The iPhone's True Market Cap Value: Apple to Double By 2008

The profitability of Apple's (AAPL) iPhone is not even close to being realized by the investment community. I have yet to read one sentence, aside from those I have written, mentioning the true profitability that the phone will provide to AAPL.

I have yet to read about how it will push both sales of music and videos for years to come as people get their hands on these, since they will purchase more music and videos and from iTunes, providing about 50% margins and no additional costs to Apple. Taken the estimates of 10 million iPhones sold by the end of 2008, I assume that 20% of the people who buy iPhones did not previously have iPods, which means iTunes will have an extra 2 million customers. At an average spend of $50 per year per customer and 50% margins, that is $1 billion in extra revenue and $500 million in profits. Put that in to Apple’s earnings and multiply by AAPL’s PE of 40, and you have additional market cap of $20 Billion.

Nor have I heard about how the iPhone will enable Apple to increase its share of the PC market. Right now, Apple is around 8% of new sales. As the iPod did and still does, the iPhone will enable Apple to capture, at least in my opinion, another 1% of the PC market. Each additional market point at this level should have very high margins as there is no additional set costs to the sales of more product. Each marginal market share of the PC market is worth at least $20 billion in market cap on APPL’s stock price, probably significantly more.

The most important aspect that investors have so far failed to see is the referral income Apple will receive from AT&T (T). They have not released any official numbers on the amount of money AT&T is paying Apple to be the exclusive iPhone provider for two years, however, I assume it is significant. I believe that the average store that signs you to a new cellular contract receives around a $250 commission. I have to assume that Steve Jobs got a much much better deal than that. If not, why would he go with an exclusive provider? It would be in his best interest not to have exclusivity. Verizon (VZ) says they rejected the deal because it was so steep.

So, assuming Apple gets closer to $400 per subscriber (I really have no idea how much they are receiving), I suspect it is more complicated than just a flat payment. Probably a combination of an upfront payment and a share of revenues generated, if I were to take a guess. The margins on this money are about 100%

Their goal is to sell 10 million iPhones by the end of next year, which seems realistic and conservative. If you add up just the extra revenue and profit they receive from AT&T, it adds up to about $4 billion. Throw a multiple of 40, APPL’s current P/E on that money, or less, even 20, since there is no reassurance of it continuing (but I suspect most of it will, at least from the phones Apple sells through its website or in its own stores), and you get a value of $80 billion, or about 2/3rds of Apple’s current market cap.

Add all the numbers together and I see the iPhone adding approximately $120 billion to Apple’s market cap, which is about what the current market cap of Apple. My prediction is for Apple to double by the end of 2008.

All these numbers are in addition to Apple’s current revenue. I am only talking about additional value the iPhone is providing to Apple. 10 million phones seems conservative to me as well, considering that about 1 million have thus far been sold, before the European market has even opened, and it has only been out for about a week and a half. Double the number of phones sold, and do the math again. Steve Jobs hasn’t failed so far…

Disclosure: Author has a long position in AAPL

AAPL 1-yr chart

Comments

[Manny:]

itunes doesnt have anywhere near 50% margins. It's more like 20% at best.

2007 Jul 11 08:27 AM

[Julian Ivan...:]

Wow - someone who gets it, does the maths, and comes out with numbers even more optimistic than mine! And that's saying something :)

I do agree on AAPL doubling by end of 08 though... and with the iPhone, AAPL has a clear shot at rapidly becoming a $300B company sooner rather than later.

2007 Jul 11 09:20 AM

[Tom B:]

MSFT is a "bubble"-- like Dutch tulips, or dot coms, or sub prime mortgages or Ford Motor company. At some point people smack themselves on the forehead and say "What was I THINKING?".

Apple will smack MSFT out of Enterprise, too, and then the dam will break open. We just need a few more DOS-brained dinosaurs to retire.

2007 Jul 11 10:10 AM

[Tree Laugh:]

Iphone will eat into Ipod revenues, canibalizing the sales of Ipods as well as sales of songs through Itune. I didnt see you discounted this into the calcs

2007 Jul 11 10:25 AM

[Tom B:]

For sure, but how much? Hard to say.

2007 Jul 11 10:31 AM

[kentog:]

I assumed that 80% of iPhone buyers already had an Ipod. That is why for 10 million phones sold, they get only 2 million new Itunes customers. I did not take in to account the amount of lost iPod sales due to the canniibilization. it was not meant to be that specific. I do not think that will be a major issue though anytime soon.

2007 Jul 11 10:46 AM

[CH:]

But there has to be SOME iPod cannibalization. I mean, no one who buys an iPhone is going to buy another iPod anytime soon

2007 Jul 11 10:57 AM

[kentog:]

True, these are rough numbers. The main factor and the reason I wrote the article was to discuss the AT&T revenue sharing. I think that is what Wall Street is ignoring entirely.

