Apple (NASDAQ:AAPL) makes money by selling maximum number of iPhones etc, at the largest possible margin.
Thesis & Catalyst For Apple Inc.
Every Apple decision is worth analyzing to refine the "Apple business behavioral model" to better predict Apple's product road map.
When it comes to the "right" smart phone screen size, it has been known for at least 3-4 years that many users prefer screen size larger than offer by the iPhone. Thus, the question of iPhone screen size has been hotly debated, even before the screen size increase to 4-in with iPhone 5 in 2012.
What could Apple have been waiting for?
1. Preparing the market by optimizing the 4-in screen size segment. If the ultimate lower-limit in terms of iPhone screen size is 4-in, it would be distracting to consumers if Apple were to increase screen size from 3.5-in to 4-in, AFTER the introduction of the 5-in or larger models. Thus, it is strategically preferred to complete the introduction of 4-in models first, before adding the 5-in and larger models.
2. Transition to 64-bit and next generation chip: to gain adequate processing speed at sufficiently low power consumption to support more pixels of the larger screen. Unlike tablets, phones need to balance power consumption with processing speed. Galaxy S4 with 5-in screen had to use a much larger battery (2600mAh) compared to iPhone 5S (1560mAh) to have similar battery life. Part of this different is due to the screen. [www.informationweek.com/mobile/mobile-devices/galaxy-s4-vs-iphone-5-display-shoot-out/d/d-id/1109714] On top of power consumption of the larger screen by itself, there will be higher processor load to support graphics due to more pixels on the screen. The transition to 64-bit architecture in 2013 and the speculated 20-nm manufacturing process for the A8 processor will both contribute to longer battery life.
3. Establish reliable supply with lower price for larger display. Securing a sufficiently large quantity of 5in display is not trivial. Display technology takes time to mature: capacity to increase, costs to come down. Note that $41 for 4-in display in 5S is the highest cost single component [technology.ihs.com/451425/groundbreaking-iphone-5s-carries-199-bom-and-manufacturing-cost-ihs-teardown-reveals] As reference, $75 for 5-in display in Samsung Galaxy S4 is also the highest cost component [technology.ihs.com/430692/samsung-galaxy-s4-carries-236-bill-of-materials-ihs-isuppli-virtual-teardown-reveals]. Apple may or may not end up paying more than $75 for larger display. The point being made here is that cost must be one of the major considerations.
22% of smart phones sold in 3Q2013 have screen size of 5-in or more, accounting for 56M devices. [appleinsider.com/articles/13/05/30/samsung-google-to-scale-back-giant-screen-sizes-on-new-android-phones] Out of the 250M total smart phones, Apple sold 30M in 3Q2013.[www.cnbc.com/id/101174395] Those who desire a larger screen size will become potential new iPhone buyers.
Using a conservative 20% estimate based on Android-to-iPhone switch rate, an estimate of 11M more iPhones will be sold in 1Q2015 compared to 1Q2014 (51M), solely due to contribution from the larger screen size. In addition, larger iPhone model will also increase upgrades among existing iPhone users, perhaps by 2M per quarter, based on estimate that 50% of iPhone buyers are upgrades and larger iPhone adds additional 15% upgrades.
These two items together point to an additional 13M iPhones per quarter, or about 64M iPhones in 1Q2015. This translates into additional $9B revenue per quarter, assuming $700 average selling price (NYSE:ASP). Roughly +$3 earning per share (NYSEARCA:EPS) per quarter, +$12 per year. At price-earning (NYSE:PE) of 12, that will be +$144 per share - added to current price of $517 = $661, based on addition of larger iPhone model alone.
- Timing. Although iPhone models with larger screen have been rumoured for 2014, it is possible that these models will arrive until 2015 or later.
- Canibalization. Introduction of iPhone with larger screen will lead to shifting of product mix towards iPhones with larger screens. If the ASP of the larger iPhones are indeed higher and with similar or larger margin, then the impact of canibalization on EPS will be neutral.
- Competition. The valuation above assumes 20% of those who would purchase Android phone with 5-in or larger display will instead opt to purchase an iPhone, if iPhone model with larger screen is available. This 20% assumption may be overly conservative. Arguably, in the higher end market which is applicable to consumers who are shopping for larger displays, iPhone should have a reasonable shot at 45% of market, based on U.S. unit-share in 2013.[appleinsider.com/articles/14/03/14/how-android-lost-global-open-market-share-to-apples-integrated-ios] If this comes true, valuation will double to +$6 per quarter and over $800 stock price.
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.