Aaplbuy PDF

December 12, 2010
ACTION
Buy
Apple Inc. (AAPL)
Return Potential: 34% Equity Research
Resuming coverage with CL-Buy: platform opportunity still nascent

Source of opportunity Investment Profile
We are resuming coverage of Apple with a Buy rating and 12-month target Low High
Growth Growth
price of $430 and placing it on our Americas Conviction List. We believe
Returns * Returns *
Apple’s platform-centric business model is the secret sauce that has
Multiple Multiple
enabled it to quickly capture market share in new computing segments Volatility Volatility
while simultaneously enjoying considerable margin leverage. Percentile 20th 40th 60th 80th 100th
Furthermore, we believe significant growth and profit opportunities for Apple Inc. (AAPL)
Americas Technology Peer Group Average

this platform still lie ahead. As a result, we expect revenue and earnings
* Returns = Return on Capital For a complete description of the
expectations to continue to trend upward, and we view the shares as investment profile measures please refer to
the disclosure section of this document.
attractive at current levels.
Key data Current

Catalyst Price ($) 320.56
Apple’s recent gross margin trends and guidance have caused some 12 month price target ($) 430.00
Market cap ($ mn) 293,623.4
concerns among the investing community. Our analysis of Apple’s
platform history not only suggests that this gross margin erosion is
9/10 9/11E 9/12E 9/13E
normal, but also that we have probably already seen the worst of it. Revenue ($ mn) New 65,225.1 91,807.0 110,772.6 122,389.7
Revenue ($ mn) Old -- -- -- --
Indeed, we believe Apple’s margins have already bottomed, and we expect EPS ($) New 15.15 19.86 24.91 28.29
the company to resume its leverage-driven upside in coming quarters. In EPS ($) Old -- -- -- --
P/E (X) 21.2 16.1 12.9 11.3
addition, we expect iPad and iPhone momentum to exceed expectations in EV/EBITDA (X) 10.2 10.8 8.6 7.5
ROE (%) 35.3 32.2 29.5 25.5
2011, driving further upside. We expect Apple to ship 37.2 million iPad
units in CY11, which could potentially make Apple one of the largest
9/10 12/10E 3/11E 6/11E
vendors in the global personal computing market (Tablets plus PCs). EPS ($) 4.64 5.41 4.30 4.39
Valuation Price performance chart

340 1,400
Our $430 price target represents a P/E multiple of 20.0 times our above-
320 1,350
consensus calendar 2011 EPS estimate of $21.46. Our target multiple is 300 1,300
14.4% below the stock’s five-year average multiple of 23.4 times. 280 1,250
260 1,200
240 1,150
Key risks 220 1,100
The key risks to our target include: macro deterioration, increased platform 200 1,050
competition, potential legal and regulatory restrictions, and uncertain 180 1,000
Dec-09 Mar-10 Jun-10 Sep-10
management succession plans.
Apple Inc. (L) S&P 500 (R)
INVESTMENT LIST MEMBERSHIP
Americas Buy List
Share price performance (%) 3 month 6 month 12 month
Americas Conviction Buy List
Absolute 21.7 28.0 63.2
Rel. to S&P 500 8.9 12.1 45.0
Coverage View: Neutral Source: Company data, Goldman Sachs Research estimates, FactSet. Price as of 12/10/2010 close.
Bill Shope, CFA The Goldman Sachs Group, Inc. does and seeks to do business with
(212) 902-6834 [email protected] Goldman Sachs & Co. companies covered in its research reports. As a result, investors should
Elizabeth Borbolla be aware that the firm may have a conflict of interest that could affect
(212) 357-4977 [email protected] Goldman Sachs & Co. the objectivity of this report. Investors should consider this report as
Cristina Colon, CMA only a single factor in making their investment decision. For Reg AC
(212) 902-9913 [email protected] Goldman Sachs & Co. certification, see the end of the text. Other important disclosures follow
Stephen Oshman the Reg AC certification, or go to www.gs.com/research/hedge.html.
(917) 343-3128 [email protected] Goldman Sachs & Co. Analysts employed by non-US affiliates are not registered/qualified as
research analysts with FINRA in the U.S.
The Goldman Sachs Group, Inc. Global Investment Research

December 12, 2010 Apple Inc. (AAPL)
Apple Inc.: Summary Financials

Profit model ($ mn) 9/10 9/11E 9/12E 9/13E Balance sheet ($ mn) 9/10 9/11E 9/12E 9/13E
Total revenue 65,225.1 91,807.0 110,772.6 122,389.7 Cash & equivalents 11,261.0 13,429.5 15,393.5 17,157.9
Cost of goods sold (39,541.0) (56,839.6) (66,785.7) (72,710.8) Accounts receivable 5,510.0 7,086.8 8,123.2 9,054.3
SG&A (5,517.0) (7,722.8) (9,264.9) (9,953.2) Inventory 1,051.0 1,320.0 1,495.9 1,631.9
R&D (1,782.0) (2,478.1) (2,966.8) (3,072.0) Other current assets 9,497.0 11,381.4 12,690.1 13,748.0
Other operating profit/(expense) 0.0 0.0 0.0 0.0 Total current assets 27,319.0 33,217.6 37,702.8 41,591.9
ESO expense -- -- -- -- Net PP&E 4,768.0 8,622.2 11,514.5 14,063.0
EBITDA 19,412.1 26,235.4 33,527.5 38,611.9 Net intangibles 0.0 0.0 0.0 0.0
Depreciation & amortization (1,027.0) (1,468.9) (1,772.4) (1,958.2) Total investments 39,750.0 58,893.3 83,983.8 113,449.2
EBIT 18,385.1 24,766.5 31,755.1 36,653.7 Other long-term assets 3,346.0 4,130.0 5,097.8 6,292.3
Net interest income/(expense) 155.0 260.0 260.0 260.0 Total assets 75,183.0 104,863.2 138,298.9 175,396.4
Income/(loss) from associates 0.0 0.0 0.0 0.0
Others 0.0 0.0 0.0 0.0 Accounts payable 12,015.0 14,755.3 16,721.8 18,241.1
Pretax profits 18,540.1 25,026.5 32,015.1 36,913.7 Short-term debt 0.0 0.0 0.0 0.0
Provision for taxes (4,527.0) (6,381.8) (8,163.9) (9,413.0) Other current liabilities 8,707.0 10,542.7 12,101.9 13,785.6
Minority interest 0.0 0.0 0.0 0.0 Total current liabilities 20,722.0 25,298.0 28,823.7 32,026.8
Net income pre-preferred dividends 14,013.1 18,644.7 23,851.3 27,500.7 Long-term debt 0.0 0.0 0.0 0.0
Preferred dividends 0.0 0.0 0.0 0.0 Other long-term liabilities 6,670.0 11,529.4 15,988.2 20,782.0
Net income (pre-exceptionals) 14,013.1 18,644.7 23,851.3 27,500.7 Total long-term liabilities 6,670.0 11,529.4 15,988.2 20,782.0
Post tax exceptionals (0.1) 0.0 0.0 0.0 Total liabilities 27,392.0 36,827.4 44,811.9 52,808.7
Net income (post-exceptionals) 14,013.0 18,644.7 23,851.3 27,500.7
Preferred shares 0.0 0.0 0.0 0.0
EPS (basic, pre-except) ($) 15.41 20.17 25.30 28.73 Total common equity 47,791.0 68,035.7 93,487.0 122,587.7
EPS (diluted, pre-except) ($) 15.15 19.86 24.91 28.29 Minority interest 0.0 0.0 0.0 0.0
EPS (basic, post-except) ($) 15.41 20.17 25.30 28.73
EPS (diluted, post-except) ($) 15.15 19.86 24.91 28.29 Total liabilities & equity 75,183.0 104,863.2 138,298.9 175,396.4
Common dividends paid -- -- -- --
DPS ($) 0.00 0.00 0.00 0.00
Dividend payout ratio (%) 0.0 0.0 0.0 0.0 Additional financials 9/10 9/11E 9/12E 9/13E
Net debt/equity (%) (23.6) (19.7) (16.5) (14.0)
Interest cover (X) NM NM NM NM
Growth & margins (%) 9/10 9/11E 9/12E 9/13E Inventory days 7.0 7.6 7.7 7.9
Sales growth 52.0 40.8 20.7 10.5 Receivable days 24.8 25.0 25.1 25.6
EBITDA growth 55.6 35.1 27.8 15.2 BVPS ($) 52.18 73.01 98.24 127.23
EBIT growth 56.6 34.7 28.2 15.4
Net income (pre-except) growth 70.2 33.1 27.9 15.3 ROA (%) 22.8 20.7 19.6 17.5
EPS growth 67.1 30.9 25.5 13.6 CROCI (%) 46.4 41.1 35.0 28.8
Gross margin 39.4 38.1 39.7 40.6
EBITDA margin 29.8 28.6 30.3 31.5 Dupont ROE (%) 29.3 27.4 25.5 22.4
EBIT margin 28.2 27.0 28.7 29.9 Margin (%) 21.5 20.3 21.5 22.5
Turnover (X) 0.9 0.9 0.8 0.7
Cash flow statement ($ mn) 9/10 9/11E 9/12E 9/13E Leverage (X) 1.6 1.5 1.5 1.4
Net income 14,013.1 18,644.7 23,851.3 27,500.7
D&A add-back (incl. ESO) 1,027.0 1,468.9 1,772.4 1,958.2 Free cash flow per share ($) 18.24 21.32 27.00 30.96
Minority interest add-back 0.0 0.0 0.0 0.0 Free cash flow yield (%) 7.9 6.7 8.4 9.7
Net (inc)/dec working capital 1,249.0 845.9 1,004.6 1,078.2
Other operating cash flow 2,305.9 2,791.8 3,035.7 3,009.0
Cash flow from operations 18,595.0 23,751.3 29,664.0 33,546.2
Capital expenditures (2,005.0) (4,039.5) (4,209.4) (3,916.5)

Acquisitions (754.0) 0.0 0.0 0.0
Divestitures 0.0 0.0 0.0 0.0
Others (11,095.0) (19,143.3) (25,090.5) (29,465.4)
Cash flow from investing (13,854.0) (23,182.8) (29,299.9) (33,381.9)
Dividends paid (common & pref) 0.0 0.0 0.0 0.0

Inc/(dec) in debt 0.0 0.0 0.0 0.0
Other financing cash flows 1,257.0 1,600.0 1,600.0 1,600.0
Cash flow from financing 1,257.0 1,600.0 1,600.0 1,600.0
Total cash flow 5,998.0 2,168.5 1,964.1 1,764.3
Note: Last actual year may include reported and estimated data.
Source: Company data, Goldman Sachs Research estimates.
Analyst Contributors
Bill Shope, CFA Stephen Oshman

[email protected] [email protected]
Elizabeth Borbolla
[email protected]
Cristina Colon, CMA

[email protected]
Goldman Sachs Global Investment Research 2

Table of contents
Investment view: A disruptive platform with plenty of room for growth 4
Three key investment themes: the platform, GMs, and the iPad push 4
Investment theme #1: The platform opportunity is still in its early stages 4
Investment theme #2: We believe gross margins have already bottomed 6
Investment theme #3: The iPad gives Apple its most significant PC share opportunity in nearly three decades 8
Key risks to our investment thesis 9
A double-dip recession could dampen Apple’s growth and margins 9
Platform competition is only increasing 9
Earnings outlook 10
Revenue growth has upside potential 10
Margin assumptions may be too cautious 11
Our earnings outlook is above consensus for 2011-12 11
Cash management could improve 11
Valuation 12
Comparative valuation analysis implies upside 13
Discounted cash flow analysis 14
Common questions 16
Will the iPad cannibalize Apple’s other segments? 16
Has Apple reached its peak margin potential? 16
Who poses the greatest competitive threat to Apple? 17
How will Apple compete in the prepaid mobile Phone markets? 17
When will AT&T exclusivity end? 17
Will Apple ever launch an iPhone nano? 17
How important is the lack of Flash on iOS? 18
What will Apple do with its massive cash balance? 18
Deep Dive #1: Platform dynamics, the core of the Apple story 18
The evolution of the Apple platform 19
Apple’s devices are the spokes that attach to the platform 22
What about the open-vs.-closed systems debate? 24
What is Apple’s competition? 25
Digging into the platform spokes 26
The iPad: a disruptive force for computing 26
The iPhone: spreading iOS worldwide 31
The Mac: becoming an outlier in the platform 35
The iPod business: shifting the installed base to iOS 37
Apple TV: A “hobby” with option value 42
What new spokes and platform enhancements are on the horizon? 43
Deep Dive #2: Can the Apple dream turn into a nightmare? 45
Potential Pitfall #1: An erosion of Apple’s installed base 45
Potential Pitfall #2: Deterioration in installed base profitability 47
Potential Pitfall # 3: Legal and regulatory hurdles to platform expansion 49
Conclusion 50
Appendix: Financial Model 53
The prices in the body of this report are as of the close, December 8, 2010, unless otherwise indicated.

Investment view: A disruptive platform with plenty of room for

growth
We are resuming coverage of Apple with a Buy rating and 12-month target price of $430
and place it on our Americas Conviction List. Apple currently trades at 15.0 times our
calendar 2011 EPS estimate, which represents a 14.1% premium to the S&P 500 and a
16.3% premium to our coverage universe. We believe this premium is set to expand further.
Our $430 price target represents a P/E multiple of 20.0 times our calendar 2011 EPS
estimate of $21.46, which is 14.4% below the stock’s five-year average multiple of 23.4
times.
We contend that Apple’s unique platform approach to mobile computing is raising barriers
to entry for competitors, providing increased long-term profit potential, and enabling Apple
to expand growth into a large and relatively untapped total available market opportunity. In
addition, we are providing investors with a framework to monitor the progress of Apple’s
platform evolution and factors that could warn investors if the company were about to hit a
wall in terms of growth and profitability.
Three key investment themes: the platform, gross margins, and the
iPad push
Investment theme #1: The platform opportunity is still in its early

stages
In this report we provide a detailed analysis of Apple’s platform dynamics. Our conclusion
is that Apple’s success has largely been driven by its positioning of its hardware devices as
delivery mechanisms for its platform (and more specifically, the content and application
ecosystems attached to that platform). We believe this has several important financial
implications for investors.
First, by leveraging one platform for its key hardware devices, Apple has been able to
generate remarkable operating leverage since the platform reached its first important
milestone with the launch of the iTunes Music Store in 2003. In fact, Apple has grown its
operating expenses by 368.8% since 2002, but its revenues have expanded by 1035.9%
(Exhibit 1). Most important, by leveraging the third-party developers and content providers
as a source of value for its software ecosystem, we estimate that Apple only had to
increase its operating system R&D by 35% from $134 million in fiscal 2002 to $180 million
in fiscal 2009, while revenues increased by more than seven- fold over the same period. As
a result of these factors, Apple has leveraged its platform ecosystem to create tremendous
shareholder value and expand operating margins from 0.8% in fiscal 2002 to 26.8% in the
most recent quarter. We expect this leverage to continue, and forecast further margin
expansion to 29.9% in fiscal 2013. We also expect EPS to expand from $19.86 in fiscal 2010
to $28.29 in fiscal 2013, and we suspect this could prove conservative.

Exhibit 1: Apple has been able to generate remarkable operating leverage through its
platform approach
$ millions
70,000
Revenues
60,000 +1035.9%
50,000
40,000
30,000
Opex
20,000 +368.8%
10,000
0
FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10
Operating expenses Revenues
Source: Company data.
Second, Apple has been remarkably successful at leveraging its platform into entirely new
market segments over the past several years. There are several notable examples of this:
the expansion into the smartphone segment with the iPhone, the expansion into handheld
gaming and media devices with the iPod touch, and more recently, the expansion into
mass market computing with the iPad. All of these devices leveraged the same iTunes
content, the same app store, and most important, the same operating system. Nevertheless,
these “iOS” devices have only been around for a little over three years, and we believe the
market opportunity is still in its infancy. Indeed, if we look at Apple’s market share in the
relevant market segments for each of its iOS devices, the untapped opportunity becomes
far more apparent (Exhibit 2).

Exhibit 2: The PC and smartphone end markets alone could fuel Apple’s growth for years
2010E end market revenues in millions
$200,000 Industry
2010E-2012E
$180,000
CAGR: 14.1 %
$160,000
$140,000
Apple's Industry
$120,000
2010E-2012E
current
$100,000 share CAGR: 28.7%
$80,000
$60,000
$40,000
$20,000
$0
Mobile PC and tablets Smartphone
Source: Goldman Sachs Research estimates.
This exhibit doesn’t even consider the potential opportunities in gaming and handheld
computing from the iPod touch and potential unannounced products from Apple as well.
The essential point is that we believe there is still an exceptional amount of room for Apple
to expand its revenues and profits. In addition, while it may seem like Apple has been
riding an incredibly fortunate streak of product hits for almost a decade now, the reality is
that this is really a steady and disruptive expansion of a platform that was first unleashed
with the iPod in 2001 and has a heritage in the Mac operating system developed years
before that. We provide a detailed analysis of these platform dynamics in the body of this
report.
Investment theme #2: We believe gross margins have already

bottomed
Apple’s recent gross margin trends and guidance have caused some concerns among the
investing community. Our analysis of Apple’s platform history not only suggests that this
gross margin erosion is normal, but also that we have probably already seen the worst of it.
Indeed, we believe the nature of Apple’s platform model suggests that the company will
often enter new market segments with relatively depressed product margins in order to
seed the installed base, developer and content opportunity. This is because the platform
ecosystem (developers, content providers, and peripheral sales) tends to receive an
exponential boost when a new product adds a large number of users to the installed base.
Most important, the stickiness of Apple’s platform then allows the company to lower prices
at a slower rate than the competition and the underlying commodity component costs, and
this eventually leads to margin leverage. For instance, we have seen a similar trend for
corporate gross margins during major platform hardware launches throughout Apple’s
history (Exhibit 3).

