The Street Gets Pre-Release Jitters On Apple's iPhone

Apple (AAPL) shares were sliding Wednesday, as the countdown to the iPhone launch on June 29 continues. Expectations for the phone are sky high; any indication that something could go wrong is going to trouble the stock at this point.

At the moment, there is some annoyance in the blogosphere with reports that the company will require iPhone users to have an iTunes account. In fact, you won’t be able to use the phone without one apparently.

Meanwhile, J.P. Morgan’s Bill Shope Wednesday morning offered a list of potential post-launch concerns Apple investors ought to be thinking about.

If iPhone supply is scarce, he warns, iPod cannibalization becomes more of a problem. The idea here is that if people who plan to buy the phone as an alternative to buying a new iPod are forced to wait for weeks or months to get a phone, you end up with a potential hit to sales in the short run.

The total price is steep when you consider the contract, he notes. In addition to paying $499 or $599 for the phone (depending on whether you choose the 4GB or 8GB version), you are going to have to sign a new two year contract which could run up to $100 a month. Ergo, he notes that the total life of contract cost is nearly $3,000. “In our view, Apple will need to go beyond just buzz to convince a large number of users to bear this expense,” he writes.

Accounting for the iPhone could be dilutive in the early quarters, he says. Apple has announced that it will use subscription accounting for the phone, and recognize revenue over 24 months. While the impact is to smooth earnings in the long run, he notes that in the short run “it has the effect of reducing our revenue and profit forecasts.”

Says Shope: “We caution that the euphoria over the iPhone could ease fairly quickly, particularly given the lofty expectations for the device."

Meanwhile, on another topic, Shope cautions investors that the big gross margin boost the company received in the March quarter from a steep drop in flash memory pricing is eventually going to fade. Apple has projected gross margins of 32% for the June quarter; he thinks there could be upside this time around. On the other hand, he points out that contract pricing for flash is up 11% since March for 8GB parts. He is looking for 34.2% gross margins for the quarter.

“The question now becomes: How sustainable are the recent improvements in gross margins beyond this quarter,” he writes.

We believe that if we take a multi-quarter view, the answer is that they are not very sustainable. This is primarily due to our assumption that the benefit to gross margins from flash price declines will have less of an impact on Apple as we progress through this calendar year.

That’s in part because flash prices are firming; it also reflects that the decline in flash pricing has reduced the significance of the parts as a percentage of the overall iPod bill of materials. Concludes Shope: “It is clear flash price changes may no longer help Apple as much as they have in recent quarters.”

Finally, one other point. The blog AppleInsider is reporting that AT&T (T) is refusing to sell the iPhone to business account customers. Now, it has never been clear that iPhone was going to be a product targeted at enterprises; but it does fuel the idea that there could be shortages of the device early on, and that it could result in some of the cannibalization problems Shope mentioned Wednesday.

Comments

[omooc:]

The noise surrounding AAPL is both extreme and extremely conflicting. Indeed, the stock behaved strangely as well, up a little bit when the market was down yesterday, and down a lot when the market was up a lot. Why so? omooc

2007 Jun 13 11:23 PM

[ET:]

I was disappointed in this article. It lacks originality and accountability, at least from a writer’s perspective. Expectations are high for the iPhone because the current offerings available to the consumer are simply lame. The truth is the media should be holding companies like Nokia, Sony, Samsung, LG, Motorola, etc. accountable for their lack of innovation and their lack of improvements of process.

Savitz’ first point really isn’t even his – he’s using Shope’s point about the cannibalization of the iPhone by the iPod; Shope’s point is silly at best. Savitz would have been served better by using some of the lines from NBC’s “Last Comic Standing” before quoting Shope.

Secondly, Shope should be pointing out that this is the same methodology that was used when Motorola came out with the Razr. It was $539.00 with a 1-year contract. It’s funny how everyone seems to forget to write about this. It’s also funny that his is an AT&T requirement but hey, why not nail Apple with it.

As to the change in Apple’s accounting, it takes the power out of the “political MBA culture’s” hands and provides clarity devoid of media manipulation. Oh, poor babies, the big money managers and media aren’t going to be able to manipulate the stock price anymore, boo hoo.

