Valuecruncher's  Instablog

It has been a crazy 15 months for the Apple ($AAPL) share price. On the 22 August 2008 $AAPL was trading at $176.79. By 16 January 2009 $AAPL had dropped to $82.33 - down over half (53% down) in under five months. Today $AAPL closed at $190.01 - up over 130% in under nine months. The graph below shows the closing prices over the period. So what do we think about $AAPL?

Valuecruncher Interactive Analysts Report For Apple ($AAPL)

We have the comparator group set as Microsoft ($MSFT), IBM ($IBM), Google ($GOOG) and Hewlett-Packard($HPQ). You can change these peer companies on the site. For example you could add:

1. Research In Motion ($RIM) - Interactive Analyst Report For $RIM
2. Palm ($PALM) - Interactive Analyst Report For $PALM
3. Qualcomm ($QCOM) - Interactive Analyst Report For $QCOM

So what do we think?

Discounted Cash Flow Valuation

We have completed a discounted cash flow valuation using our interactive tools (there is a “discounted cash flow analysis” link just under the company name on the company page). We have populated our model with a mixture of consensus analyst estimates and Valuecruncher estimates. Our analysis produces a valuation of US$176.16 for $AAPL - 7.3% below the current share price. We see $AAPL overvalued at the moment. But how about compared to a peer group?

Comparison Analysis

I changed the peer group companies to $IBM, $RIM, $PALM and $QCOM.  I am going to look at two of the metrics we use at Valuecruncher - Enterprise Value (EV)/Revenue and EV/EBITDA. Enterprise Value (EV) is simply market capitalization plus net debt [long-term borrowings less cash]. We use EV to capture the impact of debt and cash on a company’s balance sheet - market capitalization doesn’t capture different capital structures when comparing companies.

EV/Revenue shows how a dollar or revenues is being valued by the market against the comparator set. On an EV/Revenue basis $AAPL is trading at 4.5x ($AAPL is being valued at 4.5x last year’s revenues). This compares to $IBM at 1.7x, $RIM at 3.5x, $PALM at 3.4x and $QCOM at 5.8x. $AAPL’s profit margins (at the EBITDA line) are 20.9% of revenues.  A dollar of $AAPL revenues is being valued more than a dollar of $RIM revenues - despite that dollar of revenues producing less profit (on an EBITDA basis) than the $RIM revenues.  A dollar of $AAPL revenues is being valued less than a dollar of $QCOM revenues - but $QCOM produces nearly twice the profit (on an EBITDA basis) as $AAPL.  We would expect the difference between the multiples for $QCOM and $AAPL to be larger - in $QCOM’s favour. There are some big growth expectations for $AAPL - on an EV/Revenue basis there appears to be a premium being paid for $AAPL against the peer group.

If we lower the $AAPL EV/Revenue multiple to 3.75x (a slight premium to $RIM) then this gives a share price of $163.30 - 14% below the current share price.

EV/EBITDA shows how a dollar of profit (measured in as Earnings Before Interest Taxes Depreciation and Amortization) is being valued by the market against the comparator set. On an EV/EBITDA basis $AAPLT is trading at 21.51x ($AAPL is being valued at 21.5x last year’s profit at the EBITDA line). A dollar of $AAPL EBITDA is worth more than double a dollar of $IBM, $RIM or $QCOM EBITDA ($PALM is losing money at the EBITDA line).

If we lower the $AAPL EV/EBITDA multiple to 17.5x (a slight premium to $QCOM) then this gives a share price of $160.06 - 16% below the current share price.

Summary

Based on our DCF valuation - $AAPL looks overvalued. Looking at some comparators - the market is valuing $AAPL highly compared to some peers. We believe if you are investing in $AAPL at the current price - you are paying a full price and there are cheaper options available. We do recognize that there are a lot of $AAPL fans out there however.

Disclosure: no positions.

We have been participants and observers of the on-line finance  space for a period of time now. As part of that we regularly examine our view of the competitive landscape. We have decided to share some of our views on where the very broad industry may be headed. This isn’t company specific – very much the high-level perspective.

Where We Are Today

We view the on-line finance space in three broad areas: Information, Analysis and Execution.

Pre-1995 this whole area was dominated by brokerage firms with full-service offerings. They had the information, did the analysis and the executed the trades. Since 1995 that has changed pretty significantly.

