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PiperJaffray addresses 16 more 'unanswered Apple questions'

post #1 of 16
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PiperJaffray analyst Gene Munster on Thursday issued a report to clients that analytically addresses 16 more unanswered questions surrounding the Apple Computer story.

Back in May, the analyst issued a similar report with comments on more than 20 questions about the Cupertino, Calif.-based company that had been lingering in the minds of investors and enthusiasts.

The latest report addresses a broad spectrum of questions, ranging from Munster's take on Apple's upcoming iTV launch to the company's thoughts on the holiday shopping season.

Both the questions and answers are being republished in full in order to offer readers the full benefit of the analyst's insight:

Questions on General Business Operations:

How Do New Product Initiatives Like iTV Play Into Apple's Future
Apple's new wireless media hub, codenamed iTV, will be released in the Mar-06 quarter. While this product does not fit neatly into either the Mac or the iPod+iTunes sales segment, we believe this third category, the digital living room, bridges Apple's two main growth engines. The iTV lets users access iTunes content stored on a computer and view it on a television. Whereas the iPod gives portable access to the same content, the iTV brings the content into the digital living room. Therefore, the iTV provides further integration between the Mac and iPod sales segments, by adding a 3rd significant growth driver to the mix. With the addition of an iPhone in the next 6 months, Apple will add a 4th driver, as the company continues to add to the ways in which media content stored on a computer is accessible anywhere at any time.

What Is Apple's Strategy For The Holiday Shopping Season
We believe that Apple sells more of its lower ASP (average selling price) iPods during the holidays relative to the rest of the year. With the significant updates to both the Shuffle and the nano in September, it seems Apple is focusing on the flash-based iPods for the Dec-06 quarter. The simple fact is that shopping data suggests that gift-givers buy lower-ASP products for others than they do when buying products for themselves. We believe Apple recognizes this trend and is situating the iPod line accordingly for the holiday shopping season.

What Is The Status Of The Options Backdating Investigation
On October 4, 2006 Apple released the findings of the internal option grants investigation and found no misconduct by any current board members, including Steve Jobs. We believe Jobs will remain Apple's CEO, given he was aware of these favorable grant dates but was not aware of the accounting treatment and did not benefit from them. Apple has indicated that the investigation was conducted by 3 board members using independent counsel. On Oct. 27 Apple announced that the Nasdaq had granted its request for continued listing on the exchange, pending the timely submission of its delayed Jun-06 report.

Mac Related Questions:

Has The Relationship With Intel Been A Good One
Apple indicates that the company's relationship with Intel has been good for both sides. We believe the two companies are realizing synergies each did not anticipate and Apple is surprised with the level of innovation that Intel has exhibited. Moreover, with over 60 percent of all Macs sold in the Sep-06 quarter being portables, the ratio of performance to power consumption is important, and Intel chips address this issue.

What Are The Highest Priorities In Designing A Mac
In the Sep-06 quarter, over 60 percent of all Macs sold were portables, and even the most popular desktop models have space constraints (the iMac and the Mac mini). Therefore, high performance and low power consumption are top priorities. Apple has a competitive advantage in the portable space, because they design every aspect of the computer (not just hardware) and can maximize each element to run smoothly together.

Have Mac Sales Increased In The Enterprise Sector
Preliminary IDC data on worldwide PC shipments shows that Mac market share has grown from 2.5 percent in the Jun-06 quarter to 2.8 percent in Sep-06. While Apple indicates that the company is pleased with its growth in the PC market overall, we believe Apple is making slow gains in the Enterprise space. Apple does not provide forward-looking product roadmaps, which are important to Enterprise IT buyers and the company will not change its stance on this issue. In sum, Apple will continue its focus on the consumer, education, and creative professionals markets as they pursue market share gains.

