Is A Cheaper iPhone Really In The Works?

| About: Apple Inc. (AAPL)

On the iPhone's (NASDAQ:AAPL) 6th birthday, rumors are swirling that Apple is working on a cheaper iPhone to compete with the dozens of smartphones its competitors release every year. Since shares have fallen nearly $200 from the mid-September peak, investors and other market participants seem worried that Apple is losing its luster, and that consumers prefer the Galaxy SIII and the Note. Plus, market share data out of both Europe and China has been relatively bearish.

Our confidence in Apple hasn't been shaken, as we focus on what's far more important for a company than market share: profits. We think investors are reaching to explain the recent share price decline instead of acknowledging that the company's fundamentals haven't really changed. In the US where phones are heavily subsidized, iOS has taken a healthy share lead, and additional news looks positive. T-Mobile will begin selling the iPhone (and eliminating smartphone subsidies) in the next 3-4 months. We aren't expecting this to heavily swing sales, but increased distribution at a healthy margin is an incremental positive. More indicative of the iPhone's strength, Verizon (NYSE:VZ) announced that smartphone activations totaled 9.8 million units with a higher mix of Apple products than the previous year (was 56%). Because the stock price has declined, investors continue to think that Apple's losing momentum, even though the facts suggest otherwise.

We do not think a cheaper iPhone is at all necessary. Part of Apple's competitive edge is that it makes great products to be sold at premium prices. Falling prey to the myth of 'market share = success' would be a mistake, and we do not believe CEO Tim Cook is interested in jeopardizing the brand name and margin mix in search of some market share. One could argue the iPad Mini was a reaction to smaller tablets, but we think it is a great product at a premium price point. The iPad Mini is more likely to cannibalize other company's tablet sales than sales of the full-sized iPad.

Though a cheaper iPhone doesn't make any sense in the US, we could see how potentially lowering prices makes some sense in China and Europe. Without subsidies, Apple will continue to have a tough time competing in these regions, but we aren't too worried-we think Apple is best off retaining its status-symbol positioning. Discounting the iPhone 4 and iPhone 4S could make more sense, but the flagship phone should remain a premium product, in our view.

And there's the obvious issue: this is still a rumor. In fact, Apple could develop hundreds of units without it materially impacting R&D expenses. Higher R&D spending could instead be for the new Apple TV-the device that's always around the corner, but isn't actually there yet.

Although it would be hard to find a stock with more bearish sentiment at the moment, we continue to believe shares of Apple are undervalued. Margins may slip slightly due to an enormous new product lineup, but we think earnings and cash flow will remain incredibly strong. Apple remains a holding in the portfolio of our Best Ideas Newsletter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: AAPL is included in our Best Ideas portfolio.