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Investment Overview for Apple (NASDAQ:AAPL)

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Below are key drivers of Apple's value that present opportunities for upside or downside to the current Trefis price estimate for Apple:

iPhone

iPhone market share: Apple's iPhone market share has increased at a fast rate from around 0.3% in 2007 to 8% in 2012, as per our estimates. Going forward, we expect it to continue to increase steadily to around 15% by the end of Trefis forecast period. The iPhone’s unique touch screen interface, and the intuitive and user friendly features are some of the factors behind its success. Also, the updated iOS boasts many new features including the much touted voice recognition software, Siri, the iCloud, Apple's new Maps feature and the iMessage. Apple launched the iPhone 5 in September 2012 and saw record orders. It seems very likely that the latest in the iPhone series will turn out to be Apple's best-selling iPhone yet. In case one out of five mobile phones is an iPhone in the long term, or in other words, iPhone's market share increases to 20% by the end of Trefis forecast period, there could be an upside of 25% to our estimate for Apple stock. On the other hand, if Apple iPhone market share increases slowly to 10% by the end of Trefis forecast period, there could be a downside of around 11% to the Trefis price estimate for Apple stock.
iPhone gross margins: Apple's iPhone gross margins have declined in the past from 62% in 2007 to around 51% in 2010. However, Apple managed to improve its margins in 2011 to 55%, as per our estimates. Fierce competition with Android-based smartphones from Samsung, Motorola and HTC, as well as RIM, Nokia, etc, may have led to a discounting of older iPhones but component costs moved sharply in its favor to help Apple stem the decline in 2011. However, iPhone's margins seem to have resumed their declining trend by falling slightly to 53% in 2012 and we expect it to continue doing so gradually to around 34% by the end of Trefis forecast period. In case iPhone margins decline more rapidly to around 25% by the end of Trefis forecast period, there could be a downside of around 10% to our estimate for Apple stock. On the other hand, if iPhone margins decline to only around 45% over the Trefis forecast period, there could be an upside of 10% to our price estimate.

For additional details, select a driver above or select a division from the interactive Trefis split for Apple at the top of the page.

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Apple makes money primarily by selling mobile phones, computers, and portable media players to consumers worldwide. Apple's well known consumer products include the iPhone, Macintosh ("Mac") computers, iPad and the iPod media player. In addition to selling hardware, Apple makes money by brokering the sale of music, films, TV shows, games, and iPhone software applications through its iTunes platform.

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We believe the iPhone segment is more valuable than the Macintosh and iPod segments for two primary reasons:

Large mobile phone market

We estimate that about 1.8 billion mobile phones were sold worldwide in 2012 compared to 217 million notebooks, 147 million desktops, and 145 million portable media players (like iPod and Sansa). Although Apple's iPhone market share within the mobile phone market is smaller than its market shares within the PC and portable media player markets, the underlying market opportunity over the forecast period is much larger.

High iPhone profit margins

We estimate Apple's iPhone gross margins were about 53% in 2012 compared to around 29% for Macintosh.

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Tablet growth not cannibalizing Apple product sales

Apple already has a substantial share in the high end of the PC market with its Mac line of products, and the iPad now allows the company to tap the lower price range. The iPad Mini will allow the company to do so even more.

Although tablets are believed to have cannibalized a good chunk of PC sales, Apple’s Mac sales have actually maintained a solid growth pace. Rather than cannibalizing Apple’s own product sales, the iPad appears to be creating a halo effect and lifting sales for the company’s other products.

Supply chain management a major risk for Apple

Companies like Apple are more concerned about component supply related issues rather than demand issues. The 2011 earthquake in Japan created quite a few headaches for Apple with regards to component supplies, as many Apple suppliers are Japanese firms. A recurrence of similar supply chain issues, not only in terms of natural disasters but also price fluctuations, poses a major risk to Apple in the future.

Smartphone software features playing a major role in their sales

Slowly the mobile phone software is becoming more important than its hardware. The mobile phone apps' selection is also an area of growth for mobile phone companies. Features like integration with social networks and multi-tasking ability are some of the features that mobile phone companies have come forward with over the last few years. Going forward, cloud-based applications will gain in importance.

Apple, Google, RIM and Nokia have been coming up with new versions of their OSes and adding new features. Samsung, which realized that they have a good hardware but not so good software, came up with their own new Bada OS to compete in the smartphone market. Apple added an innovative voice recognition software, dubbed Siri, in their iOS 5 update, which has since proved to be one of iPhone 4S' biggest selling points. Siri is also included in the recently released iPhone 5.

Touch screen smartphones gaining popularity

After Apple iPhone’s success, every mobile phone vendor is bringing this feature to the market. For example, RIM recently came out with this feature with slight improvements to their touch screen interface. Samsung and Nokia have also come up with their own touch screen smartphones.

Browser improvements to smartphones

Mobile phone companies are looking to improve browsers so as to have faster browser access along with less bandwidth consumption. Nokia acquired Novarra in this regard.

Increasing processor speeds

Apple's new A5 processor is a dual-core affair, and the company claims that it's twice as fast as its predecessor, the A4, and capable of running at up to 1GHz. Some of Qualcomm’s Snapdragon processors sport an even higher 1.2 GHz speed.