Is The Upcoming Vista Launch A Threat Or An Opportunity
Regarding the pending release of Windows Vista in early CY07 [CY = calendar year], Apple's plan is to try to seize the opportunity to gain switchers as Windows users consider to upgrade to Vista. While Windows users contemplate upgrading software and/or hardware to run Vista, we believe Apple will continue market share gains via switchers. In the Sep-06 quarter, Apple retail stores sold 50 percent of all computers to people that are new to the Mac (inline with the previous two years) and we expect this number to increase during the Vista upgrade period. During that time (early CY07) , Apple will release its next generation of OSX Leopard, to compete with Vista, and we anticipate a new marketing strategy to draw attention away from Vista's release.

Will Vista Run On Bootcamp
We believe that Apple's BootCamp, which will be a central feature of OSX Leopard, will make it possible to install Windows Vista on a Mac. BootCamp currently enables the installation of Windows XP on a Mac, and while there will be challenges with Vista, Apple developers successfully dealt with similar challenges in building BootCamp for XP. Separately, we do not believe Bootcamp will offer a parallel Windows/Mac desktop.

How Favorable Is The Component Market Right Now
With the release of the MacBook Pro featuring Intel Core 2 Duo processors, Apple also significantly reduced the price of adding RAM to Macs. The new pricing scheme is more competitive with aftermarket RAM providers and is indicative of the favorable component market for RAM.

Questions On Apple's Retail Stores:

How Will The Addition of iTV Change Retail Stores
Apple plans to leverage the retail stores as launch pads for new products. With the addition of iTV in the Mar-07 quarter, Apple is readying its stores to launch, market, demo and sell the product. While the retail stores will use a few LCD TVs to demonstrate the features of the iTV, we believe that Apple will not sell 3rd party televisions, nor will the company develop Apple-branded TVs to sell in the retail stores. Overall, the iTV will not require a drastic reorganization of the retail stores, but they will serve as launch pads for Apple's new products in early CY07. Currently about 60 percent of the square footage at stores represents Macs and 40 percent iPods. The iTV will draw slightly from each, but over the long haul we believe Apple will continue the focus on Macs at the stores.

As The Retail Initiative Enters Its 5th Year, Is It Healthy
Apple has indicated that the retail initiative is profitable as they continue their plans to add 40 stores per year. Currently Apple has 165 stores. Overall the retail stores contribute nearly 20 percent of Apple's overall revenue and the Online store adds another 20 percent. And for Apple, these direct channels are higher-margin channels than the indirect channels. The company indicates that store traffic is high (with 10,614 visitors per store in the Sep-06 quarter), so the focus is on improving conversion. Currently, the average bill of each visitor (not each customer) was $60 in the same quarter.

Will Best Buy & Circuit City Sell Mac's
Apple currently has 40,000 indirect iPod distribution points, and 7,000 indirect Mac distribution points. Currently Best Buy (824 US stores by the end of November 2006) and Circuit City (624 US stores by the end of November 2006) do not sell Macs in-store, but are in pilot projects. Best Buy is in a pilot with 50 stores to sell Macs, with Circuit City in pilot at what we estimate to be less than 10 stores. Both Best Buy and Circuit City have stated they are "excited" about working with Apple to sell Macs. We believe by the end of 2007, a third of US based Best Buy and Circuit City stores will sell Macs. Mathematically, this would add 7 percent to the overall reach of the Mac retail (assuming 33 percent of Best Buy and Circuit city stores will sell Mac's). Conceptually, this will increase the retail reach of the Mac by more than 7 percent given Best Buy and Circuit City's store traffic is greater than the average Apple indirect retail outlet.

What Is The Key To Store Profitability
Apple's retail stores are unique because they utilize a model of face-to-face service for technology consumers. The company leverages this and monetizes it through the ProCare program, which is essentially a membership to the Apple store and all the resources that are available at the store. This includes "personal training" sessions, "fast track" access to the genius bar, and other computer or iPod help. The membership costs $99 per year and the company has indicated it has just under 180,000 members (totaling about $18m in revenue). While the company does not disclose attach rates, we estimate about 25 percent of people who buy a Mac in an Apple retail store will buy ProCare. If you assume that Apple will sell 200,000 Macs in retail stores in CY07, that is 50,000 members at $99 a year, or $4.9m in 80 percent plus margin revenue from store memberships. We believe this strategy helps the retail initiative to increase profits, add Apple Sales Consultants to help with ProCare and other support services, and ultimately sell more Apple products.