Exhibit 3: Major platform hardware launches throughout Apple’s history have been followed by margin leverage
Apple corporate gross margin
29% 31%
Higher capacity iPods iPod nano released
and iTMS launched 30%
28%
29%
27% 28%
27%
26%
26%
25% 25%
2QFY03 3QFY03 4QFY03 1QFY04 2QFY04 3QFY05 4QFY05 1QFY06 2QFY06 3QFY06 4QFY06
39% iPhone introduced 43%
37% 42%
iPad and iPhone 4 launched
41%
35%
40%
33%
39%
31%
38%
29%
37%
27% 36%
25% 35%
2QFY07 3QFY07 4QFY07 1QFY08 2QFY08 3QFY08 2QFY10 4QFY10 2QFY11E 4QFY11E
As a result of this remarkably consistent history, we believe it is clear that Apple’s recent
gross margin erosion is a natural consequence of how it seeds new market opportunities
for its platform. As with the prior launches, we believe margins could recover quite quickly.
Furthermore, the iPad in particular adds a product spoke with profit dollars per unit only
rivaled by the iPhone and the Mac. As such, growth in iPad units should drive considerable
earnings expansion, even with the initial compression of gross margins we have seen. We
assume Apple’s gross margins expand from 36.9% in the September quarter of 2010 to
38.8% in the September quarter of 2011 and we assume this rate of expansion could prove
conservative if component prices continue to decline at more rapid rates.

Investment theme #3: The iPad gives Apple its most significant PC
share opportunity in nearly three decades
Apple’s share of the total PC market stood at 4.4% in the September quarter (Exhibit 4).
This represents the company’s highest share of the industry since early 1996. Nevertheless,
it is difficult to get too excited over a mid-single digit market share, and our current
forecasts suggest this share will only increase modestly in 2011. With the iPad, however,
this type of analysis may be meaningless. If we view tablets as computing devices and we
accept that some users will use tablets as notebook replacements, then we believe tablets
should be considered part of the PC market. Furthermore, we believe the profit dollars
Apple earns from each iPad have already exceeded the average profit dollars earned on a
Wintel notebook, so growth in iPads should be preferable to growth in the lower price
bands of the traditional notebook segment from Apple’s perspective.
Exhibit 4: Apple’s share of the PC market (ex tablets) stood at 4.4% in 3Q2010
3Q2010 worldwide PC unit share
HP
17.8%
Others
31.0%
Acer
13.1%
Apple Dell
4.4% 12.6%
ASUS Lenovo
5.3% Toshiba 10.4%
5.3%
Source: IDC, November 2010.
If we include tablets in our PC unit forecast, then our estimates suggest Apple’s combined
iPad and Mac market share would reach 12% in 2011 (Exhibit 5). Based on the current
market share breakdown in the PC market, this could presumably make Apple one of the
largest vendors in the combined PC and tablet market. This would represent a profound
change in the competitive landscape for the industry if our forecasts are correct.

Exhibit 5: Apple could become the second largest vendor in the combined PC and tablet
markets by 2011
Apple unit share of the combined PC and tablet markets
14%
Market share (PCs + Tablets)

12%
10%
8%
6%
4%
2%
0%
2009 2010E 2011E
Source: IDC, November 2010, Goldman Sachs Research estimates.
This not only demonstrates how significant the iPad has been for Apple investors, but it
also highlights the power of Apple’s platform model. By leveraging the iTunes and App
Store components of the platform, Apple’s unique tablet design has been able to
potentially produce the most disruptive force to Wintel computing in the history of the PC
industry. Tablet competitors are looming, so Apple can’t rest on its laurels. Nevertheless,
we believe the iPad’s rapid success, more than any of Apple’s other products,
demonstrates how quickly Apple’s overall platform is permeating the computing industry.
Key risks to our investment thesis
A double-dip recession could dampen Apple’s growth and margins

As investors clearly remember from the 2008 recession, Apple is not immune to
macroeconomic trends. While the company’s revenue and profit performance during the
downturn shaped up better than most had feared, the company’s stock price deteriorated
nearly 59% from its pre-recession highs (compared with a 42.5% decline in the S&P 500
during the same time frame) as investor concerns over consumer-centric business models
reached a peak. As such, we are mindful of the reality that Apple could see some impact to
its revenue and profit outlook and a potentially severe compression in its valuation if the
global and domestic economies fall into recession once again.
Platform competition is only increasing

The success of Apple’s iOS platform has quickly captured attention from the leading PC,
mobile phone, and Internet companies. This shouldn’t be surprising, as we believe this is

the first major opportunity for disruption of the Wintel platform’s dominance of personal
computing in nearly three decades. In order to maintain its first-mover advantage, Apple
will need to maintain a leading level of developer and content provider support, while
maximizing its share of mobile device units and profits. In this report, we introduce our
framework for analyzing the company’s progress on these fronts, and we also discuss
factors that could lead to a deterioration in Apple’s leadership position. Our thesis is based
on the success of Apple’s entire platform, so this risk factor is critical for all Apple investors.
Legal and regulatory barriers could arise

Once a computing platform achieves critical mass, it is often difficult to stop its momentum.
Nevertheless, the same market forces that bolster barriers to entry for platform leaders can
be quickly demolished by targeted regulatory and legal pressures. Indeed, historical
examples from Microsoft to AT&T demonstrate the difficulties such actions can create for
investors. As Apple captures increasing share of critical computing markets, with an
approach that some consider to be closed and proprietary, the risks of increasing
regulatory and legal hurdles only intensifies. We believe investors should monitor trends in
this area closely, and investors should pay particular attention to any actions that limit
Apple’s control over its App Store and iTunes content.
Apple’s management succession plans are still murky

We believe the substantial appreciation in Apple’s stock price and market position has led
investors to attach significant value to the leadership of Steve Jobs and his team. Any
threats to the tenure of the existing executive team, particularly Steve Jobs and Tim Cook,
would likely have a significant impact on the share price. For longer-term investors, this
represents a risk that can be frustratingly difficult to quantify. In our view, it is clear that
Apple wouldn’t be successful today if it weren’t for the strategic vision of Steve Jobs. Mr.
Jobs saw the shifting tides of consumer computing, and he capitalized on this by leading
Apple in the development of one of the most powerful software and content platforms in
the world. This platform may have never been created with any other leader at Apple. With
that said, the platform is here now and it’s robust. We believe the current executive bench
is more than capable of managing this platform into the future, notwithstanding the
uncertainty that could be produced by a departure of Mr. Jobs or Mr. Cook.
Earnings outlook
Revenue growth has upside potential

We believe Apple’s evolving content platform will drive above-consensus revenue growth
for the company in coming years. Our forecast calls for fiscal 2011 revenues of $91.81
billion, versus consensus of $87.49 billion. Within this, we expect iPad revenues to increase
nearly four-fold to $19.76 billion, up from $4.96 billion in fiscal 2010 as the company ships
31.05 million units. This would equate to 68.8% unit share based on our forecast for the
global tablet market. In addition, iPhone sales should also continue to rise, and we expect
revenues to reach $33.91 billion on units of 57.57 million. Our iPhone unit estimate
suggests Apple is able to capture 15.1% of the global smartphone market in fiscal 2011,
based on Goldman Sachs Telecom Equipment team’s forecast for industry-wide global
smartphone shipments of 381.1 million. Meanwhile, Macs should also continue their share
gains, with shipments of 16.06 million driving revenues of $19.82 billion. This represents

4.4% unit share of our forecasted 368.2 million worldwide PC shipments in Apple’s fiscal
2011. Although we forecast iPod revenues to decline by 5.2% on a unit contraction of 6.8%,
within this, we expect iPod touch units to rise by a healthy 19.4%. We expect these overall
solid trends to continue in fiscal 2012 and 2013, where we are looking for total revenues of
$110.77 billion and $122.39 billion, versus consensus of $101.01 billion and $110.72 billion.
Margin assumptions may be too cautious

As we discuss below, we believe Apple’s unique platform allows for significant gross and
operating margin leverage. Nevertheless, we expect margins to remain somewhat
constrained near term as the company manages through the early stages of the iPad and
iPhone 4 product lifecycles. As a result, we forecast gross margins will decline to 38.1% in
fiscal 2011 from 39.4% in fiscal 2010, but we assume that the September quarter of 2010
marked the gross margin bottom for this transition. This should expand to 39.7% in fiscal
2012 and 40.6% in fiscal 2013. On the operating margin line, Apple’s mobile devices all run
on the same core software and content platforms, which enables the company to generate
R&D and marketing leverage that is unmatched in the technology industry. As a result, we
believe the company should be able to maintain a relatively stable opex ratio despite the
iPad and iPhone ramps. As a result, we believe operating margin declines will largely
mirror the gross margin declines we forecast for fiscal 2011: we assume operating margins
decline to 27.0% in FY11, from 28.2% in FY10. We believe the company’s annual operating
leverage should resume as Apple expands its volume of iOS devices. Our forecast calls for
operating margins of 28.7% in fiscal 2012 and 29.9% in fiscal 2013.
Our earnings outlook is above consensus for 2011-12

Our revenue and margin assumptions point to continued earnings growth in coming years.
We believe Apple’s platform expansion and operating leverage should continue to expand
and we are above consensus as a result. For fiscal 2011, we forecast EPS of $19.86 versus
The Street’s estimate of $19.02. Our EPS estimates of $24.91 in fiscal 2012 and $28.29 in
fiscal 2013 compare with consensus of $22.17 and $24.02.
Cash management could improve

Apple had $25.62 billion in cash and short-term marketable securities at the end of the
September quarter, and an additional $25.39 billion held in long-term marketable securities.
These long-term securities consist primarily of liquid government bonds, so we view them
as longer-duration cash equivalents. With no debt on its balance sheet, Apple had a net
cash position of $51.01 billion, or $27.58 per share ($54.92 including long-term
investments). The company’s cash balance has risen significantly with the success of its
Mac, iPod, iPhone and now iPad businesses, as well as stringent working capital
management.
We expect the company to use its cash balance primarily for capital improvements, and to
a much a lesser extent, acquisitions. Apple’s cash capital expenditures were $2.0 billion in
fiscal 2010, which represented 3.1% of sales. Of this, approximately $404 million was for
retail store expansion, and the remainder for product tooling and manufacturing process
equipment, and corporate facilities and infrastructure. A large portion was also used for the
North Carolina datacenter that Apple has recently completed. The company spent an
additional $754 million on acquisitions. In fiscal 2011, the company expects to spend
approximately $4.0 billion in capital expenditures, including approximately $600 million to
open 40-50 new retail stores, over half of which are expected to be located outside of the
United States. The remainder is expected to be spent on product tooling and

manufacturing process equipment expansion, as well as corporate facilities and

infrastructure.
Exhibit 6: Apple earnings outlook

$ in millions, except per share
FY10 FY11E FY12E FY13E

Revenues
Macs 17,479 19,822 21,091 22,578
iPod 8,274 7,846 7,562 7,270
Other music related products and services 4,948 5,575 6,251 6,783
iPhone and related products and services 25,179 33,912 41,529 46,515
iPad and related products and services 4,958 19,758 28,872 33,135
Peripherals and other hardware 1,814 2,077 2,367 2,699
Software, service and other sales 2,573 2,818 3,099 3,409
Total $65,225 $91,807 $110,773 $122,390
Gross profit 25,684 34,967 43,987 49,679
Operating income 18,385 24,766 31,755 36,654
Net income 14,013 18,645 23,851 27,501
Diluted shares outstanding 925 939 958 972
EPS—pro forma $15.15 $19.86 $24.91 $28.29
Margins
Gross 39.4% 38.1% 39.7% 40.6%
Operating 28.2% 27.0% 28.7% 29.9%
Net 21.5% 20.3% 21.5% 22.5%
Y/Y % change
Revenues 52.0% 40.8% 20.7% 10.5%
Gross profit 49.1% 36.1% 25.8% 12.9%
Operating income 56.6% 34.7% 28.2% 15.4%
EPS—pro forma 66.9% 31.0% 25.5% 13.6%

Note: Fiscal year ends September.
Valuation
We are resuming coverage of Apple with a Buy rating and a 12-month target price of $430.
We derive our target price primarily from price/earnings analysis, supported by
comparative valuation analysis of other historical multiples and discounted cash flow (DCF)
analysis. Apple currently trades at 15.0 times our calendar 2011 EPS estimate, which
represents a 14.1% premium to the S&P 500 and a 16.3% premium to our coverage
universe. Despite Apple stock rising 52.3% this year, versus a 10.1% increase in the S&P
500, Apple’s multiple has contracted as investors have digested the impact of the iPad on
the company’s growth prospects and earnings estimates have risen. We believe the story is
far from over, and we believe the company’s growing installed base of iOS users leaves
significant opportunities for operating leverage and market share expansion.

Comparative valuation analysis implies upside

Price to earnings
Apple’s P/E is near historical lows and we believe this presents an attractive buying
opportunity. Apple currently trades at 15.0 times our calendar 2011 EPS estimate, which
represents a 14.1% premium to the S&P 500 and a 16.3% premium to our coverage
universe. This is a steep discount to Apple’s five-year average multiple of 23.4 times and is
very near its one-year low of 13.2 times. Our 12-month target price of $430 represents a
multiple of 20.0 times our calendar 2011 EPS estimate, which would be 14.4% discount to
the five-year average of 23.4 times.
Exhibit 7: Apple’s P/E is at the low end of its historical range

Price to second calendar year EPS (excludes P/E > 100)
One-Year Five-Year Ten-Year

Current High Low Average High Low Average High Low Average
AAPL 15.0 26.2 13.2 17.4 44.6 12.8 23.4 66.7 12.3 30.1
DELL 10.5 12.7 8.0 9.8 22.3 6.1 12.9 41.1 6.1 19.4
EMC 14.8 16.4 13.0 14.5 30.6 9.6 16.8 95.8 9.6 25.5
HPQ 8.6 12.0 7.5 9.5 17.1 6.1 11.9 25.1 6.1 12.9
IBM 11.6 12.2 9.9 10.8 15.7 7.8 12.1 26.1 7.8 14.7
LXK 9.2 13.7 7.7 9.9 19.0 7.3 12.1 25.9 7.3 15.2
NTAP 26.1 26.3 16.1 20.2 35.9 6.9 20.2 99.7 6.9 29.4
STX 9.5 10.0 3.4 5.8 99.1 2.4 10.9 99.1 2.4 12.3
WDC 12.1 11.7 4.1 7.1 17.0 3.2 8.9 23.4 3.2 10.1
XRX 11.1 12.4 7.5 9.8 15.2 3.9 11.0 38.6 3.9 13.0
Average 12.9 15.4 9.1 11.5 31.7 6.6 14.0 54.1 6.6 18.3
SPX 13.1 15.8 11.1 12.7 16.2 8.0 13.6 24.7 8.0 15.6
Source: FactSet, Goldman Sachs Research estimates.
Enterprise value to next twelve months (NTM) sales

Apple’s EV/NTM sales multiple also supports our positive outlook. Apple currently trades at
2.9 times our NTM sales estimate of $91.81 billion. This is below the stock’s five-year
average of 3.0 times. Our 12-month price target of $430 represents a multiple of 4.0 times,
which is at the high end of the stock’s historical range. We believe Apple’s potential for
operating leverage and margin expansion suggests its EV/NTM sales multiple could
continue to trend higher over time. Our forecast calls for gross margins to decline to 38.1%
in fiscal 2011 from 39.4% in fiscal 2010, but then rebound to 39.7% in fiscal 2012 and 40.6%
in fiscal 2013.
Exhibit 8: Apple’s EV/NTM sales multiple is also at the low end of its historical range
EV to NTM sales

AAPL 2.92 3.86 2.57 3.25 5.39 1.22 2.97 5.39 0.09 1.93
DELL 0.31 0.46 0.24 0.33 1.15 0.15 0.56 2.35 0.15 1.13
EMC 2.32 2.45 1.95 2.19 3.74 1.05 2.15 17.82 0.97 3.01
HPQ 0.84 1.07 0.72 0.91 1.25 0.53 0.94 1.43 0.28 0.85
IBM 1.94 1.98 1.66 1.81 1.98 1.17 1.66 2.69 1.17 1.74
LXK 0.59 0.77 0.42 0.59 1.34 0.22 0.67 2.17 0.22 1.10
NTAP 3.09 3.42 1.89 2.47 5.22 0.62 2.65 19.44 0.62 3.80
STX 0.67 0.89 0.41 0.64 1.38 0.22 0.83 1.90 0.22 0.89
WDC 0.61 0.97 0.31 0.59 1.13 0.19 0.67 1.13 0.16 0.60
XRX 1.15 1.18 0.65 0.99 1.53 0.65 1.12 1.54 0.65 1.21
Average 1.44 1.70 1.08 1.38 2.41 0.60 1.42 5.59 0.45 1.63

