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Company Report

Apple Inc
Date: 22 January 2013

A For Apple
Apple meteoric growth in the last ve years have been driven by introduction of successful products namely iPhone in 2007 and iPad in 2010. Between 2007 and 2012, Apple revenue increased 6.5x from USD24bn to USD156bn and net income increased 12x from USD3.5bn to USD42bn. While we expect iPhone and iPad to remain dominant, it will now be increasingly dicult to signicantly increase Apple large USD156bn revenue. As such, we expect Apple revenue growth to be more subdued moving forward. Nevertheless, Apple is currently trading at net cash P/E of only 8x. China sales could provide an upside surprise and cash hoard of USD120bn provides downside protection Overall, we have a BUY on Apple with a fair value of USD600.

Buy
Fair value Previous FV Share price Yield Capital gain Total return Conviction Stock code Market cap USD600 N/A USD500 <1% +20% +20% Average AAPL US USD470bn

Analyst Robin Hu robin@nonameresearch.com

Quantitative Overview Qualitative Overview Looking Ahead Valuation and Conclusion

Very rapid revenue and net income growth

Revenue and Net Income
200,000 156,508 150,000 USD m 108,249 100,000 65,225 50,000 42,905 8,235 0 2009 Revenue 14,013 2010 25,922 41,733

2012

Revenue growing circa 50% per year Revenue multiplied 4x in 3 years from USD43bn in 2009 to USD156bn in 2012 Net income growing even faster at circa 70% Amazing in both relative and absolute terms especially for a company as large as Apple Apple added USD50bn to topline in 2012 alone

2011

Net income

Revenue and Net Income Growth

90% 70% 68% 52% 45% 32% 23% 45% 70% 85% 66%

61%

0%

2009 Revenue growth

2010

2011

2012

Net income growth

Rapid growth driven by iPhone and iPad

Revenue Contribution
100% 1% 6% 30% 75% 39% 43% 50% 99% 94% 70% 25% 54% 38% 0% 2007 Others 0% 2008 0% 2009 28% 2012 iPad 51% 8% 19% 21%

iPhone introduced in 2007 iPad introduced in 2010 iPhone and iPad

0%

Contributed 1% to revenue in 2007 But, rapidly increased to 72% of revenue by 2012

2010

2011

iPhone

iPhone now 51% of revenue iPad now 21% of revenue

Incredible demand for iPhone

iPhone Unit Sales
150.0

iPhone unit sales

112.5

increased from 1.4m units in 2007 to 125m units in 2012 CAGR of 150% per annum since introduction But last two years growth lower at 70% per annum

75.0

37.5

2007

2008

2009

2010

2011

2012

iPhone unit sales

iPhone Revenue
90,000

iPhone revenue was USD80bn in 2012, growing 71% yoy

67,500 USD m

ASP remain stable at circa USD600 per iPhone revenue also helped by accessories sales

45,000

22,500

2007 2008 2009 2010 2011 2012 iPhone and related products/services

Contributes 51% to total revenue

Incredible demand for iPad

iPad Unit Sales
60.0

iPad unit sales

45.0

increased from 7.5m units in 2010 to 58m units in 2012 CAGR of 180% per year

30.0

15.0

2007 2008 2009 2010 2011 2012 iPad unit sales

iPad revenue was USD32bn in 2012, growing 59% yoy

in contrast to iPhone, ASP not stable declining as cheaper/discounted iPad models were introduced

iPad Revenue
40,000

30,000 USD m

Contributes 21% to total revenue

20,000

10,000

2007

2008

2009

2010

2011

2012

iPad and related products and services

Mac growth driven by laptop

Mac Unit Sales
20.0

15.0

Mac sales include both desktop (iMac, Mac mini, etc) and laptop (Macbook series) Driven more by laptops

