I published a short video of my Apple earnings preview. You can take a look at the full report here.
The Battle for Mindshare
Microsoft surprised us earlier this week when a Windows 10 event geared toward the press turned into a full demonstration of the company's augmented reality computing platform. Judging by headlines, those in attendance were impressed.
- The Verge: "Up close with the HoloLens, Microsoft's most intriguing product in years"
- The New Yorker: "HoloLens: Microsoft Finally Does Something Interesting"
- Business Insider: "I Just Tried Microsoft's Remarkable Holographic Headset - Here's What It's Like"
- Fast Company: "Hands on with Microsoft's HoloLens: Windows in its most daring and unexpected form"
- The New York Times: "Microsoft HoloLens: A Sensational Vision of the PC's Future"
Microsoft was after one thing by revealing Windows Holographic and HoloLens: relevancy. In that regard, the event was a success. To be part of the conversation and debate over the future of computing was more valuable than anything else announced during the presentation. The Verge produced a good 4 minute video of the event, and it only took 25 seconds before the discussion turned towards HoloLens. The most popular video on Microsoft's YouTube channel was the HoloLens introduction with 7 million views, 100x more views than the Windows 10 highlight video. Not only has Microsoft been using this tactic for years (from the CES keynote playbook), but it is becoming a trend across the tech industry as there seems to be uneasiness over what will be the next big thing.
Mindshare represents accomplishment in consumer technology. Google's success in search turned the company name into a verb describing the act of searching the web or simply looking for information. Instagram's name became synonymous with uploading and sharing photos. Amazon spent years buying competitors in an effort to stay financially on top of the growing e-commerce mindshare game. Apple's iPod, iPad, and to an extent, iPhone, became household names used interchangeably with competing products from the same gadget category. However, like most things, mindshare evolves over time. The ideas of search and e-commerce are changing in a mobile world. Digital music trends are shifting, as seen with Apple buying Beats.
We are now at a point where the giants are looking to take the next big step, but instead of figuring it out when no one is looking, many of them have resorted to using a megaphone to announce their intention loudly and clearly regarding where they are stepping and why they are on the right path. Does the next "big thing" deal with virtual reality, augmented reality, Internet of Things, or all of them? The current debate doesn't even seem to be about the technology, but rather about the players and who will lead the way. Larger companies are battling to remain part of the conversation and to demonstrate that relevancy hasn't been stolen by smaller, more nimble companies. Does fighting for mindshare with early prototypes and ideas that aren't quite ready for prime time take the place of execution, intuition, and design when it comes to success? In the race for mindshare, many companies seem to be forgetting where the finish line is located.
1Q15 Apple Earnings Preview
Apple will likely report strong 1Q15 earnings on Tuesday. The iPhone 6 and 6 Plus have resonated with consumers across the world and will help propel iPhone unit shipments to a record quarterly high. Partially offsetting some of the iPhone strength is continued weak iPad shipments as the product finds a more steady sales run-rate. The strong dollar is serving as a headwind and will likely impact 2Q15 guidance, although Apple's foreign exchange hedging program will mitigate some of the negative impact. The combination of continued share repurchases, an updated product lineup, and additional revenue from Apple Watch, will likely result in Apple reporting 20%-30% EPS growth in 2015.
Exhibit 1: Above Avalon's AAPL 1Q15 and 2Q15 Estimates
Things to Consider
- Revenue and Margin Guidance. I will be looking for clues as to how the iPhone 6 and 6 Plus are expected to sell January through March, and if the Apple Watch will launch in March. Keep in mind, the strong dollar may impact revenue and margin guidance a bit, so the conference call may be required to get the full picture. Any negative impact from foreign exchange will likely be backed out and considered non-operating.
- Management Commentary on iPhone. Any insights as to upgrade versus new user trends for iPhone, as well as China sales will help in terms of modeling.
- iPhone ASP. With additional moving parts in the iPhone line (storage capacity mix shift and two current iPhone models), the iPhone ASP is likely to see an increase ($660 estimate, up from $637 last year). Any significant change from $660 would likely change my forward revenue estimates.
- iPad Sales and ASP. Unit sales are expected to be down year-over-year for iPad, but is there any evidence of stabilization in sales trends? Would a lower than expected ASP suggest the iPad mini is more popular than expected?
