Writing Sample - Equity Research - AAPL

Student Investment Management Report
Company Description
Apple Inc. (Apple) designs and markets consumer electronic devices,
including personal computers, mobile phones, tablets, portable
digital music players. The company also provides its own operating
systems on each products and allows customers to purchase and
storage a variety of accessories, services and digital contents through
its iCloud and iTunes stores. Apple is the pioneer in information
technology sector which re-defined several industries through its
Mac, iPod, iPhone, and iPad.
Investment Thesis
I issue a HOLD recommendation for Apple. My valuation yield a
fair value of $125.66 as of 07/24. I believe the company’s advantage
of current strong product portfolio is offset by the uncertainty of
future product initiative.
- Apple launched its latest version of iPhone – iPhone 6/6+ last
September which generated the highest additional customers in
one quarter. Given only 10-15% of iPhone users have upgraded
to iPhone 6 as of Q2 FY15, I believe there is still more room
for iPhone 6 to grow.
- The company is sitting on $32B cash & equivalent and
possesses $110B net financial asset as of Q2 FY15. It is
planning to pay back $65B of cash through share buyback and
dividend in CY15. This set a buffet for downside potential.
- Currently, I could not see a clear strategy for the long-expected
Apple Watch. There is no certain function or business need that
distinguishes the product from good-to-have to must-have. The
long term growth concern will remain an issue if the company
could not figure out a more sustainable business model.
Risk to Recommendation
- Failure to successfully launch new product will impact top and
bottom line of the company.
- Similar function of different products could lead to self-
cannibalization.
- Strong dollar and weaker economy outlook in major oversea
market can affect the company’s performance.
Apple Inc.
US Equity Research July 26, 2015
Michael Lin, 614-264-0145
mlin1120000@gmail.com
Sector: Information Technology
Ticker: NASDAQ: AAPL
Current Price: $124.50 (July 26, 2015)
Target Price: $125.66 (1.0% upside potential)
Recommendation: HOLD
Stock Price Performance
April 2014 –April 2015
Performance v.s. S&P 500
April 2010 –April 2015
Source: Yahoo! Finance
52-Week Range $93.28 - $134.54
Avg. Volume 48.57M
Beta 1.13
P/E (ttm) 14.4
Dividend Yield 1.7%
Market Cap. $709.99B
Diluted Shares Outstanding 5,773.01M
EPS $8.65
ROE (FY14) 33.61%
ROA (FY14) 18.01%
Market Profile (as of July 26, 2015)

OSU Student Investment Management July 26, 2015
2
Table of Contents
Company Overview…………………………………………………………3
Business Segments………………………………………………………3
Business Model………………………………………………………….4
Industry Overview and Competition Positioning……………………......5
Current Issues…………………………………………………………....7
Business Trend…………………………………………………………..9
Investment Thesis………………………………………………….……....10
Economic Analysis…………………………………………………..…10
Financial Analysis…………………………………………………...…11
Risk…………………………………………………………........................12
Supply Chain Risk………………………………………………….......12
Competition Risk……………………………………………………….12
Currency Risk…………………………………………………………..12
Valuation…………………………………………………………...............12
DCF Valuation………………………………………………………….12
Relative Valuation…………………………………………...…………14
Risk to Target Price…………………………………………………….15
Conclusion…………………………………………………………............15
Appendices…………………………………………………………............16
Works Cited………………..………………………………………............20

3
Company Overview
Founded at 1977, the Cupertino, California based consumer electronic
provider is now the largest public company in the world with $710B market
cap at the end of Q3 FY15. The company’s revenue can be broken down
into six regions: Americas: 46.3%, Europe: 28.1%, Greater China: 21.0%,
Japan: 13.7%, Rest of the Asia Pacific: 6.9% and Retail: 8.9% (Figure 1).
Apple designs and markets its product and outsources the manufacturing
process. While most of its peers use Windows and Google’s operation
system and follow the open source strategy, Apple provides its own
operating system and leaves less room for programmers to adjust to its
system. Similarly the company put more control on the hardware; for
instance, instead of using Intel or Qualcomm’s processor, the company
design its own CPU. This strategy leads to better integration between
software and hardware which leads to the company’s 30% installed base
market share in premium smartphone market. Another obvious advantage of
the closed platform strategy is that there are less viruses on Apple’s platform.
Unlike its competitors, Apple operates its own retail stores that accounts for
28% of the company’s revenue. The company’s revenue and net income are
$182.8B and $39.5B in FY14; the growth rates are 7.1% and 6.8%
respectively (Figure 2).
Business Segments
Apple currently reports six product segments – iPhone, iPad, Mac, iPod,
Accessories, and iTunes, Software and Services (Figure 3). The new
products such as Apple Watch and Apple Pay will be discussed in Current
Issues.
iPhone
iPhone is the most important product for Apple which represents 55.8% of
revenue. This segment enjoyed 41.9% CAGR in sales for the past five years.
Thanks to constant upgrade of its product, the ASP remains constant. iPhone
is estimated to have 20% unit sales market share by Q4 CY14. The company
sold 169M units of iPhone in FY14 at an average price of $602 (Figure 5).
Macintosh (Mac)
This segment accounts for 13.2% of revenue. As a more mature product,
Mac segment saw more cyclical revenue growth with 8.3% CAGR for the
past five years. This segment is facing a decreasing ASP trend for the past
decade due to fierce competition and short product life cycle. The company
sold 18.9M units of Mac computer at an average price of $1,273 in FY14.
iPad
Since its debut in CY11, the iPad business had grown rapidly to become the
second largest revenue generator which contributes 16.6% of sales in FY14.
However, iPad’s market share dropped dramatically from 70% to 30%.
Furthermore, after three years of rapid growth, this segment faced a 4% sales
decline in FY14. The pale result of iPad is due to lack of innovation and
increasing competition. In addition, iPad mini could also be negatively
Figure 1: Revenue Breakdown by Region
Figure 3: Revenue Breakdown by Product
Figure 2: Revenue & Net Income/Growth
Figure 4: Tablet v.s. Phablet
Source: Company Data
Source: IDC, Company Data

