Wow: Apple’s Round Trip Back Below $450 Brings Trailing P/E Down To 7x



That kind of looks like a mountain landscape I would see from higher elevations out here in Oregon, but instead it is a 1-year chart of Apple (AAPL) stock. After Tuesday’s solid but uninspiring fourth quarter earnings report, Apple’s quick fall from perceived market darling to “just another large cap tech stock that is being passed by on the innovation front” has reached a crescendo. The magnitude of the drop from the September high of $705 now sits at -37%. Instead of $800 price objectives, some are suggesting $300 may be more fitting. How times have changed in just four months.

Apple earned $44 per share last year, giving the stock (at the current $445 quote) a trailing P/E of 10x. Free cash flow in 2012 was $47 billion, giving the stock a 9x free cash flow multiple. The P/E is actually lower if you use free cash flow instead of reported earnings. That hardly ever happens and shows you just how cheap the shares are right now. And don’t forget the $137 billion ($145 per share) of cash that Apple has in the bank). Subtract out the cash position and investors are getting Apple’s operations for just $300 per share ($285 billion). That equates to a trailing P/E of 6.8x and 6.1x times last year’s free cash flow.

How do those numbers compare to others? The P/E is lower than Microsoft, Intel, Cisco, IBM, and Oracle. The free cash flow multiple is unheard of. Try finding any other company that trades at 6x free cash flow, in any industry!

Now, I did write about a month ago that I thought Apple stock was cheap at $525 (“Apple Shares Now Nearly As Cheap As Microsoft: Which Would You Rather Have?”) so it should come as no surprise that I think it’s super cheap at $445. The point is, even if you think both their growth and margins have peaked, it is not easy to justify the stock being at $445 or $300 net of cash. The business would have to decline meaningfully from here for that to make sense.

Sure, it’s not impossible, but is that the most likely outcome? Is it likely that Apple’s share of the tablet market declines meaningfully? Is it likely that their share of the smartphone market declines meaningfully? Remember, those end markets are growing, so just maintaining current market share results in Apple’s business growing, not declining from here. Is it likely that they never come out with any new products? A television? A lower cost tablet for the education market to replace expensive, heavy textbooks? A streaming radio competitor to Pandora? Something else that has not yet been rumored already (those three have)?

Yes, it is possible that nothing positive happens for Apple from here on out. That they have peaked and will graduate to “old tech” like Gateway, Dell, HP, Intel, or Microsoft. But that is what the stock is priced for right now. To me, that does not seem like the most likely outcome. And if some things start to get better, or if Apple’s 80,000 employees use their $137 billion of excess cash to create something new and great again, then the current stock price might look a little silly.

There is a difference between growth rates and profit margins peaking and massive deterioration in sales and profits. The stock has broken down technically, emotions are running high, analysts are slashing their price targets, and there are no catalysts to turn things around in the short term. But all of that could change fairly quickly. And given how cheap the stock is and how much money the company continues to print each day in its stores and on its web site, I just don’t think fair value on Apple is a 7 trailing P/E multiple.

But we will just have to wait and see. I am willing to wait this out and will likely selectively add to client positions in the stock.

Full Disclosure: Long shares of Apple, but positions may change at any time.

Netflix Stock Repricing Overdone

Netflix (NFLX) stock is soaring this morning, up 36% ($37) to $140 per share in pre-market trading. The company’s fourth quarter financial results were above expectations, but at first glance do not appear to warrant a 36% stock price increase. Revenue rose 7.9% year-over-year, leading to a very small quarterly profit of 13 cents per share.

Investors are enthusiastic about Netflix’s addition of 2.05 million domestic streaming customers (up 8.2% versus the prior quarter), but that figure is a bit misleading as actual paid customers rose by just 1.67 million (+7.0%). Obviously, lots of free trial memberships are given out at the holidays, but how many of them convert to paying customers is a big question mark.

