Revenue: $41.1 billion (AAPL guidance: $41-43 billion/Consensus: $42.5 billion)
GM: 38.1% (AAPL guidance: 37.5-38.5%/Consensus: 38.5%)
EPS: $9.55 (Consensus: $10.07)
Product Unit Sales and Commentary
Macs: 3.7 million (8% yoy decline)
iPad: 15.5 million (31% yoy growth)
iPod: 6.1 million (20% yoy decline)
iPhone: 36.5 million (4% yoy growth)
Unless earnings estimates come down drastically in the coming days, I expect Apple to miss consensus EPS on Tuesday.
In terms of 3Q13 guidance, I am expecting revenues of approximately $30-32 billion and 38-39% margins (which would equate to EPS of approximately $6.20-$6.40, or a 30% decline from 2012). The prospect of no new product launches until CY3Q13 (i.e. after June 30) will pressure iPad and iPhone sales.
Apple is currently in somewhat of a financial funk as the company battles Wall Street’s expectations game. The high-end smartphone market is becoming saturated, while the booming success of the tablet market is resulting in difficult yoy unit sale numbers. Heading into 1Q13 earnings, I thought the market was already expecting bad news, including weak guidance. I was wrong. Heading into 2Q13 earnings, consensus is for an EPS decline, but I am not convinced the Street is being realistic with 3Q13 and 4Q13 expectations as consensus numbers still look aggressive.
Quick Note on Capital Management
Some observers are predicting Apple management may try to shift attention away from weak guidance on Tuesday by announcing its latest thoughts on capital management. While anything is possible, I’m not convinced of that tactic’s effectiveness. Instead, Apple may be better suited to let the dust settle from the current earnings cycle before acting on its updated capital plan. At the current trajectory, Apple may be in a position to announce a multi-year share buyback authorization representing up to 20% of outstanding shares. More importantly, management will probably have to address its $94 billion of offshore cash as Apple has “only” $43 billion of cash currently available for capital management. A growing number of industry observers think raising debt is part of Apple’s solution to its offshore cash “problem”. While there may be financial merit in raising debt in the current environment, such an action would mark a significant new chapter in Apple’s history.
Google continues to expand its public R&D effort for Project Glass, recently announcing a call for developers to become part of the early program. While many tech adopters are becoming downright giddy towards Google Glass, I have a number of reservations about the product, but more importantly the larger implications of how technology evolution will impact society.
In a Google+ post advertising the Glass developer program, Google wrote, “[w]e’re developing new technology that is designed to be unobtrusive and liberating, and so far we’ve only scratched the surface of the true potential of Glass.”
On its surface, that brief description sounds promising. Who wouldn’t want to be liberated by additional technology, all the while still feeling secure and in a weird way; human? Of course, in its current form, Google Glass doesn’t come close to those accolades as wearing a computer on one’s face doesn’t exactly seem like an advancement for less obtrusive technology.
As smartphone and tablet proliferation continues, the limitations surrounding tech gadgets is becoming clear. With iPhone in hand, potential is unlimited as the ability to capture the surrounding world, all the while harnessing the web through curated user interfaces (apps), proves to be quite an attractive proposition. However, once a user is away from their phone (or tablet), the gadget’s usefulness is hard to measure. The preceding situation demonstrates a major inefficiency in hardware; physical dependency, which time will eventually dissolve as society moves towards a gadgetless world (don’t worry there’s still time to enjoy phones and tablets).
There are tangible signs that the world is already entering a new phase of mobile computing; wearable technology. At what may come as a surprise, Nike (via Nike+ FuelBand) and Disney (via MagicBand) seem to be leading the wearable technology army having announced inexpensive (or in Disney’s situation, free) wearable computing products. Of course, one could argue that such focused applications don’t go beyond niche needs or uses, but for that matter, wearable technology, like any disruptive force, will begin with niche uses. Add in Google Glass, and circulating iWatch/iBand rumors, and it becomes clear that the mobile computing industry may be ready to move.
In its current concept, Google Glass represents the key risk to the next phase of computing; letting technology control society while reducing user optionality. While the ability to take a picture or video of anything, at any time, through a camera near my eye may sound appealing, society can do exactly that now with a phone, which could then be easily put away and ignored. If the resulting argument is “just take off the Google Glasses then”, the added benefit of having such a device is then questioned. Early supporters of the device reiterate that Project Glass is just getting started and the possibilities are endless. While that statement may be true, it lacks the justification for why the initial product should deserve endless praise simply for being introduced. I’m sure other companies could release products that seem cool for a few hours only to discover major conceptual concerns.
Google isn’t shy in portraying Google Glass as a way to improve one’s quality of life through access to information. Having to wear a computer on one’s face doesn’t ring as some kind of industrial design breakthrough, especially compared to a simple bracelet or watch which could serve many functions by just being casually worn; hidden away under clothing. Technology can then truly melt away into the background. Having an endless amount of information at one’s disposable is not guaranteed to be a benefit and if handled incorrectly, which many companies are doing now, negative consequences are born.