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impacted by the large iPhone 6+, which is similar to the mini tablet (Figure
4). In addition, the ASP declined constantly after its appearance. Unless the
company develop new function, iPad will stay as an accessory rather than a
necessity.
2010 2011 2012 2013 2014
ASP iPhone 629.6 636.3 629.3 607.5 602.7
ASP Mac 1279.4 1301.6 1278.8 1314.7 1273.6
ASP iPad 664.8 628.4 530.7 450.2 445.5
Services
Due to the well-established ecosystem the company built and the
comprehensive compliment application, Apple has a 13.1% sales from
services, which cannot be seen in other handset providers. The revenue of
this segment come from sales on iTunes, commission from application
developers and most recently, the fee from Apple Pay.
iPod
The portable digital music device Apple created was once a disruptive
innovation that, along with the iTunes platform, has shaken the music
industry. However, iPhone is now replacing iPod in every aspect; therefore,
this segment only contribute 1.3% of sales and experienced 48% and 21%
sales decline for FY14 and FY13. The company sold 14M units of iPod at
an average price of $159 during FY14.
Business Model
Apple achieves today’s success through constant innovation. However, the
fact that it needs to continuously bring in groundbreaking products also
shows the company’s dependent on unpredictable innovation to maintain
current size. For the growing segment such as iPhone, this drawback has not
affected current performance since the company only needs to upgrade and
add in more features to sell the product at a higher price. However, the short
product life cycle is hurting the mature businesses such as Mac and even
iPad. The company saw constant price drop and decline in units sold even
when it upgraded those products every year (Figure 6 & 8). This very
phenomenon is also due to pricing strategy, the premium consumer
electronic device providers usually set higher price on the debut of new
products to attract heavy users, lower the price when the product has become
less trendy, phase out the products when they cannot meet the new functions
that other products serve. Therefore, the assumption that the revenue or free
cash flow can grow in line with the economy is not suitable for this industry.
Figure 5: Product ASP (M)
Figure 6: Mac ASP

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Although facing harsh environment, Apple is the best among its peers to
widen the moat. The self-built operating system not only differentiates itself
from its peers by delivering first class user experience but also increases the
switching cost and network externality. Users are inclined to stick with the
same operating system which they are familiar with to save time.
Furthermore, consumers are likely to choose the platform with more
applications. Currently, there are 1.2M applications for iOS and 1.3M for
Android. In contrast, there are only 0.3M application for the third largest
Window operating system’s users to download (Figure 7). Without many
popular applications in other operating systems, the current duopoly
situation in mobile OS is very likely to stay intact. Apple Watch is another
way to increase the network effect among devices; moreover, services such
as Apple Pay also aim at increasing customers’ stickiness through
memorizing users’ personal information.
Unlike many other mega-size corporations, Apple achieves today’s scale
through organic growth and in-house development of most of its important
products. The company has seldom acquired other companies to seek
growth. Figure 9 lists all the acquisitions larger than $100M Apple made
since 1997. The only large acquisition the company made is the $3B deal to
purchase Beats Audio to enhance Apple’s audio quality.
Industry Overview and Competitive Positioning
Personal Computer
An ally among Microsoft, Intel and their downstream customers such as HP,
Dell, Asus is the primary competitor of Apple in the personal computer
industry. The user base of Apple’s OS is still significantly lower than that of
the Window’s system – as of February 2014 the OS X market share is a mere
7.69% compare to Windows’ 90.62% (Figure 10); however, the ASP for
Mac is twice as much as that of its competitors. Mac has grown faster than
its peers and has reached its highest market share record of 13.4% in Q3
FY14 in the U.S. market.
Date Company
Price
(Millions)
Apple
Product
28-May-14
Beats Music &
Beats Electronics
$3,000 iTunes
2-Dec-13 Topsy $200
22-Nov-13 PrimeSense $345
26-Jul-12 AuthenTec $356 Touch ID
20-Dec-11 Anobit $500
14-Apr-10 Siri Inc $200 Siri
27-Apr-10 Intrinisty $121 A5
5-Jan-10 Quattro $275 iAds
7-Jul-08 PA Semi $270 A4, A5
2-Sep-97
Power Computing
Company
$110
7-Feb-97 NeXT $404 OS X
Figure 7: No. of App on each OS
Figure 9: Acquisition Larger than $100M
Figure 8: iPad Units Sold and ASP
Figure 10: PC OS Market Share
Source: Statisita
Source: Company Data, Wells Fargo Security
Source: Ars Technica

