Month One

Above Avalon has been in existence for one month. I would like to share some data from the first 31 days. Unique visitors is the primary metric I've been tracking, and numbers are exceeding my expectations.  

Posts: 36

Unique Visitors: 16,169 (750/day normal run rate)

RSS subscribers: 896

Podcast RSS subscribers: 2,201

The amount I have learned over the past four weeks has been incredible. I'm quite happy with how my daily Apple email is going; it now has 760 subscribers. Thank you to those who have emailed or messaged me to say how they look forward to reading the email each day. I've been fortunate enough to get some great feedback and suggestions, and I always welcome additional comments. 

I have much bigger plans for Above Avalon and the daily email, so stay tuned.  In the meantime, if you have a coworker, friend, relative, or neighbor that may be interested in Above Avalon or my daily Apple email, I would greatly appreciate it if you spread the word. A few retweets or links go a long way as well. 

Thank you to those of you that are enjoying the site each day. Your early support is greatly appreciated.  

-Neil 

If the Apple App Store Is a Battlefield, Jony Ive Is the Commander

The latest quarrel between Apple and developers seems to go a bit deeper than the cat-and-mouse game that has been played for the past five years. Without going into much detail (largely because I think that misses the big picture and there is debate over how justifiable some of these App Store review decisions are), the crux of the latest situation is that Apple released new APIs in iOS 8 and there now seems to be confusion and disagreement within Apple as to how these new features should be embraced. 

There is a growing murmur that the latest battle is a sign of internal conflict at Apple with software engineering pinned against those in charge of App Store review. Many are pointing at comments written by Greg Gardner, creator of Launch, whose app was rejected from the App Store. He says Apple wanted to use his app as an example for rethinking how developers look at app guidelines. 

“During this same conversion, I also asked specifically why Launcher was removed from the App Store after 9 days when other similar apps are still available weeks later. The answer to this question was the most interesting and informative response I had ever heard from them. They basically said that Launcher was a trailblazer in uncharted territories and that they felt that they needed to make an example of it in order to get the word out to developers that its functionality is not acceptable without them having to publish new specific guidelines. And they said that the fact that they aren’t seeing hundreds of similar apps submitted every day is proof to them that taking down Launcher was successful in this regard.

This was a pretty big revelation to me. After Launcher was rejected and the press picked up on it and started writing articles which painted Apple in a bad light, I was afraid that Apple might be mad at me. But it turns out that was actually the outcome they were looking for all along. They acted swiftly and made me the sacrificial lamb. And after that, removing other apps with similar functionality became a low priority for them.”

Instead of the App Store representing a battle between Apple and developers, I look at the skirmish as indicative of a much bigger war going on within Apple between software and hardware. The same battle ultimately costs Scott Forstall his job (internal power struggles don't help matters), transferring more responsibility to Jony Ive. I would argue that Jony Ive did not necessarily get more power from the transition as he already held more power than anyone else at Apple, as previously detailed in Steve Jobs' comments to Walter Isaacson. My theory is that Jony holds more power than Tim Cook, which makes him part of this App Store debate. 

Apple's hardware and design teams are firing on all cylinders. Apple's global supply chain is unparalleled in scope and efficiency, component supplier relationships appear to have hit a stronger and more cordial tone, and nearly the entire product lineup has been updated or revised within a short timespan, with iPhone, Mac, and iPad seeing annual refreshes. In addition, Apple is now ushering a new era of personalized hardware devices. Meanwhile, Apple's software products have seen more mixed results with a buggy iOS 8 release, lingering questions surrounding Apple's ability to handle annual iOS refreshes, and software limitations starting to hold back several product's potential. 

The debate is whether software is getting intentionally left behind, or if the lack of motivation and resources represents another power struggle within Apple where hardware and design are given priority, at the detriment of software. In both scenarios, I think Jony will play a vital role in the discussion (even if he is to blame), since I suspect the Apple we are seeing today is quickly transforming into Jony's vision of the Apple of tomorrow, a company focused on using design to create tangible products that possess passion. The challenge for Jony, and Apple, is figuring out a way to incorporate software and developers into this vision. One of the biggest risks Apple is facing by not being clear with the App Store, and developers, is that innovative apps aren't being made as developers decide not to spend precious resources testing App Store guidelines. Regardless of the outcome, including if a new VP-level executive is tasked with running the App Store and interacting with developers, or if there is a change in the SVP ranks, I expect Jony Ive will continue to play an important role in guiding Apple. 

Developers have played a big role in getting Apple to where it is today, and will ultimately play just as big of a role in determining Apple's future success. 

