Ultra Bull: A Case for Succession of Apple

| About: Apple Inc. (AAPL)

A lot of bullish financial advisors are saying that these are some of the best bargains they’ve seen in their lifetimes and that we won't see these prices again after this crisis is resolved. I would probably have to agree with them regarding Apple Inc (NASDAQ:AAPL). The company has been trading in the $80-$100 range for the last couple months now. It looked like it was breaking out last week but the drop on the disappointment in Geithner’s speech pulled it back with the rest of the market and is now trading in the high $80s.

While Apple may not break out in the next couple months as we establish a bottom, I think it's a little absurd that this stock would stay this cheap for very long. If you look back over the two years or so you can see it shot from the $120s to the $180s and back, twice. When investors start to pour in, everyone piles in. Once we see this market stabilize or if we actually get this tech rally, prepare for Apple to take off at least to the $150s. The last three times that Apple has broken out to the upside, it has rocketed an average of around 36-37%. The top end of Apple’s range is around the $100 level. Should it break out I think $135 is a given, $150 is likely. Take into account that if there is a market catalyst that gets this market moving higher, it's going to be far more substantial than what we’ve seen with Apple in the past. There are tons of private and institutional investors on the sidelines right now waiting for the all clear to get back in. Considering investors have poured out since October, we might want to count all the positive news surrounding the iPhone lately. There’s a lot of pent up good news that hasn’t helped Apple break out of its range because of all the overall miserable market sentiment.

All matters of stock valuation aside, Apple’s real ace in the hole is that it is positioning itself to sell practically every element of our not too distant digital future. It has pioneered a virtual trifecta for the digital lifestyle of no more than 3 years from now. Now in its eighth iteration, its iTunes juggernaut has moved from simple jukebox software to surpassing Wal-Mart (NYSE:WMT) as the largest retailer of music in the US. It also said in its first quarter earnings call that sales of Apple TV were up three fold over the year ago quarter. Its computers are probably some of the most advanced devices on the market and hit the sweet entry price point of $999. While the iMac is still probably one of the better desktops, the real story is the notebook sales. It still sold a record 1.8 million notebooks in the first quarter up 33%+ over the same quarter last year. The final piece of the trifecta is what will probably be the defining piece of hardware for this decade: the iPhone.

While it's fun to save the best for last, sometimes you can’t resist writing about what you love. The iPhone is a marvel of modern engineering and makes vast amounts of information available almost instantly, anywhere. Think about this, it starts at $200 which is still reasonably affordable. If there is anything we have learned about Apple though, it's that in 3 months there will be 4 new ones in different colors for half the price. So let's assume that price will not be a barrier to entry or at least not for very long. Also, the distribution model it has chosen shows just how much of an impact Apple already knows this device will have. At the time of my writing, Apple lists 91 countries in which the iPhone is already available with 6 more on the way. Granted, when it launched the iPhone a couple years ago, it was US only and locked to AT&T (NYSE:T); now it is selling through multiple carriers in some countries. Apple has made it clear it is going to make it possible to get one of these no matter where in the world you are. So we can now assume it will eventually be cheap enough that most people can afford them and you can get one anywhere in the world. Not off to a bad start.

Apple has been fine tuning this baby in secret long before most OEMs started cranking out these knockoff wannabes. You can almost get a feeling, once you step back, that the company has really thought every facet through with the iPhone. The device itself fits Apple’s unwavering standards of elegance in design. It's the concept of the iPhone, though, that is truly incredible. It's a small, sleek device that is essentially a computer that fits in your pocket. The interface has been completely designed around making it easy to use on the move and operable with nothing more than a finger. It can tell exactly where you are using GPS. It has a broadband internet connection. You can download music directly to it over WiFi or 3G, so pretty much anywhere. Oh, and there’s 15,000 applications from tons of upstart developers ready to squeeze every last possible tool out of this hardware. Never before did I think I would use my phone as a digital level, a fart machine, or even something useful like remembering where I parked the car. Did I mention it's also a phone?

When the iPhone first launched, it sent competitors scrambling to catch up. The first round of knockoffs like the LG Voyager didn’t even come close. OEMs have caught on with almost every other major phone being announced at Mobile World Congress running either Android or Windows Mobile. With these new models hitting the market this year, we're going to see a slew of new models and they will all be running one of these two competing operating systems. Android has positioned itself to be a decent competitor. Google (NASDAQ:GOOG) and Android will likely become the second most dominant mobile OS to fill the void on all the LG, Samsung, et al devices outside the Apple ecosystem.

While the new Palm (PALM) Pre is very impressive and shows that sometimes Apple doesn’t think of every cool thing, it's at a severe disadvantage considering it doesn’t launch till summer and it's launching on Sprint’s (NYSE:S) sinking ship. Hopefully it will have some subscribers left by the time the Pre launches in Summer. I would discuss the future of Windows Mobile but I can’t help but get the impression Microsoft (NASDAQ:MSFT) is about 3 years to late to this whole touch thing, sans Surface. This somewhat half-attempt at Windows Mobile 6.5 shows the company really hasn’t changed anything except using a stylus to your finger. It has more or less made the previous version of Windows Mobile more visually appealing similar to what Windows Vista gave us. If there's anything we've learned from the Mac/PC war of the '80s, it's that the developers and the money go where the market share is. One can begin to make the argument that at this point, Microsoft is likely too late to bring a respectable competing touch mobile OS to market before OS X iPhone garners the lion's share of the market. Ballmer and the folks in Redmond have really been following in Apple’s footsteps a lot lately with their ripoffs off the App Store and Mobile Me, named Windows Marketplace for Mobile and My Phone respectively. Wow...creative.