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Smartphone
The competition landscape is similar for the smartphone business. Google
and Qualcomm provide the operating system and chips for Apple’s
competitors such as Samsung, HTC and LG, etc. Apple loses its ground in
terms of OS user base market share to Android for the past three years,
which has grown from 50% to 80%. However, Apple maintains a significant
higher ASP than it peers, which is around $600 compared to $300.
Samsung is the only significant threat of Apple in high end smartphone
business. Those two companies together have captured more than 93%
market share of high end (price > $500) smartphone market (Figure 13). The
high end market is growing faster than the low end market (Figure 15).
Those two companies have filed over 40 patent lawsuits against each other
in many major countries for the past 4 years. However, they dropped patent
disputes outside of the U.S. as of last August. The fact that Samsung
produces and sometimes controls the market of several key components
such as CPU manufacturing, memory chips, LCD panel, and AMOLED
panel, makes the Korean conglomerate a real threat of Apple. Apple and
Samsung are the only two companies that can turn sales into profit – Apple
dominates 81% of operating income of the whole smartphone industry while
Samsung takes the rest.
iPad
As the pioneer of tablet business, Apple once dominated this market;
however, without meaningful ways to bundle iPad with iPhone or Mac
together through exclusive function and low switching cost, the tablet
market has gradually become fragmented with many players fighting for the
market. Samsung is again the chief competitor in this field with other
traditional PC players such as Asus, Lenovo, and Hewlett Packard trying to
gain market share (Figure 14). However, the overall tablet market did not
see growth during CY14; moreover, with the market leader Apple setting its
iPad’s price in the range between $400 to $600, which is even lower than
that of its iPhone, this line of business is not lucrative for most players.
Figure 11: Mobile OS Market Share
Figure 12: Smartphone ASP
Figure 13: High End Phone Market Share
(>$500)
Figure 14: Tablet Market Share
Figure 15: Smartphone Growth Rate
Source: IDC
Source: BMO Capital Market, Company Data
Source: IDC, Credit Suisse
Source: Gartner, UBS
Source: IDC, Credit Suisse

7
Current Issues
Apple Pay
Apple announced its plan to penetrate into payment industry by providing
Apple Pay service through its iPhone 6/6+, Apple Watch-compatible devices
(iPhone 5 and later models), iPad Air 2, and iPad Mini 3. This service
enables users to make payment in both retail stores and online checkout.
Apple Pay adopts the near field communication (NFC) technology.
Different from Apple’s previous strategy of vertical integration and
unwillingness to collaborate, Apple Pay will join force with Visa's PayWave,
MasterCard's PayPass, and American Express's ExpressPay system. The
service was exclusive to the United States market initially with international
expansion plan in the future. Apple has entered into Canada in March 2015.
There was an estimated amount of 220,000 vendors participating in Apple
Pay at the service’s debut. Macy’s, Bloomingdale, Walgreen, Subway,
McDonald’s, Uber, Groupon, Panera Bread, Target, and Wholefoods are the
initial vendors to team up with Apple while Walmart and Best Buy stated
they will not accept Apple Pay. The need to upgrade the Point of Sale (POS
system) in order to accept Apple Pay and the fact that there are many
alternative ways of payment might lower some vendors’ interest to join.
Unlike the traditional credit card transaction, Apple Pay does not require
users to transfer personal information; instead, Apple borrowed Bitcoin’s
idea of creating a single-used token and transfer the token to finish the
transaction. The information of the token (or dynamic security code) will
stay between the customers, banks and the vendors, Apple stated that they
would not track the usage to gather customers’purchase habits. This method
is said to be safer than the tradition credit card.
Apple Watch
Apple Watch is the smart watch created by Apple, and announced by CEO
Tim Cook in September 2014. The main features that have been revealed
are health monitoring and fitness tracking. The smart watch is integrated
with iOS and other Apple’s services and products. Customers can perform
services such as Apple Pay, receiving phone call, sending iMessages and
SMS texts, map services and run third-party applications. Siri, the personal
assistant is also embedded on Apple Watch.
However, Apple Watch also depends on iPhone to conduct significant
functions. For instance, the Watch needs to pair up with iPhone to play the
music.
The screen of the watch is a pressure-sensitive touch screen that can detect
the difference between a tap and a press; only two buttons are designed on
the Watch. According to CEO Tim Cook, the Watch will be shower proof to
prevent water damage but water submersion is not recommended. All
versions of Apple Watch have 8GB of storage to store up to 2GB of music
and 75MB of photos. The device is also Wi-Fi and Bluetooth 4.0 connectible.

