115 Company analysis and valuation of Apple Inc., Oracle corporation, IBM corporation and Microsoft corporation,Master''''s Thesis

Executive SummaryThis dissertation studies the 4 global leading companies in the technology sector areApple Inc., Oracle Corporation, IBM Corporation and Microsoft Corporation.. Based on

Dissertation submitted in partial fulfillment of the

UWE Bristol

University

of the West of England

Requirement for the MSc in Finance

Supervisor: Prof Dr Pham Thi Hoang Anh

September 2018

University of the West of England

Executive Summary

This dissertation studies the 4 global leading companies in the technology sector areApple Inc., Oracle Corporation, IBM Corporation and Microsoft Corporation It evaluates allinternal and external factors which influence these companies’ performance and prospects togive the investment recommendations to investors

Based on the macro- economic analysis, the US and Asia- Pacific is recognised as theregions with the most potential for the development of the technology sector Because of that,technology companies should focus on developing and increasing their presence in thesemarkets The industry analysis represents an intense competition between existing companies.Thus, they need to come up with more innovative tactics and spend more on R&D to competemore effective for the coming years

In the company analysis, it can be seen that Apple Inc and Microsoft Corporation are thecompanies have an outstanding performance IBM Corporation is having trouble when itsfinancial ratios show a worsening financial position and its sale growth is predicted to benegative in the next few years The valuation models are applied to calculate the intrinsic values

of the four companies The target price of Apple Inc., Oracle Corporation, IBM Corporation andMicrosoft Corporation are $188.3, $41.43, $124.64 and $64 respectively Combining allanalyses, recommendations are made for each stock

3

Table of Contents

Abbreviations 7

Chapter I: Introduction 8

I An overview on the technology market 8

II Area of the study 8

III Study objectives 9

IV Methodology 9

V Organisation of the study 10

Chapter II: Macroeconomic analysis 11

I. Overview of the global economy in 2018 11

1.1 II US Economy 13

1 PEST analysis: 13

2 Key macroeconomic factors analysis: 14

1.1.1 3 Summary of the US economy: 16

1.2 III European economy 17

1. PEST analysis: 17

1.2.1 2 Key macroeconomic indicators analysis: 19

1.2.2 3 Summary of the European economy: 19

1.3 IV Asia- Pacific economy 20

1 PEST analysis: 20

2 Key macroeconomic indicators analysis: 21

3 Summary of the Asia- Pacific economy: 22

Chapter III: Industry analysis Error! Bookmark not defined. I Bargaining power of buyers 25

II Bargaining power of suppliers 25

III Threat of new entrants 26

IV Threat from substitutes 26

V Rivalry among existing players 27

Chapter IV: Company Analysis 28

1.2 APPLE INC 30

1 SWOT analysis 30

2 Ratio analysis 34

3 Valuation 37

5

1.3 ORACLE 43

1 SWOT analysis 43

2 Ratio analysis 49

3 Valuation 51

1.4 IBM CORP 56

1 SWOT analysis 56

2 Ratio analysis 60

3 Valuation 63

1.5 MICROSOFT CORP 68

1 SWOT analysis 68

2 Ratio analysis 72

3 Valuation 75

Conclusion 79

References 81

Appendices 87

APPL Apple Inc.

CPI Consumer Price Index

DPS Dividend per Share

EBITDA Earnings before Interests, Taxes, Depreciation, and

Amortization

EPS Earnings per Share

GDP Gross Domestic Product

IBM International Business Machines Corporation

IMF International Monetary Fund

IT Information Technology

MSFT Microsoft Corporation

OECD Organisation for Economic Co-operation and Development

ORCL Oracle Corporation

P/E Price/Earnings

ROA Return on Assets

ROE Return on Equity

Abbreviations

7

I An overview on the technology market

The technology sector contains businesses revolving around the manufacturing ofelectronics, creation of software, computers or products and services relating to informationtechnology (Bloomberg, 2018) It is considered as a leading sector for growth- based investment.This sector performed well in 2017, it had increased 15.6% since the January 2017 (Sands,2018) However, Brexit caused a decline in the performance of technology sector It creates morerisk and uncertainty for the business when just in the UK, according to KPMG report in 2018, 70percent of tech workers are considering leaving the UK The technology sector is dominated by 3leading companies, namely Apple (APPL), Microsoft (MSFT) and Facebook (FB) The stocks ofthese companies had returned 10.8%, 14.8% and 13%, respectively, in December 2017 incompared with their performance in the same period in 2016 These firms carry out theirbusiness across the world with the main driver of sales in 2017 being focused on 3 regions:Europe, Asia- Pacific and the US (Datamonitor, 2018) In 2018, the technology sector isforecasted to have an explosive growth (Bajarin, 2017) According to researchers, there will bepotential tripling of demand for tech- related goods and services over the next decade With thegrowth of the importance of technology in society, the technology sector has become abellwether of the overall stock market and economy

II Area of the study

This dissertation not only focuses on analysing but also assessing the intrinsic values of 4largest firms in the technology sector are: Apple Inc., Oracle, IBM and Microsoft The analysisconsists of 3 main regions: Asia, Europe and US that these companies operate but US is morefocused because this in the region that all 4 companies mainly operate By doing all of these

Chapter I: Introduction

analyses, this study wants to understand deeply the technology sector’s leaders and provide someinvestment recommendations for investors who have purpose to invest in these companies.

