Apple Math
August 4th, 2008. Posted by AppleOption
Apple Math: Market Share over Margins by Jason Schwarz
Why has the impact of 3G iPhone sales been nonexistent on Apple (AAPL) stock? Because investors are flunking their Apple math exam. The iPhone story grows larger by the day, we are now on day 18 of iPhone mania. Tuesday morning the Santa Monica Apple store had a 2 hour wait by 8:30 a.m. If one million phones sold in the first three days was impressive, then what we’ve witnessed since then is even more impressive.
It’s time for a quick discourse on Apple math. Those, like CNBC’s Jim Cramer, who believe this has turned into an event driven stock are completely wrong. It’s all about the fundamentals. The lackluster response to unprecedented iPhone demand represents the greatest buying opportunity on Wall Street. Apple math sacrifices a big payday today for an even larger payday tomorrow. There are two components of Apple math creating this buying opportunity:
1.Those who don’t understand Apple math look at the recent earnings report and see a meager $419 million of iPhone revenue. This short term dilution of earnings power, caused by the 24-month deferred subscription accounting, has caused investors to ignorantly ignore the long term iPhone impact on earnings per share.
To foresee the real power of Apple math let’s fast forward to the December 2009 quarter when it’s estimated there will be 58 million iPhones reporting approximately $71.75 per phone per quarter (lonepeakportfolios.com). These numbers produce a profit of $2.5B from $4.16B in revenue for just a single quarter. Compare that to the current Q2 net income of $1.07B on revenue of 7.46B for the entire company! Investors are in store for a 1,000% increase in reported revenue from the iPhone over the next 18 months.
Apple math creates a rolling snowball effect that produces larger and larger returns while at the same time eliminating short term earnings volatility. By June 2009, earnings from the iPhone will reach current net income for Macs, iPods, Apple TV, software and iTunes combined. That is only 10 months away. This growth is happening right before our eyes but most are missing it because they fail to see the future ramp manipulated by Apple math. Apple hasn’t reported any revenue from the iPhone since the beginning of March. It’s coming.
2. The second component of Apple math that investors have incorrectly interpreted is the pending reduction in gross margins down to 30% in 2009. The incorrect assumption is that the margin erosion will reduce profits. Not so.
According to CEO Steve Jobs, Apple is in the midst of experiencing a market share tipping point with the Mac Computer. Spurred on by the complete failure of Microsoft Vista, Apple has a once in a lifetime opportunity to crack the market share dominance of not only Microsoft (MSFT) but also of their hardware competitors Hewlett Packard (HPQ) and Dell (DELL). The new Apple is all about market share. By lowering the price of their products, Apple stands to further capitalize on the iPod/iPhone halo effect that has led to market share growth 300% better than the overall PC growth rate (IDC data).
This pending drop in margin has nothing to do with a slowing economy; Apple has already proven itself with 41% year over year Mac growth in these tough conditions. The margin decrease has everything to do with their mass market share opportunity. Premium priced products won’t topple Microsoft. Apple math means lower margins produce market share madness.
Apple investors should not mistake local cloud cover to be permanent darkness. The future will eventually arrive and reward those investors who understand Apple math. Buying in-the-money January 2010 calls allows you to be out in front of any short term market weakness. Investors won’t ignore iPhone sales forever.