Thursday, June 7, 2007

The Obligatory iPhone Prediction

Based on the stock price increase since the iPhone was announced, somewhere between 25% and 33% of Apple's stock price is due to speculation on the iPhone. Instead of tradational investors, Apple gets "fanboy" investors; from a tradational investment perspective, it's a horrible investment. It's P/E is high, and they haven't paid a dividend since 1995--it behaves more like a startup than a mature company. Prices this high are due to a combination of investors expecting growth, or investors expecting the next product to drive up the stock price.

So the question is what should Apple be worth? If there's a crash, at what price should it drop to to make it worthwhile? First, if it didn't have such strong growthm, and instead matched the Nasdaq, it's F P/E would be 20.8--a value indicating it's either a little overpriced or moderate growth is expected. For comparison, this is around the average of Microsoft's P/E and F P/E--it's a reasonable value when compared to similar companinies

There are two examples to look at for guessing a reasonable price for Apple: the iPod and the Motorola RAZR (which was interestingly described as the iPod of mobile phones). The forgotten story of the iPod is that it was launched in 2001 as just another mp3 player. It became popular a few years later after 3 generations of hardware fixed the bugs. Apple kept a prices somehwhat high, balancing the phones exclusivity and profits. In contrast, the RAZR was marketed from the beginning as a stylish, exlusive phone. It followed a business model of consistent price drops, eventually leading to the comoditization of the phone. As more and more people obtained RAZRs, profit margins slipped, and Motorola was left looking for the next RAZR. The likely aproach is a phone initially introduced and priced much like the RAZR, at $400-$500, and over time, prices will be reduced, but the phone will always carry at least a $150 price tag. From a business perspective, Apple is in a good position with the product.

But one product, one $30 billion product. According to the F P/E without the recent price increase, Apple needs to increase profit by $1.4 billion per year to keep up with expectations. Apple's current profit is just under $2 billion per year. The iPhone will likely cut into iPod sales. When Motorola released the ROKR, it was rumored the 100 song limit was done by Apple to prevent the ROKR from hurting iPod sales.

The demographics of iPhone buyers probably looks like this: those under 20 probably can't afford it, and those over 35 are in the Blackberry crowd and were skipped over by iPods.

Apple will probably make the profit margin on iPhones steady (unlike Motorola and the RAZR). The 50% rumored profit margin will probably continue. Since I'm after the price Apple should be, I'll look at long term iPhone sales. Due to demographics, of the 200 million cell phone owners in the US, around 25% are in the age group likely to buy iPhones. Around 80 million mp3 players have been sold so 50 million out there, and around 70% are iPods, so that leaves 35 million buyers in the US. At best, that means 20 million iPhones (remembering that the curve representing iPhone buyer distribution is like the iPod one, only lower and narrower). At what will probably work out to $150 profit per unit, or $3 billion. Most of these phones will replace iPods (or cause someone to buy the phone, not the iPod), so the $3 billion is closer to $1.5 billion. The overseas estimate is harder, but the market is probably a lot smaller. Asia and Europe have see far more mobile phones than the US, and they won't be as easily impressed, especially liking smaller designs. If cell phones get replaced every 3 years and overseas sales is the same as US, iPhones will profit $1 Billion per year, the P/E for AAPL.iPhone will be 30. That's very close to the current F P/E.

So that makes the AAPL price apropriate. The problem is that this neglected risk, competition from Motorola, Nokia, and Sony (who knows, maybe Microsoft), and the 10% market share was generous. Since I want to know what price AAPL is actually worth, all I need to do is guess the market share. In reality and in the long term, I think it will be around 4%. I can barely see 1/20 people having one. That makes the P/E for AAPL.iPhone 75.

Going back up to the corrected F P/E, I'd like to see AAPL.iPhone down to either it or the current P/E (20-30). I'll buy AAPL if it dips below 95, presumably after a correction.

The iPhone will migrate users from the lower profit iPod to the iPhone and take another round of money away for them to say cool, but it won't expand Apple's market; it's just an upgrade. Blackberry users need a keyboard, kids need something cheap, and parents don't need the product. The iPod market is almost saturated, and whatever growth is left is already in the high stock price.

The important thing to remember is that reviews and perceptions of the iPhone within the first month will dictate what the market's reaction will be. Apple has an ace up its sleve, here: there's an opening in the market for such a product. There hasn't been a stylish, exlusive phone since the RAZR came out in 2004. It's all left to Apple's execution, though. There was an opening in the market for a similar product, Motorola's ROKR, a phone that could even work with iTunes. Ultimately, both the hardware and software were clunky, turning users off. Apple certainly has the track record to make it work smoothly, provided they get the GSM part right. After all, who wants to pay $600 for bad reception, dropped calls, and music, all in one package?

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