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. 

Looking Ahead

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. 

Dissecting an Apple Bear

From my AAPL 4Q11 recap posted last night:

"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. 

Final Thoughts on Apple's 4Q11

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.

Guidance. Strong. 

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.” 

AAPL 4Q11 Earnings Cheat Sheet

AAPL Orchard Estimates (change from previous estimate in italics)

Revenue: $32.6 billion (up $600 million) (guidance: $25.0 billion/consensus: $29.0 billion)

GM: 40.5% (down 40 basis points) (guidance: 38.0%/consensus 39.6%).

EPS: $8.55 (up $0.10) (guidance: $5.50/consensus: $7.16).

Product Unit Sales Estimates 

Macs: 4.8 million (up 100,000)

iPad: 11.8 million (up 700,000)

iPod: 7.2 million (unchanged)

iPhone: 23.3 million (unchanged)

I remain confident in my initial quarterly estimates, published July 26, making only modest tweaks to a few variables. I raised my iPad sales estimate 700,000 units to reflect a higher production yield. I am maintaining my iPhone sales estimate (which I initially thought was too high) as the iPhone 4S is pushed out to 1Q12 and iPhone 4 supply draw-down did not occur to any major extent in 4Q.

Things to look for:

iPad Sales. Apple may provide an iPad sales update at next week’s iPhone event. Apple was successful in increasing iPad production in 3Q11 and many will look for continued gains in 4Q11. While my estimate calls for 11.8 million iPads, Street consensus may actually be slightly higher. I think iPad sales greater than 10 million will be deemed okay by the Street, while more than 13 million iPads will be considered strong.

iPhone Sales. With the iPhone 4S launch pushed out to 1Q12, I don’t think we will see too much of a drop-off in iPhone 4 demand, especially considering iPhone 4 was recently brought to new carriers and countries. Apple may still get a pass if iPhone sales are on the weak side as analysts will simply blame iPhone 4S ramifications such as pent-up demand. iPhone sales greater than 20 million will be deemed good, while more than 25 million will be considered strong. iPhone 4S launch weekend sales figures may also be shared on the call (although it is just as possible that the iPhone launch will occur after October 18 or Apple will choose to not disclose initial sales).

Guidance.  Similar to previous quarters, investors will look for Apple’s 1Q12 guidance for evidence of any economic impact or weaker iPad/iPhone production plans. Unfortunately, management’s conservative nature will make it very difficult to reach solid conclusions.  My initial 1Q12 EPS estimate is $10.00 (Street consensus is $8.83) on $39.7 billion of revenue.  I would consider EPS guidance around $7.00, with revenue in high $20s billion, as solid.

Two other scenarios may occur: 1) Apple may announce extra conservative EPS guidance due to economic concerns or 2) iPhone supply concerns related to the iPhone 4S launch. I think extra conservative EPS guidance would be something like $5.50, which compares to Apple’s reported $6.43 in 1Q11 (one could make the argument that Apple will put guidance at least above last year’s $6.43 EPS).

If Apple delivers a blow out 4Q11 quarter, chances are good Apple may run with extra conservative 1Q12 guidance as analysts won’t necessarily increase 1Q12 estimates, but would still maintain Apple target prices due to the 4Q11 beat. Accordingly, expectations wouldn’t be raised too high and Apple will be in a good position for another solid holiday quarter.