Apple Inc. Investment Thesis. Key Statistics. Trading Statistics. Margins and Ratios 11/30/12. Technology. Apple Five Year Stock Price

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1 11/30/12 Technology Apple Inc. Ticker: AAPL Current Price: $ Recommendation: Hold Implied Price: $ Key Statistics 52 Week Price Range $ $ Day Moving Average $ Estimated Beta 1.03 Dividend Yield 1.9% Market Capitalization $ billion 3-Year Revenue CAGR 41.3% Trading Statistics Diluted Shares Outstanding 947,197,000 Average Volume (3-Month) 19.4 billion Institutional Ownership 68% Insider Ownership 0.05% EV/EBITDA (LTM) 9.00x Investment Thesis Apple has a loyal customer base and is in a good position to expand globally into emerging markets allowing for the firm to continue growing in the future. Apple s product pipeline is more expansive than ever. The firm has a wide range of products that appeal to consumers of all ages. The company s focus on increasing its interaction with educational institutes creates vast growth options through the institutions and the students. Management of the firm is committed to continuing to innovate as can be seen by the large investments in R&D over the past two years Apple Five Year Stock Price Margins and Ratios Gross Margin (LTM) 45.97% EBITDA Margin (LTM) 38.50% Net Margin (LTM) 26.67% Debt to Enterprise Value 0 Cameron Schwartz Cschwar3@uoregon.edu 1 University of Oregon Investment Group

2 Business Overview Apple Inc. is an American multinational corporation located in Cupertino, California that produces and sells computer hardware and software and consumer electronics. Today, the company s most recognizable products are the iphone, ipad, ipod, and Mac desktops and notebooks. Apple Inc. was established on April 1, 1976 by Steve Jobs, Steve Wozniak and Ronald Wayne and incorporated on January 3, 1977 without Wayne. The company began selling the Apple I personal computer which was hand built by Steve Wozniak. In 1984 Apple released the Macintosh computer and advertised the product during Super Bowl XVIII with the famous 1984 commercial which is now hailed as watershed event for the company. In 1985 Jobs resigned from Apple after a power struggle ensued between him and CEO John Sculley and the Apple board ordered Sculley to contain Jobs ability to launch expensive ventures into experimental products. Jobs founded NeXT Inc. that year. After Jobs left the company Apple released a multitude of products which saw minimal success except for the PowerBook portable computer. After years of Microsoft gaining market share and failed attempts to revamp Apple s Mac OS operating system, the firm bought NeXT and its NeXTSTEP operating system. By 1997 Jobs was named the interim CEO and began to restructure the company s product line. Jobs announced that Apple would release Microsoft Office for the Macintosh and received a $150 million dollar investment in stock from Microsoft. In 1998, Apple released the imac, an all-new all-in-one computer which was designed by Johnathon Ive. The imac was a great success and in 2001 the company released the revamped OS X operating system. Also in 2001, Apple announced the ipod portable digital music player which saw fantastic success. As the years went on Apple consistently released revolutionary products such as the itunes store in 2003, the iphone in 2007, and the ipad in Many people credit Jobs tenacity and innovative mind set for the creation of such a successful line of products and praise him as one of the most influential CEO s of the 21 st century. Tim Cook, former COO of Apple, was named CEO of the company on August after Jobs took a medical leave. On October 4 th, 2011 Jobs passed away due to pancreatic cancer. Since Jobs death there has been speculation about Apple s ability to create innovative products without him. Business Segments Apple currently has eight business segments consisting of Desktops, Portables, ipod, iphone, ipad, Other music related products and services, peripherals and other hardware, and software, service, and other sales. The iphone is Apple s smartphone and was released on June 29, Since then the iphone has gone through 6 iterations, the most recent being the iphone 5. Last year, 1.25 billion iphone units were sold generating over $80 billion in revenue. The iphone is Apple s major revenue driver accounting for over 50% of 2012 s total revenue. The ipad is tablet computer which was released on April 3 rd, Since inception the ipad has undergone 4 iterations. On November 2 nd the most recent UOIG 2