III Study objectives

Objectives of this study are having an overview of technology sector and provideinvestment recommendations

1) Providing current technology sector insights

2) Analysing crucial macroeconomic indicators of the economies in Asia, US, Europe

3) Analysing technology industry in these 3 regions

4) Base on the financial statements, gearing ratios, profitability ratios, investment ratios ofApple Inc., Oracle, IBM and Microsoft are analysed In the next step, this paper uses thevaluation models to calculate the intrinsic value of these companies After analysing andassessing the intrinsic value, this project will provide investment recommendations

IV Methodology

The top- down analysis method will be used in this project It will start with technologysector economic evaluation, consist of macroeconomic analysis and industry analysis Byevaluating these, the project wants to analyse industrial and macroeconomic condition, which arevital indicators of the firms’ potential profit Then, it focuses on 4 companies’ performance andrecommend a price, using the valuation models

Macroeconomic analysis: This project uses PEST analysis which include: political,

economic, social and culture impacts, aim at evaluating the important macroeconomicdeterminants: inflation, unemployment rate, GDP, exchange rate and CPI

9

Industry analysis: This study illustrates technology sector overview before pointing out

the impact of market trends on firms in this industry The determinants affect market competitionare analysed also

Company analysis and valuation: By using the financial statements of 4 companies,

financial websites: IMF, MarketLine, WB and financial databases: OSIRIS, Datastream, thisstudy will evaluate profitability and financial situation of these firms After that, the intrinsicvalues will be calculated and analysed It combines with SWOT analysis to analyse the strengths,weaknesses, opportunities, threats of companies, give an insight into these firms

V Organisation of the study

This project is divided into 8 chapters Chapter 1 provides a brief introduction to the area

of the study and the objectives of the study The next chapter is chapter 2 evaluates globaleconomy in the recent year and three regions: Asia, Europe and US In the third chapter, thestudy aims at analysing technology industry’s vital indicators and the factors affect marketcompetition To examine this, Porter’s Five Forces is used as an analytical tool From chapter 4

to chapter 7, there are brief descriptions of 4 chosen companies, their performance and theirfuture forecast The calculation of intrinsic values, investment recommendations are alsoincluded in these chapters Chapter 8 is the report summarisation

This chapter presents an overview of the global economy in 2018 Not only that, byapplying PEST method and analysing important macroeconomic determinants, it provides aninsight into three main markets, consisting of: US, Europe and Asia.

I Overview of the global economy in 2018

In 2017 the global economy has a sluggish acceleration Weak international trade andreducing investment within other culprits tended to decrease world growth to its weakest pacesince 2010 Although 2018 has a better outlook, the unusually heightened uncertainty aboutpolicy direction in some big economies may affect the recovery prospects (World Bank, 2018)

IMF (International Monetary Fund) predicted the global economic growth will increaserapidly from 3.1% in 2017 to 3.5% in 2018 This increase comes from the rebound ofinvestment, manufacturing and trade Stronger activity and expectations of more robust globaldemand, combined with oil supply agreed restrictions made commodity prices recover from itstroughs in 2017 (IMF, 2018) The higher commodity prices, the more it helps in removing globalheadline inflation, and decreasing in deflationary pressures Financial markets are buoyant andexpect continued policy support in China and fiscal expansion and deregulation in the US Whenmarket sentiment and confidence are still strong, growth in short term could be higher than theexpectation In US, because of the rebound of manufacturing activity, the economy is predicted

to grow at 2.3%, increase 0.7% in compared with last year (Amadeo, 2018) The surge of interestrate hikes in US that faster than expectation could tighten financial conditions and strengthening

of US dollar could affect the emerging and developing economies rely heavily on externalfinancing The Europe economy is expected to grow a healthy 1.7% in 2018 when the largesteconomies such as Germany, Italy, and Spain are expected to grow at 2% (European

Chapter II: Macroeconomic analysis

11

Commission, 2018) In the Asia Pacific region, growth is forecasted 5.5% but warned that nearterm outlook has significant uncertainty and medium-term growth has to deal with thedifficulties from the productivity growth slowdown of some economies IMF raises the economicoutlook of the world’s second largest economy China to 6.7% due to the policy support in publicinvestment and expansionary credit In the first quarter of 2018, China’s economy grew 6.9%which is higher than the target 6.5% of government for 2018 However, many economistsbelieve that this growth is not sustainable when the growth relies on domestic credit growth,rapid growth could cause financial stability issues (Financial Times, 2018) China has to dealwith the challenge of decreasing credit growth reliance Overall, the economic growth of globalwill grow in a rapid pace in 2018 as investment, trade and manufacturing rebound.

