The iPhone Is the New iPod

Aug. 5.11 | About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) has just become the top smart phone vendor. It has captured 66% of the profits of the whole mobile phone industry, while selling only 5.6% of units. The iPhone is just over four years old.

The odds of these statements becoming true were considered negligible four years ago. Very few people would have bet 100/1 odds on it. Even today they are mind-boggling, even though iPhone 4 is one year old, an eternity in the smart phone market. No wonder most investors don't get it. But some analysts are waking up.

Let's take a walk down memory lane and recall what analysts, CEOs and pundits thought about the iPhone in 2007.

"The iPhone will not substantially alter the fundamental structure and challenges of the mobile industry."
Charles Golvin, Forrester Research Inc., January 2007

"For starters, while Apple basically established the market for portable music players, the phone market is already established, with a number of major brands. Can Apple remake the phone market in its image? Success is far from guaranteed. Apple will likely have a tough time convincing application vendors to build specialized clients for the iPhone until the volumes are there, and the volumes could be limited by the lack of third-party applications – a Catch 22."
Jack Gold, J. Gold Associates, January 10, 2007

"We’ve learned and struggled for a few years here figuring out how to make a decent phone. PC guys are not going to just figure this out. They’re not going to just walk in."
Palm CEO Ed Colligan, commenting on the then-rumored Apple iPhone, November 16, 2006

"You could look at Apple and the iPhone as something that’s come out of nowhere, essentially, and changed the dynamics of the smart phone space–there’s every opportunity to do that in our case as well"
Palm CEO Ed Colligan, one year after the first iPhone was sold, May 28, 2008

"The iPhone is a niche product."
Nokia CEO Olli-Pekka Kallasvuo, April 17, 2008

"How do you deal with that? How do they deal with us? That’s the question."
Ed Zander, Motorola CEO/Chairman, May 10, 2007

"$500 fully subsidized with a plan! I said that is the most expensive phone in the world and it doesn’t appeal to business customers because it doesn’t have a keyboard, which makes it not a very good email machine […]. I like our strategy. I like it a lot […]. Right now we’re selling millions and millions and millions of phones a year, Apple is selling zero phones a year. In six months, they’ll have the most expensive phone by far ever in the marketplace and let’s see… let’s see how the competition goes."
Steve Ballmer, Microsoft CEO, January 17, 2007

"The truth of the matter is all the consumer market mojo is with Apple and to a lesser extent BlackBerry. And yet, the real market momentum with operators and the real market momentum with device manufacturers seems to primarily be with Windows Mobile and Android."
Microsoft CEO, Steve Ballmer, February 24, 2009

"Phones? In a year, we’ve gone from very small to … very small."
Steve Ballmer, Microsoft CEO, July 11, 2011
"The iPhone is nothing more than a luxury bauble that will appeal to a few gadget freaks. In terms of its impact on the industry, the iPhone is less relevant […]. Apple is unlikely to make much of an impact on this market […]. Apple will sell a few to its fans, but the iPhone won’t make a long-term mark on the industry."
Matthew Lynn, Bloomberg, January 15, 2007

"The iPhone’s willful disregard of the global handset market will come back to haunt Apple."
Tero Kuittinen, RealMoney.com, January 18, 2007

There are many more funny statements in a collection named "The iPhone Death Watch".

You have to wonder if there was anybody who understood the iPhone's potential.

"Every once in a while a revolutionary product comes along that changes everything. It's very fortunate if you can work on just one of these in your career. [...] Apple's been very fortunate in that it's introduced a few of these."
Steve Jobs, Apple CEO announcing introduction of the iPhone, January 2007


"But even in version 1.0, the iPhone is still the most sophisticated, outlook-changing piece of electronics to come along in years. It does so many things so well, and so pleasurably, that you tend to forgive its foibles.

In other words, maybe all the iPhone hype isn’t hype at all. As the ball player Dizzy Dean once said, ‘It ain’t bragging if you done it.’"

David Pogue, The New York Times, June 27, 2007


"I think there's almost a belligerence - people are frustrated with their manufactured environment. We tend to assume the problem is with us, and not with the products we're trying to use. In other words, when our tools are broken, we feel broken. And when somebody fixes one, we feel a tiny bit more whole."
Jonathan Ive, SVP Industrial Design, Apple, January 2007

I won't bore you with iPod quotes and past forecasts and how this story turned out. You can read some here and here. History doesn't repeat itself, but it does rhyme.

The lesson is that analysts, CEOs and pundits are the worst predictors, especially when it comes to Apple. With this in mind, I will take a shot at forecasting the probable future of the iPhone.

iPhone forecast

The smart phone market share is growing fast, especially in the U.S. Horace Dediu, the author of asymco.com and a very fine independent analyst of the phone market, predicts that the majority of phones in the U.S. will be smart phones by next summer. Those who want to have a deeper understanding of this market should visit his website regularly and listen to his podcasts. In the U.S., the iPhone has 28% of the smart phone market, 11% less than all Android phones combined. It is only available, as is well known, through two carriers.

Why is the U.S. important? First, is a huge market. Second, it is a trendsetter. So it is not such a stretch of the imagination to believe that smart phones will have a 50% market share worldwide by the end of 2013. Some estimates already put it at 28% this year. Over a third of American consumers will purchase the iPhone 5, according to this study. Sight unseen.

Some argue whether Apple has peaked or not. Others think that Android is to the iPhone what Windows was to Mac. But there are serious reasons to doubt this, too. Without going into details, Android has its own problems. Other competitors are no longer even visible in the rear-view mirror. Carriers that do not offer the iPhone suffer. Those that do, thrive. Analysts are starting to think the new iPhone will double Apple's marketshare. Apple may capture 50% of the global smart phone market by the end of 2013. Especially if they introduce a cheaper iPhone, and even faster if they finally sign a distribution deal with China Mobile.

Considering all this, I make the bold prediction that in 2014, Apple will sell about a quarter of all phones worldwide. 365 millions phones were sold last quarter and the market is still growing. 350M phones a year with an average gross margin of $250 (due to a mix of cheaper phones; last time I saw an estimate, it was around 60% or almost $400; the ASP of around $650 did not shrink for four years) means that Apple will pocket $87.5 billion in phone gross margins alone. At least 60% of that or $52.5B will get to the bottom line as earnings (we are at 61% right now and growing).

If the iPhone were a business by itself, it would worth more than half a trillion in 2014, at a messy P/E ratio of 10.

Disclosure: I am long AAPL. I leverage my AAPL investment with call options.