Apple's Growth Story

Apple is on a roll. The company is seeing record high iPhone ASPs, strong momentum with Services, and a wearables platform connecting with the mass market. Revenue growth has accelerated for the past seven quarters. Apple's growth story has returned with a vengeance. Upon closer examination, it becomes evident that Apple's three primary growth levers are not created equal. While some growth levers are at risk of slowing, others are still just getting started. 

Growth Has Returned

In early 2016, Apple hit a rough patch. The company reported its first year-over-year decline in iPhone unit sales as the iPhone 6s and 6s Plus sales cycle proved quite different from that of iPhone 6 and 6 Plus. Overall revenue trends also turned negative with Apple reporting a double-digit revenue decline in 2Q16 and 3Q16. 

Just as consensus began to throw in the towel on Apple as a growth story, iPhone unit sales stabilized. As shown in Exhibit 1, revenue bottomed in early 2017 and then once again began to increase. The most recent quarter marked a record high for Apple revenue on a trailing-twelve-month (TTM) basis and the seventh consecutive quarter of sequential growth in revenue. 

Exhibit 1: Apple Revenue (TTM)

There are three drivers behind Apple's return to revenue growth:

  1. iPhone. The average selling price (ASP) of iPhone is up $100 year-over-year.
  2. Services. Apple is seeing strong revenue growth from the App Store, licensing, and AppleCare. 
  3. Wearables. Apple's wearables platform is gaining sales momentum as Apple Watch and AirPods go mainstream. 

Measuring Growth

The interesting thing about Apple's latest growth story is that few people were forecasting that Apple would grow revenue via hardware sales. Instead, many said that Services would be Apple's growth engine going forward. As it turns out, things are developing differently than consensus assumed.  

For the twelve months ending this past June, iPhone was responsible for 57% of Apple's year-over-year revenue growth. Services was the second-largest revenue driver, responsible for 23% of Apple's year-over-year revenue growth. Wearables was responsible for 11% of Apple's growth. As seen in Exhibit 2, iPhone has been responsible for an increasing portion of Apple's revenue growth.

Exhibit 2: Measuring Apple's Revenue Growth Drivers


It is helpful to take a closer look at the factors underpinning Apple's three revenue growth drivers. 

iPhone. In 3Q18, iPhone revenue was up 20% year-over-year. The vast majority of this growth was due to Apple selling higher-priced iPhones. The iPhone 8 and 8 Plus are the highest-priced 4.7-inch and 5.5-inch iPhones, respectively, to date. Furthermore, the iPhone X is Apple's highest-priced iPhone yet. As seen in Exhibit 3, iPhone ASP experienced a step increase beginning in 1Q18, which marked the first full quarter of iPhone 8 and 8 Plus sales in addition to the iPhone X launch. Given strong flagship iPhone sales momentum, Apple has continued to report strong ASP trends. Apple reported a record high $119 year-over-year increase in iPhone ASP in 3Q18.

Exhibit 3: iPhone ASP

According to my estimates, Apple has sold approximately 120M higher-priced, flagship iPhones (8, 8 Plus, and X) since September 2017. Some of these devices were bought by former Android users switching to iPhone. However, there are only so many premium Android users out there. The majority of sales have likely gone to existing iPhone users upgrading their devices. With an iPhone installed base of approximately 750M users, less than 15% of the iPhone installed base bought a new flagship iPhone over the last nine months. 

A small percentage of the iPhone installed base is responsible for driving much of the year-over-year increase in iPhone ASP. While this doesn't necessarily mean that iPhone ASPs are more fragile than they appear, it does add clarity to the current state of the iPhone business. The iPhone upgrade cycle continues to get longer while growth in customer demand for iPhone remains mediocre. Despite these challenges, the sheer size of the iPhone installed base makes it possible for Apple to sell close to 150M higher-priced, flagship iPhones in any given year.

