Carl Icahn issues open letter to Apple CEO Tim Cook

Today Carl Icahn released the attached open letter to Tim Cook, the Chief Executive Officer of Apple Inc.

Dear Tim:

We again applaud you and the rest of management for Apple’s impressive operational performance and growth. It is truly impressive that, despite severe foreign exchange headwinds and massive growth in investment (in both R&D and SG&A), the company will still grow earnings by 40% this year, according to our forecast. After reflecting upon Apple’s tremendous success, we now believe Apple shares are worth $240 today. Apple is poised to enter and in our view dominate two new categories (the television next year and the automobile by 2020) with a combined addressable market of $2.2 trillion, a view investors don’t appear to factor into their valuation at all. We believe this may lead to a de facto short squeeze, as underweight actively managed mutual funds and hedge funds correct their misguided positions. To arrive at the value of $240 per share, we forecast FY2016 EPS of $12.00 (excluding net interest income), apply a P/E multiple of 18x, and then add $24.44 of net cash per share. Considering our forecast for 30% EPS growth in FY 2017 and our belief Apple will soon enter two new markets (Television and the Automobile) with a combined addressable market size of $2.2 trillion, we think a multiple of 18x is a very conservative premium to that of the overall market. Considering the massive scope of its growth opportunities and track record of dominating new categories, we actually think 18x will ultimately prove to be too conservative, especially since we view the market in general as having much lower growth prospects.

We are pleased that Apple has directionally followed our advice and repurchased $80 billion of its shares (yielding the company’s shareholders an excellent return), but the company’s enormous net cash position continues to grow while the company’s shares are still dramatically undervalued. With Apple’s shares trading for just $128.77 per share versus our valuation of $240 per share, now is the time for a much larger buyback. We appreciate that the Board just increased the share repurchase authorization by $50 billion, and that it continues to prioritize share repurchases over dividends (as it should). We again simply ask you to help us convince the board of how these two underlying issues (inefficient net cash growth and share undervaluation) persist and combine to enhance the opportunity for accelerated share repurchases in greater magnitude. We also ask you to help us convince the board that this is not a choice between investing in growth and share repurchases. As our model forecasts, despite more than 30% growth in R&D annually through FY 2017 to $13.5 billion (up from $1.8 billion in FY 2010) and your updated capital return program, Apple’s net cash position (currently the largest of any company in history) will continue to build on the balance sheet.

It is our belief that large institutional investors, Wall Street analysts and the news media alike continue to misunderstand Apple and generally fail to value Apple’s net cash separately from its business, fail to adjust earnings to reflect Apple’s real cash tax rate, fail to recognize the growth prospects of Apple entering new categories, and fail to recognize that Apple will maintain pricing and margins, despite significant evidence to the contrary. Collectively, these failures have caused Apple’s earnings multiple to stay irrationally discounted, in our view.

When we compare Apple’s P/E ratio to that of the S&P 500 index, we find that the market continues to value Apple at a significantly discounted multiple of only 10.9x, compared to 17.4x for the S&P 500, awarding the S&P500 with a 60% premium valuation to Apple:

Apple P/E - Carl Icahn

Importantly, as we have noted previously, we assume a 20% tax rate for the purpose of forecasting Apple’s real cash earnings, not the 26.2% “effective” tax rate used by Apple, and view this as a necessary adjustment, often overlooked by both analysts and investors. For more detail on our methodology for this adjustment, please review our letter titled “Carl Icahn Issues Letter to Twitter Followers Regarding Apple” published February 11th, 2015, which you can find here: http://www.shareholderssquaretable.com/letter-to-twitter-followers-regarding-apple/

By applying this adjustment to the current consensus FY2015 EPS of $8.96 (among the 45 analysts who have updated their EPS targets since April 22nd), the adjusted result is $9.71. Notably, while previously criticized by some of these analysts as being too aggressive, this consensus EPS forecast, which includes interest income, is now largely in line with our own forecast of $9.60, which does not include interest income. And, once again, we exclude interest income from our EPS forecast because we value Apple’s enormous net cash balance separately from the enterprise, unlike most analysts.

