“A smartwatch is very difficult for us because it is contradictory…Luxury is supposed to be eternal…How do you justify a $2,000 smart watch whose technology will become obsolete in two years?”—Jean-Claude Biver’s comments, published in a WSJ Digits post, do a great job of highlighting how the high-end watch industry views Apple and the Apple Watch. While many in the watch industry expect Apple to send an all-start lineup into the game, Apple is busy reinventing the game.
Apple reported a 4Q14 earnings beat to consensus and my estimate with strong guidance driven by iPhone sales strength.
Few takeaways and notes:
Mac. Over the past few weeks I was noticing that the Peak Mac theory, which stated that Apple will never sell as many Macs in a single quarter as occurred in 1Q12 (5.2 million Macs), was at risk of breaking apart as my long-term 4Q15 estimate was for 5.4 million Macs. Apple ended up reporting 5.5 million Mac unit sales last quarter, representing strong 21% year-over-year (yoy) growth, and a new quarterly unit sales record. Recent price cuts and upgrades resulted in strong Mac sales to college students.
iPad. Apple reported a 13% decline in iPad unit sales, which was in-line with my expectation. People calling for iPad’s death will likely be disappointed though given the likelihood of a new iPad Pro model in 2015, along with the recently announced cheaper iPad mini and refreshed iPad Air 2. I still think iPad sales will pale in comparison to iPhone over time and the iPhone 6 will continue to cannibalize iPad sales, but Apple management seemed confident that there are enough niches (education and enterprise) to at least keep iPad sales from collapsing. I think it is appropriate to view iPad more like Mac, and given Mac’s respectable growth last quarter, the iPad is far from over.
iPhone. Apple’s overall earnings per share (EPS) beat my estimate by $0.10/share on stronger iPhone sales (39.3 million vs. my 36.5 million estimate). Management provided very bullish iPhone commentary with the expectation that iPhone will remain supply constrained through the end of the year. Apple shared other data points that reinforce iPhone momentum is accelerating from 13% yoy unit growth in 3Q14 to 16% growth last quarter to expected 30% growth in 1Q15.
Margins. According to management, the stronger dollar will be a “significant headwind” for Apple in the near-term, but the 37.5-38.5% guidance range already reflects the FX impact. On a normalized basis, I wouldn’t be surprised if margin is closer to 40%, compared to 38.6% in 2014, on iPhone 6 strength.
Apple Watch Disclosure. Apple caused a minor Twitter uproar with new disclosure commentary concerning the way operating segments will be reported, including Apple Watch being lumped in with a few other products within the ”Other Products” segment. Is Apple trying to hide something? I suspect the main reason for the classification is that Apple doesn’t want to release too much information to competitors. If Apple disclosed Apple Watch revenues and unit sales, it would be possible to obtain average selling prices (ASP) and then back into which models were selling well, thereby giving key data to both low-end and high-end watch competitors. It isn’t clear if Apple will disclose Apple Watch unit sales, such as opening weekend sales. I think it is reasonable to think if the sales are good, Apple may want to say how many units are sold without breaking out revenues.
Guidance. Apple provided strong guidance beating my revenue estimate and consensus. Most of the beat can be attributed to iPhone, where Apple could sell upwards of 65-66 million iPhone units, which would be the strongest yoy growth (30%) in over two years. The exact sales number will depend on how many iPhones Apple can produce, but it is safe to say that iPhone’s growth is accelerating.
Apple is now trading at 13x forward EPS with net income growing 15-20% yoy.
I expect Apple’s revenue to increase 6% year-over-year.
Gross Margin: 38.0%(AAPL guidance: 37-38% range)
I expect Apple’s margin to decrease sequentially to 38.0% from 39.4% last quarter, primarily reflecting iPhone 6 shipments. Management’s margin guidance is approximately 0-100 basis points better than the 36.9% margin reported in 4Q13.
EPS: $1.32 (Consensus: $1.31)
I expect Apple to report 11% yoy EPS growth. I am including a 6 billion share count (implying around $5 billion of buyback - similar to last quarter).
Product Unit Sales and Commentary
Macs: 5.0 million (9% yoy growth)
Apple has reported Mac unit sales growth over the past three quarters and I expect this trend to continue with back-to-school sales and iPad fatigue (students opting for MacBooks vs. an iPad). After a difficult 2013, the Mac line-up seems to be holding its own and the idea of “Peak Mac” (Apple will never sell as many Macs as it did in 1Q12) is starting to look a bit premature.
iPad: 12.4 million (12% yoy decline. Consensus is closer to 13 million.)
I expect Apple to report continued Pad unit sales declines. As I previously highlighted, the iPad is in a perilous position and I don’t see last week’s iPad refresh as having much impact on the category’s trajectory.
iPod: 1.7 million (50% yoy decline)
iPhone: 36.5 million (8% yoy growth. Consensus is closer to 37-38 million.)
iPhone launch quarters can be a wild animal. With many moving parts, including channel dynamics, sales vs. shipped differences, and the degree of delayed purchase behavior in August and early September, the actual sales number shouldn’t be judged too harshly, but instead be included with next quarter’s results to get a better idea of overall iPhone sales trends. Similar to last year, many ordered an iPhone 6 online hours after launch only to have the phone ship in October, so it’s clear that a large number of iPhone 6 (especially the Plus) launch sales will be pushed into 1Q15. My 36.5 million iPhone unit estimate assumes 7 million units of iPhone 6 and 1 million units of iPhone 6 Plus units, along with 29 million legacy iPhone units selling at roughly a 20% slower weekly sales pace than seen in 3Q14 (2.9 million).
I expect Apple’s earnings to come in close to consensus demonstrating continued EPS growth from stronger net income and a lower share count resulting from share buyback. In terms of 1Q15 guidance, I am expecting approximately $56-60 billion of revenue (consensus is around $63 billion) and 38.0-39.0% margins (which would equate to EPS of approximately $2.25, or a 9% increase from 2014). It is important to remember that weaker iPad mini sales, as a result of stronger iPhone or iPad Air sales, will actually help Apple’s financials as the iPad mini’s lower ASP and margins weighed on Apple results.
I exclude foreign exchange impact from results given its non-operating nature. Apple is hedged against significant foreign exchange moves, but nevertheless there may be some impact flowing for the results.
The primary Apple story over the next few months will be the iPhone 6 rollout and corresponding implications on margins (iPhone 6 Plus running with a higher margin than iPhone 6, with both models positioned stronger than iPhone 5).
1) The iPad mini got 10 seconds of stage time. At this point Apple is keeping it around just to make sure they are selling tablets for less than $300. Watch the iPad average selling price (ASP) over the next few quarters to see if there is any evidence of people buying the cheap (and old) iPad mini instead of other iPads. I doubt it.
2) Most of Apple’s iPad Air 2 sales pitch focused on the camera and corresponding apps. While I’m sure there are some neat use cases (children’s sport events, physical therapy sessions, etc.), does an iPad really do a better job than an iPhone 6? For some the answer is yes, and those people will buy iPad Air 2, but for most, I suspect the answer is no.
3) Notice how “iPad apps” just doesn’t have the same ring and excitement it once had. Apple had a few demos onstage and “this is okay” seemed to keep ringing in my head. The app ecosystem is tired (not just iOS).
4) Apple announced a new retina iMac for $2500, $700 more than the non-retina option. I’m sure once you use a retina iMac you never want to go back, but as I look at my non-retina iMac, and it’s pretty decent screen, $700 seems steep.
5) New Mac mini with a lower $499 price. I’m sure there are people who were waiting for this and it will open up the Mac to new customers, but nothing too noteworthy when compared to the rest of the Apple product line. Look at the specs and no wonder it’s $499.
6) Overall, a pretty laid back Apple keynote, especially when compared to last month’s blockbuster of an event. I published my latest thoughts on iPad a few days ago and I have nothing to add after watching this event. I would expect a larger iPad Pro next year and I think Apple should get rid of the iPad mini and reduce the price of old iPad Airs.
Tim Cook almost called the Apple Watch, “iWatch”. He has already called it iWatch in public before (which is rare for an Apple executive to do). Seems likely that “iWatch” was used internally to describe the watch while it was being developed.
We may have seen our first Hitler reference in an Apple keynote (can thank Stephen Colbert). Never understood why someone would reference Hitler to anything, but that’s another topic.
Just another confirmation Apple is an iPhone (and Apple Watch) company. I suspect that is where most of the excitement and attention will be focused on for the next 2-3 years.
The iPad is at a crossroads. Introduced by Steve Jobs four years ago, the iPad has gone on to become a phenomenal success (225 million units sold bringing in $112 billion of revenue and approximately $30 billion of profit), but I suspect Apple management will alter the iPad line-up in response to wearable devices and larger-screen phones and in the process iPad’s ultimate trajectory will be more modest and niche than many expect.
Slowing iPad Sales Momentum
iPad sales growth has slowed dramatically from 65% year-over-year unit growth in 2013 to a 10% year-over-year unit decline last quarter. Such a contrast is startling given how promising iPad seemed in early 2013. When I first discussed my iPad concerns in 2013 (Apple had just reported a much weaker-than-expected quarter for iPad shipments), I received very strong pushback as many said iPad was fine and just suffering from varying release cycles. I knew that was not the reason for the sales weakness, but it was still hard to see why iPad sales and the overall tablet market were slowing so dramatically. Some pointed to longer upgrade cycles, which has some truth to it, but I wasn’t convinced that variable had enough explanatory power to turn 50%+ growth into sale declines within a few months as iPad was not near saturation (there are plenty of people who don’t own an iPad). I suspectthere has been a much broader ongoing trend for why iPad has been struggling to gain new users; larger-screen phones have been cannibalizing iPad sales and iPhone 6 is going to make things worse for iPad.
A Different World
For a new product category, iPad’s sales pitch was fairly straightforward; a device that sat between your phone and PC; able to do a few tasks better than both your phone and computer. Web surfing and email were highlighted as prime examples, as well as reading ebooks. Initial sales were very strong and the iPad was off to the races. Fast-forward four years, and iPad faces a much different consumer tech landscape.
iPhone (along with most phones) have small displays.
MacBooks are thick, heavy, and non-retina.
People are completely mesmerized by new apps.
Phones are much bigger (iPhone now comes in 4.7-inch and 5.5-inch display options).
MacBooks are thin, light, and retina.
The paid app (and even free app) ecosystem is tired and somewhat stale.
Apple now has a much harder sales pitch to make for iPad. Why buy an iPad when you could have an iPhone with a screen that doesn’t seem that much smaller than an iPad mini? Why buy an iPad when you can have a more powerful and just as easily transportable Macbook Air? The space between a phone and PC is smaller now than in 2010 primarily as the phone has become more powerful and larger. Tablets are getting squeezed.
Slowing iPad App Innovation
I can’t remember the last time I downloaded an iPad app. Curious to see how others were doing, I posed a question on Twitter, “How many iPad apps have you downloaded in the past month?” On any given question I get a decent number of responses, but this time I received a very muted reaction with a few “0” responses. Why am I not downloading iPad apps? I consider iPad app innovation to have slowed with iPhone continuing to take a disproportionately high amount of attention in the app ecosystem. Most of my daily mobile usage now occurs on an iPhone.
Messaging: iPhone (iMessage, Facebook, Twitter)
Web surfing: iPhone (Tweetbot)
Games: Not many games, but the latest fad is usually on iPhone
Video podcasts: iPad (for the larger screen)
I suspect one reason for suboptimal iPad app innovation has been that app developers have been too preoccupied with iPhone’s explosive usage to focus resources on iPad and if everyone is focused on iPhone, can you blame them? Of course, I’m not suggesting there is not intriguing software for iPad. Anyone in a specialized field (medicine, sports, film, music, etc.) will be able to point out apps that harness iPad’s potential, but that is niche – and even Apple’s latest iPad commercials reiterate the niche factor. However, for the average person interested in basic tasks like web surfing, email, and photos, phones are very capable devices and are consequently winning a larger share of app innovation. As I wrote after a few days with my iPad back in 2011, the device is all about apps. If I have no interest in downloading or even using iPad apps, I view that as an ominous sign for its future. My interest is moving elsewhere, namely to iPhone, and soon Apple Watch.
iPad’s Primary Use Cases
I don’t want to paint such a grim picture for iPad. Apple is still selling millions of iPads (likely around 12 million during the past three months down from the 14 million last year). How could this be if the space between phones and PCs has been shrinking over the years and there isn’t the same quality of app innovation?
1) Laptop/Desktop Replacement. Many people are using iPads as their main computer, replacing old laptops or desktops. Interestingly, more people are telling me their parents and grandparents love iPad as it’s the first computer that is truly easy for them to use. In many ways, this is exactly what some saw when the iPad was unveiled – a laptop/desktop replacement. Looking ahead, however, I don’t see there being much to prevent phones from doing a better job at replacing laptops or desktops. Why buy an iPhone and iPad, when you can just buy a larger iPhone?
2) Education. While there have been high profile cases where large school districts, and even countries, considered implementing iPad programs, success seems to be underwhelming due to logistical concerns as well as budgetary limitations. I also think a lesser discussed reason is the proliferation of larger smartphones leading many students to use their phones much more in 2014 for tasks that the iPad was initially positioned to do. There’s clearly still a market for iPad in education, but I suspect it’s much smaller and more niche than many imagined a few years ago.