Information – background operational and financial information. The main players in this space are now the large finance portals (Yahoo, AOL, MSN, Google, etc). They built and extended these offerings in the Web 1.0 and 2.0 days. The business model is primarily advertising – free to consumers. It should also be noted that there is still a paid market for detailed and timely financial information (Reuters, Bloomberg, Capital IQ, etc).

Analysis – what does the information mean? Should I buy a particular stock? What is this stock worth? Full-service brokers still compile research notes and reports for clients – but this space has begun to be disrupted. This disruption is coming from a number of areas:

Qualitative – primarily finance blogs. These take two main forms: user-generated content aggregators (i.e. SeekingAlpha) and traditional journalism on the web (i.e. The Business Insider).

Community Sites – where retail investors look to communities of investors for advice on where to invest. Examples: The Motley Fool, Wikinvest, Covestor, KaChing, etc.

Niche Tool Providers – primarily quantitative-based tools. For example Valuecruncher.

Execution – the actual buying and selling of stocks. The discount brokers have come to dominate this space (i.e. Charles Schwab, ETrade, etc). They disrupted full-service brokers with simple flat-rate commission structures starting in the Web 1.0 days.

That is a high-level view of where we are today. What might happen next?

We completed a scenario planning exercise based on the frameworks developed by people like Peter Schwartz.

We started with an analysis of trends and uncertainties. A trend is something that we feel certain is occurring. An uncertainty is something that could still go either way.

Trends

1. Execution becomes a commodity – executing trades will continue as a low-cost business. There will be some geographic-based regulatory moats – but no ability to generate abnormal returns. Other parties could enter this market (i.e. portals).
2. Death of traditional equity research – the current model is too expensive and producing research reports that are complex and hard for retail investors to consume. Traditional equity research will head the way of newspapers. Equity research is important but the delivery methods must change. There will be a space at the top-end for high-quality  research (that clients will pay for) but only a niche.
3. Investor knowledge continues to improve – the level of general investor knowledge continues to improve but there still remains a significant gap between the average retail investor and the corporate finance professional.
4. Financial blogs continue to be influential – high-quality analysis continues from blogs. There are two broad models – aggregating content (i.e. SeekingAlpha) and traditional journalism on the web (i.e. The Business Insider).

Uncertainties

1. Individual VS Collaborative – how will retail investors choose to research investment decisions? Individual analysis – retail investors (with improving education) complete their own analysis on where to invest – both qualitative and quantitative. Collaborative – retail investors look to communities of investors for advice on where to invest – track record is vital.
2. Free VS Paid – financial information has proven to be an isolated area on-line where paid models have worked (i.e. WSJ). Moving forward – will retail investors be prepared to pay for financial information or will free win out?

We then construct a basic scenario matrix. These scenarios are not meant to reflect concrete versions of possible future states but rather to illustrate the potential impact of the identified trends and uncertainties. There will be components of all of the scenarios in the future – this analysis is intended to emphasize trends and uncertainties. We look at the winners in each scenario and where the portals come out.

Scenarios

1. We Live In Public – Retail investors seek advice from communities of other investors. Track record is vital – this is open to abuse. Retail investors won’t pay for this advice. Community owners seek models to monetize the audience not the content – none is initially obvious beyond advertising. Winners – The Motley Fool, StockTwits. Portals – business as usual providing (mostly) raw data.
2. Rock Stars – Retail investors seek advice from communities of other investors and are willing to pay. Investors make their trading accounts transparent on-line. Successful investors open their accounts to act as virtual fund managers. Virtual fund managers and community owners split a management fee paid by investors. Winners – Covestor, KaChing. Portals – business as usual providing (mostly) raw data.
3. Super Commons – Retail investors value analysis and tools but are not willing to directly pay. There is a move from traditional on-line financial information providers (i.e. Capital IQ) to low-cost/no-cost providers (i.e. financial portals). Retail investors and corporate finance professionals use the same tools. New tools are added (i.e. Google Domestic Trends). Pay-walls come down – financial blogs are at their most influential. Winners – Portals and financial blogs
4. Walled Garden – Retail investors value analysis and tools. The financial blogs continue to exert influence. However the pay-wall remains at the WSJ and on-line information providers (Reuters, Capital IQ) have a valuable and growing business. Winners – Reuters, Bloomberg, Capital IQ. Portals – Opportunity to launch a low-cost disruption strategy aimed at on-line information providers (a good enough offering to tempt [for example] Capital IQ’s clients).
   

