There is no shortage of coverage on Apple (AAPL) stock. Inspired by the recent setback on Apple Maps, our team seeks to raise key issues that Apple must address in order to grow the company into a trillion-dollar market cap enterprise, including fixing its Apple Maps problems, improving Siri, revolutionizing the media/cable and publication industries, increasing its dividends, and more. Below is our letter to Apple. (Please also refer to Table 1: AAPL Income Statement Data, Table 2: AAPL Key Financial Data)
Dear Apple management,
As investors and customers of AAPL, we are proud to participate in Apple's success as it becomes one of the most enviable companies in the world. There is speculation that AAPL could become the first trillion-dollar market cap company on the planet - currently, at $667 per share, AAPL has a $632 billion market cap. With revenues of $108 billion in 2011, a trailing EPS of $42.5, and $117 billion in cash, AAPL is traded at 15.7x trailing P/E (or 12.8x excluding cash) (AAPL 2011 10K filing, AAPL Q3-2012 10Q filing). With these figures, AAPL is inexpensive compared to other tech or social media companies such as Amazon (AMZN)(311x trailing P/E) or Facebook (FB)(120x trailing P/E).
The company has been doing many of the right things, such as expanding its products, defending its intellectual properties, and issuing its first dividend to name a few. However, the recent setback with Apple Maps has concerned some investors: is this just a hiccup on the road to a trillion-dollar company or is it a reflection of changes in Apple's culture as the company continues to expand?
From a perspective as AAPL investors and customers, we list several key issues that Apple's management must seriously consider in their business strategies to sustain Apple's innovative growth engine.
First and foremost, Apple must win back the trust of its customers. Apple's unparalleled ability to design products that customers want is a key driver behind its business success. The company should never lose sight of this laudable mission. Indeed, it is the commitment to this mission that created iPod, iPhone, iPad, iTune, as well as numerous apps for mobile devices. These products and applications have literally revolutionized the smartphone, mobile device, and music industries. The popularity of Apple's products and the loyalty of Apple customers to its brand are paramount to AAPL's profitability.
However, the recent setback on Apple Maps is very "un-Apple" and downright embarrassing - Apple's new iPhone 5 replaces Google Maps with its own Apple Maps. Within weeks of the iPhone 5's debut, Apple received numerous complaints about its faulty mapping application (Apple's wrong turn on Maps-WSJ). Last Friday, CEO Tim Cook issued a letter to apologize for the setbacks on Apple Maps ( Letter from Tim Cook on Maps).
The incident makes us wonder: would this error have occurred if Steve Jobs were around? Some customers have indicated that they may hold back on the purchase of an iPhone 5 until the company fixes the Maps problem. This could impact iPhone 5 sales and ultimately AAPL's revenue.
To solve this problem, Apple must develop a better and more reliable Apple Maps to rival Google Maps. Meanwhile, Apple should bring back Google Maps to the iPhone and iPad and allow customers to choose which map they prefer to use. Customers need a good map, not only to find shops and stores in major cities in the world (e.g. New York City) or explore Central Park trails, but also for more adventurous exploration, such as climbing the Rocky Mountains or perhaps Mount Everest. Until Apple makes maps that trump Google's, please bring back Google Maps to iPhone 5. (Disclosure: we are also long Google (GOOG)).
iTV and Publication
There have been rumors that Apple is working on iTV, and we agree that it's time to take on the TV/cable industry. The luxury of being an Apple's customer is the great freedom of choice over the types of devices and apps that suit us. But in the old media, we remain at the mercy of cable operators (as we and others can surely personally attest).
During the Olympics, we tried to watch some of the track-and-field competitions, but couldn't find the exact times for the programs. NBC gave a broad range of scheduled events, yet we had no choice but to sit through all of its afternoon and evening programs while being fed events we had no desire to watch (like beach volleyball). Cable operators are out-of-touch with the internet world, and we gave up watching the Olympics out of sheer frustration.
We want Apple to launch the iTV and allow customers to search and watch any show they like, anytime and anywhere (Is iPad the only TV you need?). We want to have control over our choices, not being dictated to by TV/Cable providers.
Apple should also continue its plan to revolutionize the publication business, related to how we compose letters, write reports, publish articles, and how our kids will be educated in the future.