Services. Apple's second-largest revenue driver, Services, is comprised of five items:

  1. Digital content (App Store, iTunes, Apple Music, etc.) 
  2. Licensing
  3. AppleCare
  4. iCloud storage
  5. Apple Pay

A majority of Apple's Services revenue is associated with Apple distributing digital content to hundreds of millions of people via the App Store and iTunes. Accordingly, the increase in the number of people accessing Apple's content stores, combined with existing users spending more as time goes on, is a leading driver behind Apple's strong Services revenue growth.

Licensing revenue is another major contributor to Services revenue growth as third parties are paying Apple more to get their services in front of Apple's users. It helps that Apple's grip on premium users has gotten stronger over time. AppleCare revenue is also on the rise as the number of Apple devices in the wild increases and Apple expands its AppleCare distribution efforts. 

Wearables. Apple is seeing strong unit sales growth for both Apple Watch and AirPods. In just three years, Apple Watch sales have exceeded 20M units per year with a user base nearing 40M. Despite extended supply issues, Apple likely sold more than 10M AirPods during the first year on the market, and coming close to 20M unit sales is a distinct possibility in CY2018. Apple Watch and AirPods sales are benefiting from aggressive pricing, strong mindshare, growing word of mouth, and increased distribution, especially with the cellular Apple Watch Series 3. As shown in Exhibit 4, wearables unit sales (the orange portion of bar) are no longer a footnote on a Apple gadget sales chart. 

Exhibit 4: Apple Gadget Unit Sales

Future Growth

When it comes to thinking about how Apple's revenue growth drivers will perform in the coming quarters, it is important to assess the broader environment facing each driver. At the same time, a look at Apple's product strategy is required to the weigh the impact from new products and pricing decisions.  

iPhone. Among Apple's three revenue growth drivers, the iPhone faces the most headwinds. While Apple can still grow iPhone revenue with modest unit sales growth, the company will likely see less of a revenue boost from huge iPhone ASP gains. It will be difficult for Apple to increase iPhone ASP by another $100 in 2019. Instead, iPhone ASP increases will likely decline. 

Apple is expected to unveil three new flagship iPhones (6.5-inch OLED, 5.8-inch OLED, and 6.1-inch LCD) next month. Even if we assume the 6.5-inch OLED is priced higher than iPhone X, the model likely won't have as large of an impact on iPhone ASP as iPhone X, given a smaller share of overall iPhone sales. Instead, the majority of iPhone sales will be found with the 6.1-inch LCD and 5.8-inch OLED iPhones. These models will likely be priced similar to this year's flagship iPhones, making it that much harder for Apple to see another step increase in iPhone ASP. 

Services. There are a number of factors supporting continued robust Apple Services revenue trends into 2019. Apple Services will benefit from continued growth in the iPhone installed base. At the same time, larger industry themes such as video subscription services gaining popularity stand to benefit Apple Services revenue in a few ways. In addition to earning a share of revenue via third-party video subscriptions, Apple is widely expected to launch its own paid video streaming service in 2019. Additional Services growth levers are found with higher licensing fees from third parties, more AppleCare revenue, and a larger number of iCloud storage subscriptions. In a scenario in which iPhone revenue growth slows, it is reasonable to expect Services will represent a larger portion of Apple's revenue growth in 2019. 

Wearables. Apple's wearables segment will likely serve as an Apple revenue growth engine for years. The days of Apple wearables being considered a revenue footnote are over. Over the past 12 months, Apple sold over $10 billion of wearables (Apple Watch, AirPods, and Beats headphones). Assuming Apple is able to maintain at least 30% to 40% unit sales growth over the next few years, Apple's wearables platform will reach $20 billon of annual revenue within three years. Given the still relatively low adoption rates for Apple Watch and AirPods within the Apple user base, there are plenty of potential users left to fuel unit sales growth. Over the long run, Apple will likely expand the wearables platform to include new form factors and product categories. These developments will add even more growth potential to the segment. 

