Apple - The Most Important Variable

| About: Apple Inc. (AAPL)

I had earlier advocated buying Apple (NASDAQ:AAPL) stock before the start of a major new product cycle for a 20-25% upside. Technology stocks generally tend to move upwards before the introduction of a major new product and this has been a historical trend. Apple is all set to release its new iPhone and iPad in September and the stock has already moved up by 10% in recent days. The stock has also been helped by news that big hedge fund investors such as Icahn have increased their holdings in Apple. Though Apple is going to introduce a number of new products as well as upgrades, I think the biggest and most important product will be the new cheap iPhone variant. The new cheap iPhone has gotten many names such as the iPhone Lite, iPhone 5C and iPhone mini. The upgrades of the normal iPhone and iPad will help Apple retain its decreasing market share. The current news about these products indicates that the upgrades will be minor hardware ones without anything radically new. The big catalyst will be the cheap iPhone, which will help Apple break into a big multi-billion dollar low end smartphone market. This product will be the key to Apple's stock in the next 6 months, in my view. The pricing of this cheap iPhone will be the most important parameter to watch out for. I currently remain long Apple given the stock's cheap valuation and upcoming new products.

According to the tech rumor mill, September 10th will see the launch of two new iPhones - the 5S and the 5C. New iPhones for certain people are an exciting event (anyone for queuing outside the Apple store for 5 days?), but this launch is particularly significant as the 5C is going to be a budget version of the iPhone, which is a significant change to Apple's strategy… Apparently the 'C' in 5C stands for colour (no, not cheap!) - initial colours are said to be blue, red, yellow and green and should give the 5C a more funky and young feel. However, if you are a lawyer for Apple I have good news. These colours are the same as those of the Google logo, so expect another protracted legal battle between the two tech foes. It is also likely to have more of a plastic feel than the 5 or 5S.

Source - Yahoo

iPhone Lite is the only Product that will expand Apple's TAM

Apple's iPhone Lite will be the only product that will expand Apple Total Addressable Market (TAM). The smartphone industry has become too big and vast to brush it under one category. The industry can be categorized into the low, mid and high end from the pricing perspective. The low end of the smartphone market is growing at a rapid pace, while the high end has slowed down sharply. The developed markets have been saturated by premium smartphones and growth now is coming from the emerging markets. The buying power of consumer in the fastest growing markets such as India and China is quite low. This has made Android gain market share rapidly as it is the only smartphone OS with products in this market. Nokia (NYSE:NOK) is trying hard to break into the low and mid end segments with its Lumia range using the new Windows mobile OS. The low end market not only is growing fast but the size has also become quite large. I think that Apple has been too slow in recognizing the potential and growth of this segment. In the $350 billion smartphone market, I estimate that the low end segment is at least $50 billion. If Apple is able to capture even a 25% market, then its TAM will increase by $12.5 billion. It will also help increase Apple's software and iTunes sales, which have already crossed the $1 billion mark last quarter. Though the revenue figure may look small compared to Apple's overall revenues of ~$40 billion a quarter, the growth of this segment will make it one of the most important for Apple.

The low-end spectrum represents the fastest-expanding segment of the global smartphone market, with shipments more than doubling from 2012 to 2016. Low-end smartphone shipments will rise to 559 million in 2016, up from just 206 million in 2012, as presented in the figure below. Shipments of low-end smartphones will rise at a compound annual growth rate (OTCPK:CAGR) of 51 percent from 2011 to 2016. In contrast, high-end smart shipments will grow at a CAGR of only 12 percent during the same period.

Source - iSuppli

Why Pricing will be the Key for the New Cheap iPhone

The new iPhone should have the familiar iOS software and services such as iTunes. The hardware will definitely be inferior to the normal iPhone, otherwise the company cannot make the pricing different. The pricing of the cheap iPhone will be the most important factor for its success or failure, in my view. If Apple prices the phone too cheaply, then it will lose the premium branding that Apple products enjoy. If Apple prices the phone too high, it will miss the target audience in the emerging markets who cannot afford higher end Apple products. Apple's fastest growing product in India and China is its two generation old iPhone 4. The reason for its high volumes of shipment in recent quarters has been the substantial discounts that Apple has offered on the iPhone 4. With the discount, an iPhone 4 can be bought for around $300, which is nearly half the price of the iPhone 5.

What should the Pricing of the new iPhone Lite be?

Many analysts have estimated that the new iPhone Lite should be priced between $350-450. I think it would be stupid for iPhone to price in this range. Even ~$300 is a bit too high for emerging markets, but I think it is about right for Apple. This price will be high enough to maintain Apple's exclusive brand appeal. It will also allow emerging market consumers to stretch a bit to buy an Apple product. At $400 or higher, Apple will fail to reach its target audience, which will not be able to afford such a high priced product. The pricing for this smartphone is important as there are some great products such as the Nexus 4 that fall in the same price range. I think that Apple will stick to a price of $350 for this product, though I think that $250-$300 is ideal.

iPhone Lite Risks

The competition in the smartphone market has increased tremendously since the launch of the first iPhone. These days the whole smartphone market is seeing hyper competition with the likes of LG and Samsung (OTC:SSNLF) becoming quite strong. The Chinese players such as Lenovo (OTCPK:LNVGY), ZTE (OTCPK:ZTCOY) and Huawei have also broken into the global top 10 rankings due to their strong presence in China, which accounts for more than 30% of the global smartphone shipments. Google (NASDAQ:GOOG) has also introduced its first in-house designed smartphone -- the Moto X.

The pricing of smartphones has also become very aggressive with Android companies operating on wafer thin margins to gain market share. Nokia has also shown a recent resurgence with its Windows 8 mobile OS powered Lumia range of smartphones. Microsoft (NASDAQ:MSFT) is pouring a huge amount of resources into improving its mobile operating system and we should soon see the first quad core, high resolution Windows smartphones. Microsoft is desperate to get a slice of the mobile devices market, which is dominated by Apple and Google. The Seattle giant wants to become the third major mobile ecosystem, but is finding the going hard. Its tablet venture was an unmitigated disaster. However, Nokia is doing extremely well despite the Windows limitations. Microsoft has massive resources and it is early days in the mobile OS game. Apple not only has to fight Google with its ~80% smartphone OS market share, but also has to remain vigilant against Nokia-Microsoft.

Apple's Stock Performance and Valuation

Apple's stock has broken out of its $400-450 range as the imminent product releases create some excitement around the stock. I don't think Icahn was the main factor, even though the media would like you to believe so. I have been waiting for a 20-25% upside move in the stock. The valuation of the stock is still low at around 12x forward P/E. The company has got a massive cash hoard of more than $100 billion, which makes the enterprise value much lower than the market capitalization of ~$460 billion.

AAPL Total Return Price Chart

AAPL Total Return Price data by YCharts


Apple's new product cycle will see the introduction of a whole host of new products before the holiday season. There are also rumors of products such as an iWatch or iTV, but the only product investors should be watching closely now is the new, cheaper iPhone. This will not only increase Apple's TAM substantially, but also fend off the low and mid end smartphone competitors. Apple is losing millions of customers and future iTunes revenues by not targeting the mid or low end of the smartphone market. Some of these smartphone companies have become quite big and may soon target Apple's premium end market share. In fact many of these companies have already entered the mid smartphone segment where they are competing with the iPhone 4 for customer dollars. Apple's market share in the overall smartphone market is declining every quarter. The pricing of the new product will be the most important factor for the stock in the next 6 months. I will wait for another 10% upside to $550 before taking profits, or depending on the new iPhone's performance, hold on for a higher price.

Disclosure: I 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.

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