Apple: 4 Realistic Scenarios – Seeking Alpha
Apple, Inc. (NASDAQ:AAPL) has been on quite the tear lately, rising from an almost two-year slump to new record highs, and up virtually 50% over last May’s lows. Those lows represented over a year of doubt as sales slumped over the blockbuster year of the iPhone 6/6 Plus that introduced the Plus-sized models, and a rising dollar additionally cut into revenues and margins. Today, however, after a new record in sales and revenues, the story is different.
This brings the price to just over its record of May 2015. Given that the December quarter’s figures are just marginally over that of 2015, and that we now are on par price wise, it is a good time to pause and take stock of the situation.
In this article, I examine four likely scenarios for Apple’s future. Each has a basic assumption on the company’s trajectory that determines the outcome. In a sense, they represent a continuum, but at the same time, are distinct, particularly in their respective premises.
Two Unrealistic Scenarios
I will begin with what I believe are two unrealistic scenarios
A. Apple about to fall apart
The story for this scenario gives the following justifications:
A1 – Apple prices are too high and they cannot continue this indefinitely.
A2 – Apple has lost its ability to innovate (helps drive loss of high pricing).
A3 – New players will continue to take market share from Apple with products that are deemed equal in quality but lower in price.
A4 – The slow decline has just begun, and soon sales will fall of the cliff.
This to my mind is not at all realistic. The current quarter shows a return to growth, and the Street is looking to another surge in sales with the upcoming 10-year anniversary iPhone 8 (or “X”?). Furthermore, other revenue drivers (see scenarios 3 and 4) will drive some amount of growth.
Innovation is done at Apple
Many pundits and analysts are driving this meme. I find that those people really do not understand technology on any significant level. They may understand products, but not underlying technology, and so they focus on superficial, visual aspects of the products since they are unable to evaluate anything more profound. I have answered this in detail here: Misunderstanding Apple: The Lost Innovation meme.
Apple is criticized for following other companies which initiate some technology first, but this is frequently a specious argument since the quick-to-market implementation was flawed. The Motorola Atrix had fingerprint recognition, but it did not work well and the model was a flop. Apple came along with a robust and highly secure implementation that worked, but some people said it was not innovation, but copycat.
The same is true of Apple Pay. Sure Google Pay existed before, but Apple waited until the time was right with the Tokenization technology adopted in the banking system, and its own Touch ID/Secure Enclave hardware to secure the transactions. So anyone who believed there was no innovation here was only fooling himself.
B. Apple about to resume exponential growth.
The main drivers for this are:
B1 – The iPhone is returning to growth.
B2 – The iPhone 8 will drive a new surge.
B3 – New products are coming that will be as revolutionary as the iPhone.
This too, is not very probable, although more in the realm of possibility. First, while modest sales growth may be returning to the iPhone, even if the 8 model is a huge success and provides another “blip” in sales, the overwhelming truth is that markets overall are saturating, and the device is in a much more mature phase of the life cycle. Thus, it is unlikely that each new model with be able to present an overwhelming motivation to upgrade as happened when the product was new.
Note – this is not a sign of lack of innovation. It is merely the reality of a more mature product.
Secondly, even if Apple does come out with a wildly significant new product, given Apple’s current revenue size, a new product would have to be incredibly enormous to raise revenues by even 50%, let alone double it. (The long misnamed law of large numbers.)
Finally, some revolutionary new product is a cause for concern in this prospect. I am not willing to base investment decisions on mere faith in some such hypothetical future. New products there will likely be, but their success is never assured. For example, the Apple Watch appears to be a modest success, but it hardly is a great driver of growth. I suppose a car would have a large revenue affect, but I will believe that one when I see it.
Four more reasonable views
So we see here two views, one wildly pessimistic and the other the opposite. Let’s look at some other more reasonable ones.
In each case, the points listed for that particular scenario are as well the counterarguments against the other three. They are premises for the argument.
1 – Apple is beginning a slow decline
This scenario mimics the arguments of A above, but less forcefully:
1.1 – Popularity has peaked.
1.2 – Competition in China.
1.3 – All this will result in margin erosion long term.
1.4 – Innovation has ceased.
This scenario acknowledges one of Apple’s greatest assets – the ecosystem. It recognizes that Apple makes good, valuable products and has a very loyal customer base.
But, as price competition increases, Apple will inevitably lose. As evidence, is the fact that Apple is losing share in China, one of its main growth areas in the past several years. This will spread with time.
Sales will not fall of a cliff, but revenues will see a slow decline as users see little reason to upgrade often, and slowly begin to desert the overpriced platform.
2 – Apple has reached stasis
This is a further moderation of #1. It states that Apple will not shrink, but neither will it grow significantly after the iPhone 8 release.
2.1 – Competition -> margin erosion.
2.2 – New products will not provide significant additional revenue.
— Music is already topped out or near.
— Apple Pay, Apple Watch, have not provided significant growth.
— Augmented Reality will not be a significant revenue driver.
2.3 – Customer loyalty will hold a steady state of 2-4 year upgrades.
2.4 – Apple is still an innovative company, but limited by the reality of mature technologies.