10.0

5.0

Laptop sales growing faster than desktop sales 2/3 sales from laptops

2007

2008

2009

2010

2011

2012

Total mac unit sales

Mac Revenue
30,000

Mac revenue was USD23bn in 2012, growing 7% yoy Contributes 15% to total revenue

22,500 USD m

15,000

7,500

2007

2008

2009

2010

2011

2012

Total mac net sales

iPod on a decline
iPod Unit Sales
60.0

iPod unit sales continued to decline

45.0

30.0

2007 2008 2009 2010 2011 2012 iPod unit sales

sold 35m units in 2012 30% less than 50m units sold in 2010 Apple digital sales is now larger than iPod sales

15.0

iPod Revenue
10,000

iPod revenue was USD5.6 in 2012, declining 25% yoy Contributes <4% to total revenue

7,500 USD m

5,000

2,500

2007

2008

2009 iPod

2010

2011

2012

Sales growing strongly across all regions

Sales by Region
100% 17% 75% USD m 23% 50% 23% 19% 7% 28% 13% 21% 21%

23%

On relative terms

29%

26%

Americas is still the largest segment but has declined from 48% in 2007 to 37% in 2012 Europe is stable at around 23% Asia-Pacic increased from 17% in 2007 to 21% in 2012

25%

48%

45%

44%

38%

35%

37%

0% Americas

2007

2008 Europe

2009

2010

2011

2012 Retail

Japan

Asia-Pacic

On absolute terms, all segments were growing

America and Asia Pacic grew 50% yoy Fastest in Japan at 94% yoy Rest around 30%

Consistently strong margins

GP Margin
44% 44%

43%

Gross prot margin high at 40% Margin has been consistent even in period of high growth As xed costs have not increased as fast as revenue growth, EBIT and net income margin have continued to expand

41% 40% 40% 39%

40%

38%

2009

2010 GP margin

2011

2012

EBIT and Net Income Margin

40% 32% 30% 28% 19% 28% 21% 24% 27% 36%

20%

10%

0%

2009 EBIT margin

2010

2011

2012

Net income margin

10

Dividend payout still low

Dividend Paid
3,000 2,488 2,250 USD m

Historically, Apple has not been paying dividend Only began paying dividend in 2012 Even then only USD2.5bn or 6% of USD42bn net income

1,500

750 0 2009 0 2010 0 2011 2012

Dividend paid

Payout Ratio
6%

5%

3%

2%

0%

2009

2010

2011

2012

Payout ratio

11

No debt, very signicant cash hoard

Cash Balance
130,000 121,251

97,500 USD m

81,570 51,011 33,992

65,000

Because of (1) high earnings growth (2) very low payout, cash is accumulating very rapidly on the balance sheet Apple cash hoard is a huge USD121bn or a quarter of its USD470bn market capitalisation This must eventually return to shareholder

32,500

2009

2010 Cash balance

2011

2012

12

Quantitative Overview Qualitative Overview Looking Ahead Valuation and Conclusion

13

Apples competitive advantages

Edge in innovation Integrated business model Financial strength

14

The real innovator

In the mobility business

Introduced iPhone in 2007, revolutionising the phone market Introduced App Store in 2008, popularising the concepts of apps for mobile phones. The App Store is currently the largest at 700k apps Introduced iPad in 2010

And going back further

Introduced iPod in 2001 and its subsequent iterations (Shue, Touch, Nano) Introduced iTunes in 2001 as a digital content manager Introduced iTunes Store in 2003 as online digital media store and introducing the concept of aggressively priced (99 sen), volume based music sale Adopted retail presence model with Apple Retail Store in 2001. Though met with skepticism initially, this has now proven to be the correct model

And going back even further

Invented personal computer with Apple II in 1970s Invented GUI and mouse

15

What were the competitors doing all this time?

What has Apple competitors introduced in comparison? Why didnt RIM or Nokia or Samsung launched a phone like iPhone in 2007? These are players that are already in the phone business Why didnt any of the competitors see the benet of an App Store? Now, only Google App Store is a viable competitor to Apple App Store Apple took the lead with iPhone in 2007 but why did the competitors allow Apple to take the lead with iPad again in 2010? Why are the competitors always behind? Perhaps something wrong with their business model?

