Apple – Super cycle blues.

Reply to this post

 

 

 

 

 

Early data indicates that there is no super cycle

  • While it is too early to say for sure, the initial data suggests that the super cycle that the market is looking for to underpin the valuation of the shares is not occurring.
  • Mixpanel is an analytics company that tracks user interactions for the providers of apps and services on the web as well as mobile devices.
  • With 20,000 customers and 7tn data points collected every year, I think it is fair to say that Mixpanel is quite capable of collecting a data sample that is a good representation of reality.
  • The latest data from Mixpanel tracks the appearance of iPhone 8/8+/X devices in the data that it collects, giving an idea of how quickly the user base is switching to the new models.
  • In the two months since release (iPhone X one month only), the three devices have racked up the following share of the user base:
    • iPhone 8: 2.79%
    • iPhone 8+: 3.68%
    • iPhone X: 4.91%
    • This gives total penetration of the new generation of iPhones in the first two months of availability of 11.3% of the user base.
  • In comparison, the iPhone 7 and 7+ penetrated 23.5% of the user base within the first two months of availability.
  • This strongly suggests that the latest generation of devices is not generating the kind of super cycle that the market is looking.
  • I do not think that supply is an issue as I can order an iPhone X 64GB today and pick it up from the Apple Store in New York City or Palo Alto tomorrow. The iPhone X 256GB wait is four days.
  • To be as consistent as possible, it is necessary to adjust the data to reflect the fact that the iPhone X has only been available for a month.
  • If I take the penetration achieved in the first month by each model in the new generation, I end up with a total user base penetration of 8.8% after one month of availability.
  • By contrast after one month the iPhone 7/7+ had achieved 11.5% penetration of the iOS user base.
  • This is a strong indication that uptake by users of the new generation of devices is actually slower than it was for the iPhone 7.
  • It is important to remember that this is going to be offset by price as the data clearly shows that the iPhone X is much more popular than the iPhone 8, despite being 30% more expensive.
  • Hence, softness in unit shipment numbers could easily be compensated by the higher price being paid for the iPhone X.
  • However, I think that expectations for Apple for FY2018 are including both a strong replacement cycle and higher prices which is why I fear disappointment in the short term.
  • The caveats to this analysis are:
    • First, data: I have assumed that Mixpanel is a statistically significant representation of reality.
    • While the data quantity suggests that this should be the case, I have no hard data to prove it.
    • Second, availability: I have tested availability in NYC and California as they are places with the highest demand, but this may not be a true representation of supply.
    • Third, user base: The user base of iOS devices is larger this year than it was last year.
    • Consequently, it will require more devices to be sold in order to achieve that same level of penetration as the iPhone 7.
    • However, I do not think that differences in the size of the user base is enough to account for this discrepancy.
  • When I weigh up the findings of this analysis and take into account the caveats, I conclude the following:
    • First: uptake of the new generation of iPhone is slower than last year and there is no sign of the much hoped for super cycle.
    • I think this is mainly driven by the very high price of the most desirable product which will lead to many users waiting until the full screen penetrates to the lower priced segments.
    • Second: the higher price of the iPhone X will offset the impact on Apple’s revenues of a slower uptake compared to the iPhone 7, but it will not enable the company to soundly beat market expectations.
  • Consequently, I think that while demand for the iPhone X is clearly quite high, it is not high enough to allow Apple to beat the already very high financial expectations that have been set for it.
  • Hence, I can see disappointment coming through in Apple’s next few sets of earnings releases and think that the time has come to take some money off the table.
  • Tencent, Baidu and Microsoft are worthy candidates for consideration.

Apple – Tick in the box.

Reply to this post

 

 

 

 

 

Hacking of Face ID proves its security.

