Investors under appreciate Apple's (NASDAQ: AAPL) future growth opportunities, including: 1) continued iPhone share gains, 2) better than expected iPad demand, 3) investments for growth in China, and 4) increased enterprise penetration. 58% of iPhone customers expect to upgrade their iPhone in the next year, far higher than the 18% upgrade rate in 2008 – a difference of 18 million units globally in CY11. Apple could increase U.S. demand by ~40% by either a $50 drop in average iPhone selling price to the consumer (to $150) or a $20 drop in service plan costs (to $75). While Apple has not announced plans to sell the iPhone through any non-AT&T U.S. carriers, 17% of Verizon customers would upgrade to a Verizon iPhone. If launched, purchases expected to be spread over two years due to contract terms.
A combination of new product launches, broader distribution (carrier, international, enterprise), more attractive pricing and strong upgrade rates as the key demand drivers over the next two years. Additionally, we believe iPhone, Touch and iPad margins will remain above the corporate average, driving EPS upside as mix improves.
CATALYSTS
- iPhone exclusivity expiration announcements in the US, Germany, Spain and Japan.
- iPad shipment ramp as distribution expands in U.S. and Internationally.
- Further reductions in iPhone total cost of ownership (hardware or service plan cost).
- Potential new content revenue streams, including books, magazines, video.
INVESTMENT RISKS
- Pricing and gross margin pressure if carriers push back on high iPhone subsidies in the face of exclusivity expirations, rising smartphone competition (Android, Blackberry, Palm,etc), and network congestion.
- Shipment, gross margin and earnings volatility related to the launch of new products.
- Market reaction to price cuts – Although we believe that iPhone price cuts are a positive demand and margin driver longer term.
- Regulatory and legal risk as Apple gains profit share momentum in mobile devices.
iPhone Share Gains
While International markets drove much of the iPhone upside over the past six months, U.S. penetration has not peaked – highlighted by an additional 8 points of potential U.S. smartphone market share.
iPad Penetration
iPad shipments are expected to surpass market expectations. The iPad is ramping faster than the iPhone (1 million in 1 month vs. 1 million in over 2 months) and points to 7-9 million shipments in the first twelve months versus the consensus forecast of 5-6 million.
China Opportunity
A sizeable, and growing, addressable market in China has been spotted which Apple is just beginning to tap. If Apple shifts to a more affordable pre-paid iPhone pricing model ($350-400) the iPhone unit opportunity would double to nearly 10 million.
Enterprise Penetration
Consumers account for the vast majority of Apple revenues but the iPhone is increasing the company's enterprise penetration and provides another source of growth. iPhone enterprise penetration is 45% today and CIOs plan to increase spending on the iPhone more than any other handset platform over the next year. Over time, iPhone enterprise adoption should lay the groundwork for iPad/Mac adoption.
U.S. upgrade rate (for 2G and 3G subscribers) rose sharply to 58% of the installed base in Mar '10 from 18% (2G subscribers) in Nov '08. The powerful combination of significant growth in the installed base and a rising upgrade rate will drive 19M upgrade units by CY11, which is ~75% of the 25M total iPhone shipments in 2009. iPhone total cost of ownership (TCO) remains the biggest purchase barrier and Apple is expected to continue to take steps to reduce the iPhone price to stimulate additional demand. iPhone service plan pricing is the number one barrier to further adoption.
While the timing of a potential Verizon relationship remains uncertain, the opportunity is sized at approximately 7-8M units annually. There is substantial pent up iPhone demand within the Verizon installed base as 16.8% of Verizon subscribers said they are "very likely" to purchase an iPhone if offered on the Verizon Network.
According to a very recent news release, iPhone 4 pre-order sales yesterday were 10-times higher than the first day of pre-ordering for the iPhone 3G S last year. Consumers are clearly excited about iPhone 4, AT&T's more affordable data plans and our early upgrade pricing.
In addition to unprecedented pre-order sales, yesterday there were more than 13 million visits to AT&T's website where customers can check to see if they are eligible to upgrade to a new phone; that number is about 3-times higher than the previous record for eligibility upgrade checks in one day.
Given this unprecedented demand and the current expectations for iPhone 4 inventory levels when the device is available June 24, Apple is suspending pre-ordering today in order to fulfill the orders they've already received.
Microsoft, however, will never let Apple take the competition away and surely has someone up its sleeve. A recent report suggest that MSFT CEO Steve Ballmer will announce Microsoft's new, top-secret mobile phone plans next Monday at the Mobile World Congress in Barcelona.
Google's closest response to the iPhone 4 on AT&T was rolled out on June 14, 2010 and turns out to be a relatively low-end device. The Aria's launch is slated to be near that of the iPhone 4 and will have it reach stores on June 20. It will cost significantly less at $130 on contract, but only after a $100 mail-in rebate.