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There are three collections for Apple Watch – Apple Watch Sport ($349 and
$399), Apple Watch ($549 and $1,049), and the 18-karat gold version Apple
Watch Edition ($10,000 and $17,000), each of them has two sizes (38mm
and 42mm) and two colors. Each collection has three to six bands for
customers to choose. The main problem for this product is the short battery
life, which is estimated to last for only 18 hours due to it needs to constantly
connect to iPhone and leading to battery drainage. Apple Watch is available
for sales online on April 24 in nine markets, including the United States,
Australia, Canada, China, France, Germany, Hong Kong, Japan and the
United Kingdom. This product is an indication to see whether the current
management team can take on revolution rather than evolution after the long
gone of its charismatic founder.
Several competitors, such as HTC, LG, Pebble and Huawei have also been
working on the smart watch product to compete with Apple (Appendix 1).
Without revolutionary functions (or even functions that could not be found
on iPhones), the future of the Watch is far from promising. Apple did not
disclose the shipment information during the latest earning release but since
CEO Tim Cook mentioned more than 100% of the growth in “Other”
segment is contributed by Apple Watch during Q3 FY15, we can estimate
the revenue from Apple Watch is somewhere above $900 million.
Apple TV
Apple TV is the unsuccessful product Apple has spent several years working
on. The first release of Apple TV was back in 2007; the company continued
on developing this product and launched the latest TV – Apple TV Rev A in
January 2013; the company attempted to connect consumers’ TVs and
enables them to access iTunes content for Streaming video and all online
services that was accessible on personal computers, such as Netflix,
YouTube, Flickr, Disney Channel, Hulu, HBO GO and WatchESPN.
However, the idea to revolutionize the TV industry as a cornerstone of the
company’s Internet of Things has not yet been realized.
Apple Auto
“Apple is said to have hired hundreds of engineers specializing in Human
Machine Interface, EV batteries and autonomous driving” from major auto
producers “including former head of Mercedes Benz’s R&D division”
(Financial Times, 14, Feb). Although this news has not been confirmed by
the company, it is reasonable for the largest public company to seek growth
in the $1.6 trillion automobile market, which dwarfs the smartphone
industry at $400B and PC industry at $266B. Without legitimate information,
this part of information is not included in the valuation; however, it is
important to note that Apple’s ability to continue innovation is the key to
future success.

9
Business Trend
Bring Your Own Devices (BYOD)
The rapid growth of cloud computing and the transformation to more
intellectual and information based working environment have made BYOD
possible. With the increase of cross devices interaction and more
personalized devices and software, employees are more inclined to use their
own devices. A survey done by Mckinsey shows that 44% of job seekers
view an organization more positively if it allows them to bring their own
device. According to industry estimates, the global market for BYOD
created $72B in revenue in 2013. This market is expected to have a 26%
CAGR during 2013 to 2019, which implies a $284B by 2019 (Figure 16).
This on-going trend is beneficial to Apple since the company has low
penetration rate in the corporate market, especially when massive purchases
from big corporation will probably hurt Apple’s high margins. The
popularity and the ecosystem of Apple’s products in consumers area is likely
to spill over into business world if the BYOD remains robust. Furthermore,
if the BYOD becomes a phenomenon, learning Windows system and related
products may no longer be required skills. This can lower PC’s network
effect that prevents Apple from getting more market share. To enhance its
corporate footprint, the company announced an exclusive partnership with
IBM to take advantage of IBM’s big data and analytics capabilities to
implement to iPhone and iPad.
Figure 16: BYOD Market Size and Growth
Rate
Source: Marketandmarket.com

