Tag Archives: AAPL valuation

Tech Treks

One lesson from the internet bubble is that big is beautiful in tech. But longevity is another lesson, think Yahoo! So one must be fickle in ones tech affections and one must never ever pay too much. After much patience, I was lucky enough to eventually get into Apple in early 2013 when sentiment was particularly sore. I didn’t manage to heed my own advice on getting into Google at a reasonable price in December 2014 when it was trading around 60% of its current value, as per this post on internet relative valuations (more on that post later). Since 2013, I have watched sentiment gyrate on AAPL as the standard graph I use below illustrates (most recent AAPL posts are here and here). I used the current $135 price high as the most recent data point for the Q12017 valuation.

click to enlargeaapl-forward-12-month-pe-ratios-q1-2017

Investors and analysts seem giddy these days about the impact of Trump tax changes and the iPhone 10 year anniversary on AAPL and have been pointing to Berkshire’s position increase in AAPL as confirmation bias of more upside. I, on the other hand, have been taking some of AAPL off the table recently on valuation concerns and will likely again be a buyer when the inevitable worries return along the “one trick iPhone pony” lines. God bless gyrating sentiment! Even Lex in the FT was saying today that the current TTM PE ex net cash of 13 is reasonable (eh, a TTM PE ex net cash of 7 a year ago was more reasonable)! AAPL still has be a core holding in anybody’s portfolio but prudent risk management requires trimming at this price in my opinion.

In my search for new ideas whilst I await some divine sense to emerge from the Trump & Brexit fog, I thought it would be interesting to revisit the post referred above on internet valuations. First off, I took the graph showing forward PEs to projected EPS growth using analyst estimates from December 2014 and inserted the actual change in share price from then to now. Two notable exceptions, at the extremities, from the graph below are Amazon and Twitter with share price changes of 173% and -56% respectively.

click to enlargeinternet-multiples-dec14-as-at-feb17

Although every company is different and has its own dynamics, my simplistic take from the graph below is that high PE stocks (e.g. > 40) with high EPS projections (e.g. > 35%) can easily run aground if the initial high growth phase hits harsh reality. The sweet spot is decent PEs with EPS growth in the 15% to 35% range (again assuming one can get comfortable that the EPS growth projections are real) indicative of the larger established firms still on the growth track (but who have successfully navigated the initial growth phase) .

A similar screen based upon today’s values and analyst estimates out to 2018 is presented below. This screen is not directly comparable with the December 2014 one as it goes out two years rather than one.

click to enlargeinternet-multiples-feb2017

Based upon this graph, Google and Netease again look worthy of investigation with similar profiles to two years ago. Netease has the attraction of a strong growth track record with the obvious Chinese political risk to get over. Expedia looks intriguing given the strong growth projected off a depressed 2016 EPS figure. Ebay and Priceline may also be worth a look purely on valuation although I have a general aversion to retail type stocks so I doubt I’ll bother look too deeply. All of the data used for these graphs is based upon analyst estimates which also need to be validated.

Valuations currently are juicy, generally too juicy for me, so this exercise is simply one to determine who to investigate further for inclusion on a watch-list. Time permitting!

Apple Average

It’s always strange when you have a relief rally in a stock (in after hours at least) because the actual results are not as bad as expected. So it seems to be with AAPL’s Q3 results. iPhone sales were not as bad as expected (albeit the lowest unit iPhone sales in 7 quarters at just above 40 million units) and the current quarter revenue guidance was above expectations. The average revenue per phone was below $600 for the first time in 2 years due to the the latest models with promises of improvements from management in future quarters. When the dust settles on the Q3 results though it could be time to finally reassess AAPL’s future trajectory.