How Are Newer Stores Different Than Older Stores
At any given Apple store customers can receive face-to-face tech support at a Genius Bar, and some newer stores feature a creative help center called The Studio. Whereas older stores have about 8 feet of "bar" for customer support, newer stores (like the 5th Ave, NYC store) feature upwards of 45 feet of "bar." This prioritization of face-to-face support indicates that Apple has seen success with the Genius Bar strategy for offering a unique avenue for support.

Did The Intel Transition Impact Apple Retail Stores
Apple announced that the Mac line would switch to Intel chips in June 2005 and completed the transition by August 2006. During that time, the retail stores saw the traffic/store slow, but that same figure increased during the Sep-06 quarter. While Apple does not disclose historical store traffic metrics, the company indicates that it hosted 10,614 visitors per store in the Sep-06 quarter.

Have The Genius Bar Wait Times Decreased
Throughout CY05 and CY06 Apple stores struggled with long wait times at the Genius Bars and the cash wrap (lines at the register), resulting in customer dissatisfaction. Apple indicates that the average time spent in the store for support has decreased from around 30 minutes to under 20, and less than 10 minutes for an iPod-related support issue. At the cash wrap, the stores now feature an EasyPay method with significantly reduces time spent at the registers.

What Is The Ideal Location For An Apple Store
Our analysis of Apple's newest retail stores shows that the company targets high-traffic areas where people live, work and play. The plan for a new 21,350-square-foot store at 815 Boylston St. in Boston, MA achieves these three priorities with nearby residence complexes, office buildings, and tourism destinations near the store. The company states it will open a store only if it will be profitable in its first year.

Has The Apple Store 5th Ave. In NYC Been A Success
Apple's flagship store on 5th Ave. in New York City is the company's most productive store. The location is open 24 hours a day, and even between the hours of midnight and 6am the store offers all of its face-to-face support (Genius Bar, and creative support in The Studio).

PiperJaffray analyst Gene Munster maintains an "Outperform" rating on shares of Apple with a price target of $99 per share.
post #2 of 16
I wasn't asking any of those questions
post #3 of 16
An Apple Store is rumored to be coming to Greenville, SC. There are more than a million people in the Greater Greenville area, and the CompUSA is the top-sellling Apple reseller in the Southeast. The planned location is a new retail/residential center located in Greenville's busiest shopping district. 8)
post #4 of 16
Quote:
Originally Posted by AppleInsider

even between the hours of midnight and 6am the store offers all of its face-to-face support

And what kind of "face-to-face" support at 2am would that be?
post #5 of 16
Quote:
Originally Posted by AppleInsider

What Are The Highest Priorities In Designing A Mac
In the Sep-06 quarter, over 60 percent of all Macs sold were portables, and even the most popular desktop models have space constraints (the iMac and the Mac mini). Therefore, high performance and low power consumption are top priorities. Apple has a competitive advantage in the portable space, because they design every aspect of the computer (not just hardware) and can maximize each element to run smoothly together.


Oh, man. Here come the "If Apple made a 'pro-sumer' desktop, etc..." whiners. \
post #6 of 16
Quote:
Originally Posted by AppleInsider

Will Vista Run On Bootcamp
We believe that Apple's BootCamp, which will be a central feature of OSX Leopard, will make it possible to install Windows Vista on a Mac. BootCamp currently enables the installation of Windows XP on a Mac, and while there will be challenges with Vista, Apple developers successfully dealt with similar challenges in building BootCamp for XP. Separately, we do not believe Bootcamp will offer a parallel Windows/Mac desktop.

I would prefer support for Windows 2000 SP4 in Boot Camp instead of Vista support.