- Share Buyback. Was there any change in share buyback momentum during the quarter ($5 billion/quarter estimate)?
Revenue and EPS
I am calling for a slight revenue beat to both consensus and guidance on strong iPhone 6 and 6 Plus sales. Working through an above consensus revenue expectation and 38.5% margin estimate (in-line with guidance), I am expecting Apple to report EPS of $2.62, slightly higher than consensus of $2.59.
Exhibit 2: Apple Revenue and EPS Expectations
Guidance
My current 2Q15 estimate includes $56B of revenue and 39.4% gross margin. If management guides to $50B-$53B of revenue, I would't expect much change to my forward estimates. Anything under $50B of revenue and I would likely need to lower my iPhone estimates. If the Apple Watch is launched at the end of March, then guidance will likely reflect the corresponding $1-$2 billion of additional revenue.
Product Unit Sales
Even though I provide unit sales estimates for modeling purposes, it is more appropriate to consider ranges when looking at quarterly product unit sales. Exhibit 3 details my iPhone, iPad, and Mac unit sales expectation meters. My estimate is highlighted in white, while the grey area represents unit sales that would be close enough to my estimate to not elicit much of a surprise. Anything in green would be much stronger than expected, while red would indicate weaker than expected.
Exhibit 3: Apple Product Unit Sales Expectation Meters (1Q15)
One way to think of Exhibit 3 is that my thoughts about iPhone, iPad, Mac would need to be adjusted if actual product sales fell in the green or red zones. If the results fall in the grey zone, than my current expectations are mostly intact.
iPhone
Nearly every data point and customer survey over the past three months have supported the view that iPhone 6 and 6 Plus are selling quite well with lack of supply being the biggest risk to 1Q15 sales estimates. My 68.9M iPhone unit estimate suggests 35% year-over-year growth. There are still supply and demand imbalances in certain countries, which would suggest the number Apple reports on Tuesday will simply represent the amount of iPhones that were able to be shipped. The implication of this is that any iPhone shipment number (no matter how low) will likely be given a pass as investors focus on the next quarter. There has been no significant change to my iPhone estimate since November. I take the 51M iPhones sold in 1Q14 and apply 20% sell-through growth (matching Apple's stated growth trends in 4Q14). I then add 5M unit to reflect China Mobile and 2M for channel inventory build.
iPad
I am expecting weak iPad sales of 19.5M, representing a 25% year-over-year decline in unit shipments as the product continues to find its place within the Apple ecosystem. Earlier this week, I discussed how Apple is likely repositioning the iPad in relation to the iPhone and Mac, which ultimately suggest we are in the process of finding iPad's normalized sales run-rate. My iPad estimate reflects a combination of analyzing Fiksu iPad model share trends (U.S. and Europe focus) from September to December, in addition to a 1.5M channel build estimate.
Mac
All indications point to another solid quarter for Mac with IDC and Gartner suggesting 5-6.5 million units as a likely sales estimate. Mac sales may be continuing to bounce back as iPad sales cool, suggesting MacBook Air models remain a popular purchase.
Services/Other Products
Given Apple's revised reporting segments, my expectations for Services (iTunes/software/services and Apple Pay) is $4.8 billion, while I am modeling $2.3 billion for Other Products (iPod, Beats headphones and speakers, Apple TV, and peripherals and accessories for iPhone, iPad, Mac, and iPod).
Valuation
Apple is currently trading at a 17x trailing twelve month (TTM) P/E. Exhibit 4 shows that Apple has traded within a trailing P/E range of 12-18x (using year-end data) since the U.S. financial crisis. While Apple's P/E remains at a discount to the overall S&P 500, the gap has been closing. Using my 2015 and 2016 estimates, Apple's forward P/E currently stands at 13.4x for 2015 and 10.9x for 2016, which suggest there is some market pessimism that Apple will be able to meet my estimates (likely due to questions surrounding iPhone 6s sales in late 2015 and 2016 and Apple Watch sales).
Exhibit 4: Historical P/E (TTM)
Exhibit 5 includes different valuation scenarios assuming various 2015 EPS estimates. My $8.50 estimate column is highlighted in yellow.
Exhibit 5: AAPL Valuation Matrix
In terms of valuation, the iPhone continues to be the primary focus for Apple investors, while the Apple Watch remains a wildcard as expectations target 15-20M unit sales in the first 12 months.