  • The inevitable hacking of Face ID has been achieved but I think that the lengths that the hackers had to go to crack the system proves that, for all practical purposes, it is a worthy upgrade from fingerprint recognition.
  • Vietnamese cyber security firm and Android phone maker, Bkav Corp, has managed to reliably bypass Face ID (see here) by creating a 3D mask of the user’s face with special attention being paid to the eyes, nose and mouth.
  • However, it is pretty clear that a huge amount of work went into the creation of this mask as:
    • First: it was designed using expert cyber security knowledge and an intricate understanding of how Face ID works.
    • Bkav first demonstrated a bypass of facial recognition on laptops in 2008 and has been a player in the field ever since.
    • Second: 3D printing, 2D printing and hand-made artistry was used to create the mask indicating just how intricate the process was.
    • Third: each mask costs $150 to produce.
    • Fourth: it took 9 days to crack (even with at least 10 years’ experience) and I suspect Bkav was working on this flat out.
  • The net result is that Bkav continues to advocate for the fingerprint being the best method of authentication for an electronic device.
  • However, I think that the intricacy and cost of this hack combined with the fact that a detailed 3D scan of the user’s face is required, is actually an endorsement of Face ID as a verification system.
  • Taking this with surveys that suggest that 60% of users prefer the system over fingerprint (9to5 Mac) and the fact that there few reported issues with the reliability and speed of the system leads me to think that Apple has successfully ticked this box.
  • However, fast and reliable Face ID is clearly quite difficult and expensive to achieve (Samsung’s is awful) which leads me to think that Apple has set a standard for high end devices going forward.
  • I think that this will trickle down through the tiers with time, but it looks like fingerprint sensors may have a limited life span.
  • Furthermore, Apple now has a clear point of hardware differentiation over its competitors that is likely to last for a generation or two.
  • In the ecosystem, Apple is still miles ahead largely due to Google’s inability to deal with the endemic fragmentation, security and updating issues that continue to hamper the Android user experience.
  • Hence, I remain unconcerned for Apple’s iPhone gross margins for the next 12 to 18 months.
  • That being said, I think the shares continue to price in a larger iPhone X driven cycle of replacement than I see as likely.
  • This combined with excellent price appreciation so far this year, leaves me indifferent to the shares.

Apple FQ4 17 – All things X.

Reply to this post

 

 

 

 

 

X hits the spot.

  • Apple reported good results and guided strongly for FQ1 18 as it has managed to deal with some of the production problems with the iPhone X which will result in slightly better than expected shipments in FQ1 18.
  • FQ4 17 revenues / EPS were $52.6bn / $2.07 compared to estimates of $50.7 / $1.87.
  • Slightly soft iPhone 8 demand has been offset by a 25% jump in Mac shipments and a 14% jump in iPad.
  • Both of these products have clearly gained some share as the end markets for PCs and Tablets have remained quite soft.
  • The big problem with the iPhone X has been the facial recognition system where suppliers have struggled to produce enough components to the specification demanded by Apple.
  • I suspect that the slight relaxation of the original security requirement has enabled more of the 3D sensors to meet the grade enabling the slightly better supply underpinning FQ1 18 guidance.
  • As a result, guidance for FQ1 18 was slightly ahead of expectations with revenues / gross margins of $84bn – $87bn / 38.0% – 38.5% forecast compared to expectations of $84bn / 38.5%.
  • The traditional lines outside the stores that were completely absent when the iPhone 8 / 8+ became available, have formed for the availability of the iPhone X leading me to believe that the company is on track for a pretty good replacement cycle.
  • However, I do not think that the iPhone X will offer a cycle nearly as big as the iPhone 6 and my concern is that this is what the market is looking for.
  • In expectation of this super cycle, the valuation of Apple as expanded materially leaving me concerned that much of these heady expectations has already been priced into the stock.
  • Consequently, the valuation argument for Apple is not nearly as strong now as it was 12 months ago, leaving somewhat less inclined to hold the shares for the long-term.
  • I continue to prefer Tencent which has some upside left given its global leadership in Digital Life coverage and Baidu which represents the cheapest way to invest in the trend of AI.
  • Microsoft continues to be steady albeit much less exciting than the other two.

 

Apple – Expectations gap.

Reply to this post

 

 

 

 

 

iPhone X unlikely to produce the needed super cycle.

