- Apple is believed to be releasing a mid-range handset with improved internals, branded as the iPhone 5se.
- The impact on sales isn’t yet clear, but pricing would need to fall within the $400 to $500 range to drive meaningful shipment growth.
- I believe analyst expectations are too aggressive as pricing is expected to be marginally cheaper when compared to prior generation models.
Apple (NASDAQ:AAPL) is believed to be releasing a mid-range refresh to its line-up of iPhone’s called the iPhone 5Se. It’s expected to be released on 18 March 2016. It’s not yet clear whether Apple will capture enough incremental market share with its upcoming 4-inch flagship, but investors should anticipate the mid-range iPhone to capture some market share, and drive some refresh.
There are a lot of question marks with regards to the capabilities of the mini iPhone, as the upcoming handset may or may not come with force touch capabilities. The price point is up for debate as well, but it’s likely to be a sub $600 handset.
Is it just a rumor?
Well, there’s plenty of supply chain data that ties Apple to a smaller form factor iPhone, so it’s worth anticipating. After all, it’s hard to keep secrets anymore, as many noteworthy analysts were mentioning that the smaller form factor iPhone was going to be released in the late Q1’16 time frame. Now, with only two quarters remaining after release, I’m skeptical of the impact it could have on sales/earnings, and I believe that the smaller form factor will cannibalize sales for prior generation models like the iPhone 6/Plus.
Furthermore, I’m wondering if Apple will continue its shift to broaden its SKUs given the complexity of managing the supply chain for three form factors. It also takes away from the simplicity of Apple’s product cadence as they will need to market three different iPhone variations and manage inventory closely to avoid over-provisioning components for other form factors. The added confusion from an additional iPhone almost makes it a deal breaker, but then again, I’m sure many at Apple would disagree.
While there’s not a whole lot of certainty to sales, there’s no denying that 60% of iPhone users have not upgraded from the iPhone 5S. In other words, the 5S is still a very serviceable phone, and it’s not clear whether users will upgrade to the 5se upon updating internal components without a meaningful improvement to base storage or a better screen. As such, I view the iPhone 5se as more of a fan service device for those who prefer a smaller form factor. It’s not yet clear whether Apple will remain committed to smaller form factors.
If consumers upgrade to the iPhone 5Se, the prospects of further ASP improvement diminish considerably. Nonetheless, the analysts at RBC Capital Markets are in favor of the idea:
While we think the model could provide some upside bias to FTM EPS, the magnitude of this may be largely driven by what ASPs does AAPL roll-out iPhone 5se with. Assuming $550 ASP, net 10M new iPhones (post cannibalization) it would add $5.5B in sales and $0.23c in EPS or ~2% in FY16E. At a minimum, we think iPhone 5se provides a cushion to EPS expectations and could help drive a replacement cycle for those sitting on 3+ year old iPhone 5c/5s especially in emerging countries like India, which AAPL spoke extensively about at the recent EPS call.
After cannibalization, RBC anticipates the market to really open up, implying 10 million net adds for FY’16. This implies that Apple’s mid-end handset line-up could contribute 20-30 million units in incremental sales if it were sold for an entire fiscal year. This seems somewhat aggressive, but could be reasoned with assuming lower pricing does materially impact demand in emerging economies. Since Apple is releasing the iPhone 5Se during seasonally weak quarters, I come away with the impression that these assumptions could prove to be aggressive. It's also worth noting that the lower pricing does reduce margins, and if consumers find the value proposition of a lower-end handset reasonable, this will reduce the concentration of sales in higher-end phones.
20 to 30 million incremental units a year is aggressive. It’s just re-marketing after all, which reduces the sales of prior generation models. In Q1'16, 29% of iPhone sales went to prior generation models, which implies that 22.37 million lower-end iPhone's were sold, based on a UBS weighted average retail price survey. Furthermore, analysts at UBS anticipate 7% growth in iPhone sales next year, so if it's 23.93 million prior generation/low-end unit plus the incremental 5 million units per quarter, then we're looking at low-end units reaching 28.93 million units or more in Q1'17. RBC Capital estimates that consolidated revenue will grow by 2% y/y in Q1'17. So, they're probably anticipating the incremental unit assumption to be less material when compared to other analysts due to cannibalization in conjunction with lower ASPs and are more conservative in general on iPhone refresh due to elongation of the iPhone refresh cycle.
Other analysts anticipate incremental units of 40 million, but they also anticipate ASPs of $400 to $500, which is a full $100 below RBC's estimated range. In a report released in November 2015, Credit Suisse illustrates the impact of a sub-$500 iPhone, "Assuming Apple launches a new dedicated 4-inch device that is sufficiently differentiated, we look at smartphone volumes by price point and believe this would add approximately 40mn units to the $400-$500 ASP TAM in CY17." Assuming that sales do materialize at that rate, it's implied that between the March and December quarters, the incremental net addition is 13.33 million units per quarter, which seems somewhat reasonable but I find it dubious that Apple will introduce the handset at $450. They may lower pricing to $450 after they release the iPhone 7 in September of 2016 due to comparisons to iPhone 6S/S+, which have superior feature sets when compared to the iPhone 5Se when based on prevailing rumors over technical specs.
If in the event Apple does release a phone in that price range it could drive some unit growth, but given the lack of success Apple had experienced with the iPhone 5C, the iPhone 5Se/6S/6S+ may struggle to reach 40% of the iPhone sales mix. I view the 5Se as a replacement to the iPhone 5S, as they progress to the iPhone 7 generation. In other words, I anticipate the relative mix of prior/mid-end handsets to continue to uphold, which means that the iPhone 5Se will be factored back into the 30% historic sales mix for prior generation/mid-end iPhone handsets rather than being a meaningful contributor to total installed base adds. Now, I may be incorrect, but history has a tendency of repeating. If I'm not mistaken, consumers tend to avoid mid-range purchases in favor of current generation flagship iPhone products. Furthermore, emerging markets exposure comes from the re-sale of used iPhone models spanning from the iPhone 4S to iPhone 5S. I find that attempts to recapture this portion of the market will prove unsuccessful due to pricing disparity, and longevity of useful life following the introduction of iPhone 5S.
Now, I may be incorrect, but history has a tendency of repeating. If I'm not mistaken, consumers tend to avoid mid-range purchases in favor of current generation flagship iPhone products. Therefore, I view the impact as more incremental in nature. I think this isn’t a significant near-term needle mover to sales/earnings as implied by other analysts. In other words, it has the makings of being an iPhone 5C rather than a successful new product.
If Apple readjusts the pricing of the 5se, there’s a chance that it could be far more successful, but pricing would need to fall within the low $400 area to drive material shipment demand in emerging markets. Otherwise, Apple faces competition from used iPhone 5S models, as there are plenty of older generation models floating around in grey markets across China. Furthermore, it's hard to tell if Apple is committed to releasing mid-range iPhone models in each successive generation going forward. Therefore, this special edition iPhone could be temporary and may not necessarily indicate a shift towards a three-tiered iPhone cadence. However, if Apple sustains an iPhone cadence that's inclusive of 4-inch models, the long-term implications may result in further mid-range market penetration, but there's not a lot of data suggesting that Apple is committed to this price category.
Apple is really competing with itself, and that's why I'm so skeptical of whether they will succeed to any meaningful extent. I think investors ought to lower their expectations going into Apple's March launch event. I continue to reiterate my sell recommendation and $87.15 price target.