Awaiting Apple's Breakout

As Apple Inc. (Nasdaq: AAPL) appears relegated to a narrowing 2011 price channel, I can't help but wonder in which direction it will break out. I know it's a good company with stellar products and a dedicated cult following customer base. But what about its dependence on consumers' shrinking discretionary income in this jobless "recovery"?

For decades now, Apple has led the way with some of the sleekest, most functional products and the top-rated service of any consumer electronics producer. By a process of almost extreme vertical integration seen nowhere else in the industry, Apple has a tight rein on quality control -- and charges a premium for it.

At its Worldwide Developers Conference this week, ailing Apple CEO and visionary Steve Jobs unveiled the company's iCloud synching service, which promises to keep users documents, books, photos, music, calendars, apps, and more that users store on their Apple devices backed up remotely to storage at Apple's new datacenter in Maiden, N.C. Additionally, the company's new iTunes Match service addresses a pain point for consumers and record companies. It allows the conversion of non-iTunes (including pirated) music to legal, high-quality iTunes files.

The development and release of iTunes Match and iCloud demonstrate that Apple has its finger on the pulse of both consumers and the entertainment industry, and that it can identify these pain points and provide easy, integrated solutions. In the past 10 years, Apple has developed and conquered new niches by providing "Blue Ocean" products that revolutionize and dominate their segments (think iPod, iPhone, iPad).

Because of Apple's extreme level of vertical and horizontal product integration, its technologies mesh well together (sometimes exclusively), and drive consumer demand for second, third, or tenth Apple products.

My main concern in all of this success is its source, Steve Jobs. Jobs is undoubtedly one of the most successful corporate visionaries of this generation, but what would happen to Apple's growth and product development if Jobs were no longer at the helm? More importantly for investors, how would his departure affect the valuation of Apple?

Looking in the rear-view mirror, Apple has grown nearly 60% year-over-year in the past five years. Going forward, I'm projecting that rate to fall in a 12% to 14% range (although consensus is at 20.9%). Apple's free cashflow margin has been consistently increasing to the current 17% level, and with little downside at current manufacturing volume, I feel 15% to 19% is a good range for this input.

Using those forward assumptions in light of the Steve Jobs “X-factor,” I believe Apple can justify a baseline price target at $408, up to an optimistic price target of $434. That’s less than consensus at $450 but still much higher than its current trading level of $332.

Technically, we’re seeing a consolidating channel, out of which I would expect to see a positive movement on strong volume. That would be my buying signal. I would normally be a buyer near the bottom of the channel, but the decreasing volume supporting each bounce off the bottom of the channel has me concerned about a further move south.

Long term, Apple’s pricing should reach a valuation level of more than $400. But in the short term, I would hold off an acquisition until the upward momentum has been established by the channel breakout.