Enterprise value to last twelve months (LTM) sales

We expect Apple’s EV/LTM sales multiple to continue to expand. Apple currently trades at
4.1 times LTM sales of $65.23 billion. This is above the stock’s five-year average of 3.5
times and at the high end of the stock’s historical range. Our 12-month price target of $430
represents a multiple of 5.7 times, which would be closer to the stock’s five-year high of 6.6
times. We believe this multiple expansion could be explained by the company’s recent
margin expansion, where Apple’s margins set new records in fiscal 2010. Although we
expect margins to be constrained in the near term as the company ramps its new products,
we believe Apple’s leverage should continue as it grows its installed base of iOS users. Our
estimates call for Apple’s margins to rebound and set new records in fiscal 2012 and fiscal
2013.
Exhibit 9: Apple’s margin expansion should continue to drive its EV/LTM sales multiple
higher
EV to LTM sales

AAPL 4.08 4.42 3.20 3.80 6.62 1.27 3.47 6.62 0.10 2.23
DELL 0.31 0.51 0.26 0.36 1.28 0.13 0.58 2.37 0.13 1.25
EMC 2.61 2.67 2.19 2.42 4.05 1.09 2.35 23.91 1.08 3.35
HPQ 0.86 1.12 0.75 0.95 1.33 0.59 0.98 1.53 0.46 0.91
IBM 1.99 2.03 1.73 1.87 2.03 1.15 1.70 2.86 1.15 1.83
LXK 0.59 0.78 0.39 0.58 1.35 0.19 0.65 2.32 0.19 1.19
NTAP 3.56 3.82 2.11 2.86 6.74 0.68 3.17 32.64 0.68 4.67
STX 0.63 1.02 0.41 0.70 1.54 0.22 0.90 1.98 0.22 0.95
WDC 0.56 1.12 0.32 0.64 1.20 0.18 0.72 1.20 0.17 0.62
XRX 1.31 1.58 0.89 1.20 1.62 0.65 1.18 1.62 0.65 1.24
Average 1.65 1.91 1.22 1.54 2.77 0.61 1.57 7.70 0.48 1.82
Discounted cash flow analysis

We use discounted cash flow analysis in addition to comparative multiple analysis to
support our P/E derived 12-month target price of $430 for Apple. Our DCF analysis serves
as a check for our target price, and as such, we use it to determine the implied growth rates
or margin expansion the company would need to achieve in order to reach our target price.
Specifically, our DCF analysis incorporates our explicit projections through calendar 2012.
Beyond that, we assume the company maintains operating margins of 29% in order to
determine the implied revenue growth rate needed to arrive at our target price. We assume
working capital and asset turns improve modestly from current levels, where the company
continues to spend aggressively to support its growth. Using this methodology suggests
that Apple would have to grow revenues at 6.6% in calendar 2013, versus the 16.1% growth
we expect in calendar 2012 and the 31.9% growth we forecast in calendar 2011. From here,
its growth rate would decline linearly in each of the following seven years to 3% growth in
perpetuity. This equates to average annual growth of 4.8% from 2012, which we view as
achievable based on the company’s growing iOS platform and market opportunities.

Exhibit 10: Apple would have to grow 4.8% annually at constant margins to achieve our
12-month target price of $430
$ millions, except per–share data
Revenue CAGR: 2012E-2017E 4.8%

Residual value 499,158
Cumulative present value of free cash flows 159,450

Present value of residual value 219,999
Corporate value 379,449
Debt 0
Excess cash 23,746
Value of equity 403,195
Diluted shares 945
Value per share $430
Scenario analysis
In addition to determining an implied revenue growth rate, we performed a sensitivity
analysis to various terminal growth rates, discount rates and margins. We believe a WACC
of 10.1% and a terminal growth rate of 3% are appropriate.
Exhibit 11: We believe a WACC of 10.1% and terminal growth rate of 3.0% are appropriate
for Apple
Target price sensitivity to WACC and terminal growth rate
Terminal Growth Rate

430.00 2.0% 2.5% 3.0% 3.5% 4.0%
9.1% 447.26 469.35 495.01 525.21 561.29
9.6% 419.77 438.50 460.03 485.04 514.47
WACC 10.1% 395.71 411.74 430.00 450.98 475.35
10.6% 374.46 388.31 403.94 421.74 442.18
11.1% 355.56 367.62 381.12 396.36 413.71
Exhibit 12: We assume a terminal operating margin of 29% to determine implied growth
for our target price
Target price sensitivity to terminal operating margin and growth rate
Terminal Growth Rate

430.00 2.0% 2.5% 3.0% 3.5% 4.0%
27.0% 378.17 393.05 409.99 429.44 452.05
Terminal 28.0% 386.94 402.40 419.99 440.21 463.70
Operating 29.0% 395.71 411.74 430.00 450.98 475.35
Margin 30.0% 404.47 421.09 440.01 461.75 487.00
31.0% 413.24 430.43 450.01 472.51 498.65

Company overview
Apple was founded on April 1, 1976 by Steve Jobs, Steve Wozniak and Ronald Wayne.
Soon after, Apple became one of the first companies to successfully commercialize the
personal computer. It has since expanded considerably, with a software and content
platform that has fueled expanding share in the computer, mobile phone, portable media
player, handheld gaming, peripherals, software, advertising and digital media markets. The
company sells its products through its world-renowned Apple stores, online, third-party
retailers, its direct sales force, wholesalers, resellers and value-added resellers. The
company targets the education, consumer, creative professional, business and government
segments of the market. Apple is headquartered in Cupertino, California, and has a
manufacturing facility in Cork, Ireland. The company employs approximately 46,600 people
globally.
Common questions
In the following section, we highlight some common investor questions that are likely to
color the investment debate for Apple in coming quarters. Some of these issues may
warrant further discussion in future research, though we provide a summary of our current
thinking for each.
Will the iPad cannibalize Apple’s other segments?

While we believe it is reasonable to conclude that there should be some degree of iPod and
Mac cannibalization from the iPad, we believe in the end, this cannibalization is largely
inconsequential. We estimate that the average iPad unit will deliver $231.05 in gross profit
in fiscal 2011, versus $47.58 for iPods and $330.21 for Macs. Thus if we have to trade an
iPod unit for an iPad unit, that’s great news. On the Mac side, the far greater TAM
opportunity and near-parity versus profits for Apple’s low-end notebooks suggests that
investors should be relatively indifferent between an iPad or a Mac sale. In fact, we’d argue
that if we assume the iPad is a personal computer, then the device should allow Apple to
gain a far larger revenue and profit share in the PC market than the Mac ever could. Even
with these arguments, there is very little evidence of Mac cannibalization at all. In the June
quarter, Apple’s Mac units grew by 33.4% annually, versus 20.4% growth for the overall PC
market. Meanwhile, in the September quarter, Mac units grew by 27.3% annually, versus
9.7% growth for the overall PC market. In both quarters, Mac units exceeded consensus
expectations. In addition, we must consider the more bullish possibility that Mac
cannibalization forces from the iPad may be more than countered by a burgeoning “iPad
Halo Effect” that is pushing Wintel users to the Mac platform. In this scenario, the Mac
continues to satisfy the needs of “power users” in the PC market, while the iPad satisfies
the needs of the mass market.
Has Apple reached its peak margin potential?

Apple’s gross margins expanded 1169 basis points from fiscal 2002 to fiscal 2010
(excluding options expense). More impressively, operating margins expanded by 2873
basis points over the same period. While there have been quarterly fluctuations in margins
during this period of rapid expansion, we believe the company still has plenty of room for
leverage. As we discuss later in this report, Apple’s unique platform allows for significant
gross and operating margin leverage. On the gross margin line, the barriers to entry from
the company’s ever-evolving ecosystem shield it from the effects of hardware

commoditization, and it enables the company to capture the lion’s share of industry profits
through premium pricing. On the operating margin line, Apple’s mobile devices all run on
the same core software and content platforms, enabling Apple to generate R&D and
marketing leverage that is unmatched in the technology industry. These factors should
continue to work in the company’s favor, particularly as Apple expands its volume of iOS
devices. While we expect margins to remain somewhat constrained near term, as the
company manages through the early stages of the iPad and iPhone 4 product lifecycles, but
we believe gross margins bottomed in the September quarter of 2010.
Who poses the greatest competitive threat to Apple?

Given our view that Apple’s success is primarily driven by its unique platform model, we
believe it is also reasonable to conclude that any platform competitor could cause Apple’s
demise. As a result, we worry less about the various hardware leaders in the PC or handset
markets, and instead, we believe investors should monitor mobile platform vendors with
the greatest momentum. Specifically, we believe Google represents the clearest threat to
Apple over the long term. The Android platform appears to be gaining momentum in the
mobile markets far faster than other iOS competitors. While this could change, the
advantages in platform markets tend to compound over time.
How will Apple compete in the prepaid mobile Phone markets?

While Apple’s iPhone is enjoying great success in international markets, the company’s
premium-priced handsets may be a tougher sell in the prepaid segments of these markets.
Unfortunately, the prepaid market represents more than 80% of mobile phone users in
some emerging countries. Nevertheless, we don’t expect Apple to stand by idly. We
believe the company will focus its lower-cost, lower-BOM iPhone products on these
markets. Over time, Moore’s law should enable the company to hit lower price points,
though it is unlikely that Apple will ever choose to be a price leader. The other option is to
negotiate lower data plan rates with carriers, similar to the AT&T iPad partnership. Either
way, we don’t think the prepaid market will serve as a constraint for iPhone growth in the
long term, but this is an issue that Apple should eventually address.
When will AT&T exclusivity end?

Earlier in the year, the consensus view was that Apple would add Verizon as a U.S. iPhone
carrier in mid-2010. Clearly this never came to pass, so now what? We believe the end to
Apple’s exclusivity arrangement with AT&T is a matter of “when” not “if,” and all signs
point to an early-2011 announcement. As a result, we currently assume Apple’s annual U.S.
iPhone unit growth will hit 50% in the June quarter (after a brief stop at 15% growth before
the launch), and we expect FY11 and FY12 U.S. unit growth to hold at approximately 33%.
Will Apple ever launch an iPhone nano?

Market chatter surrounding a potential dumbed-down or miniature iPhone has popped up
multiple times over the past three years. Our view is that any new versions of the iPhone
will be introduced only if they are additive to Apple’s software and content platforms, and
the App Store in particular. In this case, it would be difficult to reduce the screen size for
the iPhone substantially, since it would make the device less compatible with the
touchscreen-centric applications that currently dominate the ecosystem. Indeed, on many
occasions, Apple’s management has noted that the current iPhone screen size is optimized
for the size of the average human finger. As such, we can’t imagine a smaller screen size

could be introduced without substantially limiting the device’s compatibility with Apple’s
current App Store portfolio.
How important is the lack of Flash on iOS?

If Apple were to launch a Flash-capable iOS, we believe consumers would almost certainly
react positively. With that said, we suspect Apple believes that such a platform would limit
its control over development quality, and consequently, the long-term value of the iOS
platform. As a result, we do not expect the company to reverse course in this respect. Thus
far, the lack of Flash support on iOS devices does not appear to be a major impediment to
unit demand, as it appears the overall appeal of the platform ecosystem has been powerful
enough to counter the limitations of not supporting Flash. We suspect this will continue to
be the case, though we still believe this is a critical risk to monitor.
What will Apple do with its massive cash balance?

Apple currently holds a cash balance of $51.01 billion, including marketable long-term
investments. Most of this balance is invested in U.S. government treasuries or investment-
grade corporate bonds, so the company’s yield is currently only around 0.11%. It’s difficult
to argue that this is an appropriate use of cash, and investors have consistently argued for
a more aggressive dispersal or investment of this cash. Nevertheless, Apple’s management
and board have steadfastly refused to part with this cash hoard, and it’s useful to note that
the company has not repurchased any of its shares since 2000 (missing the entire 4216%
increase in the share price thereafter). Our sense is that the company will eventually issue
this cash, probably in the form of a one-time dividend, but Apple’s history suggests
investors should not count on such an event in the intermediate term.
Deep Dive #1: Platform dynamics, the core of the Apple story
“We think as a software-driven company, we think about the software strategies first…”
—Steve Jobs, October 18, 2010
Apple’s hardware products often capture the hearts of consumer with their innovative and
elegant designs, and this has been the case throughout the company’s 34-year history.
Nevertheless, we believe Apple’s tremendous success in its most recent decade has been
primarily driven by the evolution of its content and software platform, with the hardware
devices serving primarily as platform delivery mechanisms. Starting with the success of
the iTunes Music Store in 2003, Apple has been able to attach an ever-growing content
portfolio to its devices. This created a loyal and active installed base with steadily
increasing switching costs that have shielded Apple from the forces of hardware
commoditization that traditionally plague the consumer electronics and personal
computing markets. More recently, Apple has leveraged this installed base into the mobile
computing market (iPod touch, iPhone and the iPad) with the 2008 introduction of the App
Store. This has not only added another layer of functionality and switching costs for users,
but it has also enabled Apple to build a diverse army of professional and amateur
developers for its platform. The historic and rapid growth of this platform is not only
fueling substantial hardware revenue and profit growth, but we believe it is also potentially
positioning Apple as the most disruptive force in personal computing in over 20 years.

Exhibit 13: Apple has been able to attach an ever-growing content portfolio to its devices
B
S A
W R
I R
T I
C E
H R
I S
N &
G T
O
C
O E
S N
T T
S R
Y
Source: Goldman Sachs Research.
When we look at Apple through the prism of this platform model, many of its strategic
decisions seem less mysterious. We believe the company’s primary goal is to attract users
to the platform, which in turn will make the platform increasingly alluring by capturing
more software developers and content providers. This, in turn, attracts even more users
and fuels a virtuous cycle of increasing returns. In this section, we discuss the evolution of
this platform model, the financial consequences for Apple, and where this platform may be
heading. Our primary conclusion is that Apple’s platform approach is still in its nascent
stages, and that there is plenty of revenue and profit expansion left in the system. This, of
course, serves as the core of our overall investment thesis for the company. But our
analysis is not one-sided, as we close the report with a Devil’s advocate discussion of how
Apple’s platform model could stagnate or fail longer-term.
The evolution of the Apple platform

When we discuss Apple’s “platform,” we are generally referring to Apple’s software with
an OS X based heritage and attachment to iTunes and/or the App Store. The most
significant evolution of Apple’s platform model, however, is occurring within the iOS sub-
platform. iOS is the operating system behind the iPhone, iPod touch and the iPad. Apple’s
traditional computing products run the heritage OS X operating system. iOS itself is a
derivative of OS X, and both share the same UNIX and processor-agnostic roots. The
primary differences between iOS and heritage OS X is that the former is designed
specifically for the needs of mobile devices, its GUI is based on a touchscreen interface and

its application base is largely derived from Apple’s App Store. In contrast, heritage OS X is
primarily designed for general purpose Mac computers running traditional personal
computing applications (though this may be changing with the new Mac App Store). From
an economic perspective, however, the two operating systems are similar enough beneath
the surface to share a common R&D pool.
Exhibit 14: iOS and Mac OS X are similar enough to share a common R&D pool
iOS Mac OS X
Programmed in C, C++, Objective-C C, C++, Objective-C
OS family Mac OS X/UNIX-like Mac OS/UNIX
Initial release June 29, 2007 March 24, 2001
Supported platforms ARM (iPhone, iPod Touch, iPad) IA-32, x86-64
Kernel type Hybrid (Darwin) Hybrid (based on Mach microkernel)
Default user interface Cocoa Touch (multitouch, GUI) Graphical (Aqua)
Licence Proprietary EULA Proprietary EULA
The majority of Apple’s profits and revenues are attributable to its hardware business, but
in our view, this industry-leading profitability is the direct result of Apple’s software and
content platform. While the elegant design and powerful performance of Apple’s hardware
products have been critical for the company’s resurgence over the past decade, we believe
the secret sauce is the company’s ever-evolving software and content platform.
Indeed, if we look back to the early success of the iPod, we believe there was no reason
why competitors couldn’t come up with sufficiently competitive hardware, and many did.
Nevertheless, no one could effectively dethrone Apple once it captured the market share
lead. We believe this is because the iPod story was much more than a story about the
sophisticated assembly of commodity components in an attractive shell. We believe the
iPod’s success was primarily driven by the device’s seamless integration with the iTunes
platform. Users could quickly discover and purchase content without having to worry
about malware or recording company lawsuits. Apple extended its content sphere into
television shows (2005) and movies (2006), greatly expanding the scope of iTunes.
Most important, however, the iTunes platform was “sticky.” The more music or movies
users purchased, the higher their switching costs. Even when DRM (digital rights
management) restrictions were eased in 2007, users rarely left the platform. By then, the
ecosystem had spread beyond just iTunes, with thousands of companies developing iPod-
specific peripherals and accessories. We believe these various platform switching costs
shielded Apple from the forces of commoditization that typically plague consumer
electronics devices, and it forced Apple’s competitors into unprofitable niche market
positions during the formative years of the industry.

Exhibit 15: The iPod’s success was driven by its seamless integration with iTunes
iPod units in 000s
2,500
2,000
ITMS for Windows

1,500 introduced
iTMS
introduced 10/16/03
1,000 4/28/03
500
0
Dec-01
Jun-02
Oct-02
Dec-02
Jun-03
Oct-03
Dec-03
Jun-04
Aug-02
Aug-03
Aug-04
Feb-02
Apr-02
Feb-03
Apr-03
Feb-04
Apr-04
When Apple launched the iPhone in 2007, the company’s loyal iTunes installed base
already provided it with a fairly large number of potential iPhone customers. Nevertheless,
Apple shifted its platform strategy to the next level when it leveraged the developer-
friendly OS X operating system in the iPhone to create the App Store in 2008. The App
Store immediately captured mindshare with consumers, selling 25 million applications a
few weeks after its launch. In addition to the powerful native features of the iPhone,
consumers could now tailor the functionality of their iPhones with a diverse range of bite-
sized applications. More important, both professional and amateur developers flocked to
the store, trying to figure out the best way to tap into this new software gold rush. In just
over two years since the launch of the App Store, the marketplace now boasts more than
350,000 apps and more than 7.5 billion app downloads. These apps not only provide users
with countless new sources of functionality for their Apple devices, but they also build a
second critical layer for Apple’s platform model and another layer of switching costs for the
installed base.

