2014 Outlook: No Apple iPhone Killer

| About: Apple Inc. (AAPL)

In 2007, Steve Jobs and Apple (NASDAQ:AAPL) brought the iPhone to market. Steve Jobs' work ultimately culminated with a shift in power away from engineering technocrats and towards Main Street consumers. The revolutionary iPhone was to emerge as the central gateway into an Apple iOS ecosystem that offered access to telecommunications, gaming, computing, and entertainment. Ironically, the haughty BlackBerry (BBRY) and Mike Lazaridis were to dismiss the Apple ecosystem as "amateur hour," in 2010. BlackBerry, Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC), Google (NASDAQ:GOOG), and legions of bearish analysts have grossly underestimated Apple's abilities to innovate and turn profits within the mobile space. Apple shareholders and its fiercely loyal consumers, or fan boys, may appreciate the idea that the iPhone will remain the premier handset through 2014. The haters can take a seat and wait.

Apple iPhone Sales and Profits






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iPhone Percentage of Apple Revenue






For Apple's 2009 fiscal year, the iPod and Mac platforms actually generated respective 22.1% and 37.7% shares of total net sales at the company. By the end of fiscal 2013, the Mac had accounted for 12.6% of annual revenue, while the once revolutionary iPod had been literally shelved down towards a mere 2.6% of total net sales. The iPhone, of course, is packaged with both iTunes and ear buds to convert the handset into a music player. Music aficionados may also download the Pandora (NYSE:P) application and port the iPhone to a Bose speaker dock, for a more impressive play-list and booming sound. Be further advised that iTunes sales, in terms of a percentage of total net revenue, have remained flat near 10% between 2009 and 2013. The sales statistics may serve as evidence that the iPhone has cannibalized iPod sales, while the Apple marketing apparatchik helped further improve the profile of the consumer electronics brand. Forbes had already identified Apple as the world's most valuable brand at $104.3 billion heading into 2013.

Apple bears, of course, may present declining iPhone revenue per unit sold statistics to allege that Cupertino is in danger of losing its stranglehold upon the smartphone marketplace. Apple iPhone revenue per unit sold did decline by 3.5%, from $629.60 to $607.45, between fiscal 2012 and 2013. Unlocked Apple iPhone prices now start at $549.00 for the 16GB 5C. The fully loaded 64GB iPhone 5S retails for $849.00. Language written within Apple's 2013 annual report already suggested that more consumers were purchasing older iPhones, instead of upgrading to the latest 5S editions. Last generation and unlocked 8GB iPhone 4S handsets are now sold for $450.00. Again, Apple is more so likely to cannibalize its own sales, than to lose significant ground to the likes of Android, Windows, and BlackBerry ecosystems.

Last quarter, research firm IHS iSuppli released tear down results for the iPhone 5S handset. At the time, IHS iSuppli estimated total bill of materials ($190.70) and manufacturing ($8.00) costs of $198.70 for each 16GB 5S phone that retails for $649.00. For Apple, NAND Flash memory upgrades add a mere $19.60 in bill of materials costs to offer the 64GB iPhone 5S ($218.30 in bill of materials and manufacturing costs) that retails for $849.00. In prior years, bill of materials and manufacturing costs for the 64GB iPhone 4S and 5 were $253.00 and $238.00, respectively. These 64GB 5S handsets also sold for $849.00 upon launch. Over time, Apple has leveraged both iPad and iPhone buying power to pressure suppliers into slashing prices for component parts. The case may be made that iPhone profit margins have actually expanded through product maturity. As such, market share data that includes bargain bin phone offerings out of Apple rivals may be rendered largely irrelevant in regards to long-term investment returns.

Apple iPhone Competition Lacks "Killer App"

To date, Apple competitors have largely followed a two-pronged approach to attempt to knock the iPhone off of its perch. At the high end, the Samsung (OTC:SSNLF) Galaxy, Nokia (NYSE:NOK) Lumia, and BlackBerry Z10 lines were all originally designed to match up head-to-head against Apple. At the low end, offerings such as the Acer Liquid C1, Lenovo K900, Motorola RAZR, and Safaricom Yolo, have now been pitched to value conscious consumers both at home and throughout the developing world. Besides the Samsung Galaxy, every other challenger to the iPhone has also been abandoned to the bargain bin and hawked to foreign consumers from Kenya to Bulgaria. Prospective investors within these particular failing business models should see little relief in sight throughout the course of 2014. Google, Intel, Microsoft, Nokia, and BlackBerry have all lost several billions of dollars in research and development, acquisition, and production costs, after entering the smart phone ring against Apple.

