Latepost Apple's Crown Jewel: Valuing The Iphone Franchise

If you lot are a stockholder inward Apple, it is fourth dimension to celebrate again! The concluding calendar week has been an eventful ane for the company. In add-on to claiming the championship of won its lawsuit against Samsung on "patent infringement" charges. Samsung volition non alone hold out required to pay $ 1 billion inward damages but may also receive got to take away some of it products from the the United States marketplace every bit a consequence. To add together to the mix, the iPhone v volition before long hold out arriving on the shelves too at that topographic point is utter ane time again of Apple becoming the get-go trillion dollar fellowship ever.

As alongside my concluding ii posts, I wishing to develop the tape instantly on my posts on Apple inward the concluding twosome of years. In Jan 2011, I posted on Apple's immense cash balance (of $50-$60 billion at the time). too argued that, every bit a long-term investor inward the company, it has earned my trust after an unmatched decade of success, both inward terms of profitability too stock returns, too that I was okay alongside them belongings on to the cash. In March 2012, I returned to the question partly inward answer to intelligence stories that suggested that Apple may initiate a dividend. Noting that dividends would attract a rattling different grouping of stockholders into the fellowship too set them on collision degree alongside the existing stockholder base, I posted that if Apple was intent on returning the cash (as Tim Cook seemed to be), it should exercise a large stock buyback. I also I bid my adieu to the fellowship every bit an investment, alongside much regret too gratitude. I justified my determination to sell non on valuation (since I establish the stock to hold out worth $700+) but on ii counts. First, I argued that the fellowship had larn a momentum play too that the pricing procedure had lost its connectedness to the valuation process. Second, I also felt uncomfortable alongside the mix of dividend, growth too momentum stockholders, alongside differing expectations virtually the fellowship too differing demands of it. Even though Apple’s stock cost has gone upwards virtually 10% since I sold it, I receive got no regrets virtually selling. Since my master example for selling the shares was predicated on a fickle investor base of operations alongside conflicting views, I believe that the stock cost gyrations over the concluding half dozen months supports that thesis. The stock cost dropped every bit depression every bit $530 too at nowadays risen to its high for the twelvemonth without whatever dramatic intelligence announcements for the most part driving the cost (until the concluding week). My intrinsic valuation has non changed much inward that flow too remains over $700, alongside the updated numbers through the goal of concluding quarter. 

No affair what your views (bullish or bearish) are on Apple, I intend that at that topographic point tin hold out footling disagreement on the suggestion that Apple's marketplace value rides to a greater extent than on ane product, the iPhone than always earlier too that it is worth taking a closer aspect at the underpinnings of that value. Looking at the numbers, hither are 3 telephone substitution points worth making virtually the iPhone franchise (and its value to Apple):

1. The iPhone is a coin machine: In the most recent twelve months, the iPhone generated virtually $100 billion inward revenues too unopen to $21 billion inward after-tax profits for Apple.
2. The iPhone is a dominant actor inward a growing market: The smartphone marketplace grew virtually 40% concluding year,  primarily every bit jail cellphone telephone users switch to smart phones. During the year,  more than 150 ane yard one thousand smart phones were sold, alongside Apple accounting for virtually 20% of the units sold. However, alongside its heftier cost tag on the iPhones, Apple had a 43% portion of the market, if it is defined inward dollar revenues. 
3. The iPhone has a brusk life cycle: One of the reasons for Apple's disappointing earnings inward the most recent quarter is that customers stopped buying the iPhone 4S, waiting for the iPhone v to arrive. Since the iPhone iv came out inward June 2010 too the iPhone 4S was introduced inward Oct 2011, that puts virtually a two-year life bicycle on the product.  So what? Companies similar P&G or Coca Cola arrive at products that receive got rattling long life cycles; diapers too sodas receive got non alone non changed much over the concluding few decades but are unlikely to alter past times much over the side past times side few. Protected past times potent construct names, they tin hold out expected to generate earnings for long periods, alongside relatively footling investment or conception past times the companies inward question. With a brusk production life cycle, a fellowship is faced alongside ii challenges. First, it has to come upwards up alongside innovations to its production to retain its customers when the bicycle is renewed, too that volition involve investment, particularly during the afterwards parts of each cycle. Second, fifty-fifty alongside these innovations, at that topographic point volition hold out customers who switch to competitors' products (either because they are cheaper or because their innovations are to a greater extent than attractive) too for a fellowship to maintain it's marketplace share, it has to larn to a greater extent than of it's competitors' customers to switch to its products. 

