Two days ago, Carl Icahn (Trades, Portfolio) divulged straight to the public via Twitter that he had sunk another $500 million into Apple Inc. (AAPL, Financial). That day, his total Apple investment rose to $3.6 billion. Icahn called Apple’s value a “no brainer,” but later offered a lengthy discourse on just what it actually entailed, as he vies for a larger share buyback from the company.
Valuation
The first characteristic that makes Apple an obvious choice for Icahn is its valuation.
“The S&P 500’s price to earnings multiple is 71% higher than Apple’s, and if Apple were simply valued at the same multiple, its share price would be $840, which is 52% higher than Apple’s, and if Apple were simply valued at the same multiple, its share price would be $840, which is 52% higher than its current price," he wrote in his letter yesterday,
The market’s P/E in January 2014 is 18, up from 14.2 a year ago. Apple’s P/E ratio remains below both, at 13.78, up from about 11 a year ago.
P/E (TTM) of the S&P 500 Index:
P/E of Apple over five years:
Icahn’s other similar investments – Netflix (NFLX, Financial), Hain Celestial (HAIN, Financial), Chesapeake (CHK, Financial), Forest Labs (FRX, Financial) and Herbalife (HLF, Financial) – have proven quite profitable, perhaps emboldening him on Apple.
Icahn bought Netflix in the third and fourth quarters of 2012. In that time, its P/E ratio moved from 41 to 325. Its share price has also increased about 418% from his average purchase price of $75.09 to $388.72 on Friday.
Icahn made his largest buy of Hain Celestial in the second quarter of 2011, when the stock’s P/E moved from about 30 and about 27. Its price from his average buy price that quarter has also increased about 184%, from $33 to $94.
His purchase of Chesapeake spanned 66.45 million shares of the company from the second quarter 2012 to third quarter 2013. During that period its P/E ranged from about 9.5 to 20. The price has gained about 45% from his average buy price of $18.49, to $26.90 Friday.
He bought the majority of his Forest Labs stake of 30.66 million shares from second quarter 2011 to third quarter 2012. Its P/E during that time: 9.5 to about 18. The price has surged 93% from his average price.
Herbalife was purchased in the first and second quarters of 2013, in which time the P/E was about 8.5 to 10. His average gain on his almost 17 million share holding of Herbalife is 68% so far, up to $65.60 a share Friday.
Operating Margins
Icahn feels confident that consumers will continue to pay up for new iterations of the world-class products Apple has historically made, such as a larger-screened iPhone and iPad, in spite of competition from Google (GOOG, Financial), Microsoft (MSFT, Financial) and others. He notes Apple’s operating margin of 28.5%.
The company’s operating margin for the third quarter declined year over year, as did its margin from last year. The trend has been upward, however:
New Products
What many analysts have overlooked and also makes the company undervalued, Icahn argues, is Apple’s robust potential to introduce new products and services to an eager market. The innovation that thrived under Steve Jobs will continue under Tim Cook, he believes, and Cook has insinuated. Icahn is primarily looking out for: a television, a smartwatch, Airplay and mobile payments.
Apple is very secretive about its new product development, and evidence of the existence of an Apple TV so far amounts to rumors. A number of Apple analysts have predicted the release of an Apple television for years. One such, Jeffries analyst Peter Misek, announced that he foresaw a release in 2012, then 2013. By last May, he had revised that prediction to 2014, saying Apple “wants a display that looks like 4K/Ultra HD but without the super-premium cost.”
Tim Cook’s last word on the subject came in May 2011 during a D11 conference, where he said the company is learning more about television through its Apple TV set-top box:
"I think many of us would agree that there's lots of things about the TV experience that can be better, we answered some of those, clearly not all of those, with Apple TV, and we're going to continue to make that better," promised Cook.
Cook was also nonspecific on the existence or release of an Apple smartwatch, saying at the D11 conference in May:
"I think the wrist is interesting. I'm wearing this (Nike Fuelband) on my wrist...it's somewhat natural. But as I said before, I think for something to work here, you first have to convince people it's so incredible that they want to wear it."
The same Jaffray analyst in October 2013 predicted an iWatch launch in March of 2014, with the caveat that “it could be shifted.”
Last, the next generation mobile payments platform Icahn mentions has only the barest rumors on the Internet, mostly based on an Apple job posting from November seeking a “payments software engineer” to work on a “next generation payment platform.” Fast Company posits Apple could be aiming to develop a “true electronic alternative to standard credit card processing in stores.” Such payments could take place integrating Apple’s already-released iPhone wireless service that allows retail stores to identify when a shopper enters their store and send them relevant notifications and promotions.
Icahn said of the potential technology: “… Apple could introduce a next generation payments solution. In terms of whether the marketplace is well addressed by mobile payments solutions, Tim Cook has said “I think it is in its infancy… I think it is just getting started and just of out of the starting block.” With the fingerprint sensor, iBeacon, 575+ million credit card numbers stored in iTunes, and Apple’s homogeneous iOS installed base with 79% of devices using iOS 7, we believe a revolutionary payments solution is now a very real opportunity that the company could choose to pursue.”
Though the company has remained vague on its new products, it did at least confirm that consumers can expect something in the wings this year. “We are really excited about the upcoming releases of iOS 7 and OS X Mavericks,” Cook said in July, “and we are laser-focused and working hard on some amazing new products that we will introduce in the fall and across 2014.”
Repurchases
Icahn hopes to use the above arguments to strengthen his case that the stock’s undervaluation merits a further strengthening of its share buyback plan. In large part due to the effort of some activist investors, the company agreed in April to expand its capital return program by $55 billion to $100 billion by the end of calendar year 2015. The amount averages to $30 billion annually. Under the program, the repurchase of a historic $60 billion in share repurchases was authorized, as opposed to the $10 billion in repurchases it announced the previous year.
“We are very fortunate to be in a position to more than double the size of the capital return program we announced last year,” said Tim Cook, Apple’s CEO. “We believe so strongly that repurchasing our shares represents an attractive use of our capital that we have dedicated the vast majority of the increase in our capital return program to share repurchases.”
At the end of the third quarter, Apple held $146.8 billion in cash and marketable securities.Ă‚
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