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Apple's Non-iPhone Business Makes More Cash Than Google Over The Last 9 Months

|Includes: Apple Inc. (AAPL)

Introduction

We have all heard the refrain that Apple (NASDAQ:AAPL) is only a phone company. I disagree and I will show the following:

  • Over the last 9 months, Apple has earned more from non-iPhone areas than Google when comparing operating cash flow
  • The iPhone segment is incredibly undervalued
  • I thought splitting Apple might be a good idea to unleash shareholder value, then I decided against it based on news I read recently

My analysis consisted of the following. How much operating cash flow did Google earn over the last 9 months? How much operating cash flow did Apple earn over the last 9 months? I adjusted Apple's cash flow for the proportion of the business which is not related to the iPhone to find out if Apple was truly just a phone company or something different. The results are surprising. I picked Google since they are competitors across many different areas. Here's my journey based on the numbers I uncovered.

Google's cash flow

First, let's look at Google's operating cash flow over the last 9 months.

http://1.usa.gov/1V1ikYA - Google's 10-Q ending June 30, 2015
From the SEC filings on page 5 Google had $13.602 billion in operating cash flow for the six months ending June 30, 2015.

http://1.usa.gov/1MoPdEw - Google's 10-K ending December 31, 2014

On page 47, Google's full 2014 cash flow from operations is listed as $22.376 billion.

http://1.usa.gov/1MoPffy - Google's 10-Q ending September 30, 2014

On page 5 Google's cash flow from operations through 9/30/2014 is listed as $16.012 billion.

That means they earned $6.364 billion ($23.376-$16.012) in the 4th quarter of 2014. If we add $13.602 billion from the first 6 months of the year I calculate Google's operating cash flow as $19.966 billion for the 9 months from 9/30/14 to 6/30/15.

Apple's cash flow

Let's compare Google's operating cash flow with how much Apple earned in the same time period.

http://1.usa.gov/1RDdBH8 - Apple's 10-Q ending June 27, 2015

On Page 6 we see Apple earned $67.791 billion in cash flow for the 9 months ending June 27, 2015. Very impressive.

Apple's non-iPhone cash flow

From Apple's June 10-Q here is the split by Product for the 9 months ending June 27, 2015 (pg. 25):

Net Sales by Product

Dollar Amount (millions)

Percentage of Sales

     

iPhone

122,832

67.4%

iPad

18,951

10.4%

Mac

18,589

10.2%

Services

14,823

8.1%

Other Products

7,019

3.9%

     

Total net sales

182,214

100.0%

     

That means non-iPhone sales were $59,382 billion or 32.6% of the total (10.4% + 10.2% + 8.1% + 3.9%).

When we take 32.6% of $67.791 billion in operating cash flow I get $22.0999 billion! This means non-iPhone revenue made more cash flow than Google over the same time period!! So much for Apple being only a phone company. It wouldn't be fair to say that Apple's non-iPhone business should be valued the same as Google, as Google is growing operating cash flow year over year at a higher rate. I think a conservative value is using Apple's current P/E.

As of October 20, 2015 Apple's enterprise value (NYSE:EV) according to Yahoo Finance was $652.79 billion at market close. Note that this does not exclude Apple's long term investments, which most people generally treat as part of Apple's cash. If we exclude the $168.145 billion in long term investments from Apple's enterprise value we get an adjusted enterprise value of $484.65 billion. Apple's trailing 12 month operating cash flow was $81.041 billion. Apple's trailing 12 month capital expenditures was 10.042 billion. That gives us free cash flow of $69.586 billion. I calculate from above Apple's EV / FCF estimate as 6.96. Let's round to 7 to makes the numbers easier. I will apply this estimate to Apple's non-iPhone business.

Multiplying 7 with $22.0999 billion we get $154.69 billion for the enterprise value of the non-iPhone segment, even when Apple's fourth fiscal quarter is not included. By excluding the fourth fiscal quarter the valuation of the non-iPhone segment is lower than it otherwise would be. When I subtract out that amount from Apple's enterprise value of $484.64 billion we get $329.95 billion for the iPhone segment. This is extremely low.

