By Chris Wood of Casey Research
“We want to kick off 2010 with a truly revolutionary and magical product.”
That was Steve Jobs, preaching to a packed house at the Yerba Buena Center for the Arts in San Francisco back on January 27, as he announced the iPad.
Well, the device was finally released on April 3 and is, so far, a success. First-day sales in the U.S. rang in at 300,000 units. Sales over the first week topped 500,000, slightly stronger than many analysts expected. And sales reached 1 million units over the first month. Demand was strong enough in the U.S., in fact, that Apple had to delay the international launch by about a month.
We’ve had our chance to use the iPad at Casey Research, and the general consensus is that it is a good device that is well suited for email, watching movies, and browsing photos. It’s fun to use, relatively reliable, and certainly pleasing to the eye, as most Apple gadgets are. We have no doubt it will be a good-sized hit.
But rather than talk about the specs or user-friendly nature of the device, let’s take an investor’s perspective, focus on the numbers, and consider what kind of value the iPad actually adds to the company.
On the day before Jobs officially unveiled the iPad just a few months back, Apple’s stock (AAPL) closed at $205.94 per share and its market cap was $186.75 billion. As of this writing (on June 2), AAPL is trading at $263.20 per share, near its all-time high. This lofty price produces a market cap of $239.50 billion. (It’s worth noting that Apple is now $11 billion larger than Microsoft in terms of market cap. Just three years ago, Apple was one-third the size of Microsoft.)
Thus, since Jobs announced the iPad, Apple has added $52.75 billion (28%) in market cap… raising the question: Is the iPad a $50+ billion product?
Let’s look at the better-than-best-case scenario for the iPad, keeping in mind that both of these possibilities are extremely unlikely:
It’s as successful as the iPhone was in its first year, and Its net profit margin per unit is in line with the rest of the company’s operations
In the first twelve months it was available, the iPhone – a more innovative product selling in a much bigger, established market – sold about 5 million units. Let’s say that the iPad sells at the same rate in its first year, at an average price of $600 including related products and services. (There are 6 iPads available, ranging in price from $499 for the 16GB Wi-Fi model to $829 for the 64GB 3G model – but the base model has far outsold its pricier siblings thus far.) This translates into $3 billion in sales.
If we then take the 14% average net profit margin for the company, from 2005 through 2009, and apply it to that $3 billion, we get $420 million in additional net income from the iPad over the next twelve months. With the market having added $52.75 billion in market cap for the iPad, it is granting a P/E of 125 to those incremental earnings.
Nosebleed territory. And that’s under the better-than-best-case scenario.
Looking further down the road and incorporating continued iPhone-like growth, the iPad’s valuation stillappears rich. During fiscal year 2009, after being on the market for a couple of years, the iPhone sold approximately 20 million units. Even if the iPad could somehow get to a comparable level – a feat accomplished by very few consumer electronics gadgets ever, and certainly none we know of with a $500+ price tag – we’d still end up with a multiple on its earnings of above 31.
In all honesty, not only does Apple’s iPad appear overvalued, the whole company does. Assuming the most aggressive growth model, based on a discounted cash flow analysis we figure Apple would be fairly valued today at about $190.00 per share, about 28% below where it now finds itself.
That being the case, you might be tempted to think we’ve found a prime short candidate. Easy money.
Alas, though we love easy money as much as the next guy or gal, we have to say that we would never risk shorting Apple. At least not until Steve Jobs has moved on. This is a special company. The level to which it’s been bid has little to do with the value of the iPad nor the present value of discounted future cash flows. It’s all about the brand.
No two ways about it, people just love them Apples. And as long as that’s the case, the stock is going to trade at a significant premium in the market.
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