Massive VCSEL Laser Order Confirms Apple Continues To Bet Big on Augmented Reality

Following encouraging comments from Apple’s leading VCESL laser supplier, Lumentum (LITE), on their FQ4 conference call this morning, we have become incrementally more upbeat on Apple’s next iPhone launch, and specifically the number of phones that will have advanced 3D sensing capabilities enabling augmented reality applications. We believe Lumentum is one of two to three company’s supplying Apple with VCSEL laser diodes, which is a key technology that adds advanced 3D sensing capabilities.  Given Lumentum’s comments around $200m in bookings for the rest of CY17 (up from $5m in FQ4), as well as demand trends throughout 2018, we have become incrementally upbeat on the impact Apple’s next iPhone launch will have on the company and on the augmented reality industry. In total, we expect 55m 3D sensing enabled iPhone’s in 2017, going to 160m in 2018.

What They Said. In the June-qtr, Lumentum recorded $5M in 3D sensing revenue, but more impressively they received over $200M in bookings in the quarter, which they believe will all be shipped by CY17. We believe the majority, if not they entire order, is all being shipped to Apple. We believe these comments further confirms 3D sensing (and in-turn AR applications) will be a focus feature in the next iPhone. In addition, Lumentum highlighted they have increased VCSEL laser capacity by 25 – 30% from what they anticipated only one quarter ago.  Given the uptick in Management’s demand forecast, we believe advanced 3D sensing capabilities will be integrated in more iPhones than what most were previously expecting.

We also want to highlight Lumunetum acknowledged they are working with multiple customers, but one customer (aka Apple) is accounting for most of the demand. We believe Lumentum and others supplying VCSEL lasers are supply constraint and shipping everything they can manufacture. We believe Apple has secured a high percentage of all VCSEL lasers created, which we view as a large competitive advantage and will make Apple a leading AR player in the smartphone space.

September iPhone Launch Update. We believe Apple’s next iPhone launch remains on track to be released in September. We anticipate the company will ship 133M units in the 2H of CY17. Assuming Lumentum controls ~50% of the total consumer VSCEL laser market, the majority of all VCSEL lasers produced are going to Apple, and the total VCSEL laser cost (high and low-end) is ~$6 – 7, we believe 55M new iPhones (43%) will incorporate VCSEL lasers, enabling advanced 3D sensing capabilities. Given Lumentum’s comments about demand for VCSEL lasers growing in the coming quarters, as well as well into 2018, we believe this technology will be embedded in a higher-percentage of phones in CY18. Given all VCSEL suppliers are capacity constraint, we believe ~40% of iPhones shipped in 1H of CY18 will include VCSEL lasers, but as VCSEL laser manufacturing capacity is added, we believe ~85% of the new iPhones shipped in 2H of CY18 will incorporate 3D sensing capabilities. Based on these assumptions, we believe Apple will ship a total of 239M iPhones in CY18, of which 160M or 67% will include 3D sensing.

3D Sensing Financial Impact For Apple (Higher Margins). We also believe the iPhone enabling 3D sensing will be positive to the company’s bottom line. We anticipate the high-end iPhone SKU will incorporate a low-end and high-end VCSEL laser. The low-end will be front facing, while the high-end laser will be on the back side of the device. We believe the low-end lasers will cost $2 – $3, while the high-end lasers will range from $3 – $4. When factoring in manufacturing costs the total bill of materials could cost ~$20. We believe the high-end iPhone will market for ~$950, which the company will have added ~$100 to the price to incorporate 3D sensing. This nets in an 80% gross margin  up sell to the AR rich iPhone, compared to Apple’s overall gross margin of ~40%. In addition, given Lumentum’s comments about increasing laser capacity more than what they expected one quarter ago, we believe these lasers may be embedded in more that just the high-end SKU.

3 Key Takeaways. Following, these positive data points, we have three key takeaways regarding the upcoming iPhone launch. 1) The next iPhone launch remains on track to be released in September. 2) Advanced 3D sensing technologies are likely going to be integrated in more phones that previously anticipated. 3) This, coupled with the release of Apple’s ARkit in June at WWDC, is evidence that Apple continues to bet big on AR.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Cook: AR “Is One of Those Huge Things That We’ll Look Back At and Marvel”

Apple’s Jun-17 results highlight that its iPhone and Services business remain solid, despite the headwind of consumers holding off on upgrading in anticipation of a new iPhone this fall. For Apple, this is a good place to be as the company starts down the five-year road to redefine its business around Services, AR, and AI.

