Apple as a Service Part 4: New Product Categories

  • Optionality around new product and service categories is the 4th and final pillar to our Apple as a Service thesis.
  • We expect a stable iPhone business (part 1), a growing Services segment (part 2), and capital returns (part 3) to move shares higher.
  • In part 4, we outline potential new product and service categories, including AR wearables, personal health, original video content, and autonomous vehicles, which represent additional growth drivers not yet reflected in investor thinking.
  • New hardware products generate new Services opportunities and the company will continue to develop both in tandem as it looks to expand its ecosystem.

AR wearables a great fit for Apple. Futurist Charlie Fink sums up AR best: “The world is going to be painted with data.” Tim Cook agrees, and in 2017 said, “AR is one of those huge things that we’ll look back at and marvel at.” Cook is doing everything in his power to advance the theme, as evidenced by three developments in 2017 including; releasing an AR development platform (ARKit), shipping dedicated AR optics in the iPhone X, and purchasing SensoMotoric (a wearable computer vision technology).

While the tech community believes in the long-term potential of AR as the future of experiences, most investors are understandably mixed about its potential, given the two most popular AR use cases today are Snapchat and Pokemon. Adding to investor skepticism is the failed consumer launch of Google Glass, released in 2014 and discontinued in 2015. As a society, we were not ready for people to wear cameras.

That said, we believe AR is real and Apple will be a beneficiary. We expect Apple’s AR theme to play out in three phases. First, this fall we expect 2 to 3 new iPhones to join iPhone X with advanced optics for AR (VCSEL arrays). Second, AR apps built using ARKit will slowly become the next gold rush for developers, led by games, ecommerce, and education. Last, we expect Apple will release Apple Glasses late in 2021.

This begs the question: are we ready for AR glasses? Not now, but eventually we will be. AR is better hands-free. We’re not made to experience the world holding up a tiny window. Our arms and eyes get tired. Glasses solve that problem, but they also create a problem by breaking a social dynamic around privacy. We expect minuscule wearable adoption until the utility of an AR wearable offsets the negative social dynamic. Simultaneously, the technology must advance to a point where the design of the glasses is not a negative factor (as we’ve seen with smart watches). Once that happens, wearables will likely go mainstream. We see the early flip phone as a helpful analogy. Around 2000, flip phones added cameras, and the privacy threat of a camera in everyone’s pocket created a negative social dynamic. Eventually, consumers got over it because the utility of the camera offset the negative social dynamic. In the future, we won’t be able to live without an AR wearable, and Apple will be there to sell us one.

We are pushing back our expected release of Apple Glasses from September of 2020 to December of 2021 based on recent meetings with several AR industry experts. While these people do not have direct knowledge of Apple’s plans, it is becoming clear that, as a category, AR glasses are a few years away. We’re looking for 10 million units in the first year, similar to Apple Watch’s first year. We’re using a $1,300 ASP, which yields a $13B business and should account for 3% of Apple’s revenue in CY22. See our updated model here.

Personal health and fitness Apple’s new hobby. Steve Jobs routinely referred to Apple TV as a “hobby” for the company. In 2018, the Apple TV business will generate an estimated $3-$4B in revenue. Apple Watch has well surpassed Apple TV; we estimate it will generate nearly $11B in revenue in 2018. Apple Watch is now the most popular watch in the world. And fitness is literally a hobby of Tim Cook’s. Lastly, we view Cook’s personal motivation to improve global health and wellbeing as an important factor here. The rubber meets the road with products like Apple Watch and AirPods along with software development tools including HealthKit and ResearchKit, but new wearables (and “hearables”) and new capabilities for existing products represent a significant potential growth driver for Apple in the personal health space. We estimate that Apple Watch, AirPods, and a new AR wearable (“Apple Glasses”) will generate over $71B in FY23, up from an estimated $12B in FY18.

The opportunity in original content. We continue to expect Apple to launch a rebranded, all-in-one Apple video and music offering in 2-3 years. As the company ramps its spending on original content at a clip of about 50% per year to more than $4b in 2022, it will need a new home for its video content (currently available through Apple Music and iTunes). While Apple’s original content spend of about $500M in 2017 is just a fraction of the $8B Netflix plans to spend on original content this year, we think they are committed to competing in the content space. That said, they already take a cut of subscriptions generated for HBO, Hulu, Netflix and others via Apple devices. This one-two punch in content will continue to drive consumers away from cable and satellite TV providers to a combination of over-the-top service providers, and Apple is well positioned to benefit both directly and indirectly from this shift. See more here for our thoughts on Apple’s original content strategy.

Apple’s plans in autonomy. Tim Cook has said, “We’re focusing on autonomous systems…It’s a core technology that we view as very important…We sort of see it as the mother of all AI projects.” While he notes that transportation is just one segment of autonomy, it is clear that Apple is working on autonomous vehicles, as they have recently expanded their fleet of test vehicles registered with the California DMV to 55, up from 27 earlier this year, and just 3 last year. While the company’s ultimate ambitions in autonomy are unknown, their public confirmation is noteworthy, and it is clear they are taking the opportunity seriously.

There are two ways we see Apple potentially bringing its autonomous systems to market. The first option would be to partner with a manufacturer to build an Apple-branded car, just as they do with the iPhone and iPad. By partnering with a manufacturer, Apple would have design control over the product and would be able to customize the user experience as much as possible. On the other hand, manufacturing a car is very different than manufacturing a smartphone. The second option would be to focus on developing software and license its technology to current auto manufacturers for use in their vehicles. Apple could be the OS of the future for cars. This may be the more likely option as it plays to a number of Apple’s strengths including voice, navigation, entertainment, security, and a developer ecosystem.

