Description

Cap table above adjusted for split

Short Apple

We think Apple is one of those situations where you may make a lot on the short side and will probably not lose too much. Its not the most attractive short pitch, but you probably won’t get Tesla’d. More importantly, there are many trends that are working for short sellers which we think are “cheap put options” at the current valuation.

First, Apple trades at 34x fwd earnings. This is a valuation AAPL has not seen in over a decade, when the smartphone market was rapidly growing and AAPL was quickly gaining share. Today, the smartphone market is ex-growth and younger companies like Xiaomi (founded in 2010) are growing 20% per year and gaining market share in key geographies. In 2015, AAPL generated $82bn in EBIT and the company is expected to break this high-water mark in FY21 or FY22. Despite all the analysis on product cycles and service revenue growth, AAPL has barely shown any real growth.

Second, Apple’s incremental returns on invested capital is terrible. AAPL has basically spent all its cash and cash flow buying back shares. That is fine, but the impact it will have on its EPS growing in the future it miniscule at the current valuation. If they bought back $100bn in stock tomorrow, it would only reduce the share count by 4-5%. If the biggest driver of EPS the last 5 years has been tax cuts and buybacks, those tailwinds won’t be powering EPS much in the future.

Third, we don’t have a strong view on the Apple/Fortnite situation, but its hard to argue this is good for Apple. If companies start putting pressure on Apple’s app store take rate, potential price cuts will drop straight to the bottom line. At 34x fwd earnings, that is awful for equity holders. Our personal view, which could very much be irrelevant, is that AAPL deserves a cut of profits from companies on its app store, but its treatment of Fortnite abuses its position.

Fourth, we think the equity markets are quite expensive. Over time, the market generally trade between 80-100% of GDP. Interestingly, there a few tech companies that combined equal a Mcap nearly half of US’ GDP. AAPL itself is 10% of US GDP. We understand that many big tech companies generate profits overseas, but the shear amount of Mcap awarded to various tech companies seems too large. Of them all, AAPL surprises us the most since its failed to show much growth. Its one thing if the market wants to get excited behind AMZN or MSFT, which are growing companies, its another if the Mcap wants to assign $2.1t to AAPL!  Fun fact: AAPL is about the size of the Russell 2000. This can’t last.

Fifth, we think some of the recent euphoria is due to significant retail involvement in a few tech companies. We don’t know AAPL is up $500bn in Mcap the last month or so because of its upcoming share split, but we don’t think its being done for any fundamental reasons. Should this froth unwind, AAPL is probably one of the tech stocks in trouble.

Sixth, we have been humbled looking at the TSLA re-rating. Nonetheless, its hard for us to accept the market valuations and bubble-ish trading sentiment. We want to express a negative view on this, but are concerned that its tough to time the top of a potential bubble. AAPL allows us to express this view, where we see 30-40% downside in the event AAPL re-verts to historical P/E multiples, without huge risk the trade works against us.

Seven, we have total respect for Buffett. We are shocked people are saying he lost his way when he just made the most money in a single “trade” when buying AAPL. He is up more on AAPL then some of the other “great” investors made in their whole career. Nevertheless, even Buffett said he wanted a cheaper price to buy more AAPL in early 2019 when the stock was ~$140. At $500, I am sure even Buffett would say AAPL is not a bargain.

https://9to5mac.com/2019/02/25/aapl-stock-warren-buffett/

Eight, short sellers, willing to hold the position for a while, expose themselves to several free put options. Maybe the Chinese buy less iPhones? Maybe the smartphone form factor itself is disrupted? Frankly, even if we are wrong about AAPL and the market sells off, AAPL will probably go down. Or what about the passive bubble people talk about, if that unwinds, AAPL is in trouble.

Based on our simple AAPL DCF, where the company reaches $330bn in sales in 2023 and eventually hits a 30% EBIT margin, both fairly optimistic assumptions, you need to run a 7% WACC and 3% perp growth to get $1.9t in TEV. Literally, if anything goes wrong, AAPL can’t fill a $2.1t Mcap.

Catalyst

Market sell-off

Trade war w/ China gets worse

5G cycle is a bust

App store take rate comes down

People want more then a 1% dividend on no-growth companies

Run out of buyback firepower when company reaches net debt position (1 or 2 years from now)