The 800 pound guerillas vying for market dominance are clearly Apple (AAPL), Google (GOOG) and Microsoft (MSFT). Each of these companies competes directly with at least one of the remaining two in particular market segments. Apple and Google compete for the mobile computing market; Google and Microsoft in the search space. Ostensibly, each of these companies operates in a separate market. Thomson Reuters categorizes Apple as a computer hardware company; Google is in IT services and Microsoft is a software and programming company. But are they really?
The description from Reuters for Apple includes the following:
“Apple Inc., incorporated on January 3, 1977, designs, manufactures and markets a range of personal computers, mobile communication and media devices, and portable digital music players, and sells a range of related software, services, peripherals, networking solutions, and third-party digital content and applications. The Company’s products and services include Macintosh (Mac) computers, iPhone, iPad, iPod, Apple TV, Xserve, a portfolio of consumer and professional software applications, the Mac OS X and iOS operating systems, third-party digital content and applications through the iTunes Store, and a range of accessory, service and support offerings. The Company sells its products globally through its retail stores, online stores, and direct sales force and third-party cellular network carriers, wholesalers, retailers, and value-added resellers. In addition, the Company sells a range of third-party Mac, iPhone, iPad and iPod compatible products, including application software, printers, storage devices, speakers, headphones, and various other accessories and peripherals, through its online and retail stores. The Company sells to consumer, small and mid-sized business, education, enterprise, government and creative markets. As of September 25, 2010, the Company had opened a total of 317 retail stores, including 233 stores in the United States and 84 stores internationally.”
Google is described as:
“Google Inc., incorporated in September 1998, is focused on improving the ways people connect with information. The Company generates revenue primarily by delivering online advertising. The Company focuses on areas, such as search, advertising, operating systems and platforms, and enterprise. Businesses use its AdWords program to promote their products and services with targeted advertising. In addition, the third parties that comprise the Google Network use its AdSense program to deliver relevant ads that generate revenue and enhance the user experience. In February 2010, the Company acquired Aardvar and On2 Technologies, Inc. In May 2010, The Company acquired of AdMob, Inc. (AdMob). In August 2010, the Company acquired Slide, Inc. (Slide). In December 2010, the Company acquired Widevine Technologies, Inc. (Widevine). In April 2011, the Company acquired PushLife.”
“Microsoft Corporation, incorporated in 1981, is engaged in developing, manufacturing, licensing and supporting a range of software products and services for different types of computing devices. The Company’s software products and services include operating systems for personal computers, servers and intelligent devices; server applications for distributed computing environments; information worker productivity applications; business solutions applications; computing applications; software development tools, and video games. It operates in five segments: Windows & Windows Live Division (Windows Division), Server and Tools, Online Services Division, Microsoft Business Division, and Entertainment and Devices Division. It provides consulting and product and solution support services and trains and certifies computer system integrators and developers. The Company also designs and sells hardware, including the Xbox 360 gaming and entertainment console and accessories, the Zune digital music and entertainment device and accessories, and Microsoft personal computer (PC) hardware products. In addition, it offers the enterprise client access license (eCAL) suite, which licenses access to Microsoft server software products. In October 2009, Publicis Groupe S.A. acquired Razorfish from Microsoft. Pursuant to the acquisition, Razorfish will be a wholly owned subsidiary of Publicis Groupe and a part of VivaKi, the Publicis Groupe media and digital umbrella encompassing Starcom MediaVest Group, ZenithOptimedia, Denuo, Digitas and VivaKi Nerve Center. In December 2009, the Company acquired Opalis Software Inc.”
Looking at these descriptions, I conclude that Apple is not so much a hardware company as it is a consumer products company. Google is primarily an advertising company using search to generate advertising dollars. The company’s creation of the Android operating system for mobile computing is not so much about software or mobile computing as it is to create a new platform for advertising. Microsoft remains closest to its roots. Though it has introduced consumer products such as the Xbox, its current nemesis is Google with which it competes head-to-head in the search engine segment.