3 fourth generation ipad and ipad mini were released. On the launch day Apple sold 3 million ipad products of all kinds setting a record for sales volume on an ipad launch day. Last year Apple sold over 58 billion ipads generating$32.4 billion dollars in revenue and accounting for nearly 21% of 2012 total revenue. The desktop and portables segment together make up the Mac segment. Apple s line of desktop computers consists of the all-in-one imac computer, Mac Pro (traditional tower computer), and the Mac Mini (condensed computer). Apple s portables line consists of the MacBook Pro and the MacBook Air. Total Mac unit sales were billion in 2012, generating $23.2 billion in revenue and accounting for 15% of total revenue. The ipod is a portable digital music player. The product was launched in 2001 and since being introduced Apple has evolved ipod into a product line that includes ipod touch (full size ipod with touch screen), ipod Nano (smaller ipod with touch screen), ipod shuffle (smallest ipod, no screen), and ipod classic (traditional click wheel style). Since 2011 the ipod has seen negative growth rates. In 2012 ipod unit sales totaled 25.2 billion, generating $5.6 billion in revenue and accounting for around 4% of revenue. The three remaining segments generate a much smaller portion of Apple s revenue. Other music related products and services generated $8.5 billion in revenue consisting of sales from Apple s App Store, itunes Store, and ibook store as well as ipod services and third-party iphone accessories. Peripherals and other hardware consist of displays, wireless connectivity and networking solutions and generated $2.8 billion in revenue. Software, service, and other sales consists of Apple branded and third party software. This segment generated $3.5 billion in revenue last year. Strategic Positioning Although Tim Cook may lack innovative product development skills that Jobs had, Cook s expertise in supply chain management places Apple in a strong strategic position. Furthermore, the company remains strong in sales and marketing and research and development. Tim Cook s supply chain expertise can be seen when analyzing the iphone 5 s product rollout. Within a week of the products release the iphone was available in 31 countries and by the end of the calendar year the smartphone will be available in 100 countries. To put that efficiency into perspective, consider that the iphone 5 will be available in 30 more countries than the iphone 4S was in the same period of time. The iphone 5 will be distributed through 240 carriers internationally, putting the smartphone in a prime position to further grow and capture global market share. Apple has been able to control nearly every aspect of the supply chain from design to retail store. Apple s large demand volume allows the company to gain price advantages in securing key components, airfreight and manufacturing capacity, and capital equipment. Price advantages in the aforementioned areas allow the company to grab high margins on its products. Sales and marketing are another position that Apple excels at. Dating back to the famous 1984 Macintosh commercial during the Super Bowl, Apple has continuously been able to create innovative and memorable advertising campaigns. In the 2000 s Apple launched its memorable ipod advertisement, which featured colorful backgrounds with silhouettes of people dancing to a UOIG 3

4 variety of songs with an ipod and the Apple branded white Ear buds. Apple s ability to create memorable advertisements keeps the firm relevant and exciting to consumers. Research and development is another area where Apple has traditionally succeeded over competitors. Apple believes that investing in R&D is critical to future growth and competitive position in the market. Over the past two years, R&D has nearly doubled. Last year, the company released plans to build a 300,000 square foot facility entirely for research at its Cupertino headquarters. In the past Apple was able to create revolutionary products such as the iphone and ipad that captivated the consumer market, whereas prior to the iphone and ipad tablet computers and smartphones were used solely in the business world. Business Growth Strategies Apple is committed to delivering customers the best products on the market that deliver the best user experience possible. The company leverages its unique ability to design and develop their own hardware and software in order to deliver customers products that solve problems, is easy to use, and can be integrated into daily life seamlessly. Apple provides unique sales experiences to customers and small business through its retail and online stores. Apple has been and is currently continuing to expand the number of retail stores internationally. In 2012 Apple opened 33 new retail stores, 28 of which were outside the United States. In 2013 the firm plans to build new retail stores with around three quarters being located outside of the United States. Apple retail stores are typically located in high traffic locations in quality shopping malls and urban shopping districts. By operating its own stores and locating in high traffic areas Apple is positioned to attract new customers through the exceptional customer experience of entering a retail store. The firm targets education as an area of growth. Apple is committed to delivering solutions to help educators teach and students learn. The company believes that technology integrated classrooms creates a better teaching and learning environment. itunesu supports mobile learning through the ability to distribute and download educational material. In June 2012 Apple reached new record sales in the U.S. educational sector as more and more schools start to buy the ipad. As students and teachers become more technologically savvy, the educational sector will become increasingly lucrative for Apple. Apple sells to educational institutions through their direct sales team. Geographically, the Asia-Pacific region has experienced momentous growth in recent years. The Asia-Pacific segment has seen exceptional growth since China is the worlds largest smartphone market accounting for 26.5% of the entire smartphone market. In China, Apple holds a 79% market share of the new tablet, which is reassuring due to the expected increase in the Chinese tablet market. In recent years the iphone has seen phenomenal growth in China capturing 33% of a market that grew around 200% year-over-year in Apple has contracts with the 2 nd and 3 rd largest mobile carriers in China and is rumored to be reaching a deal with China Mobile, the largest mobile carrier in China with subscribers around 703 million. A deal with China Mobile would significantly boost revenue. In 2012 the Asia-Pacific region grew 47% yearover-year accounting for 21.26% of revenue. UOIG 4