While our forecast for FY 2016 EPS is significantly above Wall Street consensus today, in October 2014 so was our original forecast for FY 2015 EPS, which is now in line with the Wall Street consensus. We are optimistic that ecosystem improvements (Apple Watch, Apple Pay, Homekit and Healthkit in particular) will drive modest growth in iPhone revenues next year, despite the difficult comparison that will result from iPhone’s tremendous performance this year. With a new iPhone expected in September 2016, Apple stands to benefit as iPhone continues to take premium market share (switchers from competitors), as the middle class continues to grow in emerging markets, and as the modest level of upgrades (only 20% to date) indicates pulling demand forward from FY 2016 to FY 2015 may not be as severe as some have highlighted. Along with a more dramatic push into the TV market, increasing traction with Apple Watch, and the introduction of a larger screen iPad, we have confidence in our forecast for FY 2016.

We believe Apple Watch, Apple Pay, Homekit, Healthkit, Beats Music, and further innovation in existing product lines collectively represent a tremendous opportunity that on their own justify a valuation that, at the very least, reflects a market multiple. That being said, we share your excitement that “our best days are ahead of us” and that Apple has “no shortage of growth opportunities to pursue.” The company’s dramatic increase in R&D spending should signal to investors that Apple plans to aggressively pursue these growth opportunities. It may be difficult for some to fathom (only because Apple is already the largest company in the world), but Apple is very much a long term growth story from our perspective, which is exactly why we believe the company’s shares should trade at a premium multiple to the S&P 500, as opposed to the S&P 500 trading at a 60% premium to Apple. While we respect and admire Apple’s predilection for secrecy, the company’s aggressive increases in R&D spending (and some of the more well-supported rumors) have bolstered our confidence that Apple will enter two new product categories: television and cars. Combined, these two new markets represent $2.2 trillion, three times the size of Apple’s existing markets (if we exclude Apple Watch).

Excluding advertising, the addressable market for television is approximately $575 billion, which is larger than the smartphone market. Also, given that people spend an average of 12% of the day watching TV (equating to 25% of their free time), we view television’s role in the living room as a strategically compelling bolt-on to the Apple ecosystem. In addition to an Ultra High Definition television set, we expect Apple to launch a related suite of tiered products and services, including a “skinny bundle” of pay-tv channels (partnered with various media companies) and an updated Apple TV microconsole (which will continue to service the massive install base of televisions offered by other OEMs). This will enable Apple to pursue the entire market by offering multiple products at various price points across the demographic spectrum. Netflix offers a similar tiered approach to pricing today by charging a higher price for those seeking the ability to receive ultra high definition content.

We believe this move into TV will also benefit all the other devices and services in the Apple ecosystem. As just one of many possible examples of this, the Apple Watch could perhaps be used as a remote control. Similarly, as we expect Apple to launch a larger 12.9” iPad, it would offer an enhanced viewing experience for an Apple pay tv service, or act an improved “second screen” to an Apple UltraHD television.

At $1.6 trillion, the enormous addressable market for new cars is approximately four times the size of the smartphone market. It’s estimated that people spend an average of 1 hour every day traveling, mostly in cars, but not everyone drives, implying that the average time that daily commuters spend in a car is much higher. We believe the rumors that Apple will introduce an Apple-branded car by 2020, and we believe it is no coincidence that many believe visibility on autonomous driving will gain material traction by then.

As autonomous driving would release drivers’ attention from the activity of driving and navigating, and perhaps even increase the time people actually want to spend inside a car, both an automobile and the services provided therein become even more strategically compelling. While Apple currently addresses this market with CarPlay, it seems logical that Apple would view the car itself as a the ultimate mobile device to which it could bring its peerless track record of marrying superior industrial design with software and services, along with its globally admired brand, and offer consumers an overall automobile experience that not only changes the world but also adds a robust vertical to the Apple ecosystem. And for Apple, the car market is more than big enough to “move the needle” significantly, even as the world’s largest company.