3) Enterprise. iPad in the workplace remains the unknown factor. I suspect iPad sales to the enterprise may represent a growing share of iPad sales. In this context, Apple’s recently announced partnership with IBM takes on a new light - one of offense to find use cases for iPad.
iPad Has a Future; It Just Needs Help
The iPad is a great device that needs some changes to reflect the current landscape.
1) Apple should stop selling the iPad mini. As a low-margin response to cheap Android tablets and given the lack of a large iPhone, the iPad mini served its purpose keeping Apple in the tablet game, but today there really aren’t many reasons to keep the iPad mini around. Consensus seems to think Apple will add Touch ID to iPad mini later this week along with some other updates, but beyond that, unless sales trends improve (I wouldn’t expect them to), I don’t see the iPad mini staying in the line-up for too long and I think that is only for the better. In order to keep product offerings in the same price range as iPad mini, Apple could work on lowering iPad Air pricing to approach that $299 level over time.
2) Introduce an iPad Pro. An iPad with a 12.9-inch retina display, new software that moves beyond just rows of app icons, and capable accessories including keyboard stands and styli. Once again, Apple’s IBM partnership comes into play. A large iPad Pro with customized software and accessories would certainly be more interesting to enterprise users than an iPad mini with basic office utilities.
Even with a product line-up consisting of an iPad Air and iPad Pro, I would still suspect phones to eventually cannibalize the larger iPad Pro, but Apple would at least be able to get another couple of years of respectable sales out of iPad. When you add Apple Watch to the equation, the scenario where people keep their large iPhones stashed away in a backpack, purse, or satchel, while their Apple Watch handles communication and notification functions doesn’t seem too much of a stretch. Maybe now you can see why I think so highly about Apple Watch’s potential while being more pessimistic towards iPad.
iPad Was the Right Product At The Right Time
I’m convinced if Apple had to do things over, they wouldn’t change a thing. The iPad was the right device at the right time. The past seven years in mobile has essentially boiled down to people discovering which sizes of glass they prefer in their pocket. In 2010, it seemed like consumers would want a phone, tablet, and laptop/desktop, with the tablet eventually replacing the laptop/desktop, although many in Asia and emerging markets disagreed. As phones become larger and more powerful and wearables become more popular, I suspect consumers will be content with just a phone and wearable device. I still see a future for iPad, but it looks more like Mac instead of an all-encompassing mobile device next to iPhone and maybe that is what Apple had in mind all along.
Last night Consumer Reports chimed in on Bendgate, concluding iPhones don’t bend under normal use. I think this report, coming from the consumer review site that infamously hit Apple hard with its Antennagate analysis, marks the unofficial close of this completely ridiculous witch-hunt.
The question all along hasn’t been, “Do iPhones bend?” Of course they bend. iPhones are made of material that will eventually succumb to a certain level of applied pressure. I haven’t tried it, but if I took my heavy-duty tools and machines to my iPhone 5s, I’m sure I will be able to get something to bend. If I really wanted to, I could gather enough arm strength to do something stupid to my phone as well. One could ask, “Why would I do such silly things?” and I would only be able to shrug my shoulders. The real question everyone should have been asking (if they were desperate to find a question to ask) is, “Do iPhones bend during normal use; walking, running, basically living your daily life?” All of the evidence (both empirical and anecdotal) support the “no bending” claims. Now a very select few have claimed their iPhones have become bent (although they also claim to have sat on them a lot - they aren’t sure). These same people admit the bending is hard to see at times and you need to look at it in a certain light. I’m skeptical. If these people are genuine, they can return their iPhone and get a new unit. Apple sells a lot of iPhones and if your phone is one of the very few bad apples that made it through the rigorous quality assurance tests (Apple claims only nine people reached out to them complaining of a bent iPhone), I would just consider myself lucky, exchange the phone, and move on with my life.
Over the past week I received many jokes from Android users about Bendgate. Nearly every phone marker chimed in with their own unoriginal bending jokes, tweets, ads, and musings. Mainstream media picked the story up and ran with it. Curiously all of these reports were missing something - evidence. No one bothered to take a step back and think about this whole debacle for a second and actually see if their iPhones were bending. I suspect one issue is there weren’t many iPhone 6 Plus units out there in the wild to even observe possible bending. Notice how these “-gates” only take place a mere few days after launch.
It’s 2014. We shouldn’t be surprised that we had to live through another iPhone “-gate”. These spectacles only reinforce my view that iPhone continues to hold significant global phone mindshare (which is much more important these days than market share, but that topic is for another day). Stories of iPhone’s demise have been in the news since 2007. Some have even tried to ridicule iPhone buyers, maybe one of the weirdest, and counterproductive, types of envy a competitor can possess. When you are in the lead, and running forward, competitors can only pin a target on your back and Apple seems to be wearing quite an effective shield.
It’s reassuring to know that while the world has been preoccupied with Bendgate, Apple engineers have been busy creating the product for next year’s iPhone “-gate”; iPhone 6s.
Development. The tech landscape saw this wearable device coming from a mile away. Over the past year, competitors have come out with their own watches, and in many cases, have already shown a few reiterations. I suspect Apple Watch development started in earnest back in 2011 with most features at least thought out by 2013 and everything largely set by early 2014. The growing phenomenon of people using the iPod nano as a watch in 2010 most likely got the ball rolling. Yes, that means Steve Jobs was around for at least the early watch discussions, although Tim Cook told ABC News that Apple Watch development began around late 2011/early 2012.
AskTog. In early 2013, former Apple employee Bruce Tognazzini wrote what I term “the iWatch manifesto”, a highly detailed, yet supposedly hypothetical, wish list of what an Apple smartwatch could or should do. As I expected, most of his commentary turned out to be true and was announced today. I suspect some of his points that were not released today will be included in future versions. One has to imagine competitors were aware of the article and knew most of the features announced today were coming.
Hardware & Software. From a hardware perspective, the Apple Watch doesn’t strike me as overly magical (like the iPhone did). However, the software is differentiated from peers.
Battery. People are worried about battery life. Apple didn’t say, but implied an Apple Watch battery will last roughly a day. I think a 12-14 battery life is probably the most likely answer and I don’t see much issue with such a span for a first release. I don’t wear a watch in bed now, so I think it would be common practice to charge your Apple Watch every night. What does this mean for sleep tracking or those with extra long daily schedules? Maybe buying two watches is their answer.
Use Case. Apple didn’t go into much detail about why someone should use an Apple Watch, instead demoing a few features that seemed cool or at least interesting. I think most of this is taken from the iPad playbook - show users various things you can do with the device and then step back and see what sticks. At one point Apple even mentioned there is much more to say about the device, but there wasn’t enough time.
Goal. Apple is going after the watch, not the smart watch.
Competition. I suspect Samsung (and many others) will come out with various watches that look very similar to Apple Watch in a few months (some larger or smaller than Apple Watch).
Pricing. Apple said Apple Watch would start at $349. I imagine some of the higher-end models will likely go for over $1000. I would not be shocked if over time, you see Apple watches retail for thousands of dollars (a special Marc Newson $5000 edition anyone?). Of course, Apple will also work to lower the entry-level price to a more manageable $99 etc.
Future. I see a world where the watch will eventually replace the phone. We aren’t there yet, but I think it’s coming and most major tech players will have a wearable tech platform up and running by 2015-2016.
Retail. Apple will need to figure out a way to showcase dozens of Apple Watch variations in Apple stores, requiring a new way of thinking of wearable retail. Angela Ahrendts has her hands full.
iPhone. New models largely as expected. The iPhone 6 Plus (5.5-inch screen) seems a tad large, especially when compared to the iPhone 6 (4.7-inch screen). The gold version does not look as good with these larger phones. I suspect the 4.7-inch iPhone 6 silver will be a top seller. These news phones will likely maintain Apple’s iPhone unit sales growth in 2015, especially from strong sales in Asia.
Apple Pay. Apple introduced a mobile payments platform and while I am interested, I am a tad skeptical at how this is going to trend in real world implications. If I still need to carry credit cards because there are various retailers who don’t support Apple Pay, how effective is such a service? Certainly Apple Pay represents the strongest movement yet for the mobile payments arena, but for now I am taking a wait-and-see approach.
U2. I still don’t quite understand the point of Apple subsidizing a U2 album. I get that Apple wanted a musical act to close out the event, but U2?
Summary. Apple did what it had to do to give Apple Watch a solid chance of succeeding. The hype for today’s event seemed higher than the initial iPad event and I think it’s clear Apple wanted people to know Apple Watch is a big deal and should garner the corresponding attention. For now, I think Apple early adopters will buy Apple Watch (5-8 million units), with a decent uptake in some market niches (another 5-10 million units). While some are expecting 60 million units sold in the first year, I am taking a more measured 2-3 year horizon before we see those kind of sales numbers. Ultimately, I think Apple has a winner with Apple Watch.
John Paczkowski over at Recode is reporting Apple will announce a wearable device in two weeks. Tim Bradshaw over at FT is saying Apple’s new wearable won’t be called iWatch. While things can obviously change, and Apple product naming is notorious for being kept close to one’s chest, both journalists have solid track records.
I have three observations.
1) No Leaks Suggest Delayed Launch. We have seen no leaks of a new Apple wearable device. While it certainly is possible that Apple doubled down on secrecy, I highly doubt that we would have no leaks of any kind for a brand new product that had entered mass production (2-4 million+ units) weeks ago. I suspect this new Apple wearable device, if announced in less than two weeks, will not go on sale anytime soon. I still would expect demos to be available at the event as Apple is fully capable of producing a few hundred devices internally. While the new Arizona sapphire plant certainly is intriguing and may play a role with wearables, there would be too many other partners involved in a wearable device for there not to be any leaks. While I still wrestle with the exact timing of shipping (I fully expect Apple to announce the ship date or at least a somewhat narrow timeframe), I think there is a low probability of an immediate launch.
2) Sharing the Stage. If Apple introduces a wearable alongside iPhones, I think the “wearable as an iPhone accessory” mantra makes a lot more sense that having a huge iWatch-only event, similar to the first iPad, where a wearable device can stand alone on its own merit and not require another iOS device. If a wearable device requires an iPhone to function, it makes more sense to announce alongside new iPhones. Over time, I expect wearables to become fully capable of moving beyond accessories, but we are only talking about the first version of a still unannounced product.
3) iWatch vs. Wearables Category. Apple may view the wearables category as requiring training wheels as consumers may not understand or connect with a full blown “iWatch” right out of the gate, so an in-between wearable device would be required to make the learning curve more manageable. For example, an iPad introduced in 2005 probably would not have done as well since people wouldn’t have been familiar with a touch interface - not to mention the lack of an app ecosystem. It is possible Apple will initially sell a wearable device similar to a fitness band, but focused on the much broader and mainstream subject of health, only to expand the lineup in subsequent years with various editions, price points, and styles. I have a growing suspicion that Apple’s wearables category will not be comprised of just one or two models but an array of devices as wearables will usher the era of fashion into personal technology. Apple’s recent retail hires support my thesis that a new way of thinking is required to sell a range (maybe up to dozens?) of wrist devices.
At this point I expect a “wearable” device to be introduced in two weeks, with the goal of getting users acquainted with this new wearables product category, while the more powerful and much more important “iWatch” is kept for 2015 or later.
What the Beats is Going on? Thoughts on Apple Acquiring Beats
Apple is reportedly interested in acquiring Beats for $3.2 billion.
Here’s what I’m thinking:
1) Separate the rumored deal price from the transaction. It’s a lot of money for Apple and in many ways focusing too much on the money will make it difficult to focus on the underlining acquisition target.
2) What is Beats? While everyone seems to have a different answer, to me Beats is a start-up music company that is after one thing: music mind share. Think of music and Beats comes to mind, right? No? Well give it a few more years and the growing popularity of those “obnoxiously large” headphones may change things. Co-founded by intelligent musicians (and businessmen) who “get” music, Beats knows what it is doing and more importantly what it’s after. Headphones, stereo equipment, music streaming service, and the list goes on. Beats wants to own music.
3) Apple is Afraid. I suspect Apple feels threatened as its mind share for music is declining. The iPod died on behalf of its older sibling, the iPhone, and following its death, the grip Apple had on music has started to slip. Think of digital music, and Pandora or Spotify may come to mind. Beats could very well be on the same path of music stardom. This past holiday shopping season, Beats headphones were everywhere (and people were buying them in droves). Walk down the street and you could tell when someone was wearing Beats. For the first time, the white EarPod was being threatened. Who knows what things would look like in a few years. Apple would be looking to change that with this acquisition. I suspect Apple is interested in buying Beats to gain music mind share.
4) Similar Cultures. Beats and Apple share similar cultures where passion is the ultimate driver. While there would undoubtedly be segments or pieces of Beats that Apple will shutter, Beats could very easily represent a decently sized (fewer than 200 people) division within the Apple system. Sure, this would mark a departure from the way things have been, but judging from Disney’s success, sometimes you have to let the past go and embrace the future.
