Icahn: iPhone 6/Plus to hurt Android, Apple severely undervalued, increased buybacks urged

Carl Icahn has posted a lengthy open letter (with extremely daunting paragraphs) to Apple CEO Tim Cook via his Shareholders’ Square Table website. Below is the beginning of the letter, verbatim (we’ve highlighted in bold certain sections of interest):

As a large Apple shareholder with approximately 53 million shares, we applaud you and the rest of management, especially in light of recent launches and announcements which further validate our view that you are the ideal CEO for Apple. It is truly a watershed moment, with Apple poised to take market share from Google (Android) in the premium device market as iPhone 6 becomes Apple’s flagship device among a growing collection of products and services that work together to form an increasingly dominant mobile ecosystem. We believe this advantaged position over Google, the company’s only real competitor, justifies our forecasts for revenue and EPS (earnings per share) growth of 25% and 44% respectively for FY (fiscal year) 2015. This strong competitive position and earnings growth compels us to remind you that Apple, adjusting for net cash, currently sells at a P/E (price to earnings per share ratio) of only 8x our FY 2015 forecast, a significantly lower P/E than a broad market index, the S&P 500, which trades today at a P/E of 15x FY 2015 consensus. In contrast to the S&P 500’s slower growth, we expect Apple to grow its EPS by 30% in each of FY 2016 and FY 2017. Assuming these growth characteristics for FY 2016 and FY 2017, we see Apple’s P/E of just 8x our FY 2015 forecast as both irrational and transient in nature, especially since many actively managed mutual funds remain underweight Apple in their portfolios. Our forecasted growth for FY 2016 and FY 2017 more than adequately justifies using a P/E multiple of 19x our FY 2015 forecast, which along with net cash values Apple at $203 per share today. Described in more detail below, these factors combine to reflect a massive undervaluation of Apple in today’s market, which we believe will not last for long. Therefore, given the persistently excessive liquidity of $133 billion net cash on Apple’s balance sheet, we ask you to present to the rest of the Board our request for the company to make a tender offer, which would meaningfully accelerate and increase the magnitude of share repurchases. We thank you for being receptive to us the last time we requested an increase in share repurchases, and we thank you in advance now for any influence you may choose to have communicating to the rest of the Board the degree to which a tender offer would have a positive impact on an EPS basis for all shareholders. To preemptively diffuse any cynical criticism that you may encounter with respect to our request, which might claim that we are requesting a tender offer with the intention of tendering our own shares, we hereby commit not to tender any of our shares if the company consummates any form of a tender offer at any price. We commit to this because we believe Apple remains dramatically undervalued. And we think you and the Board agree. If you did not, you would not continue to repurchase shares under the existing authorization. You have said before that the company likes to be “opportunistic” when repurchasing shares and we appreciate that. With this letter we simply hope to express to you that now is a very opportunistic time to do so. We think a tender offer is simply a good method of conducting a large repurchase in an expedited timeframe, but the exact method and the exact size is not the key issue for us. We are simply asking you to help us convince the board to repurchase a lot more, and sooner. We feel compelled to do so because we forecast such impressive earnings growth over the next few years, and therefore we believe Apple is dramatically undervalued in today’s market, and the more shares repurchased now, the more each remaining shareholder will benefit from that earnings growth.