Exhibit 16: The App Store immediately captured mindshare and drove iPhone sales
iPhone units in 000s
16,000
14,000
12,000
10,000 App Store

opens
8,000 7/11/08
6,000
4,000
2,000
0
Oct-07
Oct-08
Oct-09
Jun-07
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Aug-07
Aug-08
Aug-09
Aug-10
Feb-08
Apr-08
Feb-09
Apr-09
Feb-10
Apr-10
Apple’s devices are the spokes that attach to the platform

When we look at Apple’s hardware devices as spokes of its content and software platform,
it helps to explain many of the key questions surrounding Apple’s success over the past
decade. For instance, in the early days of the iPod, many believed it was only a matter of
time before the device would become commoditized. After all, the iPod was made up of
industry-standard components available to all of the competition. Clearly Apple’s design
and user interface prowess served as a barrier to entry, but it seemed clear that this was a
very finite advantage in a nascent market. Nevertheless, considering the fact that Apple’s
platform vastly increased iPod customer switching costs and added unmatched
functionality, the skeptics concerns disintegrated fairly rapidly.
Many thought the iPod’s success was not repeatable. But the iPhone was able to rapidly
capture share in the highly-competitive mobile phone market, despite the fact that Apple
had very little expertise in telephony. Finally, and perhaps most important, a fully
established App Store and iTunes media store enabled the iPad to penetrate the traditional
mobile computing market at a pace far exceeding most expectations. Indeed, we believe
there is now ample evidence that the iPad began to cannibalize the mature notebook
computing market within its first three quarters of availability.

Exhibit 17: Apple’s devices are spokes that attach to the content and software platform
Apple’s
Content
and
Software
Platform
Source: Images courtesy of Apple.
By attaching high-quality hardware devices to its well-established software and content

platform, we believe Apple is able to disrupt previously untapped mobile computing and
entertainment markets almost instantaneously. The platform also allows Apple to take a
disproportionate share of the various segment profit pools in participates in, while its
hardware competitors face ever-growing forces of commoditization. While each spoke
competes in very different marketplaces (portable computing, mobile telephony, handheld
gaming, portable media, etc.), they each deliver a piece of one core platform. In addition,
we believe Apple designs each spoke to cater to a specific use case, so cannibalization
amongst the spokes is often more limited than most would imagine. The iPod touch is
designed to be the best handheld music and gaming device, while the iPad is designed to
be the best mobile computing and media device. Meanwhile, the iPhone brings the best of
both worlds to smartphone users.
This is not to say that Apple doesn’t have a tremendous focus on hardware development.
To the contrary, we estimate that Apple still spends nearly 67% of its R&D on hardware.
Nevertheless, when analyzing the merits of a product launch or the company’s product
pricing strategy, we believe it is now more important than ever to consider the fact that
these products are primarily intended to deliver the core platform to users and maximize
the platform’s value. Furthermore, we believe it is important to remember that the power
of Apple’s platform delivers a turbo boost to the profit and market share trajectory of its
hardware devices. In addition, the platform and loyal installed base gives Apple a margin
of error on new product innovations; if a new product has flaws, users rarely exit the
platform and this provides Apple with a buffer period to make critical improvements. We
believe this buffer fuels Apple’s risk-tolerance for bold innovations that fly in the face of
conventional industry wisdom.

Exhibit 18: Apple still spends the majority of its R&D budget on hardware by our estimate
% of R&D spending
Apps
17%
OS
16%
Hardware
67%
On the pricing side of the equation, Apple’s platform is now strong enough to give it a
margin cushion that enables it to move away from its premium-pricing heritage and cater
directly to the mass market in several categories. The company is likely to always provide
high-end devices through its product family versioning, but the lower-end of its product
families are now hitting price points that compress the market opportunity for slim-margin,
commoditized competitors. Indeed, the iPad is the most recent example of this
phenomenon, with price points that are well within the high-volume, sub-$800 mobile
computing segment.
What about the open-vs.-closed systems debate?

Many of Apple’s key platform competitors are touting their systems as “open” while
disparaging Apple’s approach as “closed.” This strikes a chord in the world of computing
because it echoes the closed-vs.-open debate that eventually put Apple on the losing end
of its fabled PC platform war with Microsoft in the 1980s. But this is not the personal
computing market, and the mobile computing landscape is evolving into a very different
type of industry. The traditional PC software landscape was generally made up of packaged
software applications that only a few companies could afford to develop and distribute. As
such, PC platform vendors needed to capture the greatest number of applications by
making their platforms as open as possible. Today’s mobile computing apps are very
different. They are typically Internet-centric, with minuscule development costs and near-
zero distribution costs. As a result, large numbers of low-quality mobile apps and malware
can easily inundate a modern mobile platform.
We conclude that Apple’s developer restrictions create an important quality filter for the
rapid proliferation of apps on the iOS platform. We believe this provides a baseline of
quality that makes the App Store more palatable to the mass market, particularly versus
competitive platforms that can be rife with adult content and poorly performing apps. In
fact, Apple was able to leverage a similarly “closed” model to dominate digital music,
since its controlled iTunes platform provided more reliable (standard quality, no viruses)
media content than the free file-sharing sites earlier this decade.

On its recent earnings call, Steve Jobs argued that the debate over whether or not a mobile
computing platform is “open” is misguided. Instead, he argued that the question will shift
to “integrated” versus “fragmented.” In this case, Apple’s iOS platform is designed for a
simple set of devices, with a fairly uniform set of software features and hardware input
mechanisms. In contrast, Google’s Android platform works with hundreds of devices,
forcing developers to dumb down their apps in order to reach the broadest audience. The
jury is still out on this debate, but we suspect iPhone developers will eventually enjoy a
simpler and more cost effective development environment with Apple’s integrated
platform.
What is Apple’s competition?

We group Apple’s competitors into two distinct camps. The company’s primary
competitors are the other mobile platform vendors, including Google, RIMM, Microsoft,
HP-Palm, etc. We believe these competitors are the most important for Apple investors
because they will determine how large and profitable Apple’s platform will be over the
long term.
The secondary competitors are the individual hardware vendors within Apple’s individual
platform spokes. For instance, Dell is developing tablets that will compete with the iPad
and Motorola sells smartphones to compete with the iPhone, but the underlying platform
for these devices is Google’s Android software. These secondary competitors can have an
impact on near-term pricing and market share shifts, but in the long term we believe they
should matter a lot less for Apple investors. Indeed, if Apple’s platform continues to gain
momentum, these secondary competitors will generally face commoditization forces as
they are forced to outsource the majority of their value-add to Apple’s key platform
competitors.
Most important, looking at Apple’s primary platform competition, we do not believe this is
a winner take all market. With any computing or content platform, network effects tend to
drive the market towards increased consolidation in the formative stages. Nevertheless, in
contrast to common belief, the natural steady state in these markets is not always a
monopoly or near-monopoly state. In cases where network effects are strong or the
industry also requires significant fixed cost investments, near-monopolies tend to form.
Microsoft and Intel are generally good examples of this phenomenon within the
technology industry. Nevertheless, weaker network effects tend to produce a more
oligopolistic market structure (the printing and UNIX markets are good examples here). We
believe the mobile computing platform markets will follow latter this pattern.
While network effects are critical for platforms such as Android or iOS, the costs of
software development and distribution for apps are generally far less than they have been
for computer platforms in the past. This allows for content portability on platforms over
time, and we believe this will eventually settle into an oligopoly of 2-3 dominant platforms.
With most of the mobile platform end markets still in their nascent stages, we expect the
battle for market share will be intense as these markets develop in coming years.
Furthermore, the top one or two vendors will likely capture massive profit pools that will
extend across several industry segments. We view Android as Apple’s chief platform
competitor, while RIMM and Microsoft are next on the list. RIMM is focused on an
integrated hardware and software approach, while Google and Microsoft are partnering
with dedicated hardware vendors.
The secondary competitors tend to garner more press from Apple watchers than they
really deserve. Nevertheless, they are important components in the development of the
mobile computing ecosystem, so they shouldn’t be ignored. This bunch includes the
leading vendors in the PC, mobile phone, portable gaming, e-reader, and other mobile
device markets. We discuss these competitors further in the next section of the report.

Digging into the platform spokes

“Our goal is to make really breakthrough great products, make the best products in every
industry that we compete in, and to drive the costs down, while constantly making the
products better at the same time.”
—Steve Jobs, October 18, 2010
Apple has five distinct hardware product families: the Mac, iPad, iPhone, iPod and “the
hobby,” Apple TV. In terms of Apple’s product strategy, we view each hardware device as a
spoke in Apple’s platform-centric business model. These devices deliver Apple’s software
and content experience to consumers, and they tend to do it with remarkably innovative
design and computing functionality. Furthermore, by leveraging the strength of Apple’s
platform, each hardware family tends to generate above-average margins in the respective
industry segments where they compete. As such, by terming these products the “spokes”
in Apple’s model we are not belittling their importance. Indeed, Apple’s hardware is the
core monetization engine for its platform, and as such, the financial and competitive
dynamics within each hardware segment is a critical component of the Apple story.
Exhibit 19: Apple’s hardware is the core monetization engine for its software and content
platform
% of fiscal 2011 revenues
iPad and
related
products and
iPhone and
services
related
21%
products and
services Peripherals
37% and other
hardware
2%
Software,
service and
Other music other sales
related 3%
products and
services Total Macs
6% iPod
22%
9%
The iPad: a disruptive force for computing

Apple officially announced its long-awaited iPad computer in January of 2010, with the first
units shipping in April. At first, investors were fairly skeptical of the device, and many
pundits disparaged it as a “big iPod touch.” As time went on, however, we believe it
became apparent that a big iPod touch was exactly what the market wanted. Indeed, Apple
shipped 3.2 million iPad units in the June quarter, which was nearly five times some of the
initially conservative estimates on the Street. More important, there has been surprising

evidence that the iPad began to immediately cannibalize Wintel notebook and netbook
units upon its launch.
We believe the rapid and surprising success of the iPad is largely attributable to the fact
that while it was a unique and new product, it was attached to a well-developed software
and content platform. Indeed, we believe the large number of apps, music and video
content available through iTunes and the App Store ahead of the iPad’s launch greatly
shortened the customer evangelization period that is typically required for new consumer
electronics devices. In addition, the iPad represented a new price band and form factor for
Apple’s platform that fit nicely between the company’s MacBooks and iPod touch product
families. In addition, as the Goldman Sachs technology research team noted in their July
12, 2010 report, “The rise of the iPad and tablets: Assessing winners and losers in the
global TMT ecosystem,” the iPad hit a consumer nerve with its five-Cs functionality.
Exhibit 20: The “5Cs” of Apple’s iPad; winners and losers supplied by the Goldman Sachs Tech Research Team
CONSUMPTION
____Winners:____ ____Losers:___
Hon Hai (2317.TW) Microsoft (MSFT)
Murata (6981.OS) Micron (MU)
Citrix (CTXS) ASUS (2357.TW)
SaaS apps (CRM, Acer (2353.TW)
SFSF, TLEO)
CONTENT CONNECTED
Winners: Losers:___ Winners: Losers:____
Samsung (5930.KS) HDD makers Broadcom (BRCM) Intel (INTC)

SanDisk (SNDK) Marvell (MRVL) Infineon (IFXGn.DE) AMD (AMD)
Lam Research (LRCX) LSI Corp. (LSI) SBA Comm. (SBAC)
Media (CBS, DIS, Crown Castle (CCI)
NWSA, TWX, VIA) "5Cs" of Qualcomm (QCOM)
CDNs (AKAM, LLNW) Syniverse (SVR)
iPad
CONSTANT OPERATION COMMERCE
_____Winners: _Losers:___ ___Winners:___ __ Losers:_____
ARM Holdings (ARM.L) Intel (INTC) Amazon (AMZN) RadioShack (RSH)
Samsung (5930.KS) AMD (AMD) Best Buy (BBY)
Linear Tech (LLTC) BarnesNoble (BKS)
The iPad expands Apple’s PC market opportunity significantly

We believe these factors suggest that Apple’s iPad is not only a welcome new spoke for its
platform model, but it also provides the company with its most realistic opportunity for
penetrating the mass market for mobile PCs. While some may argue that the iPad is not
technically a PC, we believe this is really only a futile exercise in semantics. Indeed, we

believe a significant percentage of traditional PC users tend to use their devices primarily
for content consumption and Internet browsing (in fact, we believe that less than half of the
PC installed base is running MS Office). As a consumption device, the iPad is shaping up to
be a welcome notebook or netbook substitute. Furthermore, as productivity tools on the
App Store continue to mature and cloud-based productivity applications become more
prevalent, this TAM may expand further yet.
We analyze the TAM for the iPad in two ways. First, we look at the total market for
consumer notebooks in the $500-999 price band on a historical basis. In this 59.7 million
unit segment, Apple had virtually no presence in calendar 2009.
Exhibit 21: The iPad gives Apple exposure to the $500-999 consumer portable PC market
% of 2009 worldwide PC units
Home
$500-999
portable
PC
20%
All other PCs

80%
Nevertheless, longer term we believe the increasing availability of productivity apps and
private corporate apps will also expand the iPad’s TAM to the commercial market. Adding
this segment, we increase our total TAM by 32.86 million mobile PC units. As such, we
believe Apple’s TAM expanded by 92.63 million units, or $66.67 billion dollars, with the
introduction of the iPad. It’s important to remember that Apple did not (and still doesn’t)
offer traditional notebooks at price points below $999, which is why this TAM is
incremental.

Exhibit 22: Including the commercial segment, Apple’s TAM increased further
% of 2009 worldwide PC units
Home
$500-999
portable
PC
20%
All other PCs
69%
Commercial
$500-999
portable PC
11%
What about Mac and iPod cannibalization?

While the iPad has surpassed most investor expectations thus far, there are still some
lingering concerns over the potential for cannibalization of Apple’s Mac and iPod touch
product lines. Our analysis of this concern is simply: (1) in the short term, we’re actually
seeing the opposite effect; (2) in the long term, it really doesn’t matter. Digging into the
first point, we view the potential for iPad cannibalization of the Mac and iPod touch as the
result of two opposing forces. On one side, we have the obvious similarities between the
iPad’s functionality and certain elements of the Mac (particularly low-end MacBooks) and
the iPod touch. This clearly points to the potential for cannibalization, since it’s not yet clear
if users will want both an iPad and a Mac or iPod touch. On the other side, we have the
potential that the greatly expanded TAM for the iPad introduces a larger number of
consumers to the overall Apple platform. In this respect, the potential for a positive “Halo
Effect” from the iPad could outweigh any of the potential cannibalization. Thus far, in the
two quarters of iPad availability, Mac units have continued to show strength. iPod touch
growth seems to have slowed to only 12% or so growth in the September quarter
(according to our estimates), but this could have been caused by supply chain adjustments
ahead of the September product family refresh. As such, we will need to monitor touch
shipments in the December quarter see if there are any signs of iPad-related
cannibalization.
Longer term, the potential for cannibalization certainly exists, particularly as Apple’s overall
hardware installed base becomes more significant. But we believe investors should be
indifferent to iPad cannibalization in this respect. In fact, we’d prefer to see the iPad
cannibalize the Mac since it more directly ties the user to the iOS elements of the Apple
platform and the TAM opportunity is so much larger. If we conservatively assume that the
iPad’s gross margins will approach the low-40s as we exit calendar 2011, then the current
ASP would generate around $230.52 gross profit dollars per unit. Meanwhile, we estimate
the low-end MacBook (which nearly overlaps with the iPad’s TAM at the high-end) will
generate approximately $245.65 gross profit dollars per unit. In other words, the inherent
margin advantage of iOS devices suggests that the iPad can reach far more attractive price

points than Mac platform units, with a similar gross profit impact. Looking at the iPod
touch, the profit dollars per device are even less substantial, so iPad cannibalization would
be welcome in this respect.
Exhibit 23: We believe investors should be indifferent to iPad cannibalization

Gross profit per unit
$300 MacBook
(low-end)
iPad $245.65
$250 $230.52
$200
$150
$100 iPod touch

$57.51
$50
$0
2011E
Most important, we believe that Apple’s platform advantage should enable the iPad to
compete effectively with traditional notebooks and competitive tablets without ASPs
declining faster than the commodity curve would allow. In other words, Apple should be
able to once again resist the traditional forces of commoditization, while still competing in
a mass market segment. If this is true, then we believe iPad margins could easily exceed
the 40% range for many years (we currently estimate average iPad gross margins stand at
37.6% .
Competition comes in two flavors

In early 2010, when Apple first announced the iPad, there were many skeptics on the tablet
market’s potential and few serious competitors. The world has certainly changed, however,
and just about every major consumer technology vendor is now preparing to enter the
market. In fact, we believe 2011 will be analogous to a Cambrian Explosion of tablet
devices and vendors. Further extending the analogy, by 2012 we expect a Permian
Extinction, with only a handful of viable competitors remaining in the market.
Outside of the traditional PC market, we split the iPad’s tablet competitors into two
categories. The first is tablets from companies that were traditionally Wintel PC vendors,
while the second represents tablets from companies that were traditionally mobile handset
vendors. In most cases the Wintel PC vendors will compete largely on cost and distribution
prowess, just as they do in the PC market. In this respect, HP will be the notable exception
to the rule, since the company is primarily addressing the market with the proprietary
WebOS from its acquisition of Palm earlier this year. Meanwhile, the handset vendors will
have to pull together relationships in the PC supply chain, and they will likely differentiate
themselves with a carrier-centric, subsidized approach.