Writing a letter, report, or article is the most basic form of publication. Microsoft (MSFT) dominates the space with its Microsoft Office Suite for personal and business use, which includes Word, Excel, and Powerpoint. Thus far, the iPad has a limited capacity for handling the functionality and sophistication that Microsoft Office offers. However, we do hope that Apple will develop new programs that will change the way we write and publish. (Note that Google has already moved in this direction with its introduction of Google Drive, which contains programs similar to those within the Microsoft Office Suite). The bottom line is that Apple should enable the iPad to perform many of the same functions that Microsoft Office offers.
Perhaps Apple can capitalize on its unique Siri application in this space. Currently, Siri is capable of taking simple instructions, such as finding contacts, places, and websites, editing events, and replying with short messages (What Siri can do for you). Apple can make Siri smarter and more intelligent, and perhaps someday Siri will be able to type a letter or write a report via dictation - the potential of Siri becoming a truly Intelligent Assistant is tremendous.
Apple has also released a plan to change the textbook business: "Introducing an entirely new kind of textbook that's dynamic, current, engrossing, and truly interactive. A textbook created by publishers and brought to life by iPad" (Apple iBook). The beauty of it is that not only will our kids be rid of their heavy bags, but will also be freed from the limited information that a textbook offers. With an iPad in hand, they are open to a world of resources and knowledge through the internet and interactive media. Imagine every kid in the U.S. has an iPad and you can easily see how sales could expand to $16.6 billion in the U.S. market alone.
Finally, as investors, we care about how AAPL will continue to maintain its competitive advantage, create value, and returns profits to its shareholders. Apple has created significant value for its shareholders over the past 10 years as its stock price has skyrocketed from $8 to $667.
AAPL has a pristine balance sheet (AAPL 2011 10K filing, AAPL Q3-2012 10Q filing). The corporation has zero debt, $117 billion cash, and $111.7 billion shareholder equity (Table 1, Table 2). It is also highly profitable: its profit margin is 40% and net profit margin 24%. Its 3-year compound revenue growth rate and EPS growth rate are 44% and 39% respectively. Even at a growth rate of 20% per year (Apple currently has a growth rate of 40%), AAPL can reach a trillion dollar market-cap by 2015.
In July, Apple also initiated a cash dividend program of $2.65 per share, which translates to a dividend yield of 1.59%, $10 billion per year, and a 25% dividend payout ratio. Given its cash balance of $117 billion, and operating cash flows of $41B (for the 9 months ending 6/30/12), Apple has plenty of leeway to increase its dividends or buy back stock without affecting its operations. Apple currently has 947 millions of shares outstanding, and the issuance of a dividend will expand its investor base to institutional investors and pension funds which mandate investment in dividend-paying stocks.
Our team also discussed the remote possibility of AAPL being aggressive on dividends or share repurchases and paying out 7 or 8% of their market cap per year (similar to the action by Exxon (XOM)), and the attendant impact on the quest for a trillion dollar market-Cap. To get the answer, we delved deeper into Apple's free cash flow. With operating cash flows (CFO) of roughly $50B and capital expenditures comprising about 12% of CFO (or $6B), the company has $44B in free cash flows for paying dividends or buying back shares. In an extreme case, if Apple paid out 100% of its free cash flow, its dividend would be $46.50, or a 7% dividend yield on its current stock price.
Of course, it is unlikely that Apple will pay out 100% of its free cash flow - a more reasonable amount would be 60%. In that case, it would be a dividend of $27.8 or 4.2% yield. At this yield, investors would flock to the stock, which would easily approach $900. This will then bring its yield down to 3%, a P/E multiple of up to 21, and a market cap of close to $850 billion. As long as they do not cut into Apple's business operations, any dividend increase or shares repurchase would likely move the stock price to the upside. At the end of the day, the stock price is highly dependent on the company's revenues and earnings growth rates, dividend income, and investors' sentiment on the company and the markets.
Returning to the original question, can Apple become the first trillion dollar company? As long as Apple maintains its innovative culture and thrives for excellence in all its products, it is possible that AAPL will cross the trillion dollar cap by 2015 with a revenue growth rate of 20%. A high dividend payout or shares repurchase within 60% of its free cash free might even help boost the stock price to the upside.
Table 1: AAPL Income Statement Data
2011 annual data
2012 Q3 data
Gross profit margin
Net profit margin
Table 2: AAPL Key Financial Data
As of 9/28/12
As of 9/28/12
As of 6/30/12
Dividend payout ratio