It was also a good sign to see operating earnings from the domestic streaming segment rise to $109 million in Q4, versus just $52 million a year ago. The DVD mail segment earned $128 million domestically for the quarter, which just goes to show you how much more profitable those subscribers are. The DVD mail business earned more money, despite having just 8.05 million paid subs, versus 25.5 million paid streaming subs.

Netflix continues to see subscriber losses in its most profitable segment and gains in a streaming business that has very high operating costs. Just how valuable a streaming customer actually is will remain an important issue for investors. Based on the stock’s rise this morning, you would think streaming customers mint money for the company. Conversely, Netflix reported segment profits of $4.25 per paid subscriber during the fourth quarter. That comes out to less than $1.50 per month in profit from the $8.00 per month in revenue they generate.

Back in August, with the stock floundering in the mid 50’s, I wrote an article on Seeking Alpha entitled “Netflix Is Finally Cheap.” I did not buy the stock, which in hindsight was a mistake since the analysis was correct. With the stock around $140 as I write this post, I can not justify an equity valuation of $8.25 billion for the company, so if you have played this stock correctly lately, you might want to strongly consider lightening up on your long position into today’s strength.

Full Disclosure: No position in NFLX at the time of writing, but positions may change at any time

Dell LBO: A Logical Move That Others Might Mimic

Investors have been speculating for a couple of years now that Michael Dell could eventually take his computer company private, after leaving the option on the table in multiple press interviews. His large stake as founder and CEO (about 15% of the company) coupled with his transformation plan and lack of respect on Wall Street (for the stock, not himself) all make a leveraged buyout seem logical. With news that a deal is being negotiated and could be finalized shortly in the $13-$14 per share range, I think the deal makes a lot of sense and others might take Dell’s lead and follow suit.

All of the ingredients required for a successful LBO are there in Dell’s case. The stock is so unloved on Wall Street that even after a premium is attached to the shares (which were hovering around $10 before news of the deal discussions leaked) the company can be had for a very attractive price. The company generates about $4 billion of cash flow annually, with $3.5 billion or so left over after capital expenditures. With a market value of around $23 billion, which excludes $6 billion of net cash on the balance sheet, Dell and his group would be paying about 4 times EBITDA.

Bears on the stock will be quick to point out that Dell still gets the majority of its revenue from desktop and laptop computer sales and that business is in decline thanks to the emergence of powerful smartphones and tablets. Indeed, that is why the stock has been pressured lately and accounts for the meager enterprise value assigned by the public market, but it also ignores the transformation plan that Dell and his team have slowly been implementing. While PC deterioration is offsetting the financial benefits of the company’s move into the corporate world of servers, storage, security, and services right now, over time that side of the business (which is both Dell’s current focus and future) will overtake the PC side and allow the company to continue to book strong profits. Once PCs dwindle to 20-25% of the business over the next several years, Dell can re-IPO and the LBO investors can cash out big time. At that time, Dell will look more like IBM than HP.

So why might other companies seen as “old tech” go down a similar route as Dell? First, it makes it a lot easier after someone else does it first, as it gives credibility to the idea. Companies heavy into PC-related businesses are not going to get respect from Wall Street going forward. Dell’s pre-deal P/E ratio of 6x proves that. After a while, the frustration mounts and staying public loses its luster. Hewlett Packard is likely going through a similar thought process right now, even though they are far behind Dell in orchestrating a solid transitional game plan. Even PC-related software companies like Symantec are being painted with the same brush and could explore the idea of going private. Anti-virus software is simply seen as yesterday’s technology and lacking growth potential.

All in all, this Dell LBO idea makes a lot of sense on multiple fronts, and while other companies might not have as many strong cards to play to make a deal like this work, I bet a finalized Dell deal prompts a lot of discussions in board of directors’ meetings across the industry in coming months.

Full Disclosure: Long SYMC at the time of writing, but positions may change at any time

Apple Shares Now Nearly As Cheap As Microsoft: Which Would You Rather Have?