We’re optimistic that Apple will be a central player in the next wave and maintain its track record of being a disruptive force, all while maintaining profitability. With Apple’s latest results, we are updating our AAPL model.

Jun-17 Results.  Apple reported Jun-17 quarterly results fractionally above the Street’s – and Loup Ventures’ – expectations. Shares are trading up 6% in the aftermarket for three reasons (in order of importance): 1) Investors and we were expecting guidance below consensus estimates for the Sep-17 quarter due to the timing of the next iPhone. Based on guidance and comments from Cook, it appears the next iPhone will be launching in the month of September, which is good news for Apple. 2) Services growth of 22% was ahead of the Street at 18%, and an acceleration from 17% in Mar-17. We believe there are now more than 800m daily active iOS users, fueling Services growth, a segment emerging and insulated from the quarter-to-quarter fluctuations in iPhone shipments. 3) Adjusting for iPhone channel drain, iPhone units in Jun-17 would have grown 9% y/y vs. the 1% reported and down 1% in Mar-17. As mentioned, this is impressive give some iPhone purchases were postponed due to consumer awareness of the upcoming iPhone hardware upgrade.

AR: Cook finally can share more of his thoughts. Tim Cook has been waiting a year for this. He spent the past twelve months dropping 7 public hints about Apple and AR, prior to announcing ARKit in June. The Jun-17 earnings call was Cook’s first chance to talk about the theme of AR with investors, and he made it clear that Apple believes that AR will be the foundation of an upcoming paradigm shift in computing. Cook addressed the AR use case question in the prepared remarks: “We believe AR has broad mainstream applicability across education, entertainment, interactive gaming, enterprise, and categories we probably haven’t even thought of.” He also reiterated his WWDC comments that Apple will be an early leader in AR, “With hundreds of millions of people . . . as soon as iOS 11 ships.” This is noteworthy, given that we believe these numbers compare to around 10m-20m advanced AR-enabled (Tango) Android phones.

Cook didn’t stop there, he added: “I could not be more excited about AR and what we’re seeing with ARKit in the early going. . . I’ve seen what I would call more small business solutions. I’ve seen consumer solutions. I’ve seen enterprise solutions. I think AR is big and profound, and this is one of those huge things that we’ll look back at and marvel on the start of it. So I think that customers are going to see it in a variety of ways. Enterprise takes a little longer sometimes to get going. . . I couldn’t be more excited about it.”

“I think AR is big and profound, and this is one of those huge things that we’ll look back at and marvel on the start of it… I couldn’t be more excited about it.”  – Tim Cook

Machine Learning: Apple is developing ML capabilities in face detection, object tracking, and natural language interpretation. These skills are similar to other ML platforms, and now Apple competes in a crowded space with Google TensorFlow, Microsoft Azure Machine Learning, Amazon AWS, and IBM Watson. Apple’s unique approach is that its ML platform easily integrates with iOS and ARKit development. We’re doing more work on Apple ML and will report back on how we see Apple impacting the broader ML space.

Autonomy: Consistent with past comments, Cook called autonomous systems “a core technology” for Apple. He added they’re “making a big investment” in it. New comments from Cook included, “autonomous systems can be used in a variety of ways, and a vehicle is only one. But there are many different areas of it, and I don’t want to go any further with that.” Our takeaway is that autonomous technologies shouldn’t be limited to an Apple car. That being said, we believe the company wants to build an Apple branded car but understands that it’s a massive undertaking and a long shot. We believe that Apple is running parallel approaches to the market (the second approach being a licensing approach).

AAPL Near-Term Outlook. Over the next few months, investors’ anticipation of “buy on the next iPhone rumor, sell on launch date of the new iPhone” will likely grow. In addition, typical optimism around the potential of the next iPhone driving 5-10% y/y unit growth will slowly be replaced by anxiety about the tail of the next iPhone in Mar-18 and Jun-18. This could cause some bumps in the near-term.

AAPL Long-Term Outlook. Over the next few years, Apple will be a central player in the next wave and maintain its track record of disruption while maintaining profitability. We believe shareholders will be rewarded.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

The Gold Rush of ARKit

When Apple launched the iPhone SDK in March 2008, they correctly anticipated a gold rush for iOS developers selling apps on the new App Store. Another gold rush is about to begin with the debut of iOS 11 and ARKit.