Where is Project Glass headed? Judging from Google’s videos, the Project Glass team will initially try to find niche uses for Google Glass, including recreational airplane pilots, skydiving schools, taxi drivers, and circus acts. Of course, each one of those niches raises serious concerns if glasses would even be practical (and safe) in those scenarios, but that’s besides the point. Google has plenty of talent dedicated to Project Glass, which may very well open future doors for the initiative. Criticisms surrounding price and practicality for visually impaired users are somewhat misplaced as those two criteria could probably be solved somewhat easily and quickly. More importantly, Project Glass will give Google data about mobile and wearable computing; data that Nike has already been collecting, and which Disney will soon be. (It’s debatable how valuable such data is to a company. Wall Street loves it, but that’s hardly a ringing endorsement.)
While some are in a rush to applaud Google for publicly airing its R&D and introducing new products for the sake of introducing new products, it’s important to remember that tech companies don’t just sell products, but also values. For wearable computing to become a formidable force, a company’s values and beliefs will prove to be more important than the device itself. Technology has the ability to ruin society through excess noise and information. While some companies hold that fear close to heart, others seem content to usher in that doomsday scenario.
Apple’s 1Q13 results were largely in-line with my expectations.
While I was pleased with the quarter, my estimates were considered somewhat bearish compared to the crowd; so needless to say, there were more disappointed faces than smiles. Apple reported healthy growth metrics for iPhone and iPad, while iPhone ASP remained strong and iPad ASP declined due to the iPad mini.
Management altered the way guidance is presented. While the reasoning was not disclosed, I don’t think its much of a stretch to assume its management’s way of ending analysts’ nasty habit of severely overestimating guidance. When Apple’s earnings report was initially released, the stock was trading in the $490-$495 range. Guidance seemed to be of Apple’s conservative nature - in that case, guidance was O.K. When Apple clarified that it would no longer give EPS guidance, but instead release ranges (including upper limits) for several line-items used to reach EPS, the stock quickly fell to the $460-$465 range as guidance was considered NOT O.K. (it can be debated what management meant by guidance ranges, but I am assuming Apple’s actual results will fall within these ranges).
I didn’t find Apple’s 2Q13 guidance (with the new ranges) to be overly concerning. Going into the quarter, I knew 2Q13 was going to be tough due to difficult year-over-year comparisons to 2Q12. Judging from the stock’s decline, I guess I was in the minority.
Did Anything Actually Change?
Taking a step back from all of the earnings noise, I didn’t learn much new about Apple. Both iPhone and iPad unit growth is slowing, margin remains pressured due to newer products, and EPS growth will be difficult to achieve in 2013. Minor details such as the iPhone 4 remaining supply-constrained (most likely due to limited resources and parts allocated to iPhone 4 production), iPad mini coming into supply/demand balance by the end of this quarter, and the mix between new and old iPhones remaining constant weren’t exactly market-moving data points.
It is interesting to read the differing opinions on Apple’s quarter between the Valley’s reaction and that of Wall Street. In the Valley’s eyes, Apple did great and is firing on all cylinders, but according to Wall Street, AAPL stock is broken as growth is slowing. I think reality is somewhere in the middle of those two extremes.
AAPL has now been in a 4-month tailspin, including widespread shareholder rotation (meaning many of Apple’s shareholders as of the end of September are selling and being replaced by new shareholders). Such a rotation is often quite volatile, resulting in lower stock prices as the new shareholder base has different priorities and expectations for Apple (often of a lesser nature).
Back in January 2012, the consensus view on Apple was that EPS from iPhone and iPad would plateau around $60. An additional premium for Apple optionality (i.e. new products) may push EPS to $70. P/E multiple and dividend payout ratios were then calculated accordingly. Things certainly have changed. The consensus view is now of Apple EPS topping out around $40. It’s tough for a stock labeled as *the* momentum tech growth story to keep its luster when EPS expectations are cut by 30%. Of course, investors and traders love to panic and overreact, so not only is Apple’s EPS problematic, but Apple’s business model is apparently broken, management is clueless, and the company is the new Microsoft. It is what it is and I don’t see a reason to fight it.
Investors buying AAPL today (or for that matter - the past year) should not be buying it on iPhone and iPad predictions, but rather Apple’s ability to disrupt itself and introduce new product categories. Not surprisingly, when things are good and AAPL is up, everyone assumes Apple is in great shape. When AAPL is down, management is assumed to be inept; unable to innovate and remain relevant.
Looking ahead, I think it will be difficult for Apple to report EPS growth in 2Q13 and 3Q13, due to tough year-over-year comparisons related to margins. Modest growth should come back in 4Q13 and moving into 2014. I am assuming anyone with an earnings model is well aware of these trends, but judging from today’s stock price action, I may be too generous in my assumptions. Catalysts such as China Mobile selling the iPhone (not in my model) or new products are most likely not being contemplated by Wall Street and one can argue even if catalysts come to fruition, many will simply brush them off as a non-event. Just as funds had to own AAPL last year to beat certain performance benchmarks, many funds now have to sell AAPL because the stock is down.
Many are trying to find rational answers with AAPL’s price action, but since the following statements are often true, I’m not sure how many answers are actually out there:
A stock often goes up because it has been going up.
A stock often goes down because it has been going down.
A stock’s valuation matters only when valuations start to matter.
Fundamentals are important only when fundamentals become important.
