Carl Icahn Releases Apple Letter – Page 2 – ValueWalk Premium
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Carl Icahn Releases Apple Letter

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. We detail below how we arrive at these forecasts.



Composing 55% of net sales, iPhone is Apple’s largest product platform. Consumers have already responded with unparalleled enthusiasm to the new iPhones with millions of people waiting in lines all around the world to buy an iPhone 6 or 6+, and the positivity from expert reviewers and the press has been stronger than we have ever seen. Legendary reviewer Walt Mossberg simply stated, “This is the best smartphone you can buy, and I am unequivocal about that.” Now that Apple is offering larger phones with roughly the same size screen as competitors’ offerings, and targeting mainland China at the time of its 4G rollout, we expect Apple to take significant market share. As users roll off their existing wireless carrier contracts, they can choose a superior product at a comparable price. There are obviously lower priced competitive offerings, but the marginal premium one pays for an iPhone is not significant for meaningful percentages of the global population. As we explained earlier in this letter, the effective cost of an iPhone 6 is just $20 per month. Considering the increasing amount of time users spend with their mobile devices, and thereby the practical value of a noticeably superior product, it is hard to imagine why a consumer would choose an inferior phone when the marginal cost difference is so small. That is why we expect Apple to take market share not only from those competitors offering a phone at a similar price, but also those competitors offering phones at cheaper prices. As the quality of the Apple ecosystem (iPhone, iPad, Mac, iTunes, App Store) continues with new additions (Apple Watch, Apple Pay, Home, Health, Continuity, iCloud) to pull away from a relatively flawed and fragmented Android ecosystem, market share gains will continue. For next fiscal year, the new iPhone 6 and 6+ should drive iPhone revenue growth of 30%, due to volume growth of 22% (premium market share gains, category growth, upgrade cycle) and pricing growth of 7% (mix shift to the iPhone 6+ that sells for a $100 premium to both the iPhone 6 and the iPhone 5s at this time last year). In the following years, FY 2016 and FY 2017, we expect volume growth of 7% and 10% respectively and flat average selling prices as Apple experiences no pricing pressure and continues to take market share.


iPad and Mac

Contributing 17% to net sales, iPad has experienced tremendous growth since its introduction in 2010. After a disappointing FY 2014, we believe the iPad will reaccelerate growth next year, especially if Apple, as rumored, offers


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