We suspect the tablet market will have greater affinity to the PC market, so this is likely to
tilt the market towards the PC brands over time. Nevertheless, if a carrier subsidized
business model takes hold over time, then we could be wrong and the traditional handset
vendors will gain more momentum. In the end, we suspect it doesn’t matter much for
Apple: the company should be able to easily leverage its iPhone carrier partnerships if the
subsidy model becomes the dominant distribution model, and we believe the company’s
chief competition is really with the platform vendors (Google, RIMM, Microsoft, etc.) as
opposed to the tablet vendors themselves.
Our iPad assumptions are aggressive

We are currently forecasting 7.5 million iPads for the December quarter, representing 15
million units for the first three quarters of the products availability. Forecasting the iPad
beyond 2010 is challenging since the product’s adoption curve doesn’t seem to have any
historical precedent. Nevertheless, as we discuss in our industry overview report, we are
using the early stages of the netbook market as a rough framework. With that said, we
believe the iPad will grow at a far faster rate than Apple’s other product families after
launch largely because it was released after the iOS platform had already gained a fairly
strong foothold in the computing industry. Thus, the period of evangelization that was
necessary for the iPod and the iPhone has been quickly bypassed by the iPad. As a result,
we are forecasting 31.2 million iPads in fiscal 2011 (37.2 million in calendar 2011).
The iPhone: spreading iOS worldwide

The launch of Apple’s iPhone in 2007 was significant in several respects, not the least of
which being that it marked the debut of Apple’s iOS. Since then, Apple has built a very
loyal installed base of approximately 59 million iPhone users by our estimate. The
company now holds approximately 16.7% of the global smartphone market, and with its
hefty carrier subsidies, we estimate the company already held 44% of operating profits of
the entire handset industry. Most important, Goldman Sachs estimates that smartphones
will account for nearly half of the total handset market by 2014, providing Apple with an
iPhone TAM of over $190 billion in four years. We suspect Apple’s profit and revenue share
of the total handset industry will increase with smartphone adoption over the next several
years.
Apple’s iPhone margin premium is not an anomaly

We estimate that Apple generated gross margins of just over 54.9% in fiscal 2010, which is
nearly double that of most smartphone vendors. At first glance, this type of margin
premium in a competitive hardware industry seems remarkably unsustainable.
Nevertheless, when we look at this phenomenon through the prism of the platform model,
we believe it makes a lot more sense. The smartphone industry is fundamentally different
from the traditional handset market.
In the traditional handset market, the competitive landscape was largely determined by
form factor design and manufacturing scale. Smartphones, however, are fundamentally
computing devices. In any computing market, we believe the primary source of value
comes from the underlying computing platform. Over time, margins migrate to the
platform leader (or leaders), while the computing hardware vendors tend to experience
increasing pressures from commoditization. Indeed, in the early days of the computer
industry, the margins of PC hardware vendors steadily declined towards slim, commodity
levels as the platform leaders (Microsoft and Intel) captured more of the profit pool. In
Apple’s case, iOS is emerging as a dominant smartphone platform, and this is enabling to
company to gain share in the smartphone market and overall handset market. We believe
the natural consequence is that the handset profit pool is shifting in Apple’s direction

(Exhibit 24). It follows that smartphone vendors sourcing their OS from third parties will
have to live with slimmer margins, just as the PC vendors have done for three decades.
Exhibit 24: Apple taking profit share

Operating profit share of top 8 handset vendors
100%
80% Apple
HTC
60%
RIM
40% SonyEricsson
LG Electronics
20%
Motorola
0% Samsung
Nokia
-20%
2006 2007 2008 2009 2010E 2011E 2012E
Interestingly, our estimates assume that the recently released iPhone 4 had initial margins
that were around 1000 basis points lower than the previous version of the iPhone. We
believe some investors are concerned that this is the beginning of a long overdue reversion
to the mean and that Apple’s margins eventually trend towards the industry average as it
prices for market share. We disagree. The iPhone 4’s margins, like many of Apple’s new
hardware products, should eventually expand as component prices decline in the quarters
following the product’s launch. Apple’s dominant iOS platform should continue to buffer it
from the forces of commoditization and allow it to hold its pricing firm as the bill of
materials compresses. Over time, Apple may choose to give up some of this margin to
penetrate more cost-sensitive segments of the market, but our model assumes that iPhone
gross margins won’t trend below 50% for any sustained period of time.
Form factor matters: little chance of a little nano

Since the day Apple launched the first iPhone, and even before then, pundits have claimed
that the company would inevitably split the product family into a variety of unique form
factors; after all, that’s what the company did with the iPod, and it was a remarkably
successful strategy. Indeed, the most famous incarnation of this view has been the
mythical iPhone nano, a device that many have regularly predicted was just around the
corner. Yet, after years of waiting, the iPhone’s form factor hasn’t changed dramatically.
The iPhone is still a rectangular device with a 3.5-inch touch screen and home button on its
face. Despite this apparent uniformity among the various iterations of the product, the
device’s functionality has actually changed dramatically. Some of this has been due to
steady improvements in the underlying computing components and capacity points, but
the vast majority of the functionality additions have come from the underlying software. In
addition to the key new features from Apple’s major and minor OS updates, users have
been able to customize their iPhone’s functionality by choosing amongst the more than
350,000 apps now available for download.

Exhibit 25: The iPhone’s form factor hasn’t changed dramatically
2.5G 3G 3GS 4
•January 9, 2007 •June 9, 2008 •June 8, 2009 •June 7, 2010
Source: iPhone 4 image courtesy of Apple, prior versions from public domain.
Apple’s apparent unwillingness to drastically change the iPhone’s form factor may seem
odd, but in reality, we believe it’s merely a manifestation of the company’s maniacal focus
on its iOS platform. Apple wants the iPhone to be an attractive and powerful hardware
device, but more than that, the company wants developers to write apps for it. The best
way to attract the most developers and to make sure they can develop the best apps is to
make the iPhone installed base as uniform as possible. By keeping the touchscreen’s size
constant and maintaining the function of the five physical buttons on the iPhone, Apple
ensures that the entire iPhone installed base has a common hardware interface. This vastly
simplifies software design for developers looking to reach a large number of consumers.
Indeed, we believe similar reasoning explains why Apple doesn’t charge iPhone users for
OS updates: the company wants to make sure the majority of its installed base has the
same underlying platform capabilities.
International expansion, versioning and carrier expansion should expand the

TAM
Apple currently holds approximately 17% unit share in the global smartphone market and
3% share of the total handset market. We believe the company’s platform leadership
should fuel substantial share gains in coming years, and this represents a significant
revenue and profit opportunity. In particular, we believe Apple’s iPhone growth in coming
quarters and years will be driven by the following three factors:
 International expansion. Once Apple shifted its iPhone business model from
revenue-sharing to a traditional subsidy model in 2008 the company was able to
dramatically expand its footprint in international markets. The company now serves 89
countries, up from only six in early 2008. Nevertheless, the company’s share in
international markets is still relatively low, and we believe this represents a significant
avenue for growth. Indeed, in the September quarter, Apple saw iPhone sales more
than double annually in Asia, Japan and Europe. The only significant constraint on
Apple’s international expansion appears to be its limited exposure to the prepaid

market. In the United States, most carriers distribute smartphones with a subsidy in
return for a contractual commitment from customers (post-paid), but outside of the
United States, a majority of customers purchase phones with prepaid or pay-as-you-go
data plans. Indeed, the prepaid user base is approximately 30% in the United States,
but more than 80% in many developing markets. These prepaid sales minimize the
potential subsidy, thereby exposing customers to Apple’s relatively high retail prices.
We believe this can be addressed with price versioning over time.
 Product versioning. Although the iPhone’s form factor has remained relatively
unchanged, the company does version the product based on storage capacity and
compute power. This has allowed Apple to reach lower price points by leveraging
Moore’s Law to place prior generation iPhones at the low-end. Nevertheless, the
wholesale prices of Apple’s low-end iPhones can still exceed $400. Over time,
however, we believe Apple can leverage component cost declines to bring this price
down to more attractive levels (with a more limited margin impact). This should allow
Apple to produce even lower retail prices for post-paid customers and potentially
midrange price points for prepaid markets.
 Carrier expansion. Apple began to move away from exclusive carrier partnerships
over the past two years, and surprisingly, the company did not have to sacrifice
wholesale ASPs in the process. This is testament to the power of Apple’s platform
approach, as carriers have shown a willingness to use subsidies as a competitive
weapon to lure iPhone users to their network. Although the bulk of Apple’s carrier
expansion is complete in its existing countries, the next big expansion will be in the
United States. We currently believe Apple will move beyond its exclusive relationship
with AT&T by early-2011 and this should re-accelerate iPhone growth in the United
States and substantially expand the TAM.
As a result of these factors, we expect Apple’s iPhone shipments to grow by 55.2% in fiscal
2011 and we expect the company to approach 100 million annual units by fiscal 2013. This
is likely to come primarily at the expense of RIMM and Nokia, but the company’s share
gains will likely be broad based. Most important, the company’s platform leadership
should enable it to capture profit share at an even faster rate.

Exhibit 26: Apple could approach 100 million annual iPhone units by fiscal 2013
iPhone units and gross profit
$25,000 100,000
90,000
Gross profit in millions

$20,000 80,000
70,000
Units in 000s
$15,000 60,000
50,000
$10,000 40,000
30,000
$5,000 20,000
10,000
$0 0
FY07 FY08 FY09 FY10 FY11E FY12E FY13E
Gross profit Units
The Mac: becoming an outlier in the platform

Apple’s Mac business was once the flagship of the company, and it’s still a large part of the
overall business. In fiscal 2010, Apple generated $17.48 billion in Mac revenues,
representing 26.8% of the total. This represented 7% of the total PC market, though global
unit share is a more modest 4.4%. Furthermore, we estimate that the Mac business
represents approximately 18.5% of Apple’s total gross profits. Although the company has
managed to grow the Mac business faster than the broader PC industry on a fairly
consistent basis, the company has only managed to gain 205 basis points of market share
in the past five years. Investor attention has naturally shifted towards the iPhone business,
and more recently, towards the iPad business.
The Mac doesn’t easily fit into the platform strategy, but this may be changing
Although Apple’s Mac products share a common operating system heritage with iOS
devices, they are not directly attached to the same content and app ecosystem. While the
Mac can serve as a hub for iOS devices by storing music and app content, Wintel PCs can
do the same. As such, expansion of the iOS ecosystem doesn’t necessarily provide the Mac
with any substantial competitive advantage relative to other PC vendors. With that said, the
company does seem to benefit from the “Halo Effect” as iPods, iPads and iPhones expand
Apple’s broader brand appeal for consumers. Furthermore, the segment may begin to
benefit even more as Apple begins to copy some of the core components of the iOS
business model for Macs.
This latest evolution of the Mac business model became apparent at Apple’s “Back to the
Mac” event on October 20, 2010. At the event, Apple announced that its Mac OS would
soon be able to leverage the app store concept with the Mac App Store. The economics of
the Mac App Store are identical to the iOS App Store and this should enable to expand its
application portfolio beyond the traditional packaged application marketplace that has
defined the PC market for decades. In addition, the company announced that its Macs will

now support FaceTime, directly leveraging one of the most promising features of the
growing iOS installed base.
This not a mass market product, but it remains a source of growth

Although we expect the Mac to continue to gain share within the PC market, we believe the
company will continue to focus on premium price bands and this necessarily limits the
potential market share for the product. When considering Apple’s TAM in the PC market,
we view the iPad as the company’s primary tool for attacking the mass market. That said,
the Mac continues to be a critical source of revenue and profit growth for Apple and this
should continue to be the case for the foreseeable future.
Exhibit 27: Mac should continue to be a critical source of revenue growth for Apple
$1,600 6,400
$1,400
5,400
$1,200
Units in 000s
4,400
$1,000
ASPs
$800 3,400
$600
2,400
$400
1,400
$200
$0 400
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Aug-09
Aug-10
Aug-11
Aug-12
Apr-09
Apr-10
Apr-11
Apr-12
Mac ASP Industry ASP Mac units
Source: IDC, November 2010, company data, Goldman Sachs Research estimates.
We believe Apple’s primary source of share gains for the Mac business should be in
international consumer markets. Indeed, the company’s current Mac share is 12.2% in the
U.S. consumer market, but it’s only 3.5% in international consumer markets. With its
premium-price focus, the company’s share gains will likely tilt towards the developed
markets, which is in stark contrast to the traditional PC vendors. Nevertheless, the
burgeoning middle class in the BRIC countries could further expand the market opportunity
for Apple over time.

Exhibit 28: International consumer markets should be the primary source of share gains
for the Mac business
Apple home PC unit share
14%
12%
10%
8%
6%
4%
2%
0%
U.S. International
Apple’s primary competitors in the high-end of the consumer market are Hewlett-Packard
and Dell, and we expect these vendors to move further down market over time. Although
many hope that Apple will one day crack the enterprise PC market, we don’t believe this is
a realistic prospect for the Mac business. Nevertheless, we believe the iPad could make
significant inroads here over time.
The iPod business: shifting the installed base to iOS

The iPod business segment currently gets very little investor attention, which is remarkable
since it was considered the core component of the Apple story from 2004-2007. Apple’s
spoke model, however, necessitates that some spokes will be more important than others
at different stages of the platform’s lifecycle. But despite the lack of focus on the segment,
we still believe it is critical in several respects. First, traditional iPods (non-iOS devices)
tend to cater to the most cost-sensitive consumers and consumers that want a device
solely for portable media consumption. This benefits the Apple platform by providing
incremental units for content providers that judge iTunes as a distribution platform by how
many users it reaches. In addition, we believe many iPod users serve as potential iOS
converts for Apple over time. Indeed, the rapid success of the iPhone supports this
contention. Meanwhile, the iPod benefits users by providing low price points and unique
form factors for accessing the iTunes media platform. In fact, we believe a growing number
of Apple platform consumers purchase iPods as secondary devices, with an iOS product
serving as the primary device. Despite these factors, we believe it is prudent to model the
non-iOS iPod business as if it is in secular decline.

Exhibit 29: We assume the non-iOS iPod business is in secular decline

Traditional iPod installed base
120,000
100,000
80,000
60,000
40,000
20,000
0
Dec-01
Dec-03
Dec-05
Dec-07
Dec-09
Dec-11
Dec-13
Aug-02
Aug-04
Aug-06
Aug-08
Aug-10
Aug-12
Aug-14
Apr-03
Apr-05
Apr-07
Apr-09
Apr-11
Apr-13
Ideally, as users churn off out of the iPod installed base, they will convert to iOS devices. In
particular, we believe Apple’s strategy is to convert as many of these users as possible to
the iPod touch product family. We believe the iPod touch serves as a seamless “transition
product” for traditional iPod users to the iOS platform. It represents a low-cost entry point
for the platform that maximizes the installed base for Apple’s developer and media
partners. Therefore we expect Apple’s pricing, R&D and marketing efforts to focus on
speeding up this transition from the traditional iPod to the iPod touch, and this should
result in healthy installed base and unit growth for the device.

Exhibit 30: Apple may try to speed up the transition from traditional iPod to iPod touch
iPod touch installed base and shipments in 000s
60,000
50,000
40,000
30,000
20,000
10,000
0
2007 2008 2009 2010E 2011E 2012E 2013E
Shipments Installed base
Versioning should be more limited with iPod touch

One of the key reasons for the success of the iPod over the past decade has been Apple’s
relentless and targeted product versioning strategy. Although the iPod initially caught the
world’s attention as the leading high-capacity, HDD-based MP3 player, iPod units really
took off as Apple launched the flash versions of the device. These devices allowed Apple to
reach new price points, and most important, smaller form factors. This opened up the TAM
of the iPod considerably, and it eventually led to the demise of most of Apple’s pure play
competition and a 70%-plus share of the domestic MP3 player market.

Exhibit 31: iPod units really took off as Apple launched the flash versions of the device
iPod units in 000s
60,000
50,000
40,000
iPod shuffle
and nano
30,000 introduced
20,000
10,000
0
FY02 FY03 FY04 FY05 FY06 FY07
We believe this versioning strategy, however, will be far more limited with the iPod touch.
Similar to the iPhone, we believe limiting the variation in the screen size and hardware
interface provides developers with a far more uniform installed base, which makes it much
easier to target their application specifications for the largest number of iOS users. As such,
we believe changes in the casing and less-noticeable changes in the screen and input
technology are likely to be the key sources of form factor evolution.

