Tuesday, May 21, 2019

AAPL: The Anomaly of Disruption- Why an Event of This Magnitude is Rare

I read John Gruber's comments on Horace's piece (on Asymco) that stirred up thoughts I have long harbored. Horace talks about how people fail to grasp Apple because they focus on the products Apple sells- their physical attributes classifying them in a singular product category type, which is vastly different than the products Apple builds- the solutions its products provide to the user (jobs they perform). The iPhone fulfills a wide range of needs, which varies among users. In addition, the list of solutions Apple builds into iPhone has expanded and continues to lengthen. Hence, it can't be thought of belonging to a single category, such as a just a mobile phone. 

Gruber adds that Horace's point explains why many analysts incorrectly categorized Apple as PC maker in a commodity industry (back in that era), and now view Apple as a wireless handset maker in a saturated market dependent on product replacement cycles. This fails to account for all the services and content being sold that the iPhone makes possible. In addition, this flawed thinking fails to account for accessories that the iPhone makes possible as well- the Watch and AirPods. These two collectively are a business the size of Netflix-- and turn an actual profit. Apple's ecosystem and massive user base should afford it a higher multiple, yet it trades closer to a valuation shared by stodgy hardware makers, as Horace laments. 

Gruber reminds us that the same people who misclassify Apple are the same ones incessantly asking "where's the next iPhone?" Not literally an iPhone, but a new Apple product that is as successful. John's comments imply this is a very dumb question to ask. Read my statements below to see why I believe it's totally asinine. This was an "aligning of the stars" or "perfect storm" that Apple was able to take advantage because of its savviness as a technology integrator.

The introduction of the smartphone, namely the iPhone, was the product of a confluence of technologies that had simultaneously advanced to the point of feasibility allowing them to be implemented in mobile phones. Such things as 3G, miniature and power efficient components, micro GPS chips and antennas, along with services like Facebook, were in their  infancy not existing until the latter part of the first decade of the new millennium. 

The smartphone makers (non-Apple) did a poor job exploiting technological improvements. Palm's OS was developed for the very primitive Palm Pilots in the preceding era. Palm OS remained basic as it didn't evolve at the pace of hardware. Blackberry was similar. Old OS on new hardware. Microsoft took advantage of the then powerful hardware with its Mobile Windows OS, replete with menu bar drop down lists and file explorer. And, many other desktop Windows features that had no business on a mobile device. It was a very poor fit and buggy. Pre-iPhone devices had small displays due to the physical keyboard taking up so much real estate. Those devices had touchscreens, but they were the resistive type which responds to pressure, hence the stylus that's lost in the first week. These devices had internet browsers but the web experience was unbearable rendering them useless. Special mobile versions of websites were required. So while hardware had become robust, mobile operating systems were less than ideal, and in the case of Palm and Blackberry- their OS had been designed when hardware performance was not so robust. Apple enters and takes advantage of the current technological capabilities (as well as improving further); the iPhone was a coherent package of the aforementioned coupled with a revolutionary mobile OS that unlocked their full potential. In short, Apple was an integrator- combining 3G (2nd iPhone), mini components, new touchscreens (capacitive), iPod, Palm PDA-like apps, AND- HTML browser offering the full web experience for the first time. 

To understand how the iPhone was a once in a lifetime product in terms of impact and popularity, look at all the features that had to come into existence at roughly the same time. It was the collective whole of these items that allowed the iPhone to be so revolutionary. The genesis of the iPhone depended on many events outside Apple's control, as it didn't invent 3G, ARM processors, and so on. Apple just saw the possibilities and understood what it would take to bring them into fruition. Critics question Apple's innovation abilities since the company has not introduced a product as revolutionary (or close to) as the iPhone more than a decade ago. Considering that many of the required technologies were all evolving on separate paths, for them to congeal and become to synergistic making the iPhone possible- is a very rare event.  