The graph below shows the latest results by product which illustrate just how poor a quarter this was relative to historical trends, with services being the sole bright spot.

click to enlarge

AAPL Revenue by product Q32016

The split by revenue by region again illustrates the challenges AAPL is having in China. It also shows the lackluster response to Apple’s current products in the US.

click to enlargeAAPL Revenue by region Q32016

On valuation, AAPL still looks reasonable on a forward PE excluding cash basis (using analysts estimates for the next 4 quarters), as per the graph below.

click to enlarge

AAPL Forward 12 Month PE Ratio Q32016

The bulls are hyping up the iPhone 7 cycle as a source of future growth which is now the tired but only realistic growth thesis for AAPL. In the medium term however AAPL looks range bound around $100.

Level-headed

After a week like the one just gone, where the S&P500 hit the 10% down threshold for the year, it’s perversely healthy to see debates rage about the likelihood of a recession, the future for oil prices, the bursting of the unicorn bubble, the impact of negative interest rates and the fallibility of central bank macro policy in the developed world, to name just a few. Considering and factoring in such risks are exactly what should be happening in a well functioning market, rather than one far too long reliant upon the supposed omnipresent wisdom of central bankers to answer any market ills that may come along. Although the market volatility during the opening months of 2016 hasn’t been pleasant and will hopefully find a floor soon, valuations didn’t reflect risks and an adjustment was needed.

I have no idea where the market is headed, although I suspect we are just one more shake-out from capitulation. Valuations have come off their unsustainable highs and a select few are beginning to look attractive. After some of this week’s indiscriminate falls, it’s always a good risk management discipline to assess current and possible new positions in light of developments. I assessed AAPL’s valuation recently in this post and offered my thoughts on the new Paddy Power Betfair in this post.

The subject of this post is Level 3 (ticker LVLT), a facilities-based provider of a range of integrated telecommunications services. Prior to their earnings on 4th of February, I had been re-examining my investment rationale on LVLT, one of my highest conviction positions that I last posted on a year ago. As I have highlighted before, LVLT is not an investment for the faint hearted and the past week has again proven that (a beta level of 1.5 according to Yahoo just doesn’t capture it!) with daily moves following the Q4 report of +6.9%,-5.7%,-9.4%,+3.7%,+3%, 0.5%, and Friday’s +1.7%. The graphic below shows the movement in the share price in LVLT, the S&P500 and the S&P High Beta index (SPHB) since the start of 2015. Also shown are the daily changes in LVLT against those of the S&P500.

click to enlargeLevel3 SP500 Share Price & Volatility

To recap on the bull case, the strength of LVLT is its deep and global IP optic network which following the recent mergers with Global Crossing and TW Telecom now has the business scale for the experienced management team to finally achieve operating margins to support its debt (current net debt to 2016 guided EBITDA is approx 3.5) and throw off meaningful cash-flow in the coming years (average FCF growth of 8% according to my estimates over the next few years). The Q4 2015 results and 2016 guidance showed the bull case is intact and the demand for new products such as the security and intelligent network services show how LVLT’s network is a competitive advantage in today’s technology driven world. The CEO Jeff Storey summarized their case at the Q4 conference call as follows:

“Most importantly, is our movement towards our vision of one, one set of products that we take to an expanding market, one network to deliver those products globally, one set of operational support systems to enable a differentiated customer experience, and one team with the singular goal of making Level 3 the premier provider of enterprise and networking services. As we look to 2016, our strategy remains the same. We are focused on operational excellence throughout our business, providing a superior experience to our customers and developing the products and capabilities to meet their complex and evolving networking needs.”

As the talk of a possible recession fuelled worries on business telecom spend, I thought it would be useful to look at the historical “as if” results of the now enlarged LVLT through the financial crisis. This involved looking through old Global Crossing and TW Telecom results and making numerous assumptions on the historical growth of acquired businesses and the business classifications (and numerous reclassifications) of each firm over time. The historical “as if” results combined with the reported figures for 2014 to 2015 and analyst estimates for 2016 to 2018 are shown below.

click to enlargeLVLT Proforma Revenue Split 2007 to 2018

Within the context of the caveat above, the drop in enterprise revenue from 2008 to 2011 was 12.5%, primarily driven the financial crisis with other factors being Global Crossing refocusing its portfolio and the operational missteps by legacy Level3 in integrating its multiple acquisition from 2006-08. TW Telecom’s consistent top-line growth since 2007, despite the financial crisis, can be seen in this post. It’s interesting that the wholesale revenues have been relatively stable historically ranging between $2.10-2.35 billion, supporting the view that price decreases are offset by unit increases in IP traffic.