5 Traditionally, Apple has seen significant growth in Americas. Year over year growth was 50% in Americas continue to be the largest geographical segment accounting for 36.75% of total revenue. Europe has also traditionally been a large consumer of Apple products. Given recent economic crisis in Europe growth has slowed from 48.61% in 2011 to 30.76% in Regardless, Europe remains the second largest geographic segment accounting for 23.21% of total revenue. Apple is focused on organic growth through creating innovative products that produce higher user quality through exceptional experiences. Apple does not focus on growing through acquisitions. Apple is affected by cyclical sales typically seeing higher sales during the holiday season and back to school season. Furthermore, the firm is somewhat effected by economic trends given its higher price point and luxury appeal due to its high quality products. In the future Apple is expected to introduce a new Apple TV, which is a fully integrated networking device. Currently, Apple TV allows users to watch television and movies from their high definition televisions as well as steam content from itunes, Netflix, YouTube, and Flickr and content from their computers wirelessly to their television. Apple TV has seen minimal success selling only 5 million units and 2.8 million units in 2012 and 2011 respectively. For the past two years analyst rumors have speculated that Apple s newest big project is going to involve a renovated Apple TV that will consists of a fully integrated monitor rather than just the box that is currently Apple TV. Recently, analysts have speculated that Apple TV will be launched in The basis of their argument is that R&D has nearly doubled over the past two years and the only new product that has been released is a miniature version of the ipad. The launch of a renovated Apple TV could create large growth possibilities in the coming year. That being said, I did not include the introduction of Apple TV into my valuation because management has not mentioned anything about it an the rumor has been ongoing for multiple years. Industry Overview Apple operates in the technology industry, which primarily provides chip production, information and communication systems, and computer systems. Apple is most competitive in the markets for production of operating systems and productivity software and computers manufacturing. Apple holds 19.2% of the market share for the computer manufacturing industry, which generated $36.8 billion in revenue in The computer manufacturing industry has seen a decaying growth rate of 5.1% annually over the past five years and is expected to decay at the same rate for the next five years according to IBIS World. The computer manufacturing industry is characterized by high competition from imported products. Fierce competition and low input costs have lead to product homogeneity and declining margins. Apple s introduction of the ipad further troubled the market because tablet computers have begun to cannibalize laptop sales. In the production of operating systems and productivity software market Apple owns a 18.4% market share, second to Microsoft s 70.2%. This market generated $36.1 billion in revenue and has experienced 7% annually growth over the past five years. In the next five years the market is expected to decay at a 0.5% annual rate according to IBIS World. Past decreases in discretionary spending is the main factor driving the growth rate down. UOIG 5

6 Companies in the technology sector generally trade at high multiples given investor s high growth expectations. In order to stay competitive in the technology market companies must stay current with trends in increasing portability and computing power, the ability to vertically integrate hardware devices through cloud computing, and increasingly energy efficient products. Given the market saturation, product homogeneity, and low margins firms must successfully advertise and sell their competitive advantages and consumer value added benefits in order to maintain profitability. The future of the technology sector lies in all-in-one computers and cloud computing. All-in-one computers such as tablet computers and Apple s imac desktop computer integrate all the components of a computer into a slim and portable casing. Cloud computing allows users to seamlessly access and integrate all content and media through multiple devices creating a more enjoyable customer experience. As customers become accustomed to the ability to integrate multiple devices, firms that do not offer this benefit will loose demand and market share. Macro factors Macroeconomic factors that are the computer manufacturing and operating system production markets face are import penetration into the manufacturing sector, price of computer and peripheral materials and per capita disposable income. Imports have penetrated a 30% market share of computer manufacturing. Additionally, domestic firms outsource production to the Asia-Pacific region to take advantage of lower labor costs and boost their margins. IBIS World predicts that import penetration will slow in the future because most of the opportunities available have already been taken. Per capita disposable income took a hit during the financial meltdown that began in Rebound from the meltdown has been limited and firms still face a highly price sensitive consumer base. Luckily for computer manufacturing firm s price of computer and peripheral materials have fallen greatly over the past five years due to Moore s law which states that two years technology doubles its capacities on the same size chip. As computing capacity grows exponentially yearly manufacturers are able to create more powerful chips for cheaper. The cost saving gets passed onto consumers who are able to choose from a variety of products. In order for firms to stay competitive in this market they must differentiate themselves on a factor outside of price. Competition Samsung, Google, Microsoft, Hewlett-Packard, and Amazon are Apple s main competitors. In recent years, Samsung has arisen as the number one competitor for Apple s market share in the smartphone and tablet market. Samsung provides users many of the same features Apple products offer, but at a cheaper price. Samsung s product line has more variety as well offering products that fit different customer desires. Apple is currently suing Samsung over patent various patent infringements for smartphones and tablets. The companies are currently in the middle of 50 lawsuits are the globe with billions of dollars in damages UOIG 6

