Apple unveiled the iPhone 7 and Series 2 Apple Watch. Ben Gossack, Portfolio Manager & Global Technology Analyst, TD Asset Management, speaks with Kim Parlee about the potential of an ‘upgrade cycle’ and overall appeal of Apple shares.
The question is now, are they enough to see if people want to upgrade to the iPhone 7, which was announced today?
Analysts on the street say iPhone sales are not the only thing they're focused on.
Let's take a look at how Apple stock ended today.
Some say the revenue Apple gets from its services is going to be increasingly important to Apple's bottom line.
Ben Gossack is portfolio manager and global technology analyst at TD Asset Management.
He joins us again in studio.
Nice to see you.
Thanks for having me back.
OK, so we just heard from Amber.
Lots of cool stuff.
The camera seems to stand out for her.
I just wanted you to bottom line me on this.
Do you think, from what you heard today, it's enough to cause a massive upgrade cycle?
Not this particular phone.
I think we saw the rumors sort of come out.
I think it's been well telegraphed that this was going to be an incremental design.
Apple actually changed their sort of product cycles, so usually we got-- with every whole number, we got a sort of physical change, and then we get the S cycle, which is a sort of incremental change.
We got another incremental change when we should have got a big physical change.
So I think what gets the financial markets excited is not this particular iPhone, but the one that supposed to come out next year, which will be the 10-year anniversary phone, the iPhone 8. Now you got a great chart here you brought in that I want to take a look at, because I think it shows the bump that happens when actually these announcements come out.
So let's bring it up.
And this is taking a look at the announcement and the iPhone sales in terms of what actually happens.
And what you see is, again, you get a big bump every single time they come out.
We're going to bring it-- there it is, right there.
So tell me a little bit about what we're looking at.
So if you look at the red-shaded area, that's the iPhone unit.
So I've done it on a quarterly basis.
So you can kind of see the waves.
I like to think of the iPhones coming in waves.
So we had the iPhone 4, the iPhone 5. You can see a really big wave for the iPhone 6. It was almost a tsunami event.
The dotted line is the revenue for Apple.
You can see it's very correlated with the iPhone units.
And then in the green line, we've plotted the Apple stock price.
And so you can see a huge lift with the iPhone 6. Just a massive cycle unlike we've ever seen before.
I-- I mean-- go ahead, sorry.
Yeah, I remember-- so that December quarter, so the first quarter that launched-- I remember we were calculating how many phones they sold per hour per day for that quarter.
It was 35,000.
So some unreal numbers.
They finally got a big phone.
They opened up into China.
So China Mobile has 800 million users, in relation to the US population that has 320 million people.
They made the phone gold.
They gave us a Plus.
So everything was working.
We had average selling prices moving up.
We had margins moving up.
So anything after that, it's really hard to sort of achieve that bar.
So I guess, yeah, so even the iPhone 8, when it does come out, I mean, they're not going to be tapping into new markets.
They're not going to be having-- I know it's the 10th anniversary, but still, they got a big headwind against them in terms of that growth side.
I mean, that's the 6-- was that tsunami event-- we've sort of bottomed out with the 6s.
I think the 7, we may get a little bit of lift, but we're definitely bottoming in terms of revenue and units.
But that 8 is going to be an iconic design.
So we're going to get rid of the Home button.
It's going to be a full screen.
So no more of that white beveling on the side.
They're going to be able to do curve, you know, curve sort of like the Samsung phone.
The battery will be a lot better.
They could do wireless charging.
So I think there are people that should have been upgrading this year on the 7-- They're going to wait.
--that will wait for the 8, so I do suspect we'll see-- maybe not as big as a 6, but we'll see a mini tsunami event with the 8. You just convinced me to wait till the 8. So I was going to say right there, there's one more person.
Let me-- just to stick with today's announcement.
The phone, obviously, is the most important because it's 2/3 or so of Apple sales.
The Watch, is it material yet?
It's not material yet.
I think we're getting about $5 billion of contribution.
This is a company that's delivering $220 billion in revenue.
So it's small.
I like to think that it adds to the ecosystem.
So just another feature to keep someone in the ecosystem and not to churn out and go try something else.
But it's not something that's moving the top line.
Anything else in terms of the announcement today, like the iOS upgrade or anything like that?
Was that just kind of par for the course, and more just what they do when they upgrade?
I mean, it definitely didn't sort of-- nothing was earth-shattering today.