Critical to our forecast for strong earnings growth is the belief that the iPhone will take significant premium market share. Given historically high retention rates, we assume existing iPhone users will continue to act like an annuity, choosing to stay with the iPhone each time they upgrade. But now, since the iPhone 6 is the most significant improvement to the iPhone since its introduction, we expect users of competitive products to see the iPhone 6/6+ as an exciting opportunity to choose a superior product. Now that iPhone offers a larger screen size, its price competitiveness in the premium phone market is clear, as a premium Android phone such as the Galaxy S5 and Note 4 sells at a similar price point to the iPhone 6 and 6+ respectively. The choice between them is analogous to the choice between a Volkswagen over a Mercedes at the same price, and unlike a Mercedes, the $649 cost of an iPhone 6 is affordable for the mass market, equating to just $20 per month over a two year period (including a $170 estimated resale value of the phone at the end of two years, excluding financing and taxes). We see the iPhone remaining unaffected by the “junk”, as you called it, sold at lower price points, but we also see it dominating the entire class of premium Android smartphones, such as Samsung’s Galaxy phones. Because of this, we expect Apple will take premium market share, while at the same time maintaining its prices and gross margins, proving the concept of commoditization is nothing more than a myth with regards to Apple. Beyond simple price comparison, we see the iPhone as best in class, supported by expert reviews and by the lines of people all over the world waiting to buy it. Perhaps most importantly, we believe the iPhone will take market share because its merits are no longer viewed in isolation from the overall Apple ecosystem of products and services, which include iOS, iPad, Mac, Apps, App Store, iCloud, iTunes, and (more recently) Apple Watch, Apple Pay, Home, Health, Continuity, Beats. With the iPhone as the foundation, Apple’s ecosystem has come to play an important role in the daily life of Apple users, and while Apple continues to make impressive strides to improve it, the competition falls behind in what is arguably the most important race of this technological era. Analogizing Apple to a modern day Secretariat, as this race continues, the further the distance grows between Apple and Google (and Google’s hardware partners) in the premium device category. Its leading ecosystem of products and services, added to peerless hardware design and quality, differentiates Apple from a simple hardware company. And, with its users consistently upgrading to the newest version of iOS (92% of iOS devices, iPhones and iPads, on iOS 7 prior to the launch of iOS 8), Apple is able to offer its users the most up to date software and service experience, while Android can’t because it’s hindered by relatively high fragmentation among its operating system versions. App developers appreciate the difference, which is why they often choose to make an App for iOS prior to (or instead of) Android. During a recent interview, you referred to Google and only Google as your competition, as no other operating system can gain enough scale in Apps to be relevant. Furthermore, you also described how, in contrast to Apple, Google’s business model relies on advertising, which will increasingly expose products that run Android to serious privacy concerns. Considering all of this, combined with their inability to merge a superior brand, hardware, software, services, fashion and retail stores, Google and its hardware partners will remain disadvantaged in the premium device market. As this is realized, we expect that Apple will gain market share, that those gains will translate into earnings growth in line with our forecasts, and in turn translate into multiple expansion.

In addition to iPhone 6 market share gains, we assume that earnings growth will be driven by successful innovations and launches of other products and platforms. To properly forecast future earnings for the purposes of valuation, we assume further innovation on existing product lines and services (such as the larger screen iPhone 6 and 6+), but also assume that launches of new product platforms and new services will happen, predict what they might be, and estimate and include the potential earnings from such innovation and launches into forecasted future-year earnings. As our model highlights, much like the success of iPhone and iPad before it, we expect the successful launch of new premium product platforms (the announced Apple Watch in FY 2015 and the rumored TV in FY 2016) along with new services (in particular Apple Pay). These new launches will further distance Apple’s ecosystem from its peers and accelerate revenue and earnings growth in excess of the status quo. For the next three fiscal years, we forecast robust earnings growth of 44%, 30%, and 30% respectively, driven by strong revenue growth of 25%, 21%, and 21% respectively.

Icahn details below how the forecasts were derived in the lengthy full letter here.

MacDailyNews Take: There is a lot of interesting bits in this letter with much of which we obviously agree.

Analogizing Apple to a modern day Secretariat, as this race continues, the further the distance grows between Apple and Google (and Google’s hardware partners) in the premium device category. – Carl Icahn, October 9, 2014

If this is a two horse race, it’s Secretariat vs. Sham in the Belmont.MacDailyNews Take, July 6, 2012

[iPhone’s] price competitiveness in the premium phone market is clear, as a premium Android phone such as the Galaxy S5 and Note 4 sells at a similar price point to the iPhone 6 and 6+ respectively. The choice between them is analogous to the choice between a Volkswagen over a Mercedes at the same price, and unlike a Mercedes… – Carl Icahn, October 9, 2014

“iPhone user reviews Android after 6 months of use: Samsung Galaxy S4 not as good as Apple iPhone”: Next up, a BMW M5 owner will recount his 6-months in a fscking Kia Optima.MacDailyNews Take, January 23, 2014

35 Comments

  1. This is awesome. One of the most successful investors in history says that Apple is massively undervalued. He is just stating the simple truth, and the markets will eventually reflect it.

    1. Apple will stay undervalued because there are simply too many investors who believe that Android is the better choice because of its massive market share. Wall Street truly believes Android can’t possibly lose to iOS. There are so many analysts who say that Android smartphones are good enough and they’re so much cheaper than iPhones. Many analysts also believe that Android smartphones have better specs than the iPhone based on benchmarks.