  • Expectations for the iPhone X are at fever pitch and I think that a super cycle is now required to prevent a sell-off in the shares.
  • iPhone X is the first substantial revision to the design of the iPhone since the launch of the iPhone 6 and in many ways the circumstances are very similar.
  • In 2014, the biggest complaint with regard to the iPhone was the size of the screen which was considered to be tiny compared to devices being produced by Samsung and the other Android handset makers.
  • When Apple fixed this shortcoming with the iPhone 6/6+, there was a lot of pent up demand as users who could only have a large screen with Android were able to have the best of both worlds.
  • This demand led to shipments growing (calendar quarters): Q4 14 46%YoY, Q1 15 40% YoY, Q2 15 35% YoY, Q3 15 22% YoY and Q4 15 0% YoY.
  • This was followed by shipments declines in Q1-Q3 16 as the pent-up demand was exhausted and replacement rates normalised.
  • I do not think that the iPhone X will stimulate a big enough uptick in replacement rates to meet the expectation that Apple will ship more than 255m+ units in its next fiscal year.
  • This is due to:
    • First, Utility: While the new screen is nice to look at and enables a big screen on a smaller device, it does not offer an increase in utility over the iPhone 7 similar to that of the iPhone 6 compared to the iPhone 5.
    • Consequently, I think it will not create the same degree of desirability and therefore not trigger a similar degree of early replacements compared to the iPhone 6/6+ .
    • Second, Price: The device is meaningfully more expensive starting at $999 which may put some buyers off.
    • Third, Law of large numbers. The bigger Apple becomes, the more difficult it is to post the kind of growth that the valuation of the shares now demands.
  • I think that the iPhone X will stimulate a replacement cycle but one that is smaller in magnitude compared to the iPhone 6.
  • With my optimistic hat on, I can just about get comfortable with the following unit shipment growth (calendar quarters): Q4 17 15% YoY, Q1 18 8% YoY, Q2 18 22% YoY, Q3 18 10% YoY.
  • This gives me 245m units shipped during the next fiscal year which is below current expectations.
  • The net result is that I think expectations for fiscal 2018 need to come back somewhat which is likely to trigger a sell -off in the shares bringing the valuation down somewhat.
  • Hence, I think that the time is right to take some money of the table and put it somewhere else.
  • Tencent, Baidu and Microsoft have less immediate downside in my opinion.

Android – Further deterioration.

Reply to this post

 

 

 

 

 

Apple is 577x better at software upgrades.

  • Both Android 8.0 Oreo and iOS11 have been available for a few weeks and has highlighted, once again, how bad the situation in Android.
  • I continue to believe this has a fundamental impact on the Android user experience, loyalty and monetisation.
  • Data from android.developer.com shows that Android Oreo is present on 0.2% of Google Android devices while iOS11 is present on 38.5% of all iOS devices.
  • Android Oreo has been available for 44 days (August 21st 2017) while iOS has been available for just one third of that time (15 days, September 19th 2017).
  • This means that the iOS user base is, on average, being upgraded 577x more quickly than Google’s user base of Android devices.
  • To compound the problem, it looks as if the rate at which the user base is transitioning to newer versions of Android is slowing down.
  • 12 months ago, Android 7.0 Nougat had 0.1% share of the user base and currently it has just 17.8%.
  • At this rate it will take 5 years and 7 months for Oreo to completely penetrate Google’s own Android user base.
  • This is substantially worse than the 4 years that I have observed in previous years.
  • This means that when Google makes an innovation in functionality that requires a modification to be made to the underlying Android OS, it will take the best part of 6 years for this innovation to make it into the hands of all of its Android users.
  • By contrast this process is essentially complete on iOS devices within about 3 months.
  • Effectively Google is spending money on R&D that stands to benefit its competitors more than it benefits itself.
  • If Apple takes a fancy to something launched at Google i/o, it can include the innovation in its latest version and have it deployed to essentially all of its users long before Google Android makes double figures.
  • This combined with the endemic fragmentation, substantially hampers the user experience on Android making it inferior to iOS.
  • I think there is substantial financial upside for Google if it can fix this problem which is why I continue to believe that Google Android will eventually become fully proprietary.
  • This is the only way by which Google can fix these problems and it comes as no surprise that both Android Auto and Android Wear are fully proprietary.
  • While the status quo persists, Apple profitability on iPhone is unlikely to be challenged although I am much more cautious around revenue growth.
  • I continue to be indifferent to both Apple and Alphabet, preferring instead, Tencent, Baidu and Microsoft.

