Apple – Favourable Omens

Signs point to scale making up for any gross margin weakness.

• Apple has entered a new product category and is attempting to kick-start wireless payments but in the short term, financial performance will be governed by the iPhone.
• All the signs are pointing to a very strong calendar Q4 for iPhone shipments as pre-orders look to have been the strongest for 2 years.
• Furthermore wait-time on some versions of the device are now up to 4 weeks and both Apple and the biggest operators are reporting higher than expected demand.
• This does not come as a huge surprise to me as both the iPhone 6 and 6+ address the long term problem of small screen size.
• Screen sizes of 4.7” and 5.5” bring it into contention in the phablet space which Samsung created and has dominated to date.
• This combined with the thinness and sleekness of the new models make them worthy competitors to Samsung on hardware alone for the first time for some time.
• When I then also consider the superior quality of the iOS ecosystem compared to the others like Google, China etc., I can see why users may be tempted to switch.
• I suspect that the vast majority of the iPhone 6’s that are sold will be to existing iPhone users, but I am also expecting that there will be some market share gain over the next few months.
• Against this, I expect that the larger screen sizes are going to result in somewhat higher BOM costs than the market has become accustomed to.
• As the pricing of the device looks largely unchanged, I can see slight gross margin weakness from this device compared to older versions.
• While this may cause concern, I think that scale will more than compensate for any weakness.
• Market share gains should lead to greater volumes meaning that the fixed costs of R&D and Sales and Marketing will be better covered.
• Hence, I am not concerned that operating margins, net margins or cash flow will be negatively impacted.
• To the contrary, I expect a strong calendar Q4 where operating leverage more than makes up for any shortcoming at the gross margin level.
• Apple’s challenge is now to develop the exclusive Digital Life services that it needs to keep users paying over the odds for an iOS device.
• This is the key to its long-term profitability but at the moment is lagging behind Google, Microsoft and even Yahoo!