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AAPLs To AAPLs: Not All iEarnings Are Created Equal

Tyler Durden's picture




 

While we have long-argued that the discussion over the use of Apple's cash pile is somewhat circular (lower cash equals higher risk, less ability to withstand any shock, and investor perception growth/value shift) in its 'value' for the company, Bloomberg's always-sharp Jonathan Weil has a slightly different tack on the mega-firm's accounting conventions and why it may not be so cheap. As he points out, analysts (and talking heads) persistently argue that the firm's value is cheap at 14.3x T12M earnings (in line with the S&P) in spite of far higher growth (revenues and earnings). Competitive threats are often cited, future uncertainty of the consumer comes up, and the use of the cash argument we already mentioned but as Weil highlights, it seems that Apple's less than conservative accounting methods (that they lobbied for and heaven forbid Obama would re-consider a tax-the-rich opportunity) with regard to booking the revenues of bundled products more quickly than it used to (which caused, for instance, 2009 revenue to jump 44%). So while there may indeed have been record demand for the i-everythings, record 'blow-out' earnings is as likely a symptom of accounting inflation as unpaid mortgage cash being put to work. It seems the market realizes this and so the next time we are told to 'buy-the-dip as Apple is cheap', remember there is a reason for that 'cheapness' - that, as Jonathan so eloquently points out "not all iEarnings are created equal" as economic and accounting realities diverge once again.

 

 

Apple’s Stock May Not Be as Cheap as It Looks: Weil
By Jonathan Weil - Feb 16, 2012

... Apple trades for only 14.3 times its earnings for the previous four quarters -- about the same as the Standard & Poor’s 500 Index’s price-earnings ratio -- in spite of growth that’s far above average. Revenue last quarter rose 73 percent to $46.3 billion, while earnings more than doubled to $13.1 billion.

...

While each of those points has merit, here’s an explanation that hasn’t gotten enough attention: Thanks to an accounting- rule change for which it lobbied, Apple gets to book revenue from sales of bundled products such as iPhones -- which include hardware, software, services and upgrade rights -- more quickly than it used to. In short, one reason Apple’s earnings have been so high is accounting inflation, and the market realizes this.
Restated Numbers

The easiest way to see the rule change’s impact is to look back at the two sets of numbers Apple reported for fiscal 2009. Originally, the company said it had $5.7 billion of net income for the year on $36.5 billion of revenue. Then in January 2010 Apple retroactively adopted the new accounting principles and restated its previous numbers. The restatement boosted Apple’s fiscal 2009 net income 44 percent to $8.2 billion. Revenue was revised to $42.9 billion, 17 percent higher than originally reported.

Nothing changed economically, of course. Only the accounting did. On the surface, though, Apple’s valuation looked cheaper under the new reporting regime than under the old one.

...

It would appear that the market continues to consider a significant component of Apple’s revenues and gross profit to be presently unearned and not deserving of a normal market multiple,” said Charles Mulford, an accounting professor and director of the Financial Reporting and Analysis Lab at Georgia Institute of Technology in Atlanta.

... The impact for Apple seems to have been greater than for most others, probably because of the nature of its products. Dell Inc. (DELL) said the rule switch had no material impact on its results. Microsoft Corp. (MSFT) and Oracle Corp. (ORCL) said the same. Hewlett-Packard Co. (HPQ)’s earnings got a slight boost.

The FASB rule change had two main parts. One related to so- called multiple-deliverable arrangements, while another covered software sales. When Apple sells an iPhone, for example, the hardware and software are delivered at the time of sale. ...

Economic Life

The old accounting rules required Apple to defer large chunks of its revenue and recognize the amounts gradually over each product’s economic life. While the details are complicated, the gist under the new rules is that Apple is allowed to record more revenue upfront.

What’s unknowable is how much different Apple’s latest results would have looked had the FASB not amended its standards. There’s no way to tell from the company’s disclosures. Plus, Apple adopted the new accounting principles right before it introduced the iPad. An Apple spokeswoman, Kristin Huguet, didn’t return phone calls seeking comment.

Let me be clear: I’m not opining on whether Apple is overvalued or undervalued, and I’m certainly not making any predictions about its stock price. The point here is that it makes sense for Apple’s earnings multiple to have declined significantly once you consider how the company’s accounting has changed.