This recognizes that the iPhone 8 may be another huge success, perhaps as great as the 6 Plus phenomenon, but there is little to drive growth after that. In fact, if the 8 does do really well, then we are likely to see another year of declining sales next year, as numbers face the same “tough comparison” situation that occurred after the 6/6 Plus spurt.
Overall, long term, the future is one of stasis, with little growth.
3 – Apple heading into slow growth
3.1 – iPhone growing again.
3.2 – iPhone 8 should provide a large bump driven by new techs.
3.3 – Services will grow modestly.
3.4 – The dollar will stabilize.
Apple’s culture of innovation, design, and quality build will always keep it on top. Its smooth ecosystem will keep customers happy, and secure margins.
On the other hand, current technologies limit somewhat the potential for serious growth. There is no Apple Car coming (at least not in the immediate future), and AR may drive some growth, but that and other services will be limited.
There could be a strong surge in iPhone 8 sales, but after that, growth will be very modest. Services will also provide growth, but even if you were to add all of Netflix’s (NASDAQ:NFLX) annual revenue (roughly $9B) that would only add 4% to current TTM revenue.
This scenario also suggests that the dollar will stabilize near its current level and not further reduce revenues in year-over-year comparisons.
4 – Apple moving back to moderate sustained growth
This scenario takes #3 a bit farther. The premise is that many of the negative factors of the previous year and a half are behind us.
4.1 – iPhone 8 will draw many new users.
4.2 – Services revenue will grow significantly.
4.3 – Apple watch v3 solves many issues and takes off.
4.4 – Mac and iPad resume modest growth.
The premise of 4.1 is based on reports that the new phone, the tenth anniversary model, will be a significant upgrade, including major design factors. Additionally:
a. Long battery life will be a huge winner, as has been proposed by KGI’s Ming-Chi Kuo . He suggested that a significantly larger battery will be used. This combined with a more efficient processor and the reduced consumption of an OLED screen, and all together they could increase battery life by as much as 80%. This is a very large pain point for many users that would be removed.
b. The introduction of a good Augmented Reality system might be enormously popular. Tim Cook has been saying that AR is a huge development. If the idea is to make the 10th anniversary iPhone a celebratory model, then one would expect some kind of revolutionary new functionality. I imagine that Apple would offer some kind of AR app, but also a developer’s platform. If so, this should be announced at the WWDC in June.
This year the Apple Watch will see its third iteration. There is speculation that it will feature LTE cellular connectivity. This and increased functionality that comes with a next generation processor could move it out of the niche category into more widespread adoption. Over time it could add a significant amount of revenue. We should remember that both the iPod and the iPhone grew slowly at first. We do not know precisely what watch sales are, but I can imagine they are a significant business to anyone but Apple.
The Mac has turned the corner. For a year it saw declining sales, but this past quarter, it returned with positive year-over-year growth, and a new record revenue. Undoubtedly, this was due to the new MacBook Pro model, a significant update with the Touch Bar technology.
While the iPad sales continue to slide, the rate of year-over-year decline is lowering. It is not likely that the iPad is going to disappear, so at some point, it will cease the decline, and potentially return to growth, however modest. The current iPad Pro has a power that matches that of most laptops. The next generation A11 processor could put it ahead of some more high-end models.
There is always room for some new product that would add modestly to revenue.
Personally, I still believe that sooner or later, Apple will announce a low-end Mac based on its A-series processors. An under-$400 desktop would add a huge number of new customers. This, however, is highly speculative.
If this scenario plays out, then Apple would return to significant growth. While not the enormous growth of the early iPhone days, it would be significant, perhaps in the low teens percentage wise.
We have presented four likely scenarios and seen how each one follows from a given set of premises about Apple’s business and the consumer base. The investor should think about them and decide which set of premises seems most reasonable, and from there can decide an investment strategy.
Of course, growth is not the only measure for a stock value. Previously, I discussed the value of Apple’s stock repurchase program, and how it has effected EPS. In a future article, I will discuss Apple from a dividends perspective.
But other things affect any company’s revenue stream, many of these external political and economic developments. This year there is a lot of uncertainty in these areas, and Apple’s fortunes could be changed.
On the positive side, a lowering of taxes on repatriation of foreign earnings could be a large positive by making it economically feasible for Apple to bring some of its huge cash hoard back into the U.S.
On the other hand, there are some significant risks as well. The current President has said he has some radical plans for bringing jabs back to America. This is well and good, and an improved economy at home would be good for sales. But some of the policies could potentially lead to trade wars with various currently close partners. This would likely result in at least some period of chaos in which trade would be negatively affected, and could possible lead to very high barriers that would cut Apple sales short.
Already presidential actions have had unanticipated consequences. The immigration ban from seven countries has galvanized unexpected opposition. More importantly, it stranded many legal workers away from their work and families. There is even evidence that the trade ban has seriously curtailed tourist and business travel to the U.S., and that this could cost thousands of jobs. It is said that just the talks of a border tax has disrupted the Texas cattle market.
Rash and hasty implementation of changes in trade agreements could have a devastating effect on all areas of the U.S. and global economies. While we hope this does not happen, it certainly is a possibility that needs to be considered.
Your comments are appreciated.
Disclosure: I am/we are long AAPL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.