The recent rally has not changed my stance but on the other hand, it has increased my belief that Apple is trading in a bubble (Apple is overvalued). Analysts keep raising their price targets and their estimates seem to be increasingly justified by more and more aggressive valuation multiples. In this report, we look at a recent analyst upgrade by an Apple “super-bull,” and question whether the price targets makes sense even considering the arguably optimistic assumptions. When you get too close to the sun, dangerous downside catalysts magically appear. I rate shares a sell with over 25% potential downside.
Crumbling Under the Most Bullish of Estimates:
Wedbush’s Dan Ives is known to be an Apple super-bull. He recently issued a Street-high $150 price target. That equates to a market cap of around $2.5 trillion. His bull thesis centers around a “once in a decade” opportunity for Apple to drive 350 million iPhone upgrades due to the 5G supercycle over the next 12-18 months. 350 million iPhone upgrades seem aggressive especially considering that Apple generated $142.4 billion in iPhone sales in 2019. Regardless, let us assume that Apple can really hit 350 million iPhone upgrades over the next 12-18 months. To be clear, from here on out I purposefully use overly optimistic estimates to prove my point that Apple is grossly overvalued.
9to5Mac expects the iPhone 12 to have a similar pricing model to the iPhone 11. The iPhone 11 Pro Max (the largest and most expensive iPhone offering) sells for $1,249 at the 256 GB storage category. If we assume that the average iPhone 12 sold is at a $1,249 price point, then 350 million iPhone upgrades to the iPhone 12 equate to $437 billion in revenues. Apple achieved 68% gross margins on product sales in 2020 – let us assume Apple somehow improves upon that and achieves 80% net margins on iPhone 12 sales – we arrive at $350 billion in “iPhone 12 profits.”
That is no small number and is impressive by any measure. However, Apple’s current stock price appears to more than reflect that optimism. Let us forget about Ives’ price target and use the current stock price. Apple trades at a $2.108 trillion market cap. Even if we subtract $81 billion in net cash as well as $350 billion in iPhone 12 profits as computed above, we still arrive at a market cap of $1.7 trillion.
Here is my calculated fair value estimate for Apple. Because I have a bearish tilt, I continue to use the optimistic $431 billion in net cash and iPhone 12 profits. I value services at $450 billion using a 15 times price to sales multiple. I value the products (everything else) at $765 billion using a 15 times price to earnings multiple. I arrive at a market cap of $1.6 trillion – 23.8% lower than current levels. I note that this estimate is still very optimistic because I question the validity of $350 billion in iPhone 12 profits as I detail below (among other things).
Because Apple’s stock trades so richly, it has become easy to name potential downside catalysts.
For starters, valuation remains a concern. I think that 350 million iPhone 12 upgrades over the next 12-18 months are far too optimistic, as 5G is not even available nationwide (why would there be a sudden urgency to upgrade your phone if you can’t use 5G service?). The 5G supercycle is overhyped – but even when we assume the overhyped 5G supercycle takes place, shares still appear far too overvalued as we saw above. I expect the iPhone 12 release to be a “sell the news” event as analyst estimates prove far too optimistic.
I expect Apple to fall victim to antitrust pressures. Epic Games has recently renewed its legal request to bring back Fortnite to the Apple store. Apple had originally removed Fortnite because it had attempted to receive user payments from within the app, where Apple cannot its typical 30% commission fee. I think that there is significant validity to the claim that Apple has abused its platform privileges in collecting its 30% fees. Not only might the additional antitrust scrutiny lead to significant multiple compression, but it may also reduce or at least significantly slow down the services’ revenue growth rate.
Because Apple has become the US’ largest company, it has become an easy target for political retaliation. If US-China tensions escalate, China may retaliate by punishing Apple’s business in the country. China is Apple’s third-largest country by revenue and therefore poses a significant risk.
For starters, it is possible that Apple does not fall so quickly upon realizing its projected $350 billion in iPhone 12 profits. This might occur if Wall Street decides to value Apple based on the record profits. My bearish thesis rests on Wall Street being forward-looking and deciding to sell the news, I essentially see Apple selling at a single-digit earnings multiple based on record profits. It is possible that I am wrong, and Apple ends up being the exception and finds a way to avoid the forward-looking skepticism of analysts.
Second, would Buffett really sell? He is famous for “never” selling a stock. That is not to say that he has never sold a stock, however. It may be a surprise to many if Buffett really chooses to sell Apple, but I believe that Buffett will be able to identify Apple as being a bubble and will choose to not partake in bubbles. An exit by Buffett is not necessary for a steep price decline in Apple ‘s share price, but it will certainly accelerate it.
Optimism is acceptable. Irrational exuberance is not. Even using the most optimistic of assumptions of Apple’s super-bull, shares appear far too richly valued. Furthermore, Apple faces risks outside of overvaluation including antitrust issues, political risk, and the potential loss of Warren Buffett as its biggest shareholder.
Apple Short (Sell)
ENTER AT: 109.23