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  • KPB & Co Research

Ladies and gentlemen before we begin, let us give a moment of silence for the chart below. This chart shows the unit volumes of Apple's main products, including the iPhone, MacBook, iPod, and the iPad over the last 17 years. Unfortunately, Tim Cook decided to stop revealing data on Apple's unit sales. Nevertheless, this chart is still impressive as it demonstrates a couple of important points. Apple has dominated the smart phone market for more than a decade. Along the way the iPhone has grown to become the most important product for Apple. Perhaps the most important thing that is demonstrated here is that both the MacBook, and the iPod reflect a truism that is well known in business circles. The average product life cycle is around 10 - 15 years. Perhaps it is not unreasonable therefore to expect that sales of the iPhone should have already begun their descent. This leads us to the question, what product(s) does Mr. Cook have to supplement the iPhone, or does he have alternative plans?

We find it a bit strange that after 17 years of seeing unit volumes, it suddenly becomes expedient for the shareholder to cover his/her eyes. It is also hard to believe that it is just a mere coincidence that within a few months after management decided to reduce disclosure of important financial data, they have adjusted their guidance down. In a letter to shareholders dated January 2, 2019, Tim Cook outlined that the company has revised down the guidance for Apple's fiscal 2019 first quarter, owing to unforeseen softness in Chinese demand for the iPhone, and supply constraints on the Apple Watch Series 4, the iPad Pro, the Air Pod and the MacBook Air. In our view, all of this information would have been known at the time the company was building their guidance for Q1, and a conservative management team would have been very cautious. Maybe they were just hoping for the best.

While a trade war with China, and broad-based expectations of an economic slowdown could dampen sales of the company's flagship product, there are other longer-term issues at play here. Apple has tried a few alternatives but all of them combined is not enough to offset a slowdown in the iPhone. Commendably, they are working hard at building up their services business as a means to provide more option in selling services to the 900Mn individuals who use an iPhone. They have ramped up investments in music streaming (through several acquisitions including beats by Dre), and the production of original content (by signing deals with Oprah, and Reese Witherspoon). The service business currently sits at approximately US$10Bn for the quarter and is grew in excess of 15%. They have totally re-engineered the iPhone and has put it somewhat a step ahead of the pack. The Apple Watch is now the number 1 smart watch on the market. The one simple problem with all of these efforts is that none is a break-through like the iPhone was. The re-engineered iPhone is very pricey, limiting the demand uplift potential, and all the other products are in markets that pales in comparison to the size of the smart phone market.

Innovation is one of those buzz words that is much easier said than done. In many cases innovation takes years to lead to a break through. Some managers prefer to choose a short-term fix, such as financial engineering, Share repurchase, or just simply make up the numbers instead of doing the work. Tim has been doing the Share repurchase, but that started after pressure from activist investor Carl Icahn. So, it is unlikely that financial engineering was in his tool kit. We can not swear for anyone's credibility, but it appears on the surface that Apple has good board directors and a good management team. As such we believe it is unlikely that Tim Cook will resort to cooking. Nevertheless, the challenges he faces are enormous, and his recent actions are questionable, so we are taking a cautious wait and see attitude to this ticker. At the very least, we think he want shift people's attention from what will eventually be declining unit volumes for the iPhone.

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