 

iPhone X – One trick pony

Reply to this post

 

 

 

 

 

Face ID will make or break this device.

  • I have long believed that this year’s iPhone offerings will not trigger a super cycle of replacement but with a lukewarm reception for the iPhone 8 is likely to mean that it is up to the iPhone X to drive Apple’s bottom line beyond expectations.
  • When I look at the iPhone X and compare it to the Galaxy s8 / s8+ or the Note 8, it is frankly, unremarkable.
  • Furthermore, I suspect that on a side by side test, the Galaxy s8 screen may well come out on top.
  • However, the Galaxy s8/s8+ and Note 8 all fall over where every Android phone always falls over which is: software.
  • All the apps are there but they never seem to work quite as well as they do on iOS leaving the whole experience feeling disjointed despite best in class hardware.
  • In my opinion the weakest feature of this year’s Samsung line-up is the facial recognition which is very slow and unreliable on the best of days.
  • Almost anything other than a perfect situation causes it to fail and sunglasses, hats and even lollipops are a no go.
  • The end result is a trip back in time to when Nokia ruled the smartphone market where I end up using a PIN to unlock the device 90% of the time.
  • This is where the iPhone X can leave Samsung in the dust as I suspect that almost everywhere else (except perhaps the processor) it is likely to be somewhat behind.
  • However, in order to do this Face ID on the iPhone X has to be flawless which is a tall order especially as it failed to recognise one of Apple’s best-known executives first time.
  • In Apple’s defence there may have been some mitigating circumstances that caused it to fail in that instance that have nothing to do with how the technology will work day to day.
  • However, if Face ID proves to be anything less than Apple has billed, I think it will materially hurt the appeal of the device as the method of unlocking and authenticating on the iPhone 8 will instantly become far superior to the flagship.
  • This has the prospect to slow down replacement by iOS users which will materially impact Apple’s results going into fiscal Q1 (Q4 17) and Q2 (Q1 18).
  • The net result would most likely to be an unwinding of Apple’s PER multiple which has expanded nicely this year on hopes of another iPhone 6-like super cycle.
  • I think that even if Face ID works as well as hoped, I doubt it will trigger another cycle of that magnitude, especially given that the device starts at $999.
  • Consequently, I am increasingly nervous with regard to Apple’s share price as I can see only downward drivers.
  • My indifference is moving more towards the negative end as there is more value to be had elsewhere.
  • Tencent, Baidu and Microsoft leap to mind.

Apple – Worst kept secrets.

Reply to this post

 

 

 

 

 

Face ID was the star of a show where everything had been leaked.

  • Apple launched its next series of products that brings its hardware into line with the best of Android but it is in the software where the differentiation will continue to be found.

iPhone X.

  • iPhone X brings Apple into line with Samsung in terms of screen design and quality (OLED) but I suspect it is in Face ID where the real leap in innovation lies.
  • Face ID uses a 3D depth sensor and infrared camera to map the user’s face and then compare that against a previously captured map.
  • Face ID promises to be fast and not fooled by photographs or even 3D models of the user’s face.
  • It will also continue to recognise the user when wearing a hat or glasses or should the user grow a beard.
  • This should be a big improvement on Samsung’s facial recognition which is slow and unreliable to the point where it is often easier and quicker to put in the PIN number.
  • Apple has also redesigned the home button press and multitasking commands into swipes that should be reasonably easy to adjust to.
  • Beyond that there are incremental advances in the camera and image processing but at the end of the day, this device is all about the new screen.
  • Apple has brought itself into line with the high-end of Android in terms of hardware specification meaning that the price premium will be all about the iOS ecosystem.
  • Pricing is in line with expectations at $999 for the 64GB version and I estimate $100 more for the 256GB version.
  • With Android struggling with endemic fragmentation and Samsung remaining very poor at software Apple remains at the head of the pack.

iPhone 8/8+.