Thoughts on Apple's $155 Billion of Cash

Apple is relying on robust free cash flow and debt issuance to support its aggressive $130 billion capital management program. Even though Apple has $155 billion of cash, cash equivalents, and marketable securities at quarter end, the company's overall financial flexibility is limited somewhat by having approximately 90% of total cash held by foreign subsidiaries, while component purchase commitments and other obligations total $26 billion.  With approximately $50 billion of expected free cash flow, I suspect Apple will issue more debt and commercial paper to increase its capital management program in 2015, while maintaining enough flexibility to invest in organic growth opportunities, including M&A. I don't view going private as a realistic option for Apple at this time given low feasibility and practicality.

Historical Analysis

Excluding the $29 billion of debt and $6 billion of commercial paper from Apple's gross cash, Apple's net cash, cash equivalents, and marketable securities stood at $120 billion at quarter end. Exhibit 1 highlights how Apple's net cash has remained relatively unchanged since the capital management program was initiated in 2012, a testament of the company's robust free cash flow. 

Exhibit 1: Apple's Net Cash, Cash Equivalents, and Marketable Securities Position

Apple's domestic cash continues to decline, and now stands at $18 billion, due to the ongoing capital management program. With international sales accounting for 60% of total sales, Apple's foreign cash levels have ballooned to $137 billion, as depicted in Exhibit 2.

Exhibit 2: Apple Cash - U.S. Versus Foreign

At the same time, Apple's contractual obligations have been steadily increasing and now stand at $24 billion. Purchase commitments and other obligations include components, product tooling and manufacturing process equipment, and commitments related to advertising, R&D, Internet and telecommunications services and other obligations.

Apple launched a $10 billion share buyback program in 2012, with subsequent annual revisions to $60 billion in 2013, and $90 billion in 2014. Apple currently has $22 billion of share buyback authorization remaining. Exhibit 3 highlights Apple's share repurchase and dividend activity since 2012.

Exhibit 3: Apple Capital Management Activity

Forward Analysis: Apple's 2015 Capital Management Program

I expect the board to revise Apple's capital management program in 2015 to match the company's free cash flow, which would support an additional $40 billion of capital repatriation. I expect the share repurchase authorization to be increased by $30 billion to $120 billion, while the quarterly cash dividend is increased to $0.50/share, from $0.47/share. In order to fund the share repurchases and dividend using U.S. cash, I expect Apple to raise additional debt. In terms of total cash, Apple may reach $170 billion of gross cash, cash equivalents, and marketable securities by year-end 2015, of which approximately $50 billion would be from debt and commercial paper issuances.

In terms of Apple going private, the amount of debt that would need to be raised to make a leveraged buyout or leveraged recapitalization possible would likely be insurmountable at this time, even after considering Apple's $170 billion of expected cash by year-end 2015. In addition, with no significant Apple insider share ownership, it is unclear where the motive for going private would originate from as management has shown no prior desire for such a move, and shareholders would need to weigh the pros and cons of going private versus alternatives, including splitting the company up or spinning segments off.  From a purely business standpoint, while there are benefits from going private, such as being able to manage the business easier with a long-term viewpoint, there is little evidence to suggest Apple has not been able to do that as a public company. Being public also helps in terms of accessing capital markets and paying employee compensation using stock. Similar to Dell, if Apple found itself in a situation where underperforming business segments were masking better-performing pieces, going private may make more sense, although the sheer volume of funds required would be daunting. 

This report should be used to understand my views on Apple's capital management program, especially when I discuss the topic in my daily email, AAPL Orchard, or in other Above Avalon reports. Over the coming months, if new data becomes available, I will update my estimates accordingly. This report is not meant to be used as investment advice. This report was produced by Neil Cybart on December 9, 2014. 

Apple's New iPad Ad Looked Familiar

Apple's new iPad Air 2 commercial, Change, was released yesterday.

The ad was very similar to the iPhone 5s Dreams ad released four months ago. 

In each ad, Apple is stressing the user's ability to transform software and hardware into a personalized device capable of navigating the world. While a very select group of people will be installing iPads into motorcycle gas tanks, or using iPhones to check a horse's vital signs, the message isn't to make the viewer feel connected to the depicted scenes, but rather to plant the seed that these devices have the potential to be used in ways that computers have never been able to be used for before. 

The interesting part about comparing the two ads is how the new iPhones are able to handle nearly all of the activities depicted in the iPad commercial. In addition, the scenes from the iPhone ad come off as more genuine because everyone will have their iPhone with them, while the iPad as a mobile device is a harder sell (Apple had roughly 60% of the activities shown in the iPad ad depict a mobile use case, which I describe as being used outside a room with four walls). Apple's latest iPad ad is just another piece of evidence that the grey area between a phone and a tablet is disappearing. One big question heading into 2015 will be if a larger iPad Pro will change this dynamic, giving the tablet more differentiated use cases versus the iPhone.

