AAPL Bears Beware

Overview

At Friday's closing price of $235.86 AAPL is trading at a trailing 12-month price-earnings multiple of about 20 times earnings. Essentially the shares now are trading at less than one-third of Apple's earnings per share growth rate for the first six months of the current fiscal year. To make the point more dramatic, removing the company's cash from the current share price drops the price-earnings multiple to below 17 or about 26.5% of the current earnings per share growth rate. 

Additionally, the earnings per share growth rate for the first six months of the current fiscal year in not influenced by the apparent early success of the Apple iPad. The Apple iPad will only accelerate the pace of revenue and earnings per share growth for the balance of this fiscal year and beyond. I've mentioned several times the Apple iPad alone in the June quarter may represent 20% of the comparative prior year period's revenue total, pushing Apple's revenue growth in the quarter well beyond the almost 40% revenue growth experienced in the first six months of the current fiscal year.

Transcendent Revenue Growth

In the March quarter Apple's revenue segment that includes iTunes store sales represented about 10% of the quarter's revenue. For the first six months of the fiscal year this segment represented about 8.5% of the company's reported revenue. iTunes revenue from music, apps, movies and now electronic books grew 27% in the March quarter, nearly double the first fiscal quarter's rate of growth. iTunes revenue transcends the individual hardware product lines through which revenue is created and this revenue segment will continue to grow and grow almost unnoticed by analysts and journalists. For the first six months of the fiscal year this segment has produced almost $2.5 billion in revenue. 

The Non-Competition Competition

It's not that Apple is exempt from competition. Competition is an elixir that promotes innovation and competitive influences keeps Apple focused on product development. The news is filled with stories of reported iPad and iPhone competitors but competition in a practical sense doesn't exist for now. There isn't a product maker in the market today that can earnestly compete with Apple in a multi-product war. The closest Apple has in competition to the iPhone OS eco-system is coming from Google and its Android OS for smartphones. 

The challenge Google faces in competing with the iPhone is that the iPhone OS eco-system consists of multiple product offerings including the iPod touch, the Apple iPad and the iPhone. Further, Google is not a hardware device maker. It's revenue benefit derives indirectly from hardware products sales in a potentially fractured product market for which uniformity can not be established. For handset makers no matter the reported success of Android OS-based smartphones, the monetization revenue streams post purchase are diverted from handset makers to Google. This not only puts margin pressure on handset makers, it deprives these handset makers of recurring revenue from app and content sales that's necessary to compete in product development with Apple. 

Through at least the holiday season 2010 the Apple iPad lacks a major competitor in the market. HP's acquisition of Palm and its interest in developing WebOS-based devices removes the world's largest PC maker from the tablet market for now. Apple's aggressive pricing on the Apple iPad has Microsoft changing course on its tablet device strategy and not a single potential manufacturer can bring a tablet to market that provides a robust app and content store environment to attract consumers. 

For at least the next eight months Apple has the tablet market to itself, adding to the array and number of iPhone OS-equipped devices in the market. 

Competition for the iPad will come, but not until after the 2010 holiday season and not before Apple's 2nd quarter of FY 2011 begins. While Android OS-based smartphones will compete with the Apple iPhone for sales, the growth of the iPhone OS eco-system will not be impeded. The eco-system is supported by multiple hardware product lines working in concert to create iTunes-related revenue streams.

AAPL Bears Beware

The recent sell off in AAPL only makes the share more attractive relative to the company's current rates of growth and continuing growth potential. Although the Apple iPad's revenue and earnings contributions beginning this fiscal quarter will mask the pace of growth in iTunes-related by temporarily diminishing its percentage contribution to total revenue, this revenue segment will enrich gross margins for the foreseeable future. 

I expect the pace of growth in iTunes-related revenue to quicken as iPhone OS-equipped device sales continue to grow. This is no longer a battle of hardware devices. It's a contest to develop the most efficient monetization models for recurring revenue following initial handset sales. 

Due in part to the release of the Apple iPad early in this quarter, the June quarter's revenue growth for Apple will be greater than the 40% average for the first six months of this fiscal year and earnings per share growth should at least keep pace with the 63% rate for the first half of this fiscal year. 

I reiterate my 12-month price forecast for AAPL. Bears beware. 


Robert Paul Leitao