Again, I think we just sort of really set ourselves up for a bigger upgrade cycle next year.
Stay with us as we come back, we're going to move away from Ben's take on just the iPhone event and launch today.
We're going to move it into a larger discussion about all the things that Apple's facing, because we barely scratched the surface.
Of course, they're dealing with tax bills, all sorts of good things.
And we'll find out whether Ben likes the stock at these levels.
You're watching Money Talk.
We'll be right back.
I'm here with Ben Gossack, Portfolio Manager and Global Technology Analyst at TD Asset Management.
We're talking Apple.
We were just talking about the launch that took place today.
And all eyes, from an investment standpoint, on iPhone 8, I will say what's coming.
In the break, we actually just sat and had a little-- the positives and the negatives right now with Apple.
So I wouldn't mind running through some of those.
So we can kind of paint the full investment picture.
Let's start with a negative.
Everybody has one.
Yeah, no, everyone has one.
This is probably the first year where we have single-digit growth on smartphones on a global basis.
So we have slowed.
I think it was just a reflection of personal electronics in the very late innings.
So PCs are ex-growth.
Tablets have already started to decline.
So Apple, other companies, they're repositioning into other areas such as automotive, home, health care, even industrials.
So I think it's just-- there's a shifting going on, because you're right, everyone has one.
Another one, tax bill.
I'm imagining this is a negative.
So explain-- take us through actually what's going on here.
Because it gets lots of headlines.
But what are the real implications?
So there was a big headline.
I think if anyone looked at the stock price, they saw a very different reaction.
So a very muted reaction.
So the EU has-- European Commission-- has gone after Ireland and Apple, and said between 2003 and 2014, Ireland sort of gave unfairable treatment to Apple, in terms of what their tax rate was.
And so I think what's important is that we focus on it's a back tax issue.
So that's to the tune of 13 billion euros.
It's about 14 and 1/2 billion US dollars.
What's really key for the investment community is that there's no effect on Apple's tax rate on a go-forward basis.
And most stocks are valued on future cash flows discounted to today.
So that's why you didn't see the stock react as much.
And this is going to be in the courts.
And so it'll take many years.
So I assume if there's ever a settlement, it'll be less than the headline number that got reported last week.
But why-- and I just didn't mean to ask a dumb question, but 13 billion euros, $14 and 1/2 billion US, that's still a lot of cash.
And I know they have zillions-- I'm exaggerating, but it's what hundreds of billions of cash.
So on an absolute basis, it's huge.
It's bigger than the market caps of some companies.
They would be swallowed up if they ever had to pay that.
But you're right.
So they have about $235 billion of cash, so that's 6% of their cash.
It's 2 and 1/2% of their market cap.
So yes, it could wipe out another company.
For Apple, yes, it's a blip.
But the tax, again, tax on a go-forward basis was not an issue.
Is not unchanged.
And that's why, if this ever was a headwind, it's not a headwind anymore.
Lengthening products cycle is something that you say that we have to watch out for.
So people are holding on to their smartphones a little bit longer.
In Canada, our relationship with the telecom providers-- Bell, Rogers-- we buy our phones on a subsidy basis.
So we pay $300, and then we sign ourselves up for a contract.
They make back their money, because the phone actually costs $800, $1,000.
They make it up on those monthly service contracts.
In the United States, they changed that.
They made it very apparent that the consumer was buying the phone.
So they had a contract with AT&T, Verizon, where they pay the phone off in $25 installments every month.
And then the phone would become theirs.
So if you've done your contract, it's almost an incentive to hold on to your phone, because it's almost as if you're getting $25 back in your pocket.
You're getting your bill back, or you're paying less.
So in a way it sort of incentivizes customers to hold out a little bit longer.
So if people are upgrading every 30 months, it's starting to shift to 36, 37, 38.
So that means that there's less people coming to buy your phones every year.
Any other headwinds with Apple?
I mean, those are fairly significant-- well, actually the tax one probably not so much.
But I mean in terms of saturation, the product cycle.
I mean, that's a big deal.
You definitely need to find ways to get people to upgrade, so you got to bring them a new phone.
Bring them new service.
Or you shift the company and you make it a service.
So can I find people that will pay me $30 every month, and always give them a new phone.
And then those waves become more muted.
So let's go to the positives, to the services.
Again, what is Apple services?
And we have a chart here showing the revenue coming from Apple services.
But just explain what's in there.
What entails a service, so to speak?
Apple service is an amalgamation of a lot of stuff that we touch.
