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My investing philosophy mostly centers around the Value discipline and GARP- Growth at a Reasonable Price. This blog includes commentary on market conditions as well as fundamental analysis of specific companies. Graduated from Rhodes College with a degree in Business with concentration in Finance & Marketing. Currently working on obtaining the CFA designation. Previously worked in Mortgage Trading for a major bank. Use MS Excel extensively for developing investment models, notably valuation models based on DCF methods.

Tuesday, July 15, 2008

A Look at the 3G iPhone's Profitability

Apple’s 3G iPhone appears to be quite profitable. The fully subsidized price from AT&T is $199/$299 for the 8GB/16GB models, respectively- requiring a 2-year contract. If a current AT&T customer has recently purchased a discounted phone, then the price may increase up to $399/$499, depending how much subsidy AT&T needs to recover on the old phone. Without a 2-year contract from AT&T, the iPhone will cost $599/699.

The actual amount Apple receives per iPhone is uncertain. Wall Street analysts estimate AT&T is paying a $300-$350 subsidy. The AT&T pricing scheme suggests the subsidy may be as high as $400 per unit.

Even though $200 is the industry standard for smart phone subsidies, there are many reasons that support the higher estimates.

1) AT&T is increasing data plan by $10/mo and no longer offering 200 free text messages. Most iPhone plans will increase by $15/mo. This equates to a $360 increase over the life of the contract.
2) AT&T’s average revenue per user (ARPU) is roughly $50/mo, where the iPhone ARPU is north of $90/mo. Thus, iPhone users generate $960 more per 24-month contract.

Therefore, a $350 subsidy is quite reasonable and perhaps conservative. Using this assumption, Apple receives $550/$650 from AT&T.

A recent estimate by iSuppli puts the production cost at $173 for the 8GB unit. The 16GB model adds only $16 more to cost; yet it sells for $100 more than the 8GB device. Gross profit for the 8GB model is $376 at a selling price of $550. The 16GB model has a gross profit of $460 selling at $650. The gross margins calculate to 68% and 71% for the 8GB/16GB, respectively.
The 16GB adds $84 in incremental gross profit, or nearly a $1/share per 10 million units. Thus, the model mix can significantly impact the income statement.

Initial data suggests that consumers are favoring the 16GB model. This is very positive since the $16GB produces $100 more in revenue and has a higher gross margin.

According to the retail store availability information on Apple’s website, the 16GB model has been dramatically outselling the 8GB model. However, one problem is the supply of 8GB versus 16GB is unclear. Early Saturday, Apple’s website reported 20 stores sold-out of 8GB, versus 28 stores sold-out of 16GB-white and 53 for the 16GB-black. This indicates significantly higher demand for the 16GB models.

It’s also likely that Apple had a larger stock of 16GB devices due to higher demand for larger capacity historically. In addition, it’s less advantageous to carry to little stock of the higher-priced model since running out of the 8GB may persuade a consumer to trade up to the 16GB. Conversely, higher supply of 16GB models prevents losing potential sales of the higher-priced model when a stock-out forces one to purchase the cheaper model.

A survey by Piper Jaffray of 283 line waiters this weekend reported that 66% planned to purchase the 16GB model. This ratio of 2:1 would support the data gleaned from Apple’s website regarding iPhone availability.


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