2007 Jul 11 11:00 AM

[David Lentz:]

When the iPods migrate to the same physical platform as the iPhone (just minus the wifi and cellular hardware, and possibly using a spinning hard drive instead of flash memory (to keep costs down and provide more storage)), in addition to reducing costs via large volume component purchases, there will be a blurring of the lines between the iPod and iPhone product lines.

When iPods and iPhones are seen as variations within the same product line, there will be a lot less concern about cannibalization of iPod sales by iPhones, just as there is no concern today about cannibalization of nano iPod sales by video iPods. The profits all go into the same company, worrying about cannibalization of one product by another is a meaningless exercise.

2007 Jul 11 11:15 AM

[reinharden:]

Not to be a pedant, but there are more than a few problems here.

<blockquote cite="Kenneth Hartog">
iTunes will have an extra 2 million customers. At an average spend of $50 per year per customer and 50% margins, that is $1 billion in extra revenue and $500 million in profits.
</blockquote>

First, that's only $100 million in extra revenue!

Second, Apple has repeatedly stated that they intend to operate the iTunes Store at breakeven.

Third Apple doesn't even get 50% of the gross revenue of an iTunes transaction, much less maintain 50% margins Allegedly, Apple pays 70%+ to the label. Another 3% to 5% likely to a credit card vendor. From the remaining 25%, they have to operate the iTunes store. Most sources estimate that Apple makes pennies per $0.99 transaction.

All that having been said, incremental revenue is incremental revenue. And it's not like there's any marginal cost of goods sold from Apple's perspective. But I wouldn't look for it to add substantially to the earnings number nor therefore the market cap number.

<blockquote cite="Kenneth Hartog">
Each marginal market share of the PC market is worth at least $20 billion in market cap on APPL’s stock price
</blockquote>

Apple's market cap is currently only $115 billion and allegedly up to half of that is predicated upon the iPod. Realistically, I expect it's more likely 1/3 iPod, 1/3 iPhone speculation, and 1/3 Mac. But for the sake of argument, let's stick with 1/2 Mac. That means that your 8% market share (which is overstated on a worldwide basis...but let's ignore that as well) is responsible for perhaps $57.5 billion. Which would arguably yield a value of a touch more than $7B per point of market share.

I'm just saying...

#####

As we move into the realm of AT&amp;T, life gets interesting. I wouldn't invest based upon guessing that maybe Apple got something good from AT&amp;T. Although I would perhaps speculate upon that thesis. That having been said, if Apple and AT&amp;T had entered into a materially significant contract, in theory they would both have been required to disclose some portion of that information in their various SEC filings. So, if nothing else, I look forward to reading the small print of the next quarterly and annual reports. ;-)

Verizon, by the by, is mostly full of crap on this issue. There's simply no way that Apple would have shipped a CDMA phone first. Doing so limits you essentially to the Americas in terms of a target audience. A GSM phone allows you to sell to 80% of the world's population. Apple may *never* ship a CDMA phone. I'm not saying that they won't, but CDMA is "on the way out" (although one could argue that CDMA is about to explode because most of the 3G technologies use a next generation CDMA approach...but they won't be backwards compatible with plain old CDMA). Anyway, lots of chipset families have GSM and 3G in very similar packages. As I mentioned above, Apple needed a GSM approach which meant launching with T-Mobile or AT&amp;T. And if they had to go exclusive, that math is pretty easy (AT&amp;T 62 million, T-Mobile 25 million).


I wouldn't be surprised if Apple did manage to get a revenue sharing arrangement; however, I'm all but certain that Apple did *NOT* get AT&amp;T to pay upfront fees. AT&amp;T's management would have been nearly criminally negligent to have made such a deal. Doing this deal with Apple was already going to require AT&amp;T to spend probably upwards of $100 million on network and infrastructure upgrades (and that number might easily be twice that). Seeing as how they famously signed up without having ever seen the iPhone, I'm pretty sure that the deal was conservative on the front-end but perhaps heavily tilted to Apple's favor on the back-end.

#####

All that having been said, I don't disagree that Apple will do well over the coming year and they might well double. If they hit the 10 million iPhone number at even $500 per, that's $5 billion in revenue and perhaps $2.5 billion in gross profits (although net would be lower, but let's stay overly optimistic for now). A 30 to 40 multiple on top of that enhances the market cap by $75 to $100 billion. Toss in the Mac business, the iPod business, and the current $14 billion in cash. And there's definitely room to the upside. But that's, in theory, out towards the end of fiscal 2008, so it's a bit more than a year from now.


