writing sample - equity research - aapl

Student Investment Management Report

Company Description Apple Inc. (Apple) designs and markets consumer electronic devices, including personal computers, mobile phones, tablets, portable digital music players. The company also provides its own operating systems on each products and allows customers to purchase and storage a variety of accessories, services and digital contents through its iCloud and iTunes stores. Apple is the pioneer in information technology sector which re-defined several industries through its Mac, iPod, iPhone, and iPad. Investment Thesis I issue a HOLD recommendation for Apple. My valuation yield a fair value of $125.66 as of 07/24of current strong product portfolio is offset by the uncertainty of future product initiative. - Apple launched its latest version of iPhone iPhone 6/6+ last

September which generated the highest additional customers in one quarter. Given only 10-15% of iPhone users have upgraded to iPhone 6 as of Q2 FY15, I believe there is still more room for iPhone 6 to grow.

- The company is sitting on $32B cash & equivalent and possesses $110B net financial asset as of Q2 FY15. It is planning to pay back $65B of cash through share buyback and dividend in CY15. This set a buffet for downside potential.

- Currently, I could not see a clear strategy for the long-expected Apple Watch. There is no certain function or business need that distinguishes the product from good-to-have to must-have. The long term growth concern will remain an issue if the company could not figure out a more sustainable business model.

Risk to Recommendation - Failure to successfully launch new product will impact top and

bottom line of the company. - Similar function of different products could lead to self-

cannibalization. - Strong dollar and weaker economy outlook in major oversea

.

Apple Inc.

US Equity Research July 26, 2015

Michael Lin, 614-264-0145

[email protected]

Sector: Information Technology Ticker: NASDAQ: AAPL

Current Price: $124.50 (July 26, 2015)

Target Price: $125.66 (1.0% upside potential)

Recommendation: HOLD

Stock Price Performance April 2014 April 2015

Performance v.s. S&P 500 April 2010 April 2015

Source: Yahoo! Finance



52-Week Range $93.28 - $134.54

Avg. Volume 48.57M

Beta 1.13

P/E (ttm) 14.4

Dividend Yield 1.7%

Market Cap. $709.99B

Diluted Shares Outstanding 5,773.01M

EPS $8.65

ROE (FY14) 33.61%

ROA (FY14) 18.01%

Market Profile (as of July 26, 2015)

OSU Student Investment Management July 26, 2015

2

Table of Contents Company Overview Business Segments Business Model Industry Overview and Competition Positioning Current Issues Business Trend

Economic Analysis Financial Analysis

Supply Chain Risk Competition Risk Currency Risk Valuation DCF Valuation Relative Valuation Risk to Target Price Conclusion Appendices Works ..


3

Company Overview Founded at 1977, the Cupertino, California based consumer electronic provider is now the largest public company in the world with $710B market cap at the end of Q3 FY15. The ken down into six regions: Americas: 46.3%, Europe: 28.1%, Greater China: 21.0%, Japan: 13.7%, Rest of the Asia Pacific: 6.9% and Retail: 8.9% (Figure 1). Apple designs and markets its product and outsources the manufacturing

system and follow the open source strategy, Apple provides its own operating system and leaves less room for programmers to adjust to its system. Similarly the company put more control on the hardware; for instance, instead of design its own CPU. This strategy leads to better integration between software and hardware market share in premium smartphone market. Another obvious advantage of the closed platform strategy is that there are less viruses on . Unlike its competitors, Apple operates its own retail stores that accounts for 28% of revenue. The are $182.8B and $39.5B in FY14; the growth rates are 7.1% and 6.8% respectively (Figure 2). Business Segments Apple currently reports six product segments iPhone, iPad, Mac, iPod, Accessories, and iTunes, Software and Services (Figure 3). The new products such as Apple Watch and Apple Pay will be discussed in Current Issues. iPhone iPhone is the most important product for Apple which represents 55.8% of revenue. This segment enjoyed 41.9% CAGR in sales for the past five years. Thanks to constant upgrade of its product, the ASP remains constant. iPhone is estimated to have 20% unit sales market share by Q4 CY14. The company sold 169M units of iPhone in FY14 at an average price of $602 (Figure 5). Macintosh (Mac) This segment accounts for 13.2% of revenue. As a more mature product, Mac segment saw more cyclical revenue growth with 8.3% CAGR for the past five years. This segment is facing a decreasing ASP trend for the past decade due to fierce competition and short product life cycle. The company sold 18.9M units of Mac computer at an average price of $1,273 in FY14. iPad Since its debut in CY11, the iPad business had grown rapidly to become the second largest revenue generator which contributes 16.6% of sales in FY14.

