Apple (AAPL): Underdog to 'Evil Empire'

by Paul McWilliams, editor Next Inning

When Apple (AAPL) was the soft cuddly underdog, everyone loved them and rooted for the company's success and, just like when the Boston Red Sox finally won the World Series, it was easy to be an AAPL fan as the company triumphed.

However, now that AAPL has won a position near the top of the world in both its markets and for the valuation awarded by the stock market, everything AAPL does is viewed with new and critical scrutiny.

Steve Jobs has fought and slain more dragons than I can count since founding Apple some 34 years ago.

Jobs certainly didn't win all the battles. In the early years, he lost a number of the more important contests. However, he learned from his defeats and upon returning to AAPL earlier this decade, has proven himself to be the consummate Alpha warrior.

Under Jobs' leadership, AAPL has created new markets that have been wildly embraced by consumers and, as a result, driven AAPL to where it is now one of the most highly valued companies in the world, more highly valued even than its old arch enemy, MSFT.

While we could blame AAPL's recent decline on what the press has determined is a bad antenna design on its new iPhone 4 and, in doing so, we most certainly wouldn't be wrong, isolating only on that would be a mistake.

What's happening in the larger picture is AAPL has moved from being the cuddly underdog to become the new "Evil Empire," a title it has ironically taken from its old nemesis, MSFT.

Leading an "Evil Empire" is a new role for Jobs and one I'm sure will teach him some new lessons.

Regulators have questioned whether or not AAPL is treating its independent application writers fairly and if its exclusive U.S. relationship with AT&T constitutes illegal anti-competitive behavior. Of course, before the world fell in love with the iPhone, no one cared about these issues.

The short story here is its not what AAPL has or is doing that matters; it's the fact that it has been wildly successful to the point it is now seen as the dominant player that has brought its operating model into the critical spotlight and under that spotlight no one looks good.

Bottom Line: The easy side of this equation is predicting AAPL will report a fabulous fiscal Q3 (June quarter) with non-GAAP (excludes reserves, stock based compensation and other non-cash charges).

I think AAPL will report earnings between $3.50 and $3.75 as opposed to the $3.10 consensus. In addition to this, I think in spite of all the negative press, AAPL will enjoy continued strong demand for its various "i" products during the second half of the year.

However, what I'm much less sure of is whether or not AAPL will decide to play it conservatively and, in doing so, it might even take some modest reserves beyond the cost of supplying the protective covers it has promised iPhone users.

That aside, what I think we can be fairly well assured of is an inquisitive Q&A session following AAPL's prepared comments, and I think the way the stock reacts will depend much more on how that is handled than the numbers.

Setting aside emotions for now, I continue to believe AAPL merits a higher price than we saw at its last 52-week high. Again, I don't know that the market will see things this way and, at least in the near-term, I think emotions will be more important than numbers. However, in the longer term I think numbers will win.

If we move up to the fiscal 2011 consensus of $16.56, which I continue to believe will prove to be too low, and reduce our valuation multiple range to 14 to 16, the resulting estimated fair value range moves up to $271.57 to $304.69.

Based on this analysis, I think there is adequate data to support the $300+ price target we've heard several analysts mention for year-end.

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