  • Processors- low-power, high output, small. 
  • Battery- high capacity, small footprint. 
  • 3G- data speeds making the Web tolerable. 
  • Wifi- small radio, internal antenna (not a card with antennae protruding from the side like PC)
  • Capacitive touchscreen- swipe gestures, virtual keyboard- larger display, no stylus.
  • Flash storage- fast, low power needs, no spinny disks like early iPods. 
  • Camera- multi-megapixels offered decent/fair pics (no comparison to flip phones).
  • GPS- small chip/antenna, power efficient.

  • OS- touch-based, virtual keyboard, continuous zoom and scroll (pinch & swipe).
  • Widgets- stocks, weather, calculator etc borrowed from Mac OS.
  • HTML mobile browser- it's combination with swipe/scroll gestures.
  • Predictive text- not totally new but Apple integrated in virtual keyboard- after the letters T, H, are entered, the keyboard knows X is not a possibility to shrink that key's strike (landing) space and predicts E and I (and other possible letters) are probable subsequent inputs, thus it expands their keys' landing zones.
  • Maps- Apple's built-in native app (Google's API) vs other mobile maps.
  • YouTube- Apple's app with YouTube API.
  • Apps- games and services-based apps- Yelp, IMDB.
The functionality and popularity of smartphones largely stemmed from services from non-hardware entities. The marriage of social media and mobile devices was highly synergistic. Who likes to come back from a long night at the bar or long vacation trip and transfer photos from a camera to a computer to then go post on FB? It's much better to do it that when it happens. It was the existence of such services (and new possible ones) that when intelligently crafted for mobile devices boosted the their appeal- both smartphones and services, in a perpetual feedback loop. 

  • Social media- Facebook, Twitter, services born from mobile- IG etc.
  • Google maps- the service integrated into Apple's app coupled with GPS.
  • Photo / Video sharing services- Flickr, YouTube.
  • iTunes- music and movies.
  • Product reviews / price compare- Yelp, Amazon. 
  • Web-based Information Services- weather, stocks (Yahoo), news, sports scores, integrated in device-side clients (apps).
When one considers the number of devices that were replaced by a singular smartphone, it is is difficult to believe that we will see something like the iPhone (its impact) anytime soon, if ever in a lifetime.

  • PDA- Palm pilots, electric rolodex, etc.
  • MP3 Players- iPods.
  • Cameras- Digital and disposable.
  • Video Players- personal DVD players.
  • Audio Recorders- dictation devices etc.
  • Navigation devices- in-car, hand held, etc.
  • Watches.
  • Alarm Clocks.
  • Timers- forget the one on the oven.
  • Books
  • Newspapers
  • Cable TV
  • PCs
  • Calculators
  • Personal planners- physical notes, calendars, to do lists. 
  • Radios- local broadcasts, scanners for ATC, police, fire, and rescue etc.
  • Wallets- paper tickets and boarding passes, reward cards, credit cards (where accepted).
There are probably more items for each list that could be added, but I think the point is clear. The iPhone and smartphones in general have had such a monumental impact due to the integration of a plethora of features and functionalities that existed elsewhere, on other devices or in other forms. The iPhone introduced an OS that could unlock and capitalize on the hardware that was coming available. It further leveraged services to make the iPhone a highly useful and usable device. It is the most successful product ever. Taking the global population and adjusting for people too old, or not old enough, who don't have mobile access, or the financial means- we are probably looking at close to 1 out of 5 eligible humans  who are iPhone users. 

The success of smartphones have been based on the multiple needs they fulfill. The jobs that they do for the user, some formerly tasked by other devices and means. That explains the colossal impact. The inception of the smartphone hinged on many physical technologies that had to be contemporaneously present for such a powerful product to be born. 

Because this depended on so many parties, in so many places, along with a number of pre-existing and future services-  it is not logical to expect that Apple, or anyone else for that matter, can or will introduce anything close the societal impact that smartphones have had. At least not for a longtime.