Let's keep in mind the iPhone segment over the last 9 months has earned 67.4% of all operating cash flow for Apple. That gives us $45.691 billion over the last 9 months in operating cash flow from the iPhone segment. The value of the iPhone segment (iPhone EV / iPhone 9-month free cash flow) is 7.22 times. That is the equivalent of a 13.84% free cash flow yield earned compared to the enterprise value of the iPhone business. To put this in perspective, Apple can earn back the value of the iPhone business in 7-8 years, even assuming minimal growth in free cash flow. The fiscal fourth quarters will pad the numbers and increase the undervaluation.

Splitting Apple into two

If the value of the iOS group is so low, would it make sense to split the company into two pieces? By splitting the company would lose the advantages of sharing people, resources, R&D, scale, and having a common vision. That doesn't make sense. It does expose that the iPhone segment is tremendously undervalued and already taking into account many worst case scenarios. Recent evidence persuaded me that splitting Apple would not be prudent.

That evidence came from the following articles.

Apple users need a lot less help than PC users, IBM finds

MAC@IBM, Zero to 30,000 in 6 months

Note that this is not IBM surveying its customers. This is from IBM's own switch to using Macs. Some quotes are in order.

Results of the Mac@IBM program
To much fanfare from the crowd, Previn said that IBM is deploying 1,900 Macs per week and currently have 130,000 Macs and iOS devices in the hands of users. And all of these devices are supported by a total of 24 help desk staff members, meaning that each staff member effectively supports 5,375 employees. One stat that particularly stood out was that 5% of Mac users call the help desk, compared to 40% of PC users. This shows how simple it is for the staff at IBM to use the Mac platform, and reflects the hard work the team has done to make the experience seamless.

IBM's business case for Mac
Previn continued the Mac@IBM conversation by saying the upfront cost of PCs is lower, but the residual value of Mac is higher. "A Mac still has value three or four years down the road," he added. With the provisioning and automation practices used to manage Mac, IBM does not need to create images for all of their machines - saving their IT staff significant time.

"Every Mac that we buy is making and saving IBM money," Previn said.

Note the key first sentence, "...IBM is deploying 1,900 Macs per week and currently have 130,000 Macs and iOS devices in the hands of users." The quote didn't say only Mac devices, it didn't say only iOS devices, it said Mac and iOS devices. To me, that proves Apple's strategy is working and is a big negative on splitting the company. If Macs are easier for a large company like IBM they'll tell all their clients it is easier for them to switch to Mac and reap the benefits. And as a bonus, they work well the existing iPhone's already deployed in the organization.

Here's another reason I think splitting Apple is a bad idea.

Apple offers all employees restricted stock program hoping to retain talent

You don't undertake giving RSU's to all employees unless you are incredibly confident in where your business will go in the future. It is frustrating to see the undervaluation but I am confident over time it will be erased.

Conclusions

My original premise before publishing was that Apple's non-iPhone business was worth more than Google. Digging into the numbers that premise was false. What is true is that Apple is not just an iPhone company. An enterprise value of $154.69 billion for the non-iPhone areas proves the case. It does show that Apple as a whole is incredibly undervalued. Many Fortune 500 companies would gladly have such a business on their books.

Competition is heating up. Microsoft has launched the new Surface Book at price points above Apple's existing Macbook Pro lineup and has quickly sold out in five days. For the first time in a long time the latest iPhone 6s camera was not voted the best (granted it's very near the top and the difference is marginal). I don't think Apple is underestimating the threats it faces. Apple is playing the long game, which is rare for any corporation of a decent mass, let alone the largest public company in the world. I am worried that Apple is getting a bit complacent but I hope sharp competition will bring a renewed laser-like focus.

I think the market will punish Apple in the short term for earnings next week but I am bullish on the long term growth in the share price. Apple is adding many new elements to the non-iPhone segment, including the new iPad Pro, greater Apple Watch distribution, Apple TV, Apple Music, and Apple Pay. The non-iPhone segment also includes the App Store which is growing impressively. Growth in the non-iPhone section are something to keep an eye on for future earnings reports.

I plan to hold a core position of Apple and take advantage of spikes and sharp drops to add to my position. This includes the use of options.

In a future article I am going to discuss whether it makes sense to split Apple not by iPhone vs. non-iPhone but by hardware industrial design vs software.

Assumptions

It is widely assumed that the iPhone group has greater margins than the rest of the business. Since we are working with averages it might be more appropriate to give the non-iPhone group an even lower weighting of the cash flow. It would still show the iPhone segment is undervalued, just a bit less.

Happy investing and trading!

Disclosure: I am/we are long AAPL.