Wednesday, March 13, 2013

AAPL: Cheaper iPhone ‘Illusory,’ Says Pac Crest, Brand at Risk

Pacific Crest’s Andy Hargreaves this morning confronts what he calls “the illusion of a low-cost iPhone,” writing that there wouldn’t be much profit from a dramatically cheaper model of the device.

Writes Hargreaves, who has a Sector Perform rating on the stock, “the concept of a cheap iPhone violates Apple’s core operating principles,” because “we cannot think of a single thing that a low-priced iPhone would do better than the current iPhones.”

Hargreaves outlines what he sees as a possible loss of status and cannibalization of higher-margin sales:

Moving down market with an iPhone that wholesaled for under $300 would expand Apple�s unit and revenue opportunity, but we do not believe it would meaningfully increase the company�s long-term profit potential. To the contrary, a low-cost iPhone would risk cannibalizing the com- pany�s high-end SKUs and damaging its brand equity, which we believe would threaten Apple�s total earnings potential and represent a significant risk to the shares. Outside of China Mobile, which operates on a unique network technology, we do not believe geographical diversification is a compelling solution to the risk of cannibalization. The high-end smartphone market is finite, and iPhone�s extraordinary success is driving it very quickly toward saturation, in our view. However, we believe the company would be much better served by continuing to focus on capturing and maintaining share of the most profitable custom- ers in the world rather than moving down market, even if it means sacrificing unit and revenue growth [�] We estimate 2012 handset sales totalled approximately 1.6 billion, which breaks down fairly cleanly into just under 700 million smartphones that almost all wholesale for over $100 and ap- proximately 900 million feature phones that wholesale for less than $100. More specifically, we estimate there were approximately 277 million mobile phones that sold for over $300, of which Apple sold 131 million, or 49% (sell-through). We estimate there were 205 million mobile phones that sold for between $200 and $300 in 2012, of which Apple sold zero, since it does not partici- pate in that price band. Consequently, by offering an iPhone at a $250 price point, we estimate Apple could increase its unit total addressable market (TAM) by 74% [�] We do not believe Apple could build a low-cost iPhone of reasonably acceptable quality for less than $180. If we reason that the company would have to price a low-cost iPhone at $250 or less to open up significant new unit share, this suggests that the device would generate maximum gross profit per unit of approximately $70, which compares poorly to our estimate of current gross profit per iPhone of $295.

A cheap iPhone would not, Hargreaves asserts, fulfill a functional gap, as did the iPod Nano and the iPad mini.

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