The bottom line: Not all iEarnings are created equal.

 

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Fri, 02/17/2012 - 11:08 | 2169426 Cognitive Dissonance
Cognitive Dissonance's picture

iApple can do no iWrong. That is the present day meme for this pimp and pump NASDAQ scheme.

That isn't to say that Apple is worthless. Only that it is worth (much) less than the market currently assigns it.

Fri, 02/17/2012 - 11:07 | 2169436 hotkarlandthecl...
hotkarlandtheclevelandsteamers's picture

Don't get Reggie all fired up.

Fri, 02/17/2012 - 11:09 | 2169449 slaughterer
slaughterer's picture

We examined Weill's arguments, and we felt that the Y/Y growth after the accounting changes took place nullifies his valuation argument.  Nice to see ZH jump on the AAPL bashing bandwagon along with nearly every other MSM news outlet (CNBC, the Street, Bloomberg).  

Fri, 02/17/2012 - 11:20 | 2169523 adr
adr's picture

Yes but knowledge of how the accounting change allows for inflated earnings leads you to produce products for that specific purpose. The lifecycle of Apple's products might not have anything do do with demand or market need, but of maximizing the accounting gain of gaming the system Apple lobbied to create.

Apple is different from Microsoft, Samsung, and Google. Apple provides and sells a product with hardware and software owned by Apple. Google's aquisition of Motorola may have had nothing to do with true business, but enabling the same accounting gain Apple used to overstate earnings by billions over the past few years.  

Fri, 02/17/2012 - 11:11 | 2169466 I am a Man I am...
I am a Man I am Forty's picture

how about some specifics!!  geez, pathetic

Fri, 02/17/2012 - 11:22 | 2169538 I am a Man I am...
I am a Man I am Forty's picture

The first comment on Jon's article on Bloomberg.

 

"Utter rubbish!
Your implication is that Apple is booking revenue, that it doesn't get yet. Nothing is further from the truth. This is revenue Apple has already gotten, but under Sarbanes-Oxley, Apple was deferring 7/8ths of it to the next 7 quarters and only booking 1/8th in the current quarter. The balance of the revenue was sitting in Apple's accounts, waiting to be recognized. Late in 2009, the FASB created a new rule, allowing Apple to book most of this revenue, rather than wait, as the additional value Apple is adding, thru software updates to iOS were nominal. They defer about $20 for this now.

There is NO accounting inflation. This is closer to actual cash accounting, where cash in is counted when collected.

Further, the original deferral of revenue is an unusual situation. The mismatch between GAAP and Non-GAAP revenues only occur when the sales of a new product are growing so rapidly. Eventually, this mismatch will shrink as the deferred revenues become booked. This narrowing between GAAP and Non-GAAP would have happened after 2 years or 8 quarters, as iPhone sales become more steady. This has a smoothing effect upon revenues. Once, iPhone sales growth had slowed to less than 10%, you'd find that GAAP and Non-GAAP numbers would be very, very close.

In other words, if one were to have continued deferring revenue, instead of using the new FASB rule, the GAAP and Non-GAAP numbers, TODAY, would not look much different. So, your thesis that the market is somehow deflating Apple's numbers to reflect the revenue under the old rules is nonsense. And, you CAN calculate what Apple's numbers would be under the old rules, you just have to do some math. I used to calculate Apple's true revenues back in 2007 and 2008, before Apple started publishing them in October of 2008. Calculating the potential deferred numbers would be the exact same exercise.

Fri, 02/17/2012 - 17:43 | 2171503 malek
malek's picture

Too little information for a founded opinion.

If Apple recognizes the hardware and software revenue more immediately, seems fine to me.
If they also recognize their share of the 24 month telco provider contract right away, that doesn't feel clean.

Biggest problem is noone effing knows how accounting rule changes are used or abused by any company.

Fri, 02/17/2012 - 11:12 | 2169479 adr
adr's picture

Wait, a company recorded bilions in earnings that wasn't actually there??? SAY IT ISN'T SO!!!

Fri, 02/17/2012 - 11:28 | 2169575 Seasmoke
Seasmoke's picture

Steve Jobs is no longer here to clean up their next major misstep

Fri, 02/17/2012 - 12:01 | 2169757 pemdas
pemdas's picture

By analogy, if I buy a car from GM, should they book the revenue and profit over 10 years, because that is how long (admittedly with luck) I plan to use it?