ed dramatically from 70% to 30%. Furthermore, after three years of rapid growth, this segment faced a 4% sales decline in FY14. The pale result of iPad is due to lack of innovation and increasing competition. In addition, iPad mini could also be negatively

Figure 1: Revenue Breakdown by Region

Figure 3: Revenue Breakdown by Product

Figure 2: Revenue & Net Income/Growth

Figure 4: Tablet v.s. Phablet

Source: Company Data



Source: IDC, Company Data


4

impacted by the large iPhone 6+, which is similar to the mini tablet (Figure 4). In addition, the ASP declined constantly after its appearance. Unless the company develop new function, iPad will stay as an accessory rather than a necessity.

2010 2011 2012 2013 2014

ASP iPhone 629.6 636.3 629.3 607.5 602.7

ASP Mac 1279.4 1301.6 1278.8 1314.7 1273.6

ASP iPad 664.8 628.4 530.7 450.2 445.5

Services Due to the well-established ecosystem the company built and the comprehensive compliment application, Apple has a 13.1% sales from services, which cannot be seen in other handset providers. The revenue of this segment come from sales on iTunes, commission from application developers and most recently, the fee from Apple Pay. iPod The portable digital music device Apple created was once a disruptive innovation that, along with the iTunes platform, has shaken the music industry. However, iPhone is now replacing iPod in every aspect; therefore, this segment only contribute 1.3% of sales and experienced 48% and 21% sales decline for FY14 and FY13. The company sold 14M units of iPod at an average price of $159 during FY14. Business Model Apple achieves today success through constant innovation. However, the fact that it needs to continuously bring in groundbreaking products also

ent on unpredictable innovation to maintain current size. For the growing segment such as iPhone, this drawback has not affected current performance since the company only needs to upgrade and add in more features to sell the product at a higher price. However, the short product life cycle is hurting the mature businesses such as Mac and even iPad. The company saw constant price drop and decline in units sold even when it upgraded those products every year (Figure 6 & 8). This very phenomenon is also due to pricing strategy, the premium consumer electronic device providers usually set higher price on the debut of new products to attract heavy users, lower the price when the product has become less trendy, phase out the products when they cannot meet the new functions that other products serve. Therefore, the assumption that the revenue or free cash flow can grow in line with the economy is not suitable for this industry.

Figure 5: Product ASP (M)

Figure 6: Mac ASP




5

Although facing harsh environment, Apple is the best among its peers to widen the moat. The self-built operating system not only differentiates itself from its peers by delivering first class user experience but also increases the switching cost and network externality. Users are inclined to stick with the same operating system which they are familiar with to save time. Furthermore, consumers are likely to choose the platform with more applications. Currently, there are 1.2M applications for iOS and 1.3M for Android. In contrast, there are only 0.3M application for the third largest

(Figure 7). Without many popular applications in other operating systems, the current duopoly situation in mobile OS is very likely to stay intact. Apple Watch is another way to increase the network effect among devices; moreover, services such as Apple Pay also aim at increasing custommemorizing

Unlike many other mega-size corporations, Apple achieves through organic growth and in-house development of most of its important products. The company has seldom acquired other companies to seek growth. Figure 9 lists all the acquisitions larger than $100M Apple made since 1997. The only large acquisition the company made is the $3B deal to

Industry Overview and Competitive Positioning Personal Computer An ally among Microsoft, Intel and their downstream customers such as HP, Dell, Asus is the primary competitor of Apple in the personal computer

of as of February 2014 the OS X market share is a mere

7.69% compare to Windows 90.62% (Figure 10); however, the ASP for Mac is twice as much as that of its competitors. Mac has grown faster than its peers and has reached its highest market share record of 13.4% in Q3 FY14 in the U.S. market.

