Quick Thoughts: Apple – The Song Remains the Same


AAPL shares are up about 12% over the past month on little concrete news, as analysts looked to brighten the narrative. We remain skeptical. Today’s big AAPL event was underwhelming, with no product likely to spark significant new demand. Meanwhile, brokerage channel checks, an increasingly unreliable measure of iPhone demand, have wildly inconsistent, with some analysts sounding March quarter optimism and others asking investors to look past a potential disappointment. AAPL’s big product moves will come in Sept., but the rumors from the usual sources suggest nothing on tap that is likely to drive resurgent demand. Supplier leaks are suggesting a thinner, water-resistant form factor, with incremental performance improvement on many dimensions, perhaps at the cost of the 3.5mm headphone jack, but no new “killer” feature. We believe that the global market for $400+ premium smartphones is mature and increasingly price competitive. While we concur that AAPL shares are not overvalued, we believe estimates remain to high and see no catalyst to drive sustainable outperformance in the stock. We would take advantage of the recent appreciation to reduce exposure.

  • The new iPhone SE is just a 5S replacement. The few true believers who have held out for a refresh of the smaller form factor will love the SE with its up-to-date internal components and new color options. Contrary to the scuttlebutt, we do not believe the $399-$499 SE will help AAPL build share in emerging markets, where the “old look” smartphone will compete with the similar but larger used iPhone 6 models at comparable price points, and with new Android models with excellent specs selling for half as much. 4-inch models were 19.3% of new iPhones sold in 2015 and we expect a similar ratio in 2016.
  • The 9.7” iPad Pro is betwixt and between. iPad sales have been falling in recent years, in large part, because the use case hasn’t changed enough to induce happy owners of older models to replace them. The iPad Pro line takes a cue from Microsoft’s successful Surface line, pushing the platform for business uses. The new 9.7” Pro takes the iPad Air form factor, implements the fast, tablet optimized processor from the Pro’s big brother, and adds a keyboard cover and the infamous Apple Pen as available accessories. Still, software incompatibility limits the laptop replacement use case, and the ARM-based A9X falls a bit short of the Intel Core i5/i7 processors found in the latest Surface Pro. We don’t expect this to do more than slow the decline of the iPad franchise.
  • Why is AAPL cutting price? At $399, the 16GB iPhone SE is priced $50 below the 5S that it replaces. Still, aggressive rivalry has brought the price point for excellent quality Android smartphones with similar memory and display configurations to less than half that price in emerging markets. Similarly, AAPL cut the price of its entry level Apple Watch Sport by $50, not quite matching 3rd party retailers like Best Buy, that have already been discounting Apple Watches by as much as $100. We do not believe that either of these price cuts is likely to generate significant incremental demand.
  • AAPL TVOS and iOS updates just ahead of WWDC are odd. The latest updates to both of these operating systems are incremental. Some of the announced features like password and TouchID protected Notes were a dig at the DOJ and FBI in Apple’s legal battle to protect privacy. While the Night Shift feature, which adjusts display brightness to feature warmer colors at night, is welcome for insomniacs everywhere, it too isn’t enough to move the needle. Added integration of Siri for the TV App Store and dictation follow similar features in Amazon’s Fire TV offering.
  • 2016 iPhone unit sales will be down YoY and below expectations. We believe the premium smartphone market is nearly saturated and that the already high replacement rate is more likely to fall than rise. Given the ongoing “tough compare” hangover from the iPhone 6, this translates to declining sales through at least the September quarter. We also believe that expectations for the iPhone 7 are considerably overaggressive. Now less than 6 months ahead of the likely announcement, the leaks and rumors point to a thinner, water-resistant smartphone without a physical home key or a 3.5mm headphone jack. While the elimination of the 3.5mm jack could prove a problem for many would-be buyers, none of the rumored bells and whistles seems compelling enough to catalyze a new replacement boom. Moreover, new phones based on the QCOM Snapdragon 820, like the Samsung Galaxy 7, are drawing strong positive comments vis a vis the iPhone 6S. With the Snapdragon 830, designed for Samsung’s 10nm fab and due 1Q17, the Android competition will take another great leap forward in performance.
  • Still nothing big enough to make up for slow iPhone sales. The bloggers won’t say it, but the Apple Watch has been a considerable disappointment. Without any sign of a killer app and with the initial spate of true-believer early adoption complete, we are skeptical that sales will grow much in 2016, even off of the small current base. Apple Music is another high profile cloud dud from the company. With a billion AAPL device users, including 500M iPhone users locked into the closed ecosystem, it is remarkable that only 10M users were paying for Apple Music 6 months after launch. By comparison, Spotify added 10M subs of its own over the same period, topping the iTunes app chart in several weeks and growing its base by 50% to 30M. In contrast to the hype on the conference call, Apple’s cloud services revenue declined per installed device during the most recent quarter. Despite spending several billion dollars on building supposedly state-of-the-art data centers, AAPL lacks the necessary infrastructure and skill set and relies on the big three: AMZN, MSFT, and GOOGL to host iCloud and services data.
  • A selling opportunity. Given the 12% run up, the non-news around today’s announcements and the relatively unsupported optimism of bullish analysts, we suggest reducing exposure to AAPL ahead of the quarter.
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