10
Investment Thesis
Economy Analysis
Apple’s premium products are considered more luxurious than that of its
peers. As a result, Apple’s performance should be highly cyclical and
depends on the well-being of consumers.
The Consumer Confident Index (CCI) is the indicator to see how likely the
consumers are going to spend more in the future. Figure 18 shows the CCI
has raised dramatically from 20 to 90 from CY08 to CY14. This is a positive
sign for Apple since consumer are now more willing to pay for superior
products.
Another indicator is the U.S. unemployment rate, which has dropped from
10% to 5.5% from CY09 to CY14 (Figure 19). Since 46% of Apple’s
revenue are generated from the Americas, the improvement of the job
market in the United States will have positive impact on Apple’s customer
base. The macro economic factors send positive signal which provide a
tailwind for Apple.
Nevertheless, since Apple is still in its growth stage (for its main product
and future products), and involved in an ever-changing industry, the
innovation is still the single most important driver of growth. For instance,
during the financial crisis in CY08, Apple still grew its revenue thanks to
the launch of its iPhone. R&D is a barometer to see the company’s
willingness to innovate. Figure 17 shows the company has increased its
R&D over revenue from 1.5% to 2.6% from FY12 to FY14. It’s a signal that
even after giving back shareholders tremendous amount of cash, the
company still invested a lot on innovation.
Figure 17: R&D/Revenue
Figure 18: Consumer Confidence Index Figure 19: U.S. Unemployment Rate
Source: Conference Board Source: Conference Board

11
Financial Analysis
Superior Gross Margin
Apple created significantly higher gross margin through its popular products.
The company’s average gross margin of 40% is twice as high as that of
competitors’ average of 23% (Figure 20). There is also a trend that the
company earn a slightly lower margin on an “s” year, which the company
only upgrades the previous product and has less new product launches
(iPhone 4S, 5C).
Du Pont Analysis
The company keeps a trailing twelve months ROE of 33.61%, compared to
peers’ 11.64%. The astonishing return to equity could be contributed to its
six-time-higher-than-average net income margin, which is at 21.61%. On
the other hand, the company’s leverage remains low – the asset over equity
ratio is a healthy 2.078 times whereas its peers have an average of 3.06 times.
Increasing Leverage and Cash Payback
Through its premium products and rapid sales growth, the company now
possesses $32B of cash and equivalent and $110B of net financial assets by
the end of Q2 FY15. On top of that, as current management took over, the
company has been more willing to increase its leverage and payback the
cash to shareholders. As Figure 22 shows, the company has increased its
debt over asset ratio from 36.4% to 51.9% during the past five years. Apple
is planning to sell another $6.5B corporate bond for FY15. The company
has already paid back $33B and $56B to shareholders in CY13 and CY14
and has started paying dividend since FY12. In April 2014, the management
team decided to increase the company’s cash return program. The company
expects to return over $130B of its cash by the end of CY15 under the
expanded program, with $40B in dividend and $90B in share repurchases.
The company started payback shareholder since CY12. Figure 23 shows
Apple is returning 73% and 112% of its free cash flow to shareholders
mainly through share buyback in CY13 and CY14.
One concern for Apple’s ability to payback shareholders is the repatriation
taxes, which is 30% by now. Since only 11% of the company’s cash are in
the United States, the company will face the huge tax bill if they send the
money back.
AAPL Peers
ROE 35.34% 11.64%
ROA 18.01% 4.11%
Asset/Equity 2.078 3.06
Turnover 0.788 1.45
NI Margin 21.61% 3.41%
Figure 20: Gross Margin Comparison
Figure 21: Du Pont Analysis
Figure 22: Debt/Asset Ratio
Figure 23: Cash Distribution
Source: Bloomberg
Source: Bloomberg
Source: Capital IQ
($ in millions) 2011 2012 2013 2014 2015 2016E
Net Income $25,922 $41,733 $37,037 $39,510 $49,064 $52,149
FCF $33,269 $42,561 $45,501 $50,142 $66,567 $72,999
FCF% of NI 128% 102% 123% 127% 136% 140%
Buybacks $0 $0 $22,860 $45,000 $49,925 $54,749
% FCF for Buybacks 0% 0% 50% 90% 75% 75%
Dividends $0 $2,488 $10,564 $11,126 $16,642 $18,250
% FCF for Dividends 0% 6% 23% 22% 25% 25%
Total FCF Returned $0 $2,488 $33,424 $56,126 $66,567 $72,999
% of Total FCF Returned 0% 6% 73% 112% 100% 100%
Source: RBC Capital Market and Company Data