Windows 2000 can do most of the things WinXP can do, and it consumes less memory and doesn't have that much eye candy. It's my favorite flavor of Windows. (but don't worry, I run Tiger at my home computer)
post #7 of 16
//Apple's new wireless media hub, codenamed iTV, will be released in the Mar-06 quarter.//

well it aint in the apple store!
post #8 of 16
Quote:
Originally Posted by Shookster

I wasn't asking any of those questions

haha sorry that made me laugh for some reason. Anyway. lower priced expandable desktops a good idea. Any hint of it? Of course not.
post #9 of 16
Nice Article AI. Good insight.
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post #10 of 16
Quote:
Originally Posted by Wally

And what kind of "face-to-face" support at 2am would that be?

That made me laugh. Thank you.
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post #11 of 16
$99 per share? No way. At the forecasted 2007 EPS of roughly $2.70 and a cost of capital of 15% (Apple's beta is about 2.0), a quick-and-dirty, back-of-the-envelope calculation of intrinsic value would suggest that Apple will have to grow its earnings at about 12% to 12.5% per year, forever.

Apple is great and all that, but nothing grows at that rate forever. Period.

I still say: Sell at $80 (even that is stratospheric!).
post #12 of 16
Quote:
Originally Posted by anantksundaram

$99 per share? No way. At the forecasted 2007 EPS of roughly $2.70 and a cost of capital of 15% (Apple's beta is about 2.0), a quick-and-dirty, back-of-the-envelope calculation of intrinsic value would suggest that Apple will have to grow its earnings at about 12% to 12.5% per year, forever.

Apple is great and all that, but nothing grows at that rate forever. Period.

I still say: Sell at $80 (even that is stratospheric!).

Yes but they got 27%+ growth on both iPod and Mac markets presently. Then you have future markets to be factored in 2007 iPhone iTV, Leopard et al.
post #13 of 16
Quote:
Originally Posted by OfficerDigby

Yes but they got 27%+ growth on both iPod and Mac markets presently. Then you have future markets to be factored in 2007 iPhone iTV, Leopard et al.

A couple of reactions:

1) I said earnings, not revenue (which is what you seem to imply) -- Apple's earnings are growing at more like 17% to 18% currently, and not forecasted to grow at a much higher annual rate than that in the next few years.

2) Also, I said "forever." This is simple algebra: Even if Apple can grow its EPS at, say, 18% every year for the next 15 years (which would be remarkable), and then revert to a long run "normal" growth rate of say, 5% per year from then to forever (pretty generous), that still averages out to an across-the-board long run growth rate in earnings of about 7% per year.....

Do the math for 12% -- i.e., what does Apple have to achieve as EPS growth every year for the next 15 years to justify a 12% number implied by the PJ analyst's forecast of $99.

post #14 of 16
Quote:
Originally Posted by anantksundaram

A couple of reactions:

1) I said earnings, not revenue (which is what you seem to imply) -- Apple's earnings are growing at more like 17% to 18% currently, and not forecasted to grow at a much higher annual rate than that in the next few years.

2) Also, I said "forever." This is simple algebra: Even if Apple can grow its EPS at, say, 18% every year for the next 15 years (which would be remarkable), and then revert to a long run "normal" growth rate of say, 5% per year from then to forever (pretty generous), that still averages out to an across-the-board long run growth rate in earnings of about 7% per year.....

Do the math for 12% -- i.e., what does Apple have to achieve as EPS growth every year for the next 15 years to justify a 12% number implied by the PJ analyst's forecast of $99.


Hey No!. Profit is up 27%. $546 million, or 62 cents a share, up from $430 million, or 50 cents, year on year?
http://tinyurl.com/yz8zbo

OK guidance for next quarter is $0.77 up from $0.65 is 18% but they always give conservative guidance. Also the $0.65 for Q1 2006 was up 50% over the previous year..

I appreciate what your saying they are certainly not cheap shares! But for e.g. the potenial of an iPhone with only 1% of the Market share gives and estimated $2 billion added on to the revenue so..
post #15 of 16
Quote:
Originally Posted by anantksundaram

A couple of reactions:

1) I said earnings, not revenue (which is what you seem to imply) -- Apple's earnings are growing at more like 17% to 18% currently, and not forecasted to grow at a much higher annual rate than that in the next few years.