7 claimed between both companies. Interestingly, Samsung provides the processors for Apple s iphone and ipad. Google Inc. is another large competitor of Apple. The company is a direct competitor in the operating system market as well as in the hardware market. Google s Android operating system software is used on 75% of mobile devices globally. The firms Nexus product line includes tablets and smartphones that directly compete against Apple s iphone and ipod and is priced lower than Apple products which allows the product line to gain more market share in emerging markets. Microsoft Inc. has traditionally been Apple s greatest competitor in the operating system and productivity publishing market. Competition between Microsoft and Apple stem back to the early days of Apple s establishment. Microsoft s Windows operating system holds a 70.66% market share and directly competes with Apple s OS X operating system. Microsoft users are loyal to the Windows operating system because they have been using it for so long and it is ubiquitous among enterprises. Recently, Microsoft has begun to compete with Apple on the hardware front releasing the Microsoft smartphone and most recently releasing the Microsoft Surface tablet. Hewlett-Packard (HP) is Apple s main competitor in the computer manufacturing market. HP is the market share leader in computer manufacturing market, owning 27.3% of the market. HP s products directly compete with Apple s computer hardware products. Hewlett-Packard computers have been around since the 1930 s allowing them to establish a consumer presence that new entrants struggle to obtain. Amazon.com competes directly with Apple s itunes store. Amazon.com offers users the ability to browse a wide variety of music, videos, and books and purchase the products at prices that are often cheaper than on itunes. In 2012 Amazon.com released the Kindle Fire tablet computer that directly competes with the ipad. Amazon.com s Kindle Fire tablet has competitive pricing advantages selling for only $199. Management and Employee Relations Tim Cook CEO Before being named CEO in August 2011, Tim was Apple's Chief Operating Officer and was responsible for all of the company s worldwide sales and operations, including end-to-end management of Apple s supply chain, sales activities, and service and support in all markets and countries. He also headed Apple s Macintosh division and played a key role in the continued development of strategic reseller and supplier relationships, ensuring flexibility in response to an increasingly demanding marketplace. Tim earned an M.B.A. from Duke University, where he was a Fuqua Scholar, and a Bachelor of Science degree in Industrial Engineering from Auburn University. UOIG 7

8 $ One-Year Stock Chart Peter Oppenheimer CFO Peter Oppenheimer is Apple s senior vice president and Chief Financial Officer. In his capacity as CFO, Oppenheimer oversees the controller, treasury, investor relations, tax, information systems, internal audit and facilities functions. He reports to the CEO and serves on the company s executive committee. Oppenheimer received a bachelor s degree from California Polytechnic University, San Luis Obispo and an M.B.A. from the University of Santa Clara, both with honors. $ $ $ $ $ $ $ $0.00 8/15/ /19/ /23/2011 3/2/2012 5/8/2012 7/13/2012 9/18/2012 Volume Adjusted Close 50-Day Avg 200-Day Avg Date Phillip W Schiller Senior Vice President, Worldwide Marketing Philip Schiller is Apple s senior vice president of Worldwide Marketing and reports to Apple s CEO. Schiller is a member of Apple s Executive Team. Since rejoining Apple in April 1997 Schiller has helped the company create the best computers in the world with the Mac, lead the digital music revolution with ipod and itunes, reinvent mobile phones with iphone and the App Store, and define the future of mobile computing with ipad. Schiller graduated with a Bachelor of Science degree in Biology from Boston College in Johnathon Ive Senior Vice President, Industrial Design London-born designer Jonathan Ive is Apple's senior vice president of Industrial Design, reporting to CEO Tim Cook. Since 1996, he has been responsible for leading a design team widely regarded as one of the world s best. As the driving force behind the look and feel of Apple's innovative products, Jony also provides leadership and direction for Human Interface (HI) software teams across the company. Jony holds a Bachelor of Arts and an honorary doctorate from Newcastle Polytechnic. In 2003, he was named Designer of the Year by the Design Museum London and awarded the title Royal Designer for Industry by The Royal Society of Arts. Management Guidance Apple s management typically gives conservative guidance that they will be able to consistently beat. Apple s management only gives guidance for one future quarter. Management is extremely excited about Apple s product pipeline for 2013 offering more newly renovated products than ever. Management continued to stress that last year s December quarter had a 14 th week and this year s December quarter will only have 13 weeks. Management expects revenues in Q to be $52 billion compared to $46.3 billion in last year s December quarter. The firm expects gross margins to be 36% a decrease from the firm s normal 40% plus margins. They attribute lower margins in this quarter to the extensive product rollout they experienced in As new products are introduced costs of sales are high until economies of scale are reached. Based on historical data it seems reasonable that Apple will be able to beat the guidance provided by management especially during the holiday season. Let it be noted, revenue in last year s December quarter exceeded guidance by 25%. Portfolio Strategy or History UOIG 8

