At The Motley Fool investing conference last week, a panel of Fool advisors voted unanimously that Apple (Nasdaq: AAPL) would beat the market over the next five years. After all, there is a compelling case to be made for that to happen, even though genius Steve Jobs has stepped down as Apple CEO. Not only is the company sitting on two blockbuster and still fast-growing products -- the iPhone and iPad -- but it also has $75 billion it can use to develop another blockbuster product, make a game-changing acquisition, or both!
Given those attributes, paying 10 times EBITDA for one of the world's largest and fastest-growing technology companies seems like a bargain. Heck, assume that Apple can continue retaining 100% of earnings and earning a 40% on equity, as it has over the past 12 months, and the math -- demanding a 10% return -- says it's worth approximately $900 per share.
The problem with that
Apple, however, has never sustainably earned a 40% return on equity or even a 20% return on equity. Go back 20 years, and what you'll find in Apple is actually a (gasp!) cyclical business. A boom from 1990 to 1992 was followed by a bust from 1993 to 1997, followed by a boom from 1998 to 2000, a bust from 2001 to 2004, and a boom from 2005 to the present.
With it now being almost 2012, either this time it's different (and I use that phrase intentionally) or this boom is starting to get a bit long in the tooth.
Enter the competition
The word "commoditization" might as well be a four-letter word for the tech industry. What it means is that a once-novel product is swamped by competition, resulting in rapidly falling prices. Consider the Walkman, the Discman, the MP3 player, the mobile phone, the desktop computer, the laptop computer, the server -- you name it. They've all been commoditized. In the case of the laptop, for example, the average selling price dropped from $1,640 in 2001 to $615 last year -- a roughly 10% annual decline. And that commoditization of the PC, incidentally, is one reason Apple has been cyclical in the past.
This isn't to say there aren't still laptops selling for more than $615. There are. In fact, Apple released a MacBook Pro last year that was so fast and had such a big monitor that it retailed for more than $3,000. But that's a boutique product with a small addressable market, since so few users need that much computing power. Indeed, an analyst last year called the new MacBook Pro "The $3,000 Laptop No One Needs."
With relatively cheap Google (Nasdaq: GOOG) Android phones already catching up to the iPhone and Amazon.com (Nasdaq: AMZN) getting ready to release a tablet, commoditization will inevitably catch up with the iPhone and iPad -- leading to declining average selling prices (ASPs) going forward.
Can't spell revenue without ASP
Way back in 2010, Apple sold almost 50 million iPhones and 15 million iPads, each with ASPs of more than $600. This year, iPhone sales are expected to nearly double and iPad sales may triple. Thanks to that growth trajectory and better-than-expected sales in China, Apple stock is up 25% this year.
Obviously, investors who buy the stock expect this top-line growth to continue. Remember, though, that revenue is a product of unit sales and ASP. Though I don't doubt that Apple will continue to sell more and more iPhones and iPads, I don't think it can keep selling them for more than $600 each.
Enter the Kindle Fire
As my colleague Eric Bleeker reported earlier this week, Amazon is set to enter the tablet space, selling the Kindle Fire for just $199. This price point means that Amazon is sacrificing some technology with the product, but how many iPad users are using all of its computing power anyway? Furthermore, when one starts thinking about Apple selling 100 million or more tablets around the world, how many of those customers will need the $600 version? In China, for example, GDP per capita is less than $4,000. And while wealthy Chinese in Tier 1 cities are snapping up Apple products, that market is far, far smaller than the Chinese market overall. This is why Baidu (Nasdaq: BIDU) wants to launch a stripped-down mobile operating system that's more feature phone than smartphone -- it's all that most Chinese consumers need.
To show why this matters, I've lifted some unit-sales estimates from one of my bullish-on-Apple colleagues. Assuming a 3% annual ASP decline over a 10-year model with normalized profitability and holding Mac, iPod, iTunes, and other peripheral operations constant yields a fair value per share of approximately $550 -- well above the current stock price.
Assume, however, the 10% ASP declines that laptops experienced, and the stock is worth just $340 -- well below the current stock price.
The global view
To buy Apple today, an investor has to believe one of two things:
1. The iPhone and iPad will not become commoditized.
2. If the iPhone and iPad become commoditized, Apple will innovate, develop, and launch a new product to overcome the resulting revenue declines.
Neither scenario is, of course, impossible, but I do not believe that Apple is as cheap as it looks. Not only will it have to move downmarket to compete with Android and the new Kindle Fire, but the fact remains that only so much of the world can afford $600 gadgets -- with the rest not being able to afford them anytime soon.
Tim Hanson 's "Global View" column appears every Thursday on Fool.com.
