Posts At Eventide

To my friends:

I've started this informal blog entitled Posts At Eventide. As the name suggests, it's designed for posts at the end of the day and it's intended to serve as an informal repository for the day's stream-of-consciousness musings and thoughts about my favorite things, including my favorite fruit company that incidentally makes computing devices.

My desire is for the blog to serve as a testing ground of sorts for concepts, themes and topics I may develop over time and revisit from time to time as well.

I appreciate the support of readers who have followed my writings about Apple and the personal digital device markets. I look forward to continuing the conversations with each of you in this spot and at the other Web spots we frequent.

Robert (aka DawnTreader)

Apple's Market Capitalization

I was thinking about Apple's market cap earlier today. I know the company has entered or is near entry into the list of top 10 publicly-traded enterprises in the US when measured by market capitalization. I did a Google search to find a quick list based on today's share prices. Instead I came across Philip Elmer-DeWitt's recent column discussing Apple's market cap is now greater than the market caps of HP and Dell combined. It's one of the few columns he's written lately (published yesterday) that I've missed.

The Dell story has become a tragic one. To prop up earnings per share, the company has exhausted almost $28 billion in cash to reduce the number of shares outstanding. The company has used used more hard cash buying back shares than the company itself is now worth.

Apple's market capitalization at about $145 billion places the company in the thin air space among American publicly traded enterprises. Apple is one of the great shareholder success stories of this decade. Long-term shareholders have been enriched with an exponential return on their investment by buying and holding the company's stock.

Having reached the top tier of publicly-traded companies when measured by market cap and closing in on the market cap of Microsoft (currently about $212 billion), it's reasonable to wonder: How much higher can the share price rise?

Apple trades at a price to earnings multiple of about 28.5 times the trailing twelve months of earnings. As an AAPL investor I expect the share price to double from today's closing price of about $163 within the next three years.

Among the reasons for my optimism are the following:

I expect Mac unit sales to continue to rise (albeit at a slower pace of growth than what was realized immediately following the Intel transition).

I expect iPhone units sales to continue rising at a torrid pace over the next twenty four months.

I expect the much-rumored Apple tablet to establish not only a new product class, but to further erode the underpinnings of the PC market and assist in accelerating the developer migration to Mac OS X.

I expect the market itself to enter a bull market phase in the coming year, closing the space between Apple's current p/e and the market average p/e of large cap and medium cap firms.

Interest rates will be on the rise, increasing the return on Apple's holding of more than $30 billion in cash and equivalents. Remember, the company has no debt and is generating cash at a far greater rate than the p/e suggests due to the subscription method of accounting on the iPhone and other factors including the popularity of iTunes gift cards. Pre-paid gift cards are essentially interest free loans to Apple for the purchase of products at a later date. In a way, Apple has created its own form of currency through the iTunes franchise

I won't delve into the numbers right now, but here are my anticipated milestones for the Mac and iPhone maker:

Within 12 months surpassing Microsoft's market cap

Doubling GAAP eps within 30 months (yes, that's an aggressive call)

Reaching the equivalent of $300 per share within 36 months

That's it for tonight's prognostications.

The iPhone, Innovation and Subscription Accounting

I credit Mike in Helsinki of the Apple Finance Board forum for approaching the issue of the iPhone's contributions to Apple's non-GAAP revenue in the June quarter. Because Apple recognizes iPhone revenue based on a subscription revenue model, recognizing the revenue and earnings over the anticipated economic life of the product (two years), the iPhone's importance to Apple's reported bottom line is obscured while iPhone unit sales rise relative to corresponding prior periods.

In the current quarter (period ending in September), the iPhone may contribute more in revenue to Apple's corporate coffers than the Mac. While GAAP (or reported revenue and earnings) will reflect only the portions of current and prior iPhone sales to be recognized under the subscription method of accounting, the total revenue (what's reported and what's deferred to future periods) on iPhone handset sales may be greater than all Mac sales combined.

The iPod provided revenue cover for Apple while the Mac line made its transition to Intel chips. The Mac returned the favor during explosive sales growth following the transition to provide revenue cover while Apple developed the iPhone. The iPhone will provide the rich revenue to cover Apple's development costs for new products including chips developed inside Apple specifically for handheld devices.

While Apple may continue to use Intel chips exclusively for the Mac line for some time to come, the chips for the next generation of handheld products may be of Apple's design origin.

The subscription method of accounting for the iPhone reduces the reported revenue arc in current periods but extends the benefit of those sales to reported revenue and earnings for two years from the time of sale. As long as iPhone handset sales continue to grow in comparison to prior year periods, Apple is virtually guaranteed rising quarterly profits should the rate of Mac unit sales growth slow or remain static in relation to corresponding prior periods.

With the prospects for future profits growing brighter with each iPhone unit sold, there's no reason for Apple to reduce its R&D investment or commitment to new product development for the sake of operating margins. It provides Apple with clarity to its future earnings picture unlike any of its competitors and more than ample resources from operations to further the company's innovation lead over those competitors.

What Is The Personal Computing Experience?

I've been associated with ATPM (About This Particular Macintosh) since 1995. The publication was started to celebrate what we call the "personal computing experience." Back then the user experience revolved around the desktop Mac or PC and the Internet was just arriving via of modem. Those were the days of dial-up, Netscape Navigator 1.0 and an Internet experience dominated by geeks, message boards and avant-garde artists. It was not the domain of commercial interests offering multimedia rich online experiences as it is today.

Today the "personal computing experience" is as much about handheld devices as it is about desktop computers and laptops. While the form factors have changed and Internet access speeds have risen exponentially, the personal computing experience is still about the way we wish to digitally see and communicate with the world.

The iPhone has become my primary news reader, personal communication portal and always-connected source for information and musical entertainment. For $200 (and a long two-year contract) I can easily carry all of the Web and all of the personal communication resources I need in my pocket.

The iPhone is among the reasons the PC market has seen its zenith and the reason application developers (big and small) are flocking to the OS X platform. The Apple app store is an amazing virtual storefront offering almost everything imaginable and often at $.99 or less.

The iPhone has made the personal computing experience more grand in scope even if the device used has become much smaller in size.

Apple and The Hardware Monetization Model

In the 80's and 90's Microsoft changed the monetization model of the personal computing industry from a hardware-centric model to an industry that monetized software (Windows, Office, etc.) at the expense of the commoditization of PC hardware. It's why PC prices will continue to fall and Windows OEMs have a hard time differentiating their products in the marketplace to create hardware margin opportunities. They all run Windows and consumers have been trained to focus on price. Microsoft has sucked the bulk of the margin out of the PC market through Windows licensing fees leaving little in the way of resources for OEMs to invest in hardware R&D to differentiate products from those offered by competitors.

Apple has reversed the Microsoft monetization model with a focus on the hardware devices. Apple maintains high margins and is aggressively commoditizing software - iLife is free on new Macs, the pending Snow Leopard upgrade will cost $29, iPhone apps by the thousands are free or as low as $.99 at the Apple app store. The change began with the release of the original iMac and continues today in products such as the iPhone and iPod touch

Apple's focus on hardware design and the company's passion for creating pleasant-to-use products has moved the monetization model to the value of hardware versus software. This is why and why Apple has the highest hardware margins in the PC industry today and dominates the markets for PCs costing $1,000 or more.

It's also why Apple's market cap is closing in on the market cap of Microsoft as the Cupertino-based company eclipses the maker of Windows as the driving economic force in the PC market and emerges as the the most potent force in the handheld communications and computing device on the planet.