -3% 109 -5% 531 -4% 663 0%

Net Sales % Growth

5,520 4,224 1,617 11,361 768 999 746 1,745 13,874

5,601 3,852 2,053 11,506 853 2,216 1,286 3,502 15,861

12,015 5,723 2,984 20,722 1,139 4,300 1,231 5,531 27,392

9,847 6,071 3,036 18,954 1,301 3,422 1,231 4,653 24,909

11,362 7,006 3,503 21,871 1,501 4,037 1,231 5,268 28,640

12,869 7,935 3,967 24,771 1,700 4,717 1,231 5,948 32,419

14,088 8,686 4,343 27,117 1,861 5,220 1,231 6,451 35,429

15,234 9,393 4,696 29,323 2,013 5,698 1,231 6,929 38,265

16,173 9,972 4,986 31,131 2,137 6,156 1,231 7,387 40,655

17,077 10,529 5,265 32,870 2,256 6,562 1,231 7,793 42,920

17,823 10,989 5,495 34,307 2,355 6,670 1,231 7,901 44,563

7,177 15,129 (9) 22,297 36,171

8,210 23,353 77 31,640 47,501

10,668 37,169 (46) 47,791 75,183

11,358 54,320 (46) 65,632 90,540

12,113 73,603 (46) 85,670 114,310

12,940 95,096 (46) 107,989 140,409