This report was produced by Neil Cybart on January 23, 2015 and is not meant to be used as investment advice. I publish a daily email about Apple called AAPL Orchard. Click here for more information and to subscribe.
Apple's Plan for iPad in an iPhone World
The iPad was introduced five years ago when iPhones were smaller and MacBooks were larger. Apple was able to market the iPad's larger screen as a reason to not only own a smartphone and PC, but also a tablet. In the past, Apple positioned products in separate silos geared for a particular buyer. Apple has begun taking a new direction where each device is merely a piece of the bigger puzzle in which a customer chooses products based on their personality and lifestyle. The change has significant implications not only for iPad, but also for how Apple looks at future product iterations, including wearables. The iPad was crowned the future of computing. In reality, iOS is the future of computing. The iPad is now positioned to take a supporting role to iPhone as Apple expands the iOS ecosystem.
iPad in 2010
When the iPad was introduced, many were unsure if a new product category was needed between a phone and a laptop. In very simple and plain language, Steve Jobs listed seven tasks that can be handled better with a device that sits between an iPhone and MacBook.
Exhibit 1: iPad Use Cases in 2010
Source: Apple
The expectation was for people to buy both a smartphone and a tablet, and that's exactly what happened for the first few years. Sales of the iPad over the first four years on the market exceeded iPhone's initial sales during the same period. With a 3.5-inch screen, the iPhone simply was unable to beat the iPad in terms of browsing the web, checking emails, viewing photos, watching video, and reading ebooks. Meanwhile, MacBooks lacked the magical multi-touch interface and apps that came with the iPhone and iPad.
iPad in 2015
Five years later, are there still things that iPad is better at than the iPhone and Mac? While I can look at Exhibit 1 and update that list, what has happened since 2010 is people have developed different habits and lifestyles around their gadgets. For some, an iPhone 6 Plus handles email better than an iPad, while others still prefer a larger iPad Air. Over the past few months, I've been thinking of a way to describe the iPad, and I think the product has become a bit awkward when considered as a stand alone product category independent of iPhone and the Mac. When considered as part of iOS, the iPad would appear to be simply finding its place (which may very well be at a lower sales rate). Apple sold 68 million iPads last year and while sales momentum has disappeared in recent quarters, Apple is still expected to sell 50-60 million units in FY2015.
Four-Quadrant Product Grid Drawbacks
The notorious Apple four-quadrant product grid introduced by Steve Jobs in 1998 has been well publicized and discussed. As depicted in Exhibit 2, to simplify the product line and realign focus, Steve wanted a product in each of the four boxes, representing different target markets.
Exhibit 2: Apple Four-Quadrant Product Grid (1998)
Source: Above Avalon
The same kind of product analysis no longer works.
1) Apps have blurred the distinction between the consumer and professional columns.
2) Screen size and mobility have replaced desktop and laptop as the primary differentiator. There is no longer a one size fits all description for what screen size is geared for a particular segment. Small-screen iPhones have infiltrated enterprise and education, while MacBooks can be found in consumer and enterprise.
Exhibit 3 was what many would have come up with analyzing Apple's current product line, and in such a grid, having iPad by itself in the upper left corner exposes the product to incomplete analysis because the product is no longer targeted to only one type of buyer or customer.
Exhibit 3: Faulty Apple Product Analysis Four-Quadrant Product Grid (2014)
Apple's New Personalization Product Analysis
Instead of product quadrants, a new type of analysis is needed to measure Apple's long-term objective and strategy. In Exhibit 4, I highlight how Apple views its current product line where screen size and mobility are the primary differences between products. Now each device can appeal to consumers in various segments of the market from education to enterprise to content creation and content consumption. Personalization is becoming a much bigger factor. In this table, the iPad's role is to serve as a placeholder for those who want technology with a slightly bigger screen than an iPhone or someone who wants a more simple and interactive device than a MacBook. While some may enjoy the iPad, there will be others that have no use for such a device.
Exhibit 4: Apple Personalization Product Analysis
Exhibit 5 depicts what I would call an Apple Product Screen Personalization analysis, which includes unit sales estimates for every major Apple product ranked according to screen size. Over time, while the peaks may shift left or right, I think the general shape will remain true as the iPhone remains the top seller and other devices fall in line.
