Icahn's Tweet Sent Apple Above $500, But What's It Really Worth?

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Crowded Apple retail store, Cherry Hill, NJ, USA,. iPad 2 launch, March 11, 2011Apple (AAPL) is getting interesting again.

Sources are reporting that new iPhones will be introduced next month. Fading rival BlackBerry (BBRY) is trying to lure in a suitor. And despite pouring billions into promoting Windows Phone 8 as a viable smartphone platform, Microsoft (MSFT) is pulling less than 4 percent in market share according to industry tracker IDC.

It's against this backdrop of calamity and opportunity that billionaire investor Carl Icahn is starting to shake things up. "We currently have a large position in APPLE," Icahn tweeted on Tuesday. "We believe the company to be extremely undervalued."

Icahn then went on to explain that he spoke to CEO Tim Cook, urging him to consider a more aggressive share buyback plan for the meandering tech giant than the one currently in place. Icahn's chatter was enough to send the stock higher on Tuesday. The stock tacked on $17 billion in value after Icahn's post, making it one of the most lucrative tweets in Twitter history. On Wednesday, the run-up continued, as Apple shares topped $503 early in the afternoon.

So, is Icahn right? Is Apple "extremely undervalued"? That all depends on which way you're looking.

There Are Many Ways to Slice an Apple

Apple is trading at a reasonable 12 times trailing earnings, cheaper than many of its consumer tech peers. Back out Apple's ample cash hoard -- $146.6 billion when you include marketable securities -- and Apple's multiple falls into the single digits.

However, Apple has lost some of its shine.

Revenue growth has been slowing as Apple surrenders market share in tablets and smartphones to Android devices.
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After several years of profitability growth, the trend line has started to go the wrong way. Apple is coming off of back-to-back quarters of declining earnings as margins are getting squeezed, and analysts see the same scenario playing out through at least the next two quarters. Those same pros see flat revenue growth during the next two quarters -- and that's even with Cook's promise of new products coming out this fall ahead of the critical holiday shopping season.

Wall Street analysts foresee earnings falling 11 percent to $39.10 a share in the fiscal year that ends next month. They predict a bounce in fiscal 2014 -- up 8 percent to $42.31 -- but that's still well short of the $44.15 a share it earned in fiscal 2012.

Apple at 12 times trailing earnings isn't a bad deal. But if the pros are right it would also be trading at 12 times trailing earnings by the end of next year if the stock simply marched in place.
Apple may be cheap by most measuring sticks, but it won't seem like much of a bargain if Google's (GOOG) Android continues to gobble up the more of the market for smartphones, tablets, and now even laptops with its aggressively priced Chromebook line.

Rolling In Cash

Apple is putting its money where its mouth is. It returned $18.8 billion in cash to shareholders through its generous dividend and buybacks this past quarter, even though it only generated $7.8 billion in cash flow from operations during the period.

Some -- like Icahn -- feel that Apple can still dig a little deeper.

If Apple doesn't want to touch its ample cash reserves -- understandable, since most of that money was earned overseas and would require paying a hefty repatriation tax to bring back home -- the class act of Cupertino could borrow money that it would return to shareholders.

If Apple borrowed at 3 percent, then turned around and used that money to snap up more stock, Icahn believes that the share price could get to $625 without any earnings growth.

He's not the only one that has suggested that Apple leverage its stash to take advantage of low interest rates that won't be around forever. Fellow hedge fund billionaire David Einhorn made the same argument earlier this year.

The rub in the argument is that even flat earnings growth may be optimistic at this point. The proliferation of cheap Android products is leading consumers to buy cheaper iPhones, including resales, which leave Apple out in the cold. PC sales have been slumping, taking Macs down with them, and iPod sales have been sliding for a couple of years as portable media players get replaced by smartphones and tablets.

Apple's margins will likely continue to contract, regardless of what Apple introduces next month.

Fill-In-the-Blank Investing

In the end, Apple is worth what the market believes that it's worth right now. Icahn may believe that Apple is cheap at this point, but a lot of investors also felt that way when they were buying in at higher prices when the stock was rallying last year.

Apple has innovated its way out of these slumps before, but it will be that much harder to sway consumers now that Jobs isn't around the way he was in pitching the iPod in 2001, the iPhone in 2007, and the iPad in 2010.

Apple needs something new before it become old, borrowed, and blue.

Icahn's Tweet Sent Apple Above $500, But What's It Really Worth?
Operating margin: 15%
 Revenue: $1.2 billion
 Market share: Greater than 50%
 Industry: Consumer electronics

Garmin is a navigation device company, focusing on GPS technology. By far, the most profitable of the company's five divisions on a dollar basis (though other divisions have better margins) is the automotive/mobile group, which makes and sells Garmin's GPS units. This segment accounted for 55% of the company's sales in 2012 -- $221 million in operating profit on $1.5 billion in revenue. 