That’s right. With the recent share price plunge in Apple (AAPL), from over $700 to around $525, the stock is rapidly approaching the valuation of 1990’s tech darling Microsoft (MSFT). While clearly facing near-term headwinds, both on the product side (a narrowing of their technological lead over rivals) and the financial side (fiscal cliff, tax-related selling before year-end), among others, I find it hard to make an argument for why Apple should not trade at a premium to Mister Softee. To be fair, Apple still fetches slightly more if you go out to one decimal place, with AAPL trading at 6.4 trailing cash flow, versus 5.7 times for Microsoft. If Apple shares fell another 8% or so, to around $485, and MSFT stayed around $27, both would trade at 5.7x trailing 12 month EBITDA. Still, investors are having a hard time understanding exactly how sentiment on Apple has shifted so much in just a few short months.

Now I know many people come to this blog to discover new investment ideas, and Apple definitely does not qualify. However, since contrarian investing is one of my core tenets, I think it is important to point out that Apple shares are dirt cheap right now. In order to justify a lower stock price, say one or two years from now, you have to think that Apple’s sales and earnings have peaked and are headed down from here. While that is not an impossibility, especially in the world of technology, I think it is far more likely that Apple’s market share gains slow and level off going forward. Even in that case, the end markets they serve as going to grow nicely over the next few years. As a result, I don’t envision their financials petering out from here, though for a company of this size, the hey days of rapid growth are clearly over.

For those who aren’t sure such prognostications will prove true, consider again the comparison with Microsoft. Regardless of Apple’s position relative to Google, Samsung, and the like in the coming years, is Microsoft really as well positioned? I don’t think so. Even a bet that Apple will outperform Microsoft, given their stocks are nearly identically priced, is a bet investors can make in the public market by shorting one and using the proceeds to go long the other. iPod versus Zune? iPad versus Surface? iPhone vs Windows Phone? It’s not a bad play.

Although discussing large cap tech titans like AAPL and MSFT hardly uncovers anything new for curious investors, I definitely think today’s share price on Apple is worthy of discussion. The recent 200 point decline seems very overdone to me, based on what is happening out in the tech marketplace. The last time I updated my fair value for Apple stock I got a number with a “7” handle on it. Nothing has changed since then, and for the first time in a long time, I am actually looking to add to the stock in client portfolios.

Full Disclosure: Long Apple and no position in Microsoft at the time of writing, but positions may change at any time

Does Marissa Mayer Make Yahoo Stock A Worthwhile Bet?

Granted, I am a numbers guy, so even asking whether a new CEO is enough to warrant buying a stock is a stretch for me. While quality leadership is certainly important, successful stock market investments require the numbers to work and no matter how great the CEO, they can’t magically make the numbers work all by themselves (unless you want the books to be cooked of course). Still, I am intrigued by Marissa Mayer’s hire as the new CEO at Yahoo (YHOO), even though the company is clearly not gaining relevancy on the Internet. A 1990’s darling, Yahoo has lost its lead in search (thanks to Mayer’s former employer, Google) and really only has a stronghold in a few areas of the web, such as email and fantasy sports.

Still, considering who has been occupying the corner office at Yahoo over the last decade, it is compelling that a tech person of Mayer’s caliber is now running the show. From 2001 to 2007 the company was headed by a movie studio exec (Terry Semel). From 2009 to 2011, they brought in a Silicon Valley veteran (Carol Bartz), but she previously ran Autodesk, a software company that sells products to help engineers design factories, buildings, and 3D animated characters. Is it really that surprising that Yahoo has been treading water for all these years?

Enter Marissa Mayer, Google’s 20th employee (and first woman engineer) who had been leading successful efforts in areas where Yahoo actually competes, like web search. If anyone can help reinvigorate Yahoo, it might just be her. But isn’t that taking a big leap of faith? Sure, but there is another factor, other than the CEO, that makes a bet on Yahoo shares at $16 each worth a look. The numbers.