The rising cost of oil, its impact on global warming, the geopolitical risks associated with oil dependency (especially as fuel for automobiles), followed more recently by the rise of cost effective alternatives presents a “change the world” opportunity for Apple. It is widely believed that the electric battery will play a key role in this transition. The lithium-ion battery already represents a critical component across many of Apple’s existing products (iPhone, iPad, Apple Watch, MacBook, Beats) and any further innovation could be a “game changer” in terms of both battery life and form factor across Apple’s entire ecosystem. Since lithium-ion batteries represent a large percentage of the cost of today’s electric vehicle, we believe Apple should be well positioned to leverage its existing knowledge domain and more robust R&D spending in this area, and in turn apply any energy density / battery life improvements for a car across all the other products in its ecosystem that will share the benefit from such battery innovation (iPhone, iPad, Apple Watch, MacBook, Beats).

As a mobile device that is differentiated by design, brand, and consumer experience where software and services are increasingly critical, an Apple car would seem to be uniquely positioned.

While the television and the car offer tremendous growth opportunities, Apple’s core ecosystem continues to improve and grow, now sometimes referred to as a “mega-ecosystem”, a term we find increasingly appropriate, as we look at the breadth of its components, which now include existing products (iPhone, Apple Watch, Mac, iPad, Beats, Apple TV), software/services (Apple Pay, Homekit, Healthkit, Carplay, iCloud, iTunes, and rumored Beats Music, pay TV service), as well as possible new products in new categories (a Car, a TV set). Furthermore, ongoing innovations and enhancements to all of the above will drive even more premium market share gains for iPhone, which sits at the epicenter of this mega-ecosystem.

Apple has clearly demonstrated a track record of excellence and success when entering new categories. We expect this to continue with the Apple Watch, the television, and the car, and the world will look back on today’s undervaluation as a fascinating example of market inefficiency (and likewise on our valuation at 18x earnings per share as conservative). Because of this, we encourage both accelerated and larger-magnitude share repurchases as you consider how to allocate capital going forward. As you continue to evaluate this opportunity, and consider the right prices at which to opportunistically repurchase shares, we hope you give credence to our advice in light of our investment record. Unlike the many actively managed mutual funds and hedge funds that are underweight Apple and have underperformed the S&P 500, we have exhibited strong outperformance, thanks in part to our large position in Apple. The Sargon Portfolio (a designated portfolio of assets co-managed by Brett Icahn and David Schechter within the private investment funds comprising Icahn Enterprises’ Investment segment and High River Limited Partnership, subject to the supervision and control of Carl Icahn) has generated annualized gross returns of 36.9% since its formation on April 1, 2010 through April 30, 2015 with $8 billion of assets under management as of April 30, 2015.

If you choose not to pursue some of the new categories we highlighted, or you find our growth forecasts too aggressive for any one new category in particular, we’ll be the first to admit that you are more knowledgeable in these areas than we are. But we believe, that under any circumstances, you would agree that in the aggregate, all these new categories taken together (along with those of which we may be unaware) represent one of the greatest growth stories in corporate history, as well as one of the greatest opportunities ever for a company to invest in itself by repurchasing its shares.

Sincerely,

Carl C. Icahn
Brett Icahn
David Schechter

Read Icahn and co’s “key assumptions” here.

[Thanks to MacDailyNews Readers “Fred Mertz” and “Bill” for the heads up.]

33 Comments

    1. Much as I hate to agree with anything Jobs would or wouldn’t do, I liked the way he dealt with slime like Ichan (ignoring + shutting them down). Cook is finding out why Jobs treated them this way: you give them an inch…
      Overall I like the way Cook is more open about things, but this is the ugly downside to that openness.

  1. The parasite speaks. This is what’s wrong with the American stock market and economy. When you are this rich, you don’t even have to be secretive about manipulation of the market. Just take big stake in a great company and tell the world you are “guiding it” to higher share prices. As if Tim gives sh*t about his advice….

