Richard Windsor
11 October 2017

Apple - Expectations gap

iPhone X unlikely to produce the needed super cycle.

Expectations for the iPhone X are at fever pitch and a super cycle is now required to prevent a sell-off in the shares. iPhone X is the first substantial revision to the design of the iPhone since the launch of the iPhone 6 and in many ways the circumstances are very similar. In 2014, the biggest complaint with regard to the iPhone was the size of the screen which was considered to be tiny compared to devices being produced by Samsung and the other Android handset makers. When Apple fixed this shortcoming with the iPhone 6/6+, there was a lot of pent up demand as users who could only have a large screen with Android were able to have the best of both worlds. This demand led to shipments growing (calendar quarters): Q4 14 46%YoY, Q1 15 40% YoY, Q2 15 35% YoY, Q3 15 22% YoY and Q4 15 0% YoY. This was followed by shipments declines in Q1-Q3 16 as the pent-up demand was exhausted and replacement rates normalised.

We do not think the iPhone X will stimulate a big enough uptick in replacement rates to meet the expectation that Apple will ship more than 255m+ units in its next fiscal year.
This is due to utility, as while the new screen is nice to look at and enables a big screen on a smaller device, it does not offer an increase in utility over the iPhone 7 similar to that of the iPhone 6 compared to the iPhone 5. Consequently, it will not create the same degree of desirability and therefore not trigger a similar degree of early replacements compared to the iPhone 6/6+. Secondly price; the device is meaningfully more expensive starting at $999 which may put some buyers off. Lastly, Law of large numbers.; the bigger Apple becomes, the more difficult it is to post the kind of growth that the valuation of the shares now demands.

The iPhone X will stimulate a replacement cycle but one that is smaller in magnitude compared to the iPhone 6. With an optimistic hat on, we can just about get comfortable with the following unit shipment growth (calendar quarters): Q4 17 15% YoY, Q1 18 8% YoY, Q2 18 22% YoY, Q3 18 10% YoY. This gives 245m units shipped during the next fiscal year which is below current expectations. The net result is that we think expectations for fiscal 2018 need to come back somewhat which is likely to trigger a sell -off in the shares bringing the valuation down somewhat. Hence, the time is right to take some money of the table and put it somewhere else.
Tencent, Baidu and Microsoft have less immediate downside in our opinion.”

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