Wednesday, May 15, 2019

AAPL: How Popular are Apple's iPhone Financing Plans in the US? Here's a Look

Apple offers iPhone financing through 24-month zero-interest installment loans funded by Citizen's Bank (US). How popular is Apple's financing product? From the data I have gathered, the take-rate is pretty low- less than 1 million per quarter. It's probably not as low as it appears considering that a very low percentage of iPhones are bought at Apple retail stores. 

The loan payments are charged to the user's credit card each month through autopay. It's almost like financing the financing. It could be buyers don't want to fool with an installment loan and have it affect their credit report when they can just use their credit card to finance the purchase. That's less than ideal if the balance isn't paid down or off in short time. Credit card interest rates are typically relatively high, and the full balance of the purchase accrues interest from the start. 

The Apple plans are more advantageous since it's just the monthly payment (opposed to full balance) that would accrue credit card interest fees.  Given that Apple's stores are typically located in very affluent zip codes, it's likely very few buyers need financing plans.

With these plans, iPhone users can give back their iPhones to Apple after a year if they buy a new iPhone. Apple will pay off their loan balance. And the process restarts itself. 

How does Apple offer 0% financing? Especially given that not Apple, but a bank is the lender? 

Apple sells the loans at a discount. If a customer buys a 720 iPhone and agrees to 24 monthly payments of $30, Apple will sell that loan for perhaps $680. The bank earns $40 in interest income on $680 loan. Apple sweetens the deal with the bank by opening a bank account where proceeds from the loan sales are deposited. Apple has to keep a compensating balance at Citizen's- likely equal to the outstanding loan principal. Apple disclosed this arrangement in its most recent 10-Q due to the new accounting rules requiring restricted cash to be separated out on the balance sheet. 

Most often, when a company has a restricted cash balance it is due to credit quality concerns. Lenders will require cash to be set aside for collateral purposes, especially when a firm lacks other suitable assets to pledge as security. 

That is not the case here. Banks have to hold a minimum amount of deposits, or required reserves. If a bank takes in $100 of deposits they might only be able to make $90 in loans and having to keep only $10 of depositor's money on-hand (or on deposit at the Fed). If Citizen's originates $1M of iPhone loans and Apple deposits $1M in an account at Citizen's, then it doesn't eat into the bank's lending capacity. Since banks only have a finite amount of allowable lending capacity. They don't want to waste loanable funds on low margin loans when the bank has the opportunity to lend at higher interest rates. With a compensating balance on deposit, there is no opportunity cost for the bank, thus it will accept a lower rate. 

Plus, Apple reduces their cost of credit risk through loss-sharing agreements. In short, by reducing Citizen's credit and opportunity cost, Apple doesn't have to take as large of a haircut on the loan sales as Citizen's will accept earning a lower interest rate. 

Citizen's has disclosed the balance of "merchant partnership" loans which are the Apple iPhone financing plans f(or most quarters). Apple has only reported restricted cash for the most recent quarter- 2Q19 ending in March. The restricted cash balance included in non-current assets lines up with Citizen's numbers. I don't know what the restricted cash in current assets is from. The caption says "primarily" which obviously means not 100% so my take is the amount classified as current is related to something else. 

Taking the disclosed balances, I calculated the amount of new iPhone loans for each quarter. Using an assumption for ASP, the number of iPhones sold under installment plans can be calculated. 

The change in loan balance from quarter to quarter does not represent the amount of new iPhone loans extended since the previous quarter's balance will be paid down to some degree. Thus, the amount of payments made on the outstanding balance must be calculated first. 

I didn't take the time to try to be super accurate by incorporating more realistic assumptions since these numbers are so low it's not really worth the time. However, this should be roughly accurate.

1) 24 month Average loan life (none paid off early).
2) No payments are made on loan balances in the quarter which they originated.

You can see in the table the big jump for the quarters that the iPhone X and iPhone Xs / Max were introduced. 

Memphis, TN, United States