Fri, 02/17/2012 - 12:11 | 2169819 DoctoRx
DoctoRx's picture

The AAPL shorts appear pretty desperate when they have to dredge up this old, fully-disclosed garbage.

FWIW, Value Line's "value line" pegs AAPL's fair value around $750 right now based on its projection of $43 EPS this FY.  And their analyst knows all this stuff.

When Siri leaves its beta version, I am going to buy a smartphone, my wife will dump her old BBerry; when Siri comes to iMacs we will exchange our PCs for iMacs.  IMHO interactive voice control is the killer mega-app for the foreseeable future.  How long Apple stands apart from the rest in this feature is, methinks, thus the biggest determinant of its future biz success.

The friendly Apple borg:  is resistance futile?

 

Fri, 02/17/2012 - 12:11 | 2169821 DoctoRx
DoctoRx's picture

The AAPL shorts appear pretty desperate when they have to dredge up this old, fully-disclosed garbage.

FWIW, Value Line's "value line" pegs AAPL's fair value around $750 right now based on its projection of $43 EPS this FY.  And their analyst knows all this stuff.

When Siri leaves its beta version, I am going to buy a smartphone, my wife will dump her old BBerry; when Siri comes to iMacs we will exchange our PCs for iMacs.  IMHO interactive voice control is the killer mega-app for the foreseeable future.  How long Apple stands apart from the rest in this feature is, methinks, thus the biggest determinant of its future biz success.

The friendly Apple borg:  is resistance futile?

 

Fri, 02/17/2012 - 12:18 | 2169875 Stochdoc
Stochdoc's picture

The change was because FASB changed the rule.

 

So, this is more like cash earnings, a much better indication of a company's progress.

 

And yes, more and more "investors" look at cash earnings, which is an argument for not comparing current PE ratios with historical levels and averages.

Fri, 02/17/2012 - 12:17 | 2169876 Stochdoc
Stochdoc's picture

The change was because FASB changed the rule.

 

So, this is more like cash earnings, a much better indication of a company's progress.

 

And yes, more and more "investors" look at cash earnings, which is an argument for not comparing current PE ratios with historical levels and averages.

Fri, 02/17/2012 - 12:20 | 2169896 Fortunes Favor
Fortunes Favor's picture
Trouble Brewing Behind Facade Of Bull Rally

The troubling loss of a leader

 http://seekingalpha.com/article/374091-trouble-brewing-behind-facade-of-bull-rally

Fri, 02/17/2012 - 12:28 | 2169950 BaggerDon
BaggerDon's picture

This is a great article...............these accounting changes came at time that the fed and obama need to lite up the animal spirits.......and lite them up they did...........as Cramer has said, every bull crap rally needs a star....my question is, when will the Telecoms stop financing this iphone bubble???  Of all the millions of iphones sold, not one sold for the $ 800 the ostensibly charge the telecoms.............

 

BaggerDon

Fri, 02/17/2012 - 12:38 | 2169988 AllAboutTheBenjamins
AllAboutTheBenjamins's picture

Its all about the accounting! 

Fri, 02/17/2012 - 14:13 | 2170515 Bertie Wooster
Bertie Wooster's picture

Zero Head, congrats, for once again destroying namebrand capital by reprinting one of the stupidest arguments against Apple I've seen in, oh, a few days.  The moronic arguments against Apple's valuation keep coming, and your blog is all too ready to "swallow it" in the immortal words of 2 Live Crew.

Apple sells $600 phone to Verizon, Verizon pays Apple cash, Apple books $600 revenue and churns a profit after cost of goods.  The cashflows match this accounting.

That is their current accounting.  There is no problem with this accounting.  if you want problematic obfuscated accounting, try figuring out why cashflows were so much higher in 2008 due to the freakazoid accounting Apple was forced to adopt back then.

Zero Head pukes in it's mouth a little, once again, burning it's good name, all for nothing.  Seriously, can't you find some 30x EPS debt-laden POS bank institution to pick on?  Is there not enough of those for you to work 8 hours a day??

Sun, 02/19/2012 - 21:06 | 2176339 q5251355
q5251355's picture

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Sun, 02/19/2012 - 21:06 | 2176340 q5251355
q5251355's picture

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