Yahoo’s current market value is less than $20 billion. As of September 30th, the company’s stake in Yahoo Japan ($7.7 billion) and Alibaba ($8.1 billion) account for the majority of that valuation. Even if you deduct the tax liability that would be incurred if Yahoo were to monetize these stakes, the organic Yahoo operations are priced at just $10 billion. What do investors get for that $10 billion? To start, how about nearly $7 billion of net cash on the balance sheet (plenty for Mayer to begin a transformation)? That leaves a mere $3 billion valuation on Yahoo’s core operations, which generated free cash flow of $250 million in 2011. That is a low price even if the company doesn’t grow at all going forward.

Yahoo stock today looks to me like a call option on Marissa Mayer. As I said before, a CEO alone is not a good reason to buy a stock. But what if you have a unique change in leadership that could very well pay off in spades, and the meager public market valuation of the company basically affords you limited downside risk? The combination of those two factors makes the stock an interesting opportunity in my view. If Mayer, like her predecessors, fails to reinvigorate the company, then the shares likely stagnate here in the mid teens. However, if she succeeds, as her resume seems to suggest she could, there is a lot of upside to the story. It feels weird for me to say, but Yahoo at $16 with Carol Bartz running the show didn’t interest me one bit. With Mayer it’s a different story.

Full Disclosure: Long shares of Yahoo at the time of writing, but positions may change at any time


Apple Sets Market Value Record As iPhone 5 Debut Nears

Earlier this week I wrote a piece on Seeking Alpha that outlined why I believe investors are likely to value Apple (AAPL) shares similarly to other blue chip consumer brands, which would mean a valuation of 10-12 times trailing cash flow (defined as EV/EBITDA). Bulls on the stock have a multitude of reasons why Apple should trade at a premium, but in recent quarters the market has disagreed. In fact, even as Apple stock has broken out to new highs, setting a new market value record in the process, AAPL shares fetch about 9 times trailing cash flow (at the current quote of $665), a discount to other superb consumer brands.

If fair value is somewhere in the 10-12 times cash flow range, that would equate to $725-$850 per share. That would mean fair value is somewhere between 10% and 25% above current levels. That is why I continue to hold the stock, despite its enormous run-up lately.

In terms of future potential, I continue to be intrigued by the possible launch of an Apple TV set. When I think of the large market opportunities for Apple, those that can really move the needle for a company worth more than $600 billion, the television market is the only one they have yet to target that has real appeal. Outside of desktop, laptop, and tablet computers, phones, music players, and televisions, I am not sure where else Apple could find significant future expansion potential (although I am sure they would disagree and are looking for some already). After launching a TV, I think Apple’s strong growth days might fade. Assuming the stock traded in line with other blue chips at that point, I would likely look for an exit point.

I have not sold yet, mainly because a TV is still not here (some are even arguing they aren’t going to make one, just a set-top box) and the stock’s valuation on current products, at 9 times cash flow, is still below that of other large cap blue chips. So while I am not as bullish as some, I still see room to run for the stock.

Full Disclosure: Long Apple at the time of writing, but positions may change at any time

Bubble Bursting 2.0 (Part 2): Isn’t Groupon Worth Something?

Last November, in a post entitled “Numbers Behind Groupon’s Business Warrant Caution After First Day Pop”, I cautioned investors that the IPO of daily deal leader Groupon (GRPN) looked sky-high at the initial offer price of $20 per share, which valued the company at an astounding $13 billion:

“It is not hard to understand why skeptics do not believe Groupon is worth nearly $13 billion today. To warrant a $425 per customer valuation, Groupon would have to sell far more Groupons to its customers than it does now, or make so much profit on each one that it negates the lower sales rate. The former scenario is unlikely to materialize as merchant growth slows. The latter could improve when the company stops spending so much money on marketing (currently more than half of net revenue is allocated there), but who knows when that will happen or how the daily deal industry landscape will evolve in the meantime over the next couple of years.

