3G iPhone: Growth and High Margins for Apple?

Let me begin by saying: don't worry, this is not yet another 3G iPhone hype post that you can find all over the internet. Instead, this post is based on some recent information about the meaningful implications for Apple (AAPL), as a stock. We all know that the first iPhone was a semi-success, but now that AAPL will be releasing an even better version, expectations are much higher.

The initial hype surrounding the first iPhone was about growth. "Oh, this will be a huge growth product for Apple..." The point is that apparently now, not only will the iPhone be a growth story for Apple, but it could also be a huge margins story.

Portelligent (via EETimes) released research stating that it thinks that the new iPhone will cost as little as $100 to produce, when the first generation iPhone cost around $170 to produce. Note: It hasn't actually gotten its hands on a new iPhone and disassembled it. Instead, it has done some channel checks in terms of components to gauge pricing and come up with this sum. Although this can be a pretty accurate estimate, I just want to throw that caveat in there. However, even if that figure is only slightly off, the point is that AAPL will still be seeing huge margins, and here's why.

AAPL is Billy Badass when it comes to component pricing. If you're familiar with the company’s tactics, then you know they aggressively buy components to ensure its competitive market advantage. The Yankee Group's Carl Howe gives a timeline of AAPL's business savvy:

Apple paid $1.25 billion in 2005 to guarantee flash memory for iPods through 2008; that purchase made it nearly impossible for other flash music players to have competitive supplies and profit margins. Apple reportedly negotiated another similar deal in 2007.

Howe also made the following powerful statement:

In fact, if these numbers are true and the carriers are subsidizing the phone, the iPhone 3G could end up being the most profitable product Apple makes. But more likely, this means that Apple has a lot more pricing flexibility than analysts have given them credit for.

The point is that AAPL will be paying much less for components this time around due to technological/engineering advancements and the bullying approach they take in the component space. The display will most likely cost them half as much this time around. Additionally, AAPL will be getting memory for the phone on the cheap and in turn can sell it to consumers for nearly five times as much as it got it for. The point is that AAPL has significantly reduced its input costs this time around; even with more/newer components in the phone.

In terms of pricing, the phone will most likely sell for $399 straight up no-contract or $199 with the AT&T subsidy for a two-year contract. These figures already show the huge margins AAPL will be seeing with this product. The AT&T subsidy is actually a great thing for AAPL because it will be selling the phones to AT&T at full price ($399 or so), and then, AT&T will take the hit in terms of the subsidy to guarantee that it gets customers in the door buying the phone and signing up for two years of service. There is zero risk for AAPL there, and it doesn't take a hit if this fails.

Why is all of this important? Well, we all know the iPhone is a growth story for AAPL. What I don't think most people realize is the huge margins AAPL will be seeing with this product. With all the high-tech gadgetry inside this phone, people assumed it would cost a pretty penny to produce so AAPL's margins wouldn't be very high. On the contrary, since it sounds though as if those revenue figures would be massively understated. The Mac computer has been the driving force behind AAPL's success all along as it continues to steal market share and crank out sales of Mac Books and Mac computers.

This is the perfect silhouette for what the iPhone very well could be. Mac computers equal high growth, plus high margins. If the new iPhone follows this same formula, then, come September/October, AAPL could see a meaningful boost to its bottom line. Moreover, the best part is, AT&T will be taking the hit by providing users with the subsidy. This gives the iPhone a very competitive price point and many of the features the first generation iPhone lacked.

In the end, all you really have to ask is what does Apple do best? It creates high margin products that people HAVE to have.

Disclosure: None

Comments

[wallawallabingbang]

A most astute analysis.

Apple is a startup, and the most compelling revenue 'stealth' story of the foreseeable future.

Many folks, analysts included, can't get their heads around the revenue model and streams, to their detriment.

[Toni]

"A most astute analysis."

Astute! LOL !

[jswede]

good stuff. thanks for laying that out.

(meanwhile, on a ranch far removed from any media, Macs just keep chugging along, picking up market share by the percentage point... sshhhh... don't talk about it... let's keep focus on the iPhone... and the App Store... and iTunes... Macs quietly taking over is just peripheral... sshhh....)

[Tom B]

"AAPL is Billy Badass when it comes to component pricing. If you're familiar with the company’s tactics, then you know they aggressively buy components to ensure its competitive market advantage."

And you know what? Apple was totally incompetent dealing with the supply chain in th '90's. They have totally revamped their business, top to bottom:

AAPL: great stores, exposure
MSFT: NO stores

AAPL: secure, high performance, UNIX-base OS
MSFT: Ahem. Haven't even managed "UNIX-based" yet. Maybe by "Windows 8"

AAPL: Cutting edge development tools that scale from Mac down to iPhone.
MSFT: C#, a tired Java knock-off.

AAPL: useful MP3 player
MSFT: Nope.


AAPL: Office apps that are cheaper than Office, and much easier to use than either Office or open-source "OpenOffice"

I could go on. Final Cut Pro. Preview. Filemaker Pro. H.264/quicktime

[BS Detector]

"the phone will most likely sell for $399 straight up no-contract or $199 with the AT&T subsidy for a two-year contract."

In the U.S. at least, there will not be any way to buy an iPhone with no contract. AT&T is too smart for that.

As for margins, let's take a look (low end for simplicity).

For iPhone1, AAPL received $400 from the consumer, and between $8 and $18 per month from AT&T for 24 months ($10, being the most common estimate, will be mine here). If the manufacturing cost was $170, the initial gross margin was $230, with an additional $240 coming in over two years, for a total of $470 - more than 2.5x the manufacturing cost.