9 Date University of Oregon Investment Group Bought /Sold Quantity Price Realized Gains (Loses) Unrealized Gains (Loses) Cost Basis 8/3/2012 Bought 75 $ N/A N/A $46, /28/2012 Sold 25 $ $ 1, $3, $30, Current N/A 50 $ N/A $ (1,601.00) $30, Date Tall Firs Svigals Bought /Sold Quantity Price Realized Gains (Loses) Unrealized Gains (Loses) Cost Basis 2/3/2011 Bought 9 $ N/A N/A $4, /9/2012 Sold 3 $ $ $8, $22, Current N/A 50 $ N/A $ 6, $22, Apple stocks are held in both the Tall Firs and Svigals portfolio. Tall Firs purchased 75 stocks on August 3 rd, 2012 for $ per share. On September 28 th, 2012 Tall Firs sold 25 shares of Apple for $ Tall Firs realized gains of $1, from that transaction. Currently, the 50 shares Tall Firs holds have a cost basis of $30, and unrealized losses of $1, Based on the value strategy of the Tall Firs portfolio I believe Apple is a good stock to hold because it is currently undervalued due to heavy recent sell offs. Sviglas purchased 9 shares of Apple on February 3 rd, 2011for $ On April 9 th, 2012 Svigals sold 3 shares of Apple for $ Svigals realized gains of $ from that transaction. The remaining six shares of Apple have a cost basis of $2, and unrealized gains of $ Based on the strategy of the Svigals portfolio I believe Apple is fit for the portfolio because it is currently undervalued /31/2012 Apple 1 Month Stock Price 11/7/ /14/ /21/2012 Recent News Samsung Raises Prices To Apple I Wonder Why? Forbes So there s no such reason for Samsung to increase prices to cover increased input costs. They ve already built the plant in Austin TX. Of course, sometimes you increase prices just because you can. Whoever it is wants more of what you can make and cannot get it elsewhere: you ve got them over a barrel so why not gouge them? Often you can do this but you don t: you d prefer to be long term greedy, not short term. For if your desperate customer realises that you re gouging her then she ll be looking around for another supplier for the future. Possibly even going so far as to encourage the setting up of a competitor to you There have also been stories around that Apple is looking to either bring inhouse the chip fabrication itself, or to look for another fab house to bake them. Apple already does the detailed design of the chips with ARM providing the basics of the core. In the medium term, over the next generation or two of chips, it wouldn t be all that difficult for Apple to farm it out to someone else, the physical construction of the chips. Product Questions and Threat of Higher Tax Hit Apple Shares New York Times During the campaign, President Obama proposed increasing capital gains tax rates for people earning over $250,000 to 20 percent from the existing rate of 15 percent, and his re-election Tuesday night may have prompted some investors to unload shares in anticipation of a broader sell-off in stocks ahead of a tax increase, analysts said. Owners of Apple shares would have good reason to fear higher taxes on capital gains. Apple shares have appreciated mightily since 2005 when they were about $35 apiece; they began this year at $411 and peaked at more than $700 in late September. The drop on Wednesday only added to what has been a grim few weeks for Apple shares, which have fallen over 20 percent from that peak, to $558 on Wednesday. The decline has followed a sequence of seemingly unrelated events, including a broader-than-normal overhaul of its product line that is expected to hurt profit margins in the near term and a rare shake-up in Apple s senior ranks. UOIG 9

10 If Scott Forstall Joins Google - Forbes Tonight, after Apple (AAPL) effectively fired Scott Forstall as head of ios software, the initial reports we re getting via the Wall Street Journal and others is the Tim Cook and Apple side of the story for the need for the move now. It can be summed up this way: Scott was abrasive. He rubbed members of the team the wrong way. He owned two fairly big products that got a lot of criticism in the last two years Maps and Siri. He had a lot of strengths but it was seen as better for the company in the long-term to part ways now. To now see a guy like Forstall who d spent 15 years at his knee, and unquestionably built a phenomenal ios for iphone and ipad go to Google to run Android, would be the most shocking and threatening of any job Forstall could take. Catalysts Upside Apple TV successfully launches in 2013 meeting consumer expectations and revolutionizing the television market. Apple gets a deal to distribute iphones with China Mobile, China s largest mobile network provider with over 700 million subscribers Apple can successfully produce processors on their own significantly lowering product costs Apple wins lawsuits against Samsung and is awarded large cash lump sums for damages and effectively makes Samsung less competitive Downside Apple has no new product launches, solely product iterations further leading investors to believe Apple has lost its ability to create innovative products Samsung raises prices on mobile processors by 20% significantly increasing costs of goods sold Comparable Analysis Comparable companies were chosen from direct competitors within the technology sector. Companies with similar product offerings, market capitalization, growth rates, risks, and capital structure were selected for use in comparable analysis. I choose to use these metrics because Apple has an extremely large market capitalization, the firm s future success will be significantly dependent on its ability to grow, it faces risks from market saturation, and it has a unique capital structure given its 0% debt. Due to Apple s vast growth and market capitalization, appropriate comparable companies were limited. UOIG 10