Date CompanyPrice

(Millions)

Apple

Product

28-May-14Beats Music &

Beats Electronics$3,000 iTunes

2-Dec-13 Topsy $200

22-Nov-13 PrimeSense $345

26-Jul-12 AuthenTec $356 Touch ID

20-Dec-11 Anobit $500

14-Apr-10 Siri Inc $200 Siri

27-Apr-10 Intrinisty $121 A5

5-Jan-10 Quattro $275 iAds

7-Jul-08 PA Semi $270 A4, A5

2-Sep-97Power Computing

Company$110

7-Feb-97 NeXT $404 OS X

Figure 7: No. of App on each OS

Figure 9: Acquisition Larger than $100M

Figure 8: iPad Units Sold and ASP

Figure 10: PC OS Market Share

Source: Statisita

Source: Company Data, Wells Fargo Security


Source: Ars Technica


6

Smartphone The competition landscape is similar for the smartphone business. Google and Qualcomm provide the operating system and ccompetitors such as Samsung, HTC and LG, etc. Apple loses its ground in terms of OS user base market share to Android for the past three years, which has grown from 50% to 80%. However, Apple maintains a significant higher ASP than it peers, which is around $600 compared to $300.

Samsung is the only significant threat of Apple in high end smartphone business. Those two companies together have captured more than 93% market share of high end (price > $500) smartphone market (Figure 13). The high end market is growing faster than the low end market (Figure 15). Those two companies have filed over 40 patent lawsuits against each other in many major countries for the past 4 years. However, they dropped patent disputes outside of the U.S. as of last August. The fact that Samsung produces and sometimes controls the market of several key components such as CPU manufacturing, memory chips, LCD panel, and AMOLED panel, makes the Korean conglomerate a real threat of Apple. Apple and Samsung are the only two companies that can turn sales into profit Apple dominates 81% of operating income of the whole smartphone industry while Samsung takes the rest.

iPad As the pioneer of tablet business, Apple once dominated this market; however, without meaningful ways to bundle iPad with iPhone or Mac together through exclusive function and low switching cost, the tablet market has gradually become fragmented with many players fighting for the market. Samsung is again the chief competitor in this field with other traditional PC players such as Asus, Lenovo, and Hewlett Packard trying to gain market share (Figure 14). However, the overall tablet market did not see growth during CY14; moreover, with the market leader Apple setting its

$400 to $600, which is even lower than that of its iPhone, this line of business is not lucrative for most players.

Figure 11: Mobile OS Market Share

Figure 12: Smartphone ASP

Figure 13: High End Phone Market Share

(>$500)

Figure 14: Tablet Market Share

Figure 15: Smartphone Growth Rate

Source: IDC

Source: BMO Capital Market, Company Data

Source: IDC, Credit Suisse

Source: Gartner, UBS

Source: IDC, Credit Suisse


7

Current Issues Apple Pay Apple announced its plan to penetrate into payment industry by providing Apple Pay service through its iPhone 6/6+, Apple Watch-compatible devices (iPhone 5 and later models), iPad Air 2, and iPad Mini 3. This service enables users to make payment in both retail stores and online checkout. Apple Pay adopts the near field communication (NFC) technology.

unwillingness to collaborate, Apple Pay will join force with Visa's PayWave, MasterCard's PayPass, and American Express's ExpressPay system. The service was exclusive to the United States market initially with international expansion plan in the future. Apple has entered into Canada in March 2015. There was an estimated amount of 220,000 vendors participating in Apple Pay

Groupon, Panera Bread, Target, and Wholefoods are the initial vendors to team up with Apple while Walmart and Best Buy stated they will not accept Apple Pay. The need to upgrade the Point of Sale (POS system) in order to accept Apple Pay and the fact that there are many alternative ways of payment might lower some vendors interest to join.

Unlike the traditional credit card transaction, Apple Pay does not require

idea of creating a single-used token and transfer the token to finish the transaction. The information of the token (or dynamic security code) will stay between the customers, banks and the vendors, Apple stated that they

s. This method is said to be safer than the tradition credit card.

