Reconstructing Apple?s 2008 earnings to reflect iPhone sales
Now that Apple has reported its earnings for the full 2008 fiscal year, it’s important for investors to focus on how Apple would have performed if it fully recognized the revenue and earnings from its sales of the iPhone.
The Apple earnings confusion has largely been the result of Apple’s relatively (un)complicated subscription method of accounting for sales of the iPhone. Most analysts seem to be either thoroughly lazy, or genuinely perplexed by this fairly simple concept; and so I thought I might make their jobs a little easier by reconstructing Apple’s 2008 earnings results to reflect what Apple actually earned in 2008
While the broader market is down well over 40% this year, Apple’s stock has been significantly more deflated than others in the tech sector due in large part to Apple’s decision to give iPhone customers free “once in a blue moon” software updates rather than having them pay a $10.00 nominal fee. Who would have thought that a simple decision to waive a small $10 fee would cause so much destruction to shareholder value and billions in losses in market capitalization?
The table below lays out what almost no analyst has dared to show their clients regarding the reality of Apple’s earnings results in 2008. The method used for determining adjusted earnings is relatively simple and straightforward, and could be found here for those who are interested in the inane details. The table below lays out the adjusted earnings results for each of Apple’s fiscal quarters in 2008, which includes full revenue and earning recognition for sales of the iPhone and Apple TV.
Table 2 (below) lays out just how much of a difference the subscription method of accounting had on Apple’s financial results by comparing Non-GAAP earnings (which includes full recognition of revenue from sales of the iPhone) with GAAP-based earnings results which employs the deferred revenue mechanism of subscription accounting). There are a couple of key points that investors should take away from analyzing this comparison. First, that Apple didn’t record nearly 14.6% of the revenue it actually received from sales of the iPhone throughout 2008. In fact, for each quarter in 2008, Apple reported an average of $1.391 billion less in revenue than it should have reported but for the obtuse and unrealistic requirements of the Generally Accepted (Asinine) Accounting Principles (GAAP).
Secondly, one should also notice how Apple reported $2.12 or 28.4% less in EPS than what it actually earned in the “real world.” This is particularly troubling because Apple’s trialing P/E reflects a much higher multiple than what reality dictates. On a GAAP “fantasy” basis, Apple is trading at 17.19 times 2008 GAAP-based earnings. Yet, under adjusted-earnings, which contemplates actual “reality,” Apple is currently trading 12.31 times last year’s earnings. GAAP accounting principles actually makes Apple’s stock price appear significantly less attractive from a valuation perspective than it actually is.
Thirdly, one should notice how Apple reported 30.1% less in Operating Income than what it actually earned. This means that Apple is reporting only two-thirds (2/3) of the actual results from its primary operating activities.
Operating Income is supposed to be a reflection of the health of Apple’s core business. OI&E, the tax rate, and diluted shares are malleable from one quarter to the next. But operating income tells the investor how Apple’s business is really doing. EPS is for show, while operating income is for the serious analyst. I have to question an accounting measure that requires a company to simply “leave out” 30% of its primary business from earnings reports because that company decides to give its customers a “once in a blue moon” free $10.00 software update. I thought Sarbanes-Oxley and the accounting measures imposed after Enron were supposed to makes companies more transparent, not less!
Table 3 below compares 2008 adjusted earnings with 2007 adjusted earnings, which is useful in analyzing the various trends in Apple’s growth rate. Since Apple started selling the iPhone in the final days of fiscal Q3 2007, adjustments to Q3 and Q4 of 2007 were necessary to make the data comparable from one period to the next. It would be silly to compare 2008 Adjusted Earnings with 2007 GAAP based earnings. The methods used in making the adjustments from GAAP to Non-GAAP earnings can be found here.
Right away, one ought to notice the staggering growth rate in both revenue and earnings that Apple displayed in 2008. Apple’s real revenue grew 54.5% from $24.637 billion in FYE 2007 to $38.041 billion in FYE 2008 – a full $13.4 billion growth in revenues. Even more impressive is Apple’s 81.2% growth rate in adjusted net income. For a company that is trading at 12 times 2008 earnings, it doesn’t take a genius to conclude that Apple is severely undervalued. Especially since Apple currently trades at about 3.37 times its cash position – which is objectively and significantly lower than every other large cap tech company.
