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Apple: A Saga Of Big Bets And Discounted Valuation

This article is more than 7 years old.

These are troubling times for the smartphone industry, and Apple seems to be in a conundrum of its own. Aside from facing a tough time in China, the company is also having trouble convincing investors that it is destined for sustainable growth in the longer term.

Apple’s performance at the recent WWDC did improve investor sentiment about the prospects of Apple Watch, Apple TV and other services.  A dive into Apple’s valuation reveals a bet-worthy option under the right circumstances.

Berkshire Hathaway’s Warren Buffett apparently sees this option as one his company can go for, but is that his only motivation or is Berkshire lining up an activist campaign for the world’s most valuable company?

Buffett’s Big Bet

While there is ample commotion on Wall Street regarding Apple’s prospects in the face of sharply falling demand for the iPhone, its flagship product. Berkshire Hathaway has decided to rank up its gamble on the stock by as much as 55% in the second quarter. Consequent to Mr. Buffett’s vote of confidence on Apple’s stock, Berkshire’s stake in the company has gone up to almost $1.5 billion.

In May, Mr. Buffett’s holding company disclosed a $1 billion bet on Apple, which came as a surprise given the firm’s usual inclination towards financial institutions, industrial business and insurers. During the second quarter, Mr. Buffett announced an additional purchase of 5.42 million Apple shares.

To break things down, Berkshire Hathaway now owns about 15.2 million shares in the company, which were valued at roughly $1.46 billion at the end of the second quarter. After Mr. Buffett’s announcement, the stock has surged more than 20% in the past three months.

While Warren Buffett has long been an advocate of investing in prolific companies in the technology sector, according to a report by The Wall Street Journal, the initial foray into Apple was made by one of his stock-picking crew members named Todd Combs. However, this isn’t Berkshire Hathaway’s first bet in the tech sector.

Todd Combs and Ted Weschler joined the investment firm in 2011 and 2012, respectively. In the same year that Combs joined Berkshire Hathaway, the conglomerate announced a stake in IBM worth more than $10 billion at the time—the value of which has only increased since then.

While a particular reason for Berkshire Hathaway’s confidence in Apple is not outlined anywhere, it is likely rooted in the hopeful success of the iPhone 7 when it hits stores this September. Most analysts on Wall Street expect a lukewarm welcome for the new iteration due to the saturation in demand for smartphones, coupled with the availability of competing products by lower-tier OEMs, especially in emerging markets.

Recently, RBC analysts raised their estimates on the number of iPhone units Apple could sell over the December quarter.  The change was made because Apple’s first quarter of fiscal 2017 will have an extra week instead of the usual thirteen.  This would mean an additional week for Apple to muster up iPhone numbers that could surpass record unit sales seen in its last two December quarters.

So unless Mr. Buffett enjoyed an extravagant lunch with Apple CEO Tim Cook where the latter somehow convinced him of a blockbuster launch season for the iPhone 7, the only rational approach remains that Berkshire could be looking at serious sales gains when Apple reports earnings for the first quarter of fiscal year 2017.

Apple reported earnings of $1.42 per share on revenue of $42.4 billion as the company recorded a  better-than-expected quarter for iPhone units sold. When the earnings first broke, investors were pleasantly surprised by the number of iPhones sold during the quarter. However, many were disappointed when Mr. Cook attributed a chunk of the sales to the lower priced iPhone SE—which effectively lowered the iPhone’s ASP—taking a toll on Apple’s top-line.

So What Should Apple be Worth?

In May, Apple broke the ice in India after Mr. Cook visited the country to meet with Prime Minister Narendra Modi. The meeting must have gone well, as the Prime Minister allowed Apple to open its own stores in India, instead of having to rely on distributors and retailers to sell its products.

Once again, we must visit Nassim Taleb’s concept of fragility which Mr. Cook seems to have finally grasped. For a company that wishes to operate as an ecosystem, Apple shares appear to be highly undervalued—as depicted by the hefty gap between Apple’s price-to-earnings (P/E) compared to others in the space.

Apple’s growth prospects, if we go by how Tim Cook describes them, should be coupled with a much higher valuation than the stock’s current standing. For that, it is necessary that Apple investors are also convinced about the iPhone maker’s directive and be fully confident about its future. This does not appear to be case.

While Apple seems to be regaining some of the momentum it lost in the second quarter of fiscal year 2016, Bloomberg has casually confirmed that the company is gearing up to unveil the iPhone 7 in its famous September event  to be held on the 7th of the month.

It will be interesting to see how investors gauge demand for Apple’s products - post launch of the upcoming iPhone. If Apple can gain back the traction it had when demand for the iPhone was at its peak, gaining back investor sentiment does not appear to be such a long shot.

By: Muqeet Khan