Financial markets like nothing better than change ‘ as long as someone in the know predicted it and they can back the change, then a knowing investor can make a fortune. Stocks and shares don’t sell when the companies which are strong stay strong, and those who are weak stay weak. So investors often engage us in conversations about Apple and other successful companies, trying to predict the first time its numbers won’t quite add up.
There is massive investor belief in Apple purely because there is massive consumer belief in Apple. This is not always the driver for a stock, but when it is, things are far slower to change. The products sell, not because they are the best, because they work the fastest or they use the latest technology. Instead they have a kudos all of their own. Even when such a company’s products are so well purchased that the brand becomes almost sickly sweet, and no-one can manage to consume any more of the products, they can at least exchange them for newer ones, buy the rest of the product range, or purchase services, with an almost maniacal loyalty.
So things can change but they take a while to change. So while the financial analysts of the world look for cracks in the Apple stock, and they are there to see, these cracks will take a long time to hit sales. In fact product lines are so new at Apple, so recently refreshed in iPhones, PCs, operating systems, App Store, iPods of all types (both Nano and Touch) and they are so far ahead in the way the brands are regarded compared to rivals, that even if these products lines were to stand still, and Apple was to open up no new product lines or distribution routes, that the remainder of the year would perform largely on target, both in revenues terms and also in profit terms.
Analysts focus on when Apple can open up its iPhone to Verizon. We can’t really see what difference it makes. Verizon has had to stock devices which are finally offering comparable performance to the iPhone after an almost three year unassailable lead.
Every time we have discussed an iPhone killer we have ended up, when we finally put hands upon the product realizing that it had a key weakness. Too heavy, the interface doesn’t use touch enough, it relies on a stylus, it has no capacitive touch screen, the graphics or video is slow to load because the graphics integration was not tight enough. But finally there are devices out there, on every major operating system that can at last do exactly what the iPhone can – as opposed to being better at being a phone but not offering anything that the Apple loving consumer had on his or her list of ‘must haves.’
There are many weaknesses in the original iPhone design, some of which are proliferated in the iPhone 3GS 32 GB latest device, but very few of its strengths have been caught up with and overtaken. The App Store is perhaps the last in the line of Apple innovations that is not being quite caught up with.
But history tells us that despite music stores being every bit as good as iTunes, the vast majority of people still think first of iTunes when they think about a music store.
The same can be said of iPods. People rarely think of these as just another MP3 player ‘ in fact the term iPod has almost replaced the term Mp3 player in the way that Hoover has replaced the term vacuum cleaner. It is pointless arguing about the benefits of Hoover versus an Hitachi vacuum cleaner, if everyone goes into a shop and asks for a Hoover by name.
Yahoo is another case in point. Many people saw Yahoo, bookmarked it and never looked back. It has taken 15 years for the Yahoo brand to become tarnished, and even then only with the rise of a brand that is significantly cooler than Yahoo, in Google, and then only because Yahoo has largely stood still.
Apple, of course will not stand still, and we understand that it is about to target the TV industry with its own TV channels, as well as bring to market an entirely new genre of device in some kind of tablet, which may combined the capabilities of an ebook reader, a netbook and a portable TV set.
Given all of this, just how must importance should we attach to a potential future relationship with Verizon. Around the world the iPhone has largely given up its exclusivity to one cellular operator. But in the US, where perhaps over 50% of iPhones have shipped, this has not yet happened.
We supposed that the two questions to really ask are:
Would the iPhone being for sale at Verizon lead to more people or less people buying it in total.
The other question is would the iPhone being available at Verizon lead to more or less profit at Apple.
Quite simply we think the answer lies in the performance of the iPhone since it was announced in China. So far there have only been 300,000 devices shipped by China Unicom during the past 2 months.
We don’t think that’s a large number and we suspect that iPhone sales have gone down 300,000 elsewhere, because other countries are no longer finding a market for unhooking iPhones from their local networks and shipping them to China. If Apple cannot sell that many more devices by offering them in the largest country in the world, then adding them at Verizon may do even less.
In other words the number of people buying the iPhone and swapping to AT&T may go down, but the total number of iPhones shipping in the US is unlikely to go up very far. The drop in gains at AT&T may well be offset by the gains at Verizon, or at least partially offset. Overall we’d expect the numbers that ship to go up, but not much faster than they are going up now.
Let’s say that Verizon gets the device in 2011 (or begins marketing aggressively from then onwards), AT&T has installed the devices at a rate of 2 million in 2007, 6.3 million in 2008 and 16 million in 2009. We might expect AT&T sourced iPhones to go to 20 or 22 million next and saturate at around a 24% to 25% level within the AT&T base, shipping the same kind of number each year, but with say a quarter initially, rising to a half of them, acting as replacements to other Apple iPhones. If Verizon has the iPhone AT&T might ship 3 or 4 million a year less.
If Verizon did exactly that same at AT&T, pro rated to its own slightly larger base, and assuming that AT&T stopped growing quite so fast (because it is picking up customers from Verizon due to the iPhone and presumably that would stop) then Verizon might ship 6 to 7 million in its first full year of shipping iPhones, double that the next year and saturate around the same level of AT&T.