    1. Icahn is an Apple investor, cheerleader, supporter of management, defender of a higher price evaluation. If you could learn to read and think you would see that at Apple his presence has been entirely positive. But you are limited by kneejerk reactions and lack of critical thinking skills. Typical liberal moron.

        1. Steve Jobs is not part of this dialog. The idiots comment was about Carl Icahn. And Steve Jobs was not an idiot and would not have disrespected a very large investor who brought good ideas to the table. Apple increased its buyback program at Icahn’s urging and the stock price increased substantially benefitting all shareholders. Now I know that Zealander and macgadgetfreak are morons, unlike Steve Jobs.

          1. I would like to learn exactly how is Carl Icahn positive for Apple. After all, Apple doesn’t exactly directly reap any benefits from AAPL going higher; the shareholders do, and while theoretically it makes all the Apple employees who own stock options richer on paper, this is meaningless for them today, as much as it is meaningless for Apple.

            Carl Icahn has used his personal money and bought some AAPL shares on the open market. Apple didn’t benefit from that purchase; the persion(s) who sold those shares to him did. Carl Icahn is now essentially doing some PR in order to increase the value of those shares. In other words, he isn’t doing anything productive (i.e. creating a product or service), he’s just trying to convince other people to buy AAPL at higher price, so that the value of his own stash becomes higher.

            ICahn is probably not quite a parasite, but in all practicality, he is useless to Apple, as well as to the rest of the society.

          2. kent:

            Are you just another self-entitled obnoxious “shareholder”? Someone who’s never created a tech company or developed tech or actually done anything on your own other than try and call the shots after they’ve happened? Someone who thinks they’re entitled to help “run” a company because they have share certs? Is that you? Regardless, this is Carl Icahn and every other dickhead suit that papers up in a tech company.

            There is NOTHING in his letter that is not self-evident or that is easily dismissed as misguided bullshit. There is NO INSIGHT in what’s written there. And this is what people are really talking about. We don’t need stupid letters like this because these people are not qualified to create tech or even run the companies they invest in. The stock price is all they’re interested in. They don’t care about anything else and they’re no good for anything else.

            In tech we’re well ahead thinking into the future. We’re thinking about what society will be like and what kind of technology/software/hardware will work when people stop talking and start communicating through telepathy. We’re thinking about embedded computers in people’s bodies. Carl Icahn is just a fucking useless moron that could never invent the future because he’s not creative enough and passionate enough to do that.

            Car Icahn: you’re sitting where the puck has already been. Thank god you’re not running any substantive tech company. I would never take the time to read anything from shareholders unless there are statutory requirements to do so. Because it’s always such a waste.

            What a revelation Icahn, electric cars. Wow Carl, you’re so smart and insightful. And what would that electric car look like Carl? And what innovation would you build into it? Right, batteries, and I’d come in 5 colors! Super! You’re amazing Carl.

            Now here’s me: we’d innovate the crap out of it. It would not have any windshield wipers, it wouldn’t have rearview mirrors. Carl says, “But, no windshield wipers? How does that work?” We create a wind barrier on the windshield sort of like an air hockey table. This idea was inspired by playing air hockey as a kid. Carl says, “What does inspiration mean?”

            And by the way Carl, we’ve been talking about rumours of Apple doing this since at least 2005 you fuckchop.

        1. DFTT*.

          You’re responding to kent. He’s a psycho-conservative that labels anything stupid as being liberal and blasts anything liberal as being stupid. Reason and logic are not his strong suits. Blame and ignorance are his allies.

          He’ll never change, so just ignore his posts.

          *Don’t Feed The Troll.

          1. Ha!! And in parallel to writing my own comment, kent responds “The stupidity” above, simply proving me right and proudly displaying his outrageous bias and astounding ignorance yet again.

            Sorry, kent…there’s plenty of stupidity on BOTH sides of the political divide, as you continue showing.

