Thursday, September 17, 2009

AAPL Analysis Half Realistic, Half Fantastic

A recent analysis of Apple's shares provides realistic optimism in describing the substance of its transactions as poorly described by GAAP. As observed by entertainer Jim Cramer, Apple's numbers will look much better when accounting standards allow immediate realization of Apple's hardware sales profits rather than causing it to recognize profits across the duration of service providers' wireless subscription contracts. Apple has supported the proposed accounting change. The impact on Apple's per-share metrics is given treatment at both the Financial Alchemist and on Jim Cramer's show; they are genuine, and material. The GAAP earnings numbers have confused people about Apple's sales and profits (to the benefit of Apple's ability to confuse competitors, but the detriment of shareholders looking to see appreciation based on current iPhone figures), and modifications to accounting principles to allow Apple to reflect the substance of iPhone sales transactions will make the whole of Apple's finances easier to comprehend.

However, the Financial Alchemist erroneously models future share values on the basis of share buybacks for which there is little evidence management will implement. While Apple has occasionally authorized share buybacks, it has not in recent memory retired serious share volume (it made some buybacks years ago while simultaneously printing dilutive shares into insiders' incentive plans, but never made a real net reduction). Everything in the Alchemist's analysis may be technically true -- a massive buyback would have a positive effect on Apple's earnings per share and thus its share prices at likely P/E multiples -- but this kind of buyback just lacks foundation in management's apparent motives, and certainly in its recent history.

Apple's shares may be reasonably priced, but not because there's a buyback on the horizon.


Turley Muller said...

I just wanted to respond about the AAPL buybacks... To clarify, I wasn't basing my valuation on the expectation or possibility of a buyback, as I agree, the probability of that occurring is practically zero. Not just that, it's technically not feasible. If Apple were to commence a share purchase on such an immense scale, it would drive share prices up itself.

The point of my illustration was to show the theoretical value of Apple's cash holdings. I showed a valuation with cash/share excluded with the assumption Apple could pay a one-time cash dividend and then I showed a valuation with the assumption that instead of the cash dividend, Apple repurchased stock.

Those were just hypothetical exercises. I did in no way state, or intend to imply that Apple would do either. Rather, I just wanted to deconstruct the pillars of value underlying AAPL share price.

In closing, my goal was to highlight the value of Apple's cash generating ability (non-GAAP) and the value of cash on it's balance sheet. Often, investors and the press overly focus on GAAP EPS and also ignore the cash holdings, concluding that AAPL trades at ~30x and is overly rich, which I disagree with for reasons you and I both know.


Jaded Consumer said...

TMM: Figuring out how to value cash that is not actually in your hands for disposal (which has the value of the cash, naturally) is quite a trick. Your effort to value the cash by hypothesizing a share buyback isn't crazy, and I do laud you for the effort. The cash is definitely worth something.

On the other hand, Apple's use of cash has been sort of a puzzle. Some quarters, Apple makes a pittance on the cash, arguably not keeping up with real inflation. In other quarters, Apple buys for cash things like multitouch or Final Cut or Shake or hardware component designers -- which alters Apple's competitive position, positions Apple to better defend its market, and improves Apple's ability to make cash vastly more significantly than if Apple had a better interest rate on cash. Big prepayments on huge component orders give Apple a bargaining position and buying power hardly anyone can match, which is a terrific competitive advantage. Cash is very valuable.

Considering that Apple is almost certainly unable to productively spend its cash in the next few quarters -- there's just too much of it -- one would hope Apple would trade liquidity for return and employ the money in a way that would protect Apple (and its shareholders) from threats to the U.S. dollar's value over time. Maybe Apple's conservatism with cash should reassure shareholders that Apple isn't plunging recklessly into the unknown, but it also raises concerns that Apple might not be particularly concerned with shareholder value so long as the corporate officers' jobs are protected in the event of meltdown by a significant cash hoard.

Who knows?

Thanks for reading, and I appreciate the clarification. A different company than Apple (say, Exxon or IBM) might actually spend cash on a buyback and retire; this is plausible because both companies have spent billions in this way, to the benefit of shareholders. When business is good, investing in one's own stock is sometimes the best thing for shareholder value. Apple really WOULD do well to buy back shares, and to provide the kind of results you model, but that's just not the way current management operates.

Pity, that.