11 Google (50%) Google Inc. is an American multinational internet and software company that provides an internet search engine, advertising, cloud computing, and software. The company is best known for its search engine which is available to anyone with an internet connection. Google s main revenue generating service is advertising through its search engine. Google has recently emerged as one of Apple s greatest competitors because of Android software and the acquisition of Motorola. According to a report from IDC, Android software is used in 75% of smartphone s. Google allows all phone makers to use Android software for free. Google s Nexus phones and tablets are direct competitors of iphone s and ipad s and are offered at a lower price. Google s acquisition of Motorola gives it another avenue to compete against Apple in hardware. Google has partnered with Samsung and Acer to create a line of notebooks called Chromebook s which low price competitors are. Google also competes with Apple TV with Google TV. Google TV is a fully integrated television that allows users to stream live television from the internet as well as the ability to utilize the capabilities of a computer. I choose to weight Google 50% because of its similarities to Apple in growth rate, market capitalization, and product offerings. Samsung Electronics Co. Ltd. (30%) Samsung is South Korean multinational consumer electronics manufacturer, distributor, and seller. Samsung produces consumer electronics of all sorts including television, mobile phones, tablets, and personal computers. Samsung s Galaxy line of smartphone s and tablets, which run Android software, are direct competitors with Apple s iphone and ipad. Samsung s Galaxy tablet line holds an 18.4% market share as of Q3 2012, an increase from 6.5% in the year ago quarter. Galaxy smartphones and tablets are priced lower than Apple s iphone or ipad giving it a competitive advantage in emerging markets and further growth possibilities. Samsung also produces notebooks which compete with Apple s MacBook s. Samsung produces the processors and used to produce the LCD screens that are used in Apple s iphone and ipad. I choose to weight Samsung 30% because of the firm s earnings and market share growth and similar product offerings. The company would have received higher weighting but its Beta of 0.2 was significantly lower than Apple s Microsoft Corporation (20%) Microsoft is an American multinational company that develops, manufactures, licenses, and supports a vast array of computing products and services. Microsoft is most well-known for its Windows operating systems and its Office Suite software that includes Microsoft Word, Excel, and Outlook. The firm is a leader in the PC market and office suite market. Microsoft s operating systems are the main competitors of Apple s ios operating system in the personal computing market. Microsoft s Windows series UOIG 11

12 operating systems holds a 70.66% market share for operating systems used in computers. Microsoft s Windows phone and tablet are both competitors of Apple s iphone and ipad. Microsoft s phones and tablets compatibility with its Office Suite package creates a competitive advantage over Apple. I choose to weight Microsoft at 20% because of the similar market capitalization and product offerings. The company received more weight than I would have desired because of the lack of appropriate comparable companies. Amazon.com Inc. (0%) Amazon.com is an American multinational company that is the world s largest online retailer. The company focuses on offering consumers a wide variety of products that can be conveniently found, purchased at a low costs, and delivered quickly. Amazon.com started as an online bookstore but quickly began to incorporate music and video as well. It is now considered an internet mass merchant offering a wide variety of products. Amazon.com also produces consumer electronics with its Amazon Kindle e-book reader and Kindle Fire tablet computer. Amazon.com is a direct competitor of Apple in the music and video retail industry and tablet market. Amazon.com is able to compete with Apple s itunes because it offers low prices and a large selection. Amazon.com offers a fast delivery time which allows it to compete with itunes almost instant delivery. Amazon.com s Kindle e-book reader and Kindle Fire tablet computer are competitors of Apple in the tablet computer market. The Kindle e-book reader is meant solely for electronically reading and purchasing books. The Kindle Fire is more comparable in functionality to the ipad as it is a complete tablet computer. Both products are priced lower than the ipad. I choose to give no weight to Amazon.com because the company did not generate profit in their last quarter. The company s negative earnings have a large effect on its metrics, especially P/E. I did not want to skew the metrics of Apple by weighting Amazon.com in the comparable analysis. Discounted Cash Flow Analysis The percent of sales and percent of revenue method was primarily used to project the discounted cash flow analysis. Revenue Model Revenue was broken down using two models, one by product segment and the other by geographical region. Projected revenues take into account competition, market growth and saturation, product innovation, and cyclical sales that positively impact Apple s Q1 (holiday season) and Q4 (back-to-school shopping) sales. Apple has seen remarkable growth since 2009 growing at a compounded growth rate of 138%. Over the past four years all product segments except for Desktop s and ipods have seen year-over-year growth annually. All UOIG 12

13 geographic regions have seen year-over-year growth with Asia-Pacific being the fastest growing region. Apple s exceptional growth is due to the company s ability to introduce innovative products such as the ipad in I have projected revenue to grow by 23.6% and 13.41% in 2013 and 2014 respectively and from there on out growth rates decrease by 2-3% annually. Competition has created an extremely saturated market and based on Apple s current lackluster product releases I believe generating new customers will be difficult. Apple prices their products more aggressively than competitors which make them less competitive in emerging markets. Product Segment Desktops Since 2009 Desktops percentage of revenue has decreased annually and yearover-year growth was negative 6.2% in Desktop computers have become less desirable since notebooks and tablets have begun to perform the same functions in a more compact and portable form. Desktop computer market size shrunk by 0.1% in the past year. I project that revenue from Desktops will decrease by 6.4% in 2013 and annually therefore after by around 5-6%. I based this prediction off of the trend of declining sales in the desktop marketplace and the advancements being made in portable computing. Portables Apple s portable line of notebooks is rated number one in nearly every category based on the latest consumer reports. That being said, portables have decreased as a percentage of revenue since The notebook market is being cannibalized by tablet computers and analyst expects tablet shipments to outpace notebook shipments by I projected that the portable line will grow at a rate of 14.89% and 12.98% in 2013 and 2014 respectively because the new product line will sell well especially during the holiday and back to school season. After 2014, I decreased growth rates annually given the increasing popularity of tablet computing and a large drop in 2016 because I suspect this is when tablets will become the most popular mobile computing device. ipod In recent years ipod growth has decreased as more consumers convert to iphones which are available on all four major mobile network operators in America. ipod continues to see strong sales in Blackberry users, foreign visitors, and children. Looking ahead, I projected that ipod growth will decrease by 23.15% and 20% in 2013 and 2014 respectively. Portable music players market is decreasing in size and I believe consumers will choose to buy the ipad mini which is priced $30 more than ipod touch and $80 more than ipod classic. Starting in 2015 I decreased the growth at a rate of 5% and decreasing it by 1% annually to provide a conservative approach and account for possible product innovation. Other Music Related Other music related product segment reflects sales from the itunes Store which includes the App Store. As the company has grown over the years so has the UOIG 13