Revenue: $53.1 billion (AAPL guidance: $52.0 billion/Consensus: $54.5 billion)
GM: 37.9% (AAPL guidance: 36.0%/Consensus: 38.4%)
EPS: $12.75 (AAPL guidance: $11.75/Consensus: $13.33)
Product Unit Sales and Commentary
Macs: 5.2 million (flat yoy growth)
iPad: 22.4 million (56% yoy growth - when adjusted for 1Q12)
iPod: 12.0 million (16% yoy decline)
iPhone: 47.8 million (39% yoy growth)
Apple has missed Wall Street consensus EPS for the past two quarters, and unless estimates come down in the following weeks, a third miss isn’t out of the question. While it is hard to point to any one factor as driving a fundamental change in Apple’s operating performance, Apple’s prior two quarters have contained a few concerning metrics, including contracting margins and declining iPad and iPhone growth. Did the weak global economy finally catch up to Apple? Were product release cycles continuing to wreck havoc with consumer demand?
The bear argument would label Apple’s two-year stretch from 2010-2011 as an outlier, when two new products (iPhone and iPad) produced a perfect storm for EPS explosion. Going forward, bears would argue margins will decline further, effectively limiting EPS growth. Future products would then lack the size to move the EPS needle.
The bull argument would focus on iPhone and iPad as product leaders in its respective industries, while a temporary margin drop is indicative of product updates and not a fundamental change in the operating landscape. Apple’s future product plans would also occupy a spot in the conversation.
Will 1Q13 represent an AAPL inflection point? I don’t think one quarter is capable of shedding enough light to figure out where Apple stands in its long, storied history. With iPhone now entering its 6th year (iPod recently celebrated its 11th birthday), the days of 100% revenue growth may be over for the product line, but should that statement even be considered controversial? There is also evidence suggesting Apple may be looking to smooth out demand cycles by updating products more frequently, a move that may bring long-term benefits, but at short-term costs.
While much of the recent AAPL discussion has been focused on slowing growth and falling margins, it is easy to overlook fundamentals that would be considered very strong for any Apple competitor:
A few AAPL loyalists have recently declared another “bad” Apple quarter (where bad is judged merely by EPS) will signal a new Apple, an Apple not deserving of their attention and instead lumped in with the rest of the tech crowd. I disagree. One quarter, especially in the midst of an obvious change in business performance (product updates and management reshuffling), is not enough to conclude the long-term Apple story has changed. If an investor wanted to run away from Apple for near-term volatility, that decision could have been made a few months ago. Continued margin volatility may produce a scenario where EPS growth can accelerate throughout the year and 2014, even with slowing product sales growth.
AAPL’s next 3-5 years will depend on management’s ability to introduce new product categories into an ecosystem that values a set of beliefs, including two that I tried to put into words following my first days with an iPad:
That technology is too powerful of a force to enjoy without acquired perception and natural intelligence.
That product design has the power to momentarily satisfy the never-ending search for order and reason.
This past Friday, Walmart announced on its Facebook page that it was rolling back its iPhone and iPad pricing for a limited time. Within minutes, the announcement flew around tech blog circles, quickly reaching mainstream publications such as ABC and CNN.
The discussion soon took a new direction as bloggers began to wonder if Walmart’s discounted pricing actually meant Apple was imploding; unable to sell supply due to lackluster demand. One blogger summed up that attitude well, writing:
“Apple has finally thrown in the towel on pretending there is a supply shortage and admitted there is simply not enough demand at the given price point, by proceeding to sell the margin flagship iPhone 5 at a third off the original price, at the bargain basement commodity expert Wal-Mart of all places….And just like that, the “niche premium” magic of the once uber-cool gizmo is gone, not to mention AAPL’s profit margins, very much as the stock price has been sensing over the past two months…”
The blog known as Reuters added additional fuel and mystery to the Apple bear argument, in their usual naive style:
“Apple has focused on high-priced, premium gadgets for many years and has strictly enforced its prices with retailers and other distributors. However, a Wal-Mart spokeswoman said on Friday that the discounts were arranged with Apple.
‘We worked together with them on this,’ the spokeswoman, Sarah Spencer, said. ‘They are a great partner.’
Why is Walmart Discounting Apple Products?
Third-party retailer discounts are nothing new. Best Buy and RadioShack routinely sell entry-level iPhone 5 units for less than $199 (Best Buy is currently selling the 16 GB iPhone 5 for $149.99). Apple’s wholesale pricing and margins remain intact as these third-party retailers eat the discount (ignoring differences between wholesale and retail prices). Similar campaigns are seen with iTunes gift card promotions, where retailers offer free iTunes gift cards when purchasing Apple products. Best Buy is also well known for promotions similar to “Buy $100 of iTunes gift cards for $75” - where Best Buy (not Apple) is responsible for the discount.
Diving into Walmart’s latest iPhone and iPad price discount campaign sheds additional light.
1) The promotion is only valid in-store. For brick and mortar retailers, store traffic and same-store sales metrics are important. One of Walmart’s ultimate goals in discounting iPhones and iPads is having customers travel to a Walmart and make their way through the store before finally reaching the iPhones and iPads (conveniently not located near the store entrance). Walmart feels confident that it will be able to sell additional items to these customers, similar to placing milk and eggs at the back of a supermarket so that a customer has to walk through the entire store just to buy a few essentials. In addition, many consumers will narrow their holiday shopping destinations to a few stores over the next week and Walmart wouldn’t mind making that exclusive list - using discounted iPhones and iPads as the carrot for getting people into the stores.
