Key iPhone X Suppliers Provide Robust 2H18 Outlook

Special thanks to Austin Bohlig for his work on this note. 

Two of Apple’s key iPhone X component suppliers, Lumentum (LITE) and AMS AG (AMS), reported strong Dec-17 quarter results and more importantly provided upbeat 2018 outlooks. Both company’s supply key components going into the flood illuminator and dot projector on the face of the iPhone X (see below), which allows for 3D sensing and enables augmented reality applications such as facial recognition. While Apple recently guided for lower-than-expected iPhone sales in the Mar-18 quarter, we believe the robust 2018 guidance and capacity expansion initiatives indicate two things. First, iPhone X demand is healthy, and we continue to expect iPhone X will account for about 25% of total iPhones in FY18. Second, 3D sensing, as well as augmented reality applications, will remain a core feature and be added into new iPhone SKUs to be introduced in Fall 2018.

Lumentum – Lumentum is the world’s leading vertical-cavity-surface-emitting laser (VCSEL), which is the key component going into the flood illuminator and dot projector. The company reported 3D Sensing revenues of ~$200M, which exceeded the company’s expectation and is up from $40M in the Sep-17 quarter. Due to seasonality, the company expects 3D sensing revenues to be down $60 – 65M in the Mar-18 and Jun-18 quarters. However, the company continues to see strong order flow and aggressively adds VCSEL capacity. But most importantly, Management indicated 3D Sensing volume should “more than double” in 2H18 over 2H17, which we believe a high percentage of these orders will be going into current and new Apple SKUs this fall.

AMS AG – AMS is an Austria-based semiconductor that provides additional optical components for the iPhone X that enables 3D sensing applications. While the company positively preannounced last Monday, they waited to issue guidance until they announced earnings this morning.  In-line with Lumentums comments, AMS foresees a very strong second half 2018, based on currently available forecasts, with substantial sequential revenue growth rates in the second half year, similar to 2017. AMS anticipates high volume ramps in its consumer business to drive this strong expected second half development. AMS also decided to accelerate new internal production capacity for VCSEL laser products in the second half 2018 and beyond. Lastly, AMS increased their 2016 – 2019 revenue outlook to 60%+ CAGR over this time period, which bodes well for the future for AR.

What this means for Apple. iPhone X demand is healthy, and we continue to expect iPhone X will account for 25% of total iPhones sold in FY18. Given Lumentum and AMS strong 2018 outlook, we believe 3D sensing will remain a key feature in iPhone SKUs, as well as augmented reality (AR) applications. However, both companies are beginning to work with more Android related customers, and it is not 100% clear what percentage of these sales are going to Apple. Importantly, both Management’s team’s comments around contributions from new wins, we believe the majority of these sales will continue to go Apple.

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.

Simplicity Series: Augmented Reality

Last week we wrote about simplicity as a driving force behind the world’s biggest technology offerings. We’re extending our thoughts on simplicity into a series that explores the necessity of simplicity in frontier technology. First, we’ll dive into AR.

Simplicity for AR in 2018 must start with a question: “What does AR do?” Not in the literal sense. We all know it overlays digital information on the real world. What the question needs to answer is what undeniable and unduplicable benefit AR confers to its users. What can only AR do?

The smartphone put a powerful computer in your pocket that lets you work and play from everywhere. Apple makes the smartphone so simple anyone can pick it up and start working and playing instantly.

What can only AR do?

The Internet connected you with the world’s information. Google sorts it for you. Amazon lets you buy things you find.

What can only AR do?

The answer isn’t that it puts a computer with the world’s information in your eye. That’s only marginally better, maybe not even, than what we have now. Marginally better is fine as an emerging feature on smartphones today, but it won’t drive mass adoption of AR wearables that people wear all day long.

The problem is more obvious when asked what the killer use case of AR is. To be clearer, a use case the average consumer could engage in every day. It’s not envisioning a new couch in your living room or getting step-by-step instructions or doing facial/object recognition. AR doesn’t have the advantage of email, messaging, and web browsing as the smartphone inherited from the Internet. Because AR is a true paradigm shift in how we interface with computers, we need to rethink communication, information collection, and information consumption specifically for AR. That hasn’t happened in a meaningful way yet.

