We recently published an article on the irrational exuberance exhibited within small capitalization stocks. We think as the hype inevitably comes out of the small capitalization space in coming periods, this “speculative” capital, assuming some of it can cross cap restrictions, will flow into underpriced (yet growth-y) equities with extremely strong fundamentals, companies like portfolio holdings Apple (AAPL) and eBay (EBAY) that have tremendous upside potential.
Carl Icahn is working diligently to reveal the significant underpricing of eBay in requesting a spin-off of PayPal to unlock value much like that of Yahoo (YHOO) unlocking value via its initial public offering of Alibaba. Yahoo’s shares have performed wonderfully in the wake of the Alibaba IPO. We think Icahn will inevitably get his way to the benefit of eBay shareholders, and Icahn’s latest request makes a lot of sense. In Apple’s case, however, we think the launch of the iPhone 6 will be the catalyst to drive shares to intrinsic value. Apple has traditionally been a stock that trades on its product cycle, and while we think it will continue to do so (on the basis of market behavior), the expected launch of the iPhone 6 will be the catalyst that finally unlocks Apple’s true intrinsic value, which we believe to be well north of $600 per share.
According to reports, the iPhone 6 will have a larger, sapphire crystal screen, a faster and more efficient A8 chip and have a release date in the fall 2014. We’ve pasted below the rumored sizes of the iPhone 6, larger than the iPhone 5s but smaller than the iPad mini. We think either the 4.7 inch or 5.5 inch size will hit the sweet spot of usability. From our research, the iPhone 5s at 4 inches is a bit small, especially as consumers grow more comfortable with the larger iPad in day-to-day activities.
Image Source: Macrumors.com
Though there will be other features of the iPhone 6 that will attract iPhone owners to upgrade, we think the larger size will be the most important selling point. According to optimistic forecasts, the iPhone 6 launch could drive an upgrade rate of 12%-14% of existing iPhone owners. Though this rate approximates peak levels, we think the iPhone 6 will have even greater success on the basis that consumers didn’t truly know the optimal usability size until the iPad proliferated. With the iPhone’s installed base of 260 million users, an upgrade rate in the mid-teens would offer a significant boost to Apple in the back-half of 2014 when the iPhone 6 is expected to be released. Because the iPhone is a more portable, workable device than the iPad, per se, we don’t think much cannibalization will happen as a result of the size adjustment. We’re very excited about what this means for Apple later this year and into 2015 as new iPad versions hit the market.
Valuentum’s Take
We know that the market knows that Apple is cheap, and we think the launch of the iPhone 6 will be the catalyst to drive shares to intrinsic value. Our discounted cash-flow derived fair value estimate is $680 per share, but a glimpse into Carl Icahn’s math reveals that a much higher price target could be achieved (see below).
2014 consensus EBIT of $52.5B less taxes (26% tax rate on EBIT) = $39B of earnings. S&P 500 at 1844.86, trades at 16x consensus earnings of $116.65. $39B of earnings x 16 (S&P 500 multiple) = $617B. $617B plus net cash of $130B = $747B. $747B divided by average shares during 2014 of 889MM = $840 per share. $840 per share is 52% higher than its current price of $551.51 per share.
We like Apple and think the firm will continue its ascent once the speculative frenzy regarding small caps subsides and the release of the iPhone 6 is upon us. The company remains a holding in both actively-managed portfolios.
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