5) Let’s go back to price. I think Apple is overpaying for Beats. Recent valuations pegged the music streaming service at around $100 million with the entire company worth a reportedly $1 billion last year. While additional details may come out in the coming days I suspect Apple is overpaying to avoid others from coming in and competing over price. It’s a lot of money for any company, and regardless of how much cash Apple has in its bank account, it’s still a lot of money. To me this means Apple is serious about this bet.
6) Lots of unanswered questions.
- Will Apple actually promote the Beats brand post acquisition? Such an idea is still hard to grasp, but maybe they would have to in order to maintain a gripe on the music mind share they are acquiring. Is the reason Beats headphones are popular because they aren’t Apple branded? If I had to bet I would say Apple walks a thin line introducing new Apple-branded music product, while also keeping the Beats brand around. Such an idea is still hard to swallow though…
- Will there be a Beats brain drain (employees leave) and does it even matter?
- How will this impact future Apple products? I suspect we are going to see Apple attempt a very significant push at a true music streaming service where I can have any song, when I want it (NOT RADIO), wherever I want it…and it would be free for iOS users signed up for Apple’s new mobile payment system.
- Will this open the floodgates to additional Apple acquisitions? If the answer is yes, then we may be entering a new era in tech M&A as the biggest tech company in existence is officially an acquirer (I don’t think this is the case though).
Acquiring Beats would be a new type of transaction for Apple. While there are similarities to previous acquisitions, there are just as many differences and for the first time we may be seeing Apple “doing what is right” - fighting for its survival.Apple wants to own music.
14 hour update: After plenty of Twitter discussions and thought, the only additional comments I have include:
1) Jimmy Iovine may play a big role. If the $3.2 billion price tag holds up, it becomes obvious that Apple is paying for intangibles (branding, music industry relationships) and not current products or services. In essence, Apple would be buying the music industry - something that Apple would not be able to do organically. Iovine has been critical of iTunes and it’s possible Apple wants him to revamp iTunes and bring the service into a new era (with the full support of the music industry).
2) Would Apple replace the iTunes brand with Beats? Is it possible for a declining consumer electronics brand (iTunes) to turn around and regain its strength? Maybe the only way for Apple to regain its grip on music is to update its branding from iTunes to Beats (among other things). In such a case, a $3 billion price tag doesn’t seem as crazy.
Samsung unveiled its second attempt at wearables, along with its latest flagship phone, earlier this week at MWC. I was not impressed and I am growing more confident that Samsung not only has another “crisis of design”, but will also soon face major headaches from competing Android OEMs. I think we are on the verge of a new phase in mobile phone hardware: Samsung competitors will finally be able to find a footing and begin to attack the giant. Meanwhile, I suspect Apple has already placed Samsung in the same drawer as Microsoft; irrelevant. Tim Cook and company is marching to a completely different beat.
1) The Galaxy Fit looks awful. A curved AMOLED touch screen with a huge piece of plastic on its underside attached to a Modern Glam (plastic) watch strap. I’m having a hard time seeing what is so “beautiful” or “pretty” about Samsung’s new fitness device, to quote a few easily amused tech bloggers. The company’s business model is not dependent on good design and few would suggest otherwise, but I struggle to understand how people can look at the Galaxy Fit and be even mildly impressed by such a horrendous product. One tech blog went so far as to say the Galaxy Fit is a “smartly designed fitness band”. It’s a piece of curved glass set on top of a bunch of plastic with an extremely awkward user experience and interface. Smartly designed?
2) Samsung Galaxy S5. Samsung’s flagship phone now comes in gold and has a fingerprint scanner. While the joke would typically stop there and many would say “copying a good artist is a pretty good strategy”, Samsung didn’t even copy well. The gold color is the wrong shade of gold (Modern Glam gold?) and the fingerprint scanner doesn’t work. I really don’t think I need to say much more about Samsung’s new flagship phone. I suspect Samsung will unveil the real Galaxy S5 this May? Interestingly, Apple was very quiet this week versus last year’s PR push leading up to the Galaxy S4 launch. I wonder why…
3) Samsung is a fish out of water without new Apple inspiration. Samsung is struggling. The easy smart phone growth achieved by simply shipping an alternative to iPhone (bigger screen) is drying up and with no clear path to additional revenue or earnings growth, the company amusingly jumped into wearables. The Galaxy Gear was downright disgusting, while the Galaxy Fit isn’t far behind. Samsung likes to throw around the “we give consumers what they want” meme and I am left wondering who was asking for something like the Galaxy Gear or Galaxy Fit? Samsung is throwing a lot of poop against the wall and desperately hoping something sticks. While some may label such a business strategy as acceptable, I have my doubts that consumers are going to stand by a company that is willing to ship products that merely represent different batches of wall poop.
4) Samsung’s credibility is taking a hit. Last year I noticed a few of my acquaintances made the switch from iPhone to Samsung. The usual reason given for such a move involved wanting a change or simply being bored by iPhone. Interestingly, on follow-up discussions in recent weeks, these switchers are now regretting their move away from iPhone due to Samsung’s plastic and subpar build quality. More than a few people on Twitter tell me the same thing about friends or family being disappointed with their Samsung phones. The amount of negative feedback caught me by surprise. Interestingly, only a few hours after introducing the Galaxy S5, Samsung rumor blogs were talking about a new Samsung phone coming out in May that actually wasn’t made of cheap plastic. Have we reached a point where even Samsung realizes the “not an iPhone” plastic gold Urban Glam option probably isn’t going to do much in terms of winning converts from competing platforms? Consumers are starting to notice what Samsung is actually shipping and the grumblings are getting louder.
5) Samsung competitors are foaming at the mouth. The long-standing joke is that the best Android phones available in the market (never a phone made by Samsung) don’t sell well because no one cares about anything other than Apple and Samsung. I think that may change. After this week, I am becoming confident that consumers are going to stop being passive and begin seeking out alternatives to Samsung in the form of HTC, Sony, Nokia, Lenovo, or countless of other Asian OEMs, all of which are making significant progress in shipping attractive phones at attractive prices (I would include Nexus, but Tony needs to help Google rework distribution). In terms of hardware specs, most of these phones are already at parity and with several Samsung competitors now focusing on hardware design; consumers will simply have fewer reasons to instantly turn to Samsung. Whereas in the past, Samsung might have been the default choice for Android, I suspect that lead will start to slip. In addition, Samsung recently announced that they will reduce their advertising and marketing budget as mobile phone profits decline (not exactly the best timing for such a move). While smaller mobile hardware companies individually lack the ability to compete against Samsung, and just the thought of going up against Samsung can scare many executives into a cold chill, I think each competitor can take a bite out of the giant which can collectively create serious damage. To succeed against Samsung: 1) Focus on branding 2) Save or raise as much capital as you can and throw it into marketing 3) Narrow your distribution focus 4) Figure out why someone should buy your phone. The challenge is significant and Samsung will not stand still, but 2014 is the year. Wait any longer and limited resources may not allow another fight in the future.
Bonus - iWatch Implications from Galaxy Fit. The iWatch will not look like the Galaxy Fit and the iWatch will certainly not operate like the Galaxy Fit. The best way to think about this would be envisioning a small table in Jony’s design lab with various iWatch prototypes. The Galaxy Fit version (simple rectangular curved piece of glass positioned on a plastic watch strap) would be instantly cast off as a no, if it even would be positioned as a possible prototype in the first place. I highly doubt the iWatch will include a strap/buckle or a thick piece of bulging glass. The device won’t depend on an awkward user experience where you have to rotate your head and arm just to look at the device. In summary: Look at the Galaxy Fit and you now know what the iWatch won’t be.
I planned on buying a new iMac on Black Friday. In order to make the process smoother, I ordered online at 6am and chose personal pickup. Approximately one hour after I placed my order I received an email saying that my order was ready. Everything was going well since I would be able to coordinate my Apple store visit with other Black Friday observations at the mall, however my experience with the Apple retail store was very disappointing.
My first interaction with the Apple store was a greeter assigned to the entrance. After saying that I was picking up an iMac that I ordered online, he told me to go see “the guy with the grey hat”, pointing in the general direction of the rear of the store. Relative to other Apple stores this particular location is small and I would venture a guess that it is one of the smallest out there, a carry-over from the early years of Apple retail. After a few minutes it became clear that the “guy with the grey hat” wouldn’t be available any time soon, so I was off to find someone else.
Even though there were plenty of red shirts visible in the store, everyone seemed focused on some task. After finding another worker that actually was not with another customer, I was told to go see another person for personal pickup, who unsurprisingly was with another customer. A few more minutes go by and I finally get my iMac. Overall I didn’t find the experience too magical and in fact, compared to other stores during Black Friday including Macy’s, I would classify Apple’s customer service as inferior.
1) I am not a fan of having to talk with a greeter at the Apple store entrance only to be shuffled to someone who clearly is not free to assist me and repeat why I am in the store. The whole process seems highly inefficient. Instead, getting my information and then relaying that to another employee who can come forward to help me seems more enjoyable. This process may actually exist in other Apple stores and I almost remember something like this occurring to me in the past, but it has been a few years.
2) Apple retail employees have different tasks even though you would never know it because everyone wears the same shirt color. Some workers do not deal with money, others only go around answering questions. This scenario becomes tricky when trying to buy products or pick up previous orders. Compare this to Macy’s where mostly anyone you find walking around can hop over to the nearby register and take care of your order.
3) The floor layout is just unnecessarily chaotic as people are standing around for various tasks such as purchasing product or getting tech support. Generally the front of the store is geared towards selling product with the back dedicated for the Genius Bar, but the middle zone is a very awkward area with people randomly standing around.
In previous years, I recall Apple have a more traditional check-out process for gift cards and other smaller items such as iPods, but such a layout did not exist this time around. Maybe I’m being a bit unfair and I just timed it wrong?
Apple retail just isn’t working anymore and you clearly have numerous objectives to accomplish in 2014.
It was an eerily quiet 2013 for Coldplay. Besides one new song for ‘The Hunger Games: Catching Fire’ soundtrack, the band was in hibernation. If Coldplay was a stock, it would have experienced an awful 2012 and 2013. In reality, this is exactly when all of the heavy lifting is done and new songs run through the imagination, creation, and tinkering stages. Hibernation can be a healthy way of nurturing fan relationships (cravings) and resetting media’s infatuation.
Source: Google Trends
A quick look at Google Trends shows that interest in Coldplay (judged by Google searches) stands at eight-year lows. Of course, interest is largely a product of album releases and concerts (none of which occurred in 2013). Coldplay interest peaked during the very busy 2005, 2008, and 2011.
2002: A Rush of Blood to the Head
2008: Viva la Vida
2011: Mylo Xyloto
People are now wondering if Coldplay has topped, unable to match the sheer momentum experienced in 2011. Doubts over new competition, such as Imagine Dragons, or if people are just tired of Coldplay are getting louder. The latest rumors say Coldplay’s latest album may be released Summer 2014. I would bet that the album will be #1, Coldplay interest in Google Trends will once again reach a new relative high, and the Coldplay PR machine will return with a vengeance. Hibernation is a good thing. If Coldplay was a stock, I would be buying it hand over fist as 2014 will be a good year for the band.
Let’s take a step back and see how things look around the world.
Apple is Fine.
Similar to 2012, Tim Cook back-loaded Apple’s 2013. Apple went so far as to release the retina iPad mini pretty much as late as it could and still guarantee that supply would be adequate before the key holiday shopping season. From all indications, the new hardware is selling well - as one would expect - although many Apple bloggers whiffed when judging 5c popularity. While the sales gap between the 5s and 5c may shrink going forward, I would be quite surprised if the 5c becomes “the real iPhone” as many predicted. The sheer uproar over 5c pricing appears to have quieted down as well. Apple’s redesigned iOS 7 doesn’t seem to have created any new “–gate” controversies, with the only complaints coming from design snobs (I say that with genuine respect). Apple accomplished a lot in 2013, and 2014 looks to be just as jam-packed with what I would expect to be iPhone bifurcation (two distinct iPhone form factors with simultaneous development – a really big deal). An iPad pro (think larger iPad Air with possible dedicated accessories for professionals) would also seem to fit very well in Apple’s 2014 resource timeline.
Tech Industry Hardware Becoming a Snooze.
Take a look around and there really isn’t much in the way of exciting and flashy hardware innovations geared for the masses. Yes, the 5s is forward-thinking, and has the internal composition that will rival next year’s iPhone 6, but it’s hardly something to get people talking at the holiday party. The iPhone 5s fingerprint scanner is nice (continues to work well for me), but I’m not finding it nearly as much of a salesperson as Siri (those initial demos were unbeatable). On the tablet front, it has become an even bigger bore. I use an iPad 2 and have absolutely no desire to upgrade to a newer iPad anytime soon. Outside of Apple, Google is busy publicly beta testing hardware products with the ultimate intent of controlling our data and attention. Amazon is busy spending money left and right in an attempt to sell Amazon Prime subscriptions, and Samsung is twiddling its thumbs waiting for Apple to release new products.
Smartwatches Selling Like Cold Cakes.
