by Morgan Smith
After years of resisting the obvious trend towards ever-larger smartphone screens, Apple (NASDAQ:AAPL) is apparently caving in to market demand and is preparing to launch an iPhone with a display that is at least 14% larger than those on its existing 3.5 inch-display models.
Doing so would hew the iPhone more closely to a trend made popular by smartphones produced by Samsung (OTC:SSNLF), Sony (NYSE:SNE), Motorola Mobility (NYSE:MMI), LG and HTC that operate on either Google's (NASDAQ:GOOG) Android or Microsoft's (NASDAQ:MSFT) Windows Phone mobile operating systems - and a reactive strategy from a company long-considered one of the America's most innovative.
Since 2007 when the iPhone launched, the smartphone landscape has witnessed a screen arms race that has seen smartphones' screen real estate expand from a svelte 3.5-inches to an almost-unwieldy 5.3-inches. Indeed, Samsung, which is now the world s largest Smartphone maker, shipped its latest flagship Galaxy S III Smartphone with a 4.8" display - with apparently sterling results.
Up until now, only Apple had resisted the trend - even Nokia (NYSE:NOK), long considered a laggard in the smartphone hemisphere, shipped its Lumia 900 with a 4.3-inch display.
The success of HTC and Samsung in the smartphone space is strong evidence that consumers prefer larger smartphone displays - but there may also be a technical reason for doing so: larger displays mean not only larger batteries but also larger Printed Circuit Boards (OTCQB:PCBS). Larger PCBs, in turn, enable manufacturers to add components such as radios that support 4G mobile ultra-broadband systems such as Wi-Max and LTE.
Indeed, the first-ever 4G smartphone was Sprint's (NYSE:S) EVO 4G phone, which was made by HTC, came with a 4.3-inch display.
What's more, when the iPhone became available on Verizon (NYSE:VZ), it was assumed by observers that it was only a matter of time before an LTE-capable version of the phone shipped. Even the iPhone's original carrier, AT&T (NYSE:T), now boasts an LTE network. Ironically, AT&T's first LTE smartphones were Android devices.
Clearly, while Apple may be loath to admit it, the potential for profits from shipping devices with larger displays and speedier broadband was an opportunity too good to pass up - especially with its own carrier partners already looking elsewhere for alternatives.
As news of Apple's intent has spread, its PR has shifted into overdrive, with media outlets carrying stories that Apple founder Steve Jobs supposedly had a hand in designing a larger iPhone, even though Job's public statements prior to his death suggest otherwise.
Why the sudden change in direction?
Well, economics have a lot to do with it. The iPhone contributed 58% of Apple's 1st Quarter profits, while the iPad and iPod touch added another 20%. That means that Apple's dependency on iOS devices is at least 78%. Even if we consider only the iPhone, smartphones' share of Apple's revenues is more than 50% their contribution to Samsung's, whose tablets and mobile phones (i.e. not just smartphones) combined accounted for just 34% of its profits in the 1st Quarter.
What's more, Apple's iOS has been steadily losing market momentum to Android - and possibly Windows Phone. IDC reckons that by 2015, Android will account for around 44% of the smartphone market while Windows Phone will register about 20%. iOS, in contrast, will actually see a decline from 18.2% of the market in 2011 to 16.9% of the market by 2015.
iOS's expected performance is not terrible considering the smartphone market will have about doubled in the same timeframe - but still not good for a company predicted to be worth $1 Trillion by 2014.
Ultimately, that's the incongruity for Apple: how can a company that's expected to lose market share be expected to worth $1 Trillion in the same span of time?
Part of Apple's strategy to meet these expectations could be by finding other ways of distributing its device - either by partnering with more carriers or re-purposing existing, older devices to serve other market tiers. The latter might serve it well on its foray into China, where its faces competition from Baidu (NASDAQ:BIDU), which is developing its own Smartphone based on a hybrid-version of Android and - oddly enough - Microsoft, whose Windows Phones have overtaken the iPhone in China. Still, it's difficult to disregard the fact that, as other companies get their ducks in order, Apple's advantage has been diminished.
To be sure, Apple's other source of tangible profits, PCs, is expected to remain strong - especially if one considers Tablets as PCs. Tablet shipments are supposed to overtake PC shipments by the end of next year, meaning that Apple might be the strongest player in the PC sphere by then. That assumes, of course, that Android has not overtaken it by then.
That's the rub for Apple - its shares have traded softly in the past six weeks and a lot will have to go right for it to regain its stock market momentum - and even more if its hopes to see its shares go to $1,000. In that sense, Apple's prospects resemble those of Facebook (NASDAQ:FB) - they're both making huge bets on aspects of mobile that can only be judged in a few years' time and yet the markets have already blessed them with tremendous valuations.
The story of Jobs' alleged involvement in the iPhone's redesign is emblematic of Apple's struggles going forward - even with a new product set to launch in the next two quarters, it still cannot escape the shadow of its Co-Founder.
Indeed, Apple's current CEO, Tim Cook, will celebrate one year at Apple's helm in roughly a quarter's time yet - other than laying the groundwork for more amicable relationships with its competitors - Cook has yet to introduce anything new to Apple's heavily-curated stable of products. For a company that prides itself on its innovative culture, that's a major concern.
Apple's shares are priced at a Price-Earnings (P/E) ratio of 13, making it more expensive than Microsoft (10x P/E), which it is often compared to - and that was once, like Apple, the world's most valuable company.
Apple's fate could be very similar to Microsoft's.
Nowadays, Microsoft's been playing catch-up to the likes of Apple and Google, unable to escape the legacy of its Windows and Office software that, like Apple's iPhone, account for over half of its revenues.
More importantly, Microsoft's shares have basically traded in line with inflation for the past 5-years - good if you're trading fixed income securities but not if you're looking for growth in your equities portfolio.
With Apple's momentum evaporating and its pipeline seemingly lackadaisical, it is not difficult seeing Apple mirroring Microsoft's fate - right down to the behavior of its share price.
Consequently, I believe that Apple's shares could drop by as much as 40% from current levels over the next eight to twelve months, with the stock range-bound sometime afterwards.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.