- Apple stock has performed poorly following WWDC 2016.
- However, the company has delivered a meaningful breakthrough that’s worth noting.
- Apple Inc. has devised a viable solution for transitioning TV to the Internet.
I believe that the recent weakness in Apple stock price is due to broad weakness in equity flows in North America as opposed to fundamentally driven selling. Furthermore, with analysts already revising their stance going into the event, and expectations by well-reputed journalists/media already lowered, it wasn’t like Apple (NSDQ:AAPL) could have done even further damage to its own valuation. It’s gotten bad, but certainly not worse. And quite frankly, some of the new announcements at WWDC 2016 were actually quite good, but there weren’t enough near term catalysts to imply a substantial revision to earnings/revenue assumptions for the duration of the year, and expectations on feature improvement for iPhone 7 have declined given on-going leaks and comments from analysts closer to the Apple supply chain.
While Apple is the most followed stock among analysts on the sell/buy side it’s become particularly rocky given the massive variance in financial comps y/y and the substantial drop off in emerging market demand. It’s been a pretty bad year (relatively) for Apple investors. Visibility is quite low on FY’17 results, but I’m still maintaining the stance that there will be some recovery in iPhone demand and I also believe some of the new features announced at the conference were broadly ignored. Thankfully, it gives me room to insert my own comments on what was actually important coming out of the event, so you won’t suffer from another regurgitated summary on WWDC 2016.
Apple’s disruption in TV will be bigger than music
Ironically, what was really surprising was the better integration of conventional media/channel apps on Apple TV, which bypasses the conventional cable set. This is important because Apple’s approach is quite compatible with the pre-existing cable operators and channels thus creating a viable pathway for convergence of standards for linear programming and OTT bundles like Netflix, Amazon and Hulu.
That being the case, I believe Apple can saturate a meaningful percentage of the set top box market with incremental upside in the form of feature additions that can be added on an annual cadence. In other words, Apple is really committed to TV as its next major growth category, as many of their other announcements were actually marginal in nature. New Siri updates aren’t going to drive substantial improvements to iPhone sales, as the incremental software feature is included in a major update for pre-existing iPhone users. As such, the focus has really shifted to new opportunities beyond the core handset business, which is why I’m actually excited.
In a prior article titled: Intel’s Efforts in the Enterprise Will Reward Shareholders in 2017, I go into much deeper detail on the underlying difference in standards between conventional broadcast/cable versus broadband internet. Essentially, there’s going to be a convergence of TV with the Internet and it primarily hinges on the difference in encoding standards for the two mediums. However, Apple TV actually bridges that gap quite effectively without damaging the pre-existing business models of cable providers (Comcast and DirecTV) and media franchises like Walt-Disney and Time Warner Inc.
In other words, Apple is thinking big because it will save the TV industry (similar to how it saved the record labels back in the Jobs era). This is what actually mattered at WWDC 2016, quite literally. I honestly couldn’t believe the massive progression Apple has made in this specific avenue as opposed to all of the tertiary commentary on Watch OS, Mac OS and Siri. While those announcements were important, they were incremental advances whereas the development in TV was more strategic and indicative of massive shifts in the media space that could not be addressed any more effectively than by Apple itself.
Apple still moves industries, and that’s something I’ve been critical of lately. But, those concerns have actually abated a little more, because if Apple is intent on ramping its software revenue (which has phenomenal gross margins) then it needed to disrupt another category: the living room.
So, how exactly is Apple disrupting the TV-industry? Well, the company has developed a feature called single sign-on for Pay-TV applications. This makes it extremely simple for users to access channels via Apple TV using the subscription of a Pay-TV provider. It effectively transitions pre-existing cable subscribers to an application interface without the hassle of excessive log-ins. The back-end partnerships to orchestrate this is unique to Apple, and it creates an enviable durable advantage that competitors cannot easily replicate.
When a TV stream is operating out of an application environment, it’s spinning off of server instances inside of a datacenter as opposed to the conventional format by which compression occurs via a standardized bandwidth threshold based on MPEG 2, which is the current digital TV standard. The critical component for TV broadcast hinges heavily on whether there’s a successful transition to 4K, as the technology is moving faster than the industry can mobilize an effective transition.
It’s likely that Apple TV will eventually integrate the HEVC standard, but it still decodes MPEG 4 or what’s referred to as H.264. This basically makes the file size smaller utilizing less network bandwidth allowing for acceptable 4K streams. The next generation compression technology, i.e. HEVC will further reduce the usage of bandwidth, which makes 4K content via broadcast even more accessible. The beauty of transitioning to the data center is the creativity it provides ESPN, NFL TV, MLB TV, etc., as on-demand live analytics of sports statistics with 3-dimensional views and perhaps VR experiences will become far more feasible. This gives an effective transition for network operators to not only deploy 4K media but to do so in an integrated ecosystem.
Andrew Uerkwitz from Oppenheimer Co. mentioned in a recent note:
Since we picked up coverage of Apple, we have been arguing that Apple’s core capability is human interface. Superior human interface designs are ubiquitous in Apple’s hardware and software, allowing the company to deliver unique user experience and command a substantial pricing premium and customer loyalty.
I have to concur with Uerkwitz, and more specifically his comment on human interface is what’s propelling my own assumptions as to why Apple has made substantial inroads on TV. Apple has made miles of progress when compared to competing platforms like Xbox and PlayStation, as Sony doesn’t emphasize software or ecosystem development and is focused on gaming. Microsoft offers the ability to connect a TV box to Xbox, but it’s not software driven or ecosystem friendly.
Matt Burn at Tech Crunch is wrong on his assessment of Apple TV as he states:
“Gaming was key to the original pitch for the latest generation of the Apple TV. But so far the Apple TV has not become a gaming platform even though the 4th generation Apple TV packs enough horsepower to run most mobile games on the biggest screen in the house.”
It’s not pertinent as to whether Apple does compete with other game ecosystems because the cost of integrating higher-end hardware from AMD would be cost prohibitive for consumers looking for a seamless TV experience. TV is fractured and technically the older demographics are the ones who still tune into TV. What’s the point of emphasizing a feature that doesn’t even address the core demographic that Apple is intending to target?
Furthermore, it’s really the simplicity of Apple TV that has made it the most viable product for transitioning the older demographic into an internet friendly environment. Basically, gaming is not the core functionality of Apple TV, and while it was emphasized at prior events, it’s not intended to be a fill-in for hard core gamers. Apple TV could be an extension to mobile gaming, but to anticipate meaningful adoption from gamers even with the implementation of better hardware and controller functionality defeats the intended purpose of the device. A controller is less user-friendly for those wanting a simple remote that accesses content on demand.
In other words, Apple’s sticking to its platform and software specific strengths. I believe it will continue to do so. Disrupting the television ecosystem is more valuable than attacking consoles. So, game consoles and Apple TV can co-exist peacefully.
It’s a huge win for Apple, but an even bigger win for media and cable operators as well. From my understanding Apple already monetizes the subscription revenue at an 85/15 split for TV apps, it’s not exactly clear how this will work with the cable operators as opposed to the channel/app providers. I’ll have to check in with the media commentary from reputable analysts on that specific front.
However, I will create model assumptions on both hardware and software revenue from Apple TV in a future article. I believe, Apple’s presence in TV was the most important takeaway from WWDC 2016. It’s the killer app/product that will converge broadcast and online streaming.
I continue to reiterate my $107.72 price target and buy recommendation.