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.

Google Is Betting On The Right Long-Term Trends

Following the company’s Q2 earnings release, Google shares are down 3%, based on higher traffic acquisition costs (TAC). As a percentage of revenue, TAC increased to 11.1%, up from 8.8% a year ago. We think this is a classic example of investors looking at the near-term bumps rather than the long-term positives. We saw several positive themes in the quarter:

  1. Revenue growth has been stable over last 5 quarters. Google’s revenue grew 21% y/y. Over the last five quarters, revenue has grown between 20-22%, even though there has been anticipation that revenue growth would slow.
  2. AI is having a positive impact on Google. Sundar Pichai began his portion of the earnings call by saying: “Google continues to lead the shift to AI driven computing.” This was the third consecutive earnings call in which Sundar touched on AI during his commentary. In Q1 of this year, he said: “I’m really happy with how we are transitioning to an AI-first company.” In Q4 of 2016, Sundar stated: “Computing is moving from mobile-­first to AI­-first with more universal, ambient and intelligent computing that you can interact with naturally, all made smarter by the progress we are making with machine learning.” Google mentioned “AI” or “Machine Learning” 18 times during the Q4’16 call, 24 times on the Q1’17 call, and 21 times on the Q2’17 call. The focus on AI is important because AI will empower Google to have better, more targeted search results for consumers, higher ROI for advertisers (through Google’s smart bidding platform), lay the groundwork for natural language processing (the future of Google Home and Assistant), and improve computer vision-based search.
  3. Google remains heavily invested in the AR/VR theme. Google Lens, a computer vision platform driven by machine learning, is the foundation of Google’s future in Augmented Reality. Google is taking the long-term approach to Google Lens, as new computing form factors emerge (ie. AR Glasses) that lend themselves to input methods more natural than taking out a phone and snapping a picture. In addition, Google shared that by year end, there will be 11 Daydream-ready devices on the market. Most notable, Samsung’s Galaxy S8 and S8+ are Daydream-ready.

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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Swinging for Grand Slams

If we had to sum up our investment approach in one word, it would be non-incremental. Venture capital is a power law game: the vast majority of venture returns come only from a few investments. We believe we have to have the chance to hit a grand slam on every investment we make. Therefore, we look for great teams doing something a little more out there than most. Things like brain-computer interface, or connected fabrics, or creating the future of retail. And we actually think that investing in non-incremental businesses is safer than investing in incremental ones.

Before we get to why, let’s define the difference between incremental and non-incremental.

Incremental companies build for obvious or established markets. They create products and services that are 10% or 50% or even 100% better than what’s on the market now, but they don’t create products that are 10x better. They don’t create products that transform industries and change how consumers interact with the world. And that’s ok! Incremental businesses are important to the progress of the overall ecosystem and see good exits all the time.

Non-incremental companies create products and experiences that are 10x better; those that revolutionize, not merely improve. They establish new markets that are obvious only in hindsight. They create entire ecosystems of companies trying to play in the sandbox they built. It takes a founder with a big vision and a dedicated team to build something non-incremental.

With that distinction in mind, we see three reasons why investing in non-incremental companies is safer than investing in incremental ones:

First, it’s just as hard to create a great non-incremental company as a great incremental company. Either way, the entrepreneur has to convince talented people to take a risk and come work for him or her. The entrepreneur has to retain that talent as other companies come calling with better offers. The entrepreneur has to convince skeptical customers to use his or her new product. The entrepreneur has to persevere through the rollercoaster of survival as a new business. We think that last point is the death knell for most incremental companies: the entrepreneur is beaten into submission and loses interest in the business. It’s easier to stay engaged working on non-incremental ideas than incremental ones.

Second, non-incremental companies tend to have less relative competition than incremental ones. It’s red ocean/blue ocean strategy. Since incremental companies are attacking obvious problems, the market will be full of other businesses trying to solve the same thing. A non-incremental company will have less direct competition because they’re focused on something less obvious. This means that non-incremental markets look smaller than incremental ones at first, but the early non-incremental markets tend to morph into new markets that encompass larger legacy markets over time. Airbnb is an example. Air mattresses on a stranger’s floor is a weird, non-incremental market, but a platform to rent unused housing space competes with the legacy hospitality market.

Third, non-incremental companies tend to develop things that the world needs most. What’s truly valuable about the 5th food delivery company? Or the 10th ride sharing company? Or the 100th photo sharing app? Yes, there are great potential markets there, but they’re obvious markets with lots of competition and, for the most part, undifferentiated technology that creates modest incremental value. We believe that companies tend to get rewarded in proportion to the value they create in the long term. This means that some companies can be overly rewarded in the short term (see many social plays). These short-term wins are harder to predict and are more driven by luck through rapid user adoption than true value creation. Investing in things the world really needs gives us a tangible reason for future reward.

Our downside is still zero when we invest in non-incremental businesses, but the probability of zero is lower for the three reasons mentioned above, and the potential for a unicorn-sized return is greater. Even better, and cliché as it might sound, non-incremental companies are the ones that actually change the world and shape it in our vision of the future. That’s why we swing for grand slams.

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.