Does Apple Need to Be Cheap?

When Fast Company writer Adam Penenberg this week wrote that Apple (Nasdaq: AAPL  ) is as vulnerable as it has ever been, he compared CEO Steve Jobs to a hot designer headed for a cold streak. But is he really?

I don't think so.

Yet we can't forget Penenberg's other argument. He says that Apple's stock, whose trailing P/E ranks just below Google's (Nasdaq: GOOG  ) but well above Microsoft's (Nasdaq: MSFT  ) , is vastly overvalued. Surely he's right about that.

Apple couldn't possibly deserve to join Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) , Exxon Mobil (NYSE: XOM  ) , and China Mobile (NYSE: CHL  ) in the elite club of global firms worth at least $200 billion in market value, could it? Could it?!?

Sure it could. Here's why:

  1. There are now 18 firms worth $200 billion or more, up from 13 in July -- even though, in that time, Mr. Market has been as jittery as a Chihuahua in a freezer.
  2. Apple's growth trajectory no longer depends purely on innovation.

All hail retail
Seriously. Allow me to quote from page 46 of Apple's annual 10-K filing, released just two weeks ago:

The Retail segment's net sales increased by 27% to $4.1 billion during 2007 compared to 2006. Retail segment Mac unit sales increased 56% during 2007 as compared to 2006 ... The current year increase in Retail segment net sales was primarily due to stronger sales of Mac portable products, iMacs, accessories, and services. The increase was partially offset primarily by lower net sales of iPods and other music related products ... (Emphasis added.)

Higher sales of Macs. Lower sales of iPods. Huge overall gains in retail revenue. And this in the year that the iPhone became a blockbuster.

Yet no one should be surprised. Retail has long played a consistent role in Apple's growth:

Fiscal Year

Total Revenue*

Retail Revenue*

Retail As a % of Overall Revenue

2007

$24.0

$4.1

17.1%

2006

$19.3

$3.3

17.1%

2005

$13.9

$2.4

17.2%

2004

$8.3

$1.2

14.5%

2003

$6.2

$0.6

10.0%

Source: SEC filings. *Numbers in billions.

There's your answer for why Apple has improved its global market share in personal computers from 2% to today's 8%. With retail stores, customers can (and often do) play with a Mac before they buy.

Cheap, no. But reasonable?
But what if core sales slow? What if retail had to pick up more of the slack, to, say, 20% of sales by fiscal 2011? Let's do the math.

Apple had 65 retail stores at the end of its fiscal 2003, and 197 and the end of its fiscal 2007. That's 32% annualized growth. But Apple managed just 19% growth in its store count this past year. Assuming Apple continues expanding at that slower pace, it should have 395 stores by the end of fiscal 2011.

Translating that into a projected revenue figure shouldn't be difficult. We know from Apple's filings that each store took in $20.8 million in 2007. We also know that Apple has improved its per-store revenue each year. But let's remain conservative, assuming that the company's 2011 network of 395 stores will still be producing just $20.8 million each. That's still $8.2 billion in retail revenue, which represents 20% of $41.1 billion.

Still with me? With retail accounting for 20% of sales, we can assume that Apple will book $41.1 billion in revenue in four years.

But I consider that a conservative estimate. It's more likely, I think, that non-retail growth will persist as it has, and that retail will remain responsible for just 17% of sales. In that scenario, the Mac's daddy could produce $48.4 billion in 2011 revenue. If current multiples hold, that would be worth between $140 billion and $306 billion in enterprise value (EV). Apple currently sells for $146 billion in EV.

Certainly, a lot has to go right in order for Apple shareholders to keep realizing market-thumping returns. But Penenberg's Chicken Little scenario doesn't make sense to me. Apple, after all, is the only company in the history of business to introduce a product so radical (the iPhone) that distributors such as T-Mobile and Vodafone would go to court over the right to carry it.

So if you'll permit me, I'd like to suggest something crazy. Perhaps the sky isn't falling, Mr. Penenberg. Maybe Apple is valued exactly as it should be.

Even we Fools, who enjoy more than a few chuckles at the expense of the white-shoe crowd gathered at Wall and Broad in lower Manhattan, have to admit that the pros often get it right when it comes to big stocks. With Apple, they own more than two-thirds of the shares outstanding.

How about we give them, and Steve Jobs, the benefit of the doubt?


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