Will The IPhone SE Create New Growth Runways For Apple?

  • Apple has launched a mid-range iPhone, SE, to a lukewarm reception.
  • Most investors fear that the new smartphone could cannibalize sales of higher-end smartphones and lower Apple's margins.
  • But is the situation this bad or are investors unnecessarily pessimistic about the iPhone SE?

Apple's (NASDAQ:AAPL) launch of iPhone SE, a smaller low-cost iPhone aimed at the mid-range market, has mostly been met with a lukewarm reception from the market. On the outside, the 4-inch iPhone SE looks very much like iPhone 5S which is no longer available in Apple retail stores. On the inside, however, the small iPhone boasts much more juice than 5S including an A9 CPU with M9 motion co-processor, an A9 image signal processor, a 12MP rear camera, 802.11ac Wi-Fi radio, NFC radio/Apple Pay support, support for LTE download speeds of 150Mbps, support for hands-free ‘‘Hey Siri,’’ Live Photos support, and 4K video capture.

That’s a pretty impressive set of specs that puts the new iPhone at par with iPhone 6S. Apple says the new iPhone is meant for people who want a smaller-screen iPhone. The biggest tradeoff is that SE does not have the same battery life as its larger predecessor and that reading and playing games will be a bit harder on the smaller screen.

Base model 16GB SE will sell for just $399 unsubsidized compared to 5S which started at $450; iPhone 6 for $549 and iPhone 6S for $649. 64GB SE will go for $499. Pre-orders started on March 24 while the new iPhone will start shipping from March 31. Apple says the smartphone will be available in 110 countries by the end of May.

The market's reaction to the launch has largely been muted as many investors worry that a lower-priced iPhone will not only cut into Apple's margins, but might also cannibalize Apple's higher-end iPhones. Investors trying to gauge the possible effects of iPhone SE on Apple stock should take note of the fact that Apple stock usually falls by as much as 5% whenever the company launches a new product. This is something peculiar to Apple since stocks of most other tech companies make substantial gains when the companies announce the launch of new products. Apple stock price is marginally down since the announcement, but should not surprise anyone if it falls by a couple of points over the coming days.

The good news, however, is that more often than not Apple stock goes on to make good gains six months to one year after the launch of new products as shown in the chart below. iPhone 6S has not been included in the presentation because it has been available in the market for less than a year.

Apple Stock Price Performance After Launch of a New iPhone

AAPL-1

It’s therefore too early to judge the actual effect that the new iPhone will have on Apple stock based on the lackluster response from the markets.

But these fears might be overdone. While there is no denying that some degree of cannibalization is bound to occur with the cheaper iPhone depressing sales of its higher-priced siblings, the increase in Apple’s TAM, or total addressable market, mainly through Android users jumping ship is more likely to offset any current Apple customers who shift to the mid-range smartphone. During the last two quarters, Apple said that much of its growth has been coming from Android users who are switching camps. The availability of a cheaper iPhone is likely to accelerate this process. Credit Suisse’s Kulbinder Garch estimates that iPhone SE might cannibalize 16 million iPhone 6/6S units over time:

“While the market will be concerned on cannibalization of current high end users, we believe this will largely be restricted to 6/6s 16GB consumers and assume cannibalization over time of 16mn units.”

Apple is, however, likely to see a disproportionately larger gain in TAM which Goldman thinks could be as big as 150 million new iPhone users over the next three years.

JPMorgan’s Rod Hall belongs to the camp that thinks the market could be underestimating the real potential of iPhone SE and insists Apple’s margins are not at risk:

“If we assume that Apple can pretty easily take 40% of the $400-$450 market then we arrive at potential for 17m incremental iPhone units in 2016. At an ASP of $399 this equates to $6.9bn of additional revenue. We estimate that the iPhone carries gross margin of around 45% but to be (potentially overly) conservative let’s haircut that to just 40%. That’s $2.8bn in potential incremental profit. … To drop down to the earnings line you have to ask yourself where these phones might be sold. Our guess, not much in the US. So let’s conservatively assume they pay 15% tax on this profit (they would more likely pay nothing); this would leave Apple with $2.3bn of additional earnings or $0.43/share of additional EPS. That represents 4.3% upside to our current $9.89 EPS estimate and 4.6% using the lower $9.09 consensus. Not bad for a day’s work in Cupertino.”

This is not to say that iPhone ASP will remain unaffected. Apple’s ASP usually rises significantly after the first full quarter after the introduction of a new iPhone. But this is usually the case because buyers tend to gravitate more strongly towards the higher memory configurations of the new iPhone which are usually more costly. But 64GB SE will sell for $499, way lower than iPhone 6/6S. So it’s almost inevitable that iPhone ASP will fall starting from calendar second quarter this year.

The popularity of iPhone 6, however, could help balance things out. Consumer Intelligence Partners, or CIRP, estimates that 67% of buyers bought iPhone 6S during the first quarter of its launch in September 2015 compared to 75% who purchased iPhone 6 in the first quarter after its launch in September 2014. This means that as many as 30% of people who bought an iPhone last quarter purchased an iPhone 6. People who need a bigger-screen iPhone will have the two models to choose from since they both sport a 4.7-inch screen. Their much higher selling prices are likely to keep the iPhone ASP respectable.

Ultimately, iPhone SE could help Apple become an important player in the mid-range smartphone market. This will help create new growth runways for the company with its high-end markets becoming increasingly saturated.

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