Bulls vs. Bears: Re-analyzing Apple

Apple's (AAPL) "It's only rock and roll" event Wednesday triggered a flurry of fresh reports from analysts who track the stock, including Piper Jaffray's Gene Munster, Caris's Robert Cihra, Needham's Charlie Wolf and RBC's Mike Abramsky. (See AppleInsider for a concise summary of their generally positive remarks.)

But we were particularly taken by the report issued Thursday morning by Brian Marshall, who took over the Apple beat at Broadpoint AmTech when Shaw Wu left for Kaufman Bros.

Borrowing a device Wu liked to use -- and one that reflects the way investors talk about Apple on the financial boards -- Marshall set it up as a debate between the Apple bulls and the Apple bears:

What the Bulls will point to:

• iPhone ramp is in early innings: With the iPhone now available in 80+ countries (in-line with 81 in March '09, 70 in December '08, 51 in September '08 and 6 in June '08), the global ramp has just begun (recall RIMM has over 400 carriers now). Cumulative shipments of the iPhone since its June '07 inception now total 26.4mil units. [NOTE: Steve Jobs on Wednesday put iPhone sales at 30 million.]
• Best positioned company in technology sector: Apple continues to gain share across its major product lines (MacBook notebooks, Mac desktops, iPod digital music players, iPhone smartphone and the iTunes application). Its business model is becoming stronger over time as well with continued penetration of international markets (the opposite of most of its competitors).
• The Bank of Apple: Apple generated $2.3bil in cash flow from operations in the June '09 quarter and its cash hoard now stands at $31.1bil (or $34 per share) - the single largest in the technology industry. Only Cisco ($29bil cash) has a comparable cash balance to Apple when analyzing the leading technology companies' balance sheets (e.g. Microsoft $21bil, Google $14bil, Hewlett Packard $12bil, Oracle $11bil and Dell $9bil). With AAPL shares currently trading at ~$171, the cash balance represents ~20% of the market capitalization.

What the Bears will point to:

• Margins have peaked: Apple's gross margin reached 36.9% in June '07 and has since declined to 34.7% in December '08. This trend should continue as pricing pressure will intensify going forward as the company aims to maintain its market share in a declining economic environment. ASPs will simply decrease faster than cost of goods sold (COGS), thus negatively impacting the gross margin.
• iPhone will cannibalize iPod family: The iPhone has successfully integrated the functionality of an iPod into a sleek smartphone and has effectively rendered a significant portion of the iPod product family obsolete. Ever since the June '07 introduction of the iPhone, there has been a marked deceleration of unit sales of iPods on a Y/Y basis. This presents a serious problem as iPods generated 28% of Apple's total revenue in FY08.
• Stratospheric carrier subsidies unsustainable: It is estimated that Apple receives approximately $450 from AT&T Wireless on the activation of an iPhone 3GS as part of a carrier subsidy program. It is also estimated that Apple receives an average subsidy of ~$300 from its international carrier partners as well. These subsidies are well above average of what other vendors (even RIMM) collect. After the introduction buzz of the iPhone 3GS has worn off and the subsidy agreements expire, the wholesale ASP of the iPhone will likely take a significant step down.

Marshall makes no secret of where he comes down in this debate. Calling Apple "'THE' undisputed growth name in tech," he reiterated his $210 target.

Apple shares, having gained more than 5% in the week before he event, dropped nearly 1% Wednesday to close at $171.14. The stock opened higher Thursday, zig-zagged a bit, and was still up a fraction of a point in midday trading.