In this chapter, PEST analysis is used to analyse the influences of macroeconomic ontechnology sector in US, Europe and Asia Pacific

1 PEST analysis:

• Political analysis: US has a strong democratic setup which has been proved and

effective rule of law with the elections are considered transparent and fair It also has massivepolitical and economic impact on national and worldwide policymaking However, US has todeal with the increase in the threat of terrorism due to the interventionist policies regarding the

‘War of Terror’ This leads to an increasing in number of terrorist attacks and the flow of illegalimmigrants Another problem of US is many of president Trump policies counter the legacy ofObama especially in healthcare and pharmaceutical industry President Trump might dismantlethe structure of Obamacare, challenge the whole sector

• Economic analysis: US has one of the most developed economic systems in the

world with strong manufacturing and service sectors US’s real GDP in 2017 was 16.81 trilliondollars, grew 3.2%, the fastest growth in the last 2 years The economy is strengthened by itsdiversity and strong position in services and manufacturing sectors US is a forerunner inautomotive, telecom, aerospace, electronics, chemicals and IT (information technology) In terms

of budget deficit, from $1.4 trillion in 2010, 9.75% of GDP, it shrank to $587 billion in 2017,3.2% of GDP According to Congressional Budget Office (CBO), US’s budget deficit willdecrease to just $559 billion in 2018 The unemployment rate also has recovery since the GreatRecession in 2010 In April 2018, US created 211,000 more jobs and made the unemploymentrate dropped to 4.4%, the lowest level since 2008 (MarketLine, 2018)

1.1 II US Economy

13

• Social analysis: American population has a high standard of living According to

the United Nation’s 2016 Human Development Report, US was ranked eighth in 188 countries

US has household net-adjusted disposable income per capita is $41,355 on average, which ishigher than OECD with $25,908 on average Not only that, 44.6% of the adults from 25 to 64had a tertiary education, higher than 35% of OECD, indicate strong performance of Americanadults in educational attainment However, income inequality is a big problem in the US Until

2015, US is the poorest performer in income inequality among the OECD countries Wage gapsbetween genders, ethnicities remain high Moreover, the US is dealing with ageing populationproblem, baby boomer generation reaches retirement age Government budget will be put underpressure of the needs of an ageing population and falling labour force

• Technological analysis: Technology is a key driver of the US economy It is the

world leader in scientific publications production and in emerging technologies, a large number

of its manufacturing and services output requires application of sophisticated technologies The

US boost commercialization of technology by having a well-established intellectual propertyrights protection and enforcement system However, US has to deal with the intellectual propertytheft by other countries such as China and this demotivates the US to spend more on R&D(Marketline, 2018)

2 Key macroeconomic factors analysis:

• GDP growth: In the first quarter of 2018, the GDP growth of US was 0.7% This

is the slowest growth in three years and weak consumer spending is the main reason for this

sluggish pace Despite this slow growth, the US economy is still in good shape whenunemployment is low at 4.5%, job gains remain solid, gas prices are low and wage growth hasbeen increasing Moreover, due to the election victory of president Trump and his promises fortax cuts and deregulation boost the consumer and business confidence, the consumer spending isexpected to increase This will lead to the surge of GDP growth in the coming months (Gillespie,2018).

• Inflation rate: According to the US Bureau of Labour Statistic (2018), the US

CPI fell 0.1% made the US inflation rate, which is based on CPI reached 1.9% in May 2018which is lower than 2.1% in 2017 The decrease of energy index was the main factor for this fall.The energy index decreased 2.7% led to the decline of 6.4% in the gasoline index Additionally,this fall of CPI started in April, the US personal consumption expenditure slipped to 1.5% and it

is predicted to fall to 1.5%- 1.7% per quarter in 2018

• Industrial production: American industry production in April grew at the fastest

pace in more than three years as manufacturers and mines recovered from the downturn inMarch The Federal Reserve has recently reported that from March to April industrial production

at factories, mines and utilities rose 1%, which is a biggest gain since February 2015 Afterfalling 0.4% in March, factory production increased 1% while mine production rose 1.2% afterdecreasing 0.4% Utility output surged 0.7% after rising 8.2% in March From the late 2016, theUS’s manufacturing has started to recover due to the cutbacks in the energy industry and USdollar has been stronger that make US goods costlier in foreign markets

15

Figure 1: The US Industrial Production in 2017 - 2018 (Source: Federal Reserve).