  • Many of the improvements present in the iPhone X are also present in the iPhone 8 with the exception of the screen and FaceID.
  • It continues to use fingerprint recognition on the home button and has a slightly improved screen although it is in the old configuration and is not OLED.
  • It has the same photographic enhancements as the iPhone X and represents a steady upgrade to the iPhone 7 with pricing staying the same.

Apple Watch Series 3

  • Apple has recognised that almost all the usage this product is for fitness and is doubling down on this use case in the new version.
  • New functions have been added that improve the performance of the device for certain activities as well as adding some new less common activities.
  • The heart rate monitor has been improved to offer continual heart rate monitoring as well as resting and recovery heart rates thereby deepening its appeal to fitness.
  • At the same time, Apple is taking tentative steps into medical with the launch of a study that looks at alerting users to abnormal heart patterns that can lead to strokes.
  • This is a work in progress but Apple clearly intends to move deeper into this area as it is working closely with the FDA on this study.
  • Apple has also added a modem to one variant of the Apple Watch which I continue to believe is completely pointless (see here).
  • Apple has done enough to keep this category going but the real use case that will make everyone rush out and buy one remains glaringly absent.

Wireless Charging

  • Apple’s new iPhones have glass backs which enable wireless charging for the first time.
  • Apple has backed the Qi standard which is also used by Samsung which I suspect will now ensure that Qi becomes the single global standard.
  • Apple also discussed a proprietary product that enables multiple devices to charge on a single mat but as this is not in the standard it will only work with Apple products.
  • Apple is moving into line with everyone else on wireless charging as even the multiple devices on one mat is not a new idea.

Take Home Message

  • The endless leaks and speculation meant that Apple was not able to spring a single surprise on the audience this year.
  • That being said, I think it has done just enough to keep itself at the top of the industry for another year.
  • This is more about the Android camp struggling with software fragmentation and low profitability than Apple raising the bar for the gold standard in smartphones.
  • The one area where it has raised the bar is FaceID but this feature needs to tested in the wild to see just how good it really is.
  • Apple’s share has enjoyed a great rally this year meaning that the valuation argument for owning the stock long-term has evaporated.
  • With no real surprises coming this year there is a case to be made for taking some profits and looking elsewhere.
  • Tencent, Baidu and Microsoft spring to mind.

Apple FQ3 17A – No pause here.

Reply to this post

 

 

 

 

 

Solid base for new product launches.

  • Apple reported good results and guided strongly for the coming quarter stoking speculation with regards to the possible strength of the coming upgrade cycle with the new iPhones expected to be launched next month.
  • FQ3 17A revenues / adj-EPS were $45.4bn / $1.67 slightly ahead of consensus of $45.0bn / $1.57.
  • While iPhone held steady it was Services that really underpinned the results with YoY growth of 22% to $7.3bn.
    • iPhone shipments were 41m which included a 3.3m inventory reduction ahead of the new launches.
    • iPad shipments were 11.4m up 15% YoY driven mostly by the product refresh that saw a new iPad and the smaller version of the iPad Pro launch in March 2017.
    • Mac shipments were 4.3m units driven mostly by the new MacBook Pro.
  • Services was the star of the show where the Apple App Store is the main driver generating almost double the revenue of its nearest rival Google Play.
  • This was despite the fact that Android devices appear to have closed some of the monetisation gap on iPhone especially at the high end (see here).
  • Guidance was surprisingly strong with revenues / EBIT expected at $49bn – $52bn ($50.5bn) / $11.7bn – $13.0bn ($12.4bn) broadly in line with consensus at $50.4bn / $12.4bn.
  • The result was a relief rally as fears of a pause in performance ahead of the new product launches now looks unlikely to occur.
  • Consequently, all eyes are now on product launches where a major product refresh is hoped to trigger another replacement cycle.
  • Bezel-less devices are now all the rage and if Apple can replace fingerprint ID with an excellent facial recognition system, the iPhone 8 could end up triggering a good cycle of upgrades.
  • Samsung has a wealth of biometric ID systems but none of them work particularly well as the fingerprint sensor is on the back of the device and the facial recognition is not nearly as reliable as it should be.
  • I don’t think that Apple will see a cycle as strong as the iPhone 6 but there is potential for the iPhone 8 to meaningfully outperform the 6s and the 7.
  • That being said, I continue to think that much of this good news is already in the stock and the valuation argument for long term investors has long since evaporated.
  • I remain pretty indifferent to the shares.