The smartwatch appears to have finally hit mainstream in 2013 as Best Buy is now carving out more square footage to the concept. Sales are, and will probably remain, “okay” for early adopters where massive sales are certainly not on the radar, but mass adoption remains out of reach. The idea of a smartwatch makes perfect sense as the phone form factor contains numerous inefficiencies, but the smartwatch industry lacks the needed design and fashion acumen to really get things moving. The technology does appear to be available though. Interestingly, one company has been beefing up their design and fashion human capital resume.
Mobile Messaging App Fever. Yawn.
I’ll be honest, I get bored with the never-ending updates on how many users certain mobile messaging apps have. In the U.S., this fascination with mobile messaging apps remains subdued as Facebook, Twitter, iMessage, (and I suppose you can include Snapchat), pretty much represent the bulk of how people communicate with each other – oh and the phone feature on the iPhone as well. Maybe I’m just naïve (and only friends with Apple users), but I really have no desire to follow which mobile messaging app is selling “stickers” or making a play for the Indonesian mobile app market. I never have used Whatsapp and don’t know anyone who has either. The mobile space is fast moving and people love stories of how start-ups will displace incumbents, but from my vantage point in the U.S. – Facebook and Twitter will remain important communication channels, while iMessage continues to be the sleeper hit. I still think mobile carriers are the big winner as my monthly bills will continue to rise regardless of which start-up does well. Of course critics will say the U.S. doesn’t matter, or is behind the times (and that I am clueless), to which I respond as long as the Valley remains the focal point of technology and entrepreneurship in the world, the U.S. matters.
Changing of the Tech Review Guard.
Yesterday, The Wall Street Journal announced Walt Mossberg’s replacements – relatively new names that probably will get paid a fraction of Mossberg’s current salary. I actually don’t think the WSJ will miss a beat with such a strategy, which may say more about Mossberg’s inflated salary than anything else. Nevertheless, WSJ tech reviews still matter and companies will continue to treat them accordingly. The overall tech product review industry continues to morph and traditional sources for the “yea or nay” for a new product are now shifting to bloggers turned journalists where personal trust outshines all else. As seen with Apple’s latest products, tech specs don’t matter as much these days and this trend will only intensify as fashion bleeds into personal technology.
Other Random Musings.
It is now easier than ever to grab a few of your journalist friends and start a new company focused on delivering news. Oh, and charge people a lot of money to read what you have to say. I imagine this trend will only intensify as it is becoming clear that 1-5 person shops are finding a particular niche in online journalism. Some personal bloggers are pulling in more than $500,000 a year, which traditional media companies will have a hard time matching (or even justifying), while start-ups with minimal expenses require only a modest subscription base to break-even. Of course, aggregators will continue to do well in this world as well where expense growth via headcount is one differentiator versus the small shops. Slideshows put food on the table. One has to start worrying about information overload though, right? Hopefully? Yeah, I know, wishful thinking.
A wildcard for 2014 includes Apple’s new retail chief, Angela Ahrendts, which some have already labeled as Apple’s next CEO. My response would be let’s wait to see how she fits within the Apple culture, then we can start talking. Regardless, Apple retail needs some urgent help, so Angela will be busy.
The tech IPO window is wide open and many signs point to 2014 being another good year. Housing continues to stabilize and contrary to the perma-bears, I think the housing industry will be fine from here on out. The theme of rising interest rates (due to a stronger economy) makes sense to me as well. While I won’t comment on which companies will see an IPO in the coming quarters, I would focus on the quality of these IPOs as one would assume quality will decline as we move past the economic recovery years of 2010-2013.
Angry Birds (and paid iOS app?) fever is over. It was fun while it lasted. I would be interested to see if Rovio can find another “Angry Birds”, although I remain skeptical. In addition, the overall paid app boom appears to be dead (was there ever a boom?). While there will still be winners going forward, companies solely focused on selling apps for money face dwindling prospects of success. App development, as part of a bigger strategy, seems to have a much brighter future.
Predictions for 2014.
Pundits will say Apple made numerous mistakes, either in terms of product pricing, marketing, or strategy. The new iPhone will also be classified as marking the end of Apple’s popularity.
VCs will continue to pass off personal marketing blogs as independent sources of knowledge and wisdom.
Pundits will say Facebook is dead.
Mobile messaging app fever will continue.
Humans will continue to be inundated with useless information and inconsequential data points.
Revenue: $37.6 billion (AAPL guidance: high end of $34-37 billion range/Consensus: $36.8 billion)
I expect Apple’s revenue to increase 4% year-over-year.
Gross Margin: 37.1%(AAPL guidance: high end of 36-37% range/Consensus: 36.9%)
I expect Apple’s margin to increase sequentially to 37.1% from 36.9% last quarter, reflecting a modest boost from the newest iPhones. Management’s margin guidance is approximately 300-400 basis points less than the 40.0% margin reported in 4Q12.
EPS: $8.20 (Consensus: $7.93)
I expect Apple to report a 5% yoy EPS decline. I am including a 908 million share count (implying around $8 billion of buyback).
Product Unit Sales and Commentary
Macs: 4.4 million (10% yoy decline)
Mac sales continue to slow as tablets and smart phones satisfy many consumers’ computing needs. I assume 10% declines in both desktops and portables.
iPad: 12.4 million (12% yoy decline)
I expect Apple to report weak iPad sales ahead of the iPad refresh in October. With modest channel inventory fill, I expect iPad sell-through to stay somewhat consistent with 3Q13, reflecting some benefit from back to school shopping.
iPod: 3.7 million (30% yoy decline)
iPhone: 34.4 million (28% yoy growth)
I ordered my gold iPhone 5s online seven minutes after launch and my phone didn’t ship until September 30, two days after quarter end, so it’s clear that a large number of iPhone 5s launch sales will be pushed into 1Q14. Partially offsetting delayed 5s launch sales was solid 5c supply. My 34.4 million iPhone number assumes 13-14 million units of iPhone 5s and 5c and 20 million units of legacy iPhone (5, 4S and 4) selling at roughly the same weekly sales pace seen in 3Q13 (2.6 million).
I expect Apple to beat consensus EPS on Monday.
In terms of 1Q14 guidance, I am expecting approximately $55-58 billion of revenue and 37.5-38.5% margins (which would equate to EPS of approximately $14.50, or a 5% increase from 2012, marking the first quarter with earnings growth since 4Q12). The Street is nearly complete with the Great Apple Expectations Reset of 2013. Heading into 2013, most (including myself) were thinking Apple annual EPS was running around $60. The iPad mini’s lower ASP and margin along with high-end smart phone market saturation resulted in EPS closer to $40. Expectations now appear to be closer to reality as consensus EPS for 2014 now stands at $43. I am around $41-$42, which reflects no China Mobile announcement (I will include the additional $3-$4 when the deal is announced), no change in margins (most likely conservative given the new iPhone lineup), 11% unit growth in iPhone, and 15% unit growth in iPad.
I’ve been using my new gold iPhone 5s for a few days. Here are my initial impressions:
Size: I like the 5s, not sure I would enjoy a bigger phone. Upgrading from the 4S, it took a little bit of time to get use to the slightly farther thumb reaches required to touch the upper left corner of the 5s. Even though the extra screen real estate is a positive, I have doubts that I would want a bigger screen than the 5s. I often find myself in one-handed use situations and I simply would not be able to use a bigger screen. If Apple is to go bigger with iPhone 6 (seems like its more than a 50/50 probability at this point), I suspect Apple will also maintain the current iPhone size, which would be noteworthy in that Apple would be maintaining and updating two different iPhone sizes. It may just finally be that time though as the smartphone market continues to mature.
Slo-Mo: This year’s Siri. The new slow motion camera mode will be the feature everyone is demoing at the Thanksgiving table or holiday party, just like how Siri was so much fun to show friends and family. I have taken at least 15-20 slo-mo videos so far and still can’t get enough. Of course, this fascination may very well die off in a few weeks, but by then it wouldn’t matter much since everyone I know would have seen the feature.
Color: White is the new Black.Up to now, it felt that the black iPhone was the unofficial default iPhone, the color you get to be like everyone else, while the white iPhone was the designated color to stand out from the crowd. I think the 5s changes that dynamic and white (sliver and gold) will become the default color, while the space grey is the color to stand out from the crowd (even though it doesn’t stand out as much as white did in previous years). Of course, I am not taking into account case usage, which may make this a moot point, but nevertheless I think there will be quite a few gold and silver iPhones in the wild in coming months and momentum will only build.
Touch ID: Awkward at first, but still cool. It took me two days to get use to Touch ID, or should I say, break my habit of simply pressing the home button and then typing my passcode. My issue dealt with pressing the home button and not leaving my finger on the button long enough for the fingerprint scanner to do its job. I also tried to show the feature to another 4S user and they had to be walked through the installation steps and even then they had trouble, so clearly Touch ID is not the easiest feature to demo to normal non-tech users, but nevertheless it’s pretty cool.
Weight: Wow. After a few days of using iPhone 5s, my iPhone 4S feels like a brick. It’s remarkable and incredible. Not sure much more has to be said.
Battery: An improvement. I’m able to get through a day of pretty constant 5s use (a few tasks per hour, all day) without a trip to find the power cord. I wouldn’t be able to say the same with my iPhone 4S.
Speed: Hard to see a difference with LTE; iOS 7 feels faster with 5s. LTE was one of those features Android fans mocked the 4S for not supporting. I don’t see the big deal. I often find myself on Wi-Fi with fast enough speeds to make any differences with LTE negligible. I do see a difference in terms of iOS 7, especially animations. Even though my 4S was feeling a tad sluggish with iOS 7, I don’t find myself complaining with 5s.
Free iPhoto & iMovie: Useful and fun. A few seconds after launch I was asked if I wanted to download a slew of free Apple apps, including iWork, iPhoto, and iMovie. While many users may just play around with these apps here and there, I think they are plenty capable and will put a dent in third-party paid photo and video editing apps.
Big Picture: Refinement is king with 5s. When I upgraded to 4S from 3GS, the speed blew me away. Not only was the phone’s improved performance noticeable, but Siri was a pretty darn cool feature. The 5s doesn’t have that same wow factor surrounding speed improvement, but instead the subtle refinements in terms of battery, camera, apps, and color, add up. I would have a difficult time moving back to the 4S, which is the easiest way to know that the 5s is a winner and another step forward in Apple’s iPhone refinement journey.
Twitter's Problem; Not Connecting with Mainstream Users
Twitter is going public. If you are an employee, investor, or simply a tech IPO lover, this is a very exciting time. While there is much to like about Twitter, I’m noticing a trend that is somewhat concerning; Twitter isn’t connecting with mainstream users.
Twitter had 215 million monthly active users (MAUs) as of June 30, 2013, a 44% increase from 2012. In today’s mobile world, an ecosystem with 215 million users is a very respectable number, but a 44% user growth rate isn’t superb. In the U.S., Twitter saw only 32% year-over-year user growth to 49 million MAUs, adding just 1 million users in the second quarter. For a well established ecosystem, these numbers aren’t exactly thrilling.
Earlier this week, one of my Facebook “friends” posted a question on her timeline, “What’s the deal with Twitter? Should I do it?” Within one hour, five people answered - all with a “no”. Surveying my non-tech social circle, Twitter usage is abysmal. A quick check with my high school teacher acquaintance led to an expected answer, no one at school talks about or uses Twitter. At a recent state fair that saw upwards of 160,000 visitors on a Saturday, tweets mentioning the event numbered in the dozens. The list of anecdotal data points showing Twitter’s lack of connection with mainstream users goes on and on.
While Twitter is proving valuable to a select group of users, the platform is not exactly hitting mainstream usage similar to how Facebook (1.1 billion users) conquered the world, or even messaging apps such as WhatsApp (300 million users) are trending.
What is going on? I suspect Twitter is not appealing to the masses in a world where Facebook made it socially acceptable to share and more intimate social apps, like Snapchat, are using their “coolness” and “ease” to flourish. Many are confused with the concept of Twitter since the company really isn’t a classic social network, but instead an information aggregator. When a user joins, they are bombarded with suggested follows. If a user bypasses the suggested follows page, it is somewhat unclear what is the next step, especially if their current social circle is not well represented on Twitter. It takes time to find interesting channels (people, companies, concepts) worth following. Rather than being a social network where people use Twitter to update friends with actions and ideas (that’s more for Instagram and Snapchat), I think of Twitter more like an improved form of television, where a user creates a list of channels to watch or follow. Corporations, brands, and news organizations desperately want a Twitter presence to reach potential customers, further highlighting the television metaphor. The big question is if such a concept can appeal to mainstream users.
Heading into Twitter’s IPO, I suspect user growth will remain a key topic and concern among investors. While management will be judged on revenue and profit growth, including user utilization rates, I think the company faces an uphill battle with user growth as competing services continue to fight for mindshare in the maturing mobile computing era. I see the value in Twitter, but I’m concerned that mainstream users will never give the service a chance.
I felt Apple did a good job today. For the first time Apple will be selling two brand new phones, including one for under $100 in the U.S. A brand new iPhone for under $100. I wouldn’t underestimate the impact of such a feat.
While there were some interesting technologies introduced, including a fingerprint scanner and a motion coprocessor, I have learned to control my long-term predictions on what such technologies may mean for Apple’s product line. Time will tell if such innovations become major cornerstones in future Apple products.
