16 November 2015

Activism, News

Investment firm Quarz Capital Management has written an open letter to Apple Inc. (NASDAQ:AAPL) CEO Tim Cook, calling out for change to the way it reports its results.  It wants Apple to separate its soft software & services (S&S) results from those of its hardware division.  That echoes activist investor, Carl Icahn’s thinking from earlier this year

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Quarz believes Apple stock could head for $200 and more if the $672 billion business makes the change.  Back in May, Mr. Icahn had pressed the giant to repurchase shares to boost what he regards as an undervalued stock, he puts it at $240.  His contention is that the S&P 500 index has historically traded at a 60% premium over the shares.

Icahn is a major Apple shareholder, owning 53 million shares in May.

The Quarz Capital letter said separating software from hardware results would “positively reshape” investors’ perception of Apple by making it more transparent.  The margins and growth dynamics of each division, driven by a massive user base and expansion into new services, could then be properly valued.  Value will also be driven by a consistently rising number of developers around the world who add their work to Apple’s devices

The next leg of growth will, said Quarz, be dominated by software and services, making its separate valuation even more important in valuing the business as a whole.  “Splitting out the operating results of the Software & Services segment, combined with the various growth catalysts and a continued capital return program can potentially deliver an upside of 60% to Apple’s share price, yielding an attractive return to long term shareholders” it said.

Reporting sector results in a consolidated fashion is why the organization is still seen as a hardware company.  Quarz says this is a “fundamentally misguided perception” held by investors, reinforced by the rapidity of the rise of software and services in such a short space of time.

The letter challenges the idea that changing its reporting structure would cause competitive harm, mainly because Apple has no rivals.  It designs and makes the products that use its software and vice versa.  Another point is that Apple doesn’t compete on pricing, rather its plan is one of differentiated products and market revolution.

In urging the CEO, Tim Cook to follow this path, Quarz points to other tech firms, such as Alphabet Inc., Amazon, and Microsoft, have changed the way they report their results.  It says these companies have pleased investors by improving the transparency of their results, driving share prices higher.

The firm’s current valuation assigns a price-to-earnings (P/E) multiple of 35x over 2016 estimates for Apple’s software segment, which is much higher than the 16.3x P/E for its hardware business. At this level, the firm says: “Apple’s share is easily worth in excess of $200, providing investors with an excellent upside potential in excess of 60% after this move.”

Quarz’ Chief Investment Officer, Jan F. Moermann and Portfolio Manager, Havard Chi say that by reporting S&S results as a consolidated part of a whole, the true value of the business is being undermined.