16

Apples business model

[Apple] ...is committed to bringing the best user experience to its customers through its innovative hardware, software, peripherals, and services. [Apple]... business strategy leverages its unique ability to design and develop its own operating systems, hardware, application software, and services to provide its customers new products and solutions with superior ease-of-use, seamless integration, and innovative design

Apple Annual Report

17

Apple is the only player capable of full integration

Apple

Samsung

Google

HTC

RIM

MSFT

Nokia

Hardware design Components design User Interface

Yes

Yes

No

Yes

Yes

No

Yes

Yes

Yes

No

No

No

No

No

Yes

No

Yes

No

Yes

Yes

Yes

Operating System

Yes

No

Yes

No

Yes

Yes

No

App Store

Yes

No

Yes

No

Yes

Yes

Yes

18

Benet of full integration

Full control of user experience

Apple controls Mac OS, iOS, App Store, iTunes, iBookstore This provides (1) integration (2) consistent user experience across Apple products desktops, laptops, iPhones, iPads This help cross selling and lock-in users into Apple ecosystem

Clear dierentiation

If you like iOS, Mac OS or App Store, you must buy an Apple product In contrast, if you like Android, you can pick a device from Google, Motorola, HTC, Samsung, Sony This creates clear dierentiation for Apple that can not be replicated by competitors Not only are Apples competitors ghting Apple, they must also ght amongst themselves since they sell similar products

19

Other competitive advantages

Limited portfolio and sheer volume

Apple has a streamlined product oerings e.g. Apple introduces only one iPhone per year Allow cost savings through bulk buying of components, easier repairs and after sales service Also, allows a healthy third party accessories market as manufacturers only need to design for one or two iPhone models Same for application developments on the App Store In contrast, competitors products fragmented across dierent platforms and models

Signicant retail presence

Apple decided to establish retail presence in 2001 through Apple Retail Stores Allows Apple to control user experience and after sales service Such strategy is being replicated by competitors but Apple already has a headstart

20

Apple is nancially stronger than all its competitor

USD bn Apple Samsung HTC Microsoft Nokia Google RIM Revenue Net Income 156 220 9 74 52 38 18 42 21 1 17 (2) 10 1

On a net income basis, Apple is

2x that of its nearest competitor Samsung (and this is after including Samsung non-mobile related income) 2x of Microsoft which still has limited presence in mobile 4x that of Google whose primary business in advertising

21

HTC, RIM and Nokia are trying to stem losses Also, Apple enjoys margin advantage due to volume and concentrated product line Thus, Apple in superior nancial position to respond competitively

Apples competitive advantages

Edge in innovation Integrated business model Financial strength

22

Quantitative Overview Qualitative Overview Looking Ahead Valuation and Conclusion

23

What would Apple look like in the short term?

Revenue composition continues to be dominated by iPhone/iPad

By virtue of size, iPhone and iPad will continue to dominate revenue New products rumored to include iPhone 5S, cheaper iPhones, Apple TV But unlikely to have any impact in 2013

Revenue growth may be more subdued

Two sources contribute to revenue (1) upgrade buyers (2) new buyers Upgrade buyers merely replace their existing Apple products hence serve to maintain revenue Only new buyers capable of creating strong revenue growth Apple revenue is biased towards hardware hence need to introduce new product to sustain growth But what else can Apple introduce after iPhone and iPad? Very little other than cheaper iPhones to drive volume in emerging market Also, it is hard to grow a USD156bn revenue meaningfully Therefore, we believe Apple revenue will now grow at markedly lower rate compared to previous years

24

Rapid rise in sales from China

Revenue From China
30,000

Revenue of USD23bn in 2012, up 83% yoy 15% of Apple total revenue of USD156bn Revenue included desktops, laptops, iPhones, iPads, iPod, peripherals, software, etc Market still nascent

22,500 USD m

15,000

7,500

2009

2010 China

2011

2012

Note: China includes HK

Apple added China Telecom as ocial iPhone carrier only in 1Q12 Still in discussion with China Mobile that controls 70% or 700m of Chinas mobile subs

25

How many iPhones did Apple sell in China?