Given how the App Store story has played out over the last decade it’s hard to believe it started like this:

Look at all those empty seats. On stage, from left to right, was Scott Forstall, Steve Jobs, and Phil Schiller. I don’t think anyone in the room, except perhaps John Doerr from Kleiner Perkins, who announced the launch of the $100m iFund during the event, understood the magnitude of what had just happened.

Since then, the App Store has been the single biggest driver behind the power of the iPhone to change the world. In order to better understand the iOS platform that has emerged over the last nine years, and the platform on which ARKit will sit, we took a look at the growth of the App Store, the number of apps available, and the money paid out to developers. The growth isn’t all that surprising, but the accelerating pace of growth of the App Store ecosystem is staggering.

The growth isn’t all that surprising, but the accelerating pace of growth of the App Store ecosystem is staggering.

As of June 2017, iOS users had downloaded over 180B apps, which represents nearly 150M app downloads per day, a rate 82% faster than it was a year prior, at 80M app downloads per day in June 2016. This implies that each of the over 1B active iOS devices downloads 1 app per week.

As of January 2017, there were over 2.2M apps available on the App Store, which represents about 1,000 new apps available per day, a rate that has also shown an accelerating trend.

And as of June 2017, Apple has paid out over $70B in app revenue to developers, which represents $68M paid out to developers per day, a rate 26% faster than it was a year prior, $54M paid out to developers per day in June 2016.

ARKit and the possibilities it represents now sits on the shoulders of a massive and fast-growing iOS platform. There are now well over 1B active iOS devices around the world, although not all will run iOS 11 and ARKit apps. Given the broad ARKit compatibility (backward compatible to the 2015 iPhone 6s), we estimate that Apple’s device ecosystem for iOS 11 and ARKit will be over 200m devices at the launch of iOS 11. And if just 5% of paid apps leverage ARKit, the augmented reality apps on iOS would generate $1.7B in gross revenue per year (before Apple’s 30% take and the developers’ 70% net revenue). But many of the applications for augmented reality are entirely new and will justify – or even necessitate – an entirely new app, suggesting that our estimate is likely conservative. See a few early examples of ARKit apps here.

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AR Is Coming To Life via Apple’s ARKit

At Apple’s Worldwide Developers Conference in June, the company announced ARKit for developers to create augmented reality-driven apps. Apple describes ARKit as a platform that, “combines device motion tracking, camera scene capture, advanced scene processing, and display conveniences to simplify the task of building an AR experience.”

Now that ARKit has been available to developers for over a month, app demos have started popping up. Apple will likely select a few of the best ARKit apps and highlight them during the fall launch event for iOS 11 and the new iPhone. Until then, we’ll be tracking the demos that surface. Here are a few of our favorite applications:

Measuring Tool. The most-watched ARKit demo shows an AR tape measure.  Users can measure objects in the physical world using an iOS device.  Applications of the technology for remodeling, manufacturing, design, and home repair will be transformational within those sectors.

Ikea recently confirmed a development partnership with Apple to co-build an app that will allow customers to see what Ikea furniture would look like in their homes.  ARKit allows Ikea customers to make “reliable buying decisions,” according to executive Michael Valdsgaard. We see this partnership as the tip of the iceberg for consumer brands and online retailers to solve a real problem that exists today in online shopping.

Gaming.  Developers are keenly aware that AR provides a massive monetary opportunity for gaming, the gaming and entertainment spaces have generated the most ARKit demos to date. Developers, eager to try to replicate the success of the wildly popular Pokémon Go, are diving into game demos. Some of the most noted demos are AR Minecraft and portal travel.

Drawing and Sketching. ARKit will give iOS users the opportunity to draw in 3D using only their device. Laan Labs gives us an insight as to what this could look like.

Ordering Food. The use case for AR in restaurants surprised us. How many times have you ordered something and, once it is set down in front of you, immediately regretted your decision? One ARKit developer has tried to solve that problem.  The app allows customers to explore dishes on the menu before placing an order.

