Posted by on January 9, 2019 3:51 pm
Categories: Economy

For those who thought that the latest news that Apple was slashing iPhone production again, this time by 10%, for the second time in 2 months was as bad as it would get, we have some bad news.

Earlier, when commenting on the latest production cut, we had a modest proposal: “Maybe, just maybe, they should consider cutting prices?”

Any other day, such a proposition would be apocryphal: after all Apple never makes wholesale price cuts – after all the key part of its cache and “coolness factor” is that its products are so unnecessarily expensive they are a status symbol.

Only in this time it appears that Apple listened to our “advice”, and according to the National Business Daily, prices of iPhone models at some Chinese vendors in Shenzhen have been cut. According to the paper, wholesale vendors in electronics product markets in Shenzhen city received price change notice from the U.S. on Jan. 8. The resulting price cut was for models including iPhone XR, iPhone 8, iPhone 8 Plus, iPhone X, iPhone XS and iPhone XS Max; Separately, the prices of new iPhone devices started to drop in a wholesale market in Shenzhen, where the iPhone XR had biggest price cut of 450 yuan ($66.02) at channel vendors.

“What does that matter?” Apple bulls will counter: after all, the world’s formerly biggest company is no longer a product company (at least since the shocking announcement that it would stop disclosing iPhone sales numbers late last year), and is instead only focusing on services.

Well, there is a problem here too, because as Nomura’s Jefrey Kvaal writes, Apple last week “offered a bit of a paradox.

Specifically, Apple announced record F1Q Services revenue that easily exceeded consensus, before offering a “rather uninspiring” account of its holiday week Services revenue growth.  However, on Tuesday night Apple unexpectedly restated FY18 Services revenues for ASC 606, and as a result, Kvaal concludes that “the uninspiring view is the correct one” as Apple missed in Services too; this in turn has prompted the Nomura analyst to retain his view that “Services growth is in part dependent on now wobbling iPhone unit volumes.”

Here are the additional details from Kvaal’s note:

  • Wait…is Services good or bad? Apple noted Services revenue of $10.8bn as a bright spot in last week’s negative preannouncement. This exceeded consensus estimates by $300mn and represented 28% YoY growth.  Oddly, the very next day, Apple announced soft and seemingly contradictory holiday week App Store sales growth of 20%. New Year’s Day growth was only 7%. Please see AAPL: And In Other News, Services Underwhelms for more details.
  • Oh. It’s bad. Services revenue has slowed to ~20%, and missed.  The new ASC 606 standard required Apple to reclassify $2.6bn in 2018 revenue (from Apple Maps, Siri, and free iCloud) from Products to Services.  This adds $620mn to F1Q19 and lowers the Services growth rate to 18%. This is a miss; consensus had expected 24% growth.  F4Q18 Services growth was 27%.
  • Our Services estimates now imply a 2019 slowdown. Our FY19 Services forecasts now imply a growth rate of 20% rather than 28% given $2.6bn in higher revenue to FY18’s base. This aligns closer to recent App Store growth of 18% in F1Q based on SensorTower’s data. China’s decision to re-start gaming reviews should lift growth modestly – gaming is 80% of China App Store sales – though Apple’s holiday sales figures did not show as much improvement as hoped.  
  • Proof point that Services is not independent of Units. We believe it fair to argue Apple’s iPhone unit wobbles are slowing its Services business.  Apple’s installed base growth has slowed from ~15% to ~8%.  App Store growth has obviously slowed; we believe Apple Care revenue is also suffering from lower unit volumes.  
  • A bit of an unforced error.  Our preference would have been for a simultaneous disclosure of the unit weakness, holiday week sales, and accounting adjustments.

Summarizing, the “Kvaal call”, the Nomura analysts concludes that “It’s not just units but services too.” Of course, looking at the AAPL stock price over the past week, which has rebounded strongly on hopes of an imminent US-China trade deal (which we now know isn’t coming) and more stimulus by the Fed and FOMC, and recouped much of last Tuesday’s shocking revenue guidance cut, one would think that it is only smooth sailing from this point on for Tim Cook. One would be dead wrong.

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