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Summary

  • A declining iPad business makes Apple even more dependent on the iPhone.
  • Being the device with the highest GM, the iPhone is responsible for a disproportionate amount of the company's profit.
  • Given the current smartphone landscape, this could actually be a positive for Apple going forward.

Not only Apple (NASDAQ:AAPL) now listens to Wall Street, but apparently it even works hard to please it: allegedly the company went to the extent to hold talks with Goldman Sachs to find the best ways to push its stubborn stock a little to the upside. The results, obviously, were an oversize buyback and a peculiar 7:1 split - a split that, by the way, was dismissed just two years ago by CEO Tim Cook as something that "does nothing".

But buried below this grandiose spectacle of shareholder-friendly initiatives, we could also get a glimpse of the state of affairs in Cupertino - and things are actually pretty interesting. In fact, even though the iPhone scored its third best quarter ever, the iPad is now officially contracting, posting a YoY decrease of 16%. As much as the iPhone keeps growing, albeit moderately, and has yet to post a quarter of negative growth, the iPad has seen its sales decrease for two out of the last four quarters:

(click to enlarge)

This has actually big implications on Apple's bottom line or, more precisely, on where it comes from. It is no news that the iPhone is Apple best selling product - it has been so since the end of 2009. The fact that Mac sales have grown a fifth of those of the iPhone and that the iPod business has, essentially, collapsed have led Apple to rely, for a disproportionate amount of its sale, on the iPhone. Looked at in terms of where every dollar comes from, Apple's sales for the last five years look like this:

(click to enlarge)

As you can see, as much as the iPad roared in the mid of 2010 taking almost 15% of the total sales, the iPhone has never represented a bigger chunk of Apple's top-line than today. Looked at in another way, the iPhone has now comfortably led to more sales than all other Apple's product/service combined for six straight quarters - and the gap is all but widening:

(click to enlarge)

The magnitude of the iPhone cannot be overstated. A product than did not exist just 7 years ago now has annual revenues 64% higher than Google (NASDAQ:GOOG) (NASDAQ:GOOGL), and almost 20% higher than the whole Microsoft (NASDAQ:MSFT):

The iPad, on the other hand, teeters. After peaking in 2013, revenues from the device are now at their lowest level in more than two years.

Nevertheless, Tim Cook continues to love the device: asked for his take on the tablet's weakness, Apple's CEO went on a 900-words monologue to defend the results and proclaim that "the trend over time - over the arc of time, that things look very, very good, that iPad has a great future". It might be, and actually nobody more than Cook has data on hand to judge, but what it is clear today is that the tablet market is no smartphone market (less than a fifth of it precisely), and that the iPad is certainly no iPhone, mainly due to the fact that the tablet is suffering the same pains as the PC: improving quality and low deterioration rate lead to longer and longer replacement cycles. To push consumers to buy more iPads, Apple has diversified its once single-product category into a behemoth made of 4 different products, each coming in different colors, different memory sizes (one more than the iPhone) and different connectivity options (WIFI-only versus WIFI+LTE). To be fair, apart from the OS, the iPad category resembles much more the Mac than the iPhone, both in terms of product line-up and in terms of margins and revenues.

Indeed, not only is the iPhone Apple's best selling product, it is also the one with the highest estimated[1] gross margin. If we try to dissect the company's net income, the picture that emerges is that of a bottom line relying more heavily on the iPhone's performance than the top-line itself. I estimate that, since the introduction of the iPad, the iPhone's share of the company's profits has risen steadily every year from around 45% to the current 75%[2]:

(click to enlarge)

This is the results of three key happenings:

• rising iPhone sales with stable GM (between 52% and 58%)

• declining iPad GM (to the low 30%)

• declining Mac sales

Effectively, not only has Apple introduced different variations of the iPad (Air, mini, mini with Retina display) it has also significantly lowered the entry-point price for such device, consequently driving the iPad Average-Selling-Price down by 30% compared to when it launched (the iPhone, by comparison, saw its ASP decline by only 12% since its debut).

(click to enlarge)

As much as such a huge reliance on a single product is generally a bad sign, I actually believe that the fact that Apple's almost-exclusively depending on the iPhone to bring-in its stratospheric profits is actually a positive going forward. Where the Mac is declining (albeit slowly) and the iPad is a question mark, the iPhone shines in a market still undergoing explosive growth. And even though the main growth will come from low-end smartphones, in the high-end Apple has virtually no competitors for the foreseeable future:

• Samsung is seeing faltering sales, and its flagship Galaxy S5 has been introduce with much fanfare to poor reviews (I, II)

• Sony (NYSE:SNE) is burning more cash quarterly that it has ever earned from selling smartphones

• Microsoft's Lumia sales are a blip on the radar

• HTC is the shadow of its former self, undergoing an improbable turnaround

For these reasons, and because of the upcoming new product categories Apple's CEO has been promising for quite a while, I reiterate the recommendation I made last September, ACCUMULATE/BUY.

[1]Note that while Apple does release data on sales by product category and whole-company gross margin, it does not state each product's gross margin. Hence the necessity to rely on third-party analysis to estimate the GM for each category.

[2]The chart was obtained by reviewing the data compiled by IHS for the iPhone/ iPad's gross margins and by Asymco for the Mac gross margins, elaborating it accordingly to take into account royalties, licensing and other expenditures, and comparing it to the Company's filings. Since Apple is a functional organization, and therefore has only one P/L, finding the GM makes it possible to estimate its profit share

Source: The iPhone Now Accounts For 75% Of Apple's Profit - And It's Actually Good News