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Will Apple (AAPL) Stock Continue to Outperform Despite Late Arrival of 5G iPhone?

support@smarteranalyst.com (Ben Mahaney)

Things continue to get murkier for Apple’s (AAPL) iPhone transition to 5G Modems, with more and more expectations shifting to a 2021 launch for an iPhone model with 5G capabilities. This will lag Samsung (SSNLF) by two-years, and it puts somewhat of a damper on expectations for iPhone upgrades, as it diminishes the perceived value in comparison to smartphone peers. It doesn’t necessarily mean consumers won’t upgrade to new iPhone’s, but it gives them less of a reason to do so.

Apple’s stock has continued to rally despite declining expectations tied to the hardware business, and with more emphasis on software and services revenue.

Given Apple’s growing installed base of users, and opportunities to continue monetizing that base of users with a plethora of new and pre-existing apps, services, and app store sales it’s not a matter of whether or not Apple can continue to monetize the pre-existing base, but whether they can continue to generate excitement in the foreseeable two-years absent of 5G capabilities. Apple’s business model does remain attractive, and it’s difficult to imagine consumer preferences changing just because Apple doesn’t transition beyond LTE as quickly as other high-end variant phones.

However, rather than the risk of smartphone market share loss, what’s more probable is a loss of interest tied to smartphone upgrades in the upcoming cycles without a new killer-feature tied to next generation iPhone’s. Furthermore, Apple may have exhausted a lot of in-house efforts to improve the iPhone from prior-generations with the launch of iPhone X and X S. The perceived value of these phones gets diminished by the increase in pricing, and the absence of the home button. Some would prefer to have the home button, and others would not. It’s certainly a feature of the iPhone I don’t want to let go of, which is why I’m not in any hurry to upgrade my iPhone to any of the iPhone X variants. Some would call the new design change innovation, but others who are more stubborn may hold onto iPhone 6, 7 and 8 generations longer. The performance of prior-generation iPhone’s remains serviceable in most instances even when tied to gaming and tend to have similar response times to loading apps, hence the need to upgrade has become more questionable.

Source: UBS

The iPhone installed base has reached 900 million iPhone’s, and the growth of that installed base has slowed to single-digit percentage points, so if we forecast the addition of new smartphone users tied to the Apple ecosystem, units shipments from new customers would probably add 50 million to 90 million in annual shipments based on the single-digit growth rates. For Apple to reach consensus estimates, it would need to sell $140B worth of iPhone’s at an ASP of $700 or 200 million units this fiscal year. The bulk of sales happen in Q1’19 where Apple reports holiday results, the rest of the year tends to slow down based on consumer buying and spending habits. With sales comps weak in Q1’19, the rest of the year will likely exemplify the same weakness in comps, hence the introduction of some other feature not tied to a major design overhaul would be welcomed at this point. However, the prospects of creating some new technology in such a short window is also unlikely. 5G would be welcomed at this point, but the on-going complications with the Qualcomm (QCOM) lawsuit has made Apple dependent on Intel.

However, this is the sticking point for Intel, which only has 1 customer for its modems, which is Apple. It’s not a profitable segment for Intel, and the cost of developing new modems has gone up considerably, as they continue to lag the roadmaps of Qualcomm. Intel isn’t likely to release a modem this year, or even next year according to UBS commentary from their Asia Technology supply chain, and the earliest window has now moved to 2021 where Apple might in fact develop its own 5G Modem in-house. The added cost of developing a modem in-house might not even be worth the cost outlay, as there’s a lot of patents tied to 5G technologies that Qualcomm owns, outright. The other alternative that could be pursued is Apple’s acquisition of Intel’s entire wireless division just to gain access to the IP and commence more in-house R&D, where they have continued to hire more and engineers in wireless modem design. Again, Qualcomm spent $5.4 billion on just R&D tied to wireless technologies in FY’18, and Apple tends to split its R&D into a number of categories not tied to wireless development. Even if Apple were to pursue an expensive venture like buying-out Intel’s modem capabilities and plowing more resources into R&D, it’s not the soundest strategy for them to pursue given the delayed timeline and added cost that would surface in its financial results.

This all points to a heightened likelihood that Apple will pursue a settlement at some point with Qualcomm and source the 5G modems from them. The challenges tied to developing entirely new silicon or acquiring new technologies and then developing in-house isn’t only just cost prohibitive, it could delay upgrades in next-generation iPhone units, and upgrades have become more than 60% of annualized iPhone revenue currently. Throwing financial resources at a problem, and delaying iPhone upgrades isn’t a sound strategy, and if anything, if the next iPhone launch in Q1’20 turns out to be worse than the prior one, Apple might eventually cave to Qualcomm and opt for a simpler upgrade cadence that might bring a bigger chunk of its installed base for upgrades.

Features will become important for the next iPhone launch, and some miss steps in pricing, and design might have put a damper on expected upgrades, but the absence of 5G could lead to fewer upgrades, and the loss of sales from upgrades isn’t something Apple can actually afford given the slowing growth of its installed base. Therefore, Qualcomm will likely win from a strategic perspective, and when Apple eventually pivots to Qualcomm as a supplier for modems, Qualcomm’s results could significantly surprise. Investors should keep a close eye on Qualcomm, as its 5G capabilities gives the company a lot of leverage, especially in the higher-end segment of the smartphone market.

Disclosure: The author has no position in any of the stocks mentioned in this article. The information contained herein is for informational purposes only.


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