2) The promotion is only good while supplies last. Many consumers have flocked to Walmart’s Facebook wall to point out that quite a few Walmart locations don’t have iPhones or iPads in stock. Walmart receives good press coverage from discounting popular items, while not losing much money as product supply limits sales; sneaky, but efficient.
3) Brand awareness. By advertising discounted iPhones and iPads, Walmart is using the promotion as a marketing campaign to strengthen consumer’s association between Walmart and Apple. Many consumers don’t think of Walmart as the first place to visit for iPhones and iPads. I can only imagine how many people now have Walmart at the top of their destination list in search of that perfect Apple gift for the holidays.
What about that little gem from Reuters indicating Apple was working with Walmart on this discount? On the surface, it sounds somewhat damning for Apple, but in reality, it doesn’t mean much; only that Apple is okay with Walmart eating iPhone and iPad price discounts. Sounds like an iPhone and iPad boom to me.
Everyone wants to create a story for why Apple’s stock dropped more than 6% today. While daily stock fluctuations are hardly worth mentioning, a 6% drop on seemingly no news does stand out as an outlier.
I have difficulty believing that a stock moves up or down on a specific news item because I am unable to verify why everyone is selling (and buying) a particular stock. Those selling shares at 9:30 AM may have a completely different motive compared to those selling at 3:59 PM. The same philosophy applies for a stock on the rise.
As Apple’s stock collapsed throughout the day, news sites were fumbling over each other trying to guess what could possibly cause Apple shares to fall. Several reasons floated around the web included:
1) A DigiTimes Article. I assume this article talked about all iPhone production coming to a halt, because I have a hard time thinking of any other topic that can cut $30 billion of Apple market cap in a few hours.
2) Tax Selling. This one just won’t die. Are investors selling their Apple shares today (25% off the high) only to avoid paying 5% more taxes on dividends and maybe 5-10% more for long-term capital gains?
3) China Mobile Approves a Nokia Phone. So Apple loses $30 billion of market cap in a few hours because China Mobile announces it will sell a Windows Phone made by Nokia? Really?
4) Samsung is Crushing Apple. Let me guess. Teens are ditching their iPhones and iPads and switching to Samsung phones because they are just that cool. Surely that would cause Apple to lose $30 billion of market cap in a few hours.
5) Some rumor about retail margin requirements being increased for only one stock; Apple. At first glance, this one at least sounds somewhat plausible, until one realizes most individual investors highly levered with margin already faced tough times a few weeks ago when the stock crashed to $505. Even if this rumor was true, individual investors would be unable to account for $30 billion of Apple value vanishing in a day.
6) Apple Maps. If all else fails, blame Apple Maps (ok…maybe I was the one to tweet this one as an excuse for Apple’s drop).
All of these possible explanations for today’s stock drop are nothing more than attempts of adding context to mystery; creating a story out of the unknown. Unfortunately, many are missing the big picture.
There are very few news items that are even capable of moving Apple’s stock price by 6% in a day (the worst daily decline in years). Such a move is typically left for monumental events such as a CEO departure or natural disaster impacting production or distribution, and even then those events would often be met with a rush of buyers willing to support the stock.
Is there anything we know for sure about today’s price action? Yes.
For every trade, the marketplace needs a buyer and seller. A stock price is the equilibrium where a buyer and seller are willing to exchange a share. Today, sellers were outnumbering buyers at $569 (Apple’s stock price at 9:31 AM), so the marketplace had to lower the price until sellers and buyers were in equilibrium. At 3:59 PM, the equilibrium for Apple’s shares was down to $538. Selling pressure remained elevated for most of the day, and as the share price declined further, additional selling pressure came in, forcing the shares to fall even more. Apple shares haven’t seen this type of price action in years (the typical retracement was only around 15%, which would take a few weeks to occur). Buyers would typical come in and support the stock (the Flash Crash of 2010 stands out as another notable exception).
The next question is what caused all of this selling? Unfortunately, we are forced to think of possible reasons for the selling to create a story because we hate the unknown. I could end this post right here and call it a day, but what’s the fun in that? Sometimes even I need a story or two.
I’m skeptical that any rumored (or even factual) news story was capable of causing the world’s most valuable company to drop 6% in a few hours. Instead, I think the intense selling pressure was caused by several mid-sized hedge funds forced to sell Apple positions because their computer models were programmed to sell Apple. In an effort to remove emotion from trading, some funds program models to buy and sell stock given certain market conditions (most likely momentum characteristics). By removing the human from the equation, one is unable to avoid selling a stock on no news (in many ways, for the model to be successful, all decisions have to be followed). I think a rather large fund (or a few) were forced to liquidate or reduce their Apple positions simply because the stock was in collapse mode. Add in differing degrees of leverage (money borrowing) and you can see how things can snowball out of control very quickly. I also believe a similar thing happened last month when Apple shares fell 8% in only two days. The harder Apple fell, the faster the models said sell. Meanwhile, buyers were simply unable to outnumber the sellers, causing the equilibrium price to remain under pressure. Of course, I’m sure there were plenty of retail investors selling Apple shares for completely different reasons, which supports my skepticism for labeling specific news items as stock price drivers.
