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
