Neil Cybart

Finding the Middle Ground between Apple Pay and CurrentC

We have a legitimate battle in the mobile payments arena as Apple Pay goes up against a powerful consortium of retailers, collectively known as MCX, and their payments solution, CurrentC. A mere few weeks ago, we didn’t even know a battle was going to occur, which underscores how complicated mobile payments are and how various parties have different goals in mind. Apple Pay is guided by ecosystem lock-in and privacy, while CurrentC is about better competitive positioning in terms of payment processing while collecting customer information. I suspect we are seeing the beginning of back and forth negotiation between Apple and the MCX consortium to find a middle ground focused on how to track customer information while keeping payment transactions secure.

I’ve long felt that Apple Pay adoption is dependent on universal acceptance as using Apple Pay, instead of credit card swiping, requires behavioral change and if Apple Pay is only accepted at a handful of retailers, the overarching impact will never go mainstream. Gas stations, fast food restaurants, and supermarkets are among the most frequently visited retail establishments, sometimes more than once a week, and Apple Pay’s current mind share in that space is low. While it is early in the game, many of these “convenience” retailers are already part of MCX and look at Apple Pay with caution as the service doesn’t put data collection as a priority and relies on credit cards (and we know how Americans love their credit cards).  

Among the biggest complaints about MCX’s CurrentC is how information is collected about consumers, but there may be beneficial aspects of collecting such information, including reward points and loyalty sales. However, well-publicized recent data breaches have reinforced the view that there should be a clear limit as to what kind of information is tracked or shared with the retailer. Can Apple Pay’s treatment of credit card information be combined with opting-in to retailers loyalty programs in order to satisfy user’s privacy demands while supporting retailers’ business models?

In order to get a different look at the current mobile payments battle, Starbucks and Panera Bread represent interesting case studies.  Starbucks is embracing Apple Pay by letting people use the service to reload the Starbucks mobile app, which is then used to pay at kiosks.  Starbucks has previously said that roughly 15% of sales are done through the Starbucks app (not a trivial number).   Panera is trying something a bit different with customers either required to hand the cashier a popular loyalty card, or providing a phone number, to receive benefits, and then using Apply Pay for payment. Starbucks and Panera are two restaurant chains that value timely ordering and payment, while relying on data utilization to improve offerings. Is this a pattern for other retailers to follow? Whole Foods has announced plans to rollout its own rewards program in 2015, which may involve downloading an iOS app. With Apple Pay rumored to eventually include loyalty programs via Passbook (I assume this would make a great home for these loyalty apps?); will this new feature entice MCX fringe members to jump ship?

I suspect the MCX consortium is positioning itself to gain leverage for getting technology companies, and their respective mobile offerings, to be more hospitable to retailers’ business models.  This may be a longer-term issue with shifting credit fraud liability in the second half of 2015 representing another twist to this battle. While  “power in numbers” may not work in some fights, for mobile payments it’s a formidable near-term strength for MCX.  It’s clear that CurrentC is an inferior answer to Apple Pay, and even to the payments system consumers rely on now, so the question isn’t, “Will CurrentC beat Apple Pay?”, instead the question should be, “What elements of CurrentC are worth salvaging and then reworked to be included in Apple Pay?”  Consumers like their credit cards, but dislike using credit cards. I think the credit card is here to stay and Apple Pay’s usage of credit card data is the way forward, voiding CurrentC, although Apple’s acceptance of loyalty programs is still a work in progress, keeping many retailers from moving away from MCX.

Friction exists between Apple and retailers as Apple Pay is focused on privacy while retailers have spent the better part of the last decade building their businesses on collecting the information that Apple Pay doesn’t value. I suspect Apple and MCX will eventually find some middle ground pertaining to tying in loyalty cards or rewards programs into Apple Pay, thereby enticing many MCX members to embrace Apple Pay.  

Quote of the Week

"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. 

AAPL Earnings Recap; iPhone Growth Accelerating

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. 

AAPL 4Q14 Preview. Solid Quarter; Solid Outlook

Revenue: $39.8 billion (AAPL guidance: $37-40 billion range/Consensus: $39.9 billion)

  • 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). 

Apple iPad Event Notes

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. 

Random bits:

  • 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.