1.1.1 3 Summary of the US economy:

Overall, the US economy is still the largest and most important in the world It has a goodbusiness environment, which is dominated by services-oriented companies in the sector such astechnology, financial services, and retail Therefore, the US market is a good market for thedevelopment of technology companies

1 PEST analysis:

• Political analysis: The European countries such as Germany, France and Italy are

big players in the global politics These countries have strong political positions and affectmultinational organisations such as IMF and World Bank However, there are some big issuesthat EU have to deal with The first issue is the Brexit Brexit would impose significant costs notonly on the UK but also on the EU’s economy Integrated production chains such as automotiveand aerospace industries will have to deal with some obvious difficulties Moreover, therestriction of the free flow of capital between the continent and London could affect financialopportunities across Europe Another issue with European countries is migration and refugees.The EU- Turkey migration deal in 2016 caused the refugee crisis in EU, migrants from WestAfrica reaching Italy rose 20%, reached a record high Terrorist is also a big problem, althoughthe number of people killed by terrorist attacks in Europe remains low, the public concern is stillvery high

• Economic analysis: Despite a number of challenges, the European economy is

performing well After 1.8% in 2017, the GDP growth in euro area remains steady at 1.7% in

2018 and is forecasted to increase slightly to 1.8% in 2019 Private consumption, remains themain growth driver, which grew at the fastest pace in 10 years in 2017 seems to moderate thisyear as inflation partly erodes gains in the purchasing power of households However, inflation ispredicted to ease in 2019 so private consumption should rise up slightly In terms of investment,

it is expected to increase steadily but remains hampered by the modest growth outlook

1.2 III European economy

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Unemployment keep having a downward trend, it is expected to decrease to 9.4% in 2018 before8.9% in 2019, which is the lowest level since 2010 This fall comes from the increasing indomestic demand and government policies that encourage job creation The core inflation whichexclude volatile energy and unprocessed food prices remains stable and below the long-termaverage Inflation has surged considerably in the recent months because of increasing oil price.However, when the effect of increasing oil prices fades away, the inflation is expected to reducefrom 1.6% in 2018 to 1.3% in 2019 (European Commission, 2018).

• Social analysis: Human Development Index ranked European countries in high

ranking and indicate these countries are good place to live in However, they have to deal withthe problems from aging population and high unemployment The minimum wage has risen butthe labour productivity has not increased by the same proportion This put pressure on theEuropean countries government to handle the problems such as fast reduction in the workforce,increase government expenditure on healthcare for elderly, welfare and statutory pensions

• Technological analysis: Europe area is one of the most advanced regions in the

world, which is recognised as a leader in technological innovation, research landscape with highlevel of integration and networking However, some European countries is facing problem ofdeficit of high skilled engineers and a significant decline in the technical workforce

1.2.1 2 Key macroeconomic indicators analysis:

• GDP growth: GDP in the euro area has grown for 15 consecutive quarters

because employment is increasing at a robust pace while the unemployment continues to fall.Another reason for this recovery is the growing of private consumption European CommissionWinter Forecast has recently reported that GDP growth of euro area could be 1.6% in 2018before increase to 1.8% in 2019

• Inflation rate: Inflation of euro area has recently increased as the fall of energy

prices has given way to an increase After being very low over the past 2 years, inflation is set toreach higher this year and next It is forecasted to increase to 1.8% in 2018 and 1.7% in 2019.Core inflation, which excludes volatile energy and food prices, is set to increase gradually

• Industrial production: The growth rate in the euro area industrial sector was

slow in April, however, the period ended with a strong boost to output The total output was1.4% higher than the previous April Although the energy production falls, the production ofconsumer goods rises significantly, reflect stronger consumer spending Monthly growth ratepicked up in April to 0.5%

1.2.2 3 Summary of the European economy:

Despite of the uncertainties from the Brexit, European economy has a steadyperformance which maintain high ranking in the world of business and investment However, theregional growth in long term will gradually slow down due to the influence of Brexit and thepopulation ageing faster than other parts of the world This will lead to the weakening ofpurchasing power Because of that, the consumptions of technology sector can be influencednegatively

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1 PEST analysis:

• Political analysis: Developing countries in the Asia- Pacific area are being the

participants of WTO- Doha, climate change and global security conferences, multilateral andbilateral trade agreements It represents the increasing political influence of this region In theregion, an increasing number of countries have developed the trade relationships over the lastfew years For instance, in 2016, Singapore launched talk with China for China- Singapore FreeTrade Agreement (CSFTA) Currently, CSFTA eliminated 95% of the tariff exports to China.However, the relationship between some countries is tense The China’s relationship withVietnam, Japan and Philippines remains a matter of concern owing to tensions in the SouthChina Sea and East China Sea (Marketline, 2018)

• Economic analysis: The economic growth of Asia- Pacific region is estimated to

reach 5.5% this year, increase from 5.3% in 2017 The growth will remain strong in 2019 at5.4% and this region continues to be the leader of global growth In China, one of the biggestregion and the world second largest economy, the demand is expected to be supported by thepolicy stimulus The growth is predicted to slow down to 6.6% in 2018 and 6.2% in 2019.Reasons for this slowdown are the cooling housing market, partly reflecting weaker wage andconsumption growth and a stable fiscal deficit Another big economy is Japan which growth isforecasted to reach 1.2% in 2018 This increase comes from the expansionary fiscal policy andconsumption tax hike postponement Other Asia economies also have positive outlook which

1.3 IV Asia- Pacific economy

growth is expected to be supported by robust domestic demand (Asian Development Bank,2018).