Exhibit 32: We believe limiting the variation in the screen size and hardware interface
provides developers with a far more uniform installed base
The screen size limits

the potential versioning
of the form factors
Source: Image courtesy of Apple.
Furthermore, the underlying software capabilities of the iPod touch should be the same
across all versions of the product, since it is critical that the installed base exhibit as much
OS version uniformity as possible for iOS developers. This, coupled with form factor
constraints, is important because it suggests that Apple’s versioning will be limited to
factors beyond the form factor including price, capacity, and processor speed. These types
of hardware variations will offer differing value points for consumers, but they will not
drastically change the look and feel within the iPod touch product family. This stands in
stark contrast to the wide variety of traditional iPod products that exist today. In the end,
this shouldn’t matter to investors, since we believe the functionality and competitive
differentiation should be largely software-based as Apple’s platform evolves.
Our iPod outlook: It’s all about managed cannibalization

The iPod was the earliest beneficiary of Apple’s platform model, so in contrast to the other
platform spokes, the iPod has already dominated its core market opportunity. Indeed, the
iPod has over 70% of the U.S. market for MP3 players. While this has resulted in minimal
unit growth over the past two years, there’s a lot more going on within the segment than
the overall unit trends would suggest. Indeed, while much of the stand-alone MP3 player
market is being subsumed by smartphones over time, we believe Apple’s iPod touch is
capturing the intermediate opportunity for users that want a handheld computing device
without voice functionality. In our view, this has been particularly attractive to younger
consumers as well as handheld gaming enthusiasts. So while, the traditional iPod business
has declined at a 21.4% average annual rate since 2007, the iPod touch business has
expanded by 372.6%. As a result, we believe Apple is leveraging its iOS platform to
manage and monetize what we view as the inevitable cannibalization of stand-alone MP3
players over time.

We expect this trend to continue, and as a result, we expect traditional iPod units to decline
at an average rate of 23.1% through fiscal 2013 and we expect iPod touch units to expand
at a 13.9% rate. This results in a modest decline in overall iPod units through fiscal 2013,
while the iPod touch expands to 76.7% of the total from 50.4% in fiscal 2010.
Exhibit 33: We expect iPod touch to expand to 76.9% of total iPods by fiscal 2013
Units in 000s
60,000
50,000
40,000
30,000
20,000
10,000
0
FY07 FY08 FY09 FY10 FY11E FY12E FY13E
touch Traditional iPod
Apple TV: A “hobby” with option value

Apple launched Apple TV to much fanfare in 2007, but demand for the device quickly
deteriorated. Apple has since labeled the device as a “hobby” for the company, in contrast
to its four key business units (Macs, iPhones, iPod, and iPad). As a result of lackluster sales
over the past three years and Apple’s self deprecation of the business, we believe most
investors choose to ignore this business segment. From a purely financial perspective, this
makes sense. In spite of this, we believe the device merits some attention as a spoke in
Apple’s platform model, if only for its real option value. In particular, we believe the latest
refresh of Apple TV (September 2010) vastly changes its functionality and gives it a shot to
finally make some headway in the elusive “consumer living room opportunity”, though we
recognize it’s still a long shot.
In particular, we believe there are three key reasons why Apple TV (and competitive
devices) have failed:
 Consumers don’t appear interested in adding another box to their televisions.

 Content providers have been reluctant to agree to affordable pricing mechanisms.
 Storage constraints make seamless content management unattractive.
Apple seems to have addressed the last issue by abandoning local storage completely with
its latest Apple TV iteration. Nevertheless, we believe it’s still an uphill battle to capture the
appropriate content at the right prices, and consumers still don’t seem to be rushing out to
purchase an incremental peripheral for their televisions. Over time, Apple may make more

headway in this market by integrating the technology into an Apple-branded television, but
this doesn’t seem like a near-term project the company would be interested in.
For fiscal 2011, we are forecasting 3.09 million Apple TV units, and we expect that to grow
by 13.3% and 16.3% in fiscal 2012 and fiscal 2013. This translates into revenues of $278
million, $281 million, and $289 million for the next three fiscal years, respectively. While
this would be considered a healthy business trajectory for most companies, it does not
exceed 0.3% of Apple’s total revenues over our forecast period. As such, this is not
currently a critical component of our investment thesis for Apple’s stock. Nevertheless, if
we’re wrong, and the product eventually finds a mass market audience, then this could be
a powerful tool for Apple to dominate the consumer living room. As such, we view this as a
hobby, but a hobby with some interesting real option value.
What new spokes and platform enhancements are on the horizon?

The blogosphere, Wall Street, and many everyday consumers are often obsessed with
predictions on which products Apple may or may not launch in the future. While the sheer
volume of predictions can be somewhat mind numbing, this focus on Apple’s product
pipeline is understandable given the influence Apple’s products can have on the
technology industry. In this section, we outline our assumptions on this topic, with a
specific focus on upcoming iOS product launches (Exhibit 34). These are the same
assumptions we use for our Apple financial model, and as such, this should also help
investors understand the cadence of our EPS and revenue outlook for the company.
Exhibit 34: We believe Apple will have a strong product line up in the first half of 2011,
which should provide several catalysts for the stock
Apple forecasted product line up
Announcement of streaming iTunes and App Store content
Jan Feb Mar Apr May Jun
CDMA iPhone 5G
iPhone released
announced
iPad 2nd generation
Source: Goldman Sachs Research.
The first major product we expect to see from Apple in 2011 is the long-awaited CDMA
version of the iPhone. This will also be one of the most important products from a financial
perspective, since it should offer a healthy boost to Apple’s U.S. iPhone shipment growth.
We expect the product to be announced some time in the March quarter, but we don’t
begin to model shipments until the June quarter. We expect Verizon to be Apple’s key
carrier partner for this product, though we expect Apple to continue to ship the traditional
iPhone through AT&T. Historically, iPhone refreshes occur in June, but this product
appears to be the exception to the rule. There already appears to be widely reported

manufacturing evidence of the device throughout Asia, and we believe Apple has already
put the support infrastructure for the product in place. These data points make it unlikely
Apple will wait until June to release the device. We expect the device to offer the same
capacity points as the current iPhone, and at the same wholesale prices. Although there
has been some concern that Apple would lose some subsidy dollars once its exclusive
relationship with AT&T ends, we would note that this has not occurred in any of the
regions outside of the United States when Apple introduced multiple carriers. As a result of
this launch, we expect U.S. iPhone shipments to grow by 50% year-over-year in Apple’s
June quarter, versus 15% annual growth in the March quarter. For FY2011, we expect 33%
U.S. iPhone shipment growth.
The next product refresh should be the second-generation iPad. We are assuming this
product will be fully available by late March or early April, or a year after the release of the
first-generation iPad. We expect the new iPad to come with a front-facing camera (enabling
the use of FaceTime video chat) and we expect Apple to increase the high-end version’s
storage capacity. Apple currently offers the iPad in 19 countries, and with this second
generation device, we expect Apple will have already broadened the geographic
distribution considerably. We also expect Apple to lower the iPad’s price points by
approximately 10% for each sku, and we have explicitly modeled this reduction in our
financial model. The price cut, expanded distribution, and improved feature set should
further broaden the appeal of the iPad, and we are forecasting 135% annual unit growth in
the June quarter and 134% growth in the September quarter.
In June, we expect Apple to launch the fifth-generation of the traditional iPhone.

Pinpointing June as the month of release is not rocket science, since this has been the
release month for all prior generations of the device. Of course, Apple could presumably
change its product release patterns, but we believe the early supply chain chatter still
suggests this is not the case. We believe the fifth-generation iPhone will look somewhat
similar to the last four versions, but it is likely to be thinner and presumably somewhat
lighter. We also believe it’s reasonable to assume it will include the next generation of
Apple’s A4 microprocessor, and each SKU should have increased storage capacity. We
believe it is also possible the device will have NFC support for mobile payments, but data
on this feature is limited thus far. We do not expect any major change in the retail price of
the device, though we are conservatively modeling modest (single digit) wholesale ASP
declines.
Finally, with the recent completion of Apple’s $1 billion data center in North Carolina, we
believe 2011 will be the year when we finally learn what the company plans to do with it.
We assume that sometime in the first half, possibly at WWDC in June, Apple will begin to
offer streaming iTunes and App Store content for iOS devices. Downloadable content will
still exist, but we believe Apple will increasingly offer streaming as an option. The initial
focus will likely be on iTunes music, but cloud-based apps and video content should
become more common over time as well. We have no specific data points on precisely
when this will occur or what the underlying business model will be, so we are leaving this
particular product launch out of our financial model.
We believe this frenzied product release schedule should offer a steady stream of positive
catalysts for Apple’s stock throughout the first half of the year. Furthermore, the resulting
demand for these devices should allow for healthy revenue and earnings upside in the
second half.

Deep Dive #2: Can the Apple dream turn into a nightmare?
Much of our report has focused on how Apple’s success has been driven by its adroit
platform management over the past decade and why we think this success will continue in
coming years. While we view our analysis as unique, we understand that 89.4% of the sell-
side currently has a Buy rating (or its equivalent) on Apple’s stock, so we believe it is even
more important to consider the potential pitfalls of Apple’s platform model and how that
could impact the stock price.
If Apple’s platform approach eventually fails or its growth hits a wall, we believe there are
effectively two consequences for investors.
1. First, if expectations are sufficiently high before the platform failure is obvious, then
the stock could fall precipitously. Numerous examples of this scenario can be garnered
from the technology bubble collapse a decade ago. Within our coverage universe, EMC
serves as the most notable example. At its peak, the stock traded at $104.31
(representing a $229.12 billion market capitalization) As the technology bubble
unwound, the stock deteriorated rapidly, reaching a low of $3.67 in 2002. We
characterize this as the near- worst case scenario for Apple investors, and of course,
we believe this is a low probability event.
2. The second possible scenario is that Apple’s platform deterioration is less severe and
the company merely reaches a period of stasis or saturation. In this case, the stock
could merely remain within a trading range for a frustratingly long period of time. We
believe Microsoft represents the best example of this, with the stock remaining near its
current $25 stock range for most of the past decade. This occurred after Microsoft
dominated 90-95% of its core market, and more important, after legal actions from the
U.S. Justice Department and European Union effectively blocked off many routes for
Microsoft’s potential expansion. This negative scenario is obviously more preferable
for Apple investors than the more dramatic EMC example.
Given our current optimism over Apple’s platform opportunities, it is difficult for us to
imagine either of these scenarios occurring anytime soon. Nevertheless, we have
attempted to explore these unpleasant possibilities, and we believe they could be preceded
by the following factors:
3. Apple’s installed base begins to erode
4. The installed base shifts to lower profit dollar units
5. Legal or regulatory factors halt or reverse platform expansion
These factors are not meant to replace standard analysis of the company’s key financial
metrics such as revenue, profit and cash flow growth. Nevertheless, we believe these
factors could show cracks in the platform before we begin to see the consequences in the
financial statements. We explore each of these factors in the remainder of this section.
Potential Pitfall #1: An erosion of Apple’s installed base

Key metric: iOS installed base trends
A platform is only as valuable as its installed base. As a result, the growth of Apple’s iOS
installed base should be a key metric for investors to monitor. As discussed earlier in this
report, we estimate that Apple’s iOS installed base has gone from zero to 105.6 million
users since the launch of the iPhone in 2007. If we add the iPod and Apple TV to this
installed base, Apple’s platform users have increased by 551% over the past five years,
representing an average annual increase of 45.5%. While we believe investors should
monitor the installed base for both iOS and the broader iTunes installed base, we currently

believe the iOS installed base is a far better indicator of Apple’s impact on the broader
computing and content markets. Furthermore, we believe Apple’s strategy is to convert as
many of its non-iOS iTunes users to iOS devices over time, further supporting the factors
behind our focus on the iOS installed base.
It should come as no surprise to investors that this particular metric has been astoundingly
positive for Apple in recent quarters. Indeed, we estimate that the iOS installed base
increased by 131.1% in 2009, and then by another 53.8% in the first three quarters of 2010.
Just as we would expect with the platform framework, this growth rate accelerated in the
June quarter of 2010 as the iPad spoke was added to the model.
Exhibit 35: We estimate the iOS installed base grew by 53.8% in the first three quarters of
2010 alone
iOS installed base in 000s
120,000
100,000
80,000
60,000
40,000
20,000
0
Sep-07
Sep-08
Sep-09
Sep-10
Mar-07
Mar-08
Mar-09
Mar-10
Jun-07
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Apple only provides installed base updates for its key products on a fairly sporadic basis,
so there is some analysis required to judge installed base trends. For instance, if we see
quarters where the total units shipped begin to exceed the implied replacement rate for
each platform spoke by a smaller and smaller margin, then we could assume we may be
heading towards a period of platform saturation. We suspect 75% of units coming from
replacements would be the key threshold for this warning sign. More important, Apple
tends to provide fairly regular updates on App store downloads and iTunes songs sold. If
this data suggests that the implied apps downloaded by each installed base user is
declining, this could either signal installed base saturation or a fundamental weakening of
the platform. As a baseline for these metrics, we note that for the September quarter of
2010, we estimated that 39% of iOS shipments were upgrades/replacements, while we
assume that 14.2 apps were downloaded per iOS user in the installed base.
Any sustained decline in the iOS installed base or any sustained stagnation should be an
important warnings sign for Apple investors. Nevertheless, we note the following
confounding factors that could minimize the effectiveness of this metric:
 Any material change in the average replacement rate could trigger a false
alarm. Replacement rate assumptions can be the Achilles heel of any installed base

analysis. We try to keep it simple in our model by assuming a 2-year replacement rate.
This makes the math simpler, irons out seasonal noise, and it seems to foot with
historical installed base comments from Apple’s management. Nevertheless,
replacement rates can change, and such changes are rarely obvious. Furthermore,
replacement rate changes may be ephemeral, triggering false alarms in any installed
base analysis. For instance, during a severe recession, the replacement rates on iOS
devices could decrease as customers delay upgrades. This would lead the model to
assume that a larger portion of device shipments are replacements when they are
actually net additions to the installed base. As such, this would trigger a false alarm on
the long-term health of the platform, and worse, it would prevent investors from
capitalizing on an inevitable cyclical recovery in shipments as the replacement rate
normalizes. Indeed, we believe such a phenomenon occurred in the printing industry
during the recent global recession.
 A high-value spoke (iPad) could cannibalize a lower-value spoke (iPod touch)

without materially impacting the value of the platform. Although we firmly believe
that fears of iPad cannibalization within Apple are overblown, it’s feasible that such
cannibalization could occur over time. Indeed, the iPad could eventually cannibalize the
iPod touch installed base if some users find that they no longer desire the portability
and affordability of the iPod touch. Nevertheless, this would presumably be a good
thing for Apple investors, since the iPad generates far more profit dollars per unit than
the iPod touch. Furthermore, the developer base would presumably prefer this
scenario as well, since the iPad can support richer content than the iPod touch. As we
discuss later, this flaw in the iOS installed base metric can be addressed with a
simultaneous analysis of the average profit dollars per iOS unit.
 Apple could artificially inflate the installed base trends with aggressive pricing,
though this could covertly compress the value of the platform. It seems almost
heretical to suggest that Apple would ever seek to drive installed base with overly
aggressive pricing. With that said, the company recently shown a penchant for testing
mass market price points with its devices so it’s reasonable to consider this scenario. If
Apple’s platform power was deteriorating, the company could presumably extend the
life of its installed base by lowering prices aggressively. This would appear obvious to
investors if the average profit dollars of iOS units deteriorated or if corporate gross
margins declined for an extended period of time. Nevertheless, investors should be
careful with this scenario. In particular, when Apple is launching new products, it often
introduces them with relatively compressed gross margins, and then the margins
expand over time as commodity prices fall at a faster rate than Apple cuts product
prices. We believe this is a desirable platform strategy, and it shouldn’t confused with
a sign of deteriorating platform health. On the other hand, if we see deterioration in
installed base profit metrics without a material product launch, then we may have a
problem.
As a result of these potential problems with the model, we believe a qualitative analysis of
these factors is necessary for any material change in the iOS installed base trajectory. In
addition, these factors suggest that the iOS installed base metric should not be used in
isolation. In the following section, we introduce other metrics that should also be
considered by investors.
Potential Pitfall #2: Deterioration in installed base profitability

>Key metric: Average profit dollars per iOS unit
We believe a decline in the average profit dollars per iOS unit would also serve as an
important warning sign that Apple’s platform dominance was coming under pressure.
Nevertheless, it is important to tie this metric with the installed base growth metric

discussed above. Indeed, a modest decline in average profit dollars per unit should be
palatable to investors if it results in substantial incremental growth in the total number of
iOS users. For instance, if we were to look at Apple’s total product installed base (including
Macs), we would have seen a material decline in profit per unit when the iPod began to
gain momentum in the early part of the decade. Of course, it would have been foolish to
conclude this was a negative sign for the company, since it triggered a significant increase
in the size of the company’s overall installed base. Indeed, this may be the case whenever a
lower ASP product spoke is first launched within the platform (we saw this happen again
when the iPod touch was launched).
While we believe it is also important to monitor gross margin trends for each of the
product spokes in the iOS platform, we believe it is more important to focus on profit
dollars for installed base analysis. The primary reason for this is that since we are working
with spokes that participate in distinct end markets, overall installed base margins could
easily steer us wrong. For example, if the iPad captures significant share in the PC industry
over time, it may end up having lower margins than the iPod touch. This would
presumably lower the average gross margins for the overall installed base. Nevertheless,
we should want the iPad to become a larger business than the iPod touch because it
competes in a market with a much larger profit pool, generates more value for developers,
and it carries far higher profit dollars per unit. In this case, a deteriorating installed base
would be coupled with higher profit dollars per installed base unit, and the latter metric
would be a better indicator of platform health.
Over the past several years, the average profit per unit for the iOS installed base has
hovered around a constant rate, and it has begun to trend upward at an accelerating rate
with the introduction of the iPad and the increasing success of the iPhone (though it comes
down every December quarter, due to the high mix of iPods). This, coupled with the
growth in the size of the installed base, tells us that the platform’s health is improving
rapidly. Clearly the stock’s performance since the iPad was launched suggests investors
already know this, but we believe it’s an important trend to understand nonetheless.
Interestingly, Apple’s recent September quarter earnings release highlighted why too much
focus on near-term gross margin performance can distort the real strategic picture. Apple
missed consensus gross margin expectations for the quarter, and this has caused some
investor angst. But in our view, the positive trends in the installed base dynamics more
than counter the near-term pressure on gross margins. We believe the margins are likely to
improve as commodity prices decline at a faster rate than Apple has to lower its iPad and
iPhone prices in coming quarters, and this is precisely because Apple’s platform is
becoming increasingly robust. It follows that at some point in the future, Apple’s platform
could begin to fail while the company is simultaneously generating better than expected
gross margins. In this case, gross margins could be masking a potentially severe secular
problem.