After just 30 days, developers have made a ton of progress with ARKit. For more, and to track developers’ progress, check out the Twitter feed @madewithARKit.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Model 3 Could Change The World: A Cost Of Ownership Study

Model 3 Could Change The World. Over the next 10 years the Model 3’s value, in combination with its technology, has the potential to change the world and accelerate the adoption of electric and autonomous vehicles. This should propel shares of TSLA higher and, more importantly, advance us to a new paradigm in transportation, car ownership, ride hailing, city development, and energy usage. We believe we will eventually look back at the launch of the Model 3 and compare it to the iPhone, which proved to be the catalyst for the shift to mobile computing.

 

Model 3 Cost of Ownership Estimate Lower Than Expected. Loup Ventures did an analysis of Tesla’s Model 3 total cost of ownership and the results surprised us: Owning a Model 3 is only 13% more expensive than owning a Toyota Camry over a 5 year period. Note that our analysis assumes no state or federal EV tax credits, given that we expect those incentives to end before Dec. 2020. Consensus thinking is the Model 3 expanded Tesla’s addressable market from about 1 million cars a year to 4 million cars a year. However, based on our cost of ownership work, we believe the Model 3 expands Tesla’s addressable market to about 11m vehicles per year in North America alone.

Owning a Model 3 is only 13% more expensive than owning a Toyota Camry over a 5 year period.

Tesla’s Opportunity. If Tesla captures 25% of this 11 million vehicle addressable market by 2025, Tesla would generate $105 billion in annual revenue from the Model 3. It will likely take a few years for Tesla to ramp production; we see 2019 as the first year the company will tap into this broader market.  Using the Street’s $20 billion revenue estimate as a starting point in 2018, and growing that to $105 billion in 2025 (from the Model 3 only) implies a 27% average annual growth rate for revenue from 2018-2025.

Profitability is a Wild Card. Most investors we’ve talked to ascribe to the “love the product, don’t like the stock” narrative. The most common cause for concern about owning shares of TSLA is a belief that the company has a decade of profitless prosperity ahead of it. It’s an understandable concern, given that in 2017 the Street is looking for around -5% operating margins, inching up to around +1% over the next several years. We believe the longer term operating margins can be closer to 15% based on our view that Tesla’s car and battery profitability are more like consumer electronics than traditional cars.

Hardware Can Scale.  Imagining that Tesla could produce 2.5m cars by 2025 may seem hard to believe, especially given that the company only delivered about 100k cars in the past year. Hardware does not scale as easy as software, but it can scale. Looking back at the iPhone in 2007 it was a stretch to envision the company producing 50m phones a year, but in 2015, the company sold 232m units.

The Slow Rollout. Later this month, initial shipments of the Model 3 will be on the road with waitlisted deliveries starting in October. We believe there are more than 500k Model 3 reservations, with Tesla reporting 373,000 reservations placed six weeks after the vehicle’s preview on March 31, 2016. The reservation number would be higher but Tesla has been under selling pre-orders given the long lead times, including no advertising, anti-selling, and nothing to test drive. If you’re a first time Tesla buyer and reserve a Model 3 today, you should expect to get it in January 2019.

Autonomy Is 2-3 Years Out. At a TED talk in April, Elon Musk suggested that Tesla will send a fully autonomous car from Los Angeles to New York by the end of 2017. The company has been clear that Tesla drivers should expect full autonomy by the end of 2019. In Musk’s words, “Once you solve cameras for vision, autonomy is solved.” GPS, radar, sonar, and computer vision all work together to create autonomy on a Tesla.  We do not believe there are any existing sensor technologies (even LiDAR) that would add any incremental benefits to Tesla’s suite of autonomous technologies. There is, however, a missing piece in the suite related to “cameras for vision,” and that’s AI. Tesla is solving the AI challenge with a bottoms-up approach. Teslas that are on the road today using Autopilot are gathering data that’s being fed into Tesla’s autonomy AI. In about 2 years the company expects to have enough AI learning to turn on full autonomy at no additional cost. In other words, for every mile a Tesla drives today, traditional auto manufacturers fall a mile further behind.

Autonomy & the Fleet.  Factoring in delays, we expect it will be 2-3 years before Tesla vehicles will be fully autonomous.  In 3-5 years, we believe Tesla will have a new fleet service, comprised of both company-owned and customer-owned cars. When you’re not using your Tesla, turn it over to the fleet to earn money.