Implications

• Discount Brokers – Challenged across all scenarios. Must follow a low-cost strategy and only add services if that will increase trades (and commissions).
• Financial Blogs – Winners across all scenarios (a role to play in all scenarios). Two distinct approaches – aggregating content VS traditional journalism on the web. We would expect one to come to the forefront (our bet would be on aggregating content – but it is too early to say).
• Community Sites – Winners in the “We Live In Public” and “Rock Stars” scenarios. Significant opportunity if community is the way that people choose to make investment decisions. A business model has proven to be a challenge to date for players like the Motley Fool (“We Live In Public” scenario). It is more obvious if investors will pay to be part of the community (“Rock Stars” scenario) – this is currently unproven however.
• Paid Finance Services – Business as usual in the “Walled Garden” scenario and challenged across all other scenarios. Even in the “Walled Garden” scenario there is the potential for the paid financial services to be disrupted (low-cost disruption) by the portals offering extended services (i.e. Google Domestic Trends). Currently users of paid services also use the free portal services (Yahoo Finance and Google Finance). There are limited options to defend this. Paid services do provide the data used by the finance portals. Reuters are also moving into the free space.
• On-Line Finance Portals – Winners across all other scenarios. In the “We Live In Public” and “Rock Stars” scenarios – it is closest to business as usual. These players are the ones with the ability to acquire or build community sites. Investors that are part of communities still require basic financial information and tools. In the “Super Commons” and “Walled Garden” scenarios there are big opportunities. Both require adding analysis tools. Partnering with financial blogs is key. Adding analysis tools is an arms race between the different finance portals.

This is one view of the potential future. Tell us what you think.

Valuecruncher Future Of On-Line Finance Summary (Four-page PDF summary).

Disclosure: No Positions

Starbucks ($SBUX) is in an interesting position. You would expect premium coffee purchases to be down in the current economic climate. The company has also just raised prices on some beverages. Yet $SBUX is currently trading toward the top of their 52-week range at US$19.35. Time to have a bit of a look.

Valuecruncher Interactive Analysts Report For Starbucks ($SBUX)

The key comparators are Tim Hortons ($THI), a direct competitor, and McDonalds ($MCD), a low-cost substitute.  You can change the generated peer companies on the site.

So what do we think?

Discounted Cash Flow Valuation

We have completed a discounted cash flow valuation using our interactive tools (there is a “discounted cash flow analysis” link just under the company name on the company page). We have populated our model with a mixture of consensus analyst estimates and Valuecruncher estimates. Our analysis produces a valuation of US$11.95 for $SBUX - 38.7% below the current share price. We see $SBUX well overvalued using a discounted cash flow model. But how about compared to a peer group?

Comparison Analysis

I am going to look at two of the metrics we use at Valuecruncher - Enterprise Value (EV)/Revenue and EV/EBITDA. Enterprise Value (EV) is simply market capitalization plus net debt [long-term borrowings less cash]. We use EV to capture the impact of debt and cash on a company’s balance sheet - market capitalization doesn’t capture different capital structures when comparing companies.

EV/Revenue shows how a dollar of revenues is being valued by the market against the comparator set. On an EV/Revenue basis $SBUX is trading at 1.5x ($SBUX is being valued at 1.5x last year’s revenues). This compares to $THI at 3.0x and $MCD also at 3.0x. $SBUX’s profit margins (at the EBITDA line) were 11.6% of revenues last year - against 25.4% at $THI and 31.5% at $MCD.  A dollar of $SBUX revenues is being valued at half that of a dollar of $THI and $MCD revenues - this is broadly in-line with the difference in profit margins in the businesses last year.  This is what we would expect.

EV/EBITDA shows how a dollar of profit (measured in as Earnings Before Interest Taxes Depreciation and Amortization) is being valued by the market against the comparator set. On an EV/EBITDA basis $SBUX is trading at 12.7x ($SBUX is being valued at 12.7x last year’s profit at the EBITDA line). $THI is trading at 11.8x and $MCD is trading at 9.3x. This difference will represent the different expected profit margins and growth prospects between the businesses - as being valued by the market. We are surprised that $SBUX profits are being more highly valued than their competitors. This suggests that the market currently believes that $SBUX’s fortunes are about to improve significantly and some of the gains are already being priced into the stock.

Summary

Based on our DCF valuation - $SBUX looks significantly overvalued. Looking at some comparators we are surprised that $SBUX is being so highly valued (especially on an EV/EBITDA basis) agaist key comparators $THI and $MCD. $SBUX looks a sell at these prices.

Disclosure: no positions.