It's been a while since famed investor Carl Icahn wrote Apple (NASDAQ:AAPL) CEO Tim Cook, so the greater investing community figured it was only a matter of time until a new letter appeared. And on May 18, the chairman of Icahn Enterprises indulged us all with an open letter to Apple's CEO -- which was posted on the Shareholders' Square Table website and claimed Apple was worth $240 per share. And if this seems oddly familiar, it's because it's been done before.
Last October, Icahn penned a passive-aggressive, half-effusive praise/half-diktat letter praising Cook for his efforts thus far, but imploring Cook to commence an immediate tender offer for $150 billion, as Icahn felt the stock was undervalued. Icahn went as far as filing a shareholder proposal to implore Apple to buy back $50 billion in stock last December before withdrawing the request two months later, as other large investors sided with Apple.
After the last letter, Icahn was called out for favorable growth and pricing assumptions, and it appears this letter shares some of these favorable assumptions.
Easy valuation, but some asterisks apply
For a famed corporate raider, and one considered a "Master of the Universe," Icahn has a rather straightforward valuation. Of course, that doesn't make it wrong, but it's not as if Icahn is uncovering new data, either. From the letter:
To arrive at the value of $240 per share, we forecast FY 2016 EPS of $12.00 (excluding net interest income), apply a P/E multiple of 18x, and then add $24.44 of net cash per share. Considering our forecast for 30% EPS growth in FY 2017 and our belief Apple will soon enter two new markets (Television and the automobile) with a combined addressable market size of $2.2 trillion, we think a multiple of 18x is a very conservative premium to the overall market.
Why treat Apple's cash different from the S&P 500's?
Sometimes it's easiest to hide things in plain sight -- and that's what the valuation did. Breaking apart Apple's cash from its price-to-earnings ratio and treating it as a stand-alone entity, adding it to the final total, treats Apple differently from the comparison against the S&P 500 Icahn uses as reference.
And while much has been made of Apple's legendary cash pile, because of the tremendous growth of its market capitalization, the company's cash-to-market capitalization ratio isn't unheard of, nor does it warrant special treatment. As a quick example, Apple's net cash (cash, cash equivalents, and marketable securities minus long-term debt) is roughly 18% of its market cap, while Microsoft's figure comes in at 17.4% and Google's is 16.8%.
Treating Apple's cash differently while using a cash-included P/E for a benchmark is simply a bad comparison.
Two high-growth EPS years and two low-margin products
Icahn thinks Apple will continue its high-growth rate. In the letter, Icahn expects 40% growth this year and 30% in the following year. Oddly enough, Icahn mentions two new markets for growth catalysts -- televisions in 2016 and automobiles in 2020. There's just one problem with those markets: Both are notoriously low margin, at least when compared with the type of margins Apple's investors are accustomed to.
For perspective, last fiscal year Apple's operating profit margin (not the more heavily watched gross profit margin that excludes research and development and selling, general, and administrative costs) came in at 28.7%, where luxury carmaker BMW reported an operating-profit margin of only 10%. Meanwhile, televisions have gone from a high-margin product to a commoditized one, with former market leader Sony spinning off its TV business while admitting the business was unprofitable.
Apple would probably command a premium price on the basis of its brand cachet, but to expect a massive earnings boost from these products is probably wishful thinking. It is entirely possible for Apple to achieve those admirable growth rates, but probably not on the basis of a new television set in 2016 and an automobile when it comes online. Very quickly after Icahn's comments, sources leaked to The Wall Street Journal that Apple shelved the television set last year amid a lack of compelling differentiation features. Right now, and for the foreseeable future, Apple is an iPhone-driven company, and that's where Apple's future growth will probably come from.
Investors, be patient
For long-term investors, be patient. This letter, like others, implores Cook to buy back Apple shares, as Icahn feels they are undervalued. While I disagree with the math provided, I agree with Icahn's premise. But here's the rub: So does Tim Cook. Since the start of Apple's capital return program, the company has bought back $80 billion in share repurchases -- just last month, the company increased its buyback authorization to $140 billion, up 56% from the prior authorized amount of $90 billion.
So for investors, that leaves nearly $60 billion in repurchases available. Not only that, but the company also continues to mint cash, as the company's signature iPhone has found strong demand in China. I'm willing to trust Cook to allocate Apple's capital more than I trust Icahn to do it. But it's good to see a legendary investor share your investor thesis.