Big Picture

On the last two quarterly earnings conference calls, Tim Cook has talked about the smartphone market being one of the best for a company like Apple in the history of the world. There aren't too many markets capable of supporting 215M+ annual unit sales at an average selling price exceeding $750. Read between the lines, and Cook's confidence signaled Apple's belief that nothing will displace smartphones as the most valuable computer in our lives in the near term. For example, Cook's answer to an analyst's question about tech in the home didn't make it seem like Apple management was worried about stationary smart speakers. 

Much of Cook's optimism around smartphones is supported by recent Apple financial trends as revenue growth has been driven primarily by iPhone, with Services and wearables serving in more supporting roles. 

However, this doesn't mean that Apple is betting on iPhone over the long run. In fact, over the next few quarters, it is reasonable to expect that iPhone will become less of a growth driver for Apple, with the growth spotlight turning to digital content distribution and wearables as Apple's primary growth engines. 

Apple continues to place bets on new products that have the potential to gradually serve as iPhone alternatives (not replacements). In essence, Apple wants to be the one to disrupt the iPhone. These iPhone alternatives, having to be powered or supported by iPhone out of the gate, will initially be viewed as rudimentary or even as toys. However, these products will be placed on the path to independency from iPhone. The Apple Watch is a great example of such a product. Apple Glasses have the potential to be an even bigger catalyst for growth

At the same time, we are seeing Apple gain confidence in delivering services focused on distributing digital content and adding value to hardware used by a billion users. As the average number of Apple products per user increases, thanks to wearables, these services will prove essential in delivering personalized and proactive solutions to the Apple community. This strategy will provide Apple years of revenue growth opportunity and pave the way for Apple's eventual entrance into the transportation industry.

Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on memberships, visit the membership page.

Apple 3Q18 Earnings Expectation Meters

The ingredients are in place for Apple to report an all-around solid 3Q18. If Apple reports more than $52.5B of revenue, 3Q18 would mark the company’s seventh consecutive quarter of accelerating revenue growth. A higher iPhone average selling price (ASP) driven by iPhone 8, 8 Plus, and X will likely represent the largest driver behind Apple's year-over-year revenue growth. Services and wearables are positioned to represent Apple's second and third largest revenue growth drivers, respectively. 

The following table contains my Apple 3Q18 estimates.

The methodology and data behind my estimates are available to Above Avalon members. (Become a member to access my full 5,400-word Apple 3Q18 earnings preview that is available here. To sign up, visit the membership page.)

Each quarter, I publish expectation meters ahead of Apple's earnings release. Expectation meters turn single-point financial estimates into more useful ranges that aid in judging Apple's quarterly performance.

In each expectation meter, the gray shaded area represents my expectation range. A result that falls within this range signifies that the product or variable being measured is performing as expected. A result in the green shaded area denotes strong performance and the possibility of me needing to increase my estimates going forward. Vice-versa, a result in the red shaded area has the opposite effect, potentially leading me to reduce my assumptions going forward. 

I am publishing three expectations meters for Apple's 3Q18:

  1. iPhone unit sales
  2. "Other Products" revenue
  3. 4Q18 revenue guidance

My 3Q18 iPhone sales expectation range is for Apple to report between 41M and 45M units. A result within this range would be viewed as expected. If Apple reports iPhone sales greater than 45M units, results would be described as strong. A sub-41M iPhone unit sales result would be considered weak and likely lead to a reassessment of my iPhone unit sales expectations going forward. 

Apple's "Other Products" is a catch basin for a number of Apple products. "Other Products" include revenue from Apple Watch, AirPods, HomePod, Apple TV, Beats headphones, iPod touch, and Apple-branded and third-party accessories. If Apple reports close to $4 billion of "Other Products" revenue, the implication is that Apple Watch and AirPods were strong sellers in 3Q18. In addition, Apple would have likely sold a respectable number of HomePods. A result closer to $3 billion of revenue would reflect somewhat weak wearables sales. 