The most controversial aspect of today’s event was iPhone pricing. I see a schism developing among the tech punditry. On one hand, there is the belief that market share is king and Apple must address the bottom of the market because developers will begin to focus on Android’s sheer numbers instead of iOS. On the other side, where I stand, market share is not created equal. It is okay if Apple doesn’t address the lower end of the market since five consumers who don’t buy mobile apps or content is not equal to one who does. Looking at today’s events, I think Apple is doing the right thing gradually moving down market (iPhone 4 and 4S have not been discontinued). This strategy will only expand in coming years. With approximately 400M-500M (and growing) active iOS users with credit cards, I view the iOS ecosystem as now self-sustaining, capable of app innovation as long as the hardware and software back developers up. If I changed sides and instead only looked at market share, I’m sure I would have been championing Symbian, then Blackberry, and now Android. Market share is not everything.
Moving to more minor topics, Apple is still addicted to case money, now selling iPhone 5s and 5c cases. Selling cases is a good and easy business decision and judging from the popularity of iPhone cases, Apple will make a decent amount of profit (and margin) from going down that road. Apple also announced it will give away $40 of software with new iPhone and iPad purchases. While I am not a big user of Apple’s mobile productivity apps, quite a few people are and I suspect there will be many happy iOS users.
There are still plenty of questions remaining about Apple and strategy.
Did Apple’s keynote contain a bit too much of tech jargon? Maybe.
Will mainstream consumers accept iOS 7 without any major complaints? Maybe.
Will Apple’s margin actually benefit from the new iPhone line? Maybe.
Nevertheless, with a new flagship phone that has enough differentiation to stand out from competitors, a more value-oriented option for consumers with slightly different priorities, and the desire to maintain older iPhone models in order to address the mid-tier phone market, I like where Apple is sitting and the outlook for the iPhone business over the next 6-12 months.
Apple’s 2013 iPhone event is here. At the end of the day, everything comes down to expectations. If reality is unable to meet expectations, disappointment is not far behind. If expectations are kept measured, reality may still be able to deliver a positive surprise. Taking into account weeks of rumor, speculation, discussion, and simply “educated” guessing, here are my expectations:
Subsidy Land (Countries where phones are subsidized by mobile carriers)
$199 – iPhone 5S with a 128GB option, “gold” color option, fingerprint scanner, improved camera, faster processor. (95% confidence)
$99 - iPhone 5C available in various colors. (75% confidence)
$0 - iPhone 4S (51% confidence)
Non-Subsidy Land (Countries where phones are not subsidized by mobile carriers. Pre-paid option in subsidy land. For simplicity, I’m not considering various taxes/international fees.)
$650 – iPhone 5S with a 128GB option, “gold” color option, fingerprint scanner, improved camera, faster processor. (95% confidence)
$499 – iPhone 5C available in various colors. (75% confidence)
$399 - iPhone 4S (51% confidence)
$349 – iPhone 4 (50.1% confidence)
1) The “cheap” iPhone won’t be cheap. Consensus seems to have settled around the $399-$499 range, therefore I suspect $499 is the floor. For the first time, Apple will be selling a brand new iPhone for under $100 in the U.S.
2) I think the iPhone 4S and 4 will stick around (in somewhat limited capacity). I have received the most push-back on this point, but I still see a large market need being met by the 4S and 4 (having an iPhone at a sub-$400 price point is important).
3) The iPhone 5 will see end-of-life, to be replaced by the very capable iPhone 5C.
4) Notice the subtle differences in subsidy and non-subsidy wholesale pricing. Apple may be willing to sacrifice $50 or so in non-subsidy land for more aggressive iPhone 5C pricing (coinciding with China Mobile launch).
5) I think an iPhone 5S fingerprint scanner could be a pretty big talking point during the keynote (think this year’s Siri). Expect very limited functionality, but a ton on security and privacy.
6) Other topics such as a refreshed Apple TV (not a TV set), updated iPods, and a few more new iOS 7 features are probably more likely than not at this point.
Other Random Musings
As usual with Apple keynotes, the safe bet is to collect all rumors and divide by half to get closer to reality. There will likely be disappointment around iPhone 5C pricing and chatter that the iPhone 5S isn’t different enough from previous models. Let’s not even begin to discuss iOS 7 reactions.
The first half of 2013 felt weird. Even though plenty of phones and tablets were sold, as well as several laptops, the excitement level seemed less inflated compared to last year. Consumers are content with their gadgets and remain busy uploading personal information to a dozen or so social and messaging networks. Nevertheless, there were some stories in the first half of 2013 primed for riveting Twitter debates. To sum up my stance on these issues, I came up with an easy to remember platform, akin to a politician. I am pro-iWatch, pro-expensive cheap iPhone, anti-Glass, and pro-Schiller.
Pro-iWatch. Wearable gadgets interest me and I think there is something there. Back in February, former Apple designer Bruce Tognazzini began what turned into a multi-month parade of chatter related to Apple developing its own smartwatch. I still think Bruce’s piece is the best words on the device and I have a feeling that a few years from now most of his post will have become reality. My conspiracy theory is that Bruce was frustrated with iWatch progress and released some of the work Apple had already done as a bribe to get Apple to finally decide to give the project the green light. In reality, Apple probably has been working on a gadget for the wrist for years (yes, that would make it a Steve project) and there was enough chatter floating around for Bruce to collect into a post.
I suspect Apple did give the iWatch a green light as seen by numerous talent acquisitions and other signs including industry and management chatter. I think consensus is unsurprisingly naive, if not downright clueless, when it comes to thinking of how an iWatch would look and function. People need to stop picturing a classic watch when rethinking the watch. I am not a fan of today’s smartwatch as the genre fails to answer many questions that the 21st century has placed on the classic watch; primarily purpose and functionality. The current smartwatch market isn’t seeing massive adoption and the industry lacks a cash-rich leader. Samsung and other giants are quickly rushing to market with their own smartwatch, but I am not optimistic that much will come from these early efforts. Instead, I would look more towards Nike’s Fuelband for signs of reinventing the watch. Add in device independency and fashion conscientiousness, and we start to peel the skin to iWatch’s core.
Pro-Expensive Cheap iPhone. Apple continued to show healthy iPhone sales last quarter with 20% unit growth. Average selling price (ASP) fell as consumers continued to buy the discounted iPhone 4 and iPhone 4S. It seems fairly certain that Apple will release two new iPhone models next month; a “5S”, or the latest iteration to the iPhone 5, and a less expensive iPhone (think iPhone 5 only with a plastic casing and I suspect lacking the ability to support iOS 7 features exclusive to the iPhone 5S). Price points remain a controversial topic, boiling down to two schools of thought; the cheap iPhone will be priced closer to $200 in order to gain traction in emerging markets where phone subsidies don’t exist versus priced closer to $399-$499 as Apple continues to gradually move downmarket, attempting to create demand in the $399-$499 no-man’s land of new phone pricing. Even though Apple may be able to manufacture a phone for $200 and still make an “ok” profit, I suspect Apple’s larger strategy is to make sure that all profit layers are captured as the iPhone moves downmarket. If the strategy backfires, Apple can discount the one-year old iPhone 5C for $299 next year and give it another try.
I also think a new $399-$499 iPhone fits well within a possible pro-forma iPhone lineup of iPhone 5S for $650, iPhone 5C in various colors for $450, and iPhone 4S for $350. Such a line-up could be sold across the world, including subsidy land. While a $450 “cheap” iPhone does not address the army of Android phones selling for $99, I wonder if that target is something Apple needs to even shoot for in the near-term.
Anti-Glass. I summed up my Google Glass angst in a prior AAPL Orchard post, largely questioning the product on poor industrial design. Having a product on my face, during both usage and non-usage, strikes me as terribly inefficient and ineffective, not to mention obtrusive. Regardless of design, I also suspect the widespread popularity of contact lenses represent a strong case that glasses aren’t exactly a desirable body modifier. Sure, Google Glass represents something new, but new is not the same as good. Many pundits are hedging bets with assertions that Google Glass may find its niche audience. In retrospective, such a statement can be said about any new product as long as the company making that product remains committed to funding the project. Instead, I think Google Glass will largely be ignored once wrist devices flood the market.
Pro-Schiller. This is the pro-freedom part of my platform, the idea that probably isn’t too controversial yet often goes unnoticed. I consider Apple SVP of Marketing, Phil Schiller, as the embodiment of Apple’s culture. Yes, Jony is Apple’s soul, but Schiller represents the hard work that occurs at Apple HQ, along with the fun, jokes, and general love for the journey taken. Any quick YouTube search would reveal plenty of clips showing wacky Schiller during Apple keynotes. Earlier this year, Schiller made headlines for pumping a bit of Apple PR before Samsung’s keynote unveiling the latest version of its flagship phone. In retrospective, Schiller didn’t need to say anything as Samsung relied on racist and sexist undertones to unveil a phone that didn’t live up to Apple-like expectations. Looking ahead, Schiller’s input on product pricing placement and marketing will continue to take the spotlight.
Apple continues to feel margin pressure from its current product lineup. Management’s margin guidance is approximately 940 basis points less than the 47.4% margin reported in 2Q12.
EPS: $9.55 (Consensus: $10.07)
I expect Apple to report a 22% yoy EPS decline. My $9.55 estimate is less than the Street’s $10.07 average.
Product Unit Sales and Commentary
Macs: 3.7 million (8% yoy decline)
Mac sales continue to slow as tablets and smartphones satisfy many consumers’ computing needs. I assume declines in both desktops and portables.
iPad: 15.5 million (31% yoy growth)
I expect Apple to report solid iPad sales for 2Q13. My iPad estimate assumes approximately 8-10 million iPad mini sales and approximately 1-2 million units added to channel inventory in order to meet management’s target range.
iPod: 6.1 million (20% yoy decline)
iPhone: 36.5 million (4% yoy growth)
With iPhone channel inventory already within management’s target range, I expect Apple to report a significant slowdown in iPhone unit growth (30-90% unit growth over the past four quarters vs. 4% in 2Q13) as the smartphone market matures. Verizon activated 4 million iPhones in 2Q13 and if Verizon represents a similar share of total iPhone sales during the quarter, my 36.5 million unit estimate may be too optimistic on the order of 20%. If iPhone sales are trending closer to 30 million units, I think Apple may resort to stuffing the channel by at least 1-2 million units, resulting in a bear case of approximately 31-32 million iPhones (resulting in EPS around $8.60).
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.
Revenues beat ($54.5 billion vs. my $53.1 billion)
Margin beat (38.6% vs. my 37.9%)
EPS beat ($13.81 vs. my $12.75)
iPhone was an exact match (47.8 million - equal to my estimate)
iPad was slightly stronger than expected (22.9 million vs. my 22.4 million)
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.
I expect Apple’s revenue to increase 23% year-over-year after adjusting for the 14 weeks in 1Q12.
GM: 37.9%(AAPL guidance: 36.0%/Consensus: 38.4%)
Apple’s margin is expected to decline sequentially from 4Q12 primarily due to the wide range of updated products. Margin remains a key near-term unknown for AAPL. Management’s 36% margin guidance is 870 basis points less than the 44.7% margin reported in 1Q12, making EPS growth difficult to achieve. I still include expanding margins throughout 2013. Further weakness, or a shallower rebound, may result in an additional EPS growth headwind.
I expect Apple to report a 1% yoy EPS decline, when adjusting for 1Q12. While my $12.75 estimate is less than the Street’s $13.33 average, I attribute much of the variance to my lower gross margin expectation.
Product Unit Sales and Commentary
Macs: 5.2 million (flat yoy growth)
Mac growth continues to slow as tablets and smartphones satisfy many consumers’ computing needs. I expect 10% growth in portables driven by holiday shopping to be mostly offset by nearly a 30% decline in desktop sales due to the new iMac release schedule.
iPad: 22.4 million (56% yoy growth - when adjusted for 1Q12)
I expect Apple to report record iPad sales for 1Q13. My iPad estimate assumes approximately 8-10 million iPad minis and 12-13 million iPad 2 and fourth generation units. The iPad mini went on sale November 2 with an aggressive rollout, despite significant pent-up demand and limited supply. Apple was able to sell three million iPads in the three days following the iPad mini and fourth generation iPad launch. My estimate assumes approximately 25-35% cannibalization of the larger iPad models (1 out of 3 consumers willing to buy a larger iPad purchased an iPad mini instead). Going forward, I expect iPad mini sales to approach, if not exceed, those of the larger iPad models.
iPod: 12.0 million (16% yoy decline)
iPhone: 47.8 million (39% yoy growth)
Apple made significant progress in reaching supply/demand balance for iPhone 5 in the U.S. and other launch countries. My quarterly estimate is largely based on AT&T’s recent comments on October and November smartphone sales (and additional extrapolation). Historical averages for AT&T’s share of global iPhones (and assuming a slighter higher mix of international sales) would imply 40-50 million iPhone sales, which I would consider the high probability estimate range. I then assume channel fill of at least 1 million units, which positions my estimate in the narrower 46-48 million estimate range.
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 smartphone pulling in $80 billion of revenue annually and growing at least 30%.