Can Tesla Meet its Ambitious Goals? Tesla shares are down this week as the company announced 47,100 vehicles delivered in the first half of 2017, at the low end of its delivery goal of 47,000-50,000 vehicles. Coming in at the low end of the range makes it difficult for investors to believe Tesla will be successful in ramping Model 3 production to the levels they have outlined. Tesla believes it will manufacture 100 Model 3’s in the month of August and ramp production up to 20,000 in the month of December. Overall, Tesla’s goal is to deliver 500,000 cars annually by the end of 2018. Near-term, investors will grow weary of the risk to the quarterly production numbers. Long-term, investors should remain confident that production will ramp in time and the company will capitalize on growing demand for the Model 3.

Cost of Ownership Analysis:

Model 3 Vs. Camry. We focused our total cost of ownership exercise on the Toyota Camry because it’s a good example of an affordable quality car sold in the U.S. At first glance, Camry is in a different segment than the Model 3, given that a Camry costs an average of 42% less than an average Model 3 and Camry is an ICE (internal combustion engine). However, looking at total cost of ownership, the price gap closes based on savings from fuel, insurance maintenance, and repairs, ultimately yielding a 13% price difference over 5 years.

Little Cost Difference, Infinitely Better Car. Tesla wins over a Camry when it comes to customer experience, due to its acceleration, Autopilot, elimination of gas station stops, and the high-quality entertainment system. There is evidence of this in a Consumer Reports survey, where 91% of Tesla owners state they would “definitely” buy their cars again, the highest rating of any automaker. The next two closest automakers were Porsche at 84% and Audi at 77%. As more Teslas find their way onto the road, the general public will become increasingly aware of the benefits of Tesla ownership and likely view the 13% total cost of ownership difference as insignificant. We expect this “see it and want it” phenomenon to cause an acceleration in Model 3 demand in 3-5 years. Detroit, Japan, and German car manufacturer feature shortfalls will compound around the end of 2020 when Tesla adds autonomy to approximately 2 million Teslas on the road virtually overnight (including all Teslas sold from Jun-17 through Dec-20). Note that every Tesla sold today has the hardware for full autonomy. When Tesla turns on full autonomy, we believe the market will tip away from traditional autos to Tesla.

Methodology. To calculate total cost of ownership over a 5-year ownership period, we used information released about the Model 3 and Model S.  Additional costs to the advertised base price of $35,000 include: lease payments, initial down payment, interest rates, taxes and fees, insurance, Tesla fees, maintenance plans, repairs, and electricity costs, as shown in the figure below. In total, the additional costs are estimated to be $7,220 annually (over a period of 5 years), with a total cost of $36,104.  The Model 3’s total cost of ownership is compared to the 2017 Toyota Camry LE and 2018 Audi S5 Coupe Prestige in the first figure below. We’ve also compared the Model 3 to the 2017 Model S in the second figure below.

 

Behind the Numbers. The base price of the Model 3 is 42% higher than the base price of the Toyota Camry; however, total cost of ownership of the Model 3 is just 13% higher than the total cost of ownership of the Toyota Camry. The Model 3 costs $7,220 per year, $847 more annually than the Camry at $6,373. For all car models we compared, we based our analysis on a 6% sales tax, 3.5% annual insurance increase, and 1.1% annual license tab fee. Regarding fuel and electricity differences, the U.S. Energy Information Administration reported prices of $2.37 per gallon and $0.12 per kWh. The average American drives 13,476 miles per year, and we calculated Tesla owners spending $541 on electricity annually, which saves $947 in fuel costs annually, or $15.43 per charge. Maintenance costs are low for Tesla models due to the vehicles only having 18 moving parts, compared to about 20,000 in an average ICE. They are less likely to malfunction, and if they do, the majority of the expensive parts are covered under warranty. After talking to our insurance companies, researching online, and talking to a salesman at the Tesla Dealership in Minneapolis, we estimate that the cost to insure a Tesla is the same price as a car half of its price, as noted in the tables. The main driver for the lower insurance rate is the high safety ratings of Tesla vehicles.

Our Analysis Excludes Tax & Fleet Benefit. Our analysis assumes no state or federal EV tax credits, given that we expect those incentives to end before Dec. 2020. Separately, our analysis excludes any benefit from the Tesla ride hailing fleet, which we expect sometime between 2020-2025. Once Teslas are fully autonomous, we believe that Tesla owners will have an option to temporarily turn their car over to a fleet, allowing owners to earn income while saving on parking.  Factoring in these two benefits would likely put the Model 3 total cost of ownership on par with the Camry.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.