• Social analysis: The population of Asia- Pacific region is 4.48 billion, account for

the world largest work force (Worldbank, 2018) The average age is 30.7 years old, show that thesociety is substantially young In compared with the Europe which the ageing population andincreasing of social expenditure, the work force of Asia- Pacific region is abundant and keepincreasing Although the economic performance in Asia- Pacific region has improved over thelast 20 years, the population’s living standards have not improved much According to WorldBank’s report in 2017, there are still 766 million extremely poor live below the poverty life of

$1.9 a day (Marketline, 2018)

• Technological analysis: This region is one of the most vital emerging market for

IT suppliers Asia- Pacific IT market has a rapid and strong growth in the last few years whichmost notably is Taiwan, is regarded as one of the top suppliers of information hardware systems,behind only US and Japan Nevertheless, R&D expenditure of the region is low compared withother regions The policies of Asia- Pacific countries are trying to promote R&D in order to raisethe contribution of technology to economic growth and reduce the dependence on importedtechnology China, the biggest country in the region, target to invest 2.5% of GDP in researchand development in 2020

2 Key macroeconomic indicators analysis:

• GDP growth: The growth of Asia- Pacific is estimated to increase from 5.3% in

2017 to 5.5% in 2018 In 2019, growth is expected to remain strong at 5.4%, as Asia- Pacific

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• Inflation: The stronger consumer demand and increasing global

commodity prices will boost inflation in (Asian Development Bank report, 2018) Afterincreasing 0.3% to reach 2.5% in 2017, the inflation of Asia- Pacific region is expected

to accelerate to 3% in 2018 and 3.2% in 2019 This increase reflects the temporaryeffects of some Central Asian economies’ large devaluations In general, the price risesare reasonable, unlikely to alter Asian expectations of relatively stable prices

• Industrial production: There is a mixed picture for Asian industrial production.

It is different in each country in the region, while Japan and China are expanding output, SouthKorea and Thailand log declines The industrial production index of Japan reached 103.8 inApril, which is the highest since October 2009 Two main contributors for this strong growth aretransport equipment, increase 10.8% and general machinery, up 9.2% In terms of China, theslightly stronger foreign demand boosted the industrial production On the other hand, SouthKorea witnessed the decline 2.2% of industrial production on April due to sharp fall insemiconductor production and weak auto output Industrial production of Thailand also dropped1.7%

3 Summary of the Asia- Pacific economy:

Overall, Asia- Pacific region has a strong economy with a steady growth The biggesteconomies in this region are: China, Japan, Singapore, South Korea have positive outlook andexpected to keep growing in the future Furthermore, the policies of Asian economies support thedevelopment of companies, offer positive economic environment Because of that, technologycompanies can gain high profits and expand brands in this market

region continues to be the leader of global growth This GDP growth is supported by the more

favourable global environment with rapid growth in many major advanced and emerging market

Chapter III: Industry analysis

The technology sector has market cap of $6,205 billion which software and infrastructure

is the largest industry with $2,156 billion In the first quarter of 2018, the technology sectorposted strong year-over-year growth of 9% However, there was a 12.9% decline quarter- over-quarter (Pwc, 2018) The overall growth of technology sector was led by the internet,semiconductors and system and PC hardware sectors Technology sector is predicted to keepgrowing in the future when the demand for tech- related goods and services increasing

Reven ue growt h (local CU r reπ cyj

TecHirnoLogy - Hardware ⅛ SiirnicrjndiJ-CtCirS TeeHirnCjLogy - Software ⅛⅛ S⅛rvicas

23

EBITDA margin (adjListed)

TechneLogy - HardwaKS à Semiconductors Techno Logy - Software S Services

Figure 3: Global technology’s EBITDA margin forecast (Source: S&P global ratings).

EBITDA margin measures the technology sector operating profitability as percentage of its totalrevenue The figure illustrates an upward trend of the technology’s EBITDA margin In 2019,this ratio is forecasted to increase slightly, reach 24% It indicates the rise of operatingprofitability in technology sector

There are some new trends of technology sector in the last quarter of 2018 and 2019 (S&P globalratings, 2018) A rapid increasing share of corporate IT workloads moving to public and privatecloud architecture is expected to support growth for technology providers The software- definedarchitectures will keep pressuring hardware sales and software delivered as service models willprevail over legacy consumer and enterprise software licenses Besides that, the hardware isexpected to remain weak The traditional technology hardware providers will continue to witness

a fall in the revenue The last trend is semiconductor is expected to grow, primarily frommemory The temporarily constrained memory semiconductor capacity, growing NAND content

in computing hardware and more rational capacity management will make memory and overallsemiconductor sector grow in the revenue

I Bargaining power of buyers

Technology is a massive industry so buyers are almost everyone in the world With thisconsiderable number of buyers, it could be said that the buyers control the technology sector.Buyers have many choices because there are many firms in this industry Combing with theminimal switching costs, customers in the technology sector are not locked in to just 1 company

