Apple Case Study

Apple, Inc.

Finance Case

Raymond H. Lopez, Ph.D.

Lubin School of Business

Pace University

1 Martine Avenue

White Plains, NY 10606

914 422 4165

Fax: 914 422 4184

rlopez@pace.edu

November 2012

Apple, Inc.

        Revenue and profit growth over the last six years had been exceptional, especially for a company the size of Apple.  How had this growth been financed and what assets have been utilized to support it?  Can the firm expect to continue this combination over the next three years?

        These were some for the interesting questions faced by both the management team at Apple as well as security analysts, institutional and individual investors at the end of 2011.  The stock price had been roaring upward since the middle of 2008, following exploding quarterly earnings growth.  Yet the firm’s price/earnings ratio, using trailing twelve month earnings per share remained in the low teens.  While using analyst’s estimates of forward earnings (which the firm consistently beat) the price/earnings ratio barely exceeded single digits.

        With high margins and tight cost controls, the firm continued to accumulate excess funds and invested them in primarily short term marketable securities.  By year end 2011 (September fiscal year) this account, along with longer term marketable securities, amounted to over $82 billion or approximately 75% of the firm’s total assets!  With these funds earning barely 1 percent in a very low interest rate environment and the firm’s cost of capital exceeding 10 percent, investors expected some financial management changes in the near term.  Perhaps a cash dividend?  What about a share buyback program? Or a stock split to bring the price per share into a range that might expand the shareholder family?  These were some of the financial decisions facing the firm as the year 2012 unfolds.

Company Background 1

        Apple, Inc. and its wholly – owned subsidiaries designed, manufactured and marketed mobile communication and media devices as well as personal computers and portable digital music players.  They also sold a variety of related software, services, peripherals, net-working solutions and third–party digital content and applications.

        More specifically, Apple’s products and services included iPhones, iPads, Macs, iPods, Apple TV, along with a portfolio of consumer and professional software applications.  They also produced the iOS and Mac OS X operating systems, iCloud and a variety of accessory, service and support offerings.  Digital content and applications were sold and delivered through the iTunes Store, App Store, iBookstore and Mac App Store.

        Worldwide product sales were made through retail stores, online stores and a direct sales force, as well as through third – party cellular network carriers, wholesalers, retailers and value - added resellers.  Additional sales were generated through a variety of third-party iPhone, iPad, Mac and iPod compatible products, including application software printers, storage devices, speakers, headphones, and various other accessories and peripherals, through its online and retail stores.  Sales were made to consumers, small and mid – sized business, educational, enterprise and government customers.

Company History – The Early Years

Apple Computer was founded by Steve Jobs and Steve Wozniak in April of   1976 2.  A pair of college dropouts, their first product Apple I was built in the Jobs family garage in Los Altos, California.  Within a few months, they were able to make and sell 200 units.  Later that year, a new partner entered the firm, A.C. “Mike” Markkula, Jr. a recently retired employee from Intel, who brought business experience to the firm’s management.  While only 33 years old, Mike also was successful in attracting venture capital to Apple, critical for its future expansion.  He complemented Wozniak, the technical genius and Jobs, the visionary who sought “to change the world through technology.”

        Apple’s mission was to bring an easy-to-use computer to the marketplace. In April, 1978 the Apple II was launched, a machine that could be used by customers right out of the box.  It proved to be a revolutionary product that led the PC industry to annual sales that exceeded $1 billion by 1981 3.  By year end 1980, Apple was the industry leader, with annual sales of 100,000 units.  With the success of this machine, the firm’s management team decided on a public offering to diversify their financing sources.  In December, 1980 a successful IPO was completed, bringing public investors and institutions into the firm’s shareholder family.

        Apple’s competitive position in the PC industry changed significantly in 1981 with the entry of IBM.  The IBM machine incorporated Microsoft DOS operating system and a generic microprocessor (a CPU) made by Intel.  It featured a relatively “”open” system that other producers could clone.  In contrast the Apple II relied on proprietary designs that only Apple could produce.  While both PC businesses continued to grow, the IBM – compatibles rapidly took market share from Apple’s operations 4.  

        As the market structure of PC sales evolved, Apple went back to its creative roots and, in 1984, introduced the Macintosh.  This PC marked a breakthrough in ease of use, industrial design and technical elegance.  While the Intel chips continued to increase in processing speed and capabilities, they relegated the Macs to relatively slower speeds and reduced software compatibility, thus limiting sales and revenue growth.  In fiscal 1984, Apple’s net income actually declined by 17 percent as the company faced crisis conditions internally and in its product marketplace.

        In April of 1985, the board of directors voted to remove Mr. Jobs from his operational role at the firm.  They felt that a more professional manager was needed to execute their vision for the future growth and development of the firm.  They chose John Sculley to be the CEO.  He had been recruited from Pepsi-Cola in 1983 and worked in an executive capacity alongside Jobs.  While at Pepsi-Cola, Scully had successfully led the firm against its rivals in the soft drinks industry.  The board believed the firm needed these capabilities to guide Apple towards successfully competing against dominant firms in the PC industry.  Later in 1985 Jobs left Apple to found a new company named NeXT.