      1. I am an apple cheerleader, invester, supporter of management, and defender of price evaluation. I have been a share holder since it was 12$ and an owner since the quadra 800. This guy is a freekin leech of the worst kind who only gives a sh*t about apple profits (as they recently serve him)- not products. Typical liberal moron? I am a conservative leaning libertarian…I care about Apple the company and its products and our country, which is being ruined by the mega financial puppet masters (who incidentally control both parties)…open your eyes and shut your mouth bro…you might learn something

  2. Apple can also go to planes and ships, those are huge industries, right?

    Not so fast.

    If, in fact, Apple develops actual automobile, then still it is not guaranteed they will actually make the product (though mostly likely they will) — even though those efforts are costly and serious, as WSJ and other outlets notice, there is no final decision on anything.

    Apple’s main principle is to release products that have something fundamentally new.

    Apple Watch has proven that Apple can still deliver it — the new UI paradigm with ForceTouch, Haptic Feedback and Digital Crown changes the way people interact with their electronics.

    Apple Car will also have to bring principal changes — if Apple will release it only if it will see that they have achieved that.

    My point is that Icahn’s arguments on about how huge car market is are not key factor on whether Apple will participate in such market. Throwing big numbers at Apple will not convince them in anything.

  3. Of course, Apple does have the incentive to buy back their stock in massive volume if only to be free of manipulative asshole stockholders. If the biznizz bozoz really were to take a hand in running Apple, there would be no more Apple.

      1. For all we know, dear Carl is hanging onto every share and thereby increasing (albeit slowly) his voting rights. So many games. So many game players. So many people oblivious to the real world of miracle planet Earth, our only home.

    1. As an Apple investor I don’t mind Carl’s letters as the stock goes up when he writes them. As far as Carl running Apple that would be a bad idea and I think he would agree.

  4. P/E ratio blah blah blah shares repurchase blah zzzzz blah undervalued vs S&P 5000 zzzzzzzzz blazzzzz

    Who cares about Apple’s share price, and what Carl iCant thinks of it ?

    What we all care about is Apple consolidating already great products (but not without faults), and bringing new ones WHEN THE TIME IS RIGHT.

    If anyone is in doubt as to whether Apple can do that, well, they have not been paying much attention.

  5. “We are pleased that Apple has directionally followed our advice and repurchased $80 billion of its shares”

    Fallacy of logic, called: post hoc, ergo propter hoc. Just because something followed something else, does not mean that the previous “event” caused what followed.

    Carl, you are a maroon. Apple is not taking any of your advice. If they happen to do something that you agree with, it is coincidence rather than causal. Give it a rest.

  6. As I’ve said before, it does not matter if Apple does or does not take Carl Icahn’s advice about stock buybacks. And I don’t think Carl Icahn actually cares either. The POTENTIAL for Apple doing more aggressive stock buybacks at a time when AAPL seems increasingly underpriced… THAT is what will help AAPL move upward toward a more reasonable price per share. And I have no problem with Carl Icahn “helping” to make the case.

    I agree with him about TV and auto, particularly TV in the near term. Here’s the thing about TV that is different from most other business areas for Apple. With Apple, it’s usually about profiting from selling hardware (Mac, iPhone, iPad, iPod, Apple Watch…). The “services” (including the “big” ones such as iTunes Store, App Store, and Apple Pay) are offered as value-added “features” to make Apple’s customers happy and loyal, promoting continued hardware sales.

    TV is different for Apple. With TV, the “service” is the intended profit-maker, not selling the hardware. And Apple knows it… That is why Apple lowered the price of the Apple TV mini-box to $69, to maximize the potential audience for a new (paid) TV content service right before it is rolled out this summer. This is different from the existing non-Apple content services on Apple TV (which will continue) because Apple is packaging and offering the content, and making a direct profit. So, Apple TV (hardware) is not aimed at being a profit center to the same degree as iPhone and most other Apple hardware products.

    In fact, I can see Apple promoting its TV service by offering the Apple TV mini-box for “free,” with contract for one-year (paid) subscription to [whatever Apple’s Internet TV bundle is called]. Sounds like how iPhone is sold, but with Apple providing its own subsidy in order to promote the TV service (which customers will keep using “indefinitely”).

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