2) Also, I said "forever." This is simple algebra: Even if Apple can grow its EPS at, say, 18% every year for the next 15 years (which would be remarkable), and then revert to a long run "normal" growth rate of say, 5% per year from then to forever (pretty generous), that still averages out to an across-the-board long run growth rate in earnings of about 7% per year.....

Do the math for 12% -- i.e., what does Apple have to achieve as EPS growth every year for the next 15 years to justify a 12% number implied by the PJ analyst's forecast of $99.


A couple of reactions:

1) Using your second set of assumptions (18% growth for the next 15 years and then reversion to 5% growth thereafter), AAPL would be valued at $78.36 per share. That said, you get roughly the same value if we assume that earnings will grow at 28% in fiscal 2008, 2009, 2010, and 2011, and then 12.5% from 2012-2021, and then 5% thereafter. You get the same answer again if you assume earnings will grow around 20% in fiscal 2008, 2009, 2010, and 2011, and then 12.5% from 2012-2021, and then 9% thereafter.

2) My point is, Apple seems to be in a period of "supernormal" growth, when its growth exceeds its cost of capital. Usually, the growth rate would "revert to the mean," meaning that a company can't grow faster than its cost of capital for long, because of competition, etc. However, in this case, I think Apple's in a better position than most companies for 2 reasons. First, Apple has a good patent portfolio, which protects it from competitors (in particular, I'm thinking of the click-wheel patent, one of the most distinguishing features of the iPod). Second, if we assume that a great deal of growth will come from Macs (which I believe it will), Apple will be able to sustain its high growth rate because it's the only company that offers Macs. (True, the Mac's competitor is the Windows PC, but my point is that this isn't Dell: there isn't a pure substitute for the Mac like there is for a generic PC.)

Quote:
Originally Posted by anantksundaram

...but nothing grows at that rate forever. Period.

3) I agree with you: but the question isn't at what growth rate will Apple grow forever but rather for how long it can grow at an above average rate. As you can see from my point in number 2, I think the answer is "pretty long," based not only on Apple's iPod/iPhone/iTV business (not including other media-related offerings that Apple could branch out into), but also Apple's Mac business, which I foresee booming over the next 5 years at least (pushing Apple's growth above its cost of capital), and even into the following years. In short: I don't think you're looking into your crystal ball enough to think of what areas Apple could potentially branch into.

4) Neither your estimates nor mine include the hoard of cash Apple has, which theoreticaly would boost value per share even over the $78.36 I calculated. So, perhaps PiperJaffray's $99 target is fairly close to the mark.

5) Just for my own edification, I took a look at MSFT's net income growth rate since 1985, and found that for FY88-FY99, growth rates averaged 52%, and then around 10% thereafter (FY00-FY06 were pretty choppy). So maybe Apple growing at 20% over the next five years, then at around 14-15%, and then at 7.5% isn't that unrealistic.
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post #16 of 16
OK.... this will be my last post on this issue!

1) To OfficerDigby: I am using annual numbers. Normally, in order to do any intrinsic value analysis, that is what one would use (not quarterly, I am afraid). For a publicly available source on past and forecasted annual EPS performance, see, e.g.,

http://finance.yahoo.com/q/ae?s=AAPL

2) To Mr. Dirk: (a) Yes, Apple has about $10 billion in cash, but you're double-counting its effect: The EPS forecast of $2.70 for FY07 that I used includes the effect of non-operating income from cash; if anything, unless Apple finds a good use for it soon, a "cash drag" will start to affect its growth and performance; (b) Of course one can generate many plausible growth scenarios that lead to the share price of $80; but I still stand by my question on what these growth scenarios would have to look like in order to justify a perpetual EPS growth rate of 12% per year forever (which is what is required for $99); (c) If you are forecasting the $99 price betting on Apple becoming another MSFT, fine, that it certainly a viewpoint; that is not my view! (We certainly have a basis for a trade here!).

Somehow, this is starting to sound a bit like 1999 and dotcom all over again.....
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