Since 2012, the benefits of scale combined with the integration prowess of the current LVLT management team (Jeff Storey became CEO in 2013) are vividly shown in the impressive increase in EBITDA margin from 22% in 2009 to 32% in 2015. After cutting capex in 2008-09, the combined business has required 14%-16% since then, now targeted at 15% to support the 8% annual growth in enterprise revenues (on a constant currency basis) that management have set as their target.

In Q4, LVLT’s revenue was derived 80% from the US and management claim that their enterprise business has only a single digit market share in the US leaving plenty of room for growth, particularly against the incumbents Verizon and AT&T. The graph below shows enterprise and wholesale revenues from each firm with AT&T showing revenue stability against a declined trend for Verizon.

click to enlargeVZ AT&T Business Telecom Revenue

Numerous analysts confirmed their estimates on LVLT following the Q4 results and the average target is above $60, approximately 30% above the current level. Regular readers will know that normally I don’t have much time for analysts’ estimates but in this case my own DCF analysis suggests a medium term target of per share in the low 60’s is reasonable. According to my estimates that translates into an EV/EBITDA multiple of approx 8.5 in 2018 which looks reasonable given LVLT’s free cash growth. I used the historical “as if” figures above to calculate a downside valuation for LVLT on the basis of a recession occurring over the next 2 years. I assumed that a 2016-2018 recession would have approx half the impact of the 2008-2011 crisis upon LVLT’s enterprise revenue (e.g. approx 7% decline) before stabilising and recovering. My valuation of LVLT in such a scenario was in the mid 30’s or an approx 25% downside potential from Friday’s close. So at a 25% downside and a 30% upside, LVLT’s risk profile is finely balanced.

LVLT itself may become a target for a firm like Comcast or CenturyLink or another large communication firm looking to bulk up its regional reach or network business. Two interesting items came out of LVLT’s Q4 call; the first being the tightening of its target leverage range to 3 to 4 times EBITDA (from 3 to 5 times) and the second being a renewed appetite by management to use free cash-flow for disciplined M&A rather than shareholder returns such as buy-backs or even initiating a dividend. With LVLT proving their ability to get in excess of $200 million in EBITDA savings from adding TW Telecom’s revenue base of $1.6 billion at the time of the merger (or an impressive 12.5% EBITDA pick-up), the case for disciplined M&A by LVLT’s management is strong. Possible targets in the US include Zayo (their share price is having a hard time of late) or Carl Icahn’s privately held XO Communications (now that the maestro has milked the firms of its tax losses), amongst others. In Europe, possible targets include the now private Fidelity owned COLT (see this post on background) or Interroute, another privately owned pan-European network.

Whatever happens, I am content to hold my position in LVLT at this level. I like the firm’s current risk profile, the developing product range in the ever important network age, and particularly the recent execution record of management. As ever, I would highlight the stock’s volatility and recommend the use of options to protect downside risks (which are not inconsiderable if the probability of recession grows). I again repeat that LVLT is not one for the faint hearted, particularly in this market where near term volatility looks all but certain, but one I trust will be an attractive investment.

Apple below $100

In a market like this one, it’s impossible to tell what is going to happen next. The smell of fear has been in the air with greed cowered by uncertainty. Greed may push back soon with earnings, and particularly guidance, dictating the short term path whilst oil and China, amongst other macro factors, will continue to dominate the overall direction.

