More Pigs Over Cupertino

Signs of the real apocalypse are supposed to come in bunches. Accordingly, you can color me a little worried this morning. Just days after Microsoft (Nasdaq: MSFT  ) cuddled up with the Linux penguin, Apple (Nasdaq: AAPL  ) announced that it would allow users of its newest systems to run both Windows and Mac OS X. Hide the children, folks. Judgment Day is upon us, and pigs are doing loop-de-loops over Cupertino.

Or maybe not. Microsoft and Apple may make for strange bedfellows in the history of personal computing, but more recent developments, including a contest in which two hackers made Windows XP work on an Intel (Nasdaq: INTC  ) Mac, suggest that this cataclysmic shift was all but inevitable. So let's move on and ask the question that first crossed my mind when Boot Camp was announced: How do we value Apple's stock now?

"The first effective strike against Dell"
To answer, we'll need to dig into Apple's strategy. I've got my own opinions on that, but I'll first give the floor to an old friend of mine, Rich Levin, a former InformationWeek editor and host of a national radio show covering tech topics. We've debated this and that about the Mac for what seems like just short of forever. This time, however, I think he's spot-on:

"It's the first EFFECTIVE strike at Dell. It's also a strike at Microsoft, and uses its own OS against them. Andit's a dual-edged 'Win' [sic] for Microsoft ... Every Windows user will consider a Mac if Apple prices them competitively, and continues to produce computers that have style, superior engineering, and better quality overall in a world of commodity tin-box PCs ... Flip side: Apple's strike at Dell and Microsoft will not be maximally effective unless users don't encounter limitations. They have to embrace Windows hardware, games, etc."

I couldn't agree more. (Another sign of the apocalypse?)

What about Sony?
There's just one problem: Focusing the lens on Dell (Nasdaq: DELL  ) ignores the biggest piece of Apple's business, the iPod. (It was worth $1.2 billion in the first quarter, compared to $1 billion for desktops and $600 million for portables.)

Remember: There's a legion of pundits out there who believe, as I do, that the ultimate aim of the Mac maker is to run your living room. Isn't it possible, then, that Boot Camp is nothing more than an attempt to keep the Mac relevant in an increasingly Windows world?

Yes, but Apple's courtship of Windows users isn't new. Ever since October 2003, when Apple first released the iTunes Music Store for Windows, Apple has been on a mission to woo PC loyalists. And that makes sense. If CEO Steve Jobs really wants a spot on the couch, he's got to have a platform that, at the very least, offers the most and best video games. That's not the Mac today. It's Windows. (After the Xbox, Playstation, and the like, of course.)

Think about that for a second, and then think about this: Every PC maker -- Dell especially -- wants to be your coach in the Couch Potato Games. To date, they've had two advantages over Apple: price and Windows. The first was eroded substantially when the Mac mini debuted with PC-like pricing. The second died with the introduction of Boot Camp. That leaves design and brand appeal as differentiators. Do you really believe Apple can't win that battle? (If not, I refer you to BusinessWeek and its annual design awards. Please look up how many times Apple has taken away honors.)

So if Dell is the target...
Here's the rub: For Apple, it all comes down to the number of boxes (and iPods) it can sell. That makes it a hardware company, and the stock should be valued accordingly. I'd say the best way to do so is to compare Apple today to Dell in 1998:

Apple (TTM)

Dell (1998)

Revenue

$16,190

$18,243

EPS

$1.85

$0.53

Operating margin

12.4%

11.8%

Net margin

9.9%

8%

Return on equity

22.7%

80.8%

Return on capital

17.7%

61.7%

*Numbers in millions except for per-share amounts
**Apple and Dell data provided by Capital IQ.


Over the ensuing five years, Dell managed to grow earnings by an average of 12.6% annually. Current estimates call for Apple to grow earnings by 22% out to fiscal 2011. I can't say that's entirely unreasonable. After all, with a dual-boot machine, Apple could double its 3.5% global share of annual PC sales. And the company remains the heavy in the hypergrowth mobile-entertainment market. If you accept that logic, here's what happens to Apple's per-share earnings over the next five years:

2006 (est.)

2007

2008

2009

2010

2011

$2.12

$2.59

$3.15

$3.85

$4.69

$5.73



Next we have to select a multiple to 2011 earnings. Value Line may help here. It says that, in 2003, Dell's P/E was roughly 80% higher than that of the overall market. If it seems ludicrous to use a similar figure for Apple, consider that, in 1998, Dell's average P/E was 158% higher than that of the overall market. Apple's trailing-12-month P/E of 36.25 is roughly 107% higher than that of the S&P 500, according to Capital IQ.

That's pretty close. Besides, even if the Mac maker doesn't deserve to trade for 80% more than the market average, a 60% premium seems fair. Do the math (15 x 1.6) and you get a 2011 multiple of 24 times earnings. That puts the stock at more than $137 a share, or at least a double from yesterday's close.

Tell me I'm wrong
Nice, right? Indeed. Just bear in mind that this valuation has several flaws. For one, Apple may already be richly valued. Second, Apple may not convince a substantial number of Windows users to buy Macs. Third, iPod and iTunes may not remain as dominant as they have been. Finally, there remain distinct differences between Apple and Dell, which could corrupt my assumptions.

For example, Dell is strictly a hardware company, dependent on a hyperefficient supply chain. Apple, on the other hand, is a systems company that depends on software. Apple has long been known as a premium supplier. Dell? Not so much. Yet in spite of these obvious differences, Dell and Apple have come to resemble each other much more than in years past. For example, Apple is now a price- and brand-conscious supplier whose goal is to move volume (witness colossal iPod sales). To me, that sounds an awful lot like Dell in 1998, especially when you compare that year's hypergrowth PC market to the equally hot market emerging in mobile media.

Bottom line: Apple may end up as the next Gateway (NYSE: GTW  ) . Or it may be the next Dell. Personally, I think the latter is much more likely. Think I'm wrong? Tell me. I'll publish the best responses in a follow-up one week from today.

Both Dell and Microsoft are Motley Fool Inside Value selections. Get anall-access passto Inside Value to find out which other stocks are helping chief advisor Philip Durell beat the market by more than 4%. You'll also receive instructive lessons on valuation and company analysis. Try Inside Value free for 30 days.

Fool contributorTim Beyerswonders what it would be like to spot a fleet of pigs flying over Cupertino. He didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what is in Tim's portfolio by checking his Foolprofile. Dell is also a Motley Fool Stock Advisor pick. The Motley Fool has an ironcladdisclosure policy.


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