What is truly going to differentiate the iPhone is two fold. First, the OS X iPhone operating system that runs on the iPhone and iPod Touch is light years ahead of anything else out there. Apple had been developing and perfecting the interface for years before this launched. The sheer fact that all the new touch screen competitors are essentially the same touch screen, minimal button hardware, reinforces the importance of the software and the user interface. Second, Apple is leveraging its mobile OS as a platform for Applications to turn the iPhone and perhaps more importantly, the iPod Touch, into almost anything imaginable. A key advantage here for Apple is that its massive iPod user base is motivated to trade up to the iPod Touch or an iPhone to gain access to the rapidly expanding world of Apps. It is very likely that current iPod owners will at least trade up to the iPod Touch. The number of people using the OS X iPhone platform will begin to grow rapidly as iPod users trade up to these two touch models.

The masses of current iPod, iPod Touch, and iPhone users are all downloading music en masse from iTunes and organizing their ever growing libraries of digital music. While many analysts focus on the high growth rates in the iPhone and Mac divisions of the company, most neglect what could be considered the hub of the Apple ecosystem. The masses of iPod and iPhone owners are connecting their devices through iTunes regardless of whether they’re using a Mac or PC. They’re organizing their music and making playlists on iTunes. If you have ever had your computer crash or have it stolen, you realize what a huge financial and time investment your music library can be. Since the launch of the iTunes Music Store, now the iTunes Store, Apple has risen to become the largest retailer of music in the US. Its massive installed user base of iTunes users has become a huge distribution channel for digital media. As society progresses towards a much more digital lifestyle, the value of this massive digital distribution network only increases.

The last piece of the Apple trifecta is the Mac family of computers. Yes, the iMac is a beautiful piece of engineering but the real growth engine is the MacBook family of laptops. The entire line has just been revamped. The new computers are using a new unibody method of engineering each case from a single piece of aluminum. Its website has a video with Jonathan Ive, the VP of Industrial Design, talking about the manufacturing process. If you ever want to see how obsessed Apple is with perfection, this video offers a pretty good insight. While most of the PC makers are suffering from a dismal PC market in the face of recession and corporate cutbacks, Apple just reported a 33% rise in its shipments of notebooks over the same quarter last year. Studies of freshmen entering college have shown that as many as 1 in 2 students are opting for the Mac when heading to college. There is a fundamental shift happening in this market over the next couple years from the Mac being a niche player to commanding what I think will be a surprisingly high market share. Microsoft’s slipups with Vista’s launch and the success of Apple’s "I’m a Mac" ads and aggressive retail push will help to speed up this process. Assuming you are no stranger to pop culture, you may have noticed whether it's President Obama’s Campaign, Entourage, The Office, or almost anything else in TV or Film, they are likely using a Mac product on screen.

News came out earlier this week that Apple will be revamping the layout of its expanding retail store base to offer a new section solely devoted to introducing “Switchers” to the world of the Mac. I think this move shouldn’t be underestimated. Apple reported in January that 1 in 2 of the Macs sold in its retail stores in the last quarter were to people new to the Mac. The Apple Retail stores are always packed at Christmas and normally get considerably more foot traffic than other stores. If they begin to use this network of stores to more aggressively target switchers, it could really help Mac sales. Many other analysts have drawn importance to the Mac’s rapid growth because that is where the company drives the largest margins. Did I mention its also the greenest line of notebooks on sale right now?

So by this point we should all be ready to rush out and invest in Apple. But how do we want to do that? The market is kind of a mess and we’re still a little afraid to go back in. The equity is trading right near the bottom of its range. As a way to play the eventual reversal in the longer term, I’m looking to options.

Since the market is still very much on edge and is scraping along below the November lows, I think it's a great time to pick up some long term call options. I’m looking to the Jan 2010 $200 calls. Assuming that the analysts are right and we see the economy start to recover in the second half of 09, we should see the market rebound before January. The price for the Jan $200 calls has been hovering around a floor while Apple trades in its $80-$100 range. I picked up some contracts on Tuesday at $0.62. The lowest these contacts have closed is $0.40. I think once we start to see government programs gain traction and signs of improvement in the economy there could be some tremendous upside. Options provide an excellent way to play the eventual recovery in the market because they require considerably less capital upfront and considerably larger upside if you load up on contracts while the stock is dragging along the bottom in this range. If you’re looking on a similar time horizon as I am in the January timeframe, there’s decent volume in the $130/$140 calls and in the $250 calls. While I’m bullish on Apple, I think it could be more of a long shot to load up on $250 calls. That would require a 250% move over the next year. I would rather opt for the more attainable $200 calls and sell after a large run up in the price.

Disclosures: Long AAPL.