Why is it not at $240?

Photographer: Peter Foley/Bloomberg

Carl Icahn Likes the Apple Watch, TV, Car, Stock Buybacks

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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A good data journalism project would be to build a calculator that will tell you how much Carl Icahn thinks Apple is worth in real time. You can't really get real-time access to Carl Icahn's mind, though he is on Twitter, so you'd have to make some assumptions. But I bet I could do it. My algorithm would go something like:

  1. Look up the current price of Apple's stock.
  2. Double it.
  3. Print that.

And you're done! Last October, with Apple trading at about $101 per share, Icahn fired off a letter to Tim Cook valuing it at $203. And this morning, with Apple trading at about $129, Icahn fired off another letter valuing it at $240. My model gets you pretty close, and is useful for those times when you want to know what Carl Icahn thinks Apple is worth, and he hasn't written a letter in a while.

When Icahn wrote his last letter, I made fun of it at some length. I hereby incorporate that post in its entirety into this post, since all the things I said about the last letter are equally true about this one, which is more or less the same letter with a bigger number on top. Let me embellish a few of them here. Icahn's financial model for Apple still relies on a lot of guesswork about what products Apple will introduce and how well they will sell. For instance, he estimates that Apple will sell $73.5 billion worth of the Apple Watch in its first three years of existence, or more than the iPhone or iPad did in their first three years. He also estimates that Apple will sell $52.5 billion worth of the new Apple television set in its first two years of existence, more than the first two years' worth of iPhones and iPads combined.  Note that the Apple television set, unlike the iPhone or iPad (or Apple Watch, or the Apple TV device for that matter), does not exist. 

Now, these numbers sound a little optimistic to me, but what do I know? They may well be right. The point is that, compared to Apple, what does Carl Icahn know? Like, if Carl Icahn says that Apple will sell $22.5 billion worth of watches in 2016, and I think that number is too high, you should probably believe him rather than me. (He's done research; I have not.) But if Carl Icahn says that Apple will sell $17.5 billion worth of televisions in 2016, and Apple says that it won't introduce a television in 2016, that pretty much ends the debate. You can't make billions of dollars selling televisions if you don't sell televisions. 

This all goes double for the Apple Car, a non-existent product to which Icahn devotes more than 400 words, including the phrase, "it seems logical that Apple would view the car itself as a the ultimate mobile device." To be fair the car doesn't appear in his financial projections. 

Icahn knows that this is a little awkward. He says: "If you choose not to pursue some of the new categories we highlighted, or you find our growth forecasts too aggressive for any one new category in particular, we’ll be the first to admit that you are more knowledgeable in these areas than we are." I would dispute his claim that he's the first to admit it, but whatever. The point is that Carl Icahn is advising Apple to buy its stock based on his own assumptions about Apple's product strategy. Apple, which presumably knows a lot more about its product strategy, can probably draw its own conclusions without this advice.

Last time I also questioned Icahn's view that the stock price "reflects an undervaluation anomaly that will soon disappear." Seven months, two Carl Icahn letters and $12 billion of share repurchases later, the stock is up almost 30 percent, a pretty good run, but not, you know, doubling. By Icahn's math, Apple has gone from trading at 8 times forecast earnings to 10.9 times, as the S&P 500 has gone from 15 times earnings to 17.4 times. That is, Apple's valuation, relative to the overall market, is roughly in line with where it was seven months ago when Icahn said it was off by 100 percent. This suggests that he has identified not a quick-to-close anomaly but just a disagreement with the market.  

There's also continued blather about a "de facto short squeeze" that I continue to find funny. The idea is that the price will go up, causing "underweight actively managed mutual funds and hedge funds" to underperform, leading them to "correct their misguided positions" by buying more Apple stock. But, you know. Then someone has to sell it too. For every underweight buyer there's an overweight seller, etc. etc. etc. etc.  By this logic, there would be a "de facto short squeeze" any time any stock goes up. Maybe there is.

Also there is this sentence:

Therefore, when assessing the multiple of earnings at which Apple should trade, we believe it is appropriate to use a 20% tax rate for Apple in order to make such comparisons Apples to Apples, no pun intended.

If you didn't intend a pun, why capitalize "Apples"?  When I am king this will be actionable securities fraud.

Finally, there is this, in Icahn's financial assumptions: "Cash Flow – for simplicity purposes, we assume net income equals cash flow other than dividends and share repurchases." It's hard to more perfectly fulfill the stereotype of the shallow buyback-obsessed activist than by assuming away capital expenditures entirely. Sure, Apple, build cars and televisions; just don't invest any money in car or TV factories. Matt Yglesias says:

Icahn's letter is full of rah-rah talk about how he loves Apple and how he thinks the Apple Watch and hypothetical Apple car and television products will be huge hits. But his bottom line is that rather than spending its enormous pile of cash on shoot-the-moon efforts to do those things, he wants to see Apple spend its enormous pile of cash on buying shares of Apple stock.

Because Icahn's letter is only marginally about persuading anyone, at Apple or elsewhere, that the stock is undervalued. It's about prodding Apple to return cash to shareholders, an area where Icahn's track record is pretty good. But here's the thing: Surely Icahn is right, no? I mean, I get it, people want to see Apple spend its money on inventing flying cars or whatever, instead of buybacks. But let's have some perspective on that. Apple currently has $193.5 billion of cash and marketable securities. Wall Street estimates that it will have almost $68.8 billion in free cash flow this year. On the other hand, it has spent $32.8 billion on research and development, total, in its history since 1992.  In the same period of 23 years, it's spent $43.6 billion on capital expenditure. 

