Apple: Going Smaller Can Be A Big Move

| About: Apple Inc. (AAPL)

Summary

Apple's 4-inch phone launch reportedly is in mid-March.

I believe skeptics who believe this is a desperate move are mistaken.

Apple is catering to a large portion of the market, which bodes well for future growth.

I've been talking about Apple (NASDAQ:AAPL) launching a new smaller screen iPhone for quite a while, and it appears the company will finally launch a new 4-inch smartphone sometime in mid-March. While there seem to be a number of critics regarding this device, I believe the rumored iPhone 5se is a critical part of the company's smartphone strategy.

Until the product is finally announced, we'll continue to hear a number of rumors as to the device's specifications. At the least, this new phone is likely to have a massively upgraded chipset, potentially containing the A9 chip used in the 6s line. The phone should contain Apple Pay support, and might even have a larger battery. While the camera might not get a full upgrade to the 6s line equivalent, Apple is likely to advance the camera specs forward to the 6 line, still a decent improvement.

With the success of the larger screen phones Apple went to with the iPhone 6 launch, some would wonder why the company is going smaller again. Well, the 5s is still selling, so there is obviously some demand for a smaller phone. In fact, let's look at an analyst question on the recent conference call:

Kulbinder Garcha:

And the other follow-up I had was that you've mentioned in recent calls, helpfully, the percent of the base, prior to when the 6 came out, that were now on the larger screen phones. Can you give us an update on what that number is? I think the last time it was in the low 30s. Thanks.

Apple CEO Tim Cook:

Yeah. So, last question first. The number of people who had an iPhone prior to the iPhone 6 and 6 Plus announcements -- and so this was in September of 2014 that have not yet upgraded to a 6, 6 Plus or 6s or 6s Plus is now 60%. So, another way to think about that is 40% have, 60% have not.

So three out of every five people still had a phone with a smaller screen. While a good percentage of those could buy a larger screen phone, there is demand for a 4-inch screen, and I've heard from many consumers who don't want to go bigger. When you're talking about a company that sells over 200 million phones annually, even 10-20% wanting a smaller screen equals tens of millions of phones per year.

In a recent article, fellow SA contributor Paulo Santos stated that the rumored iPhone 5se was a desperate move by Apple. He believes this is aimed at trying to offset a weak fiscal Q3 period, and that the product went through a very short design stage. Because the 5s has been on the market for a number of years, I disagree with that second statement. Apple has been working on this phone for a while in my opinion, as there were many who believed it would come out in September 2015 with the 6s line.

Apple management also discussed a theme on the conference call that many are aware of - currencies. With the dollar rising tremendously in the past year or two, Apple has been forced to raise prices, in some cases quite a bit, across its product line. In some markets, this has made the iPhone a bit of a reach for some consumers, and that has impacted demand.

This is where the new phone slots in perfectly. The iPhone 5se will likely be priced a bit below the 6s line, while offering a dramatic improvement from the features of the 5s model. In certain markets like India where Apple is trying to grow tremendously, a lower priced (but not necessarily "cheap") phone will certainly help. In the most recent quarter, Apple actually reported a rise in iPhone average selling prices, despite a huge currency hit, showing that consumers are still willing to pay a premium for the company's devices. Bringing in this mid-tier phone opens up a new segment of the market, allowing for market share growth over time.

A phone release in mid-March also allows Apple to even out its yearly revenue stream a bit more. Perhaps the company will expand its upgrade program, launching a smaller phone each March with upgraded specs to reduce the average replacement cycle of the phone. Even if this phone brings down the iPhone's average selling price by say 10%, the company can still benefit if it boosts unit sales by more than that. With the iPhone being high margin, a return to growth for the iPhone will help grow future earnings.

While the reveal of this new iPhone may come in mid-March, it likely won't be available to consumers till late in the month, near the end of the company's fiscal second quarter. Usually, only a small amount of markets get products at first release, so Apple will likely expand availability throughout April and May, during fiscal Q3. Analysts are currently calling for a more than 10% decline in Q2 revenues over the prior year period, primarily thanks to such a hard compare period. But the revenue drop for Q3 is expected to be less than 4%, because this new launch will certainly help.

While there are a number out there who think a smaller iPhone is a desperate move from Apple, it really is the next step in the growth process for the device. Apple dominates the upper end of the smartphone arena, but currency prices have made the phone a bit too expensive in certain regions. Also, there is a lot of demand from consumers who still want a 4-inch phone, but are looking to upgrade from the current specs of the 5s and older models. A new mid-tier phone can help the iPhone return to growth, smooth out revenues over the fiscal year better, and potentially reduce the replacement cycle average time if Apple launches a new model every March.

Since the day after earnings, Apple shares have actually outperformed the tech sector. I recently argued that the company should issue more bonds to help the buyback program, and perhaps some share repurchases are helping support the stock currently. For those that believe this is just a temporary tough period for Apple, now would seem like the time to buy.

Disclosure: I/we 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: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.