deagol

Are Fortune's Most Admired Companies Also the Most Investment Worthy?

So, you spout about how you supposedly take into account "what it takes for management to create wealth, understand Management Quality, and see how EPS alone falls short in estimating a company’s value" and then you not only clearly ignore the first two points, but then go right ahead and use EPS in your AAPL valuation scenarios (in yesterday's article)? WTF??

iPhone Sales Drastically Surpass Q4 Consensus; Apple Reaches 10m Goal

Andy, credit should also go to howlongtoretire from the Apple Sanity board at InvestorVillage for starting and continuing this effort.

How Much Will the App Store Contribute to Apple’s Bottom Line?

"the original title of the article on my own site was “Modeling iTunes AND App Store EPS potential.”"

Yes, but it reads as if you needed the iTunes exercise to derive some numbers which you would then apply to the App Store model, which is not the case. Again, I will quote from the article:

"A comprehensive model with a chance at accuracy would need to account for many of these factors. There’d be a lot of “if” and “then” elements; a lot of variables. That’s not only a lot of work, it’s probably impossible to render with the existing public data. There’d be too many random guesses.

Fortunately, there seems to be another way – we can compare iTunes to the App Store."

The fact is that the iTunes model is not at all required to derive your App Store model. You just used the same model on both segments. What you ended up doing is exactly what you described as "probably impossible to render with the existing public data" and then applied it to both the iTunes Store and the App Store. Those "too many random guesses" are all still there, and on top of that, you piled on the additional “if-then” that both stores share "similar earnings to revenue relationships." You're adding an additional arbitrary constraint to what should be two different models (that they are similar) and argue that doing that somehow makes your theory more valid. It's actually the opposite.

The acrobatics you resorted to when coming up with a Net Margin guesstimate for iTunes in no way validate anything about the App Store model, and assuming the models are similar doesn't help either. They are both guesstimates, far from facts, and the assertion that this exercise "creates a factual framework" is wrong.

Had you said "in my opinion, even if we assume the App Store could become a one billion enterprise at some point, as Steve Jobs said, it still would not be a significant contributor to EPS" and then wrote an article about why you believed that (say you quoted Steve Jobs or Peter Op. when they've said they plan to run the App Store just like the iTunes Store "at a slight profit" or quoted other analysts who've talked about this as a "loss-leader" strategy, or anything BUT this whole "doing the maths" farce), then I would have thought your reasoned opinion was valuable, and in fact I would have agreed for the most part. If you then pegged the annual EPS contribution of the one billion dollar App Store at a 4.8 cents through some quick back-of-the-envelope calculation, I would probably disagree to the precision implied in that result (a range of 5 to 25 cents would be my guess), but I wouldn't have any problems seeing it as what it was: just a guesstimate, and not pretending to be something it's not.

But I guess when you throw a lot of numbers and math formulas and complicated models, a lot of people believe it must be true, or more accurate, or "a better factual framework." It really hides all the subjectivity behind all the math, doesn't it? And I don't hold this against you, it's just a fact of how people perceive things. I've also developed my own model for Apple, and it's very complicated and I don't expect many to understand much of it. But I still share it with people and I always insist that it's not one bit less subjective just because it uses a lot of math instead of pulling an EPS number out of thin air, and there's always some who think that it must be more factual because of the math or because its historic accuracy. I see you're acknowledging some of those disclaimers here, but there remain some inconsistencies and logical fallacies being passed as reasonable analysis.

Sorry for the awfully long comments and having wasted even more time on this.

How Much Will the App Store Contribute to Apple’s Bottom Line?

"It’s not like they’re sharing 60% of MacBook or iPod product revenue with partners."

In fact, this is exactly the case. That's what the Gross Margin is. Apple is indeed sharing (i.e. paying) an average of about 65% (obviously it varies by product) of their revenue with their suppliers and contract manufacturers. The costs of running the business are not included there yet, expenses like running the retail stores, the online store, customer support, R&D, advertising, administrative costs, etc. It's clear to me that hosting and credit card fees fit the definition of Operational Expenses, and the 70% they pay to content creators (music or apps) fit the definition of "cost of sales". So after taking out these costs and expenses, and after paying out taxes you get your Net Margin. Once again, this Net Margin of 14% is not only out of the portion of revenue they get to keep after paying off suppliers and contract manufacturers of MacBooks or iPods or music or apps (35% overall), it's 14% of the whole thing.

I will quote from your own article and use your own numbers:

"With about $800.2m [in revenue] attributed to iTunes [...] Net Margin would be $33.6m for Q3"

Well, Net Margin of 33.6m on 800.2m revenue would mean iTunes Net Margin is 33.6 / 800.2 = 4.2%. What happened to the assumption of 14% Net Margin? Furthermore, that means the Net Margin for the rest of the business is close to 16%. So, you're saying "for the sake of putting something together, let's use the same company-wide Net Margin for the iTunes store" but actually end up with iTunes enjoying only ONE FOURTH of the company-wide Net Margin. Insisting that "using a Net Margin percentage taken as an average from the entire business [...] could be off in either direction" when the actual number hidden in the math is considerably off in one direction (down) is clearly contradictory.

To me that seems quite a bit disingenuous, or a mistake. Why not just say "I will grant iTunes a much lower Net Margin than the rest of the business, about one fourth, just to be conservative"? Wouldn't that be much more frank and clear?

How Much Will the App Store Contribute to Apple’s Bottom Line?

First things first, your application of the Net Margin formula is flawed. It's 14% of the revenue number, not the gross 30% take. So, your estimates are off by more than a factor of 3.

Second, you did all those iTunes calculations for nothing. If you are treating the 14% Net Margin as a given, you don't need to know anything else. 99% of the article is running around in circles going nowhere. Here's a shorter version of it:

"The EPS contribution from Steve Jobs' estimates of the App Store sales (annualized) would be:"

$360m * .14 / 903m = $.056 (5.6 cents)
$500m * .14 / 903m = $.078 (7.8 cents)
$1b * .14 / 903m = $.155 (15.5 cents)

That's it. That's all this article is about. And it's still worthless, as you point out in the conclusion (applying the same company-wide Net Margin to any/all business segment is just inane). I completely disagree with your final statement that "this at least creates a factual framework for looking at it."

Sorry if this was harsh. Nothing personal, but if I were you I would want to delete this whole article, and maybe leave an apology to my readers, hoping that they understand that we all make mistakes once in a while.