Buyer beware seems to definitely be warranted here.”

A few things have happened since then. First, Groupon has cut back on marketing spending and is now making a profit (free cash flow of $50 million in the second quarter). Second, the post-IPO insider lockup period has expired, removing a negative catalyst that the market knew was coming. Third, and most importantly, Groupon’s stock has plummeted from a high of $31 on the first day of trading ($20 billion valuation) to a new low today of $4.50 ($3 billion valuation).

Here is my question, as simply as I can put it; “Isn’t Groupon worth something?” The stock market seems to be wondering if many of these Internet IPOs will exist in a few years. Today’s 8% price drop for Groupon was prompted by an analyst downgrade to a “sell” and a $3 price target. Here is a company with $1.2 billion in cash, no debt, and a free cash flow positive business that will generate over $2 billion of revenue this year. That has to be worth something. How much is another story.

I would argue that it is too early to write off companies like Groupon as being “finished.” It is far from assured that they will be around in 3-5 years, but many of them have huge cash hoards ($2 per share in Groupon’s case), no debt, and a business that is making money today. My most recent blog post made the point that many of these Internet companies are going to survive, and in those cases bargain hunters are likely to make a lot of money. Will Groupon be one of them? I don’t know, but if an investor wanted to make that bet, at $4.50 per share, they are paying about $1.8 billion ($3 billion market value less $1.2 billion of cash in the bank) for an operating business that is on track for more than $2 billion in sales and $200 million in free cash flow in 2012. And who knows, with this kind of negative momentum, the shares could certainly reach the analyst’s $3 price target in a few more days.

Bottom line: these things are starting to get pretty darn cheap. If they make it, of course.

Full Disclosure: No position in Groupon at the time of writing, but positions may change at any time.

Bubble Bursting 2.0: Coming To A Dot-Com Stock Near You

By now you probably know the poster children for the bursting of the 2012 Internet bubble:

Facebook (FB) IPO price: $38.00, Current quote $21.75 (down 43%)

Zynga (ZNGA) IPO price: $10.00, Current quote: $2.95 (down 70%)

Groupon (GRPN) IPO price: $20.00, Current quote: $6.66 (down 67%)

And as was the case in 2000, we are seeing violent selling in most any Internet company that reports a less-than-impressive quarter as a public company. We are also likely to get a repeat scenario in terms of bargain basement prices, for a time anyway, even on those companies who are able to survive and grow with a profitable business model. I think it is time to start monitoring these dot-com IPOs in search of those that might be written off prematurely. After all, unlike the late 1990’s, many of these companies do make a profit. The issue today is more that they don’t always make enough to justify multi-billion dollar stock market valuations.

Today’s disaster du jour is CafePress (PRSS), a profitable e-commerce site that has been around since, you guessed it, 1999. CafePress, which projects 2012 revenue of more than $200 million, went public in late March at $19 per share, giving it a market value at the time of about $325 million. In today’s trading the stock is falling by nearly $6, or 42%, to a new low of under $8 per share. Loss since the IPO: 58%.

So why bring up CafePress? I think it is the kind of company (a viable, profitable, and growing Internet operation) that might fall into that “written off way too early” category as the air continues to flee from the 2012 Internet company bubble. Granted, I have only spent an hour or so looking at CafePress specifically, so this is by no means a huge ringing endorsement yet, but it is the kind of stock I think warrants a closer look.

Even with reduced financial guidance for 2012 (the reason for today’s steep stock price decline), CafePress is predicting more than $20 million in EBITDA on more than $200 million in sales this year. With sales growing by about 20%, coupled with an 11% cash flow margin, PRSS is certainly a viable company. And yet, at under $8 per share, the stock price is indicating otherwise. The market value is now down to $135 million. PRSS has $60 million in cash on the balance sheet, so at current prices Wall Street is saying that the CafePress operating business is worth just $75 million, or 3 times EBITDA. That is the kind of valuation that Wall Street normally reserves for companies in a steep decline. As a value investor, numbers like these can’t help but get my attention.