Exhibit 36: The average profit per iOS unit has begun to trend upward with the
introduction of the iPad and the increasing success of the iPhone
Gross profit per iOS unit
$300
$250
$200
$150
$100
$50
$0
2007 2008 2009 2010
Potential Pitfall # 3: Legal and regulatory hurdles to platform

expansion
>Key Metric: Qualitative analysis
Apple’s platform approach, by definition, can allow the company to obtain a remarkable
amount of control over content providers and customer behavior. This, coupled with the
company’s consumer-centric business model, can easily attract the attention of domestic
and international regulators. For instance, earlier this year the U.S. Federal Trade
Commission and the European Union launched an investigation into Apple’s policies for
software development on its mobile devices. Apple has since eased its restrictions on
developers by allowing third-party development tools and other concessions, and the EU
has now officially dropped the investigation. Furthermore, there has been speculation in
the mainstream press that the U.S. Department of Justice launched an informal inquiry into
Apple’s control of the digital music industry (“Apple is Said to Face Inquiry About Online
Music,“ New York Times, May 25th, 2010). We do not believe these investigations are
surprising and they are quite common for leaders in any industry segment, nonetheless
these types of investigations should be monitored closely by investors.
In most cases, these investigations can be resolved with fairly minor concessions by Apple,
and this was proven with the relatively short-lived EU investigation into Apple’s policies
towards mobile software development. Nevertheless, as we have seen with Microsoft over
the past two decades, more severe antitrust actions can substantially alter a company’s
ability to expand the breadth and profitability of a leading platform. Furthermore,
government investigations can linger for many years, generating substantial uncertainty
for investors. Indeed, Microsoft’s antitrust difficulties began with an FTC inquiry in 1991,
but they didn’t go to trial until seven years later. Furthermore, Microsoft wasn’t able to
settle the case until 2004, more than thirteen years after the inquiry began.

We don’t see any immediate regulatory threats to Apple’s business model, largely because
Apple’s device share remains fairly low in its core markets. Furthermore, as we argue
earlier in this report, we believe the mobile device market will evolve towards an
oligopolistic, not monopolistic market structure. As such, Apple’s market impact should be
far less concerning for regulators than that of Microsoft on personal computing in the
1990s. We believe political winds can change quickly, however, so investors should remain
vigilant in this respect.
Conclusion
With the exception of the legal and regulatory risks, the primary threats to Apple’s platform
value come from two key sources: (1) increased platform competition; and (2) market
saturation. The former threat should presumably come from platform competitors such as
Google, Microsoft, and RIMM. Again, these vendors could begin to erode Apple’s platform
prospects before it becomes obvious in the financial statements, so the aforementioned
risk metrics could become increasingly important over time. As for market saturation, we
believe that the market for mobile device platforms will eventually settle out as an
oligopoly, not a monopoly. In addition to the obvious economic consequences of this
viewpoint, we believe it also suggests it will be challenging to determine when Apple’s
market opportunity is fully saturated. It could happen at 20%, 40%, or even 60% of the total
available market. Whatever the saturation point, we should begin to see signs that the key
platform metrics are stagnating.

Management overview
Exhibit 37: Apple’s Management Team
Name Age Position

Steven P. Jobs 55 Director and Chief Executive Officer
Timothy Cook 49 Chief Operating Officer
Scott Forstall 41 Senior Vice President, iPhone Software Engineering & Platform Experience
Jonathan Ive 43 Senior Vice President, Industrial Design
Ronald B. Johnson 51 Senior Vice President, Retail
Robert Mansfield 49 Senior Vice President, Mac Hardware Engineering
Peter Oppenheimer 47 Senior Vice President, Chief Financial Officer
Phillip W. Schiller 49 Senior Vice President, Worldwide Product Marketing
Betrand Serlet 49 Senior Vice President, Software Engineering
D. Bruce Sewell 51 Senior Vice President, General Counsel and Secretary
Jeff Williams NA Senior Vice President, Operations
Note: Age as of January 26, 2010.

Steven P. Jobs founded Apple in 1976, and he is now the chief executive officer and a
director of Apple. He has also been on the board of Walt Disney Company since it company
purchased Pixar in 2006, and he is the largest individual shareholder of Disney. Mr. Jobs
was Apple’s chairman of the board from 1981 until his resignation in 1985. Thereafter he
founded NeXT, which was a computer company focused on the education market and was
eventually sold to Apple in 1996. The NeXT OS eventually became the core of the operating
system Apple’s businesses depend on today. With the sale of NeXT, Mr. Jobs eventually
came back to Apple as interim CEO, and he became the official CEO in 2000.
Timothy Cook has served as Apple’s chief operating officer since 2005. Cook also oversees
Apple’s Macintosh division. Previously, Mr. Cook was the Executive Vice President of
Worldwide Sales and Operations from 2000-2002, and joined the company in 1998 as
Senior Vice President of Worldwide Operations. Prior to joining Apple, Mr. Cook served as
vice president of Corporate Materials for Compaq, and additionally worked at IBM for 12
years, where he most recently was director of North American Fulfillment.
Scott Forstall is Senior Vice President of iPhone Software at Apple. Mr. Forstall joined
Apple in 1997 and is one of the original architects of Mac OS X and its Aqua user interface.
Prior to joining Apple, Mr. Forstall worked at NeXT developing core technologies.
Jonathan Ive serves as the Senior Vice President of Industrial Design at Apple. He assumed
this role in 1996 and joined Apple in 1992. Mr. Ive worked at the London design agency,
Tangerine, prior to his time at Apple. Mr. Ive is widely credited for being the chief designer
of the iMac, iPod, and iPhone.
Ron Johnson is Senior Vice President of Retail, and joined Apple in January 2000. Mr.
Johnson previously spent 16 years at Target Stores, where he held various management
positions, most recently serving as Vice President of Merchandising.
Bob Mansfield has served as Senior Vice President of Macintosh Hardware Engineering
since 2008. Mr. Mansfield joined Apple in 1999 with Apple’s acquisition of Raycer Graphics,
where Mr. Mansfield was vice president of Engineering. Prior to his time at Raycer
Graphics, Mr. Mansfield was a senior director at SGI, overseeing and working on the
development of various microprocessor designs.
Peter Oppenheimer is Apple’s Senior Vice President and Chief Financial Officer. Mr.
Oppenheimer joined the company in 1996 as controller for the Americas. In 1997 he
became vice president and Worldwide Sales controller, and then subsequently was

promoted to corporate controller. Prior to his time at Apple, Mr. Oppenheimer served as
CFO to one of the four strategic business units at Automatic Data Processing. Mr.
Oppenheimer also worked for six years in the Information Technology Consulting Practice
with Coopers and Lybrand.
Philip Schiller is Apple’s Senior Vice President of Worldwide Product Marketing. Mr.
Schiller rejoined Apple in 1997 after serving as Vice President of Product Marketing at
Macromedia, Inc. from December 1995 to March 1997, and as Director of Product
Marketing at FirePower Systems from 1993 to December 1995. Mr. Schiller previously
worked at Apple for six years in a variety of marketing positions.
Bertrand Serlet, Ph.D., serves as Senior Vice President of Software Engineering and joined
Apple in 1997, with Apple’s acquisition of NeXT. At NeXT, Dr. Serlet held several
engineering and managerial positions. Dr. Serlet also spent four years at Xerox PARC prior
to his time at NeXT.
Bruce Sewell is Apple’s general counsel and Senior Vice President of Legal and
Government Affairs. Mr. Sewell joined Apple in 2009. Prior to Apple, Mr. Sewell worked at
Intel, where he was responsible for Intel’s legal, corporate affairs, and corporate social
responsibility programs. Mr. Sewell joined Intel in 1995, and became vice president and
deputy general counsel in 2001. Prior to his time at Intel, Sewell was a partner in the
litigation firm Brown and Bain P.C.
Jeff Williams is Senior Vice President of Operations and joined Apple in 1998 as head of
worldwide procurement. In 2004 he was named vice president of Operations and since
2007 has run worldwide operations for the iPod and iPhone. Prior to his time at Apple, Mr.
Williams worked in a variety of operations and engineering roles at IBM Corporation from
1985 to 1998.

December 12, 2010
Goldman Sachs Global Investment Research
Appendix: Financial Model
Exhibit 38: Apple Inc. income statement

$ millions, except per-share data
2010 2011E 2012E 2013E

Dec-09 Mar-10 Jun-10 Sep-10 2010 Dec-10E Mar-11E Jun-11E Sep-11E 2011E Dec-11E Mar-12E Jun-12E Sep-12E 2012E Dec-12E Mar-13E Jun-13E Sep-13E 2013E
Revenues $15,683 $13,499 $15,700 $20,343 $65,225 $24,659 $20,296 $20,986 $25,867 $91,807 $30,731 $24,819 $25,572 $29,650 $110,773 $33,570 $27,433 $28,339 $33,048 $122,390
Y/Y % change 32.0% 48.6% 61.3% 66.7% 52.0% 57.2% 50.4% 33.7% 27.2% 40.8% 24.6% 22.3% 21.9% 14.6% 20.7% 9.2% 10.5% 10.8% 11.5% 10.5%
Q/Q % change 28.5% -13.9% 16.3% 29.6% 21.2% -17.7% 3.4% 23.3% 18.8% -19.2% 3.0% 15.9% 13.2% -18.3% 3.3% 16.6%
COGS 9,272 7,874 9,564 12,831 39,541 15,497 12,515 12,987 15,840 56,840 18,621 14,831 15,383 17,951 66,786 20,149 16,215 16,765 19,582 72,711
Gross profit 6,411 5,625 6,136 7,512 25,684 9,161 7,781 7,999 10,026 34,967 12,111 9,988 10,190 11,698 43,987 13,421 11,218 11,574 13,466 49,679
Gross margin 40.9% 41.7% 39.1% 36.9% 39.4% 37.2% 38.3% 38.1% 38.8% 38.1% 39.4% 40.2% 39.8% 39.5% 39.7% 40.0% 40.9% 40.8% 40.7% 40.6%
SG&A 1,288 1,220 1,438 1,571 5,517 1,886 1,827 1,889 2,121 7,723 2,459 2,184 2,250 2,372 9,265 2,518 2,359 2,465 2,611 9,953
% of revenues 8.2% 9.0% 9.2% 7.7% 8.5% 7.7% 9.0% 9.0% 8.2% 8.4% 8.0% 8.8% 8.8% 8.0% 8.4% 7.5% 8.6% 8.7% 7.9% 8.1%
R&D 398 426 464 494 1,782 567 609 630 673 2,478 768 720 767 712 2,967 772 713 793 793 3,072
% of revenues 2.5% 3.2% 3.0% 2.4% 2.7% 2.3% 3.0% 3.0% 2.6% 2.7% 2.5% 2.9% 3.0% 2.4% 2.7% 2.3% 2.6% 2.8% 2.4% 2.5%
Total operating expenses 1,686 1,646 1,902 2,065 7,299 2,454 2,435 2,518 2,794 10,201 3,227 2,904 3,018 3,084 12,232 3,290 3,072 3,259 3,404 13,025
Operating expense ratio 10.8% 12.2% 12.1% 10.2% 11.2% 10.0% 12.0% 12.0% 10.8% 11.1% 10.5% 11.7% 11.8% 10.4% 11.0% 9.8% 11.2% 11.5% 10.3% 10.6%
Operating income 4,725 3,979 4,234 5,447 18,385 6,708 5,345 5,481 7,233 24,766 8,884 7,084 7,172 8,615 31,755 10,131 8,146 8,315 10,062 36,654
Operating margin 30.1% 29.5% 27.0% 26.8% 28.2% 27.2% 26.3% 26.1% 28.0% 27.0% 28.9% 28.5% 28.0% 29.1% 28.7% 30.2% 29.7% 29.3% 30.4% 29.9%
Other income (expense) 33 50 58 14 155 65 65 65 65 260 65 65 65 65 260 65 65 65 65 260

Pretax income 4,758 4,029 4,292 5,461 18,540 6,773 5,410 5,546 7,298 25,026 8,949 7,149 7,237 8,680 32,015 10,196 8,211 8,380 10,127 36,914
Pretax margin 30.3% 29.8% 27.3% 26.8% 28.4% 27.5% 26.7% 26.4% 28.2% 27.3% 29.1% 28.8% 28.3% 29.3% 28.9% 30.4% 29.9% 29.6% 30.6% 30.2%
Income taxes 1,380 955 1,039 1,153 4,527 1,727 1,380 1,414 1,861 6,382 2,282 1,823 1,845 2,213 8,164 2,600 2,094 2,137 2,582 9,413
Tax rate 29.0% 23.7% 24.2% 21.1% 24.4% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5%
Net income—pro forma 3,378 3,074 3,253 4,308 14,013 5,046 4,031 4,132 5,437 18,645 6,667 5,326 5,392 6,467 23,851 7,596 6,117 6,243 7,544 27,501
Net margin 21.5% 22.8% 20.7% 21.2% 21.5% 20.5% 19.9% 19.7% 21.0% 20.3% 21.7% 21.5% 21.1% 21.8% 21.5% 22.6% 22.3% 22.0% 22.8% 22.5%
Post-tax exceptionals 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
GAAP net income 3,378 3,074 3,253 4,308 14,013 5,046 4,031 4,132 5,437 18,645 6,667 5,326 5,392 6,467 23,851 7,596 6,117 6,243 7,544 27,501
EPS—pro forma ex ESO $3.81 $3.50 $3.66 $4.80 $15.87 $5.60 $4.48 $4.58 $5.94 $20.60 $7.31 $5.81 $5.85 $6.98 $25.94 $8.17 $6.56 $6.67 $8.02 $29.42
EPS—pro forma reported $3.67 $3.33 $3.51 $4.64 $15.15 $5.41 $4.30 $4.39 $5.75 $19.86 $7.02 $5.58 $5.62 $6.70 $24.91 $7.86 $6.31 $6.41 $7.72 $28.29
GAAP EPS $3.67 $3.33 $3.51 $4.64 $15.15 $5.41 $4.30 $4.39 $5.75 $19.86 $7.02 $5.58 $5.62 $6.70 $24.91 $7.86 $6.31 $6.41 $7.72 $28.29
Diluted shares outstanding 920 923 927 929 925 933 937 941 945 939 950 955 960 965 958 967 970 974 977 972
Apple Inc. (AAPL)