Meanwhile, in the last three years, since it started giving money back to shareholders, Apple has spent $112 billion on dividends and share buybacks, and it plans to get that number up to $200 billion over the next two years. That's Apple's plan, not Icahn's; Icahn is just asking for incremental speed and size. Icahn says:

As our model forecasts, despite more than 30% growth in R&D annually through FY 2017 to $13.5 billion (up from $1.8 billion in FY 2010) and your updated capital return program, Apple’s net cash position (currently the largest of any company in history) will continue to build on the balance sheet.

That is: Icahn's model predicts that Apple will spend more on dividends and buybacks in the next two and a half years than it's spent on research and development and capex, combined, in the last two decades. It also predicts that Apple will spend almost as much on research and development in those two years as it has in the previous 23. And it still predicts that Apple will have a bigger cash pile at the end of that period than at the beginning. Some of that might be based on optimism about the non-existent television, but even so. Apple just has a lot of cash, and keeps getting more cash faster than it can spend it, and you can't just exhort Apple to find interesting uses for that cash without grappling with the sheer scale of it. There's so much cash! 

My simple dumb model of corporate finance is that a company is good at one thing, raises money to do the thing, does the thing, rakes in cash doing the thing, and then either returns the cash to shareholders so they can find new things to invest in, or blows the cash doing things other than the thing it's good at. In this model, modern capitalism is endlessly innovative, but individual companies might run out of ideas. The point of a company is to take an idea, turn it into money and give the money back to the people who invested in the idea, so they can invest it in new ideas. Apple has had, by any standard, a really good run of ideas! It's spent an enormous amount of money creating and commercializing those ideas. But now it has just so, so, so much money. Apple's free cash flow this year will be more than twice as much as it's spent on research and development over the last two decades. Those were pretty inventive decades. It would be weird if Apple could reliably put 40 times as much money to work inventing things in the future as it did when it was inventing, you know, the iPhone.

Instead, Apple looks increasingly like an investment fund, generating tons of cash and investing it in marketable securities. Why not give it back to Carl Icahn? He's a pretty good investment manager too, as he'd be the first to point out.  Or give it back to the other Apple shareholders, the ones who -- unlike Icahn -- have been selling into Apple's buybacks. Someone can probably find a good use for that money. Why should it have to be Apple?

  1. Icahn on the Apple Watch: "We forecast revenues of $6 billion in FY 2015, $22.5 billion in FY 2016, and $45 billion in FY 2017." On the TV:

    Apple Television Set – after many years of rumors as part of Apple’s push into television and as we referenced previously, we expect in FY 2016 Apple will sell 55” and 65” ultra high definition television sets.  We forecast revenues of $15 billion in FY 2016 and $37.5 billion in FY 2017 on 10 million and 25 million units respectively with average selling prices of $1,500.

    From Bloomberg I see iPhone segment revenue of $630 million in fiscal 2007, $6,742 million in 2008, $13,033 million in 2009 and $25,179 million in 2010; to be generous I start the iPhone clock at 2008 for $20 billion/$45 billion of first-2/3-year revenue. I see iPad segment revenue of $4,958 million in fiscal 2010, $19,168 million in 2011 and $30.945 million in 2012, for first-2/3-year revenue of $24 billion/$55 billion.

  2. Unless ... I mean, Icahn sometimes has dinner with Tim Cook. One assumes that these dinners consist of Icahn shouting "MORE BUYBACKS!" for two hours, and that no inside information about product strategy leaks out. 

  3. As he says this time:

    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 recognize the growth prospects of Apple entering new categories, and fail to recognize 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.


  4. Also excellent:

    As you continue to evaluate this opportunity, and consider the right prices at which to opportunistically repurchase shares, we hope you give credence to our advice in light of our investment record. Unlike the many actively managed mutual funds and hedge funds that are underweight Apple and have underperformed the S&P 500, we have exhibited strong outperformance, thanks in part to our large position in Apple. The Sargon Portfolio (a designated portfolio of assets co-managed by Brett Icahn and David Schechter within the private investment funds comprising Icahn Enterprises’ Investment segment and High River Limited Partnership, subject to the supervision and control of Carl Icahn) has generated annualized gross returns of 36.9% since its formation on April 1, 2010 through April 30, 2015 with $8 billion of assets under management as of April 30, 2015.

    Apple should listen to Carl Icahn's stock-buying recommendations because Carl Icahn is good at buying stocks. I mean, fair enough. (For what it's worth, Apple has generated annualized returns of about 30 percent over that period, so Icahn wins this round.)

  5. Also note that this argument is similar to the TVs-and-cars one, in that it relies on Icahn knowing Apple's actions better than Apple does. Icahn:

    Effective Tax Rate – importantly for the company’s income tax rate, we consider 20% a more appropriate tax rate for the purposes of forecasting real earnings, not the 26% effective tax rate Apple uses in their income statement. Most companies in the S&P 500 state that they plan to permanently reinvest their international earnings and therefore do not have to accrue for an income tax on unremitted earnings and thus show a lower tax rate. Google is a good example of this, as its effective tax rate is 20%. Apple, unlike Google and most companies in the S&P 500 has chosen to accrue income taxes on some of its unremitted international earnings and according has an effective tax rate of 26%.  

    But if Apple does plan to repatriate more cash than Google does, then its higher tax accrual makes sense. Icahn just assumes that it won't -- which is weird because he's effectively arguing for Apple to repatriate cash for a giant buyback.

  6. Source: Bloomberg, which shows consensus free cash flow estimates of $67.8 billion for fiscal 2015 and $58.8 billion for 2016.

  7. Source: Bloomberg, Apple filings through 2Q2015 (note that Apple has a September fiscal year). I used 1992 since it's the oldest 10-K that I could easily find. Bloomberg capex data goes back to 1987, adding another $912 million.

  8. See footnote 4!

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net