Valuing Apple Inc: Pricing the “Jobs Put Option”
Overview
Today’s article in Bloomberg got me thinking about how investors are dealing with the uncertainty surrounding Steve Jobs, namely the possibility of his removal in the wake of the options backdating scandal. However, I think this mis-characterizes the true underlying fear investors have (and which is the real risk facing the stock): the negative impact on Apple’s share price given Job’s departure, regardless of reason. It just happens that the backdating scandal is currently in the forefront of most investors’ minds, yet this is a man that has fought cancer, and faces that same risks that any of us do who buy insurance to protect our families and loved ones given an unexpected adverse event. Yet I’m not confident that this is how investors are valuing Apple’s shares, and pricing in the array of risks facing Jobs (and, therefore, Apple investors) in an insurance oriented, value-weighted, probabilistic manner.
Apple’s shares have behaved like a yo-yo as different
interpretations of the SEC and DoJ’s likely actions concerning Job’s
role in options backdating have come to light:
Jan. 17 (Bloomberg) — Apple Inc. may find its most valuable
asset is something it can’t protect through patents or secrecy:
Chief Executive Officer Steve Jobs.If Jobs were to leave, shares of the Cupertino, California-
based company might drop 25 percent or more, analysts say. That
would erase about $20 billion in Apple’s market value.
“It would be a disaster,” said Gene Munster, an analyst
with Piper Jaffray & Cos. in Minneapolis, who’s had an
“outperform” rating on Apple’s shares since June 2004. “He
would be almost impossible to replace.”The computer maker’s dependence on its CEO was illustrated
the last week of December, when the stock dropped as much as 5.8
percent after the Recorder, a San Francisco-based legal
publication, reported Apple had faked documents to backdate stock
options.
On Dec. 29, the company said its own investigation, led by
Apple director and former U.S. Vice President Al Gore, cleared
Jobs of any wrongdoing. That eased concern Jobs may have to step
down and sent the shares up 4.9 percent.********************
When “analysts” say the shares might lose $20 billion in value, how are they quantifying this amount? Are the oscillations of Apple’s share price when each piece of news concerning the options investigation come to light reflective of shifting probabilities of his ouster, or something on a more visceral level? I don’t know. But I’d certainly like to know.
Analysis
As an ex-derivatives guy, it seems to me that the rational investor would value Apple’s shares in the following fashion:
Fair Market Value of Common Shares (Apple) = PVFCF (Apple) - Put (Impact of Jobs’ departure)
And to value the “Jobs Put” correctly, one needs to consider the following three factors. And this analysis needs to be run for each of the different risks that could give rise to Jobs leaving Apple’s helm:
- The timing of an adverse outcome
- The likelihood of an adverse outcome
- The negative payoff associated with an adverse outcome
These are all complex issues, but the negative payoff is certainly the most difficult to quantify. How much of Jobs’ DNA has been embedded in the organization? How deep is the creative bench at Apple? What is the real value of his PR glamour status? How long would it take for his departure to impact the fundamentals of the stock? Is he the single most valuable executive in the U.S. today? All hard yet critical questions to consider when seeking to quantify the absolute impact of his not being the CEO of Apple. But, of course, this number needs be discounted by the probability of his not being CEO together with the timing of when this outcome might occur. What the rational investor should probably do is construct a matrix of possible scenarios by flexing factors 1-3 above, and build a range of values for the Jobs Put that is netted against Apple’s discounted free cash flow projections.
Conclusion
The Apple situation is very interesting. I’m not sure I can think of another firm whose share price is so inextricably tied to its CEO, a person whom is facing an array of serious risks that could be of great consequence to the firm. And it is precisely because of this unique dynamic that Apple’s share price subjects itself well to an options pricing framework, essentially bifurcating the value of the firm into two distinct pieces: Apple (with Jobs) - Apple (without Jobs) = Value of Jobs Put, or by shifting terms;
Apple (without Jobs) = Apple (with Jobs) - Value of Jobs Put
Whether Apple investors are aware of it or not, they are short an option - a big, valuable put option, which they should be attempting to value. If not, may the force be with them. And be careful out there.