In order to counter this strong force, the key players in this industry such as Apple continue tomake substantial capital expenditure in R&D which enable the company to keep developing newand unique products such as Apple Pay or Apple Watch and building significant brand loyalty.Moreover, majority of technology sales come from the large firms which always make largepurchases, they are vital and powerful with the technology companies These technologycompanies often provide incentives to these businesses to persuade them to choose their productsrather than competitors The buyers are usually sensitive to the price; however, technologyservices and products are necessary to the businesses so they can spend a lot of money in order toget good quality products

II Bargaining power of suppliers

Bargaining power of suppliers is a weak force with the companies in the industry Withthe leading companies in technology sector such as Apple, the high number of potential suppliersand the ample amount of supply weaken this force Apple has many choices among the largenumber of potential suppliers for component parts for its products Moreover, the industries forthese suppliers are highly competitive while the switching cost to change suppliers is low Apple25

The 5’s forces analysis is used to analyse more deeply about the characteristics of this

is a major customer for its suppliers so Apple’s position is strengthened in negotiating withsuppliers (Bloomberg, 2018) Another big competitor of Apple in this industry is IBM also hasweak force of bargaining power of suppliers The high overall supply is an external factor thatweakly intensifies this force For example, an individual supplier’s change in operations has lowimpact on the overall supply level, thereby also having low impact on IBM (Rowland, 2018).

I Threat of new entrants

Due to the rapid growth and attractive customer base, the technology industry may beattractive with the new entrants Although it is possible for some new companies, especially thecompanies enter the internet and application industries such as Chinese companies which havefinancial backing from the government to enter and challenge the existing big players, for theimmediate future, the likelihood of such a challenger arising is remote There is not any realthreat for the large players There are 2 factors that can make this force relatively low: theextremely high cost of establishing a company in the technology sector and high cost ofestablishing brand name recognition Any new entrant to the marketplace such as personalcomputing or smartphones need to have a huge amount of capital to spend on R&D andmanufacturing to develop its products before selling it to the market and generating revenue.Additionally, these new entrants must deal with strong competition from the existing playerssuch as Apple, Microsoft and all other large and well- established firms Establishing brand namerecognition in this industry is another obstacle when competing with other strong brand namerecognition companies such as Google, Apple, Microsoft

II Threat from substitutes

Substitute products are not products that directly compete with a company’s products butpossible substitutes them In all of the large companies in the technology sector, this threat is aweak force With Apple, landline telephone is a substitute product which might be a substitutefor owning an iPhone However, this force is low for Apple because most of the potentialsubstitute products have limited capacities compared to Apple’s products, landline telephonecompared to an iPhone that has the capability to do much more than just make telephone calls Inthe software and infrastructure industry, Microsoft also deal with the low force from substitutes.Substitutes, such as non-online or manual-mechanical processes, tend to have lower performancecompared to Microsoft’s current products In relation, the global adoption of increasinglyadvanced technologies decreases the availability of substitutes and further weakens the threat ofsubstitution that Microsoft experiences While moderate switching costs help facilitatesubstitution, this external factor is not enough to significantly strengthen substitutes.

III Rivalry among existing players

The technology industry has a very high competition A main reason that many newentrants cannot be successful comes from the intense rivalry between existing companies Theyhave to compete with Apple Inc., Microsoft Inc., Amazon, Inc., all of these companies expendsignificant capital on research and development (R&D) and marketing Large firms in thisindustry take advantage from the economies of scale which is very valuable and they willcompete to not to lose it These firms have higher ability to invest in sales and advertise theirwell branded products Moreover, the low switching cost also causes the highly competitive intechnology industry It does not require a substantial investment for a consumer to ditch Apple'siPad for an Amazon Kindle or other tablet computer It can conclude that the threat ofcompetitive rivalry is high

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Chapter IV: Company Analysis

Key performance indicators

Table 1 : SWOT analysis of Apple Inc.

High average selling prices (ASPs)

Strong R&D capabilities

Robust and extensive distribution channels

High dependence on iPhone and iPadproduct lines

1.4 APPLE INC

Apple Inc is a world leader in the consumer electronics industry It is headquartered inCupertino, California, the US and employs 116,000 people The company operates globallyacross the US, Europe and Asia- Pacific and its products are sold in 180 countries Apple Inc.operates in three segments: product, consumer and professional software application, digitalcontents and applications Product segment consist of Iphone, Ipad, Mac, Ipod, Apple Watch,Apple TV Software application includes: iOS, macOS, watchOS and tvOS operating systems,iCloud, Apple Pay In digital contents and applications, Apple Inc provides iTunes Store, AppStore, Mac App Store, TV App Store, iBooks Store and Apple Music In 2017, the revenues ofcompany were $215, 639 million, decrease 7.7% in compared with 2016 This decrease comesfrom the year- over- year decline in iPhone net sales and the influence of the weakness in mostforeign currencies relative to the US dollar, partially offset by an increase in Services UnitedStates has been the biggest market of Apple Inc which revenue from the US accounted for 35%

of sales in FY16 China is the second biggest market, contributed 21% of Apple revenue inFY16

1 SWOT analysis

The global smartphone market has a positive

1.1.

