And with good reason.
Most Apple observers expected the iPhone 5 to be released a year ago, when Apple instead underwhelmed with an iPhone 4S "refresh." So the world has been waiting for this product for almost two years. (Rumors this week put the phone's release out Sept. 12)
And make no mistake:
The iPhone 5 also has more riding on it than pretty much any product in history.
Good or bad, the iPhone will define Apple's financial performance and reputation for at least the next couple of years.
If the iPhone 5 blows people away, Apple will be set up to clock another year of astounding revenue and earnings growth, at rates of growth never before seen for a company of this size. And the halo of magic and genius that still surrounds Apple and Apple products will allow the company to continue to command premium prices from consumers and a premium stock multiple.
If the iPhone 5 disappoints, meanwhile, analysts may have to cut their earnings projections for Apple. Worse, Apple will clearly have lost the lead in a market it created, one in which it used to be a full year ahead of any competition. If that happens, the magic halo will go "poof," and Apple will be perceived as just another company, rendered mortal and ordinary by the death of Steve Jobs.
Why is the iPhone 5 so important financially?
Because new information suggest that the iPhone is responsible for the vast majority of Apple's profits.
Last week, in a lawsuit with Samsung, Apple was forced to release documents that showed the relative gross profit margin for its iPhones and iPads.
This information allows us to estimate, to an extent never before possible, just how much profit Apple derives from the iPhone.
The bottom line?
The iPhone likely accounts for almost two-thirds of Apple's profits.
This means that the company is even more highly dependent on the iPhone than most Apple observers realize.
(The iPad, meanwhile, likely accounts for almost a third of the company's total profit. The Mac, iPods, Apple TVs, and other Apple products, meanwhile, likely account for about 10% or less of Apple's profits. I'll walk through these calculations below).
Because of this extraordinary dependency on the iPhone, Apple's ability to continue to grow its profit faster than Wall Street expects depends on two things:
- Continuing to rapidly grow the number of iPhones sold. This will depend in large part on the iPhone's attractiveness relative to other smartphones.
- Maintaining the high gross profit (more than 50%) on each unit. This will depend on Apple's ability to maintain its high average selling prices, even as the smartphone market expands into lower-income demographics and the products become increasingly commoditized. This will likely be difficult.
Let's Go To The Numbers...
Working with Apple's financials can be confusing, because the company's fiscal year ends in September, while most people focus on calendar years. All of the numbers below are for calendar years.
The goal of this exercise, meanwhile, is to determine how dependent Wall Street's financial expectations for Apple are on the continued success of the iPhone, as well as whether those expectations are aggressive or conservative.
First, here are Gene Munster's projections for Apple's overall revenue for the next few years:
CY 2011 (Actual): $129 billion, +71% year over year
CY 2012 (Estimate): $164 billion, +28%
CY 2013 (Estimate): $196 billion, +20%
CY 2014 (Estimate): $251 billion, +28%
Note that Munster's 2013 estimate calls for a sharp deceleration in Apple's revenue growth. Ironically, this is actually good news, because it means that there is upside to the estimate. If Apple delivers a strong growth rate next year, the 2013 estimate will go up.
Also note, though, that Munster's 2014 estimate calls for Apple's revenue to reaccelerate. This estimate is more aggressive.
It's also worth noting that growth rates like these for a company this size are unheard-of. The expectations for Apple are already high.
Next, let's look at the share of that projected revenue that is expected to come from the iPhone:
CY 2011 (Actual): $61 billion, +103% year over year, 48% of total revenue
CY 2012 (Estimate): $83 billion, +35% y/y, 51% of total
CY 2013 (Estimate): $103 billion, +25% y/y, 53% of total
CY 2014 (Estimate): $138 billion, +34% y/y, 55% of total
So Munster projects the same sharp slowdown in iPhone revenue next year as he does for overall revenue. Again, ironically, this is good news. The estimate seems conservative. If the iPhone 5 is a big hit, the estimate is likely to go up. Also again, however, Munster projects a reacceleration of iPhone sales in 2014. This projection is more aggressive.
Note that, this year, the iPhone will account for more than half of Apple's total revenue. This dependency is expected to increase each year.
So that's revenue. Now let's look at the likely profit contribution for Apple's 3 main product lines:
- Macs and Other
The information produced in the Samsung lawsuit reveals something startling:
- iPhones likely account for more than 60% of Apple's profits
- iPads likely contribute about a third of Apple's profits (~33%)
- Macs and Other likely contribute only 5%-10% of Apple's profits
Importantly, these are my estimates, not Gene Munster's. I am basing them on the "gross profit" percentages for iPhones and iPads revealed in the lawsuit documents.
One assumption I am making that some analysts might quibble with is that the relative contribution percentages of gross profit for each product (profit after direct product costs) are the same as the relative contribution percentages for net profit (profit after all costs). I think this is a reasonable assumption, but some analysts might disagree.
Specifically, the lawsuit documents reveal that the iPhone had gross margins of 49%-58% from 2010-2012 (I've used 53%).
Meanwhile, the iPad had gross margins of 23%-32% (I've used 28%).
When you apply these numbers to the revenue for each product, you get the gross-profit shares I described above.
So, what about the future?
Let's look at Gene Munster's projections for Apple's gross profit margin for the next few years. The message here is that Munster (and Wall Street) expect Apple's profit margin to stay basically the same.
APPLE GROSS PROFIT MARGIN
CY 2011 (Actual): 42%
CY 2012 (Estimate): 43%
CY 2013 (Estimate): 42%
CY 2014 (Estimate): 41%
Given the different profit margins for Apple's three product lines, the critical assumption here is that the iPhone will continue to grow rapidly and maintain its extremely high gross margin. The estimates allow for some drop in this margin, but not for a sharp slowdown in sales or a sharp drop in the iPhone's profit margin.
Importantly, the estimates do not allow Apple to gradually "become an iPad company." Thanks to the difference between the iPad and iPhone margin, if the iPad quickly became Apple's dominant product, it's profit margin would get crushed. This is likely especially true if the company releases the widely expected "iPad Mini," and it has a lower gross margin than the current iPad.
The Bottom Line
The bottom line is that Apple's profits are much more dependent on the iPhone than a glance at revenue would suggest.
Although Wall Street's expectations for Apple's revenue and profit growth in 2013 seem reasonably conservative (and, therefore, have room to rise), the expectations for 2014 are more aggressive.
If Apple's iPhone 5 is a monster hit, Apple has room to blow away Wall Street's current forecasts, especially in 2013.
If Apple's iPhone 5 is a dud, meanwhile, Wall Street may have to cut its Apple estimates.
The difference between these two scenarios would likely affect not only Apple's earnings, but the price investors will be willing to pay for those earnings. So the difference between a "hit" and a "dud" iPhone 5 would likely be hundreds of dollars per share.
If the iPhone 5 is a dud, moreover, Apple will likely have a hard time regaining its market lead (and aura) with future generations of the product. Rather, unless its competitors stumble, Apple will be forced to play catch-up.
If that happens, consumers and investors will likely conclude that Apple's magical run is over and that the company is no longer the company it was before Steve Jobs died. In short, Apple will, once again, become ordinary.
So all eyes are (and should be) on the iPhone 5...
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