A tablet pulling in $30 billion of revenue annually and growing at least 45%.
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.
Walmart Discounting Apple Products: Gloom or Boom?
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.
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.
I expect iPad and iPhone to represent approximately 69% of Apple’s quarterly revenue.
GM: 40.8%(AAPL guidance: 38.5%/Consensus: 40.4%)
Apple’s margin will likely decline sequentially from 3Q12 due to the iPhone 5 and continued iPad 2 sales. A key question facing AAPL in the near-term is the margin run rate. In 2011, Apple reported a 40.5% gross margin, which increased to approximately 44% in 2012. Looking at 2013, I expect margins to decline a few hundred basis points to 42% related to the iPad mini and ongoing costs related to the iPhone’s new form factor.
EPS: $8.95(AAPL guidance: $7.65/Consensus: $8.85)
I expect Apple to report 27% yoy EPS growth. Interestingly, my $8.95 estimate is close to the Street’s $8.85 average, with 17 analysts projecting EPS higher than my $8.95. I attribute my low estimate to weaker iPhone sales, a lower iPhone average selling price (ASP), and a lower overall margin.
Product Unit Sales and Commentary
Macs: 5.5 million (12% yoy growth)
Mac growth is slowing as tablets and smartphones satisfy many consumers’ computing needs. I expect double-digit growth in portables, driven by back-to-school purchases, to be partially offset by a modest decline in desktop sales due to stale models.
iPad: 18.4 million (65% yoy growth)
I expect Apple to report record iPad sales for 4Q12. My iPad estimate assumes approximately 1.5 million iPads sold per week (including iPad 2 sales), which compares to the approximate 1.4 million weekly run rate last quarter. Supply/demand is in balance. Anecdotally, iPad 2 sales in education and business appear robust following the price cut, while lower component and manufacturing pricing should help limit drastic margin compression.
iPod: 6.1 million (8% yoy decline)
iPhone: 24.8 million (45% yoy growth)
My estimate reflects 7 million iPhone 5 units and approximately 18 million iPhone 4S units (and to a lesser extent iPhone 4 and 3GS). Apple is currently suffering from a supply/demand imbalance for iPhone 5, which will limit sales in the near-term (including 1Q13). Other unknowns include the iPhone 4S sales run-rate prior to the iPhone 5 introduction and iPhone 4S popularity following the price drop. My 18 million iPhone 4S estimate reflects the impact from consumers delaying iPhone purchases ahead of the iPhone 5 release. I am including a declining ASP due to robust iPhone 4S sales following the price drop (an observation partially derived from Verizon’s earnings which showed strong non-iPhone 5 sales, which I attribute to the price drop).
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.
I expect iPad and iPhone to represent approximately 75% of Apple’s quarterly revenue.
GM: 45.5%(AAPL guidance: 41.5%/Consensus: 43.3%)
Apple’s margin jumped to 47.4% last quarter, from 40.5% in 2011. Weaker iPhone sales should serve as a headwind for sequential quarterly GM expansion in 3Q12, although attractive component pricing will continue to provide support for yoy improvement (Apple reported 41.7% margin in 3Q11).
I expect Mac shipments to show continued strong yoy growth following updates to the laptop lineup at WWDC. Pent-up demand and early back-to-school purchases should help offset MacBook Pro with Retina display shortages.
iPad: 21.3 million (130% yoy growth)
Apple will report record iPad sales for 3Q12. My iPad estimate assumes approximately 1.8 million iPads sold per week (including iPad 2 sales), which compares to the approximate 1.2 million weekly run rate during the last holiday quarter. Management commentary regarding continued iPad supply/demand imbalance bodes well for record iPad sales. Anecdotally, iPad 2 sales in education and business appear robust following the price cut, while lower component and manufacturing pricing should help to limit margin compression.
iPod: 6.6 million (13% yoy decline)
iPhone: 29.5 million (45% yoy growth)
My estimate reflects an average 2.5 million weekly iPhone sales run rate. At the end of 2Q12, Apple reported 8.6 million iPhones in the channel inventory, a sequential increase of 2.6 million units. Backing out the inventory build, Apple reported an average 2.7 million weekly sales run rate last quarter. With supply/demand in balance and rumors of the new iPhone building, I expect the weekly sales run rate to decline into the fall.
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.
With WWDC winding down in San Francisco and chatter concerning next week’s Google I/O picking up, few would have expected this week to be dominated by Microsoft news. Late Monday evening, after the East Coast had largely gone to sleep, at an event that was oddly so secretive that the press was not made aware of the venue until a few hours prior to start time, Microsoft announced its revamped Surface tablet and I felt somewhat duped. A team of executives got on stage in Los Angeles and put on a scripted show, only I was led to think it was reality. Microsoft faces an uphill battle and while consumers are now talking about the company and Surface, I have little confidence that Microsoft’s ultimate destiny was altered this week.
Surface Event Lacked Direction and Message, but Microsoft Accomplished Goal
At Apple’s iPad unveiling in 2010, Steve carefully crafted his sales pitch to show why the iPad should exist and be worthy of consumer’s precious dollars (pundits still questioned iPad’s purpose for the weeks, months, and years following the event). On Monday, Microsoft lacked a similar sales pitch, instead relying on teleprompters, and hobbling through failed demos, in an attempt to show that the lights were still on in Redmond. Microsoft’s event actually reminded me of HP’s TouchPad event in early 2011, where HP showed a general lack of direction and enthusiasm for the device. Reading off of teleprompters can really kill the passion. It has been four days since the Surface was unveiled, and with more questions than answers, I think Microsoft’s primary goal was accomplished; being mentioned in tablet (and phone) discussions between WWDC and Google I/O.
The Big Question
The Surface discussion can be reduced to one question: Is the Surface a proof of concept device meant to spur OEMs into action or is the Surface a sign that Microsoft is entering the tablet hardware space in response to changing market dynamics? It is easier for one to assume that Microsoft intends for OEMs to remain in the game, announcing the Surface as a means to drum up support and give OEMs confidence that there is interest for devices running Windows. However, if MSFT is looking to change strategies and develop the entire Surface device alone, I will give Steve Ballmer a pat on the back as that is one daunting move given the sheer difficulty in manufacturing desirable hardware.
The lack of available Surface devices for journalists to play with (unattended) and horrid onstage demos leads to me think that the Surface is very far from a shippable state. While working prototypes are common place in Silicon Valley, it is incorrect to assume mass production is only a few short months away as the task of figuring out how to turn a prototype into a mass-produced product at a particular price point (not discussed by Microsoft) by a specific deadline (also not discussed by Microsoft) may end up being just as difficult as building the original prototype.
Tablet hardware is tricky. From my initial iPad 2 review: “After a few minutes of using iPad 2, I found myself forgetting that I was using iPad 2. My entire thought process was given to the app that I was using. While iPad looks and feels amazing, the iPad dissolves away when in use, exactly how Apple planned it. Remove the intermediary and let users interact directly with innovation. I don’t care what is or isn’t inside iPad 2, as long as iPad 2 has the ability to run the highest quality apps possible.” After 15 months, I am unsure if the iPad’s software or hardware is more intriguing. Apple, a company built on the seamless integration of software and hardware, spent years mastering the art of making iPads. Does Microsoft, a company built on software, have the capabilities of designing and producing an intriguing tablet offering in a few months? While some point to Xbox and Zune as examples of Microsoft’s hardware success, the world is now a different place with substantially higher barriers of entry for hardware makers. HP, a company built on hardware, was forced to manufacture the TouchPad with parts deemed unworthy of the iPad since Apple had procured all available resources through long-term contracts. Meanwhile, PC OEMs are seeing their sales decline as their designs are falling flat with changing consumer preferences. I enjoy iPad because the hardware melts away. Is Microsoft capable of beating Windows OEMs and produce tablet hardware that is truly revolutionary, but still let app interaction resonate? Daunting would be an understatement.
Microsoft faces an uphill battle with tablets, regardless if they intend OEMs to help out or they go it alone. The most likely scenario is that Microsoft will try to have one’s cake and eat it too; bring the Surface to market while keeping OEMs in the loop about broadening the Windows mobile platform. Microsoft will likely face an increasing number of manufacturing difficulties leading to certain things being left out, or altered, in order to stay near competitive prices. I would look at HP TouchPad and RIMM PlayBook hardware and price points as goals that Microsoft will try to meet, let alone beat (the TouchPad and PlayBook failed in the marketplace). I expect subpar Surface hardware, wrong price points, and limited distribution to become major headwinds for Microsoft. In order to beat iPad 2’s $399 price point, the Surface needs to come in at least $100 lower given Apple’s superior brand – a price I don’t think Microsoft will be able to meet without reporting huge losses. Instead, Microsoft will talk up the increased functionality of Surface (to validate a higher price) and the message will go in one ear and out the other as consumers realize laptops already fill that spot of the market. The Surface’s software, which many have continued to give praise for, will probably be up to Microsoft’s standards, however hardware limitations may spoil the treat, and as the iPad demonstrates (along with every other tablet), hardware cannot be ignored, regardless of how great the software is. Microsoft faces an uphill battle. Arriving at the baseball game in the 4th inning can make winning the game somewhat of a challenge.
"Customers love [Siri]. It’s one of the most popular features of our most popular phone. But there’s more that it can do. And we have a lot of people working on this. And I think you’ll be really pleased with some of the things that you’ll see in the coming months…we’ve got some cool ideas about what Siri can do...[w]e’re doubling down on it.” - Tim Cook at D10
I expect Apple to report 79% yoy EPS growth, which is slightly less than the 83% yoy EPS growth observed in 2011.
Product Unit Sales and Commentary
Macs: 4.3 million (14% yoy growth)
With no Mac updates during the quarter, I expect Mac shipments to show continued yoy growth, albeit at a slower pace than 1Q12. iPad cannibalization is also picking up as consumers bypass Macs for lower-priced iPads.
iPad: 12.0 million (155% yoy growth)
Apple sold three million new iPads during opening weekend (includes pre-orders that shipped for the 12 days leading up to the March 16 launch, but not iPad 2 sales). My iPad estimate is primarily based on weekly sales run rates, using Apple’s new iPad opening weekend sales as a benchmark between slower iPad sales in January and February and the supply/demand imbalance at the end of March. Unlike last year’s iPad launch, Apple seemed to have a better handle with new iPad supply, as online shipment waits did not reach 2011 levels, even with a more extensive international rollout. My estimate assumes approximately 6 million new iPads sold during the last 3.5 weeks of March and an additional 6 million iPads sold in January, February, and the beginning of March.
iPod: 6.8 million (25% yoy decline)
Representing only 2.7% of estimated 2Q12 revenue, the iPod is a footnote.
iPhone: 36.4 million (95% yoy growth)
My estimate reflects an average 2.2 million weekly sales run rate and the addition of approximately 6 to 8 million iPhones into the distribution channel (approaching Apple’s desired 4 to 6 week range). For some perspective, Apple saw a 1.6 million weekly iPhone sales run rate during 2Q11 (pre-iPhone 4S). My 2Q12 estimate assumes 38% yoy growth in the weekly run rate, which I think is reasonable given the iPhone 4S and increased iPhone penetration at newer carriers (including Verizon and Sprint) and countries (China).
When Apple releases earnings on April 24, many will look at iPad and iPhone sales as an indicator for continued strong consumer demand. I suspect Apple may be allowed some breathing room on iPad sales given the supply/demand imbalance and trickiness surrounding a new product launch. Meanwhile, iPhone lacked any significant interferences during the quarter, with results dependent on demand, and to a lesser extent, the number of units added into the distribution channel.
Why has iPad been so successful? Intriguing software? Gorgeous hardware? After using iPad 2 for a year, my connection with the device has been formed by the seamless interaction between software and hardware. The iPad form factor seemingly disappears as I interact with iOS apps. Meanwhile, iPad competitors have focused on only one aspect of the software & hardware duplex; either shipping okay software (“okay” can be an overstatement) with mediocre hardware, or okay hardware (again, I am being generous) with buggy software. The new iPad’s improved hardware features, along with new apps, combine to form a package that can appear to be “magical” to the user.
Motorola RAZR Syndrome
One of the bigger risks Apple faces is the “Motorola RAZR Syndrome”, or reliance on your current success at the detriment of your future success. After three generations of iPads, it is clear that Apple understands its biggest competitor is Apple. The new iPad’s biggest competition will come from iPad 2, while the original iPad was iPad’s 2 biggest competitor. Even though the original iPad sold well, Apple continued to push the envelope with iPad 2, and now the same can be said with the new iPad. Cameras, a Retina display, faster guts, amazing software, improved battery life, and 4G LTE, all at the same $499 entry-level price point.
iPad 2 Price Drop
Although Apple devoted only a brief minute to iPad 2’s new $399 price, consumers will give the $100 price drop much more attention. For many, price remains king. While $399 is still a lot of money, consumers are starting to compare iPad to regular laptops, in which the $399 price tag doesn’t look nearly as steep. Similar to the iPhone 3GS and iPhone 4 being bought by former feature phone owners, the iPad 2 will continue to sell well as laptop owners look at iPad for the first time.
More iPads in the Wild?