Comments on the Internet stocks in general, or CafePress specifically, are always welcomed.

Full Disclosure: No positions in the stocks mentioned at the time of writing, but positions may change at any time

Values Abound in Enterprise Computing

With the European recession beginning to impact earnings guidance for U.S. companies in recent weeks, one of the sectors to really get hammered is enterprise-focused technology. While second quarter profit reports and forward guidance will likely be unimpressive this month, some of the current valuations on Wall Street make little sense even in that scenario. As a result, I would expect strategic mergers and private equity buyers to begin looking at some of these companies.

There are far too many ideas to list here, or buy for clients, so I will just point to one that looks intriguing; enterprise collaboration hardware maker Polycom (PLCM). Polycom earned $1.18 per share last year, but weakening demand has pushed forecasts for 2012 down to just $0.89 which has crushed the stock from $32 a year ago to a recent quote of just $9 per share. What really bulks up the bullish case for the stock is that Polycom has no debt and a whopping $600 million of cash in the bank, which equates to about $3.50 per share in net cash. Investors are getting the business for only $6 per share, or 5 times trailing earnings.

With such a pristine balance sheet, the odds of Polycom being acquired rises materially relative to the average hardware company. It would be a logical target for a Cisco, HP, or Dell, all of which are companies that either compete with PLCM or are looking to expand their product offerings to enterprise customers. Even without a deal, the stock should likely command at least a market multiple, which would put fair value in the high teens inclusive of cash. This is just one of many enterprise computing companies that have been decimated in recent months, which make them very attractive in my view.

Full Disclosure: Clients of Peridot Capital own shares of Polycom at the time of writing, but positions may change at any time.

The Most Surprising Thing About Facebook’s IPO? Trading Has Been Completely Rational!

Today’s Facebook (FB) IPO is the first time I can remember being completely shocked at the lack of trading excitement and volatility for a much-hyped IPO. Ironically, the reason for such unexciting, rational behavior is because of how hyped the Facebook IPO was to begin with. The share allocation to retail investors at the $38 offer price was huge. I put in orders for my larger clients at E*Trade, one of the brokerage firms that got a sizable piece of the IPO, but did not really think they would allocate us any shares (there were reports that Fidelity would not even consider giving out shares to any clients who had less than $500,000 with them). What happened? We got every share we asked for.

With that much hype, especially from the retail side, and with that many investors actually getting 100 or 200 shares, it would be completely rational that, since the supply was very large and the price was fair, a large first day surge would be unwarranted. But we are not used to seeing first day rationality for hot Internet IPOs. In hindsight, it makes sense that Facebook opened at $42.05, only up $4. With so few incremental buyers (given the huge retail allocation at the IPO price), it also makes sense that the stock would see selling at the open, which did occur, sending the stock down to $38 exactly within the first 30 minutes of trading.

So while I am pretty shocked that this IPO has been so calm, I think it bodes well for how the financial market worked. For what could very well be the most hyped IPO ever, investors are acting completely rational and the investment bankers have done a really solid job of not only correctly pricing the deal, but also letting the “Average Joe” participate. The retail brokerage customer won’t be getting rich off of this IPO on day one, but that is not the way it should work anyway. With so many people getting stock, the immediate paper gains should be modest. That is how the marketplace should work. It is all about supply and demand after all.

Full Disclosure: I received Facebook shares at the IPO price, as did a few of my clients. I was planning to look for a chance to flip them today, after a nice pop, but with this interesting trading action to start the day, we have yet to sell a single share as of the time of this post. As always, positions may change at any time.

UPDATE (5/18): I sold my client’s Facebook shares after this post was originally published, in afternoon trading at $40.09 each.