iOS vs. Android – Catch-up

Reply to this post

 

 

 

 

 

Android is snapping at Apple’s heels.

  • Android is showing signs of catching up with iOS in terms of user spending at the high-end, but further down the pricing tiers and in mobile advertising, I think that iOS remains miles ahead.
  • A recent study of the habits of 1.4m USA based users during the month of June 2017 was carried out by DeltaDNA, an analytics firm.
  • The study only measured gaming but this is already well known to be by far the biggest revenue generator from any Digital Life segment.
  • Almost all games these days are free to play and have in-app purchases for monetisation.
  • It is these that the survey measured and I have expressed these as ARPU $ / month.
    • Samsung Galaxy s8 / s8+: $6.30 / $16.20
    • Google Pixel / XL: $6.30 / $9.60
    • iPhone 7 / 7+: $8.40 / $10.80
    • Other US Android devices: $6.00
  • From this I conclude:
    • First: Screen size and quality is a big determinate in game monetisation.
    • The Samsung Galaxy s8+ which has by far the best screen (and the best audio in my opinion) available on the market today, is clearly making a difference to game play with the observed results.
    • Second: On normal screens, iPhone is still comfortably ahead of both the s8 and the Pixel but the gap is closing.
    • Third: Both the s8 and the Pixel are not meaningfully better than other Android devices implying the that user experience on the s8+ and Pixel XL has nothing to do with their better monetisation.
  • Although these models are clearly closing the gap on the iPhone, when it comes to total revenue generated there still remains a vast chasm in terms of total revenues generated.
  • In Q1 17A, Apple generated $7.04bn in revenues from services while Google other revenues were $3.10bn ($3.09bn in Q2 17A).
  • These figures are not direct comparisons as there are other businesses also included in these figures, but I think it is pretty safe to say that Apple App Store is easily generating double the revenue of Google Play.
  • A large part of this will be because in the high-end segment Apple has much higher share but also because Apple does still clearly offer a higher quality apps and services experience as the data for the regular sized phones indicates.
  • Furthermore, I have not seen a shift in the mobile advertising metrics and so I still believe that an iOS device generates double the advertising revenues of an Android device.
  • This data should send a warning shot across Apple’s bows as the better Android devices are certainly snapping at its heels.
  • Should they finally catch up, Apple may find it starts to feel the dreaded pricing pressure that will hurt profitability.
  • This is why I continue to believe that Apple needs to make its ecosystem sticky in areas other than its App Store which is what I think its strategy around HomeKit, HealthKit and Apple Pay are centred around.
  • However, to date, not a huge amount of sustainable traction has been generated by any of these services and so Apple has to radically improve them or think of something else.
  • This is one reason why the iPhone 8 is so important as once again it has slipped too far behind the hardware curve and needs to catch up.
  • With the rally that we have seen in 2017, the valuation argument for holding Apple has long since evaporated which is why I would prefer to hold Tencent, Baidu or Microsoft for this year.

Qualcomm FQ3 17 – Strong stomach

Reply to this post

 

 

 

 

 

Qualcomm has the stomach for a fight.