Screen Shot 2018-07-30 at 4.38.56 PM.png

Apple's 4Q18 revenue guidance will include the initial weeks of Apple's largest product launch of the year. In terms of new iPhones, Apple is expected to unveil three flagship iPhones. Even if Apple ends up needing to push the launch for one flagship iPhone into 1Q19, sales associated with the other two flagship iPhones will likely be strong enough for Apple to provide solid 4Q18 revenue guidance. Revenue guidance that exceeds $60 billion would be viewed favorably while revenue guidance closer to $56B to $57B would likely lead to analysts wanting additional clarification from management on the earnings call. 

Above Avalon members have access to my full 5,400-word Apple 3Q18 earnings preview, which includes the methodology and data behind all of my financial estimates (four parts):

  1. Setting the Stage
  2. iPhone Estimates
  3. iPad, Mac, Apple Watch, Other Products, and Services Estimates
  4. Revenue, EPS, Share Buyback, 4Q18 Guidance

Members will also receive my exclusive Apple 3Q18 earnings review (two parts: major themes and my full notes) once Apple reports earnings.

To read my full Apple 3Q18 earnings preview and receive my earnings review, sign up at the membership page

Above Avalon Podcast Episode 130: What's a Computer?

Episode 130 is dedicated to discussing how Apple has become comfortable in accepting, and even embracing, the awkwardness that exists between the iPad and Mac. The discussion begins with a closer look at the fascinating juxtaposition between Apple's recent Mac campaign and its iPad ads from earlier this year. We go over what the ads tell us about Apple's thought process regarding the iPad and Mac. Things then turn to how the iPad vs. Mac juxtaposition hasn't been static over the years. After briefly recapping the post-PC era debate, the episode concludes with my thoughts on where Apple will bring the iPad and Mac platforms and why the company faces a large screen paradox.

To listen to Episode 130, go here

The complete Above Avalon Podcast episode archive is available here

The iPad vs. Mac Juxtaposition

Apple has always publicly supported the iPad and Mac. However, that hasn't prevented questions regarding Apple's commitment to the two product categories from popping up. In recent months, Apple has shown a new level of openness when it comes to embracing both the iPad and Mac as unique and differentiated platforms for creative endeavors. The change is noteworthy when thinking about each category's future. 

Ad Campaigns

A few weeks ago, Apple unveiled a new Mac ad campaign, "Behind the Mac." The ads were meant to elicit fond memories professionals have of using Macs to get their work done.

The main ad stood out because, aside from one shot showing the Touch Bar, it could have easily passed for something released by Apple a decade ago. Even the plastic white MacBook made a cameo appearance. After watching the ad, words like "familiar," comfort," and "nostalgia" came to mind. Apple was targeting long-time Mac users.

The song used for the ad, "The Story of An Artist," reinforced this point. Here are the beginning lyrics:

Listen up and I'll tell a story

About an artist growing old

Some would try for fame and glory

Others aren't so bold

The ads also gave a subtle nod to people using their Macs for a long time, which possibly served as a response to the recent uproar surrounding Mac keyboard reliability. 

The Mac ads stood out that much more by being released a few months after Apple's "What's a computer" ad campaign for iPad Pro. That ad featured a young girl using her iPad (and Apple Pencil and Smart Keyboard accessories) around her neighborhood in various activities and adventures. 

After watching the iPad ad, words like "new," "different," and "controversial" were the first to come to mind. Here was a young person using an iPad in different, and in some cases, fascinating ways, while drawing into question the traditional definition of a computer. The ad upset quite a few Mac users. 

Apple relied on a similar message with the iPad ad shown at the end of its education event in Chicago back in March. A group of students use iPads (and Apple Pencil) to complete a group homework assignment about gravity. In each case, an iPad is being used for tasks that a Mac or PC wouldn't be able to handle. 

With the Mac ad, Apple was selling comfort to a small percentage of its user base. Meanwhile, the iPad ads were selling newness to a different customer. The juxtaposition of the Mac and iPad ads symbolize the awkward relationship the iPad and Mac have within Apple's product line. 