GOOG trades at 7.18 times its cash position, RIMM at 15.51 times cash, AMZN at 9.15 times cash, MSFT at 9.13 times cash, CSCO at 3.62 times cash, IBM at 10.96 times cash, INTC at 6.54 times cash, and HPQ at 5.15 times cash. What is more, only GOOG, AAPL and MSFT have no debt of the companies mentioned above. Apple has the largest net cash position than any of those companies and Apple has more net cash than RIMM, GOOG, AMZN and IBM combined.
I will take up the issue of valuation later on this week where I’ll give a comprehensive analysis of several large cap tech companies. Preliminary research indicates that Apple is extensively more undervalued than every other large cap tech company at current levels and this is due almost exclusively to the subscription method of accounting.
In order for Apple to be trading at the same current valuation as GOOG, RIMM, AMZN, MSFT, CSCO and IBM, Apple would have to be trading at $206.25 – and that’s after this current correction in the market place. The fact of the matter is, Wall Street never valued Apple properly prior to the beginning of this bear market. Apple could have been trading at $300 before this recent downturn and even after this excessive sell-off, Apple should be trading at $158.92 at current S&P levels. I leave it to my readers to make their inferences about where Apple might be headed in 2009 and 2010. Much more to follow.
Disclosure: Long Apple. The information contained in this blog is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.
The Apple earnings confusion has largely been the result of Apple’s relatively (un)complicated subscription method of accounting for sales of the iPhone. Most analysts seem to be either thoroughly lazy, or genuinely perplexed by this fairly simple concept; and so I thought I might make their jobs a little easier by reconstructing Apple’s 2008 earnings results to reflect what Apple actually earned in 2008
While the broader market is down well over 40% this year, Apple’s stock has been significantly more deflated than others in the tech sector due in large part to Apple’s decision to give iPhone customers free “once in a blue moon” software updates rather than having them pay a $10.00 nominal fee. Who would have thought that a simple decision to waive a small $10 fee would cause so much destruction to shareholder value and billions in losses in market capitalization?
The table below lays out what almost no analyst has dared to show their clients regarding the reality of Apple’s earnings results in 2008. The method used for determining adjusted earnings is relatively simple and straightforward, and could be found here for those who are interested in the inane details. The table below lays out the adjusted earnings results for each of Apple’s fiscal quarters in 2008, which includes full revenue and earning recognition for sales of the iPhone and Apple TV.
Table 2 (below) lays out just how much of a difference the subscription method of accounting had on Apple’s financial results by comparing Non-GAAP earnings (which includes full recognition of revenue from sales of the iPhone) with GAAP-based earnings results which employs the deferred revenue mechanism of subscription accounting). There are a couple of key points that investors should take away from analyzing this comparison. First, that Apple didn’t record nearly 14.6% of the revenue it actually received from sales of the iPhone throughout 2008. In fact, for each quarter in 2008, Apple reported an average of $1.391 billion less in revenue than it should have reported but for the obtuse and unrealistic requirements of the Generally Accepted (Asinine) Accounting Principles (GAAP).
Secondly, one should also notice how Apple reported $2.12 or 28.4% less in EPS than what it actually earned in the “real world.” This is particularly troubling because Apple’s trialing P/E reflects a much higher multiple than what reality dictates. On a GAAP “fantasy” basis, Apple is trading at 17.19 times 2008 GAAP-based earnings. Yet, under adjusted-earnings, which contemplates actual “reality,” Apple is currently trading 12.31 times last year’s earnings. GAAP accounting principles actually makes Apple’s stock price appear significantly less attractive from a valuation perspective than it actually is.
Thirdly, one should notice how Apple reported 30.1% less in Operating Income than what it actually earned. This means that Apple is reporting only two-thirds (2/3) of the actual results from its primary operating activities.