Overall I remain cautious on equities with a downward bias. I am sticking to my conviction stocks whilst keeping cash on the sidelines until I find a blatant bargain or two. Notwithstanding that stance, it’s always good to look at your positions and see if some risk management re-weighting is called for. And that’s the reason for a quick look over Apple before its earnings next Tuesday.

Apple is in a hapless position currently and likely has to blow away the December quarter estimates (on the number of iPhones sold, the average price, and the gross margin received) PLUS give a strong March quarter guidance to move up in a meaningful way. Given that a repeat of the outstanding results of last December’s quarter (see post here) compared to current expectations is improbable, I would suggest Apple could trade around or below $100 for a while yet. Analysts, whilst screaming about its valuation, have become increasing negative on the December quarter and guidance for their Q2 quarter. Apple may struggle to come in much above the top end of its guidance of 77.5 million iPhones (it has come in above guidance for 5 consecutive quarters albeit at a steadily reducing level above the top estimate).

The geographic split of revenue, as per the graph below, will also be closely watched to see if China’s economy is impacting Asian growth.

click to enlargeAAPL Revenue by region Q42015

Despite its best efforts, Apple remains primarily a phone company with last year’s iPhone revenues making up two-thirds of the total, as per the graph below (with my estimates for Q1).

click to enlargeAAPL Revenue by product Q42015

I played with some estimates to stress the view on an AAPL valuation below $100. Taking a jaundice view of adjusting average analyst non-GAAP estimates for 2016 and 2017 plus some pessimistic estimates of my own on 2016 and 2017 (with iPhone slowing to sales of 220 million and 200 million compared to around 230 million for 2015), I estimated the forward PEs, excluding net cash (currently around $150 billion), as per the graph below (based upon diluted GAAP EPS, not the adjusted EPS analysts love) using tonight’s close of $96.30. The multiples are quarterly point estimates using the share price one month after the quarter’s end.

click to enlargeAAPL Forward 12 Month PE Ratios Q4 2015

The graph above clearly shows the swings in sentiment on Apple over recent years as the market grapples with the future demand for the iPhone after each upgrade cycle. Tuesday will indicate whether the current concerns about iPhone sales and margins peaking are justified. Other concerns, such as a possible $8 billion tax bill from the EU, pale in comparison to those iPhone concerns. Notwithstanding these real concerns, forward multiples of below 8 look too low to me given Apple’s operating record (unless you buy into the Apple could be the next Nokia thesis which I don’t).

By way of a comparison, my estimate for a similar graph for Google is below (again using diluted GAAP EPS). Google will be another stock where earnings for Q4 will be very interesting as they split out their figures in line with the new Alphabet structure and (maybe) demonstrate again their new emphasis on cost control. Expectations look high based upon its current valuation.

click to enlargeGoogle Forward 12 Month PE Ratios Q4 2015

The comparison does reflect positively on Apple’s current valuation multiple and I’m happy to hold the AAPL position I have. A key outcome from the AAPL earnings call will be if Cook can provide sufficient catalysts for Apple’s value to trade significantly above $100.

As always, time will tell.

 

Follow-0n Evening 26th after earnings: Over the next few days and weeks, I’m sure the chatter about Apple and the iPhone will likely get over-bearing. The delicately posed share price of $99.99 before earnings will come under pressure. Q1 revenues were at the lower range of expectations and Q2 guidance at $50-$53 billion is weaker than expected. China revenues showed slowing growth. On the positive side, the average revenue per iPhone in Q1 was higher than expected and operating margins were strong. I revised down my estimates for AAPL’s 2016 and 2017 diluted EPS (to $9.15 and $8.60) and iPhone sales to 210 million and 190 million. The revised revenue splits and forward PE multiples (at share price of $99.99) are shown below. Thesis, as per post above, on AAPL’s valuation remains basically unchanged although the share price see some selling pressure in the short term.

click to enlargeAAPL Revenue by region Q12016

click to enlargeAAPL Revenue by product Q12016

click to enlargeAAPL Forward 12 Month PE Ratios Q1 2016.png