The comment related to the pricing of memory flash is the best joke I’ve heard in years. Do any of the writer’s have any idea what the costs actually are? The answer is no. Do they (Savitz or Shope) provide any detail to research? The answer is no.

So what is Savitz really offering in this article? A verbal diuretic; all of these guys are simply trying to sell themselves these days.
BTW, maybe the stock’s volatility simply reflects greed - people jumping in and out looking for a quick buck.

2007 Jun 14 07:59 AM

[mike hough:]

Sorry Eric but this article is not worthy of you. I think a little more investigation and a little less copy and paste was needed. However, you have saved me the bother of reading any more advice from "J.P. Morgan’s Bill Shope".

"cannibalization of the iPhone by the iPod". Does anyone reading this actually own an iPod or know a substantial number of people who do? How many iPods have I cannibalized without owning a single iPhone. I currently own 3 iPods and did not buy any of them myself. A large % of iPod owners have more than one.

"Shope cautions investors that the big gross margin boost the company received in the March quarter from a steep drop in flash memory pricing is eventually going to fade." Did Shope also report that Intel has just announced a 50% drop in the price of CPUs? The saving on one CPU alone would cover many Flash drives. Did he also point out that Apple has placed huge forward contracts for Flash drives with manufactuers? It would be very surprising if those contracts did not deal with the issue of price!

And as for the "sliding" in share price, I suppose this has nothing to do with the fact that a lot of options on Apple's shares expire on Friday.

2007 Jun 14 08:41 AM

[David Lentz:]

Most of the point made are valid, but the hoopla surrounding the "disclosure" that iTunes will be required to do anything with an iPhone is simply meaningless media noise.

Can one do anything with an iPod except via iTunes? No. Why would one ever expect the iPhone to be any different, as it is merely an iPod with a cellular connection and a wifi connection? Of course iTunes is a requirement!

And expectations/projectio... regarding the TCO are also just media noise until AT&T actually releases the pricing plan for the iPhone. While I'm not holding my breath on this, it is perfectly possible that Jobs has been able to convince AT&T not to stick it to their customers with a pricey plan, but instead to break ground with a plan that is less expensive than competing plans. It worked with digital music via iTunes -- the $0.99/song formula was a break from prior music industry trends and made possible the great growth in legal downloaded music. But like I said, I'm not holding my breath on this.

But the point is that there is absolutely no data available on what kind of pricing we're going to see from AT&T on iPhone contracts. If you want to make the case that AT&T is trying to derail other carriers' 3G cellular network success, then a low price with a winning hardware platform is a great way to do so without having to revamp your laggard 2.5G EDGE network. Especially a plan with a 2-year contract.

But that scheme is also just whistling in the dark, as there is, I repeat, absolutely no information about what kind of pricing plan AT&T will offer. I would be surprised to see only a single plan offered.

2007 Jun 14 09:51 AM

[Lucmee:]

Well said regarding the RAZR release pricing... And while I don't expect to see $50 iphones going out the door any time soon... if ever... You can take it to the bank that AT&T has done their homework on what the market will bear. And as soon as their are enough expensive iphones out there to whet the appetite of the teeming masses... the operative word will become "volume".

All Apple equipment goes at premium prices... So it will be interesting to see where it bottoms out for an iphone... I suspect somewhere in the $200 range with a 2 year commitment... If so... Then we can expect a Wii like phenomenon... Not enough to go around but can't sell enough of em. Also... There doesn't appear to be anything particular about an iphone that would make it much more expensive to manufacture than a high end ipod... And we know Apple's margins on those are very nice indeed... Another reason to look at volume vs pricing.

2007 Jun 14 12:59 PM

[Julian Ivan...:]

Apple sell out of the expensive $599 version and people are worried about the price? Lol...

I can't even credit this article - and especially Shope's comments - with further analysis. Its beneath me. AAPL sells 500K - 1M iPhones in 2 days, and he's disappointed? Lol. Enough said.

2007 Jul 02 08:42 AM