Apple Softens Stance On iPhone Discounts As iPhone 5 Launch Nears

Sluggish iPhone sales in the final quarter of FY 2012 seem to have finally forced Apple’s (NASDAQ:AAPL) hand. In a departure from its usual hardline stance on iPhone pricing, the tech giant has authorized the Apple Store employees to match the discounts offered on the iPhone by other retailers such as Target (NYSE:TGT) and Best Buy (NYSE:BBY). ^[1] This comes on the back of Sprint (NYSE:S) slashing $50 off the subsidized iPhone 4S price last week. While it is early to read into these developments considering that the iPhone 5 launch is nearing and the holiday quarter will shortly be upon us, it does seem that a highly competitive smartphone market as well as the one-year product cycle of the iPhone are finally catching up with Apple.

See our complete analysis for Apple stock here

Rising Competition

In a recent report by Strategy Analytics, Apple’s primary smartphone competitor, Samsung, managed to ship more than 50 million smartphones in Q2 2012, almost twice as many as Apple during the same period. This followed the 44.5 million smartphones that Samsung shipped in the previous quarter, ahead of Apple’s 35 million iPhone shipments for the same period. While a major part of the Korean giant’s success can be attributed to its much larger portfolio of smartphones, it was also able to take advantage of flagging interest in the two-quarter old iPhone 4S to drive demand for its high-end flagship smartphone, the Galaxy S III. Samsung managed to sell more than 10 million units of the S III in less than two months since the launch. (see Apple Falls Behind Samsung In Smartphone Sales But iPhone 5 Is Near)

Samsung’s growing appeal among high-end consumers is a concern for Apple, which has until now only dropped the prices of its older models to appeal to the price-sensitive. If Apple continues to maintain status quo on the current year long product cycle for the iPhone, it gives competitors such as Samsung leeway to grab market share in the lean periods of iPhone demand as was seen in the last quarter.

Holiday quarter important for Apple

There is however no near-term pressure on Apple to change its policy since Samsung’s big market share gains have largely come at the expense of others such as Nokia and RIM as opposed to Apple, which lost less than 1% market share last quarter. With rumors about the iPhone 5 circulating in the media, we believe that many customers may have postponed purchasing iPhone in anticipation of the iPhone 5. This could be easily gleaned from Apple’s last quarter financials as well, which showed that the company’s margins came under pressure from a drop in the iPhone’s average selling prices (ASPs). What this means is that the iPhone mix tilted toward the low-end, probably because many high-end smartphone buyers deferred their iPhone purchases until the launch of the iPhone 5, while lower-end purchases remained steady.

The pent-up demand might mean a phenomenal holiday quarter for Apple, like last year, but it also puts its stock under the risk of the iPhone 5 not meeting customer expectations. We believe the iPhone 5’s performance in the December quarter is critical since it determines the company’s strategy on the iPhone product cycle, going forward.

Meanwhile, Apple’s margin compression seen last quarter may continue this quarter as well, as expectations of an imminent iPhone 5 release strengthen and Apple is forced to move older inventory by offering discounts.

However, the fact that emerging markets are still a largely unexplored market for Apple keeps the upside potential intact. China, for example, holds a lot of promise for Apple considering the huge 2G subscriber base that the carriers there are trying to transition to 3G (3G penetration is currently only 17% in China and growing at a good rate). A deal with China Mobile, the largest carrier in the world by subscriber base, is looking increasingly likely following Qualcomm’s recent announcement and Apple’s similar deals with the other two carriers. This deal would be crucial for Apple as it would instantly double its addressable market for the iPhone in China and could act as the next big boost to its stock. This is especially true because the iPhone accounts for more than 55% of the company’s value, according to our estimates. (see China Mobile In Talks To Offer The iPhone; Can Alone Take Apple Past $800)

We have a $700 price estimate for Apple’s stock, about 12% ahead of the current market price.

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1. Apple Retail Stores Offering to Match Discounts on iPhones, WSJ, August 9th, 2012 [↩]