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How Much Of An Impact Would An Apple Car Have On Apple's Stock?

The Wall Street Journal reports that Apple ( AAPL ) has accelerated efforts to build an electric car that could possibly take on the likes of Tesla, targeting a "shipping date" as early as 2019. The prospects of seeing an Apple-branded vehicle are indeed exciting, given Apple's track record of redefining product categories. However, there are still many unanswered questions and there's no guarantee that a final product will materialize (related: Can Apple Pull Off An Electric Car Project? ). That uncertainty notwithstanding, Apple investors and analysts only have one major question: would a potential automotive foray pay off in terms of earnings and the company's valuation? In this note, we discuss some of our expectations for Apple's car business, and use a discounted cash flow model to estimate the impact of an Apple Car on the stock.

Our $140 price estimate for Apple is about 25% ahead of the current market price.

See Our Complete Analysis For Apple Here

Valuing The Apple Car Project

We are valuing the business in present value terms, with a forecast period spanning between 2015 and 2025, assuming Apple begins incurring capital expenditures and other sunk costs from 2015 onwards. We forecast the revenue stream kicking in beginning in 2020, when we assume the Apple Car will begin volume sales.

Pricing: Unlike Apple's consumer electronics business, which is a high-volume, high-margin endeavor, the company will face a big trade off in the electric car market. Battery technology is evolving slowly, and battery costs account for a substantial portion of an electric car's cost base. Taking these constraints into account, we believe that Apple will likely focus on the lower-volume, high end of the electric vehicle market (much like the Tesla Model S), since this would allow enough headroom to make a truly innovative, high-margin product without being constrained by battery costs. We assume that the car will have an average selling price of $100,000 - comparable to the average selling price of the Model S - and that it will remain stable over time, since it seems unlikely that Apple will cater to the mass market, risking its brand image and margins.

Volumes: We believe that Apple would start relatively small, shipping about 10,000 units in the first year. In an optimistic scenario, the number of shipments could grow to over 250,000 units by 2025, assuming that the company launches more models and variants along the way, while expanding distribution into international markets. For perspective, Tesla Motors is projected to sell over 60,000 units of the Model S in 2015, and we estimate that the number could grow to about 125,000 units by 2020. So while this is an optimistic estimate which would make Apple a legitimate rival to Tesla in the electric car space, it is certainly possible given Apple's success in so many other product categories.

Apple_car_revenues

Gross Margins: The automotive business in general sees very thin gross margins. However, Apple does have a proven track record of cost management and this - coupled withthe expectation that it will maintain a presence in the high end of the market - allows for the possibility of above-market average gross margins. In this model we forecast margins of about 24% for the car business in 2020, with the number growing to about 32% by 2025 as economies of scale in manufacturing and operational efficiencies improve. This would be slightly ahead of Tesla and Japanese players such as Honda, who see adjusted gross margins in the range of 27-30%, although it would be below ultra-premium brands such as Volkswagen's Bentley.

Apple_Nopat

We assume that Apple's indirect expenses relating to the car
project (selling, general and administrative costs and research and
development) will stand at about 40% of gross profits each
year. We are assuming a tax rate of 25%, in line with
the effective tax rate in our Apple model. We assume
that car-related capital expenditures will average above
$1.5 billion per year following the launch of a vehicle
in 2020, as the company scales up manufacturing. Our model also
assumes that working capital for the business will grow at $50 to
$100 million per year.

Indirect Expenses: We assume that Apple's indirect expenses relating to the car project (selling, general and administrative costs and research and development) will stand at about 40% of gross profits each year. We are assuming a tax rate of 25%, in line with the effective tax rate in our Apple model. We assume that car-related capital expenditures will average above $1.5 billion per year following the launch of a vehicle in 2020, as the company scales up manufacturing. Our model also assumes that working capital for the business will grow at $50 to $100 million per year.

Sunk Costs: Separately, we are also modeling sunk costs related to R&D and product development to the tune of $150 million per year for each year prior to the launch of the car (not shown in the table above). We also assume that the company will incur average annual capital expenditures of about $400 million between 2015 and 2019 related to setting up potential manufacturing facilities (owned or contracted). These costs add up to about $2.3 billion in present value terms.

Valuation: We have taken a terminal growth rate of 5% from 2025 onwards, assuming that the Apple Car and electric cars in general will outpace the growth rate of the broader automotive market. Discounting the cash flows back to 2015 using a weighted average cost of capital of 8.5% would imply a present value of close to $28 billion for the car project.

Apple_car_valuation

How Much Of A Valuation Impact Would It Have?

Our optimistic $28 billion present value estimate would amount to under 5% of the company's current market cap of about $650 billion. For perspective, that is less than the iPad segment, which we value at $35 billion, and just a fraction of the valuation of the iPhone segment, which we peg at over $400 billion. There is certainly a possibility that Apple's ambitions are much larger, targeting a broader spectrum of the automotive market, with lower-priced luxury cars that could do higher volumes. However, our initial assumptions in this case are already fairly bullish, so it's unlikely that the upside would be more than $50-60 billion (less than 10%) to Apple's market cap. Though Apple has an impressive track record of surpassing expectations in its core consumer electronics business, the auto industry is an entirely new space for the company. It would have to come up with something truly revolutionary to really move the needle in terms of earnings and valuation (related: Apple: Too Big To Grow?).

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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