History: It's Complicated

This iPad vs. Mac juxtaposition hasn't been static. At launch, the iPad was like a rocket, fueled by apps and intrigue found with larger a touch screen powered by iOS. After just a few months, iPad sales surpassed Mac sales. The iPad went on to double and even triple Mac sales. In an iPad vs. Mac battle, the iPad seemed to be the clear winner. 

Screen Shot 2018-07-25 at 4.34.19 PM.png

While Apple management never publicly showed disdain for Mac, the level of attention given to the iPad in the early 2010s likely corresponded with a declining amount of time and focus dedicated to Mac. Some of the Mac decisions made around this time, like the Mac Pro's design, later came back to haunt Apple. 

The iPad vs. Mac relationship started to change after iPad sales peaked at the end of 2013. Management's efforts to entice iPad users to upgrade proved futile as iPad sales declined from a 75M units per year run rate to a 40M units per year sales pace. While iPad sales were in free fall, the Mac remained a steady ship, not moving far from its 20M unit sales per year pace. The Mac demonstrated a level of sales consistency that management may not have expected given iPad's popularity.

Apple now finds itself with an iPad business that is twice the size of Mac in terms of unit sales, but smaller than the Mac when it comes to revenue. The iPad user base is nearly three time as large as the Mac user base and is growing by 20 million new users per year while the Mac user base is seeing more like 10 million new users per year. In a nutshell, both the iPad and Mac businesses have found stability and continue to connect with their respective user bases. 

Different Tools for Different People

The fact that Apple gave such dramatically different Mac and iPad ad campaigns the green light provides clarity regarding management's approach to the two product categories. Apple has become comfortable in accepting, and even embracing, the awkwardness that exists between the iPad and Mac. Apple isn't trying to hide the differences that exist between the Mac and iPad as creation platforms. Instead, Apple is embracing the unique attributes found with each platform.

Instead of trying to come up with scenarios in which the average consumer will have a use case for both iPad and Mac in their lives, Apple is embracing its heterogeneous user base. For iPad owners, the Mac ads probably didn't connect on an emotional level. Meanwhile, the iPad Pro ad's hostility towards "computers" likely infuriated some Mac users. Apple is OK with such a situation. Their aim isn't to sell consumers on both the iPad and Mac as computing platforms, but rather to ship different kinds of tools that can improve people's lives. 

Apple is betting that the Mac will appeal to some users, potentially those users with legacy workflows, while the iPad will appeal to a different set of users - a younger generation of creatives. Of course, the iPad is appealing to two to three times more people than the Mac, but the overall point still stands.

Post-PC Era?

For every Mac that Apple sells, the company sells approximately 15 non-Mac devices. This ratio is near an all-time high and is very likely to increase over time considering the growing momentum found with Apple wearables. If that doesn't describe a post-PC environment, it's difficult envisioning what would. 

However, for many people, it doesn't feel like we are in a post-PC environment. There are at least 100 million people still using a Mac. More importantly, there are tens of millions of people with workflows that aren't handled by iOS. This group is unable to move beyond the Mac. The continued importance of Mac and PC have led some to conclude that the post-PC era has been a farce. However, this doesn't feel right either given how hundreds of millions of people have positioned their smartphones as the most valuable, and in some cases only, computers in their lives. 

The reason the post-PC era has been so controversial is that smartphones and iPads have become Mac and PC alternatives, not replacements. This subtle, but important, distinction means tens of millions of people still need a Mac to get work done. However, for a much larger number of people, smartphones and iPads have been able to handle certain workflows formerly given to laptops and desktops. We are experiencing the post-PC era. It's just a bit more nuanced than initially imagined.

Looking Ahead

There's always been a grey area between the iPad and Mac within Apple's product line. Questions have swirled as to how Apple can best bridge the gap between iOS and multi-touch computing with macOS and the accompanying mouse and cursor. Some pundits have been vocal that Apple should follow Microsoft and ship hybrid devices that utilize elements from both paradigms. Others think a more practical solution is for Apple to ramp up its bet on the Mac as the iPad sees its use cases eaten by larger iPhones. 