Exhibit 5: Apple Product Screen Personalization Analysis (2015)
The primary takeaway from Exhibit 5 is that future product innovation will largely be based on Apple continuing to ship a product line that appeals to different lifestyles. The iPad is merely a part of the Apple product lineup designed to appeal to lifestyles where a touchscreen ranging from 7 to 12 inches makes sense. Looking at quarterly unit sales by total iOS devices may make more sense than looking at iPad sales down 25%, but iPhone up 35%.
Over time I would expect Apple to continue to refine screen sizes. For now, it would seem like consensus has landed on 4.7 inches for iPhone and 9.6 inches for iPad. In the future, the phone may continue to get bigger, which will force Apple to push a larger iPad Pro more, so the line in Exhibit 5 will shift to the right a bit, but the overall iOS product line stays intact. The Apple Watch at the far left may also see some interesting sales trends, causing another peak at that part of the line.
Apple visualized this analysis in a slide from the iPad keynote this past October, shown in Exhibit 6.
Exhibit 6: Apple Product Screen Personalization Visualized (2014)
Source: Apple
Here is Tim Cook describing the keynote slide from Exhibit 6:
“This is the strongest line-up of products that Apple has ever had. And we believe that each one of these play a very important role. People need different types of technology for the way they live their lives. We all do different things.
In fact, many of us and many of our customers use more than one of our products every day. Sometimes you want to sit at your desk in front of a huge beautiful immersive screen, packed with powerful technology. And we’ve made that much better today with the Retina 5K screen for iMac.
Sometimes you want to take that powerful technology with you wherever you go, and we’ve made our notebooks even better this year with MacBook Air and MacBook Pro.
Sometimes you want to be close to your content, touching it and we’ve made that experience even better today with the iPad Air 2, more powerful and incredibly thin.
Sometimes you want to hold that powerful technology in the palm of your hand and there’s no better thing for your hand than the iPhone 6 and iPhone 6 Plus.
And soon, you can wear that powerful technology right on your wrist...
They are designed to be incredible products individually but they are also designed to work together seamlessly.”
Apple has moved beyond product grids and quadrants as the combination of hardware and software have created a vibrant device ecosystem suited for various lifestyles.
iPad's Role Going Forward; Time to Reset Expectations
The iPad will likely be repositioned to appeal to consumers looking for that larger iOS companion device that may make video better to watch, Twitter easier to use, or ebooks more relaxing to read. In addition, a new iPad Pro would be geared toward content creators that may be unsatisfied with the Mac's capabilities. Accordingly, I suspect sales will likely reflect this new status. I don't view the iPad as on a trajectory to outsell iPhone, but at the same time, there will likely be buyers that need a computing device that is bigger than an iPhone with a 5.5-inch screen, but more nimble than a MacBook.
I see two factors serving as the primary buying variables going forward across the Apple product lineup: screen size and price.
Screen Size
We are still in the phase of figuring out which size of glass we want to carry in our pockets or hold in our laps in bed. I would expect continuing shifts in trends, especially once the Apple Watch goes on sale and consumers interact with a small screen on the wrist.
Price
As depicted in Exhibit 7, Apple now sells five iPad models at five prices, which isn't exactly the easiest thing to decipher when buying. Why is Apple doing this? The iPad does a great job at addressing price umbrellas.
Exhibit 7: Apple's Current iPad Line - This Is Getting a Bit Awkward (2014)
Source: Apple
By selling older iPad models for $249-$399, Apple is appealing to those consumers that value price over certain features or components. Apple doesn't want competitors to ship capable devices that may undermine some of these smaller iOS screens. The iPhone "subsidy" in many countries complicates this a bit for the iPhone line since there are already phones being sold for free (but with a monthly fee or a subsidy). As smaller devices continue to outsell Macs by multiples, I would expect this trend of Apple relying on iPad to address the low-end of the market to continue, and eventually the same strategy may spread to Apple Watch in a few years. Meanwhile, the MacBook and iMac lines don't have the same type of price umbrellas given that iPhones and iPads address the lower-end of the market.
Currently, the $199 iPod touch is likely selling around 1-2M units a quarter. Combined with the 2-3M older iPad minis, Apple is selling around 20M iOS devices a year, or roughly 8% of total iOS devices, for less than $300.
