Pacific Crest Securities Blew It

January 16, 2013 (6:00 pm)

Can we agree on something? Pacific Crest Securities blew it this morning and have forever discredited themselves. They recommended to their clients that they sell Apple at the absolute low. They were shaken to the “core” (forgive the pun) and downgraded shares of Apple on a faulty assumption. In the short-term, Apple ≠ AAPL. But in the long run, they are one and the same. Technical’s may run the near-term price action, but fundamentals eventually take over.

Pacific Crest analyst Andy Hargreaves is “downgrading the stock to ‘sector perform’ giving it a price target between $440 and $550 for the next twelve months. The high-end market for smartphones and tablets are going to be saturated sooner than expected which will lead to poor growth for Apple.” Further, he explained that “demand for incremental hardware improvements is waning and [he doesn’t] believe people will continue to upgrade to a new iPhone.”

Right. So, where do we start?

PRICE TARGET: First, let’s take a look at the price target. He forecasts a $110 price movement over the next twelve months. This is extremely unlikely. We’ve been looking at quarterly volatility over the past few years, and the median price move in any given quarter is 3.3x the trailing twelve month P/E. Currently that P/E stands at $44.17, implying a $147.50 price move in any given quarter. Forecasting an entire year’s price range based on 2.2x P/E is completely without merit.

GROWTH OUTLOOK: Second, let’s briefly look at the smartphone and tablet markets. Over the past year, Apple has sold a total of 125 million iPhones and 58 million iPads globally. Fortune reports that China is estimated to have over 500 million smartphone users by the end of 2013. If Apple is able to capture just 10% of China’s estimated smartphone users in 2013, that would just about equal its entire 2012 iPhone sales. While that may not be a realistic goal, the point is that this single market illustrates the unbelievable growth opportunity ahead. Not to mention the fact that iPhone’s have barely started moving into India and Brazil. Besides these enormous emerging markets for new growth, let’s also look closer to home. Reports suggest that approximately half of all mobile users in the United States have a smart phone. With subsidies provided by the carriers allowing users to purchase an iPhone 4 for $0.99, what’s to stop the non-smartphone users from upgrading? Lastly, smartphone shipments are expected to top one billion in 2013. What share will Apple have?

Now let’s take a step into the tablet market. We’re going to approach this a bit differently. Forget about emerging markets. Let’s look at potential uses and users of tablets that haven’t historically used a powered device. Think of the global demand for a $329 consumer device that delivers a true computer replacement experience for a vast majority of the population. Now add students bringing a tablet to school in lieu of a heavy backpack filled with books. And doctors across the world replacing charts with a small, secure, wireless device (no more worrying about terrible handwriting). Then there’s the already evident demand from retailers looking to replace cash registers with iPads. Demand for this device is and will continue to be enormous. We don’t care if they sell more iPad mini’s than iPads – and we believe they eventually will. The higher volume will more than make up for the lower profit per unit. Especially because it locks users into its…

ECOSYSTEM. Andy also argues that demand for incremental hardware improvements is “waning”. He’s missing the point, at least with smartphones. Consumer behavior has been shaped by the telecoms. AT&T, Verizon and a majority of other telecoms have taught us to upgrade our phones every 18 to 24 months. They pay us to do so. When our contracts are up after two years, they deeply subsidize the newest phones. And we buy them. Let’s think about this for a moment from a purely anecdotal point of view.

For those of you living in New York, it’s likely that you don’t see as many iPhone 5’s as you would have expected on the subways and walking around the city. This might seem counter-intuitive, but we believe it’s a bullish data point. What we do see is an enormous number of older iPhone’s – namely the 4 and 4S. What’s going to happen when their two year plan is up? They’re going to get the newest iPhone. But this won’t happen immediately. And that creates a recurring revenue stream for Apple going forward. We’re locked in. The headache, heartache and expense of switching to Android or Windows is an enormous incentive to simply upgrade to the newest handset. But maybe not when it first arrives. When our contract is up. I’ll leave you with this thought: It’s the ecosystem, stupid. Let us know your thoughts.

  • Tim

    For those of you living in New York, it’s likely that you don’t see as many iPhone 5′s as you would have expected on the subways and walking around the city. This might seem counter-intuitive, but we believe it’s a bullish data point. What we do see an enormous amount of are older iPhone’s – namely the 4 and 4S. What’s going to happen when their two year plan is up?

    They are going to consider alternatives and if Apple does not have products to compete in all markets those who desire a larger, cheaper, or smaller phone will switch. Apple needs to understand that when the IP was first introduced there was no competition. Now the market has fractured into those who want large, medium and small phones, those who want an all in one ipad phone, those who want a cheap cell phone that might run a weather app and a few more, those who don’t even care about apps…etc.. Apple with one product can’t please everyone, this is a key error in their thinking and this is why the stock got crushed and they are not growing. They don’t have a technological lead that makes the iPhone the only game in town.

    • It’s a mistake to think that Apple needs to make a bunch of different-sized iPhones to make people happy. Some people actually would be better off with larger or smaller phones, but those outliers are a lot smaller group than the people who _think_ they’d want a different-sized phone. Apple figured out the size that works best for the largest number of people and went with that. They’d rather than person be a bit less-satisfied at first, but happier in the long run, than dupe someone with a big screen that results in them buying a phone that can’t be used with one hand, doesn’t fit well in pockets, is heavier, etc.

      They _are_ going for the most post-purchase satisfaction, and poll after poll shows they are right. People do sometimes buy other phones, but market research shows those people aren’t as happy with their choices.

      As far as cheaper, at least in subsidized markets, the iPhone 4 can be had for $0. Now, in markets where subsidies are rare, it could be a bit of a different story, but Apple isn’t going to make a bad phone just to get a low-profit sale. That choice is what got them where they are today.

      The reasons the stock is down have nothing to do with Apple’s technological capability nor with their product design decisions. They are clearly based on market myths and deliberate manipulation. The news cycle of “bad news to push down, then good news to pump back up” has been repeated so often one either has to be woefully unobservant not to have noticed it. Or, perhaps a participant in the scheme.