Mostly in Cash

I am mostly in cash, the only long I have is an AAPL June 220 Put sold for $5.  My AOL and BP shorts are doing a good job keeping me above water on big down days.  I only wish I had sold more than 100 shares of AOL short at $24.  I have been keeping track of the institutional ownership of AOL, as of a week ago Google Finance reported that AOL had institutional ownership of 84%, this morning that has dropped to 81%.  I think institutions will slowly drop AOL shares as they realize that this company is not going to make a turnaround.

Even buying Apple at $220 seems a little too bullish this morning.  I'll stick to my guns though as I agree with Stefan Sidahmed that Apple's crisis September 2010 price should be around $195, derived from fiscal year earnings of $15 and a crisis P/E multiple of 13 that Apple sported during the previous 2008 crash (when using revised earnings).  So buying in at an effective $215 leaves only 10% downside risk.

There are two potential problems with this model, either that Apple's earnings fall short of $15 or that the market prices Apple to even lower valuations that during the 2008 crisis.  Apple has already earned $7 of these $15 to earn by September, I think they will make it there with the inclusion of iPad sales and a strong iPhone refresh.  I estimate that every 1 million iPads sold will add closer to $0.20 in earnings than the $0.10 others have estimated.  Using an ASP of $600, 1 million iPads yields $600 million in revenues.  During the last conference call Apple reiterated several times that the iPads were very competitively priced with lower than average margins.  However, to me it came off as an excuse to hoodwink their analysts and guide really low once again.  Using a gross margin of 35% on iPad sales, a little lower than Apple's 39-40% overall gross margin they've been running, and Apple's 29% corporate tax rate: $600 million * (.35) * (1 - .29) = $149 million.  $149 million / 910 million shares = $0.164.  From there, it's easy to see how 2 million iPads sold in this quarter and 3 million in the next could add almost $1 in earnings.

I think the 35% margin is consistent with parts cost estimates from iSuppli.  The component and assembly costs do not include the entire cost of the product, for comparison Apple's iPhone 3GS gross margin is estimated to be about 45-50% with component costs of $174 and ASP of $550.

The other problem with the model is that Apple could be discounted to a valuation even lower than that seen during the 2008 crisis.  In that case, I will have much larger problems than the value of my portfolio.