Sales Scenario I: (Ceiling) Assume 100% China sales from iPhone Scenario II: (Realistic) Assume 70% of China sales from iPhone Implied units 38m

About 1 billion mobile subscribers in Mainland China (ex Hong Kong) Scenario 1 estimates of 38m translates to only 3.8% penetration rate Scenario 2 estimates of 27m translates to only 2.7% penetration rate Hence, under both scenarios, iPhone penetration is still very low and has more room to grow

USD23bn

USD16bn

27m

26

Expect more upside from China

Share Total (incremental) units 150m (123m) 100m (73m) 50m (23m) Incremental revenue USD74bn USD44bn USD16bn

Typically Apple has 10%-15% smartphone market share in developed countries Assume Low-High scenarios with penetration rate ranging from 5%-15% Based on this, China incremental revenue can potentially add between USD16bn-USD74bn to Apple total revenue

High Mid Low

15% 10% 5%

27

Quantitative Overview Qualitative Overview Looking Ahead Valuation and Conclusion

28

Lets recap
Revenue Net income Revenue CAGR Net income CAGR Gross prot margin Net income margin Net cash Market cap USD156bn USD42bn 50% 70% 40% 25% USD120bn USD470bn

Since revolutionizing smartphone market with iPhone in 2007, Apple has been and continues to be the key innovator Only company with fully integrated business model, allowing Apple to control user experience and clearly dierentiate from competitors Financially in a markedly superior position to competitors allowing for strategic exibility

29

On the positive side

Integrated business model is not replicable by competitors

Competitors unable to take customers away from Apple through imitation but only through superior product Currently competitors fragmented and at a disadvantage both nancially and strategically

This means Apple sales growth will decline or reverse only if

Consumers stop viewing Apple products as better than competitors product Apple run out of consumers to sell to at premium prices

We believe both risks are mitigated in the short term

Firstly, Apple ability to innovate will not diminish overnight even though a series of missteps will be fatal. As such, brand goodwill should be protected short term Secondly, still room for Apple to grow especially in China

30

On the negative side

USD bn Revenue iPhone iPad Others Changes in revenue 2009 43 11 0 (1) 10 2010 65 12 5 5 22 2011 108 22 15 6 43 2012 156 33 12 3 48

Apple has been heavily reliant on iPhone to drive growth in the past

More than half of revenue growth was due to iPhone Reliance on iPhone to drive growth presents concentrated risk

Size is now a problem. Apple revenue at USD156bn is huge

Rapid growth at this size is dicult as it requires exponential growth in sales Such growth is not achievable and revenue growth should trend towards teens

Also, potential risk of margin compression if Apple start competing on price

31

Valuation and conclusion

Fair value Previous FV Share price Yield Capital gain Total return Conviction Stock code Market cap USD600 N/A USD500 <1% +20% +20% Average AAPL US USD470bn

Key estimates

Revenue growing 20% to USD190bn in 2013 iPhone growing 30%. Anything less would disappoint GP margin maintained at 40% Net income USD45-50bn

Due to size, growth would be more subdued moving forward but China could surprise on the upside Cash hoard of USD120bn provides downside protection Overall, we have a BUY on Apple with a fair value of USD600

32

Rating structure The rating structure consists of two main elements; fair value and conviction rating. The fair value reects the security intrinsic value and is derived based on fundamental analysis. The conviction rating reects uncertainty associated with the security fair value and is derived based on broad factors such as underlying business risks, contingent events and other variables. Both the fair value and conviction rating are then used to form a view of the security potential total return. A Buy call implies a potential total return of 10% or more, a Sell call implies a potential total loss of 10% or more while all other circumstances result in a Neutral call.

Disclaimer This report is for information purposes only and is prepared from data and sources believed to be correct and reliable at the time of issue. The data and sources have not been independently veried and as such, no representation, express or implied, is made with respect to the accuracy, completeness or reliability of the information or opinions in this report. The information and opinions in this report are not and should not be construed as an oer, recommendation or solicitation to buy or sell any securities referred to herein. Investors are advised to make their own independent evaluation of the information contained in this research report, consider their own individual investment objectives, nancial situation and particular needs and consult their own professional and nancial advisers as to the legal, business, nancial, tax and other aspects before participating in any transaction.

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