Apple 2.0

Covering the business that Steve Jobs built

Apple: The bull case, the bear case

July 7, 2010: 1:52 PM ET

An analyst takes his quarterly look at the company from both sides now

There are a lot of superlatives being thrown around this week as analysts position themselves for Apple's (AAPL)'s fiscal third quarter earnings report, scheduled for July 20.

In a note to clients issued Wednesday, Bernstein Research's Toni Sacconaghi, not always the company's greatest booster, called Apple "the most secularly attractive name in our coverage universe."

Brian Marshall of Gleacher & Co. (GLCH), meanwhile, called it "the best technology company on the planet" as he raised his price target to $370 from $355 -- nearly 50% above the stock's current price.

Of course Marshall is a true Apple enthusiast, and he uses that "best technology company on the planet" line every chance he gets. But once a quarter he tries to balance his bullishness by channeling the bears in an instructive exercise he calls "What the bulls will point to ... What the bears will point to."

We've pasted the current edition below the fold:

What the Bulls will point to:
•    iPhone ramp is in early innings: With the iPhone now available in ~90 countries (compared to 80+ in June 2009 and 6 in June '08), the global ramp has just begun and AAPL now has 150+ international carrier partners (recall RIMM has well over 400 carriers). Cumulative shipments of the iPhone since its June '07 inception now total 51.2mil units.
•    Best technology company: Apple continues to gain share across its major product lines (iPhones, Macs and iPods). Its business model is becoming stronger over time as well as the company benefits from an increasing richness of its revenue mix and when ASP cuts come, customers typically migrate up the "SKU stack" and buy higher priced items with higher associated gross margins.
•    The Bank of Apple: Apple continues to generate tremendous amounts of cash flow from operations and its current net cash hoard (i.e., total cash minus total debt) now stands at $41.7bil (or $45 per share) - the single largest in the technology industry by far. This compares favorably to other large technology leaders with large net cash positions including: MSFT (~$27bil), Cisco (~$25bil) and GOOG (~$25bil). With AAPL shares currently trading at ~$250, the cash balance represents ~18% of the market capitalization (net cash $45.19/share).

What the Bears will point to:
•    Margins have peaked: Apple's gross margin reached 41.8% in September '09 and based on management's guidance, gross margins are expected to decline significantly to ~36% in June '10. This trend should continue as pricing pressure will intensify going forward as the company aims to maintain its market share in a competitive environment. ASPs will simply decrease faster than cost of goods sold (COGS), thus negatively impacting the gross margin.
•    iPhone/iPad will cannibalize iPod family: The iPhone/iPad has successfully integrated the functionality of an iPod into a sleek smartphone/media player and has effectively rendered a significant portion of the iPod product family obsolete. Ever since the June '07 introduction of the iPhone and the April '10 introduction of the iPad, there has been a marked deceleration of unit sales of iPods on a Y/Y basis (in fact, posting a Y/Y decline in units the past four reported quarters). This presents a serious problem as iPods generated 17% of Apple's total revenue in CY09.
•   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.

Traders Wednesday seem to be favoring the bull case. Apple closed at $258.67, up $10.04 (4.04%), in mid-afternoon trading.

See also:

[Follow Philip Elmer-DeWitt on Twitter @philiped]

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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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