12
Risk
Supply Chain Risk
Apple outsources most of its components and manufacturing process to third
party Asian suppliers. For instance, four Taiwanese companies namely Hon
Hai Precision, Pegaton, Compal and Quanta together assemble most of
Apple’s products. For the company’s state-of-art CPU, only Taiwan
Semiconductor Manufacturing Corporation and Samsung Electronic are
capable of producing the cutting-edge chips. The high definition camera lens
is largely provided by Largen, yet another Taiwanese company. The flash
and other memory chips are mainly from its main competitors Samsung. The
concentration on few providers in same region and the reliance on certain
competitor to provide key components can lead to supply chain risk if any
political or economic uncertainty were to happen.
Competition Risk
Apple faces fierce competition in each product segment. The premium price
the company charges position itself in a riskier situation if an economy
downturn were to happen. The closed platform strategy also puts more risk
on Apple. For instance, if Google stops providing all the services such as
Google map, YouTube, Chrome and its search engine, Apple’s user might
find difficulties in sticking with Apple without those services.
Currency Risk
The on-going strong dollar could be a potential threat to Apple. As EU and
BoJ planning to launch massive quantitative easing, and People’s Bank of
China lowered its prime rate and is also likely to start a quantitative easing
program, the U.S. dollar becomes the strongest currency in the world.
Moreover, Fed’s intention to raise the interest rate almost promises a further
appreciation of dollar. Under this premise, Apple’s oversea revenue, which
is more than 60% of its total revenue could be hurt badly. Although Apple
is involved in currency forward to hedge the currency risk, it is hard for the
company to hedge the risk if the dollar appreciate significantly and stay at
the relatively high level for a long period of time.
Valuation
DCF Model
Although the future cash flow for Apple is more difficult to capture, the DCF
model is still the best and theoretically correct model to forecast the
company’s value. I use a five year forecast period due to the fast-changing
nature of Apple’s business and difficulty to quantify innovation that has not
taken place. Each business segment’s revenue are forecasted separately. The
followings are the assumptions behind the model.
Revenue
Mac: The CAGR of this segment is 8.3% for the past five years, given that
personal computer is a more mature market and competitors keep competing
on price and features, I give this segment a 6% revenue growth for the

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following three years and 4% for the other two.
iPad: Without significant breakthrough in developing new function, the
market size for tablet is relatively limited. The sales for iPad grew at a mere
3% in FY13 and encountered a decline of 5% in FY14. Furthermore, the
larger phone is likely to be the mainstream in the future. This might sabotage
iPad mini’s sells, which accounts for 41% of total iPad sales. Thus, I give a
sharp decline for the forecast period for this segment.
iPhone: iPhone will still be the main driver of Apple’s growth in the
foreseeable future. Based on the company’s past record to publish a new
phone every two years, and launch similar but upgraded version in between
(such as iPhone 4S and iPhone 5C), there is an obvious 2 to 2.5 year cycle.
Moreover, by adding more feature (larger screen), Apple raised its selling
price significantly and received best sales record in respond. However, I
expect its pricing power will deteriorate as the market mature. I forecast the
revenue growth will be 50%, 6%, 15% 6% and 8% for FY15 to FY19. The
huge increase in FY15 is justifiable since Apple sold 76M iPhone 6 during
Q2 FY15 yet only 10% to 15% of iPhone installed base had upgraded to
iPhone 6.Not to mention the company announced the highest additional user
in Q2 FY15. The iPhone 6/6+ is expected to have extremely high penetration
in the growing Asian market where larger screen is popular among
customers. The increase in shipment and price are both factored in to reach
the revenue growth numbers.
Apple Watch: Since the Watch has to pair with iPhone for significant
functionality, I use iPhone installed base (past two years’ shipment unit) to
estimate the Apple Watch’s unit sales. The all-in cost I used for this product
is $450, which is higher than the retail price of $350 since users will need
two wrist straps to work with the watch, which will cost $100 extra. Without
too many wow-factors from the previous product announcement, and the
idea that this product can hardly be a necessity like mobile phones, I use
only 1%, 2%, 3%, 2%, and 2% of iPhone’s forecast installment as Apple
Watch’s penetration into iPhone installed base for the forecast period.
Apple Pay: This segment plays a role to increase customers’ reliance and
would not be a major revenue driver in the near future. However, it could be
a more stable stream of revenue with extremely high margin business for
Apple. Apple charges a 15bps per transaction for interchange fee from banks.
The plastic card transaction volume (including both debit and credit card) is
estimated to be 200B and will grow to 240B by CY18. According to Cowen
and Company’s survey, over 35% of iPhone 6/6+ owners used Apple Pay
service, and among them, 65% use it several times a week. Based on the
positive number, I use a 2% increase of non-cash transaction market share
each year for Apple Pay for the forecast period (exclude online payment
system), starts from a 2% at CY15. After CY19, I assume Apple will change
to a percentage fee of 0.3% commission for each transaction and have a
stable 10% market share of the non-cash transaction.
Services: The services sector includes all the revenue from application,
software and other service excluding the payment service (in my model). As