With iPhone2, AAPL is paid up front, $200 by the customer and some unknown subsidy from T, widely assumed to be $200. If the manufacturing cost has in fact fallen by 40% to $100 (which is possible, even with the addition of a GPS receiver), the gross margin will be 3x the manufacturing cost, though it will have fallen from $470 over three years to $300 immediately.

It doesn't take much in the way of additional shipping and packaging costs to make the margins equivalent. Which makes sense - Apple would likely pursue a business model that would keep margins at the same level. Gross revenue will break even with an increase in sales of just 60%; most analysts see much greater growth than that.

[Long AAPL and T, AAPL options]

[jmmx]

I saw another analyst projecting $500/600 for the iPhone - so a $300 subsidy from ATT. With the extra $10/month, they make that up in less than a year. They were paying apple $240 over the 24 months, so at $300 when they get the extra $10, ATT still comes out ahead.

The story here is how fast Apple can change its model to adopt to a reality that is different from what they anticipated. That is - the emergence of the huge unlocking movement.

They sat down and said "Hey this is not working as we planned. How can we fix it?" And then they did.

What other huge corporation will turn on a dime like that? I think the word is "Pragmatic."

[jmmx]

Other big news of the day - Apple is selling/renting 50,000 movies per day.

That is 1.5 M per month. Now I don't think iTunes music makes very much money for Apple, but I think they are in the movie business for $. This is beginning to get pretty appealing.

IMHO

[Tom B]

"Other big news of the day - Apple is selling/renting 50,000 movies per day."

Whoa! no sh*t?

[jptao]

"MSFT: C#, a tired Java knock-off. "
I think that's actually the other way around.

[glen engelmann]

nice analysis... but why the "?" in the title. i suggest an "!"...

[sbjforever]

Tom B: agree with you except for one absolute gleaming jewel in that crown; MS Word, a version of which is fortunately available for Mac. And don't spout off about Pages. Instead, go lay out a book with multi-section titling, page numbering and chaptering with intelligent double-sided printed output! After ten trashed reams you'll get the picture.

[BS Detector]

"They were paying apple $240 over the 24 months, so at $300 when they get the extra $10, ATT still comes out ahead."

Let me just clarify some math here.

AT&T will no longer be paying Apple a monthly cut, which has been estimated at anywhere from $8 to $18 - usually $10. It will also charge $10 more per month for the data plan. So it appears that they will bring in (24x20) $480 more during the 2-year contract.

Not so fast. AT&T has indicated that it makes $95/month from iPhone1 users, which is well above its overall average. Assuming that the lower phone price draws in users who will also be more conscious of monthly charges, this average will go down.

There are two things that will cause the average voice plan to decrease. First, the average person buying a $200 phone will have a lower-cost monthly plan than the average person buying a $400 phone. Second, there will be some pushback on the voice side because of the $10 increase in the data plan.

How much? I don't know, so I'll split the difference and say $5. So overall, AT&T will keep $10 that was going to Apple, collect $10 from the higher data plan, and lose $5 due to more frugal customers and pushback on the voice side. Net: +$15/month or $360 over the contract.

I meant to put in my previous post that if the assumptions on the old payment to Apple and the new subsidy were wrong, the calculus changes dramatically. Together, AAPL and T stand to reap significant rewards, which is why I own both. That and a fat dividend from T.

[SequimRealEstate]

jswede you are so right investors just do not get that the big story is the Mac market share that keeps increasing. As to the story when is good business practices ie keeping costs down called bullying?

[rweflyn]

To jmmx - On the movie comment, you'd be right if all sales and rentals were $1.00. If all the transactions were only rentals at an average cost of $3.50, then the annual dollars accrued to Apple would actually be over $63M. That should buy a few more servers... It's actually more than this because many people actually buy, not just rent. Not bad!

[Tom B]

"And don't spout off about Pages. Instead, go lay out a book with multi-section titling, page numbering and chaptering with intelligent double-sided printed output!"

I semi-concede the point. Pages works great 98% of the time, but I, also, have to do super-duper, heavily-formatted technical writing on occasion and I won't tell you to use Pages for that! Having said that, as a long time Word user, I can say it STILL frustrates me by not doing what I want fairly often.

As a long-time technical presenter, I WILL argue that Keynote beats the socks off Powerpoint and that, for MY uses, Numbers out-classes Excel.

[mrtaxx]

When Toni Sacconaghi ,of Bernstein, finally gets it, it will be to late and probably out of a job. I'm surprised he still is with Bernstein.

[Belltribe]

"And don't spout off about Pages. Instead, go lay out a book with multi-section titling, page numbering and chaptering with intelligent double-sided printed output!"...

Leave both Word and Pages down in your dock, if you are serious about laying out a document with any sort of depth and want it to be an intuitive, and dare I say pleasurable experience, shell out the cash for Adobe CS and use InDesign. It tromps all over anything Word could hope to do, handles native layered Photoshop and Illustrator files seemlessly, kicks out beautiful PDFs and like Word is cross-platform compatible.

I have to deal with Word documents through work, but if I'm going to create something that I want to enjoy working on and have control over every aspect of the design and production process, I'm going to do it in INDD. ADBE like AAPL is doing great things these days in terms of ease of use and user interface, which is the main reason I cant stand Word, I'm getting a migraine just thinking about using it to layout anything more complicated than a carwash flyer. If tons of people have to work on a document I could maybe see using Word as almost everyone has it, but not for anything very sophisticated.

[User 126397]

APPLE '' ROCKS'' IT HARD TO EXPLAIN GREATNESS.