Looking at the long-term, Apple is facing several headwinds that may give buyers pause. I have a difficult time modeling much in the way of EPS growth in 2013 given tough year-over-year margin comparisons. In addition, recent Apple management changes have not been tested in the marketplace. I’m sure one can also come up with a few other things that would elicit fear about Apple’s future, but at a certain price and after a set amount of time, these fears are fully realized and digested by the market. I suppose one can also come up with good scenarios for Apple, but what’s the fun in that? When Apple’s stock plunges on heavy volume, skepticism should take hold, helping to usher in clear thoughts. Short-term stock trading is a fool’s game and I would love to be proven wrong.
Changing of the Guard.
There is a lot to like about this photo.
A few years ago, I coined the phrase “anti-Apple militia” to describe the disjointed and incoherent group of SAI commenters that were not happy with Apple’s growing success. As Apple’s increasing dominance became clearer, the anti-Apple militia would desperately think of a new plan of attack, often shifting themes within weeks. Some of my favorites were:
1) iPhone 3GS will flop because it looks just like iPhone 3G.
2) Palm Pre will crush the iPhone.
3) People don’t want a curated Apple App Store.
4) Android will crush Apple in the U.S.
5) iPad will flop because it’s just an oversized iPhone.
6) No one is buying iPhone 4 because of Antennagate.
7) No one is buying iPhone 4S because it looks like an iPhone 4.
8) No one is buying iPhone 5 because of Maps.
Recently, I’ve seen the anti-Apple militia shift tactics and instead of attacking a specific iPhone or iPad feature, the detractors are going after the intangible; Apple’s popularity and coolness. Many anti-Apple comments are falling under the same genres, including:
“My daughter says all of her classmates are switching to Samsung and Windows phones. iPhones just aren’t cool anymore.”
“Has anyone gone to an Apple store lately? They are empty and the only people I see are older folks. Meanwhile, Microsoft stores are packed with kids. So crowded.”
“I was at the market yesterday, and some kid came up to me and couldn’t stop asking about my kick-ass Samsung phone. Youth just aren’t interested in the Phone anymore.”
I think one of the main catalysts for this new attack campaign was Samsung’s ads that mocked people waiting in-line for the iPhone 5, including the scene of a son holding a spot in line for his parents. Samsung is going after one of Apple’s largest competitive advantages: it’s coolness. I look at these shifting attack tactics as desperation. If using the battlefield analogy, Samsung and the anti-Apple militia are firing all remaining ammunition in the general direction of the enemy hoping something will stop the advance.
1) Kids can’t get enough of iPhones and iPads (literally - parents are often not willing to buy new iPhones for their children until at least 8-9th grade).
2) College students continue to embrace Apple products at an alarming rate.
3) Apple stores are more packed now than ever, with some complaining about how loud the stores have become. Will the anti-Apple militia soon proclaim “no one goes to Apple stores because they’re too loud”?
4) Despite much broader product roll-outs, including massive pre-order allotments, people are still lining up for new Apple products.
Apple competitors see the writing on the wall. Not only is Apple continuing to broaden its reach across the world, including advances into enterprise and education, but it’s coolness factor is actually expanding. As for the surveys and guesstimates showing Apple’s market share is getting trounced in China and markets where Apple has a weaker presence; a true battle is one where both sides are present.
Apple reported another weak earnings report. Even though Apple plays the expectations game, I see no reason to spend time hating those involved in creating the game. Apple’s quarterly reports contain a lot of information, most of which is more suitable for tweets and random musings. I will leave all of the growth rates and other metrics to others and instead focus on the big picture.
Apple is still in the beginning of a massive capital investment phase (which has been detailed in 10Q and 10K filings). In the span of four weeks, Apple updated practically its entire product line. Few were expecting such widespread updates. While the iPhone 5 was the worst kept secret, as well as the rumored iPad mini, Apple surprised us with new iPods, new Macs, and a new iPad with Retina display. All of these updates are taking a toll on the company in terms of upfront costs, hurting margins. The first iPhone 5 produced is more expensive than the Xth iPhone 5 produced next year. The same can be said for every updated Apple product.
When thinking of massive capital investment plans, Disney comes to mind. As the U.S. economy was collapsing in 2008, Disney’s management team, which I regard as one of the most talented teams in this global economy, placed the bet that it was the right time to increase capital spend and make needed improvements to its Parks division. The stock market hated the idea (due to the unknown involved), but management stayed the course. Fast forward to 2012, Disney’s Parks margins are only now beginning to increase as guests enjoy the final product. Disney is now able to turn on the earnings faucet and reap the rewards.
I think Apple is following a similar path.
Once Apple perfects the processes required to make all of these new iGadgets, the costs will come down and margins will rise. The iPhone 5 form factor will most likely stay around for the new iPhone in 2013, helping margins. The iPad lineup will probably not see any additional revisions until next fall (when I expect a thinner and lighter iPad with Retina display). Constrained supplies will dissipate and the Apple earnings faucet will be operational once again. Additional implications include the high likelihood of no new Apple products until at least WWDC in June 2013, as well as continued lumpy quarterly earnings. Competition and component availability may also change product plans. In terms of modeling, I think Apple is becoming harder to forecast. I am afraid many independent (and professional) analysts will continue to forecast near-term earnings incorrectly as the number of input assumptions increase. Finally, I have been very public about my concern that product cycles were becoming too planned and orderly (i.e. iPad in March, iPhone in the fall), which artificially impacts demand as customers alter purchasing habits, but all of this is more noise than anything else, and these patterns eventually end.
