- Apple’s upcoming iPhone 6 carries significant upside assuming production runs are inclusive of sapphire.
- A pricing tier may offset supply chain constraints.
- Assuming Apple can earn higher incremental profit from each consumer, Apple should have no difficulty with meeting FY 2014 consensus EPS estimates.
There has been a lot of speculation over whether or not Apple's (NASDAQ:AAPL) upcoming flagship device will come equipped with a sapphire screen.
This has led to two opposing arguments. One is based on the practical production possibilities coming out of the sapphire plant, and the other believes that GT Advanced Technologies has stockpiled enough sapphire to meet the initial stages of the production run.
Based purely on those two arguments Apple will not have enough supply to make sapphire a component across the iPhone 6 line-up. What you're most likely going to see is the low-end version will have gorilla glass, and higher tier versions will come equipped with the sapphire glass. In this case scenario Apple can maximize its profitability, run reasonable production rates, and offer a feature that differentiates itself from competitors.
The two most important arguments
GT Advanced Technologies recently lowered its full-year revenue guidance range, which indicates that there's not a whole lot of upside to production, and it may give investors a clue as to where Apple may be heading with regards to the larger form factor device.
According to Yole Development:
As of August 2nd 2014, Yole estimates that the supply chain capacity is currently ~2.1 million units per month. If yields don't improve rapidly, Apple walking away from sapphire is still a possible scenario. The company believes that moderate quantities of supplemental material is currently being sourced from GTAT equipment customers in China. But even if all partners manage to improve yields rapidly, Yole's analysis still excludes the possibility that sapphire can be used on all models of the new 2014 iPhone. However, Yole still expects that at least one model (SKU) will be offered in 2014 with a sapphire cover.
Matt Margolis, someone who specializes on supply chain issues believes that GT Advanced Technologies has been hoarding sapphire for quite a while (perhaps two years) and that 15-19 million screens worth of sapphire may have been set aside well in advance.
Quoted from Forbes:
"What this means is GT is already sitting on enough sapphire to satisfy Apple's needs for the iPhone 6 launch in September," Margolis said. "This deal was in the making for 2 years. They've been preparing this for quite some time."
GTAT offered revenue guidance that would be inclusive of the iPhone. For GTAT to earn that revenue, it would have to deliver goods to one of Apple's suppliers, and if anything, that inventory will not sit on shelves for long. Therefore sapphire is set to be launched with the upcoming iPhone, but it’s doubtful that it will be made available across all iPhone 6 variations.
Apple will most likely make sapphire a higher-tier purchase
Apple iPhone 6 will need production of sapphire screens to reach 10-15 million per month (based on historical iPhone shipment volume) in order for the screen to become available in all iPhone 6 variations. Therefore, supply chain capacity will need to quadruple over the next year. However, it’s unlikely that Apple will stall on releasing sapphire, so Apple may attempt tier-based pricing.
Historically iPhone 16GB off contract was $650, 32GB off contract was $750, and 64GB off contract was $850. Instead of marketing different storage amounts for the various iPhone devices, Apple may opt to use screen size and sapphire to market higher-end iPhone devices to capture more incremental profit from consumers who are willing to pay more.
Also, if Apple does pursue such a strategy it will still be able to sell a version of the iPhone that uses gorilla glass, which will not have any significant supply chain constraints. So maybe the 4.7 inch model with gorilla glass costs $650, the sapphire version costs $750. The gorilla glass 5.5 inch model costs $750, and the sapphire 5.5 inch model costs $850. If iPhone is released in this specific way, it can overcome supply chain constraints, while marketing a novelty of a product.
Also, by Apple avoiding to market 16GB, 32GB, 64GB variations of the iPhone, it no longer competes with iCloud. The concept of storing everything in the cloud, and sharing resources via a third-party server, makes a little more sense in this day and age. So instead of offering more memory (which has diminishing marginal utility) offering an indestructible screen, or a larger screen, as a part of a pricing tier probably makes more sense from a business standpoint.
Also even if GTAT did stockpile sapphire, according to Margolis, 15-19 million worth in iPhone screens is still not enough to meet full-year demand for the iPhone. Therefore, a pricing tier segments the market enough so that there's adequate supply for Apple enthusiasts at the higher-end.
So as long as Apple is able to sustain demand for its smartphone lineup, and is able to source components, Apple will have no difficulty with reaching consensus estimates. A combination of organic growth, higher pricing, along with market share gains will have a three-fold effect on top-line sales. Therefore, Apple will most likely beat on Q4 results, but only under the condition that sapphire doesn't become the primary component of the iPhone 6, and it's sold as a part of a higher tier package.
There may not be adequate supply of sapphire screens to appeal to a base of consumers who are willing to pay a full $200 above the base iPhone 6 versions. If shortages were to occur at higher-tiers, Apple will have to figure out a way to balance pricing in the mid-stages of the production ramp-up, which isn't a very good scenario.