Operating Income is supposed to be a reflection of the health of Apple’s core business. OI&E, the tax rate, and diluted shares are malleable from one quarter to the next. But operating income tells the investor how Apple’s business is really doing. EPS is for show, while operating income is for the serious analyst. I have to question an accounting measure that requires a company to simply “leave out” 30% of its primary business from earnings reports because that company decides to give its customers a “once in a blue moon” free $10.00 software update. I thought Sarbanes-Oxley and the accounting measures imposed after Enron were supposed to makes companies more transparent, not less!
Table 3 below compares 2008 adjusted earnings with 2007 adjusted earnings, which is useful in analyzing the various trends in Apple’s growth rate. Since Apple started selling the iPhone in the final days of fiscal Q3 2007, adjustments to Q3 and Q4 of 2007 were necessary to make the data comparable from one period to the next. It would be silly to compare 2008 Adjusted Earnings with 2007 GAAP based earnings. The methods used in making the adjustments from GAAP to Non-GAAP earnings can be found here.
Right away, one ought to notice the staggering growth rate in both revenue and earnings that Apple displayed in 2008. Apple’s real revenue grew 54.5% from $24.637 billion in FYE 2007 to $38.041 billion in FYE 2008 – a full $13.4 billion growth in revenues. Even more impressive is Apple’s 81.2% growth rate in adjusted net income. For a company that is trading at 12 times 2008 earnings, it doesn’t take a genius to conclude that Apple is severely undervalued. Especially since Apple currently trades at about 3.37 times its cash position – which is objectively and significantly lower than every other large cap tech company.
GOOG trades at 7.18 times its cash position, RIMM at 15.51 times cash, AMZN at 9.15 times cash, MSFT at 9.13 times cash, CSCO at 3.62 times cash, IBM at 10.96 times cash, INTC at 6.54 times cash, and HPQ at 5.15 times cash. What is more, only GOOG, AAPL and MSFT have no debt of the companies mentioned above. Apple has the largest net cash position than any of those companies and Apple has more net cash than RIMM, GOOG, AMZN and IBM combined.
I will take up the issue of valuation later on this week where I’ll give a comprehensive analysis of several large cap tech companies. Preliminary research indicates that Apple is extensively more undervalued than every other large cap tech company at current levels and this is due almost exclusively to the subscription method of accounting.
In order for Apple to be trading at the same current valuation as GOOG, RIMM, AMZN, MSFT, CSCO and IBM, Apple would have to be trading at $206.25 – and that’s after this current correction in the market place. The fact of the matter is, Wall Street never valued Apple properly prior to the beginning of this bear market. Apple could have been trading at $300 before this recent downturn and even after this excessive sell-off, Apple should be trading at $158.92 at current S&P levels. I leave it to my readers to make their inferences about where Apple might be headed in 2009 and 2010. Much more to follow.
Disclosure: Long Apple. The information contained in this blog is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.
Comments
Apple's cash position and it's actual earnings/income are key to a rational analysis of true value.
GAAP rules are not transparent.
Apple has never been the darling of Wall Street, but this is just ridiculous.
ANALists need to wake up and do their jobs right.
I just hope someone big and bad doesn't try to do a hostile takeover after spreading more false rumors around Christmas... I can see it now: "Apple is hit hard by lack of consumer spending while Jobs is in the hospital with shin splints!!!" when the reverse is true (he is fairly active, so no shin splints
I bought at $65, then sold at $185 last year. Then bought back again at $112.
Studiomusic rates AAPL as a buy with a 12 month price target of $240.
I just hope someone big and bad doesn't try to do a hostile takeover after spreading more false rumors around Christmas....
If that happens I rekon we all pile down as a mob and give em a knuckle sandwich for xmas.
Excellent article by the way. The lone sane voice of the web.
The whole thing reads like the rantings of someone who bet too much on Apple and got hit hard by the market downturn. This should not be posted as an article on AI.
I agree, lets be consistent and keep the web entirely fictitious.
by how its technology is being adopted. The evidence is very clear, when you look at real sales that the
State of the Mac is very very strong and getting stronger everyday. The more people experience Apple products, the more likely they will get use to its quality, ease and enjoyability of its use. More and more people are only buying Apple products. This is different from HP, Dell, Toshiba etc. where brand loyalty
is a fraction of Apple's. Steve may be right that people may delay new purchases, but soon enough they'll
definately need a new computer and they will remain loyal to the Apple brand...this may make earnings
stronger in 6 months or a year when they can delay no longer...everyone needs a computer!
