Carl Icahn thinks Apple is worth $US1.4 trillion, or $US240 per share.
On Monday, shares of Apple were up about 1.3% to $US130.
Leaving aside that Apple is currently the world’s most valuable company by market cap (~$US760 billion), or that it is about double the size of the next largest company, or that Apple itself has doubled in value over the last 2 years, Icahn’s argument comes down to one thing: he thinks he’s the only one that really understands what the company is worth.
Here’s the key paragraph from Icahn’s letter to Apple CEO Tim Cook:
It is our belief that large institutional investors, Wall Street analysts and the news media alike continue to misunderstand Apple and generally fail to value Apple’s net cash separately from its business, fail to adjust earnings to reflect Apple’s real cash tax rate, fail to recognise the growth prospects of Apple entering new categories, and fail to recognise that Apple will maintain pricing and margins, despite significant evidence to the contrary. Collectively, these failures have caused Apple’s earnings multiple to stay irrationally discounted, in our view.
This paragraph is basically a broadside against anyone who follows Apple and has any kind of opinion on the company’s value. It is Icahn saying that no one else sees what he sees, and that he is right.
But outside of the intellectual grandstanding, what Icahn most simply wants is Apple to have an earnings multiple that is comparable — but slightly higher — to the S&P 500’s.
Let’s walk through the maths.
Currently, Apple’s price-to-earnings multiple is about 13.4x (taking Friday’s closing share price of $US128.77 and dividing this by the $US9.60 of forecast earnings for Apple this year).
The S&P 500, by contrast is, trading at around 17.4x forward earnings (Friday’s closing price of 2,122.73 divided by forecast earnings of $US122.11).
The price-to-earnings ratio, or “earnings multiple,” is the most commonly cited valuation metric among stock analysts. What it most simply tells investors is how many dollars per share they must pay for each $US1 of earnings.
And so right now, Apple is trading at a discount to the S&P 500. But the Icahn catch is that this current discount understates the actual discount.
To find Apple’s “correct” earnings multiple, Icahn wants the company’s $US194 billion cash hoard netted out. And after removing the cash per share, Icahn finds that Apple’s earnings multiple is actually 10.9x.
Here’s Icahn’s maths:
So how do we get to Icahn’s called-for $US240 per share valuation for Apple?
Icahn assumes that in 2016, the company will earn $US12 per share — a ~33% earnings improvement year-over-year. He then takes this $US12, multiplies it by his desired 18x earnings multiple to get $US216. Icahn then adds back the $US24.44 per share in cash to get $US240.44 per share.
Look at how easy that is! A fourth-grader could do this maths.
Now, the reasons
why Icahn wants Apple to have an 18 multiple aren’t just “because.”
Apple’s earnings growth is going to be well ahead of an average S&P 500 company, which has ~6% growth in earnings year-over-year. So, an 18 multiple is justifiable.
Icahn thinks the company has the opportunity to do big things in the car industry, and also thinks the introduction of Apple Watch and a potential TV are big drivers for the company as well. As Ichan writes:
Apple has clearly demonstrated a track record of excellence and success when entering new categories. We expect this to continue with the Apple Watch, the television, and the car, and the world will look back on today’s undervaluation as a fascinating example of market inefficiency (and likewise on our valuation at 18x earnings per share as conservative).
And even if new categories don’t work out for Apple, Icahn said the company’s cash hoard gives it, “one of the greatest opportunities ever for a company to invest in itself by repurchasing its shares.” So to Icahn’s mind, there is no way the stock doesn’t go higher — way higher — from here. And to Icahn’s mind, he’s the only one that understands this. At least for now.
The crazy part here, then, is not Icahn’s maths or process, as this is more or less how stock analysts come up with price targets on companies they cover. Analysts run a few models on what earnings might be in the next quarter or year, plug in a few potential multiples, and you’ve got a few price targets. You can then home in your most likely scenario and boom, you’ve got a price target.
The crazy part is that Icahn, who owns around 52 million shares of Apple, or $US6 billion of the company, is saying the world’s most valuable company is worth almost double what the market currently values it at — and is more or less getting away with it.
After Icahn released the letter, our editor-in-chief Henry Blodget said Icahn’s price target on Apple is the kind of thing that would have most analysts on Wall Street “pilloried.” People would call the analyst “irresponsible” and “ridiculous” for taking such a bold stance.
Certainly, the success Icahn has had over his career gives him some leeway with regard to how bold his calls for some stocks might be. But the other side of this is that Wall Street as a whole has become completely enamoured with Apple to the point where Icahn’s call for the stock to nearly double isn’t even all that crazy.
Currently, 2 different Wall Street analysts — Brian White at Cantor Fitzgerald and Daniel Ives at FBR Capital Markets — have price targets on Apple that would give the company a market cap over $US1 trillion. Recall that 2 years ago, Apple’s market cap was less than $US400 billion.
At $US195 and $US185, respectively, White and Ives’ price targets call for roughly 50% and 45% price increases from Apple’s share price today. And according to data from Bloomberg, Wall Street’s consensus 12-month price target on Apple is around $US149 per share, with just 3 out of 57 analysts covering the stock maintaining a “Sell” or equivalent rating on the stock (meaning these analysts recommend investors either sell their Apple stock or not buy anymore right now).
And all this while Apple shares have gained 52%, with the stock’s total return coming to around 55% including dividends. So any way you cut it up, owning Apple in the last couple years has been a phenomenal investment.
Looking at the company’s balance sheet (it has around $US194 billion in cash), its clear domination of the high-end smartphone category (the company has sold a staggering 135.7 million iPhones in the last 6 months), and its overall cultural ubiquity, it’s easy to think that the company will continue its dominance as far as the eye can see.
But Icahn’s letter on Monday makes it clear that he can say just about anything he wants about the company (while still being taken seriously), and that more broadly, the market will hear just about anything positive on Apple.