But if Apple announces a non-3G launch in Europe, I think we'll see a buying opportunity. :-( And if Apple doesn't announce their Asia launch plans by MacWorld 2008, I think we might see another one. Not to mention the Mac revs, the iPod res, shipping Leopard, and, oh yeah, whatever happened to the AppleTV and will there ever be any movies on iTunes and what about HD? So there's a lot of execution between here and two times here. ;-)

But I, for one, am still long AAPL...

reinharden

2007 Jul 11 11:41 AM

[ET:]

Thanks for your note but I'm not sure about the margins you've used in your projections but you're dead on accurate that the iTunes methodology can be consistently built upon for years to come without the need to reinvent the wheel.

Secondly, the estimates for iPhones contained in your missive still fail to include a view for a global marketplace and let’s be clear, it’s both the analysts and the media that have missed the real story.

Under another name I use on another board I shared a few additional thoughts as to what the analysts may have missed as to future earnings and valuation.

First of all, Apple is somehow behind the scenes with Google, lobbying hard for the conditions attached to the new proposed FCC draft rules that could pave the way for companies like Google and Apple to acquire spectrum for the first time.

Secondly, should Google or Apple or a JV ultimately win the auction for radio-spectrum (22 megahertz of spectrum out of a total 60 
megahertz), the winning company will be enabled to begin competing with the large providers of broadband service to customers and businesses.

The result of a combination of a VOIP endgame as well as the ability to control 
spectrum is HUGE; especially because the goal for hi - tech is to allow end-users and vendors the 
ability to attach any device or application to that spectrum.

We all understand that Apple's set of established strategic alliances as well as the addition of several new ones (i.e. major movie distribution companies) in addition to enhancements and refinements on its proven itunes methodology scores big.

Lastly, Apple’s innovation and improvements of processes (core competencies) is second to none and as such, Apple is now uniquely positioned with it's combination of products and 
services i.e. hardware, software, distribution, content and 
community to leverage B2B, B2C and C2C strategies like never before.

All the best.

2007 Jul 11 12:15 PM

[peter02l:]

Both the 50% margin on music sales and using a PE pe of 40 for price estimates are way off. Inflating the prospects in such ways is to turn investing into gambling.

By the way, I hope the PE value of 40 is not based on future earnings.

2007 Jul 11 02:27 PM

[peter02l:]

Also, according to Apple, average purchase of music per iPod is less than $5, or a tenth of your estimate.

2007 Jul 11 02:34 PM

[reinharden:]

<blockquote>
Also, according to Apple, average purchase of music per iPod is less than $5, or a tenth of your estimate.
</blockquote>

I'm not sure about the $5; however, with a touch more than 100 million iPods sold and more than 2.5 billion iTunes songs sold, we know that the number is around $25 per user. But I wouldn't want to try and project a revenue run rate from that.

On the other hand: 1.5 billion was announced in September, 2006; 2 billion in January, 2007; and 2.5 billion in April, 2007. With only 100 million iPods that's approaching $5/iPod/quarter.

2007 Jul 11 03:06 PM

[Camden:]

I've never bought an iPod but I've purchased 150 songs from iTunes. And I know a couple people that have purchased three iPods over the years but have purchased very few songs (just listen to their CD collection). Trying to project the future iTunes revenue from iPod sales is virtually impossible. Having said that, it seems to me iTunes will become increasingly important as CDs disappear and the iTunes platform helps to sell hardware: iPods, iPhones, Apple TV's and who knows what else.

2007 Jul 11 08:10 PM

[Neil Anderson:]

If buyers of iPhones new to the platform are pleased with the product they may buy iPods for other family members and thus alleviate the cannibalization side of the equation.

2007 Jul 11 08:18 PM

[John Warren...:]

I do not disagree whatsoever with any of either the details above or the pushing of them to their limits. I just want to say as an old Mac-user and as one who has used a variety of PCs; I have come back to the MAC/MUG families not only as a consumer but too as an investor in AAPL for the very long haul and too my arts house in Budapest to Apple and Steve Jobs. As a long-tiume investor I too have followed too Erik Schmidt (Google CEO and Apple Bd member) before he joined Novell. Locking Jobs and Schmidt at the hips and you a critical mass for long-term transformation. I have consolidated most of liquid wealth into AAPL for the very long term. I believe with the three legs to Jobs' milking stool: Macs, iPods-iTunes and now iPhones ---that all the other stuff iTV, iNAV (navigation systems--- and whatever is coming from Jobs and Schmidt in creating an "ecosystem"---will no doubt create one helluva paradigm shift. Ride on Steve!!!

2007 Jul 12 10:24 AM

[kentog:]

I was the first. Now others are noticing. All the Analysts are talking about the exact thing I mentioned.
I was the first and they are stealing my insights without giving me any credit at all!

2007 Jul 24 06:41 PM