Up to now the iPad had been looked at as largely an “inside the home” device, confined to the living or play room. With the original iPad not having any cameras, using an iPad at a social event, such as a family occasion, picnic, or concert, was questionable. Apple’s new video and picture software (and improved cameras) will give people a greater incentive to bring iPad to different gatherings and events. While iPad is still no where near as convenient to transport as iPhone, it is easier to transport than any other computing device. As more iPads find their way into the wild, a whole new marketing realm will kick in. While advertisements can be effective, seeing friends or family enjoy their iPad outside the confines of their home represents a brand new marketing angle.
Jony Ive and New Product Form Factors
The new iPad’s form factor has subtle differences from iPad 2 (the minor variances might even be hard for a normal consumer to see or feel). While Apple’s SVP of Industrial Design, Jony Ive, is intimately involved in any form factor change, no matter how minuscule, my gut tells me we might see some interesting new form factors for most, if not all, of Apple’s product lines over the next year. I think this is what Tim Cook hinted at at the end of the new iPad’s unveiling when he said, “Across the year, you’re going to see a lot more of this kind of innovation. We are just getting started.” What is the point of changing form factors that seemingly don’t need to be fixed? How much can you change a phone or tablet form factor? Apple doesn’t settle. New product form designs will focus on greater functionality and feasibility, all while keeping design at the forefront. Dimension barriers will be dismantled. A new round of product design and manufacturing innovation is on the horizon and Jony is guiding the ship.
"[Apple is] going to continue to make the best products in the world that delight our customers and make our employees incredibly proud of what they do."
- Tim Cook in his first email to Apple employees as Apple’s new CEO sent August 25, 2011
"The path [Sony] must take is clear: to drive the growth of our core electronics businesses - primarily digital imaging, smart mobile and game; to turn around the television business; and to accelerate the innovation that enables us to create new business domains."
- Kazuo Hirai in response to being appointed Sony’s new President and CEO on February 1, 2012
Apple’s 1Q12 earnings report will boil down to two simple data points: iPhone and iPad sales. Guidance will take a back seat, as will margin expectations and management commentary. The market wants confirmation that iPhone and iPad demand is robust, especially after Apple’s disappointing 4Q11.
The magic numbers will be 31 and 13. If Apple sold more than 31 million iPhones and 13 million iPads, Apple will have met expectations (sky-high for iPhone and lukewarm for iPad). Whisper numbers (the numbers that analysts secretly discuss) probably stand somewhere near 34 million iPhones and 15 million iPads, but missing whisper numbers usually won’t lead to negative EPS estimate revisions.
In an attempt to put the last few weeks of heightened iPhone 1Q12 expectations (and reduced iPad expectations) within context, and using my 1Q12 estimates published on November 18, 2011, I would put 27 million iPhones and 12 million iPads as the minimal bar Apple has to jump over in order to avoid significant negative EPS revisions and price target cuts.
Research in Motion (RIMM) is in a death spiral. Consumers are moving away from the platform in droves, Blackberries have lost the “cool” factor, and RIMM management is unable to control Wall Street expectations. RIMM’s primary problem is incompetent management.
At first, it is difficult to believe that such a large company (at least in the eyes of Canada) could possibly have inept management. People assume if you are CEO of a company, you know what you are doing. How else would you get to the top position of a multi-billion dollar company?
Unfortunately, RIMM management is indeed inept and incompetent. RIMM understands its main problem; no one wants the current Blackberry phone line-up. Don’t be fooled by RIMM sales figures still in the millions of units. Quarterly sales are declining in absolute terms (in a market that is booming). A bad sign to say the least. However, RIMM doesn’t know the solution to its problem. According to RIMM, the solution is introducing new Blackberries. Take the Blackberry that everyone loved, and just give it incremental updates or speed bumps. Problem solved. You can see how this solution is inadequate and simply wrong. According to management, RIMM is facing hard times because Blackberry updates are delayed (It’s hard to recall a moment when RIMM management actually admitted things aren’t going well - a tell-tale sign that incompetency is running the show). Management is living in a fairy tale where iOS and Android aren’t the problem. Some may say that RIMM knows it has no viable solution to compete against iOS and Android. If true, I don’t see how the current management team and Board are still working for RIMM shareholders. It speaks volumes that not even activist shareholders want to get involved in RIMM…yet.
Making matters worse, RIMM is now unable to push out new Blackberries until the end of 2012. I assume RIMM employees are still going into the office each day and doing something. The question is what exactly are they doing?
How did RIMM get in this position? I suspect the timeline went something like this:
1) iPhone is introduced. 2007.
RIMM laughs it off and is confident that RIMM sales won’t be impacted. iPhone doesn’t have a physical keyboard. Who would want that?
2) Significant iPhone updates are introduced, including the app store. Android begins to take off (largely resembling iOS - apps and touch screens). 2008 and Early 2009
RIMM sales are still growing and RIMM’s stock price hits an all-time high in the middle of 2008. The subsequent global financial crisis hits RIMM’s stock price (along with every other company) masking some of the growing issues around the company.
3) iPhone and Android are exploding. Middle to Late 2009.
Up to this point, I really don’t think RIMM was too concerned with its prospects. Consumers (enterprise) were still addicted to Blackberries and its email capabilities and physical keyboards. Fundamental holes are forming though. ASPs are beginning to fall and RIMM is starting to lose grip of the high-end market. Channel fill is at all-time highs. Developed country growth is no longer increasing. Management’s solution is to focus on emerging markets. Problem solved.
4) iPhone 4. 2010.
The game has changed - again. RIMM has to see signs that things are not going well. iPhone blows past RIMM in sales. RIMM introduces its flawed Playbook. RIMM’s plan for phones? Updated Blackberries, of course. Research and development is caught flat-footed and asleep. RIMM has little to nothing in terms of alternatives beyond its signature Blackberry keyboards.
5) Current Day.
Playbook is a disaster. RIMM is in a death spiral. Incremental updates are now in disarray. iPhone and Android are eating up RIMM’s marketshare.
RIMM will make a classic business school case study. RIMM was a company that became a powerhouse for doing one thing really well (email) at a time when the smartphone market was a disaster and phones really weren’t too smart. Apple introduced the iPhone and everything changed. Even though many of RIMM’s metrics appeared healthy (subscriber growth, increasing sales) for a number of quarters post-iPhone, tumors were forming. Consumers were offered a better alternative and RIMM was unable to respond due to their inability (or lack of desire) to move beyond its core competency and lead the market into new innovation.
RIMM now faces a number of severe and multifaceted problems that could very well lead to the end of the company. I don’t think RIMM R&D is capable of innovating. RIMM has already lost the cool factor and chances are slim they will ever get it back. RIMM management seemingly never planned for the product after Blackberry. I don’t think its a stretch to think of it as Apple never planning for the day after the iPod. Sounds incomprehensible. Should companies that make such fatal errors, throwing innovation aside to instead milk current successes, deserve to survive? Even if RIMM does introduce a good phone in the future, consumers won’t care. If one thing is clear in consumer technology, it’s that momentum can be your friend (or in RIMM’s case, your enemy).
I expect iPad and iPhone to represent nearly 70% of Apple’s quarterly revenue. My projected revenue is 38% higher than any previous quarter (closest was $28.6 billion revenue reported in 3Q11).
GM: 41.3%(AAPL guidance: 40%/Consensus: 41.6%)
Apple’s margin in 2011 ranged from 38.5% to 41.7%. A higher iPhone mix during 1Q12 (including 3GS and 4 models) should benefit overall GM with component pricing remaining largely unchanged from previous quarters.
Mac experienced 22% yoy growth in 2011 (34% growth in portables and 1% in desktops) and I expect similar growth during 1Q12 as consumers flock to the MacBook Air. Apple will continue to take market share from Windows (early stages of 5-10+ year trend). As the PC market struggles to grow (thanks in part to the proliferation of smartphones and iPad), I view long-term Mac growth near 10% as very respectable.
iPad: 14.7 million (100% yoy growth)
iPad supply/demand returned to equilibrium during 4Q11 with Apple reporting an average weekly sales rate of 925,000 iPads. My 14.7 million iPad estimate assumes an average 1.1 million iPad weekly (13 weeks) sales rate (higher than 4Q11 due primarily to holiday shopping). I am not forecasting any significant change to the iPad channel. While there have been many rumors and reports indicating softening iPad demand, I think some of that is the reduction of overly optimistic iPad expectations towards a more conservative consensus expectation. I think iPad will remain a top holiday gift. My 100% yoy growth does contain some conservatism when compared to 334% yoy iPad growth reported in 2011.
iPod: 16.5 million (15% yoy decline)
Continued strong iPod touch sales will partially offset the continued decline in Apple’s other iPod models. Apple refreshed the iPod line-up in 4Q11 and iPods do make great stocking stuffers, so my 15% yoy decline is slightly higher than the 20% and 27% yoy declines registered in 3Q11 and 4Q11, respectively.
iPhone: 28.4 million (75% yoy growth)
iPhone 4S sales are off to a fast start with 4 million devices sold during opening weekend, a 1-2 week backlog on Apple’s online store (my iPhone 4S ordered from Apple took 15 days to arrive), and continued extended shipping waits at mobile carriers. It is clear that iPhone 4S supply/demand is not in equilibrium. iPhone 3GS (and iPhone 4) price reductions should also benefit 1Q12 sales. Apple’s largest iPhone quarter prior to 1Q12 was 20.3 million sold during 3Q11 (average of 1.7 million per week). My 28.4 million estimate reflects an average 2.2 million per week sales rate, but I admit that sales will be limited to Apple’s iPhone production levels. Another way to conceptualize my estimate: I am assuming 4 million iPhone 4S devices sold during opening weekend and then a subsequent 2 million units sold each following week (not out of the question given continued stockouts and the impact from 3GS and 4 models).
iPhone Accounted for Nearly 40% of U.S. Smartphone Sales in 3Q11
Nielsen’s third quarter survey of mobile users seemed to reaffirm what many have been saying; Android continues to grab more smartphone market share, with 43% U.S. share compared to iPhone’s 28%. This morning, I thought a little bit more about Nielsen’s data and something just didn’t seem right.
Since I follow AT&T’s and Verizon’s quarterly earnings, I recalled how AT&T’s most recent report indicated iPhone accounted for approximately 60% of AT&T’s smartphone sales. How was it possible that iPhone has less than 30% overall smartphone share in the U.S., while iPhone share at AT&T (the carrier with the highest smartphone penetration rate) is over 60%? After collecting a few more data points and running with conservative assumptions, I estimate that iPhone accounted for close to 40% of U.S. smartphones sold during 3Q11.
How Many Smartphones Were Sold in the U.S. During 3Q11?
One of my goals in this analysis was to rely on as little estimation as possible. In order to accomplish this, I was interested in only iPhone share (the rest of the mobile pie can be figured out at a later time). Fortunately, both AT&T and Verizon supply concrete iPhone and total smartphone sales data. During 3Q11, AT&T sold 4.8 million smartphones, of which 2.7 million were iPhones (56%). Meanwhile, Verizon sold 5.6 million smartphones, of which 2 million where iPhones (36%). Combined, iPhone accounted for 45% of smartphones sold at AT&T and Verizon during 3Q. What about Sprint and T-Mobile? Neither provide concrete smartphone sales data, primarily because they pail in comparison to larger competitors, AT&T and Verizon. Sprint indicated 8% of its 28 million postpaid ‘Sprint brand on CDMA’ subscriber base upgraded during 3Q, of which 80% were smart phone upgrades, which would lead to approximately 1.75 million smartphones sold during the quarter. With T-Mobile being much smaller than Sprint, I peg smartphone sales closer to 1 million. I assume that no unlocked iPhones made their way over to Sprint or T-Mobile during the quarter, which isn’t the case as T-Mobile recently indicated 1 million iPhones were are on their network (for comparison, T-Mobile has 10 million phones on its 3G/4G network).
iPhone’s Share of U.S. Smartphones Sales
Running with conservative estimates and adding up sales at the four largest U.S. carriers, approximately 13.1 million smartphones were sold during the quarter, of which 4.7 million, or 36%, were iPhones. Adding the impact from unlocked iPhones, and the share would be even higher. Remaining U.S. mobile carriers are too small to change the calculations one way or another.
iPhone Sales Were Down 16% in 3Q
iPhone 3Q sales trends are even more striking when considering total iPhone sales were down 16% sequentially during the quarter (I estimate the U.S. market saw a steeper decline of 20%+). iPhone sales were 17.1 million during 3Q, compared to 20.3 million in 2Q and 18.9 million in 1Q. Many consumers held off on smartphone purchases, or upgrades, since rumors of an updated iPhone were in the marketplace for a number of weeks (if not months).
Total iPhone Market Share
Nielsen’s market share data appears to show share of current smartphone usage, which I think is faulty and error-prone (one could make the argument that Nielsen is in fact just looking at 3Q sales data, however my previous calculations would prove otherwise). How does one measure how many phones are currently in use? Is Nielsen adding all of its prior quarterly shipment data to reach current market share usage? Such a method would lead to inconclusive data as it is unclear how many phones are still in use or have since been discarded. As an example, I bought an iPhone 3GS in 2009 and it has since been discarded to a pseudo iPod Touch. Since it is tough to estimate iPhone’s current overall usage share, one could instead look at big picture themes. According to Nielsen, iPhone has 28% share and it is reasonable to assume that iPhone’s share has improved with iPhone at Verizon. Is it possible that iPhone had less than 28% U.S. smartphone usage share in 2010 when iPhone accounted for over 60% of AT&T smartphone sales? I have my doubts.