Much of the segment's success was due to Garmin's nüvi product line, which accounted for 43% of the company's total revenue in 2012. Garmin is by far the largest participant in the GPS market, with over a 50% market share, according to Consumer Reports.
Operating margin: 23.6%
 Revenue: $2.3 billion
 Market share: 11.8% (U.S.)
 Industry: Packaged foods and meats

Folgers is owned by the J.M. Smucker Company, which reported sales of $5.5 billion in 2012. Of those sales, $2.3 billion came from coffee. The company's U.S. retail coffee unit, of which Folger's is the top-selling brand, reported an operating margin of 23.6%, which is down from 27.8% in 2011 and 28.5% in 2010. We estimate that Folgers has an operating margin of at least that. The brand is the market leader for instant coffee in the U.S., commanding an 11.8% market share as of 2012. However, this is down from 13.2% in 2011. J.M. Smucker cut the price of coffee by 6% in 2012, which will affect the bottom line for both its Folgers brand and Dunkin' Donuts-licensed coffee.

That high profitability is even more impressive given that it was earned in a highly competitive market niche, vying against brands like Maxwell House and Starbucks.
Operating margin: 24%
 Revenue: $2.3 billion
 Market share: 15.1%
 Industry: Packaged foods and meats

The Mead Johnson Nutrition Company primarily sells infant formula and nutritional products for children, and formula accounted for 59% of its total sales in 2012. The vast majority of that came from Enfamil, one of the best-selling infant formula brands in the U.S. The product comes in several varieties designed for babies with different types of feeding problems, intolerances and nutritional needs.

According to Crain's Chicago Business, Mead Johnson had the second largest market share in infant formula as of mid-2012: 15.1%. The company was also the leader in the rapidly growing Chinese formula market. The company's operating margin in fiscal 2012 was 22.3%. We estimate Enfamil has a margin of at least 24%, thanks to the higher retail prices it can command due to its strong brand, as well as lower production costs due to economies of scale.
Operating margin: 25%
 Revenue: $14.3 billion
 Market share: 41.9%
 Industry: Soft drinks

Coca-Cola and Diet Coke were the two most popular sodas in the world as of 2011, Diet Coke having recently surpassed Pepsi to become the second-most popular soft drink in the U.S. Overall, trademark Coca-Cola products accounted for approximately 48% of all case sales of finished products sold by the company in fiscal 2012.

Given that Coke's finished products unit, which includes the Coca-Cola brand, accounted for 62% of total revenue for the company, Coca-Cola trademark drinks accounted for roughly 30% of the company's total revenue. Overall, the Coca-Cola Company reported 2012 sales of $48 billion and an operating profit of 22.4%. We estimate that the tremendous sales of the company's flagship brand push its operating margin to 25%. BrandZ reports that Coke is the world's sixth most valuable brand name, with an estimated value of $74.3 billion.
Operating margin: 26.7%
 Revenue: $1.9 billion
 Market share: 37.2%
 Industry: Soft drinks

Monster Beverage Corporation had net sales of roughly $2.1 billion in fiscal 2012, with an operating income of $551 million. According to market research company Symphony IRI, in the 52 weeks ending February 24, Monster-branded energy drinks accounted for 37.2% of the market, just behind rival Red Bull. In that period, the company sold approximately 1.2 billion cans of its Monster-branded products, including almost 776 million cans of its original Monster beverage. Because Monster-branded drinks accounted for 92.3% of total company revenue, we have treated the company's 26.7% operating margin as a proxy for the energy beverage.

However, business isn't entirely a fairy tale at Monster. The company has recently faced criticism and legal troubles, including a wrongful death suit and a Food and Drug Administration report that linked several deaths to Monster Energy beverages.
Operating margin: 30%
 Revenue: $19.0 billion
 Market share: 42.6%
 Industry: Tobacco

Marlboro cigarettes are sold by Altria Group in the U.S., and elsewhere by Philip Morris International -- which Altria spun off roughly five years ago. Marlboro branded cigarettes have made both companies extremely profitable. Altria's sales of smokeable products totaled roughly $22.8 billion in its most recent full year. That figure accounted for 90% of total company revenues, and 85% of units sold were Marlboros. Altria's smokeable products unit has an operating profit of 28%. Because Marlboro is the company's strongest and best-selling brand, it is 24/7's estimate that costs to produce those cigarettes are lower than the company's discount cigarette lines. As a result, we estimate that Marlboro has an operating margin of at least 30%. BrandZ calculates that Marlboro is the world's seventh most valuable brand at $73.6 billion.
Operating margin: 40%
 Revenue: $80.5 billion
 Market share: 20.9%
 Industry: Computer hardware

The iPhone is by far the most successful product Apple sells. Of the company's $156.5 billion in 2012 worldwide sales, $80.5 billion came from iPhones. Apple sold more than 125 million units last year, a 73% increase over 2011. In contrast, Apple sold 58.3 million iPads that year, generating just $32.4 billion in gross revenue. Each iPhone is far more profitable than each iPad, the company's second best-selling product. According to documents released as a result of the patent lawsuit between Apple and Samsung, Apple's gross margins on the iPhone were between 49% and 58% from April 2010 to April 2012, nearly double those of the iPad. This is partly because wireless carriers subsidize the iPhone heavily -- an average of $425 apiece, according to a recent Stifel Nicholaus analysis. Based on the available data, we calculate the iPhone's profit margin is 40% -- even higher than Apple's overall 35.3% margin.
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Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and Microsoft.

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