Quick Thoughts: AAPL – The Aftermath

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January 3, 2019

Quick Thoughts: AAPL – The Aftermath

  • AAPL’s problem is much more flawed vision and strategy than deteriorating economic circumstances. It needs a radical shift to fully embrace the cloud, but it will probably just double down.
  • AAPL’s big miss was inevitable. The smartphone market has been ex-growth for two years. Competition has caught the iPhone on tech. Small innovations did not justify upgrades, particularly given big price hikes.
  • China is as much or more an AAPL problem as an economy problem. Switching costs are very low there because of WeChat – Huawei and others have been taking big share from the iPhone, which is priced out of reach for most Chinese consumers. Poor results in India hurt too.
  • Services and peripherals are a function of installed base in AAPL’s closed ecosystem. Installed base is a function of unit sales. Soon, the installed base will stagnate, and service and peripheral revenues will follow.
  • AAPL is good at peripherals but is getting WAY too much credit for services. The 30% take from the App Store is most of it, and it will be under legal and competitive pressure. The $29 battery replacement program has also juiced services growth (and will probably go away, given its effect on new iPhone sales). AAPL is flat out bad at cloud-based services.

Pre-announcements can reveal a lot about company management. Two months prior, the CEO had sounded so confident on the conference call with analysts, pish-toshing questions of gathering threats. Now, that same CEO needs to explain how things came off the rails in the last few weeks of the quarter. It’s nice to get a Mea Culpa, an admission that maybe, just maybe, the company could have avoided the situation with a more honest assessment of their position and the quality of their strategy. More typically, CEO’s blame it on some sort of unimaginable Act of God, a stroke of horrific bad luck that just happened to fall on management’s blameless shoulders. Then Cisco CEO John Chambers said on his pre-announcement conference call, in the aftermath of the Internet Bubble bursting in his company’s face, “It was a 100-year flood that NOBODY could have predicted”. Except there were plenty of people who did predict it, and Chambers had spent six months laughing at questions about the solidity of his order book when his carrier customers were contemplating bankruptcy.

Now it is Tim Cook’s turn. Announcing a 6% miss against the lower end of revenue guidance offered just 63 days prior, Cook mostly blamed the Chinese economy, with an admission of weaker than expected upgrade activity in other regions chalked up to “consumers adapting to a world with fewer carrier subsidies, US dollar strength-related price increases, and some customers taking advantage of significantly reduced pricing for iPhone battery replacements.” No admission that the company was overwhelmingly reliant on a completely saturated premium smartphone market that has been ex-growth for at least two years. No acknowledgment that Apple’s recent product innovations have had lackluster reception and that competitors had closed significant gaps on performance. No consideration that consumers were balking at a second straight year of significant price hikes on the flagship iPhones. The carrier subsidies have been gone for a couple of years. The FX-related price hikes paled in comparison to Apple’s own price hikes (and Apple could have priced down its products to absorb the currency effects), and the $29 battery replacement program was Apple’s own penance after it was found to be throttling the performance of older iPhone models to hide their deteriorating batteries. A bit of humility would have been nice.

As for China, indeed there are signs that the economy there is weakening, but not so much that it should have caused a 40% YoY decline in Chinese iPhone sales, one quarter after delivering growth. Because of the dominance of Tencent’s WeChat platform, which effectively fronts for most of the functions usually bundled with the OS, Chinese consumers can easily jump from Apple’s iOS to Android or one of those funky forked versions of Android found only in China. While Apple has struggled to hold on to market share (and evidently leaking it all over the place in this quarter), indigenous rivals Huawei, Oppo and Vivo have been grabbing it with increasingly attractive and high performing products and MUCH lower prices. Maybe, iPhones, which cost months of salary for all but the very richest Chinese consumers, are losing their cachet. Certainly, the Indian market where Apple has made next to no market share progress despite calling it out as a key future market, is another indicator that less affluent consumers may no longer aspire to iPhone ownership as they once did.

“But services and wearables! The installed base is still growing!” Yes, it is, but for how long? The installed base is growing because the sale of new iPhone units is still greater than the number of phones taken out of service for the year. Older phones are passed down in the family or sold on the used market. If the number of new phone units is in decline, and as Android phones, used and new, become better, cheaper alternatives to used iPhones, this dynamic will slow or even reverse. Moreover, used phone buyers are not likely to be as enthusiastic buyers of Apple Watches, AirPods or Apple Music subscriptions as those ponying up for the $1,200 iPhone XS Max. This is rapidly becoming an ARPU game, where Apple tries to pry as much annual spending as they can from a fixed set of captive users.

At least Apple is good at peripherals. AirPods are more than two years in the market with no real parallel for the Android set. The Apple Watch is obviously the class leader of the wrist-based wearable class, and the company has delivered real innovation, particularly in the health monitoring functionality. Still, there have been clunkers. The Apple Home Hub has been a non-starter in a world of Amazon Echo Dots and Google Home Minis are offered “free with sale”.

The company is NOT good at services. The App Store monopoly and its 30% tolls is the biggest piece of that, but new app downloads are slowing, old apps are pushing back hard against the fees (Netflix will no longer allow subscriptions via the app), and the iron-fisted control that Apple exerts could be catnip to the EU competition committee. The second biggest piece is Apple Care, including those $29 battery replacements that got called out as a factor for slowing iPhone upgrades – hard to see why that should grow faster than the installed base. Finally, Apple has its home-grown services and most of these are far worse than alternatives from third parties. Apple Music took three years and hundreds of millions of free trials to grow to 45M paid subs. Spotify, which had 14M subs the day Apple Music launched, was at 83M on its rivals 3rd birthday.

So, iPhone unit sales are declining. Price hikes have only exacerbated the situation. Peripherals are good but limited by the inevitable stagnation of the iPhone installed base. Services are protected by a walled garden strategy that depends on iPhone sales to drive growth. What to do? If the last 6-7 years are any guide, the answer will probably be: double down. Use promotion to try to reignite iPhone upgrades without explicitly cutting price. Tell investors that AR glasses and self-driving software are coming. Hope it works. If we were in charge, we would consider some more radical changes:

  1. Bring out a $300 entry-level iPhone to draw new users into the ecosystem.
  2. Focus on battery life, fast charging, peripheral support, cloud services, durability more than “thinness” – everybody puts your phones in cases anyway
  3. Invest HEAVILY in improving cloud applications and Siri. Buy something splashy (Spotify? Netflix? Twitter? Square?) as much for the talent and the culture shift as for the product.
  4. Launch your best cloud applications to ALL platforms, not just iOS
  5. Invest to build a real hyperscale datacenter platform
  6. Go heavy on AirPods – make them work on Android smartphones. OWN this interface, since you’ve lost the home speaker market
  7. Commercialize your semiconductor expertise – Apple processors are amazing and could be used in many things if they were for sale

Any of these things would bring some excitement to the Apple narrative. We won’t hold our breath.

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