      The stock market is irrational thinking that market share is valued higher than everything else. If that were true, Samsung’s profits wouldn’t have imploded. Samsung did everything that analysts said Apple should do. More variations of smartphones at lower price points. It didn’t help Samsung in the long run.

      Yet Wall Street keeps betting on Google and Android because supposedly Android One will gain a billion more BRIC consumers with the cheapest smartphones in the world. Android One will bring about even more fragmentation of Android with dirt cheap smartphones that will likely be worth next to nothing in a year.

      1. i believe that the Android market share affords Apple ample room to grow, by taking an increasing share of the only business that matters, which is profitable business. I have owned Apple stock for a long time, and I believe that it is in a great place right now. It is conservatively valued, with plenty of upside.

    1. lol, two days ago you would get 5 stars.

      No one has a “problem” with Icahn, Woz or Dvorak (did I put them in the same sentence? Oops), they have a problem with what they say. They can say brilliant things one day, and flub the next. Some tend to flub more often than not.

      When a good day comes, it’s nice to “reward” or approve the message, and maybe, just maybe they will get the hint.

    1. Less cynically…

      • The market is waking up to the fact that Android is crap and will always be crap
      • APPL has huge growth potential, Android does not
      • This will drive huge earnings, which will double Apple’s stock price.
      • Buy now while it’s cheap

  2. Apple has bought on the dips. Problem is we are at the historic highs so buying now does not make much sense except to help fuel the brokers yo-yo games.
    If the market forces the stock down 10 points then Apple will buy in wholesale. First the buy back price is cheaper and second it help boost the stock price back up.
    As for Icahn, he is getting impatient with the inability to break out of the $100 zone. He is trying to create some positivity to help drive the price up. It worked in the past so not surprised he will try it again.

  3. I completely agree that AAPL is undervalued, but I completely disagree that Apple should initiate a huge AAPL buyback. The current buyback strategy is sufficient.

    Horace debunks this and shows historically the larger Apple grows, the more undervalued this is.
    http://www.asymco.com/2011/06/20/thinking-over-apples-value/

    Icahn says “massive undervaluation of Apple in today’s market, which we believe will not last for long”, but that is completely incorrect. History shows the larger Apple grows, the more undervalued the stock becomes. I believe part of this is analysts simply can’t wrap their heads around the market cap of Apple if it had a reasonable P/E ratio.

    As an Apple investors I have come to understand the P/E ratio will always be low and the stock will be undervalued. This no longer bothers me. It’s still a great investment. Just buy AAPL, hold onto it for a few years, and you’ll be very happy.

    If you want to make a quick buck from AAPL, like Icahn, it’s not the stock for you.

    1. Oops. I meant to put Icahn’s quote about the link from Asymco. Like this:

      Icahn says “massive undervaluation of Apple in today’s market, which we believe will not last for long”, but that is completely incorrect. Horace debunks this and shows historically the larger Apple grows, the more undervalued this is.

      http://www.asymco.com/2011/06/20/thinking-over-apples-value/

      History shows the larger Apple grows, the more undervalued the stock becomes. I believe part of this is analysts simply can’t wrap their heads around the market cap of Apple if it had a reasonable P/E ratio.

  4. Icahn is asking for 25 billion in share repurchasing in each of the next 3 years. That’s a big number but doable.

    He is forecasting a dramatic increase in total sales for Apple over the next 3 years making Apple one of the largest companies by sales in the world.

    He is forecasting an Apple “Television Set” that will outsell the Macintosh by 2017. He says 1/3 of iPhone buyers will buy an Apple Watch by 2017. I personally don’t see these two things, but what do I know- his net worth is literally 5000 times greater then mine.

    He is forecasting no unit growth in the Mac over the next 3 years.

    1. from Wikipedia:
      As of September 2014, his net worth is estimated to be $26 billion.[1]

      26000000000/5000=$5,200,000

      You are not doing too bad, are you cuter than him?

  5. Having a tremendous amount of cash makes it possible for AAPL to not only survive in down times but to dominate. It enables them to buy other companies and IP without a dent to the bottom line. I’d rather see a low P/E with a realistic future than some speculative ratio that may never materialize. I don’t need a massive buy back as long as AAPL has the share majority to control the company. I’ve had shares, held some and sold some. My strategy is waiting for the splits and swing the subsequent rise. Icahn’s advice benefits the investment community, not the really long term stability of the company.

Reader Feedback

This site uses Akismet to reduce spam. Learn how your comment data is processed.