Strengths :

High average selling prices (ASPs) of Apple Inc.

The company’s products ASPs keep remaining stable when the rest of the industry witnessedfalling ASPs In the smartphone category, Apple’s iPhone which has been sold at $600 remainedresistant to the decline in ASPs The estimates show that in FY2017, iPhone sold at an ASP of

$645.2, indicating a healthy demand for iPhone in 2017 Also during the last quarter of 2017, thecompany sold 78.3 million units Apple's products can maintain high ASPs although entering thedeveloping economies that ASPs of consumer goods are usually a pressure

Strong R&D capabilities

Research and Development capabilities is another strength of Apple Inc Strong R&Dcapabilities provide a competitive advantage to the company by enabling it to launch newproducts that effectively enhance revenues and market share Apple has been consistentlyspending on the R&D functions It devotes significant resources and attention to developconsumer-preferred products In order to compete successfully with other companies in themarkets, it is necessary to have ability to ensure that the competitive products, services andtechnologies have a continual and timely flow to the marketplace By having strong R&Dcapabilities, Apple keeps developing new technologies to improve its existing products and toexpand the company’s products range, licensing of intellectual property and acquisition of third-party businesses and technology In three years: 2017, 2016, 2015, the company spent $10billion, $8.1 billion and $6 billion on R&D respectively The strong R&D capabilities allowedthe company to introduce new products For instance, in 2017, Apple introduced TV app, which

31

offers access to TV shows and movies from multiple apps on Apple TV, iPhone and iPad andhelps discover new content to watch Further, the company introduced MacBook Pro whichreplaces row of function keys with a Retina-quality Multi-Touch display called the Touch Bar.Also in the same year, Apple introduced AirPods, a wireless headphone with advancedtechnology, and smartwatch Apple Watch Series 2.

Robust and extensive distribution channels

Apple has used both direct and indirect distribution channels to effectively reach its customersprimarily in the consumer, small and mid-sized business, education, enterprise, and governmentmarkets Through Apple’s retail and online stores and direct sales force, the company sells itsproducts and resells third-party products directly to consumers and small and medium sizedbusinesses Moreover, Apple has been continuously improving its distribution capabilities byexpanding the number of its own retail stores worldwide Retail stores of Apple are located atquality shopping malls and urban shopping districts By locating stores in high-traffic locations,Apple want to ensure a high-quality customer buying experience and attract new customers Thestores are designed to marketing the company’s products and boost its presentation Few ofApple’s competitors have their own physical retail stores and none have such a vast network ofthem

1.2.

Weaknesses:

High dependence on iPhone and iPad product lines

The Apple’s revenues depend highly on iPad and iPhone product lines This product lines took73% of the Apple’s total revenues in FY2017 Because these product lines have been the growthfactors for the company, any fall of the growth rates in the future could influence the Apple'sperformance A company which depend on a small number of product lines has to face the

market share losses of main products could have a material adverse effect on the Apple's growthprospects.

The global smartphone market has a positive outlook

The global smartphones market has been growing rapidly over the last few years and isforecasted to keep growing in the coming periods According to industry estimates, theworldwide smartphone shipments are expected to reach 1,530 million units in 2018 Moreover,the shipments are expected to grow at a compound annual growth rate (CAGR) of 4% during2018-21 periods to reach 1,770 million units by 2021 Apple gains a lot of benefit from thegrowth of markets The company’s iPhone is a leader in the smartphone products, in FY2017,nearly 211.8 million iPhone were sold In the coming years, the sales of Apple is expected tokeep increasing

Smart Wearable Devices market has a rapid growth

The market for wearable devices has been growing rapidly over the last few years The wearabledevices market size is expected to reach $12 billion by 2023 growing at a CAGR of over 24%during 2017-23 periods Apple gains benefit from the growth of these markets through the sale ofApple Watch

High selling price of products could limit the growth of Apple in the emerging markets

Price is one of the key competitive drawbacks of Apple that the rivals can take advantages of it

to gain market share This is a big challenge with Apple in the emerging markets, which is vital

as the advanced economies' smartphone markets attain maturity The emerging markets do nothave enough carrier subsidies while these market’s customer base is very sensitive with the

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change in price and because of that competing with Android products which have lower pricecould be a challenge The emerging market revenues for Apple products will come from a highermix of older models This points out that the smartphone markets move towards emergingcountries, the average prices will start to decline, influencing the margins The company hasbeen dealing with the marginal falls in average price per product Apple has not been able toeffectively gain market share in emerging markets which phones with lower price are popularbefore Apple's high selling price strategy will be challenging and could impact negatively on thecompany's gross margins.