Apple's Accelerating iPhone Business; Establishing 2015 Estimates

I expect Apple's iPhone business to report accelerating growth in 2015 due to a combination of strong iOS user loyalty trends, carrier and geographic expansion, and share gains in developed markets. Following my 1Q15 iPhone sales estimate note published two weeks ago, I am establishing my quarterly iPhone unit sales estimates for the rest of 2015. Based on the initial success of iPhone 6 and 6 Plus, I expect Apple to report 25% unit growth for full-year 2015, up from 13% growth in 2014.  Exhibit 1 highlights my quarterly iPhone estimates for 2015, while Exhibit 2 puts my 211 million iPhone unit estimate for 2015 in perspective with previous years. 

Exhibit 1: Above Avalon iPhone Estimates

Exhibit 2: Annual iPhone Sales (fiscal year)

Topics to consider:

User Loyalty and Vibrant Upgrade Cycle. Apple has loyal iPhone users that upgrade on a regular basis, and the iPhone 6 launch looks to have successfully continued that trend. CIRP estimated  that approximately 80% of U.S. consumers that bought the new iPhone 6 and 6 Plus in the first 30 days after launch were current iPhone users, up from 74% for the iPhone 5s launch in 2013. Kantar Worldpanel estimated that 86% of British iPhone buyers upgraded from an older iPhone for the three months ending October 2014.  User loyalty is only one piece of the puzzle, as Apple needs a vibrant upgrade cycle to build and retain that loyalty. Apple has remained on a two year upgrade cycle built around a new form factor, with the off, or "S", years focused on refinements and component upgrades.  

Additional Carriers. It may be easy to underestimate the impact from new carriers on iPhone's growth, but Apple has had a few recent high-profile additions. Apple launched the iPhone on NTT DOCOMO in 2013, and China Mobile in 2014. I estimate Apple is selling around 5-7 million iPhones a quarter through China Mobile, which would represent approximately 30% of my 2015 iPhone unit growth estimate. My declining quarterly iPhone unit growth estimates through 2015 partially reflects normalizing growth rates related to China Mobile. 

In many other countries, including the U.S., Apple has been steadily working on bringing the iPhone to additional carriers, albeit much smaller than NTT DOCOMO and China Mobile. While individually each carrier may not contribute much to the bottom line, collectively they do represent a noticeable addition to iPhone's distribution channel.  

Emerging Market Expansion/Further Penetration in Developed Markets. Apple expects the new iPhones to reach 119 countries by year-end, the fastest roll-out for iPhone. Apple is still in the early stages of tapping iPhone retail distribution in China, India, and Brazil.  A report published last week discussed Apple's plans to expand its retail capabilities in India by opening 500 retail stores using a franchise model.  In many developed countries, iPhone 6 and 6 Plus sales share is tracking ahead of iPhone 5s sales trends in 2013, suggesting Apple is capturing share from competing platforms. 

Apple has a few levers to pull to maintain iPhone growth:  

Upgrade Cycle.  Apple has been successful in releasing iPhone features that do not over serve the market. It is in Apple's best interest to keep the iPhone upgrade cycle as short as possible by pushing the envelope with features that matter to iPhone users: screen, camera, sensors like Touch ID, and design. I would not be surprised if Apple continues to use the "S" cycle to come out with different iPhone colors, similar to the iPhone 5s. 

Geographic Expansion.  Apple will continue to focus on bringing the iPhone to new markets beyond just continued development in China and India. I also expect Apple to continue lowering iPhone's entry-level price, which will help drive sales in countries that do not rely on carrier-financed "subsidies" or installment plans.

Ecosystem Services. With Apple Pay, Apple is beginning to flex the iOS ecosystem by providing consumers additional value, while looking to find new lock-in mechanisms as media and content no longer increase ecosystem switching costs. Apple Pay's eventual expansion into new markets may also have a larger impact on sales in countries that were once considered outside Apple's core iPhone sales focus.  

This report should be used to understand my views on Apple's 2015 iPhone sales, especially when I discuss the topic in my daily email, AAPL Orchard, or in other Above Avalon reports. Over the coming months, if new data becomes available, I will update my estimates accordingly. This report is not meant to be used as investment advice. Downside risks to my estimates include: iPhone supply issues and weaker-than-expected customer demand. Upside risks to my estimates include: stronger-than-expected customer demand, especially in China.  This report was produced by Neil Cybart on December 8, 2014. 

I publish a daily email about Apple called AAPL Orchard. Click here to subscribe.