The iPhone 5: Apple's Last Hurrah

| About: Apple Inc. (AAPL)

The iPhone 5 will be another blockbuster hit for Apple (NASDAQ:AAPL). Asymco analyst Horace Dediu has set an aggressive projection of more than 200 million units sold for the iPhone 5. At these levels, the iPhone 5 will account for more than half of Apple's total revenue. Over the next year, handset sales alongside ongoing growth in iPad profits will continue to power Apple's story stock. Apple fan boys, of course, will eagerly anticipate yet another game changer at that point. The rumor mill is then likely to degenerate into stand up comedy, as foreshadowed by the 2011 South Park episode mocking the Apple cult. South Park's HumancentiPad caricature is capable of reading, connecting to the Internet, eating, and using the bathroom.

With all things tech, fused products and commoditization are inevitable markers of the product cycle. The iPhone 5 will be Apple's last hurrah as competitors increasingly gain ground. For shareholders, Apple's strong financials will neutralize this inevitable trend. At worst, Apple is set to transition into its next act as a beta stock. Certainly, Microsoft (NASDAQ:MSFT) shareholders are familiar with the idea of owning an investment that simply tracks the Standard and Poor's 500 Index and makes regular dividend payments.

The Apple Brand

Apple's looming iPhone 5 release highlights a transitional passing of the torch period between visionary Steve Jobs and the nut-and-bolts operations man Tim Cook. Jobs, infamous for his nearly dismissive nature of operations actually welcomed shortages for hit products. Because of product shortages, your local Apple Store effectively transformed into a nightclub, upon the release of each iPod, iPhone, and iPad upgrade. Consumers lined up and happily paid top-dollar for a $600 iPhone, in order to pledge allegiance to what the New York Times described as a cult. The iPhone 5 launch will continue Apple's trend of backlogged orders.

Over time, the Apple mystique is likely to fade. Violet Blue and ZD Net argue that "fan boys" are damaging Apple's reputation. Fan boys who are hostile to any criticism of Apple are inadvertently forcing the counter-culture appeal of the Apple brand into mainstream society. At this ironic inflection point, Apple is now Top Dog, which leaves the door wide open for the likes of Microsoft, Google, Amazon, and Nokia to capture market share as bullied underdogs. The iPhone 5 will be Apple's Last Stand as an iconic symbol of "cool." Over the next two to three years, Apple's storybook profit growth will fall victim to the backlash against faceless, but powerful Corporate America.

Apple's latest quarterly report proves that this corporation is largely guilty of cannibalizing its own products. The Apple iPhone effectively fuses a telecommunications handset alongside a minicomputer that can play games and download music. Alternatively, the Apple iPad bridges the gap between smartphone and laptop within the consumer electronics spectrum. During Q3 2012, Apple sold 6.7 million iPods, 26 million iPhones, 17 million iPads, and 4 million Mac computers. For the quarter, Apple reported 28 and 84-percent year-over-year growth in iPhone and iPad unit sales, respectively. Alternatively, quarterly Mac unit sales grew by a mere two-percent, while iPod unit sales actually declined by ten-percent over last year's comparable period. In terms of functionality, the Apple iPhone and iPad overlap and nearly cancel out the market's need to ring the register for the iPod and Mac.

Naturally, Apple's success within the smartphone and tablet spheres will attract competition that erodes profit margins. The Google (NASDAQ:GOOG) - Samsung Android platform remains as the most formidable challenger to Apple iPhone dominance.

The Competition

Until now, the Apple brand has largely consolidated upon what Warren Buffett would refer to as a "moat" around the smartphone market. Both Nokia (NYSE:NOK) and Research in Motion (RIMM) teeter upon the brink of collapse, while Microsoft remains largely shut out, despite its massive war chest. In fact, The Wall Street Journal reports that Microsoft is entering into an agreement to share its Windows 8 operating system with Huawei Technologies, a Chinese handset device maker. This deal would put Microsoft in direct competition with Nokia, its own partner and designer of the Lumia phone. After a spectacle of hype, Nicki Minaj concerts, and $100 rebates, Stephen Elop, Nokia CEO, concedes that Lumia - Windows phone sales are "mixed."

Quietly, Samsung has emerged as the world's leading handset manufacturer according to units sold. The Samsung Galaxy SIII is most comparable to the Apple iPhone. Samsung Galaxy SIII and Apple iPhone design, technical specifications and price points are eerily similar. Over time, the choice between the iOS and Android operating systems has largely come down to personal preference. A dual-core Qualcomm S4 processor powers the Galaxy SIII, while Apple is likely to unleash its new A6 processor within the iPhone 5. According to Jeff Bertolucci and Information Week, the difference in performance between these two smartphones "won't be too dramatic." In retaliation, Apple has taken to the courts to sue Samsung over patent infringement over data tapping, search features, and auto-correct spell checking. On August 24, a California jury ordered Samsung to pay $1.05 billion in damages to Apple for patent infringement. Samsung is expected to appeal this decision, in order to protect its presence in the U.S. market.

Ironically, this legal wrangling serves as proof that Apple is losing its vice grip over the smartphone market. The iPhone 5 alongside the iPad may very well serve as Apple's last blockbuster hits. Going forward, it is inevitable for iPhone and iPad releases to generate less and less buzz. The Apple iPhone will remain popular, but it will lose its Revolutionary appeal. I foreshadow that the iPhone is destined to settle within an iconic consumer product cycle stage comparable to the Nike (NYSE:NKE) Air Jordan franchise. Years from now, diehard "fan boys" will salivate over minute annual iPhone upgrades and gimmicks for the sole purpose of remaining "cool."

For shareholders, this worse case scenario still makes Apple a buy at these levels.

The Bottom Line

At $675, Apple stock trades for sixteen times earnings, while averaging 66-percent annual profit growth over the past four years. Super investor Peter Lynch identifies stocks featuring a one-to-one price-to-earnings-to-growth (NYSE:PEG) ratio as fairly valued. According to Lynch's metric, Apple shares remain wildly cheap. As a bonus to this favorable PEG ratio, Apple closed out its Q3 2012 books with $117.2 billion in cash and securities on the balance sheet. On a per share basis, Apple's liquidity breaks down to $125 in cash and investments. With such stellar financials, only a disastrous iPhone 5 launch would trigger sustained deterioration in Apple's share price.

I speculate that Apple will sell 150 million iPhone 5 units over the next year. At this level of sales, Apple would collect roughly $95 billion in iPhone related revenue during fiscal 2013. $95 billion in iPhone sales will trickle down to $25 billion net income at the bottom line. When Apple closes the books on 2013, the iPhone will account for half of this corporation's projected $50 billion net income. At 15 times earnings, Wall Street would then value Apple at $750 billion and shares would trade for $800. My estimates assume rough 20% and 50% year-over-year increases in iPhone and iPad sales activity, respectively, over top of 937 million Apple shares outstanding.

Going forward, "haters" will celebrate the iPhone 5 as Apple's last hurrah. The critics who patiently await the alleged demise of this stock, however, will remain disappointed. Ironically, the End of Revolution will mark another leg up for Apple shareholders.

Disclosure: I am long AAPL. 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.