It doesn’t matter if Apple is a few dollars short of expected 1Q13 earnings or if iPad mini margins are a few 100 basis points lower than normal. Such details change from quarter to quarter. At the end of the day, Apple’s most important goal is making great products. Everything else is mostly noise.
Humans hate the unknown. Some look towards charts and tables, while others simply create stories to turn the unknown into easy to understand answers.
Apple is currently facing the following questions (I suppose you can say its my attempt at tackling the unknown):
1) Is iPhone growth slowing? Maybe. We don’t know. iPhone 5 supply/demand is not in equilibrium. Apple is currently selling every iPhone 5 it can produce. After reporting 81% annual iPhone unit sales growth in 2011, Apple is tracking towards 70% growth in 2012. Will growth continue to decline or can the iPhone 5 stem the inevitable for a few more quarters?
2) How should we think about iPad? I’m left somewhat confused following Apple’s iPad event. Heading into today, my gut was telling me the iPad (3) was not selling too well compared to the iPad 2 - a sign that consumers’ needs were being met with a cheaper, lower quality iPad. I also assumed an iPad mini would be positioned as a content consumption device to the iPad 2 and 3.
Instead, Apple revised the iPad (4), kept the iPad 2 alive (seemingly to float in no man’s land), and unveiled an iPad mini that by all measures is as capable as a full-size iPad and just as worthy as its larger, and more expensive, siblings. Will iPad’s ASP continue to decline? Where are margins heading? Are consumers’ technology needs being met by iPad? Questions are certainly outnumbering answers.
3) Will Apple introduce new product categories? Maybe. We don’t know. We can assume that Apple has plenty of new stuff cooking in the labs, but we have few concrete details on anything. Will 2013 be the year of the next “big thing”?
4) Is the economy impacting Apple? Maybe. We don’t know. Apple was able to survive the financial crisis of 2008-2009 without much damage, however Apple was a much smaller company at that time appealing to a more niche audience. Are consumers delaying technology purchases due to economic pressures? Apple continues to have supply issues, but once demand/supply equilibrium is met, sales are increasingly disappointing as product cycles appear to be accelerating.
Now compare today’s unknown with the “AAPL story” of early 2012:
1) The iPad (3) was widely expected to be introduced and replace the iPad 2 as the top-selling iPad.
2) The iPhone 4S was selling well and the iPhone 5 was widely believed to be in the works.
3) Overall product margins were making new highs and expected to continue.
4) Management announced a dividend initiation (which may have included some front-running by AAPL shareholders).
AAPL observers had a much easier time turning the unknown facing Apple from January to April into a convenient and easy to understand story. AAPL stock also went up 50% during the same time period. Are the two related? Does a stock go up or down due to a specific reason or is that another example of humans trying to cope with the unknown?
Apple’s unknown will eventually be packaged into a clean story. It may take a day, week, month, or year, but it will happen because humans hate the unknown.
Revenue: $36.2 billion (AAPL guidance: $34.0 billion/Consensus: $36.2 billion)
GM: 40.8% (AAPL guidance: 38.5%/Consensus: 40.4%)
EPS: $8.95 (AAPL guidance: $7.65/Consensus: $8.85)
Product Unit Sales and Commentary
Macs: 5.5 million (12% yoy growth)
iPad: 18.4 million (65% yoy growth)
iPod: 6.1 million (8% yoy decline)
iPhone: 24.8 million (45% yoy growth)
When Apple releases earnings on October 25, investors will focus on product ASPs and margin. Publicized iPhone 5 supply shortages and iPad mini rumors should go a long way in explaining any moderate misses in iPhone and iPad unit sales, respectively. Nevertheless, any evidence of continued margin weakness and declining ASP in iPad and iPhone may push observers to reduce forward earnings, which have a high sensitivity to margins. A 100 basis point change in margin corresponds to a 3% change in Apple quarterly EPS.
Urban Outfitters, a clothing retailer with $2.5 billion in annual sales, held an analyst/investor day on September 27 and to say that iPad and Apple played a minor role would be an understatement. Management outlined how iPad is increasing customer satisfaction, in addition to improving Urban Outfitters’ efficiency and financial performance. I found the presentation quite revealing and helpful in trying to understand, straight from the source, one example of how iPad is invading enterprise.
All quotes are attributed to Calvin Hollinger (Chief Information Officer), unless noted otherwise.
Two years ago, we deployed iPad point-of-sale into all the stores. An iPad point-of-sale is pretty much — it looks like your iPhone. It has a little case around it. You can scan bar codes. You can swipe the credit card, and it does everything that a normal point-of-sale system does, except you can’t take cash obviously. We don’t have a debit device. You can’t take debit transactions, and you can’t take checks. But it does everything else that a point-of-sale device can do.
When we deployed it, again, two years ago, it was very well received by our customers. There’s a very personal interaction between a sales associate and the customer. It was well received by sales associates. They had fun having a customer sign their signature with their thumb. And it was especially well received by Frank Conforti, our CFO, because this device, fully loaded, fully installed, is about $500 and register is about $5,000. So it also made financial sense.
Not only are iPads improving customer satisfaction (which is an important piece of brick and mortar retailing), but Urban Outfitters is saving money by moving to mobile point of sale. What is a drawback? An iPad can’t physically hold cash. As more customers move away from cash and towards other forms of payments, this “drawback” will become less relevant and judging from how cash is handled in Apple stores (hidden cash drawers), a cash-paying customer can still have a carefree transaction with mobile point of sale.