One way to address this grey area is to think about inspiration. 

It's easy to think that Apple is getting inspiration for the iPad from the Mac. New multi-tasking features, an updated dock, and apps like Files would seem to bring up memories more reminiscent of Mac than iPhone. However, I think the opposite is true. Apple is using the iPhone as ultimate inspiration for where to bring its larger iOS sibling. Moreover, even the Mac is getting inspiration from the iPhone.

Apple is bringing things like its custom silicon and Touch ID to the Mac platform. It's not a stretch to envision Face ID eventually making its way to the Mac (after first being brought to the iPad). There is then Apple's focus on making it easier to port iOS apps to macOS. All of these efforts demonstrate Apple utilizing the iPhone (and the iOS developer community) as a catalyst to push both the iPad and Mac platforms forward. This makes sense given the iPhone's ability to connect with the mass market as seen with a user base of approximately 900M users

In terms of where Apple will bring the iPad and Mac platforms, a few things stand out: 

  • Larger, more powerful, iPads that share many features with their iPhone siblings.
  • Macs powered by Apple chips (likely starting at the low end of the Mac line) and gaining features made popular by iOS.
  • Powerful Macs that push the boundaries of a Mac. 

In essence, Apple will continue to dedicate resources to pushing both the iPad and Mac categories forward, even if it means the products target increasingly different types of users.  

Where things aren't headed:

  • Apple coming up with hybrid devices that amount to combining multi-touch tablets with laptops and desktops. 
  • An overall move away from iPad or Mac. 

There is no evidence that Apple is growing frustrated or tired of the differences found between iPad and Mac. Instead, Apple's strategy for iPad and Mac is to position each as its own creative platform. The iPad ends up being a creative arm for iOS, while the Mac harnesses the potential with macOS to power the needs of a wide variety of creators. While this strategy doesn't prevent Apple from trying to share features between the platforms, Apple seems set on recognizing the key differences found with iPad and Mac - iPad's multi-touch user interface and Mac's cursor and mouse paradigm. 

Large Screen Paradox

Three major computing themes have grabbed Apple's attention in recent years:

  • Wearables
  • Smaller, more intelligent screens
  • More powerful and intelligent cameras 

Apple is excelling in each of the preceding themes with clear vision and strategy. However, what about the largest screens in our lives? Is it a coincidence that these devices lack the compelling vision found with the smallest screens in our lives? If AR glasses were to become a mainstream Apple product one day, where would that leave the long-term trajectories for large screens like televisions, iPads and Macs? It's not entirely clear. 

For now, Apple's strategy for iPad and Mac appears to be to position each as a tool for creators. While a growing number of people will be able to do more with smaller screens worn on the body, the iPad and Mac are allowed to handle workflows that require additional screen real estate and power. This doesn't mean Apple is free of challenges and risks.

The company's approach to Mac continues to be a controversial one as legacy users feel uncomfortable with the direction in which Apple wants to take the platform. At the same time, there are some who think Apple isn't moving fast enough with iPad as a tool capable of handling legacy workflows still given to the Mac. Many of these challenges will likely remain for Apple in the near term. However, by embracing the somewhat awkward iPad vs. Mac juxtaposition, Apple is revealing to the world that it will remain true to each platform and focus on the attributes that make the iPad and Mac stand out as creator platforms.

Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on memberships, visit the membership page.

Above Avalon Podcast Episode 129: Giants on Wall Street

A select group of corporate giants have been gaining influence and investor dollars on Wall Street. Episode 129 is dedicated to discussing today's corporate giants (Apple, Amazon, Alphabet, Microsoft, and Facebook) including the key differences and similarities between the five. The second half of the episode goes over why I think odds are good that today's giants won't be tomorrow's giants. The episode concludes with a closer look at Apple's quest to do the seemingly impossible - remain relevant. 

To listen to Episode 129, go here

The complete Above Avalon Podcast episode archive is available here