Software Moves to Middle
One likely theme going forward is that software differences between iOS and Mac will continue to move to the middle, which will call for some new and different things where the iPad meets the MacBook. What works great on an iPhone will likely not work great on a laptop, so a solution that takes the best of both worlds may be needed in that big tablet/small laptop area. Incidentally, Apple is rumored to have a new iPad and a new MacBook Air in the pipeline, so that intersection would appear to be an exciting one in 2015.
Next Marginal Apple Product Buyer
Even though the probability is that Apple's next marginal buyer into iOS is likely an iPhone buyer from Greater China (looking at current sales), from Apple's perspective, it doesn't matter if a new user enters iOS by buying an iPhone 6, iPad mini, iPhone 6 Plus, or iPad Air. Devices have matured to such a degree and are now positioned in such a way that consumers don't need to buy 3-4 Apple products. While certain products are more universal such as iPhone, others are more personal, such as iPad. Accordingly, the shift to a more personalized product line based on screen size and mobility would suggest there will be continued effort and innovation across the product line, despite some products selling at a fraction of others. For iPad, the spotlight may continue to dim a bit, especially when compared to iPhone, as the product finds its place within the Apple ecosystem.
This report was produced by Neil Cybart on January 20, 2015 and is not meant to be used as investment advice. I publish a daily email about Apple called AAPL Orchard. Click here for more information and to subscribe.
Apple Rethinking the Pen: Initial Thoughts on 'Apple Pen'
Apple analyst Ming-Chi Kuo is out with a new report suggesting Apple will launch a stylus in a few months alongside a new, larger 12.9-inch "iPad Pro." Judging by the sheer volume (over 30+) of patents for a stylus going back to the iPad launch, I don't think the question has ever been about whether or not Apple has been working on such a device, but instead if Apple would ever release such a product. Would a stylus receive one of Apple's rare "yes" votes and make it to the marketplace?
A quick glance at Apple's patents for what I call the "Apple Pen" would suggest that such a device is not simply a stylus used to draw on an iPad, but a comprehensive solution for reinventing the modern-day writing instrument. Apple would be reinventing the pen. The use cases are broad and extensive:
- Enterprise. There are many situations in the corporate world in which a keyboard is not appropriate for taking notes. Whether it is used during a formal board meeting or a quick brainstorming session, a laptop often hinders discussion and interaction. In that same vein, an iPad doesn't offer any additional benefits and very often makes it even harder to record notes or thoughts. Instead, paper and pen continue to be utilized (or third-party styli with iPads) because it is much easier to record notes and thoughts in free-form on paper or a tablet. An Apple Pen would find a nice fit in this type of setting. Additionally, if the Apple Pen can be used to capture information such as distance, shape, texture, and angles, the implications expand into many different industries such as industrial and into various commercial settings from Fortune 500 companies to independently owned and operated businesses.
- Education. Obvious implications for an Apple Pen would include taking notes, but deeper applications involve content creation in the arts and sciences including math, chemistry, physics, and biology, where a keyboard (or finger) is less effective than a fine point writing instrument. As Chromebooks gain ground in education, a touch-screen device with an accompanying smart pen would stand out as adding to the classroom not only utility, but also new forms of creativity and imagination.
- Consumer. Imagine tasks for which a pen and paper are still used such as creating shopping lists and writing letters. In each of these cases, a smart pen can increase utility.
I still have more questions than answers regarding an Apple Pen. How much would an Apple Pen cost? Would the device be initially compatible with just an iPad Pro in order to boost sales of the device, or would the smart pen work with any iOS device? How many functions would such a device include in the first version?
I see an Apple Pen being positioned not only to replace the modern-day pen, but also to serve as a new way to gather and input data. I can see an Apple Pen eventually work without the need for even an iPad or iPhone as a screen isn't necessary to capture data. As sales of third-market devices show, there is already demand for a stylus. An Apple Pen would eventually be positioned as a device that we can't imagine living without. In reference to competing products that came with a stylus, Steve Jobs once said, "if you see a stylus, they blew it." He was right. An Apple Pen wouldn't be a stylus. It would be a data collector and interpreter that just happens to take quick notes and drawings on a screen.
I publish a daily email about Apple called AAPL Orchard. Click here for more information and to subscribe.