As far as a stock goes, I have never been so frustrated when I see the stock drop despite Apple exceeding all estimates, even estimates made when the economy was much stronger. Clearly its cash position, deferred income, brand loyalty, and even earnings it has reported is not being taken into consideration and liquidations are being done in an end-of- the- world panic situation or because funds are liquidating to meet redemptions, not anything based on the long term earnings of Apple, thats for sure.
I agree, lets be consistent and keep the web entirely fictitious.
LoL since when it is real? hehehe
AI breakup is awesome, 3rd great analysis!
I agree, lets be consistent and keep the web entirely fictitious.
Since thats always been possible
_________________
The whole thing reads like the rantings of someone who bet too much on Apple and got hit hard by the market downturn. This should not be posted as an article on AI.
What a nasty thing to say about a well written, acurate and factual story.
This should be posted here.
I have Apple earning $8.50 in non-Gaap in F09 which puts them at about 8.2 trailing P/E after you strip out $25 a share in cash. GAAP earnings will eventually "catch up" to adjusted numbers roughly 2yrs after iPhone unit sales have stablized which I see happening in F10. Once the market does find a bottom, I fully expect a high-beta stock like AAPL to see significant multiple expansion.
Another way to value the stock is on a multiple of free cash flow (although that's not what the street is looking at). I just get to GAAP earnings after cash taxes then adjust for working capital that includes the huge increase in net deferred earnings.
I'm just curious, but how did you arrive at non-GAAP financials for quarters 1-3? Did you just make assumptions as to the GM's of the iPhone 2G and the actual ramp-up of unit sales through each quarter? I'm waiting for the K to be filed to get a bit more clarity and see how far off my assumptions are.
Private message me if you'd be interested in swapping assumptions for modeling purposes. I have a fairly complex iPhone waterfall that gets flexed on multiple cases (worst - bull).
[I'm long Apple]
I happen to be long on AAPL, and incredibly bullish on their prospects, and as your numbers reveal, they did astonishingly well this past quarter.
Let's face it; the market gravitates between fear and greed, and right now we are on the sheer terror side of fear so until there is some conviction about anything, my guess is that Apple's grand story will be neutered by the market.
It sucks, because Apple is without peer at this point in the market - who else has three high margin, differentiated mult-$B product lines? - but it will even out in the long run.
For what its worth, here was my analysis of the call:
Ringing Up Apple?s Earnings Call
http://thenetworkgarden.com/weblog/2...g-up-appl.html
Check it out if interested.
Mark
I agree, lets be consistent and keep the web entirely fictitious.
Best reply of the month winner. October 2008.
Cash should be spent to grow the company. In this case, Wall Street feels that Apple should be spending more on R&D, software development, strategic acquisitions, etc.
The suggestion that Certified Financial Analysts don't understand Generally Accepted Accounting Practices and therefore undervalue AAPL is absurd.
Wall Street feels that Apple should be spending more on R&D, software development, strategic acquisitions, etc.
The suggestion that Certified Financial Analysts don't understand Generally Accepted Accounting Practices and therefore undervalue AAPL is absurd.
So how would you account for the fact that 'certified' analysts often have wildly varying advice? This is not art where there can be more than one correct analysis. Unless they all live on separate parallel quantum universes SOME or ALL are wrong. Any person capable of processing logic should be able to comprehend that these humans are clearly quite fallible.
They are often exceptionally off the mark. These same 'professionals' were advising to sell AAPL suggesting Apple was a "dead company" a decade ago. Dead... Worthless... thats what they said! Back then like now, there was handful of people that hung out on forums such as this, shunned the 'professional' opinion, and actually had a clue
(and many made a tidy profit
How bloody wrong do they have to be before people wake up, smell the coffee, and realize they are better off rolling a dice.
It was also so called 'certified' professionals that have lead us into the current world recession.