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a healthier stream of revenue, this segment grew by 13% and 25% for FY14
and FY13. An 8% revenue growth is expected for the following five years.
Others: This segment includes iPod and other accessories. Due to the sharp
decline of iPod’s sales has already taken place – a 48% and 25% decrease
for FY14 and FY13, this segment is forecasted to decline by 2% each year
for the forecast period.
Operating Margin
Apple has the highest customer loyalty in the industry, thus the company’s
ability to maintain margins is better than most competitors. Furthermore, the
increasing revenue from high margin segment such as Apple App store and
Apple Pay can offset the declining ASP for iPad segment. Therefore, I
estimate the company will have operating margin around 28% to 29.5%, and
maintain a 29.5% operating margin which is slightly lower than the past five
years average of 30.7%, at the end of forecast period.
Terminal Growth
As mentioned earlier, the consumer electronic products tend to have short
product life cycle and thus face price decrease; therefore the terminal growth
of these companies should be lower than average. As a result, I choose a 2%
terminal growth rate of free cash flow after the forecast period.
Net Financial Asset
Unlike most other firms which have to borrow money to sustain their
operation, Apple possessed an astonishing $110B net financial asset as of
Q2 FY15. The company can keep running without most of those financial
assets; furthermore, the management team is willing to pay back the excess
cash to shareholders. Therefore, I take $100B of net financial asset into
consideration and reduce the interest income the company will have going
forward.
Discount Rate
The industry Apple is involved in has less durable competitive advantage
and the players face rapid change constantly, which leads to higher business
risk. Companies such as, Nokia, Motorola, Sony and even Apple itself, have
once dominated the market but failed nevertheless; therefore, I believe the
discount rate for most companies in this industry should be higher than
average. Therefore, I use an 11.0% discount rate for Apple.
The model I built yield a target price of $124.88 with a price range from
$118.63 to $131.65.
Relative Valuation
For the relative valuation, I choose Microsoft, Lenovo and Asustek to
compare their operating system, laptop and mobile phone business with
Apple. I do not include Apple’s chief competitor – Samsung in the
comparison since Samsung is involved in other businesses such as
semiconductors, which generates a substantial amount of profit for Samsung.
Price over earing (P/E) and enterprise over EBITDA (EV/EBITDA) method

15
are used in the valuation. On the other hand, the price over book (P/B)
method is excluded, since this method fails to measure the enormous brand
name value Apple possess. The target price under this method will be
$128.77, ranging from $92.0 to $154.17
I weight 80% to the DCF and 20% to relative valuation since there are no
close comparison for Apple in the relative valuation model. Furthermore,
the relative valuation model also fails to capture Apple’s wider moat and
higher customers’ loyalty.
Risk to Target Price
The effectiveness of the DCF valuation depends on my forecast on the
company’s revenue, margins, terminal income growth and cost of capital.
The assumption are made given my best knowledge of the company at this
stage. My estimated discount rate is higher than Bloomberg’s WACC.
Should my estimation fail to capture the company’s fundamentals, Apple’s
shares could underperform or outperform.
Conclusion
I believe the current market price of AAPL reflects the company’s intrinsic
value and thus I recommend a HOLD on AAPL with a target price of
$125.66.
- The latest iPhone 6/6+ is expected to generate significant revenue
growth for the company by attracting more new users and retaining the
old customers with a meaningful price increase.
- I believe Apple Pay can increase its popularity and provide high margin
revenue for Apple. This service also increase users’stickiness to iPhone
and its ecosystem.
- Without irreplaceable function, I am not bullish on the long-expected
Apple Watch and assume it will become another expensive leisure
product.
- The company’s dependence on revolutionary innovation for significant
growth is the risk factor for investors.
- The management looks to return $65B of cash to investors in CY15,
the frequent share buyback hedges the downside potential for near term.

16
Appendix 1: Smart Watch Comparison

17
Appendix 2: Income Statement
Source: Company Data, Analyst Estimate
Segment
(millions) 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
Sales
Mac 23,221 21,483 24,079 25,524 27,055 28,678 29,826 31,019
iPad 30,945 31,980 30,283 24,226 22,288 19,614 18,437 17,331
iPhone 78,692 91,279 101,991 152,987 162,166 186,491 197,680 213,494
Apple Watch - - - 1,675 3,801 6,277 4,554 4,874
Service 12,890 16,051 18,063 19,508 21,069 22,754 24,575 26,540
Other 10,760 10,117 8,379 8,211 8,047 7,886 7,729 7,574
Apple Pay - - - 600 1,296 2,070 2,880 8,750
Total 156,508 170,910 182,795 232,731 245,722 273,770 285,679 309,582
Cost of sales 87,846 106,606 112,258 143,403 154,607 171,066 177,268 190,757
Gross Margin 68,662 64,304 70,537 89,328 91,116 102,704 108,411 118,825
Operating Expense
Research and development 3,381 4,475 6,041 6,490 6,997 7,742 8,022 8,633
Selling, general and administrative10,040 10,830 11,993 15,346 16,545 18,307 18,971 20,414
Total operating expense 13,421 15,305 18,034 21,836 23,542 26,048 26,993 29,047
Operating Margin 55,241 48,999 52,503 67,492 67,574 76,656 81,419 89,779
Interest and Other 522 1,156 980 800 400 200 200 200
Taxes 14,030 13,118 13,973 17,756 17,673 19,982 21,221 23,394
Net Income 41,733 37,037 39,510 50,536 50,300 56,873 60,398 66,584
Weighted-average Diluted Shares6,617.48 6,521.63 6,122.66 5,694 5,295
Diluted EPS 6.31 5.68 6.45 8.88 9.50 10.74 11.41 12.57
ProjectedHistorical
AAPL