53
December 12, 2010
Exhibit 39: Apple Inc. segment forecast

$ millions
2010 2011E 2012E 2013E

Revenues $15,683 $13,499 $15,700 $20,343 $65,225 $24,659 $20,296 $20,986 $25,867 $91,807 $30,731 $24,819 $25,572 $29,650 $110,773 $33,570 $27,433 $28,339 $33,048 $122,390
Desktops 1,692 1,532 1,301 1,676 6,201 1,718 1,564 1,499 1,556 6,337 1,584 1,477 1,445 1,497 6,003 1,528 1,429 1,398 1,448 5,804
Portables 2,758 2,228 3,098 3,194 11,278 3,357 3,016 3,393 3,720 13,485 3,686 3,428 3,784 4,189 15,088 4,096 3,814 4,208 4,657 16,774
Total Macs 4,450 3,760 4,399 4,870 17,479 5,075 4,580 4,892 5,276 19,822 5,270 4,905 5,230 5,686 21,091 5,624 5,243 5,606 6,105 22,578
iPod 3,391 1,861 1,545 1,477 8,274 3,124 1,626 1,688 1,409 7,846 2,967 1,587 1,636 1,372 7,562 2,841 1,515 1,584 1,331 7,270
Other music related products and services 1,164 1,327 1,214 1,243 4,948 1,405 1,569 1,299 1,303 5,575 1,541 1,728 1,499 1,484 6,251 1,686 1,857 1,619 1,621 6,783
iTunes Music Store 733 898 633 597 2,861 726 889 627 591 2,832 718 880 621 585 2,804 711 871 615 579 2,776
iPod services and accessories 130 130 130 130 520 127 127 127 127 510 125 125 125 125 499 122 122 122 122 489
App Store 150 197 328 351 1,026 402 417 410 442 1,671 508 548 584 599 2,239 629 656 684 716 2,685
Apple TV 151 102 123 119 495 81 66 66 65 278 79 68 67 67 281 78 70 70 71 289
iAd 0 0 0 46 46 69 69 68 77 284 110 107 102 109 428 146 137 127 133 543
iPhone and related products and services 5,578 5,445 5,334 8,822 25,179 8,820 7,224 7,265 10,603 33,912 11,210 9,150 9,137 12,031 41,529 12,423 10,207 10,167 13,719 46,515
iPad and related products and services 0 0 2,166 2,792 4,958 5,019 4,057 4,677 6,005 19,758 8,384 6,063 6,769 7,656 28,872 9,478 7,062 7,912 8,684 33,135
Peripherals and other hardware 469 472 396 477 1,814 535 543 455 544 2,077 610 619 519 620 2,367 695 705 592 707 2,699
Software, service and other sales 631 634 646 662 2,573 681 697 711 728 2,818 750 767 782 801 3,099 825 844 860 881 3,409
Units
Desktops 1,234 1,147 1,004 1,242 4,627 1,215 1,140 1,100 1,180 4,635 1,185 1,170 1,155 1,235 4,745 1,201 1,188 1,173 1,255 4,816
Portables 2,128 1,796 2,468 2,643 9,035 2,900 2,560 2,842 3,126 11,428 3,352 3,119 3,409 3,795 13,676 4,004 3,725 4,071 4,534 16,334
Total Macs 3,362 2,943 3,472 3,885 13,662 4,115 3,700 3,942 4,306 16,063 4,537 4,289 4,564 5,030 18,421 5,204 4,913 5,244 5,789 21,149
iPod 20,970 10,855 9,406 9,051 50,282 18,900 9,451 9,743 8,766 46,860 18,087 9,711 9,754 8,913 46,465 18,981 10,151 10,278 9,425 48,835
Apple TV 750 500 600 700 2,550 900 720 720 749 3,089 973 827 828 869 3,498 1,087 978 978 1,027 4,070
iPhone 8,737 8,752 8,398 14,102 39,989 14,870 12,036 12,068 18,597 57,571 20,081 16,184 15,828 23,361 75,453 25,040 20,103 19,689 28,678 93,510
iPad 0 0 3,270 4,188 7,458 7,543 6,029 7,675 9,804 31,051 13,704 9,839 11,628 13,131 48,301 16,223 11,984 14,088 15,442 57,737
ASP
Desktops $1,371 $1,336 $1,296 $1,349 $1,340 $1,414 $1,372 $1,363 $1,319 $1,367 $1,337 $1,262 $1,251 $1,212 $1,265 $1,273 $1,203 $1,193 $1,154 $1,205
Portables $1,296 $1,241 $1,255 $1,208 $1,248 $1,158 $1,178 $1,194 $1,190 $1,180 $1,099 $1,099 $1,110 $1,104 $1,103 $1,023 $1,024 $1,033 $1,027 $1,027
Total Macs $1,324 $1,278 $1,267 $1,254 $1,279 $1,233 $1,238 $1,241 $1,225 $1,234 $1,162 $1,144 $1,146 $1,130 $1,145 $1,081 $1,067 $1,069 $1,055 $1,068
iPod $162 $171 $164 $163 $165 $165 $172 $173 $161 $167 $164 $163 $168 $154 $163 $150 $149 $154 $141 $149
Apple TV $206 $206 $206 $173 $197 $89 $89 $89 $85 $88 $80 $80 $80 $76 $79 $72 $72 $72 $69 $71
iPhone $620 $600 $595 $610 $607 $572 $571 $563 $541 $560 $534 $540 $542 $488 $523 $474 $484 $482 $451 $471
iPad $0 $0 $640 $645 $643 $642 $648 $584 $587 $612 $586 $588 $554 $555 $570 $557 $559 $532 $533 $545
Gross profit 6,411 5,625 6,136 7,512 25,684 9,161 7,781 7,999 10,026 34,967 12,111 9,988 10,190 11,698 43,987 13,421 11,218 11,574 13,466 49,679
Total Macs 1,251 1,043 1,203 1,243 4,739 1,319 1,213 1,347 1,477 5,356 1,441 1,322 1,412 1,542 5,717 1,542 1,419 1,520 1,662 6,143
iPod 1,058 544 445 361 2,408 866 465 483 417 2,231 829 462 492 410 2,193 810 444 483 409 2,146
Other music related products and services 237 286 219 224 966 255 317 261 265 1,099 298 363 314 315 1,289 341 403 351 357 1,451
iPhone and related products and services 3,384 3,249 3,000 4,190 13,823 4,380 3,735 3,675 5,035 16,825 5,647 4,787 4,759 5,803 20,995 6,119 5,241 5,204 6,749 23,313
iPad and related products and services 0 0 826 1,049 1,875 1,884 1,562 1,745 2,320 7,511 3,375 2,520 2,689 3,077 11,662 4,031 3,120 3,435 3,677 14,264
Peripherals and other hardware 84 94 71 86 336 96 98 82 98 374 110 111 93 112 426 125 127 107 127 486
Software, service and other sales 397 408 374 359 1,537 361 391 405 415 1,572 412 422 430 441 1,705 454 464 473 485 1,875
Gross margin 40.9% 41.7% 39.1% 36.9% 39.4% 37.2% 38.3% 38.1% 38.8% 38.1% 39.4% 40.2% 39.8% 39.5% 39.7% 40.0% 40.9% 40.8% 40.7% 40.6%
Total Macs 28.1% 27.7% 27.3% 25.5% 27.1% 26.0% 26.5% 27.5% 28.0% 27.0% 27.3% 27.0% 27.0% 27.1% 27.1% 27.4% 27.1% 27.1% 27.2% 27.2%
iPod 31.2% 29.2% 28.8% 24.5% 29.1% 27.7% 28.6% 28.6% 29.6% 28.4% 27.9% 29.1% 30.1% 29.9% 29.0% 28.5% 29.3% 30.5% 30.7% 29.5%
Other music related products and services 20.4% 21.6% 18.0% 18.0% 19.5% 18.2% 20.2% 20.1% 20.3% 19.7% 19.3% 21.0% 21.0% 21.2% 20.6% 20.2% 21.7% 21.7% 22.0% 21.4%
iPhone and related products and services 60.7% 59.7% 56.2% 47.5% 54.9% 49.7% 51.7% 50.6% 47.5% 49.6% 50.4% 52.3% 52.1% 48.2% 50.6% 49.3% 51.3% 51.2% 49.2% 50.1%
iPad and related products and services 0.0% 0.0% 38.1% 37.6% 37.8% 37.5% 38.5% 37.3% 38.6% 38.0% 40.3% 41.6% 39.7% 40.2% 40.4% 42.5% 44.2% 43.4% 42.3% 43.0%
Peripherals and other hardware 18.0% 20.0% 18.0% 18.0% 18.5% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0%
Software, service and other sales 62.9% 64.4% 57.8% 54.2% 59.7% 53.0% 56.0% 57.0% 57.0% 55.8% 55.0% 55.0% 55.0% 55.0% 55.0% 55.0% 55.0% 55.0% 55.0% 55.0%
Apple Inc. (AAPL)

54
December 12, 2010
Exhibit 40: Apple Inc. balance sheet

$ millions
2010 2011E 2012E 2013E

Assets
Cash $7,609 $10,018 $9,705 $11,261 $11,261 $11,619 $12,293 $12,711 $13,429 $13,429 $13,828 $14,174 $15,047 $15,394 $15,394 $15,686 $15,667 $16,675 $17,158 $17,158
Short-term investments 17,187 13,137 14,583 14,359 14,359 14,815 16,121 16,669 17,611 17,611 18,133 18,587 19,731 20,186 20,186 20,570 20,545 21,866 22,500 22,500
Cash & short-term investments 24,796 23,155 24,288 25,620 25,620 26,434 28,414 29,380 31,040 31,040 31,961 32,761 34,778 35,580 35,580 36,256 36,211 38,541 39,658 39,658
Inventories 576 638 942 1,051 1,051 1,148 1,001 1,299 1,320 1,320 1,379 1,186 1,538 1,496 1,496 1,493 1,297 1,676 1,632 1,632
Accounts receivable 3,090 2,886 3,447 5,510 5,510 5,405 4,893 5,520 7,087 7,087 6,736 5,984 6,726 8,123 8,123 7,358 6,614 7,453 9,054 9,054
Deferred tax assets 1,180 1,142 1,216 1,636 1,636 1,660 1,600 1,680 1,750 1,750 1,780 1,700 1,760 1,850 1,850 1,880 1,800 1,860 1,950 1,950
Other 3,690 4,515 6,140 7,861 7,861 9,190 8,142 8,393 9,631 9,631 11,127 9,220 10,003 10,840 10,840 11,951 10,051 11,176 11,798 11,798
Total current assets 33,332 32,336 36,033 41,678 41,678 43,837 44,050 46,272 50,828 50,828 52,983 50,852 54,806 57,889 57,889 58,937 55,974 60,706 64,092 64,092
Net property, plant and equipment 3,115 3,504 3,990 4,768 4,768 5,802 6,765 7,631 8,622 8,622 9,456 9,928 10,229 11,514 11,514 12,433 12,910 13,336 14,063 14,063
Long-term investments 15,024 18,549 21,551 25,391 25,391 30,778 32,624 37,192 41,283 41,283 48,507 53,212 57,735 63,798 63,798 72,347 78,713 83,593 90,949 90,949
Goodwill and other 2,455 2,668 3,151 3,346 3,346 3,681 3,717 3,755 4,130 4,130 4,543 4,588 4,634 5,098 5,098 5,608 5,664 5,720 6,292 6,292
Total assets 53,926 57,057 64,725 75,183 75,183 84,097 87,157 94,849 104,863 104,863 115,489 118,581 127,404 138,299 138,299 149,324 153,260 163,356 175,396 175,396
Liabilities & shareholders' equity

Accounts payable 6,511 5,666 8,469 12,015 12,015 12,907 10,698 12,666 14,755 14,755 15,509 12,678 15,003 16,722 16,722 16,782 13,860 16,351 18,241 18,241
Short-term deferred revenue 2,590 2,542 2,691 2,984 2,984 3,000 3,100 3,200 3,300 3,300 3,400 3,500 3,600 3,800 3,800 4,000 4,100 4,200 4,400 4,400
Accrued expenses 3,996 4,021 4,452 5,723 5,723 6,904 6,495 6,548 7,243 7,243 8,605 7,942 7,979 8,302 8,302 9,400 8,779 8,842 9,386 9,386
Total current liabilities 13,097 12,229 15,612 20,722 20,722 22,812 20,292 22,414 25,298 25,298 27,514 24,120 26,582 28,824 28,824 30,181 26,739 29,393 32,027 32,027
Long-term deferred revenue 922 941 1,021 1,139 1,139 1,162 1,162 1,185 918 918 936 936 955 740 740 754 754 769 596 596
Other liabilities 4,139 4,539 4,981 5,531 5,531 6,886 8,036 9,051 10,612 10,612 11,936 12,696 13,247 15,249 15,249 16,906 17,766 18,550 20,186 20,186
Total liabilities 18,158 17,709 21,614 27,392 27,392 30,860 29,490 32,650 36,827 36,827 40,386 37,752 40,784 44,812 44,812 47,841 45,259 48,712 52,809 52,809
Shareholders' equity 35,768 39,348 43,111 47,791 47,791 53,237 57,667 62,199 68,036 68,036 75,103 80,829 86,621 93,487 93,487 101,483 108,000 114,643 122,588 122,588
Total liabilities & shareholders' equity 53,926 57,057 64,725 75,183 75,183 84,097 87,157 94,849 104,863 104,863 115,489 118,581 127,404 138,299 138,299 149,324 153,260 163,356 175,396 175,396
Apple Inc. (AAPL)

55
December 12, 2010
Exhibit 41: Apple Inc. cash flow statement

$ millions
2010 2011E 2012E 2013E

Cash from operating activities
Net income $3,378 $3,074 $3,253 $4,308 $14,013 $5,046 $4,031 $4,132 $5,437 $18,645 $6,667 $5,326 $5,392 $6,467 $23,851 $7,596 $6,117 $6,243 $7,544 $27,501
Depreciation & amortization 209 216 273 329 1,027 395 325 336 414 1,469 492 397 409 474 1,772 537 439 453 529 1,958
Other 636 702 629 376 2,343 700 718 723 651 2,792 773 788 785 689 3,036 780 767 769 692 3,009
Δ Working capital 1,558 (1,662) 646 670 1,212 746 (753) 867 (13) 846 982 (463) 525 (40) 1,005 986 (523) 251 365 1,078
Net cash provided by operating activities 5,781 2,330 4,801 5,683 18,595 6,886 4,320 6,057 6,489 23,751 8,913 6,049 7,112 7,590 29,664 9,899 6,800 7,716 9,131 33,546
Cash from investing activities

Acquisitions (5) (352) (321) (76) (754) 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Investments (3,577) 543 (4,514) (3,547) (11,095) (5,843) (3,152) (5,116) (5,033) (19,143) (7,747) (5,159) (5,667) (6,517) (25,091) (8,932) (6,341) (6,202) (7,990) (29,465)
Capital expenditures (376) (274) (595) (760) (2,005) (1,085) (893) (923) (1,138) (4,040) (1,168) (943) (972) (1,127) (4,209) (1,074) (878) (907) (1,058) (3,916)
Net cash used in investing activities (3,958) (83) (5,430) (4,383) (13,854) (6,928) (4,045) (6,039) (6,171) (23,183) (8,915) (6,103) (6,639) (7,644) (29,300) (10,007) (7,219) (7,109) (9,047) (33,382)
Cash from financing activities

Net common stock issuance (repurchase) 523 162 316 256 1,257 400 400 400 400 1,600 400 400 400 400 1,600 400 400 400 400 1,600
Net cash used in financing activities 523 162 316 256 1,257 400 400 400 400 1,600 400 400 400 400 1,600 400 400 400 400 1,600
Net increase (decrease) in cash 2,346 2,409 (313) 1,556 5,998 358 675 418 718 2,168 398 346 873 347 1,964 292 (19) 1,008 483 1,764
Cash at beginning of period 5,263 7,609 10,018 9,705 5,263 11,261 11,619 12,293 12,711 11,261 13,429 13,828 14,174 15,047 13,429 15,394 15,686 15,667 16,675 15,394
Cash at end of period 7,609 10,018 9,705 11,261 11,261 11,619 12,293 12,711 13,429 13,429 13,828 14,174 15,047 15,394 15,394 15,686 15,667 16,675 17,158 17,158
Apple Inc. (AAPL)

56
Reg AC
I, Bill Shope, CFA, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or
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Bill Shope, CFA: America-IT Hardware/Systems.
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Price target and rating history chart(s)

Apple Inc. (AAPL) Stock Pric e Currency : U.S. Dollar
Goldman Sachs rating and s tock price target history
300 1,600
185 200 125 175 220
210
250 110 160 1,400
195
145
200 105 130 1,200
115 125
150 1,000
230 270
190
220 240
100 205 220 800
175
50 600
Dec 14 Jun 10
Stock Price
Index Price
B N CS
N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S
2007 2008 2009 2010
Source: Goldman Sachs Investment Res earc h for ratings and pric e targets ; Fac tSet clos ing prices as of 9/30/2010.
Rating Cov ered by c urrent analys t
Price target
Price target at remov al Not c ov ered by c urrent analys t
S&P 500
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December 12, 2010

Resuming coverage with CL-Buy: platform opportunity still nascent

Americas Technology Peer Group Average

Key data Current

Valuation Price performance chart

The Goldman Sachs Group, Inc. Global Investment Research

Apple Inc.: Summary Financials

Capital expenditures (2,005.0) (4,039.5) (4,209.4) (3,916.5)

Dividends paid (common & pref) 0.0 0.0 0.0 0.0

Bill Shope, CFA Stephen Oshman

Cristina Colon, CMA

Goldman Sachs Global Investment Research 2

Goldman Sachs Global Investment Research 3

Investment view: A disruptive platform with plenty of room for

Investment theme #1: The platform opportunity is still in its early

Goldman Sachs Global Investment Research 4

Operating expenses Revenues

Source: Company data.

Goldman Sachs Global Investment Research 5

Source: Goldman Sachs Research estimates.

Investment theme #2: We believe gross margins have already

Goldman Sachs Global Investment Research 6

39% iPhone introduced 43%

Source: Company data, Goldman Sachs Research estimates.

Goldman Sachs Global Investment Research 7

Goldman Sachs Global Investment Research 8

Market share (PCs + Tablets)

Source: IDC, November 2010, Goldman Sachs Research estimates.

Key risks to our investment thesis

A double-dip recession could dampen Apple’s growth and margins

Platform competition is only increasing

Goldman Sachs Global Investment Research 9

Legal and regulatory barriers could arise

Apple’s management succession plans are still murky

Revenue growth has upside potential

Goldman Sachs Global Investment Research 10

Margin assumptions may be too cautious

Our earnings outlook is above consensus for 2011-12

Cash management could improve

Goldman Sachs Global Investment Research 11

manufacturing process equipment expansion, as well as corporate facilities and

Exhibit 6: Apple earnings outlook

FY10 FY11E FY12E FY13E

Gross profit 25,684 34,967 43,987 49,679

Operating income 18,385 24,766 31,755 36,654

Net income 14,013 18,645 23,851 27,501

Diluted shares outstanding 925 939 958 972

EPS—pro forma $15.15 $19.86 $24.91 $28.29

Source: Company data, Goldman Sachs Research estimates.

Goldman Sachs Global Investment Research 12

Comparative valuation analysis implies upside

Exhibit 7: Apple’s P/E is at the low end of its historical range

One-Year Five-Year Ten-Year

Source: FactSet, Goldman Sachs Research estimates.

Enterprise value to next twelve months (NTM) sales

One-Year Five-Year Ten-Year

Source: FactSet, Goldman Sachs Research estimates.

Goldman Sachs Global Investment Research 13

Enterprise value to last twelve months (LTM) sales