Our tone here is tough, but only because we think the AR space has been taking a pass at answering this hard existential question in favor of experimentation with hopes that customers figure it out for them. We remain bullish on the future of AR and think the answer to our core question here might have something to do with the relative “nearness” of information it creates. To elaborate, we’ve evolved from a limited keyboard-style interface to a touch interface to a mixed reality interface that might incorporate gestures, thoughts, voice, etc. Interacting with information is becoming much closer to how we interact with the real world. This answer isn’t perfect, but we think it’s in the right direction.

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.

Apple is Flush With Cash, But Don’t Expect Big M&A

Don’t expect any big M&A. Everyone is asking who Apple will acquire. The answer is: nobody. At least nobody big ($5B+).

  • Apple announced they’re paying $38B in repatriation taxes, which implies they’re bringing $215B back to the U.S.
  • If there was no tax holiday Apple would have paid about $80B in repatriation taxes, compared to the $38B they actually are paying.
  • Apple also announced $30B in capex investment over the next 5 years, including a new Apple campus for technical support.
  • We don’t expect this infusion of U.S. cash to change Apple’s capital allocation strategy and believe share buybacks will be the primary use of funds.
  • We don’t expect any big M&A deals above $5B, but see the company continuing to do tuck-in deals and invest in their supply chain.
  • We believe 80% of Apple’s motivation related to today’s news is for economic reasons, 20% for political reasons, and both are good for the company long-term.

Potential uses of cash, by order of significance.

1. Returning capital back to AAPL investors. AAPL will increase its buyback over the next 3 years by about $70B. We also believe Apple will announce a one time cash dividend of $12B. Lastly, we anticipate a 15% annual dividend increase that will cost Apple about $10B over a 4 year period. We expect these three to be announced when Apple reports their Mar-18 quarter sometime in April. We believe most of this is already priced into AAPL’s stock price.

2. U.S. capital expenditures. As mentioned, Apple also announced $30B in capex investment over the next 5 years, including a new Apple campus for technical support. Separately, Apple increased its commitment to its Advanced Manufacturing Fund to $5B from $1B.

3. Invest in component suppliers. As they’ve done in the recent past (Corning, Finisar), Apple will continue to invest in key component suppliers, likely optics, displays, or processors, to lock out competitors and expand their lead.

4. Tuck-in acquisitions. This includes hardware, apps, and services. Hardware: Magic Leap’s AR hardware is a logical acquisition on the heels of Apple’s recent (summer of 2017) purchase of SensoMotoric. Magic Leap’s last private round was valued at $5.5B, suggesting this deal is slightly more than Apple typically would pay. Services: Apple Watch and its ecosystem would be bolstered by Peloton. This reminds us of Beats – hardware that adds to the lineup and, most importantly, a services play that would also expand the Watch/fitness data platform. Apps: We could see similar deals to the Lattice Data acquisition related to apps and AI.

5. Longshot: Auto. For starters, they should buy Tesla. But it will never happen because Musk won’t sell. Clearly, Apple believes in autonomy, through what appears to be a smart-shuttle approach. Since the shuttle initiative is early, it’s a high-probability M&A area for Apple.

6. Employee bonuses. Bloomberg is reporting that Apple will be giving to $2500 bonuses in restricted stock to most employees. We estimate about 100,000 employees will benefit, which implies a $250m liability that will vest likely in 2 years.

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.

AR and VR: Living, Breathing Storytelling

Written by guest author Jesse Damiani, Founder and CEO at Galatea Design

Story telling yesterday and in the future. For the past several millennia, our stories have lived in two dimensions. We translated our creative impulses into 2D formats—whether it was around a fire, painting, page, poster, motion picture or video game. But with VR and AR, that’s all changing, and fast; it’s no exaggeration to say that we can’t even begin to grasp what the storytelling content of 2028 will look like. The irony, of course, is that this shift to spatial media just means we have to revert back to our spatial understanding of the world—something we engage with every moment of every day—except now we’re no longer constrained by the physical laws of nature. The stories of the future are not just pieces of content, the spaces for immersive experiences.