Recent forays into wearable computers out of both Samsung and Google may serve as evidence that mining the smartphone space for a "killer app" to take down the iPhone is a fool's proposition. Standalone developers, such as the popular Snapchat, typically launch applications on the iOS platform before releasing reconfigurations made available for Android. Going forward, the iPhone will remain the alpha dog on the block, as an entry point into the grander Apple ecosystem. As such, long-term Apple shareholders may expect alpha returns that outpace the S&P 500 Index. Main Street hipsters, teenagers, and chic professionals would describe Apple as "cool." Wall Street analysts, of course, would make the claim that the Apple business model benefits from several billions of dollars in goodwill each year.

On December 5, 2013, research firm comScore released its October 2013 U.S. smartphone subscriber market share report. The title of the report is somewhat misleading, as comScore statisticians actually presented averages of data taken from the August to October quarter. As always, market share data will somewhat favor Android, because Google literally gives its operating system away, in order to drive traffic towards Search. Still, Apple closed out this latest quarter as the leading smartphone original equipment manufacturer, with a 40.6% share of the market. As operating systems, Google Android (52.2%) and Apple iOS (40.6%) duopoly combined to dominate 92.8% of the U.S. smartphone subscriber market through this recent time frame.

HTC, Sony (NYSE:SNE), and Nokia are set to roll out several different handsets throughout 2014, in an attempt to grab share within this winner-take-all market. Still, offerings out of these fringe players appear to be a repeat of 2013 - with the Qualcomm Snapdragon 800 chip powering premium Android and Windows phones. Last year, Apple unveiled its 64-bit A7 chip as the driving force behind the iPhone 5S. Technology analysts have speculated that Apple will break out a quad-core 20nm A8 chip for the iPhone 6. Designers of both the iPhone 6 and Samsung Galaxy Round may experiment with more pronounced curvature in casing and display glass. Consumer gadget magazine Pocket Lint has already anticipated that the Samsung Galaxy S5 will feature the highest pixel density out of this 2014 smartphone class, at 2560 x 1440 resolution and 560 pixels per inch. The relatively minor upgrades, however, will be far from revolutionary. No "killer" app will emerge to dethrone the Apple iPhone in 2014.

The Bottom Line

Apple stock closed out the January 16, 2014 trading session at $554.25 per share. At this level, Wall Street traders have effectively applied a $500 billion market capitalization price tag to Apple Corporation. Apple did close out its latest 2013 fiscal year ended September 28 with $146.8 billion in cash and investments above $83.5 billion in total liabilities. Be advised that the liabilities side of this ledger did include $10.1 billion in deferred revenue. Current deferred revenue actually increased from $5.9 billion to $7.4 billion through fiscal 2013. Going forward, this deferred revenue will ultimately fall off the balance sheet and transition over to the income statement. For now, analysts should acknowledge the idea that 2013 revenue ($170.9 billion) and net income figures ($37.0 billion) were somewhat understated due to Apple's more aggressive stance towards deferring sales. Apple also expensed $6.8 billion in depreciation through fiscal 2013, which was up from $3.3 billion, the prior year. Apple generated $53.7 billion in cash flow from operations through 2013. Going forward, only a disastrous 2014 iPhone 6 launch could derail this cash cow. The 2014 smartphone competition, however, will lack the elusive killer app, yet again.

In effect, Apple could pay off all liabilities, and still be left with $73.4 billion in cash and investments on the balance sheet. On a per share basis, this liquidity would also calculate out to $80 in cash and investments. Wall Street is therefore valuing Apple business operations for a mere $475.00, or an estimated 11 times current earnings. Apple has also pledged to return $100 billion back to shareholders through stock buybacks and dividends, by the end of 2015.

On January 15, 2014, Apple announced a new partnership initiative with China Mobile (NYSE:CHL), the world's largest carrier, after several years of negotiations. China Mobile did bring 763 million subscribers to the negotiating table. Still, Paul Carsten and Reuters have projected that Apple wields enough muscle to literally force China Mobile into a phone subsidy price war with other carriers, if necessary. The full ramifications of the China Mobile deal have yet to be priced into Apple shares.

Billionaire investor Carl Icahn, of course, may describe any decision to buy into Apple stock as a "no brainer."

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.

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