Either way, across these two companies, it is difficult to make a case for more than 20% penetration of the respective customer bases if they both have it, which would means something like 75 million iPhones in use around 2014 and annual shipments of around 30 million a year in the US. Without Verizon the annual shipment number might top out at 22 million or so. But that’s by 2014, suggesting that nothing bad, and actually nothing significant to the share price of Apple, is going to come out of how Apple manages its US exclusivity ‘ apart from sentiment.
Other analysts have estimated a number closer to 50 million a year in the US, and another 50 million outside the US, and come up with 100 million shipment figures. But so far we have assumed that the other US cellcos would never be allowed to ship these devices and between them they currently account for another 130 million live customers, so if Apple opens them up as well, perhaps it can ship those kinds of numbers. In fact the biggest problem is shipping the non-US portion of those estimates, and that’s the real news, if Apple’s move to non-exclusivity outside of the US works.
There is a strong argument that it will. Very simply the operators that are taking it fresh in 2010 are going to commit to advertising it. The iPhone and Apple brand is not the pull it was inside the US, so naturally there are many customers who did not leave the safety of their existing cellular contracts just to get an iPhone, but they might want one if their operators offer it. A kind of delayed action appeal.
The issue on profits for Apple as regards losing its US exclusivity, is perhaps a different story.
The payment which AT&T makes to Apple for a share of its data service revenue, may well be contingent upon continued exclusivity. Verizon may not agree to such a deal for its own data revenues (alternatively it may be so upset at the rise in AT&T net adds that it might go ahead and sign the same terms). But overall we would expect each device to be less profitable after Apple ends the AT&T exclusive.
So perhaps Apple is in a position where it can choose. Does it want more revenues on perhaps the same overall profit, or does it want less devices out there, for the same revenue. The answer is very simple. Although it may dilute overall margins, Apple should be worried that if it does not get its iPhone into the hands of Verizon soon, then Google will find that Verizon champions mostly Android devices.
This will give oxygen to its rival Android Market and in turn push up Android sales. The result of that would be to make developers more attracted to the Android market, and it might create a more powerful competitor for itself.
What is ideal for Apple is to get a device to Verizon that can use its App Store, but do it in such a way that AT&T still has the upper hand, probably because it has a better device. That way it may be able to keep its higher margins at AT&T, bring Verizon into the fold, and keep Android Market marginalized. Whether it can pull that off will be interesting, but we expect it to try, through some kind of complicated product refresh of the iPhone line.
One way it might manage this is by replacing the iPhone 3GS 32GB early, with this supposed 4th generation device that the Korean newspapers were talking about last week, which they insist is due in April or May. That could elave Apple free to offer the older iPhone to Verizon or the new device can be FOR Verizon, but as a low end CDMA version, which still leaves AT&T in pole position (not that we are sure that Verizon would take such a device).
The other thing that can affect Apple’s future is a device more obviously designed for the very low end, the tied Pay as you Go market, as much overseas as in the US. That would be particularly interesting for markets where Apple is currently badly represented.
But if you are looking for a massive potential downside for Apple, you need to look no further than the patents battle that it just cannot win with Nokia.
A lot of drivel has been published about Nokia trying to steal Apple innovation in US papers, written by Apple Fanboys. The truth is that Apple certainly has patents, but they are very few and far between when compared to Nokia’s. The company does no real pure R&D whatsoever, and most of its recent patents are in how it puts its products together, not in introducing technology that it owns.
Nokia on the other hand has both types of patents ‘ interfaces and menuing systems and UI, but also pure R&D and it helped invent each of the latest core modulation techniques used in GSM and 3G. You can’t make a mobile phone without paying Nokia, Ericsson and Qualcomm patent royalties, and if you try, you end up in court. And it looks as if Apple has tried. And of these the Nokia patents have had the most recent successful court outing, and that was against Qualcomm. And so far Nokia has only tried to hit Apple with the fairly soft patents of user interface, camera, antenna and power management, with no 3G technologies coming into it.
It was power management that hurt Qualcomm, one of the finest chip makers in the world, in an earlier dispute with Broadcom, which it lost.
Both Nokia and Apple have asked the International Trade Commission to ban each other’s imports into the US. In the past Apple has seen these types of cases up to the court room doors, then settled for $100 million or less and gone on its merry way. Not this time. The royalty cost for making phones is going to be far more than that, and after Nokia there will be a queue of other complainants. This could be bad enough to block iPhones from the US while Apple resolved its dispute with Nokia. Apple at best might get one design banned from the US for Nokia, one out of perhaps 100 devices, on the same principles. That would mean that it would affect less than 1% of Nokia’s revenues. A similar ban would affect 50% of Apple’s phone revenues, so it has significantly more at risk.
But given the nature of the dispute it will take about a year for discovery and longer to be scheduled in a courtroom, so unless there is a banning decision by the ITC, this will sit on each other’s books well into 2011, and potentially beyond. But we think that in the end it will be resolved in Nokia’s favor. So investors, if you are looking for a downside, that’s the one that might bite Apple.
Kodak added some grist to the mill when it also said this week it would sue Apple over image viewing patents which it says it has been chasing in negotiations for years. If the ITC issued a ban, as it did in Qualcomm’s case on the Broadcom power saving chip patents, then Apple would have to settle virtually overnight, or its numbers would see a big hole within one quarter.