18
Appendix 3: DCF Model
Source: Company Data, Analyst Estimate
Forecast Revenue Growth 2015 2016 2017 2018 2019
Mac 6% 6% 6% 4% 4%
iPad -20% -8% -12% -6% -6%
iPhone 50% 6% 15% 6% 8%
Apple Watch - 127% 65% -27% 7%
Service 8% 8% 8% 8% 8%
Other -2% -2% -2% -2% -2%
Terminal Discount Rate 11.00%
Terminal Growth Rate 2%
Assumptions
Year 2014 2015E 2016E 2017E 2018E 2019E
($ in million)
Revenue 182,795 232,731 245,722 273,770 285,679 309,582
% Growth 27.3% 5.6% 11.4% 4.4% 8.4%
Operating Income 52,503 67,492 67,574 76,656 81,419 89,779
Operating Margin 28.7% 29.0% 27.5% 28.0% 28.5% 29.0%
Interest and Other 980 800 400 200 200 200
Taxes 13,973 17,756 17,673 19,982 21,221 23,394
Tax Rate 26.1% 26.0% 26.0% 26.0% 26.0% 26.0%
Net Income 39,510 50,536 50,300 56,873 60,398 66,584
% Growth 27.9% -0.5% 13.1% 6.2% 10.2%
NPV of Cash Flows 354,701$ 56%
NPV of terminal value 279,723$ 44%
Projected Equity Value 634,424$ 100%
Expected Excess Cash Return 100,000$
Shares Outstanding 5,881
Current Price 124.29$
Implied equity value/share 124.88$
Upside/(Downside) to DCF 0.48%
DCF Output ($ in millions)
124.88$ 10.00% 10.50% 11.00% 11.50% 12.00%
1.00% 131.65$ 125.36$ 119.70$ 114.59$ 109.95$
1.50% 134.96$ 128.20$ 122.16$ 116.72$ 111.81$
2.00% 138.67$ 131.37$ 124.88$ 119.08$ 113.86$
2.50% 142.89$ 134.94$ 127.93$ 121.69$ 116.12$
3.00% 147.70$ 138.98$ 131.35$ 124.62$ 118.63$
Discount Rate
Sensitivity Analysis
T. Growth Rate

19
Appendix 4: Relative Valuation
Source: Bloomberg, Analyst Estimate
Price Multiples
Mkt Cap
(USD)
Price-to-earnings (P/E) EV/EBITDA
Apple (AAPL) 711.20B 17.04 7.43
Microsoft (MSFT) 369.40B 15.99 8.39
Lenovo (0992) 12.98B 18.29 9.1
Asustek (2357) 7.23B 12.4 7.14
Competitors Average 15.56 8.21
Target Price 115.4552 142.080315
% chg from Current Price -7.9% 13.4%

20
1. Apple Q2 FY15 Earning Call
2. Apple, Larger base, longer cycle, Credit Suisse, Kulbinder Garcha, Achal Sultania, Vlad Rom, William
Chu, Ji Park
3. Apple, Sizing Up The Next Capital Allocation, RBC Capital Market, Amit Daryanani, Mark Sue, Mitch
Steves
4. Autos & Auto-Related, Apple Auto: World’s Most Valuable Company Meets Most Disruptable Industry,
Adam Jonas, Katy Huberty, Ravi Shanker, Jerry Liu, Neel Mehta, Paresh Jain
5. Apple, Big and Loyal Installed Baes Helps, Keith Bachman, Jung Pal
6. Apple, Prolong Product Cycle at Play, Credit Suisse, Kulbinder Garcha, Achal Sultania, Vlad Rom,
William Chu, Ji Park
7. Apple, UBS, Steven Milunovich, Peter Christiansen
8. Lisa Ellis, Jeffrey Saret, and Peter Weed (2012)
9. Marketline, Datamonitor Independent Research 03/18/15
10. Financial Times, 14, Feb.
11. Apple, New Global Survey Says Set-Up Still Favorable; Target to $135, Cowen and Company, Timothy
Arcuri, Bryan Prohm, Karl Ackerman, Wayne Loeb
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