What Is Going On?
My primary theory for why Nielsen’s market share data is wrong, or at least misleading, is that some OEMs have altered Android to such a degree that many “Android-powered” phones are actually better classified as feature phones - great for text messaging, but lacking mobile browsers or apps. Nielsen is then unable to distinguish Android-powered feature phones from smartphones and simply assumes any Android-powered phone must be a smartphone. Alternatively, AT&T and Verizon data is pretty straight forward with no confusion between feature phones and smartphones. I don’t think the shipped vs. sold argument is as relevant for mobile phones because the sales numbers being thrown around are much higher than that of the much smaller tablet market.
iPhone 4S sales are off to a fast start. Upcoming sales data points that I will be looking for will come from Apple, AT&T, Verizon, and Sprint. Until Nielsen, and other market survey companies, reveal where they are getting their data and how it is being calculated, I don’t think it should be relied on for investment or app development decisions.
"Earnings misses are not the end of the world. They can be healthy, serving as a foundation for further gains. Misses act as a reset for increasingly lofty expectations. Problems arise though when people look for answers to an earnings miss and are quick to make incorrect assumptions…. Apple bears are getting louder. People are wondering. People are asking.”
It wasn’t too hard to find an Apple bear (or a “trader” with provocative thought questions as they often want to be thought of) with a good list of questions for AAPL shareholders. Today it’s courtesy of Doug Kass writing for the Street. I think his questions are a good summary of the main bearish arguments that are being floated against Apple.
(my comments in bold).
Kass: If I were an Apple shareholder, I would be asking myself the following eight questions this morning (I don’t have the answers, and I didn’t have the foresight to buy the shares at lower levels!):
Valuation is rarely a market catalyst. Who doesn’t know that Apple’s valuation, excluding its cash position, appears inexpensive?
Since when was Apple’s valuation looked at as a catalyst for the shares? I actually have Apple’s P/E multiple declining through 2013. If you ask me; iPhone, iPad, iOS, and Apple management & culture isn’t too shabby of a catalyst list.
In reading the analysts’ earnings post mortem and explanation of why the company missed on the bottom line, why is it only now so obvious to analysts that Apple has been impacted by iPhone purchase deferrals ahead of the introduction of the iPhone 4S? Why wasn’t that included in analysts’ estimates?
My post from last night pretty much answers this question. We still don’t know how people buy phones.
In my few decades of investing experience, when companies cite the impact of weather, seasonality or product transitions (as was the case with Apple) as reasons for a profit miss, it is usually a sign of a company’s maturing (sales and earnings) growth cycle. Have we seen a peak in growth rates at Apple, and beyond the quarter catch-up, might we begin to see decelerating growth at Apple in 2012-2014?
If Apple actually missed its guidance, this question would make a lot more sense.
Size matters. Should investors be surprised that, with annual revenue having risen (fiscal 2011 September year just completed) to over $108 billion, sales and profit growth will become more difficult going forward? Fiscal 2014 sales are projected to approach $200 billion. Have the outlook and expectations for Apple grown too optimistic?
Is he suggesting to buy smaller companies with weaker fundamentals because they have a smaller market capitalization?
A 3 million unit shortfall in iPhone sales and slightly weaker iPad numbers (11.1 million vs. consensus of 11.6 million, but there were estimates for 13 million units!) resulted in the profit miss. Are investors overestimating the short-term growth prospects for the overall tablet market? And what about the weakening trend in iPod unit sales (down 27% year over year) that signal a secular decline in the product category? Doesn’t this place more pressure on the success of future new products?
His iPad question, addressed in my piece last night, contains some validity, however, its funny that these same people will then tout how other tablets - without an Apple logo - will do just fine. If the tablet market is not as big as initially thought (11 million iPads/quarter doesn’t seem too small to me), that doesn’t just spell trouble for Apple, it will mean Amazon, Google, and any other player looking to actually gain a footing in tablets will have a tough time.
Apple’s corporate and product success are well known. Are these success too well known as manifested in a near unanimity of bullishness on the part of Wall Street’s sell side?
Is he suggesting to buy a company with more corporate and product failures because less people will be bullish on the stock?
The ownership of Apple shares is broad, and institutional sentiment toward the company appears to be approaching a positive extreme. One could argue that the long side in Apple is crowded. Doesn’t everyone own the stock? Who will be the next investor in Apple’s shares that will catapult the valuation and shares toward the next and higher level)?
I thought everyone who wanted to own Apple already owned shares back at $250? Institutional owners aren’t allowed to add to their positions?
Most recognize that Steve Jobs has already thought about and has contributed to another few years of new product innovation. But will the miss last night revive the issue whether the remarkable disruptive innovation instituted by Jobs (in the past) can be continued into the future after his imprint is removed?
Would this question have been asked if analysts’ expectations weren’t high and Apple instead blew consensus numbers out of the park?
Doug Kass did a good job at asking the obvious bearish questions, from a traders’ perspective. There is a bear argument to be made for every company (including Apple), but Kass’s arguments are largely irrelevant, focused on short-term stock movements. The actual long-term Apple bear argument centers around the scenario where Apple products become stale (see RIMM) and people begin to move away from iOS, iPhones and iPads. Additional Apple problems would center around conflict within Apple’s management team post Steve Jobs or post Tim Cook.
The best part about this post is I am only writing it - answering these bearish AAPL questions - because Apple is executing on all cylinders.
iPhone. We Still Don’t Know How People Buy Phones.
While everyone has been quick to blame unrealistic expectations for Apple’s 4Q11 “miss”, I think the rare earnings disappointment was partially due to a lack of understanding on how iPhone demand fluctuates and how people buy phones. Apple just became a much harder company to model.
It is incorrect to say that analysts never considered people waiting to buy iPhones ahead of a rumored iPhone refresh. Almost every analyst note published in the past three months mentioned an iPhone refresh and the tendency for pent-up demand to build as consumers wait on iPhone purchases. Apple management forewarned the same scenario on Apple’s 3Q11 earnings call. People were expecting it. Even my analysis was based on the idea that a slowdown in iPhone 4 sales in countries that typically get the new iPhone on launch would be offset by continued strong iPhone 4 sales in countries where the new iPhone would take months to reach. That didn’t happen.
Instead, the world pretty much stopped buying iPhones in September. I don’t think it’s much of an exaggeration to say that iPhone sales almost came to a screeching halt towards the end of September. Apple specifically mentioned that sales slowed further in the second half of the quarter. Running rough calculations, I estimate iPhone sales may have been tracking down 20-40% yoy in the U.S. towards the end of September. Pretty remarkable. I wonder if Apple retail stores saw this noticeable decline in demand? Analysts underestimated how many people were aware of iPhone rumors and were waiting to buy. Apple was surprised too, with both Tim Cook and Peter Oppenheimer mentioning “rumors” as one cause for weak iPhone sales. Anecdotally, I talked with quite a few BlackBerry and Android users over the summer, all of whom were well aware of a new iPhone coming out sometime in the fall. I assumed there were other people still buying iPhones.
The iPhone miss (and let me be clear, the iPhone number was pretty negative at only 21% yoy growth) came as a huge surprise with analysts and the investment community thinking the iPhone demand cycle had become independent of product transitions. We thought that sequential quarterly iPhone growth is the new normal, regardless of how a new iPhone impacts deferred sales. Apple’s significant 3Q11 iPhone beat cemented the idea of sequential quarterly growth. Ironically, many analysts thought the new iPhone was going to be unveiled at WWDC and had modeled for declining iPhone sales in 3Q11 due to deferred sales (people waiting). Instead, Apple beat everyone’s iPhone estimate by a mile as iPhone rumors really didn’t grow until August. Independent Apple analysts (including myself) concluded it would be unlikely that Apple would report a sequential quarterly decline in iPhone shipments in 4Q, which meant Apple would sell more than 20.3 million iPhones (their 3Q11 total). We weren’t necessary making a call on growth assumptions, or at least I wasn’t. Some analysts did get it right. Goldman Sachs modeled 16.9 million iPhones – essentially spot on. Still wondering why Goldman was picked first for Apple’s earnings Q&A?
I don’t think our iPhone expectations were overly optimistic though as our previous demand forecasts have now shifted to 1Q12. Our annual iPhone sales estimates remain largely unchanged. Instead, our timing was wrong. I think iPhone’s increasing demand complexity was the main culprit for the iPhone miss. Even Apple management thought they would sell more iPhones in 4Q11.* We still don’t understand how consumers buy phones. For many, buying a phone is categorized as “the big purchase” even though the actual cost of the phone is spread over 2 years. A $110 monthly cell phone bill 17 months from now is not as important as the difference between a free subsidized phone and a $199 subsidized phone today. People wait to buy phones until their contract is up and - this is key - they are willing to wait after their contract is up to take advantage of the carrier’s subsidy and buy a phone that they really want, even if it means holding off on a new cellphone for an extra 4 or 5 months. This trend will only grow as smart phones flourish.
Reports of record iPhone 4 sales over opening weekend (including positive commentary from AT&T, Verizon, and Sprint) are evidence that iPhone demand is back. Going forward, analysts should model a slowdown in iPhone sales during product transitions. If a new iPhone is rumored for October 2012, one should assume people will stop buying iPhones in September. Seems obvious now, but many got it wrong. In addition, a new form factor will also lead to difficultly in meeting initial supply, which could hurt early sales.
iPad. The Wild West.
Apple sold 11.1 million iPads in 4Q11. I expected 11.7 million and I had originally expected 11.1 million, so iPad is performing near my expectations. Unfortunately, many independent analysts have been running with extremely aggressive iPad expectations. I do think these expectations need to come down. Apple noted iPad supply and demand is now in balance. Apple sold every iPad that consumers desired; 11.1 million/quarter. I still get nervous with iPad because it is such a young product. What if demand really isn’t as good as we think? It doesn’t mean the product is a failure, instead maybe people just haven’t yet become comfortable with tablet computing. Sales fluctuations will occur and people need to plan for it. I found it interesting that Tim Cook made the claim that iPad could turn out to be larger than the PC market. In the past, Apple’s remarks were more vague and general. Apple wants to set the tone for iPad. This is the bet. This is the future.
Mac. Steady as She Goes.
Apple’s forgotten child (at least in many investor’s eyes) continues to do well, taking market share from Windows with both hands. Strong 37% yoy growth in portables (thank you Macbook Air) speaks well of Apple’s growing brand in the traditional PC market. Yet compared to iPad and iPhone, Mac’s influence is just too small to impact earnings to any large degree.
iPod. Out to Pasture.
Declining iPod sales are now normal and to be expected. In fact, iPod declines are accelerating. Sure, the “newer” iPods might change this trend a bit in the near term, but when excluding iPod Touch, the iPod is only a fraction of its former self.
Apple’s 1Q12 guidance was very strong, near current consensus (which is very rare). Management indicated they will sell a record number of iPhones and iPads during the holiday quarter (not that shocking). Since Apple “missed” earnings, analysts will be more conservative with their forward expectations, unsure of how much cushion Apple built into its guidance. Many analysts were already running with conservative assumptions so the 4Q11 “miss” should not weigh much on forward EPS estimates.
Thoughts on Apple. Quarterly Results Rarely Matter For Superior Management Teams
Earnings misses are not the end of the world. They can be healthy, serving as a foundation for further gains. Misses act as a reset for increasingly lofty expectations. Problems arise though when people look for answers to an earnings miss and are quick to make incorrect assumptions. A prime example is Apple’s retail store trends. Same store sales were down approximately 10% (which means that your local Apple store reported 10% less revenue, on average, this past quarter vs. last year – a pretty sizable decline). Well, hello, iPhone sales were miserable. With an ASP of over $600 and a concentration of Apple retail stores in the U.S., a slowdown in iPhone sales (maybe as much as 30-40% in September in the U.S.) will have an impact on total retail store revenue. It doesn’t take a genius to figure that out.
Apple will get penalized in the near-term because of its earnings “miss”. People will remain more cautious on iPhone and iPad growth. Expectations are being reduced (especially among the independents). Apple bears are getting louder. People are wondering. People are asking. Earlier this week, the biggest question was how high the stock would gap up after earnings. Now people are thinking of the “what ifs”, what if people stop buying iPhones, what if iPad sales slow down. While such questions might seem silly to think given the technicalities of Apple’s “miss”, its nevertheless happening.
Good companies sometimes have “bad” earnings reports (who would have thought 50% EPS growth would be considered bad). In such circumstances, time is your friend. For long-term investors, quarterly results shouldn’t even matter much, instead attention should be given to the current management team and its ability to innovate.
*UPDATE: Thanks to @adamthompson32 for pointing out that Apple actually said 4Q11 iPhone sales were better than expected. Tim Cook: “And as we have predicted…(iPhone) sell-through decline did occur in the quarter, but not nearly to the extent that we thought and therefore, we significantly beat our guidance.”