Last week, Carl Icahn released yet another open letter to Apple, (NASDAQ:AAPL) CEO Tim Cook, applauding his work, calling for additional share buybacks, and setting a sky-high valuation estimate. This time, Icahn claims that Apple stock is worth $240.
That's more than 80% above Apple's recent trading price, and it's more than four times the low point Apple stock hit just two years ago.
However, this valuation estimate depends upon unrealistic projections of Apple's future growth, as well as aggressive accounting. Apple stock still has plenty of upside, but it isn't worth $240, and investors shouldn't expect to see it hit that level anytime soon.
Roses all around
Throughout his open letter, Icahn claims that he's being conservative. But Icahn's projections of Apple's growth are far from conservative -- with the exception of his forecast for iPhone revenue growth of just 2.3% in FY16 and 6.7% in FY17.
For example, Icahn writes confidently that Apple will start selling its own branded TV next year and an "Apple Car" by 2020. In doing so, he is merely regurgitating rumors that have already made the rounds long ago.
The idea that Apple would make a television set has a particularly long history. Noted Apple analyst Gene Munster has been touting the imminent arrival of an Apple-branded TV almost continuously since 2009. Yet while Apple had been working on a TV, it shelved the project more than a year ago, according to a recent Wall Street Journal report.
Munster accepted the apparent reality: that he was wrong. Thus far, Icahn has refused to do the same. And he has big hopes for Apple's (probably nonexistent) TV: sales of 25 million units by FY17 (its first full year on the market) at an average selling price of $1,500. That would yield $37.5 billion in revenue -- more annual revenue than any non-iPhone product category has ever achieved.
But that's not the only product that Icahn sees flying off the shelves. He expects Apple Watch to reach 10 million unit sales by the end of the current fiscal year (with less than six months of availability) at an average selling price of $600.
While this estimate seems very plausible, Icahn expects Apple Watch revenue to soar to $45 billion by FY17: its second full year on the market.
Thus, Icahn is counting on a product that just hit the market -- to mixed reviews, no less -- and one that may not even exist to be two of Apple's three largest product lines in just two years. Is it possible? Perhaps. But it's certainly not conservative, and it's not a solid foundation for financial projections.
As for the supposed Apple Car, that product is even more speculative. While there have been lots of rumors about Apple entering the car business, that's no different than the many rumors about Apple entering the TV business, which appear to have come to nothing. Apple may be investigating the auto market, but that doesn't mean it will follow through by building a car.
Icahn compounds his rosy growth forecasts for Apple's non-iPhone product lines by using some creative accounting to juice Apple's earnings.
Icahn has repeatedly insisted that Apple's earnings should be modeled as if it has a 20% tax rate, even though the company usually reports an effective tax rate around 26% and the U.S. statutory corporate tax rate is 35%. His justification is that 20% approximates Apple's "cash" tax rate because it accrues (but does not pay) repatriation taxes on some of its foreign earnings.
However, Apple's untaxed foreign earnings are stuck outside of the U.S., and they will stay abroad unless Apple is willing to pay repatriation taxes of up to 35%. To continue paying its dividend and buying back stock -- let alone ramping up its buybacks, as Icahn wants -- Apple will have to issue more and more debt or bring home (and pay taxes on) foreign cash.
For now, Apple can continue down the debt path as its absolute debt burden remains very manageable and interest rates are near historic lows. But as Apple's debt burden grows and interest rates rise, it will become less and less feasible for Apple to minimize its tax burden in this manner.
Thus, in the long run Apple will have to pay the full 35% tax rate if it wants to use any of its international earnings. Icahn's calculations could thus be exaggerating Apple's "true" earnings by more than 20% just through his aggressive tax assumption.
Of course, it's possible that the U.S. will eventually reduce its corporate tax rate. But unless it also moves to a "territorial" system where foreign earnings are never taxed, a tax code change would benefit virtually all companies, not just Apple.
Optimism run wild
There are plenty of reasons to like Apple, both as a company and as a stock. However, for Apple to be worth $240, as Carl Icahn claims, a lot of things need to go right.
Demand for the Apple Watch will have to soar over the next two years. Apple needs to introduce a TV and a car -- and both products need to be incredibly successful. And in the meantime, Apple can't cannibalize any of its major present-day product lines, which include the iPhone, iPad, and Mac. Even if this all goes according to plan, Icahn relies on some aggressive tax accounting to justify his $240 fair value estimate.
All of this makes Icahn's estimate seem much more like a best case scenario than a conservative fair value estimate. Apple stock could be worth $240 if everything goes right. But there are a lot of ways that Apple could fall short of Icahn's lofty expectations, justifying a significantly lower valuation.