There are important trend lines to note as we unpack Apple’s latest earnings. Perhaps one of the more interesting observations was a dynamic I had not fully internalized before, which was the degree in which a good quarter for Apple impacts a number of other tech stocks. I read several investor notes that hinted at this but did not show exhaustive evidence, that when Apple does well, it seems to lift investor confidence and tech stocks, and sometimes the overall index seems to see a lift. This could be due to confidence, and Apple viewed as a bellwether for tech as a whole, or for other reasons, but I find that fascinating. A health Apple is helpful to a healthy tech ecosystem.
A few points are worth analyzing related to Apple’s latest earnings.
For iPhone, there were a few things that are worth noting. The first is what most news outlets pointed out which was iPhone revenue being less than 50% of Apple’s total revenue for the first time. This simultaneously a story and a non-story. It’s a story because it is notably the first quarter in many where this has happened. But, this will also only likely be a habit of a mid-year quarter. The Dec quarter will be a large iPhone quarter revenue-wise, as will the March quarter. The June and September quarters will see dynamics similar to this one where iPhone is closer to 50% for the foreseeable future.
The worry, I see, is the potential narrative to distort the incorrect narrative that Apple is the iPhone company. I’ve never viewed Apple this way, as I see Apple more as a customer experience company which can manifest itself in the shape of any number of products. The iPhone is simply the biggest hit Apple has had to date, but not necessarily its only massive hit. I worry when December and March quarters come around that the focus goes back to largely on iPhone and then we are back into confusing public narratives. The iPhone is great, but it isn’t the end of the story.
Taking the long view on iPhone, for a moment, it looks as though after a period of hyper-growth followed by an overall market slowdown, iPhone sales are stabilizing. This was the main thing I wrote about to watch when all the sky is falling articles were written as Apple reached peak iPhone. We knew it would decline, and the question was what number of annual sales would Apple stabilize at for iPhone. It looks like Apple’s annual iPhone sales will stabilize in the 189-200 million unit range for at least the next two years. This would indicate roughly a quarter of their base upgrading each year and around 4 to 4.5 years to refresh their base to modern technology and the average Apple user standardizing on around a three-year refresh cycle.
The only material possibility to change this is if some dynamics around trade-in or another stimulus from Apple can move their base to upgrade on a shorter cycle regularly, but I do not see that happening for the bulk of their customer base. From the data and sales trends we see now, it seems as though the nearly billion iPhone users out there have settled into predictable buying patterns and that is a good thing.
Wearables are the Future
I’ve been long Apple wearables since day one that I tried Apple Watch. It was clear to me back then Apple has a future with computers we put on our bodies and the wrist was the first bit of body real estate Apple tackled. AirPods are Apple’s play at the ears, and sometime in the next five years, we may see their first attempt to bring computers to our eyes. My theory all along is all these Apple wearables will create a complete system (or computer) and work as a synchronous whole going beyond even where iPhone could go.
Apple’s wearable business saw 48% growth with AirPods continuing to penetrate into Apple’s base and Apple Watch now on a continued growth trend. The one stat that stood out to me the most with Tim Cook’s commentary was how 75% of Apple Watch sales in the June quarter were to brand new Apple Watch owners.
We have studied Apple Watch owners greatly and know they are a loyal bunch, who also hold onto their Apple Watches a long time. Series 4 was the first Apple Watch that materially moved the base to a new Watch, so it is encouraging a good portion of quarterly sales are to new customers. The Apple Watch installed base is likely in the 60 million range by now via my model and growing.
With wearables, Apple is laying a new foundation for a new paradigm of computing.
Services Ebbs and Flows
Commentary around Apple’s services growth-focused more on it being a bit “light.” A key debate here is whether services have seasonality like much of Apple’s other product lines or whether we should assume some level of a bell curve trend. This clearly depends on the quality of Apple services and ability to compete, but beyond those things like overall subscription billions (now over 420 million) as well as the continued growth of iCloud an Apple Care will likely steadily contribute.
Apple didn’t seem to give us much about Apple News+, but I take the lack of commentary around conversion rates to suggest Apple News+ is not off to the start Apple hoped. When Apple Music came out, management was quick to give us some numbers around subscriptions and with the Apple News+ absence of that I take it as a negative.
We know Apple Card is coming out in August, and Apple Arcade and Apple TV+ will be launching in the fall. Commentary strongly suggests these will be paid services, likely charged a la carte to start, which is not a surprise. The service I am most interested in is Apple TV+, and beyond Apple Music, TV+ has the most potential upside of all Apple’s services in my mind. Consumers simply love entertainment content and video in particular.
Modeling services are going to remain tricky, and given the huge investment producing a quality, video is, we should assume Apple’s services gross margin will go down as they grow the video platform.
Lastly, on services, the points I made about iPhone stability and Apple’s commentary the installed base continues to grow, is important to the services narrative. iPhone customers continue to go deeper into the Apple ecosystem of products and services the longer they are customers. Which means as Apple grows its base, they have a highly engaged and easily accessible addressable market in their user base. This is not a dynamic I see of any other consumer tech company.
The biggest question for me is how far Apple takes their services beyond their ecosystem. As I pointed out last month, Apple’s inroads to India may be through their services, but those services need to all run on Android. Tim Cook’s commentary seemed to suggest, for now, that some Apple services will be cross-platform and others will be tied to their devices. I think this is the correct approach to start, but I’m not convinced this is the best strategy for the long-term. But again, this is a key debate.