  • Despite the seemingly challenging situation the company is currently experiencing, I think the company has a better chance of beating Apple than it did of beating Nokia back in 2006.
  • FQ3 17A revenues / Adj-EPS were $5.3bn / $0.83 compared to consensus at $5.3bn / $0.85.
  • This was in line with consensus which has now been adjusted to account for the fact that royalties from the iPhone are no longer forthcoming.
  • Technology licencing revenues (QTL) fell by 42% YoY and 48% QoQ while QTL EBIT fell by 51% YoY and 56% QoQ highlighting just how significant the revenue generated by the iOS ecosystem is to Qualcomm.
  • Guidance for fiscal FQ4 2017 will be similarly impacted with revenues / Adj-EPS of $5.4bn – $6.2bn / $0.75 – $0.85 compared to consensus $5.6bn / $0.95.
  • While, Qualcomm has been transparent for many years about how QTL generates a disproportionately high share of profits, the market appears to have got its spreadsheets in a muddle and misread the impact of the lower revenues on QTL EBT margins.
  • These are expected to be around 66% which is the main reason why the EPS guidance is below consensus.
  • Included in this are the legal expenses that are being incurred to defend its business model, which I think in the long-run will be money well spent.
  • Most of the arguments that Apple is making to explain why it has an issue with Qualcomm’s business model have been made off and on for the last 15 years so the case it is bringing is nothing new.
  • These arguments were made most vocally by Nokia in 2006 and while the companies did come an eventual settlement, this time around the situation is quite different.
  • I think that these differences strengthen Qualcomm’s hand as:
    • First Contract validity: The dispute that arose between Nokia and Qualcomm in 2006 occurred because Nokia’s contract had come to an end and the companies were unable to reach agreement on terms for the renewal.
    • Nokia stopped paying Qualcomm as it had no idea how much to pay and instead accrued an estimate of the cost in its balance sheet.
    • The contracts upon which Apple has ceased payment have not expired and I can’t see any contractual grounds upon which to cease making payments.
    • As a result, I do not think that it will not be difficult to show to a court that Apple is acting in bad faith and to win an enforcement order.
    • Second: Third party suppliers. Apple does not pay Qualcomm directly as the payment is made by its manufacturing partners who make its products.
    • This means that Apple is getting involved in contracts that are in place between entities that have nothing to do with Apple other than it being the end buyer.
    • I do not think it will be difficult to argue that Apple has no real grounds to be involved in these contracts and is acting in bad faith.
    • Third: Non-standard essential patents. As Apple is no longer paying Qualcomm for its IP, it is not unreasonable for Qualcomm to sue Apple and its contract manufacturers for patent infringement.
    • Standard Essential Patents (SEPs) are those patents that have to be used to get a standard (like LTE) to work properly. One cannot design around them.
    • It is easy to prove infringement of a SEP (assuming that its valid) but patent holders are not allowed to be nasty when it comes to licensing terms.
    • When one contributes standard essential IPR, one agrees to license the technology to anyone who wants it.
    • This has to be done at a fair price and one agrees not to seek injunctions.
    • Historically, Qualcomm has tended to assert SEPs but this time it is asserting implementation patents against Apple and its manufacturers.
    • Implementation IPR is another kettle of fish entirely.
    • It is much more difficult to prove infringement as this IPR can be designed around, but when infringement is proved, the holder can pretty much do what it likes.
    • There is no limit to the royalties that can be charged, injunctions can be sought and the holder can force the infringer to redesign his product to get around the innovation.
    • If there is one thing that Qualcomm knows it is patents and I am certain that it has asserted implementation IPR that Apple is most likely to have infringed as well as patents that are fiendishly difficult to design around.
    • However, I am pretty sure that the engineers at Apple are now beavering away to work out how to do just that.
  • The net result is that I think of all the battles that Qualcomm has fought in the past (and there have been many), it has the best chance of winning this one.
  • However, to slug it out is going to take a long time it could easily be 2020 before this issue is fully resolved.
  • I think that this creates an excellent long-term investment opportunity in the stock but timing of entry is difficult to gauge and it is going to be a bumpy ride.