Apple Watch Apple Watch is the smart watch created by Apple, and announced by CEO Tim Cook in September 2014. The main features that have been revealed are health monitoring and fitness tracking. The smart watch is integrated

services such as Apple Pay, receiving phone call, sending iMessages and SMS texts, map services and run third-party applications. Siri, the personal assistant is also embedded on Apple Watch. However, Apple Watch also depends on iPhone to conduct significant functions. For instance, the Watch needs to pair up with iPhone to play the music. The screen of the watch is a pressure-sensitive touch screen that can detect the difference between a tap and a press; only two buttons are designed on the Watch. According to CEO Tim Cook, the Watch will be shower proof to prevent water damage but water submersion is not recommended. All versions of Apple Watch have 8GB of storage to store up to 2GB of music and 75MB of photos. The device is also Wi-Fi and Bluetooth 4.0 connectible.
http://en.wikipedia.org/wiki/IPhone_6http://en.wikipedia.org/wiki/Apple_Watchhttp://en.wikipedia.org/wiki/IPhone_5http://en.wikipedia.org/wiki/IPad_Air_2http://en.wikipedia.org/wiki/IPad_Mini_3http://en.wikipedia.org/wiki/PayWavehttp://en.wikipedia.org/wiki/PayPasshttp://en.wikipedia.org/wiki/ExpressPay


8

There are three collections for Apple Watch Apple Watch Sport ($349 and $399), Apple Watch ($549 and $1,049), and the 18-karat gold version Apple Watch Edition ($10,000 and $17,000), each of them has two sizes (38mm and 42mm) and two colors. Each collection has three to six bands for customers to choose. The main problem for this product is the short battery life, which is estimated to last for only 18 hours due to it needs to constantly connect to iPhone and leading to battery drainage. Apple Watch is available for sales online on April 24 in nine markets, including the United States, Australia, Canada, China, France, Germany, Hong Kong, Japan and the United Kingdom. This product is an indication to see whether the current management team can take on revolution rather than evolution after the long gone of its charismatic founder. Several competitors, such as HTC, LG, Pebble and Huawei have also been working on the smart watch product to compete with Apple (Appendix 1). Without revolutionary functions (or even functions that could not be found on iPhones), the future of the Watch is far from promising. Apple did not disclose the shipment information during the latest earning release but since CEO Tim Cook mentioned more tsegment is contributed by Apple Watch during Q3 FY15, we can estimate the revenue from Apple Watch is somewhere above $900 million. Apple TV Apple TV is the unsuccessful product Apple has spent several years working on. The first release of Apple TV was back in 2007; the company continued on developing this product and launched the latest TV Apple TV Rev A in January 2013enables them to access iTunes content for Streaming video and all online services that was accessible on personal computers, such as Netflix, YouTube, Flickr, Disney Channel, Hulu, HBO GO and WatchESPN. However, the idea to revolutionize the TV industry as a cornerstone of the

ings has not yet been realized.

Apple Auto

(Financial Times, 14, Feb). Although this news has not been confirmed by the company, it is reasonable for the largest public company to seek growth in the $1.6 trillion automobile market, which dwarfs the smartphone industry at $400B and PC industry at $266B. Without legitimate information, this part of information is not included in the valuation; however, it is important to note that Apple to continue innovation is the key to future success.


9

Business Trend Bring Your Own Devices (BYOD) The rapid growth of cloud computing and the transformation to more intellectual and information based working environment have made BYOD possible. With the increase of cross devices interaction and more personalized devices and software, employees are more inclined to use their own devices. A survey done by Mckinsey shows that 44% of job seekers view an organization more positively if it allows them to bring their own device. According to industry estimates, the global market for BYOD created $72B in revenue in 2013. This market is expected to have a 26% CAGR during 2013 to 2019, which implies a $284B by 2019 (Figure 16). This on-going trend is beneficial to Apple since the company has low penetration rate in the corporate market, especially when massive purchases from big corporation will probably s. The

to spill over into business world if the BYOD remains robust. Furthermore, if the BYOD becomes a phenomenon, learning Windows system and related products may no longer be required skills. This effect that prevents Apple from getting more market share. To enhance its corporate footprint, the company announced an exclusive partnership with

implement to iPhone and iPad.

Figure 16: BYOD Market Size and Growth

Rate

Source: Marketandmarket.com

writing sample - equity research - aapl

Documents