Apple is doing great. Apple reported that one million consumers downloaded the new Lion operating system on the day it was released. The company had a great quarter with sales up 82% year-over-year and EPS up 122% over the year-ago quarter. Sales are $100,322 million for the 12 months ending June 2011 compared to $57,089 million in the comparable period; EPS is up to $25.26 as compared to $13.28. Reuters reports that according to Bloomberg, Apple has joined talks to acquire Hulu.com in MarketWatch, John Dvorak suggests that Apple should buy the consumer electronics giant Sony (SNE).
Google is busy in its own backyard. It has introduced Google+ to go head-to-head with Facebook and has the infrastructure to build upon. This new product seems to reflect the lessons learned from the failure of Buzz. Google is also having a great year. For the June 2011 quarter, Google had revenues of $9,026 million as compared to $6,820 million in June 2010, a 32.3% increase. EPS for the June quarter were $7.68 as compared to $5.78, for a 32.9% gain. Sales for the TTM are $33,327 million compared with $26,213.7 million. EPS are $27.72 as compared to $23.03. Google is also reported to be in talks to purchase InterDigital (IDCC) and thereby gain access to InterDigital’s treasure-trove of patents. This is a counter-move to apple’s successful acquisition, as part of a consortium, of Nortel Network’s (OTCPK:NRTLQ) patent collection.
Microsoft is no slouch either. For the June quarter, it reported sales of $17,367 million versus $16,039 million in June 2010. EPS were reported as $0.69 as compared to $0.51 in June 2010. For the 12 month period ending June 2011, sales grew at the rate of 11.9% and EPS by 28.0%. Separately, Microsoft was part of the consortium acquiring the Nortel Network patents. The company is also expanding its footprint on the web by introducing the Office product as a SaaS product. The online version of Office will compete with Google products. Bing has been taking market share from Google’s search engine business. Microsoft also has a cloud platform called Azure.
So what do we know? We know that all three companies are terrific at what they do. Their financial strength is so well known, we will not take the time to review it here. Suffice it to say, if they colluded and combined their available cash, they could buy all of the sovereign debt of Greece and then have change left over. They compete with one another in various market segments. The competition benefits the consumer with better product.
As investors, we need to consider if one company is a better investment than another. Our initial metric is the S&P 500 PE. The S&P 500 has a trailing PE of 15.78X and a forward PE of 13.15X. Apple is selling at 25.26X trailing earnings and 14.3X estimated earnings. The forward PEG is a low 0.6X. Microsoft has a TTM PE of 10.1X and a forward PE of 9.5X. The forward PEG is 1.0X. Google trades at 21.8X trailing EPS and 17.0X estimated EPS. The Forward PEG is 0.9X.
Based on trailing PE multiples, Apple is trading at a significant premium to the market; Google a smaller premium and Microsoft at a large discount. The PE’s based on estimated earnings tells a similar story. However, the PEG ratios suggest a different story. In this scenario, Apple is the bargain with a forward PEG of 0.6X and Microsoft is fairly priced with a forward PEG of 1.0X.
Are there other valuation metrics that can be used here? We include in all our analyses Enterprise Value to Sales. We think this metric provides some insights others do not. We also make our own estimates of EV/Sales.
Microsoft has a current EV/sales ratio of 3.34. We estimate that this ratio should be 4.13 thus implying the company is undervalued by 24%. Apple is trading with an EV/sales ratio of 3.38 and an estimated ratio of 5.73. This suggests that Apple is undervalued by 70%. Google has an EV/Sales ratio of 5.65 and an estimated ratio of 5.87 suggesting a 4% discount.
Our conclusion is that Apple offers the best risk/reward characteristic. Despite the growing strength of Android-based telephones in the marketplace, the iPhone is the product to beat. There are several tablet computers on the market but none challenge the iPad as the dominant product and we doubt that a Google introduced tablet will fare any better than the other competitors. Apple is rumored to be planning the introduction of a television. This too can be a disruptive technology. Apple and Google already compete on set-top add-ons for the television screen and Google is experiencing more returns of its product than new sales.