Given the iPhone's profitability too authorization inward the growing smartphone market, I tried to value the iPhone franchise, incorporating the effect of the brusk life cycle. In assessing the value, I made the next assumptions.

1. Profitability: Apple volition hold out able to maintain its electrical current after-tax operating margin of 21% on futurity iPhone sales. 
2. Smartphone market: The smart telephone marketplace volition proceed to grow at a 6% compounded charge per unit of measurement for the side past times side 10 years, alongside growth tapering downwards towards the growth charge per unit of measurement of the economic scheme inward the long term. 
3. Product life cycle: The life bicycle for a novel iPhone volition proceed to hold out ii years too Apple volition receive got to reinvest one-half its after-tax operating income inward the 2d twelvemonth of each bicycle (this 50% also contain the lost sales inward the 2d year, every bit each iPhone ages too customers hold back for the side past times side version).
4. Switching assumptions: iPhone customers are assumed to hold out loyal, alongside alone 5% switching to competitors' products at the goal of each life cycle. Apple volition hold out to a greater extent than successful at attracting competitors' customers, alongside 10% switching into iPhones. 
5. Risk: Needless to say, at that topographic point is substantial direct chances inward this procedure too the cost of upper-case alphabetic lineament of 11% (at the 90th percentile for the United States companies) reflects that risk.

The value that I guess for the iPhone franchise is $307 billion, working out to a multiple of 3.39 times revenues too virtually 16.17 times internet income on the iPhone. You tin download the spreadsheet that I used too alter the assumptions, if you lot then desire. In fact, every bit alongside my Groupon too Facebook valuations, I receive got opened a shared Google spreadsheet for you lot to travel inward your estimates of value for the iPhone franchise.

Here is the larger point, though. About 55% of Apple's trouble organization value comes from its iPhone franchise too at that topographic point are 3 pull per unit of measurement area points that volition exam this value.

• The get-go is Apple's capacity to maintain pricing power too earn its electrical current margins; at that topographic point isn't a competition inside shouting distance of Apple, when it comes to margins. If the after-tax margin drops to 15% from its electrical current 21%, the value of the franchise drops to $219 billion.
• The 2d is that Apple volition hold out able to prevent the life bicycle from speeding up farther too that it tin continue to innovate at a reasonable cost (with this cost inward conjunction alongside the loss inward earnings during the 2d part of the bicycle non exceeding 50% of the after-tax earnings during the period). Reducing the life bicycle to ane twelvemonth from ii almost halves the value of the franchise.
• The 3rd is that Apple is able to maintain a internet positive switching ratio (more of the competitors' customers switch to Apple than vice versa), allowing it to growth inward marketplace portion inward dollar value terms. Assuming a neutral switching ratio (customers switching inward = customers switching out), reduces the value of the franchise to $255 billion. 

There is an internal tension betwixt these 3 variables, since keeping iPhone prices high (preserving the high margins) too spending less on conception (reducing the cost of innovation) may growth the direct chances that to a greater extent than customers volition switch away than into the iPhone. Using the "life cycle" model also provides some perspective on why the lawsuit victory against Samsung may receive got a bigger effect on the value of the iPhone franchise than how the iPhone v fares alongside customers inward a few weeks. Samsung's loss volition receive got a deterrent effect on competitors planning an develop on on the iPhone kingdom, hence increasing Apple's pricing mightiness (preserving margins) too improving its odds of belongings on to its customers (improving its switching ratio).

With the iPod, iPhone too iPad, the fellowship has been able to count on the unmatched loyalty of its customers, piece both attracting customers of less innovative competitors too increasing overall marketplace size. The interrogation that investors confront correct at nowadays is whether Apple tin proceed its winning streak. The high valuations attached to the fellowship assume that the fellowship tin maintain doing what it is correct now, that the iPhone v volition non alone launch successfully, but hold out followed past times the iPad Mini too the iPhone 6 too then on. The direct chances that investors receive got to receive got into trouble organization human relationship when investing inward Apple is that somewhere along the way, the winning streak may volition hold out broken. Unlike other large marketplace cap companies alongside long production life cycles or diversified production portfolios, Apple’s value rests on beingness a Phoenix, constantly reinventing itself every few years.

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