Back on topic, Apple is NOT Microsoft, the model does not fit. I shall repeat..
THE MODEL DOES NOT FIT!
Why is this so hard to grasp. Apple is lean n mean, and its hard to imagine how the purchase of random company X 'just cos wall street said so' would do anything other than be a hinderance to apples current exceptional focus.
they don't know jack. believe!
So how would you account for the fact that 'certified' analysts often have wildly varying advice? This is not art where there can be more than one correct analysis. Unless they all live on separate parallel quantum universes some or all are wrong.
They are often exceptionally off the mark. These same 'professionals' were advising to sell AAPL suggesting Apple was a "dead company" a decade ago. Dead... Worthless... thats what they said! Back then like now, there was handful of people that hung out on forums such as this, shunned the 'professional' opinion, and actually had a clue
Of course the analysts are often wrong. They are human. However, the suggestion that the reason they are wrong is that they don't understand accounting fundamentals is absurd. I used to work on Wall Street. The analysts often don't understand the technology, sometimes don't understand the market sentiment, but they absolutely understand the accounting.
This article is absurd in exactly the same way as if I were to say that the reason a professional poker player lost is because he didn't understand how the cards are scored. There are many reasons why a professional poker player might lose, but not understanding how the cards are scored is not one of them. Similarly, there are many reasons why a Certified Financial Analyst (much, much tougher exam than CPA, BTW) might mis-predict the future performance of a company, but not understanding accounting is not one of those reasons.
Of course the analysts are often wrong. They are human. However, the suggestion that the reason they are wrong is that they don't understand accounting fundamentals is absurd. I used to work on Wall Street. The analysts often don't understand the technology, sometimes don't understand the market sentiment, but they absolutely understand the accounting.
This article is absurd in exactly the same way as if I were to say that the reason a professional poker player lost is because he didn't understand how the cards are scored. There are many reasons why a professional poker player might lose, but not understanding how the cards are scored is not one of them. Similarly, there are many reasons why a Certified Financial Analyst (much, much tougher exam than CPA, BTW) might mis-predict the future performance of a company, but not understanding accounting is not one of those reasons.
Fair enough, I took what you said to mean they know their stuff both in accounting AND the intricacies of the technologies themselves.
You would have thought that decent skills in the latter would come in handy ! Being tech analysts and all...
I presumed it was an equal if not more important requirement of the job. Least one would hope
This article is absurd in exactly the same way as if I were to say that the reason a professional poker player lost is because he didn't understand how the cards are scored. There are many reasons why a professional poker player might lose, but not understanding how the cards are scored is not one of them. Similarly, there are many reasons why a Certified Financial Analyst (much, much tougher exam than CPA, BTW) might mis-predict the future performance of a company, but not understanding accounting is not one of those reasons.
Well, if your analogy is apt, that would be reason enough to ignore CFAs anyway.
That is, if financial markets are as unpredictable as poker hands, nobody should
sell their pretense of expertise in making predictions.
Fair enough, I took what you said to mean they know their stuff both in accounting AND the intricacies of the technologies themselves.
You would have thought that decent skills in the latter would come in handy ! Being tech analysts and all...
I presumed it was an equal if not more important requirement of the job. Least one would hope
I was surprised by how shockingly little many of the analysts understood about the technologies. I think the reason is that, historically, it was never a needed part of the job until about the 1980s. Corporate culture changes very slowly -- if ever. Also, it is more difficult to test or certify and the analysts' bosses don't understand the technology either.
So how would you account for the fact that 'certified' analysts often have wildly varying advice? This is not art where there can be more than one correct analysis.
Yeah... it's predicting the future, not art. I don't see how anyone could disagree on the future.
DUH!
Well, if your analogy is apt, that would be reason enough to ignore CFAs anyway.
That is, if financial markets are as unpredictable as poker hands, nobody should
sell their pretense of expertise in making predictions.
Of course. Which makes me wonder why so many people here fail to ignore them. Instead the bitch and moan, as if the analysts have any control over what happens to the stock. It's a straw man. The immature investor blames analysts, the mature investor understands that the market moves independent of analysts except in the very short term.