And in fact, we told the stores, “Give us back your fixed register that we can refurbish and use somewhere else. Give us back one register, we’ll give you five of these devices.” I don’t have the exact numbers. John [ph], you can correct me. Between the brands, I think we’ll be sending about 1,100 of these devices for peak of this year.
Compared to the millions of iPads Apple sells each quarter, 1,100 iPads are drop in the bucket. However, more importantly, Urban Outfitters is planning on replacing every cash register with five iPads, expanding iPad’s usage and relevancy within each store.
Richard Hayne - Co-Founder, Chairman of the Board of Directors, CEO, and President:
Right now our store associates can better service our customers by selling merchandise from the web inventory using an iPad in stores. This is a very impactful thing that we have rolled out this year, and it’s been incredible for us. And vice versa, the web can now sell merchandise that’s from our stores, so customers can be shipped items from their local store, which is resulting in fewer broken sales in the web, better use of slow turn merchandise in the stores and faster delivery times for the customer. So all in all, a happier customer.
Helping customers while improving business fundamentals, all the while saving cash - hard to say no to that proposition. The ability to seamlessly sell web inventory in a physical store is a big deal as the retailer is able to save in inventory costs, while not losing a potential sale. Anecdotally, I have heard the ability to order different clothing sizes, colors, and styles from the web (after first trying on in-store) is a big deal.
The iPad is a very, very powerful device. So in addition to being a register, we can download a lot of content down to the stores, maybe training videos, maybe, Hey, this product sells or this product, the whole market buys it, all the reports, sales reports, a lot of information because it’s a very, very powerful device, and it’s very, very easy to use. A big screen, very, very intuitive.
That’s a lot of verys. Not only will Urban Outfitters use the iPad as a point of sale, but it will truly transform the way business is done at the brick and mortar retailer.
Now although this is a mobile device, iPad is a mobile device, we have to set up with the pilots to have it on a swivel arm, so it’s very clean. If it’s not in use, you can take the swivel arm and put the iPad away and you can use this as a packing space or maybe to display more items to sell, et cetera. And then from a customer’s point of view, here’s the customer, return the iPad to the customer, she’s confirming her shipping address. We could also use it to — well, and used to be, for example, a gift registry. A very, very powerful device.
Gift registry. Yet another use for iPad.
2 or 3 weeks ago, we placed our very last register order. We’re out the register business. Going forward, we had placed the orders. We’ve got some new stores coming up. But once we successfully make sure this iPad works in all the stores, all stores will be designed and equipped with iPod Touches and iPads. And Frank is, again, happy, because the iPad is $1,000 fully installed versus $5,000. But all our stores going forward will have iPads and iTouches.
Regardless of a fully installed iPad’s cost - ranging from $500 to $1000, the price pales in comparison to a cash register’s $5,000 price tag.
Similar stories and case studies of iPad being used in enterprise are occurring in a range of industries and companies as iPad’s disruptive capabilities are becoming more valuable. iPad’s invasion into enterprise is only getting started. A full transcript of management’s presentation can be found here.
Marketing is an art, not a science. We were fortunate to see this art first-hand on January 27, 2010 as Apple unveiled the iPad. Technological and engineering marvels aside, Apple faced the daunting task of marketing a disruptive product that had to grow into its role of replacing the modern-day PC. Jump ahead 33 months and it appears Apple has had some initial success, selling 84 million iPads. Within weeks, the world will see Apple’s second test marketing iPad, but this time it will be a new form factor, a smaller iPad.
Marketing; Portraying the Product
The most important aspect of marketing is the product; the look, feel, and sound (fortunately iPad’s smell and taste aren’t a major factor in this discussion). Apple eloquently marketed the iPad as a sexy device that could do a few things extremely well, all the while feeling great in your hand. The consumer was left focusing on iPad’s strengths, and not its short-comings, or mysteries, such as if its weight becomes an issue after extended use. In subsequent years, Apple began the task of marketing the iPad as a device capable of content creation, in an effort to begin cementing its path to replacing the modern-day PC. When unveiling a smaller iPad (7.85-inch screen) in October, Apple will be given 60 minutes to tell a story; why a smaller iPad should exist.
Apple may take two paths:
1) Positioning a smaller iPad as a replacement to the current 9.7-inch iPad. Apple’s presentation will include all of the features a smaller iPad could do well, such as web surfing, content consumption and creation, but in a smaller form factor and at a lower price point. Consumers will have to decide between a small or large iPad.
2) Positioning a smaller iPad as a companion to the current 9.7-inch iPad. Apple’s story will include the few things a smaller iPad could do extremely well, such as content consumption, in a more convenient form factor for extended passive use, such as reading or watching movies. Consumers will understand the differences between a small and large iPad and come away from the event wanting both, not one or the other.
Apple will most likely choose the second path, positioning the smaller iPad as a companion device to the current iPad line-up, and in doing so will not only sell a lot of small iPads, but keep the large 9.7-inch iPad as the powerhouse in the tablet market.