14 revenue from the itunes and App Store. Apple currently has around 700,000 applications in the App Store, 250,000 which are native to ipad. icloud, a cloud computing software between Apple devices, allows users to access their media on all of their devices which creates a better user experience. Going forward I grew revenues from the itunes Store at a similar percentage of revenue as it has been historically until 2014 and at a higher rate beginning in 2015 when hardware sales from desktops and portables slow allowing for other music related sales to increase as a percentage of revenue. iphone and related products The newest model, the iphone 5, is the sixth generation of the iphone and features a larger retina screen, 4G LTE wireless capabilities, and a new powerful Apple designed A6 chip. Consumers, critics, and analysts were disappointed by the lack of innovation that the iphone 5 offered and many have begun to question Apple s ability to innovate. By the end of year the iphone 5 will be available in 100 countries on 250 carriers. Apple holds 15% of the global market for smartphones, second to Android who holds 75%. That being said, Android is free to any phone manufacturer to use while Apple is exclusive. Apple s small global market share can also be attributed to its relatively high price points and the fact that many consumers in emerging markets cannot afford to buy an iphone. In attempt to reach consumers at a lower price point, Apple has lowered the prices of their iphone 4 model.. Going forward I calculated iphone sales as a percent of revenue and increased it at conservative rate because of competition, market saturation, and lack of innovation from recent product releases. ipad and related products. The current ipad is the 4 th generation and features retina display as well as a new dual core A6X processor. Along with the release of the ipad with retina display, Apple released the ipad mini which features a 7.9in screen, retina display, and the A5 processor. Apple released the ipad mini to compete in the smaller 7in tablet market and offer a lower priced tablet. In Q Apple controlled 50% of the global tablet market, slipping from 66% in the prior quarter as Samsung and Amazon gained market share. Although Apple s market share dropped there was speculation that this was a result of consumers waiting for the new ipad. The global market for tablets is becoming highly saturated and Apple suffers from being the high priced competitor. Going forward I trended the ipads percent of revenue upwards as it becomes a more consumers adapt to tablet computing but kept my upward trend conservative due to market saturation created by intense competition. Peripherals and other hardware Peripherals and other hardware consist of Apple TV, monitors, printers, and other third party branded products for Apple devices. I did not integrate the possible launch of Apple TV into my projections because there has been speculation for such a long time period and Apple management has mentioned no plans or advancements in production of a new Apple TV. Therefore, going forward I projected revenues as a percentage of revenue and decreased annually to mimic historical trends. UOIG 14

15 Software, service, and other sales Apple offers various software products for consumers, small businesses, education, and enterprise and government customers. The company s flagship software is the ios and OS X operating system software. ios is the company s mobile operating system that runs on iphones, ipods, and ipads. ios 6,the most recent software, is enabled with icloud and Siri voice activated intelligent assistant. OS X is the company s Mac operating system. The newest release, OS X Mountain Lion includes icloud and supports multiple applications. The company offers application software s ilife and iwork. ilife is a consumeroriented digital lifestyle application that allows users to take pictures, create movies and DVD s, and songs using GarageBand. iwork is the company s productivity suite that competes with Microsoft Office Suite. Looking into the future, I projected future revenues as a percent of total revenue and followed historical trends by decreasing it as percent of revenue. Geographic Segment The company breaks down revenues by geographic segments which include Americas, Europe, Japan, Asia-Pacific, and Retail Stores. Americas Americas consists of countries in North and South America. Traditionally, this segment has accounted for the largest percentage of revenue given that Apple is an American firm and their products are relatively more accessible to consumers. Growth in Americas slowed in 2012 due to competitors saturating the smartphone and tablet market. Going forward I projected revenues based of a percentage of total revenue. In 2013 I believe America will decrease a percentage of revenue compared to 2012 because of an increase in sales in China and fierce competition in the smartphone and tablet market in America. In 2014 and forward I projected that they would be a steady 36% of revenue because Apple will focus on growing emerging markets but American consumers will continue to purchase Apple products. Europe In recent years percentage growth in Europe has decreased and percentage of revenue decreased in years 2011 and With the Eurocrisis ongoing and no end in near sight I believe that this trend will continue. I projected revenue on a percentage of revenue bases and decreased the percentage of revenue that Europe accounts for. I believe that the Eurocris and growth in the Asia-Pacific segment will be the largest factors affecting this area in the coming years. Japan Japan has generally seen increases as a percentage of revenue since Apple and Samsung control the consumer electronics market in Japan. Apple s bestselling product in Japan is the iphone which is also the top selling smartphone in Japan. I based future revenue projections on Japan s historical percentage of revenue and kept it consistent throughout all six years. UOIG 15