Lawsuits and Litigations

The company is subject to the several legal proceedings and claims and this may happen in thefuture In 2017, in order to settle down the Siri patent lawsuit, Apple had to pay $24.9 million toDynamic Advances After that, Apple will be allowed to continue using Siri for its devices Also

in the year 2017, Apple had to pay $626 million for VirnetX’ after finding that iMessage,FaceTime and other Apple software infringed this company patents In the same year, afterpatent lawsuit loss, Apple faced to pay $862 million in damages to University Of Wisconsin.Apple’s A7, A8, and A8X chips used in iPhone 5S, iPhone 6 and the new iPhone 6S violate thetechnology covered by a 1998 patent filed by the Wisconsin Alumni Research Foundation

2 Ratio analysis

This part focuses on analysing three main categories: profitability, gearing and investmentratios These ratios will give an overview of Apple’s financial performance, financial risks andreturn on investment

2.1.

Profitability ratios

Ratios (%) 2013 2014 2015 2016 2017 Industry

Gross Profit Margin 43.87 37.62 38.59 40.06 39.08 52.88

Net Profit Margin 26.67 21.67 21.61 22.85 21.19 15.02

Table 2: Profitability ratios of Apple Inc.

Source: Bloomberg as of24/07/2018

As can be seen from the table above, the GPM ratio of Apple fluctuated slightly After improving

in 2 years 2015, 2016, this ratio deteriorated in 2017 With 39.08%, Apple had and received 39%

of the company’s total revenue after paying for its inventory In terms of net margin, Appleexperienced the lowest NPM since the last 5 years With low NPM ratio, the company couldtranslate a lower degree of its revenue to profits Other profitability ratios of the Apple alsofollow this similar trend The lower of profitability ratios in 2017 indicates the less efficient inusing material and labour in the production process and performance of the company This fallcomes from the strengthening of foreign currencies which increase the Apple’s cost of productcomponents denominated in those currencies (Apple annual report, 2017) However, exceptingthe ROCE and gross profit margin, these profitability ratios of the Apple are higher than theindustry on average Although having a decline in the efficiency and performance, Apple is stillperforming better than the industry especially in the smartphone market

2.1.

Gearing ratios

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Table 3: Gearing ratios of Apple Inc.

Source: Bloomberg as of24/07/2018

The company’s debt-to-equity ratio has experienced dramatic growth This measurement is bestused for determining the amount of ownership in a corporation versus the amount of moneyowed to creditors It is calculated by dividing a company’s total liabilities by its shareholders’equity (Bloomberg, 2018) In 2013, Apple had a debt to equity ratio of 0% but over the course of

4 years, this ratio soared to 58.81%, representing how quickly capital structure can change Interms of gearing ratio, it indicates investment quality by comparing a company’s long-term debt

to its total equity In the fiscal year ending in September 2017, Apple had 47.15% gearing ratiowhich was up from 43.09% in 2016 Although the company took more debt between 2016 and

2017, gearing ratio indicates it is still in satisfactory financial health

2.3.Investment ratios

Ratio MSFT SAMSUNG IBM Mean APPL

3 Valuation

3.1.

Price Multiples Model

The Price multiples model as presented in the table below, estimates that the intrinsic value ofApple’s stock is $146.02 The ratios from Apple main competitors Microsoft Corporation;Samsung Electronics Co., Ltd; International Business Machines Corporation are used to find outthe fair value per share of Apple Inc

Source: Bloomberg as of24/07/2018

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Financial Statement Item Actual Financial

Statement Data forAPPL

Mean MarketRatio

Suggest Value ofEquity

NPV (WACC 9.9%) 459,116

Source: Bloomberg as of24/07/2018

M/S, M/B and P/E ratios are lower than its main competitors A lower P/E ratio of Apple makesthe company’s stock become more attractive to the investors who finding stocks with lowermarket values per dollar of equity Compared to the target share value of $146.02 per share, thecurrent market price of $150.27 as of 24/07/2018 is overvalued

3.2.

The free cash flow model will be discounted at the weighted cost of capital to find out the value

of the company

(Assumption as in Appendices)

Add in initial cash and mkt.

By using the free cash flow model, the value per share is lower than the stock’s current price($150.27 as 24/07/2018) The Apple stock is currently traded as overvalued

Valuation method Target

Price

Average Target Price

Price as of 24/07/2018

Recommendation

Dividend Discount Model $320.28

Value per share is higher than the stock’s current price ($150.27 as 24/07/2018)

Recommendation

The stock of Apple, one of the largest company in the consumer electronics industry is expected

to outperform the market in the near future The key growth drivers for Apple as its newerlaunches, solid business model, impressive resources and its technological prowess are thereasons for Apple growth in the future (Morningstar, 2018) In the near term, Apple’s fortunesare tied to its most important offering iPhone The company launched the iPhone 7 and iPhone 7Plus handsets, which have been doing pretty well Considering the upgrade cycle trends, thecompany seems well placed to gain, especially in mature markets Additionally, Apple has beentaking a lot of initiatives to boost its presence in emerging nations like India (Apple annualreport, 2017) India presents an attractive growth opportunity for the company over the long rungiven its younger population and increasing investment in 4G network infrastructure Because ofthat, the buy recommendation stems from the belief that Apple will continue generate highrevenue, increased margins and high return on invested capital With the intrinsic value of

$188.3 is 25.3% premium above the prevailing share price of $150.27, Apple’s stock is a goodinvestment opportunity