Phil Cusick, Managing Director of Mcquarie Research, was a guest on CNBC’s December 30 Power Lunch. The topic was Apple (AAPL), and the prospects for Apple's stock with all of the buzz surrounding the rumored iTablet.
CNBC hosts Simon Hobbs and Michelle Caruso-Cabrera were spoiling for a fight and fired a series of loaded questions suggesting that Apple might not be attractive at the current price ($210 at the time of the interview). Mcquarie Research has a $250 price target for Apple and Phil Cusick likes the value in Apple at the current price.
Simon Hobbs hyperventilated; "That's a hella'va call ($250 target for AAPL) ... 20% upside from here?"
Keeping his cool, Cusick responded:
What really drives this stock is the ability to beat (Street earnings estimates) and force people (analysts) to raise numbers. So we're looking for nearly $12 in earnings (per share) in 2010, and with iTablet you could see another .50 cents to $1.00 in there, and probably a bit more from iPhone as well.
Not ready to listen, Hobbs continued:
The Heard on the Street column in the Wall Street Journal says that buying shares (of AAPL) enthusiastically over the prospects of the iTablet might be putting the Apple cart before the horse ... This is a very expensive stock is it not? ... Thirty (30) times earnings?
The unflappable Cusick patiently explained (what he may have been thinking "read my lips ... I'm going to speak very slowly so you can follow"):
Number one ... we think that revenue is going to grow by 25% in 2010. Number two ... The most important thing to understand is that the GAAP (Generally Accepted Accounting Principals) EPS (earnings per share) that Apple reports are not a real earnings number ... The real number to look at is the NON-GAAP number, which is closer to what Apple is going to report in 2010 as they shift their accounting a little bit ... And again, we're looking for $12 bucks in 2010 in NON-GAAP earnings. And so ex-cash, it's trading at less than 15 times (a price/earnings multiple less than 15 times projected 2010 earnings).
The Apple GAAP v NON-GAAP story: When Apple first launched the iPhone, they employed a conservative "subscription accounting" methodology. Under GAAP rules, if you are going to provide ongoing value-added services with a product at no extra charge (as in "free" software updates for iPhone owners) then you are not allowed to realize (book) the revenues from the initial product sale in the quarter that it's made. Rather, you must take the revenues over the depreciable life of the product (2 years [8 quarters] for iPhone).
In the case of iPhone sales, Apple is providing ongoing "free" software updates to iPhone owners. Consequently, (until a recent FASB ruling) Apple was not able to book the revenue from iPhone sales upfront. The iPhone revenue is spread out over eight (8) quarters. The result is that Apple's near term price/earnings (P/E) ratio is artificially high. Put another way, the "E" in the ratio is artificially low, due to the simple fact that only one-eighth (1/8) of the actual revenue from current iPhone sales is reflected in the current quarter's earnings.
The Apple valuation story: Members of the press and far too many unenlightened analysts, look at Apple's financial data and they see a stock that had a nice run from March 2009 lows and is now "priced at 30 times earnings." What they don't understand, or conveniently fail to acknowledge, is that Apple's NON-GAAP numbers present a more accurate picture of operations. The NON-GAAP numbers show the full revenue contributions to EPS from iPhone sales in the current quarter. The iPhone contribution is NOT a small number. Broadpoint AmTech analyst Brian Marshall estimates that the iPhone will deliver $20 billion (that's billion with a "B") to Apple's revenue in 2010.
What might happen if Wall Street were to awaken to revised Apple financials that reflect the NON-GAAP numbers ... the true value of the company? Hmmm? Well, you're about to find out. Apple and several other firms who've been providing free ($0.00) ongoing services with a product, petitioned the Financial Accounting Standards Board (FASB) to allow them to fully capture (book) the revenues from sales in the quarter in which the sale was actually made. The FASB very recently ruled in their favor (i.e. allowing Apple to book their iPhone revenues upfront). During the next quarterly earnings report (Q1 2010 circa Jan 22) Apple may opt to report their NON-GAAP numbers as allowed under the new FASB ruling.
Pssst, to the Simon Hobbs of the world, get ready for a surprise, Apple is not an overpriced stock at $210. As Phil Cusick points out ... on a NON-GAAP basis, Apple "ex cash, it's trading at 15 times" forward earnings. Folks, that's cheap.
Now toss in the fact that Apple has zero debt and a truly massive cash position. In 2008/9 Apple was approaching $30 billion in cash. Apple has since moved some of their cash into intermediate term securities (not defined as cash) so that number has dropped a bit. Nonetheless, Apple has one of the largest cash hoards on the planet.
Why is Apple still a good buy? According to Thomas Weisel analyst Doug Reid, iPhone and Mac sales are booming. Reid projects that iPhone sales will exceed 8 million units for the December quarter and 31.5 million units in fiscal year 2010. Reid also points to Apple's successful iMac line refresh and has raised his iMac sales estimate to 721,000 units for the December quarter. Broadpoint AmTech analyst, Brian Marshall, also sees strong overall Mac sales and he is looking for 3.3 million Macs for the December quarter -- an all time record for Apple (current record is 3.05 million). Want more? Apple has shown consistent earnings growth, tremendous ongoing cash-flow from operations, and oh yeah ... they continue to innovate and will not be left behind by any (yes any) competitor.
There are many reasons why Apple stock is approaching an all time high (yet only scant 4% above the Dec 2007 high-mark). Somewhere near the bottom of the "AAPL price-mover" list is the rumored iTablet. Yes, the much rumored, and still unnamed, tablet device is an important catalyst that can create some near term stock price momentum, but it's not fundamental to Apple's present valuation.
So-called financial journalists, bloggers and pundits should all take a few collective breaths into a paper-bag and then carefully reexamine the Apple valuation story. When they do so, they may understand that Apple's stock approaching all-time highs has far more to do with the aforementioned earnings, cash-flow and ability to sustain earnings momentum ... and far less to do with the iTablet that everyone wants to talk about. That said, the iTablet is important to Apple's future and it could very well turn into an exciting story on its own (in due time).
NOTE: The preceding post contains an ample amount of personal opinion and should not be construed as a recommendation to invest. Individuals should do their own due diligence and consult with their financial advisor before investing in the stock market.
Disclosure: Long AAPL