The Tablet Story
On January 27, 2010, Apple could have unveiled an iPad with a 7-inch screen, or 8 inches, or maybe even 12 inches, but settled on 9.7 inches. Apple knew there would be plenty of television commercials marketing iPad, but the biggest marketing ploy would be the product itself, a device capable of eventually replacing the modern-day PC as the primary form of computing. Apple wanted (or needed) consumers to begin thinking of an iPad as a possible laptop replacement from the start. The “iPad as your new laptop” thought didn’t need to be completely formed on Day 1, or even by Year 3, but Apple needed to plant the seed on Day 1 and a 9.7-inch device was an easier sell than a smaller 7-inch device.
Fast forward a few years, and the tablet market is now flooded with smaller 7-inch tablets. Besides not being given an adequate reason for their existence, consumers are confused by these 7-inch tablets labeled as a “full tablet” despite failing in comparison to a laptop’s immense feature list.
So why should Apple introduce a smaller 7.85-inch tablet now? It is time because the 9.7-inch iPad is a success.
A Smaller iPad; Companion to the Current iPad
The iPad is now well established as a successful tablet and cornerstone to Apple’s product line-up. While many have fallen in love with iPad, the device does have some minor drawbacks, namely form factor for extended use and price. The device tends to feel heavy in hand after extended use, such as reading or movie watching, while the $499 entry price is still unattainable for a large swath of the population, including education and business, leaving wiggle room for competitors to try something at the bottom-end of the price ladder. Are these two factors (heavy form factor and price) enough for Apple to introduce a smaller iPad?
In October, Apple will address the space between an iPhone and a 9.7-inch iPad and most likely market a 7.85-inch iPad as a companion to the 9.7-inch iPad. Books, movies, TV shows, podcasts, and games will be shown as more enjoyable given a smaller iPad form factor. Apple will need to walk a delicate line though positioning a smaller iPad as the best way to consume content, as many will continue to enjoy content on their large iPads (as well as on their iPhones).
More importantly, Apple needs to portray a small iPad not as a 9.7-inch iPad replacement, but as an iPad companion. If consumers begin to think of a smaller 7 to 8 inch device-great at content consumption but not so great at other aspects-as an iPad replacement, the effort of positioning iPad as the disruptive force will be in jeopardy since wide-spread adoption would come under pressure and laptops would continue to appear superior to the average 7-inch tablet.
For those who would buy a smaller iPad due to price, proper marketing will position the smaller iPad as a gateway drug to a larger iPad. If a consumer enjoys content on a small iPad, the thought of not only consuming the same content, but also creating content on a larger iPad will only be enhanced.
Price. If given three $5 casino chips and told to guess the small iPad’s price, the $199, $249, and $299 squares would be occupied with a chip. If given one $15 casino chip, the $249 price point would be occupied. Not only is the product itself a form of marketing, but a device’s price can say a lot. Priced too low, a small iPad may have a hard time losing the “just a content consumption” tagline, while priced too high and the small iPad becomes an iPad competitor as consumers assume the two devices must be similar in compatibility. A $249 price point would be the best of both worlds; a device $150 less expensive than the entry-level iPad 2, but still more expensive than other 7-inch tablets.
Future iPads. One could replace any mention of “small iPad” in this piece with “larger iPad” and the same overall thesis would apply. A larger iPad (greater than 9.7 inches) for content creators (movie makers, artists, designers, etc.) would certainly make an interesting proposition.
iPod touch. The updated 5th generation iPod touch (and all of its amazing features) is sold for just $299, which could very well be more expensive than a 7.8-inch iPad. Apple is positioning the iPod touch as that powerful guard, awake all night, preventing any Trojan horse from causing havoc.
Product Quality. It says a lot that throughout this entire discussion, the idea of Apple selling a small iPad with superior quality and craftsmanship is simply assumed to occur. Anything else would be a disappointment. High expectations can be both a blessing and curse.
One of Amazon CEO Jeff Bezos’ answers from his recent AllThingsD interview stood out to me:
“[Amazon’s] approach is, if we have a good idea, and if it’s something we think customers would care about…then we don’t ask why do this, we ask why not do this? We have a high bar for doing those things. We don’t want to do me-too things. The people we’ve attracted over time to Amazon want to be pioneers. They want to be inventors. They want to do new things.”
Sounds like Amazon will not only be entering the phone market, but also simultaneously inventing a new business model along the way. I have a feeling Walmart and Target executives will be reading technology blogs a little more closely these days.
Revenue: $41.3 billion (AAPL guidance: $34.0 billion/Consensus: $37.4 billion)
GM: 45.5% (AAPL guidance: 41.5%/Consensus: 43.3%)
EPS: $12.30 (AAPL guidance: $8.68/Consensus: $10.34)
Product Unit Sales and Commentary
Macs: 4.7 million (19% yoy growth)
iPad: 21.3 million (130% yoy growth)
iPod: 6.6 million (13% yoy decline)
iPhone: 29.5 million (45% yoy growth)
When Apple releases earnings on July 24, iPad and iPhone sales, along with reported margin, will represent investor’s primary focal points. Apple’s prior commentary foreshadows a strong iPad quarter, surpassing the 15.3 million units sold in 1Q12. Any iPad sales number solidly above 17-19 million units will be looked at positively by the Street. With iPhone supply/demand having been in equilibrium for some time, Apple will not benefit from any significant inventory build this quarter, although carrier and country distribution expansion will result in solid yoy growth. Sell-side iPhone sales estimates have been set at somewhat realistic levels and one should not be surprised with sales between 25-30 million units, although iPhone sales estimates become somewhat irrelevant as we get closer to the new iPhone launch.