Gray market proliferation hurting mobile phone companies

Emerging markets such as China, India and Africa have recently seen the growth of unlicensed and illegal mobile phone vendors that peddle their products on the gray market. Since these phones are unlicensed, they are sold at much cheaper prices. This has started to hurt the established players.

Increasing smartphone demand and competition

In June 2007, when Apple entered then nascent smartphone market with the iPhone, Nokia and RIM were the only players in this segment. iPhone's success led to the entry of other players in the market, that has seen a huge spurt in demand in the recent years. Today, consumers have a huge array of smartphones to choose from, including but not limited to the Apple iPhone, RIM's BlackBerry, Android smartphones from Samsung, HTC, etc and the demand is only going to increase from hereon.

Increasing Wi-Fi and mobile broadband availability

The increasing availability of mobile high-speed Internet access creates opportunities for smartphones to move beyond e-mail and basic Internet surfing to new competitive fields. The availability of mobile TV shows, films, games, photo sharing, software applications, and video conferencing are potential points of differentiation among smartphone competitors.

Shift from desktops to notebooks (and netbooks)

We believe that the recent shift of consumer preferences from desktops to notebooks will continue as the performance and pricing gap between desktops and notebooks narrows.

Demand for e-readers and tablet PCs

With Amazon Kindle and Apple iPad, the demand for e-readers and tablet PCs has increased at a rapid rate. The recent introduction of the Kindle Fire and the Nook tablet saw huge orders being placed during the holiday season. At the same time, RIM and Motorola met with dismal failures. We believe that the tablet market is still in a stage of infancy and as new competitors such as Dell emerge and older competitors improve on their existing tablets, the demand in this market segment is set to rise.

Trefis Forecast Rationale for iPad Pricing

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This represents the average price of an iPad.

iPad pricing is distinguished by the version of the iPad as well as the memory and wireless capability.

The new iPad pricing is as follows:

16 GB

$499 with WiFi
$629 with WiFi and 3G/4G

32 GB

$599 with WiFi
$729 with WiFi and 3G/4G

64 GB

$699 with WiFi
$829 with WiFi and 3G/4G

The older models of the iPad have lower price points, as does the iPad Mini. The iPad Mini pricing is as follows:

16 GB

$329 with WiFi
$459 with WiFi and 3G/4G

32 GB

$429 with WiFi
$559 with WiFi and 3G/4G

64 GB

$529 with WiFi
$659 with WiFi and 3G/4G

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iPad was launched in April of 2010, and Apple launched iPad 2 in March 2011. The HD iPad and iPad Mini were launched in 2012.

iPad's pricing is based on the amount of memory included and whether the device is 3G/4G capable. Buyers may be deterred from purchasing an iPad with 3G/4G not only because of the higher price tag for the device, but also because of the monthly fees to AT&T/Verizon/Sprint for use of their mobile networks. An AT&T/Verizon/Sprint data plan is necessary (in the U.S.) for transferring data over these networks. For example, AT&T charges $15 for up to 250 MB of data per month, or $30 for 3 GB of data per month, or $50 for 5GB of data per month. This raises the total ownership cost for an iPad with 3G/4G by $180 in the first year of ownership alone.

iPad's average pricing reduced from $647 in 2010 to $523 in 2012 due to an increasing mix of the older models that were offered at discounted prices as well as the introduction of the lower-priced iPad mini. We believe that Apple will reduce ${forecast} over time.

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Trefis considered the following factors for its forecast:

Pricing to decline as Apple slashes prices of older iPad versions
- After Apple released HD iPad in 2012, it reduced the pricing of the iPad 2 16 GB to $399.
- The Kindle Fire and Nook tablets were launched at $199 and $249 respectively and saw loads of buyers lining up for the extremely cheap tablets. As the tablet market matures and includes more price-conscious consumers, Apple may be forced to bring down the prices of the future iPads as well.
- The cost of ownership for the 3G/4G iPads can be even higher than the purchase price since an AT&T/Verizon data plan is necessary (in the US) for transferring data over 3G networks. For example, AT&T charges $15 for up to 200 MB of data per month, $25 for 2 GB of data per month and $45 for 4GB of data per month. In comparison, the Kindle Fire and the Nook do not come in 3G versions.
Declining netbook prices could force Apple to reduce iPad's pricing
- Apple has deliberately not forayed into the low priced netbook market as it is a highly competitive market with vendors living on razor thin margins.
- However, the iPad could be cannibalize the netbook sales of competitors since the iPad does have comparable capabilities to some netbooks. Pricing will play an important role as some consumers opt for cheaper devices in a weak economy. Most of the netbooks are priced below $400 compared to the $499 price for the basic iPad model.
iPad Mini has lower price point
- Apple launched the iPad Mini in 2012. It has a 7.9-inch screen and weighs less than 0.7 pounds. We expect it to compete effectively with some of the smaller tablets and readers in the marketplace. It is offered at a lower price point (starting at $329) than the newest iPad. As iPad Mini sales ramp up over the next few quarters it will likely result in pressure on average iPad pricing.

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How Does Trefis Modelling Work?

How do we get the historical numbers for this chart?

Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.

Who came up with the Trefis forecast for future years?

The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.

How does my dragging the trendline on the chart impact the stock price?

We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.

See more on: DCF Methodology

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