So it's the App Store, it's iTunes, it's Apple Music, it's Apple Care, it's Apple Pay.
It all gets lumped together.
What's really interesting is that from 2010 to today, that revenue has doubled.
It's about 12% of the top line revenues, so in relation to the iPhone, that's about 63%.
So it's not iPhone levels, but it's growing.
What's really nice is that it comes in a high margin.
So we're looking at 60% plus gross margins on a company that's doing about 38% to 40% margins.
So you're getting a good lift on the bottom as well, as these things grow.
I would think, also, that might come under attack, though, with companies like Google.
And I'm just using my own personal experience because, you know, iCloud storage for every 16,000 pictures I take of my son, I have to pay for them to be stored somewhere, but then Google Photos started doing it for free.
And I just know-- myself, I opted out of that.
I was like, oh, I don't need it there anymore.
And there's privacy, there's all sorts of things you have to manage within that.
But I wonder is the services revenue something that has to be watched as well?
I think there's enough momentum.
So let's just talk about games.
I know you spoke about that with Amber.
So Pokemon GO, Super Mario, all this stuff's taking off.
Those stocks, the Nintendo stock was up and down.
I think people don't realize is that the App Store gets a 30% cut of all the revenue that goes through there.
So yes, they'll be some services that will come for free, and companies will try to make up that revenue elsewhere.
But gaming is huge, especially in mobile devices.
And services participates in that, and then Apple doesn't have to worry about what's the hit as long as hits keep coming out.
There are pipelines.
They get 30% of what's being monetized in that app.
What about-- we talk about iPhone 8 and how important that is and all the features.
How much do you think that people are counting on that, to be a big deal?
I mean, how much is that is priced into the stock right now?
Yeah, so I'd say a bit of it's priced in.
If we go back to 2013, so we got the same sentiment where it's, oh, Apple hasn't innovated.
It doesn't know what to do anymore.
Everyone else has moved ahead with bigger phones.
We knew a bigger phone was coming-- the iPhone 6-- but it was bigger than we ever expected.
And so we had a huge pop in the stock.
So yes, we are looking to iPhone 8. It's not a secret that it will be a better phone.
I don't know if it's all priced into that stock, which is why I still think at these levels, Apple shares can appreciate quite a lot.
Which brings us to-- I was going to ask you about the stock price itself.
So I mean, you hold the stock right now in your funds.
The catalyst being iPhone 8, Apple services, and I mean, we did see a little bit of a pop, not much today, but we did see a movement.
I think after people digest it a little bit of what the iPhone was about.
But tell me a bit more about just like the investment thesis right now, in terms of why you like this one.
Yeah, so again, we have to put it back into context.
It's product cycle driven, so you can't just close your eyes.
It will be volatile, so it got up as high as $135 and it retraced back to $90 off the iPhone 6, that really tough bar it set for itself.
So we think from now going into maybe in 2018, that everything will lift off that iPhone 8, off the services.
So that's exactly what we're focused on.
Let me ask you, in terms of also the icing on the cake.
I mean, the things that we don't know, TVs.
You mentioned industrial, you mentioned health care.
Which of those are interesting that you would watch in terms of where things could go?
So I think the biggest thing on the radar are the-- sort of that secret that everyone knows about is automotive.
So that's definitely an outside surprise-- And what would that be?
Just the automotive.
So it could be as simple as Apple having the operating system for a car.
It could be them providing a car service.
So any of those facets.
That could be really material for Apple.
So I mean, that could be an outsized surprise beyond just doing phones and services.
And what about health care?
Because I would think that would be a big one, too, especially with aging populations.
And I've noticed as well in terms Apple tends to be used by those getting a bit older.
And we see the Android and Samsung being with the younger.
I've now categorized myself, I'm in the Apple category now.
But I would think health care would be a huge need for them.
It's huge opportunities.
Apple's focused on health care, even IBM is focused on health care.
I think if Apple could put a blood pressure measuring device in its Watch, it would be revolutionary.
You could prevent heart attacks.
You'd know when people are about to have certain health issues, need to get to the hospital.
So again, if they're able to put that into the Apple Watch 3, I'd say that would be revolutionary.
Again, watching 3, and watching iPhone 8, those ones.
Ben, always a pleasure having you here.
Thanks so much.
Ben Gossack, he's a Portfolio Manager and Global Technology analyst with TD Asset Management.
And a great overview of what's interesting about Apple as we move ahead.
Thank you so much for watching.