16 Asia-Pacific The Asia-Pacific region has been a large growth segment in the past years and is expected to be the largest market for smartphones in China in particular poses great opportunities for Apple to grow. China s lack of ability to support 4G may adversely affect iphone 5 sales. Looking forward, I projected revenues based off of percentage of revenue. Given the large size and growth of China s market I increased the percentage of revenue that Asia-Pacific accounted for in the next six years. Retail Stores Apple has 394 retail stores in 13 countries including the U.S. In 2012 the company opened 33 new retail stores, 28 of which were outside the United States. In 2013 the company aims to open new retail stores with approximately three quarters outside of the United States. Historically, retail stores have decreased as a percentage of revenue which I believe is due to increased distribution channels. In the future, I projected sales as a percentage of revenue and kept it consistent because the company will consistently expand retail locations. Major Line Items Beta SD Weighting 1 Year Daily % 1 Year Weekly % 3 Year Daily % 3 Year Weekly % Apple Inc. Beta Beta I estimated a beta of 1.03 for Apple. In order to calculate beta I ran regressions of the stock against the S&P 500 for the following time periods: 1 year daily, 1 year weekly, 3 year daily, and 3 year weekly. I choose these time periods because I believe they best capture Apple s risk going into the future. I weighed the 1 year weekly Beta and the 3 year daily betas the highest, assigning 30% to each. I choose the 1 year weekly beta because over the past year the company has seen a plethora of product releases and I believe the firm will employ a similar strategy of releasing product renovations frequently. I chose to weight the 3 year daily highly because according to the CFA it is considered the best estimate of beta. I chose to weight both the 1 year daily and 3 year weekly 20% each to diversify my beta and account for all risks that the firm will face in the future. I believe this to be a reasonable beta given the firm operates in the technology industry and its ability to consistently generate high profit in the past three years. Comparable companies have somewhat similar betas. Samsung has the most different beta, Samsung s low beta is uncommon for the technology industry. Capital Expenditure Capital expenditure is spent on new retail stores, product tooling and manufacturing process equipment, and other corporate facilities infrastructure. Last year the company opened 33 retail stores and the company plans on opening more in I increased capital expenditure as a percentage of revenue to follow historical trends as the company continues to expand. UOIG 16

17 COGS When projecting Costs of Goods Sold (COGS) I employed a percentage of revenue method. To project Q COGS I used management s guidance of a 36% gross margin to target a gross margin of 40%. I choose the target margin of 40% because traditionally Apple has beaten managements gross margin guidance by 2% and our method of taking out depreciation and amortization from COGS leads to a 2% higher gross margin that found on Apple s income statement. Moving forward I aimed to decrease COGS as a percentage of revenue in Q2 and Q3 because Apple faced higher than normal COGS in Q1 due to the large number of product releases in Q3 and Q4 of Whenever Apple releases a new product the firm experiences higher than normal costs initially and then costs decrease as economies of scale come into play. Given the recent history of product releases I believe that Apple will aim to release newly renovated products towards the end of Q3 just in time for the holiday season. Based off of this theory I projected an increase in costs in Q4. I applied a similar method projecting the 2014 quarters. From 2015 on I decreased costs significantly as I believe Apple will move away from purchasing processing chips from Samsung and move to a lower cost provider. R&D Research and Development (R&D) is an important aspect of Apple s growth. In order to stay competitive the firm must create innovative products. It is interesting to note that research and development has nearly doubled since 2010, yet no major new products have been released. In the future R&D will increase as a percentage of revenue as Apple attempts to create revolutionary products. SG&A Selling, general and administrative (SG&A) costs are incurred as Apple expands its retail segments and increases advertising for products. As the company continues to open retail segments and advertise for new product launches and releases in the future SG&A will stay constant as a percentage of revenue. Depreciation & Amortization Most of Apple s depreciation expense comes from property and equipment. Using straight line depreciation I calculated the relevant depreciation expense for the future. In the future depreciation increases steadily based on my calculations. Net Working Capital I projected net working capital to decrease as a percentage of revenue going into the future at a rate similar to historical rates. Beginning in 2013 and taking place over the next three years Apple will use $45 billion to repurchase common stock which will decrease cash and cash equivalents. In October Apple announced that for the first time it will pay dividends of $2.65 to shareholders which will also decrease cash. Given the recent demand for Apple products and supply UOIG 17