The “Narrative Potential” of space. Ask any architect, interior designer, or DIY home-renovator: every space tells its own story. Take the example of a library. When you walk into it, what’s communicated to you? Lots of carpeting muffles sound, and often, high ceilings dissuade us from speaking too loudly. Shelves of books, ample desks, and fluorescent lighting imply a place intended for scholarship. These embedded details drive us to make automatic assumptions about how to behave and what to expect—the “story” of that space in time.These perceptual opportunities constitute “Narrative Potentiality,” the chance for creators to fill the space with information that will kickstart our brains’ native storytelling impulses. If I, as a VR experience designer, seat you in front of a table where a vase is positioned precariously close to the edge, I’m tapping narrative potential by making you think about it falling and shattering around you.

The space is the story. In other words, in VR/AR, the space is the story. It won’t be long before most of the digital materials we currently conceive of as 2D exist as 3D spaces. What might your favorite website or social media page look like as a “real” space?

Living, breathing stories. Buckle up: it gets wilder. Our understanding of stories is rooted in linear storytelling—the model we’ve had since we invented storytelling sitting around the fire with each other. In this model, a teller projects the story, and audiences receive it. It has a beginning, middle, and end. Audience participation (listening) doesn’t impact the outcome in any significant way. Where we’re headed is toward participatory stories that we share with each other in real time—whether we’re talking about AR or VR.

It’s a shift from linearity into semi-linearity and non-linearity, from pre-written stories experienced from a remove to stories optimized for impromptu co-creation (using narrative potential). Think about it, when you show up at a wedding, you have a general sense of what’s going to happen—but the fun of it is the experience of it spontaneously unfolding around you, and your ability to participate and impact it. The memory you leave with is your story of that event. Everybody else has a story too, both similar to yours and altogether unique.

In VR, reality is the medium. A friend of mine put it best: “In VR, reality is the medium.” Science tells us that our brains are incredibly plastic; they have space to carry multiple, simultaneous realities in them. If you’re in a story experience with your mom and she’s a purple alien, you carry two versions of her in your head: human and purple alien. Of course, she’ll be playing with her new identity as a purple alien, so your understanding of her will have to expand to include this new information. The point is: it’s all up for grabs. Want to be able to control a third arm using your pinky finger or two winks? Want to bend the laws of physics? That’s the narrative potential that VR and AR open up for us. The best part is we’ll be sharing in them together.

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.

App Store Retains Healthy Growth, ARKit Next Gold Rush

App Store revenue grew about 30% in 2017. Apple announced App Store revenue reached $300 million on New Year’s Day 2018, a single day record. They also reported for the period of Christmas Eve to New Year’s Eve, App Store revenue hit $890 million. Most importantly, Apple announced in 2017 iOS developer payouts increased 30% year over year, compared to 40% growth in 2016.  While not identical, developer payout growth mirrors App Store revenue growth.

Slower growth but still healthy. We estimate App Store revenue is the largest segment of Services accounting for 37% of Services revenue,  growing at 30%. Tonight’s App Store update is in line with our estimate calling for 30% App Store growth in 2017.  While 2017 App Store growth slowed to 30% from 40% in 2016, it’s still advancing at a healthy rate given the law of large numbers (largest segment of Services) and the fact that this growth is supported by only about 2% iPhone unit growth during that period.

Services revenue by segment. Below is our estimate of Services revenue by segment. Our full Services model expects growth to decline at a slow rate, going from 23% in 2017 to 15% in 2022.

ARKit, the next developer gold rush.  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, earning developers over $86 billion since launch. In the years to come, another iOS developer gold rush will begin around AR and ARKit. This is based on our belief that AR will fundamentally change how we interact with information throughout our days. AR (starting with ARKit), will enable the future of computing – a more immersive paradigm for computing in which the digital information we need is available within our real-world field of view.

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.