At the moment, Apple is likely pursuing both options under the R&D umbrella of Project Titan. The most near-term application of their efforts is an autonomous shuttle called PAIL (Palo Alto to Infinite Loop) that will transport employees around campus, likely to collect data in a semi-controlled environment. True to form, they’ll watch this market emerge and enter when the time is right – from both a product and a market standpoint.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. 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. 

AAPL’s Paradigm Shift

  • We’re entering a new paradigm related to investing in Apple defined by 4 key themes that we call ‘Apple as a Service.’
  • 1. Greater visibility in the iPhone business (62% of revenue), albeit at a 0-5% growth rate. This stability is representative of a hardware business performing increasingly like a software business, a positive for AAPL’s multiple.
  • 2. Services. Building off of this predictable iPhone business, Services (now 15% of revenue) should grow at ~15% for the next few years.
  • 3. Capital return. Consistent annual share buybacks could approach $40- $50B per year. Assuming AAPL shares rise, that buyback alone could move shares 5% higher this year, 4% higher in 2019, 3% higher in 2020, etc.
  • 4. New products. Innovation will still be required for Apple to maintain its high iPhone retention levels (above 90%), but, in the new paradigm, new product categories represent optionality to the AAPL investment story. Specifically, we believe original content, AR (including glasses), and automotive autonomy are opportunities not yet reflected in Apple’s valuation.
  • Putting it all together, this yields a stable business that is growing at 5-10% per year and returning the majority of its profits to shareholders.

As Apple’s market cap approaches $1T, it begs the question; can shares move higher? At Loup Ventures we do believe the Apple story is well positioned for future appreciation based on a longer-term, more sustainable investing paradigm. The recent move higher in shares of AAPL is likely an early reflection of this emerging paradigm shift. Starting next week, we will publish a four-part series on each of these themes.

Apple investing paradigms. About every 10 years, there is a new paradigm that drives investor thinking on the Apple story. It started with the growth of the Mac (’80-’85), then post-Jobs and competition from the PC (’85-’97), then the iPod along with its halo effect which increased Mac market share (’01-’06), and most recently, the iPhone (’07-present). We define the next paradigm as Apple as a Service.

Drifting away from product cycle hype and disappointment. What will slowly go away (may take a couple years) in this new way of thinking is hype ahead of new product releases and the inevitable anxiety related to unit sales once a product ships. We still think anticipation around new products will influence shares, but that influence will be shorter-lived. For example, Apple will likely release a larger-screen along with a lower-priced iPhone this fall, which will be good for iPhone demand but unlikely to yield a super cycle (greater than 10% y/y iPhone unit growth). The Apple as a Service paradigm will not need a super cycle for the Apple story to remain favorable with investors.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. 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. 

All Technology is Good and Evil

Ready Player One showcased both the promise and the pitfalls of our technological future. A virtual world that enables your wildest dreams, on demand, on top of a real world that rots in decay because the virtual one is so much better. All great sci-fi achieves this balance — a healthy observation about what can go right and how right can evolve to wrong.

The core insight of science fiction is that all technologies live on a spectrum of good and evil, useful and harmful, and our perception of their place on that spectrum vacillates over time. It’s a truth that we’ve long known innately but are now being forcefully reminded of in our real world. In just the past couple months, we’ve dealt with major Facebook data privacy issues, multiple self-driving car accidents, and increasing discussion about smartphone addiction. These technologies that were largely accepted, if not embraced, have turned on us. Perhaps it’s more correct to say we turned on them.

All technologies live on a spectrum of good and evil, useful and harmful.

So, what is it that turns technology from good to evil in our eyes? It seems to happen for one of two reasons.

First, in the early adoption phases of any technology, the majority tends to have a healthy skepticism laced with fear. It’s the reason why most people don’t adopt new technology, only innovators. When a new technology has early failings, the skeptical, fearful majority find reason to double down. They feel validation and their skepticism grows, allowing them to make a case for why some new technology is more evil than good; why it should never exist. This creates an even higher hurdle for a new technology to move into the early adoption phase. Autonomous vehicles seem to be living through a mild version of this scenario now. In fact, the discussion about the perils of AI in general also fits here.

Second, in the later stages of adoption when a majority of people use a given technology, consumers tend to view the technology with a dose of fear laced with resignation that can easily flip to anger. When people believe that too much power is consolidated in any endeavor, technology included, there lurks a possibility of revolt. That possibility turns to reality when power is perceived to be abused and anger takes over. Evil is perceived to outweigh good, and people question whether they want to continue to engage in using the technology. Facebook is living through anger-driven revolt now. You could argue that the firearm debate also fits in this category.

If a technology avoids the anger phase for a long enough period, it can move into a stable acceptance of the good and the bad. An example might be the car, which enables large scale movement of humanity and suburbanization, even though over a million people die every year in car accidents and gasoline-powered cars pollute the environment. The Internet fits here too, even if the smartphone as an extension of the Internet does not yet. Apple is doing all it can to demonstrate its respect of the power it wields in bringing highly addictive Internet services to everyone, all the time.

Just as Viktor Frankl observed that, “No group consists entirely of decent or indecent people,” no technology is purely decent or indecent; none is purely good or bad, which are human judgements anyway. The lesson from Ready Player One as well as our situation today is that we should always be willing to accept good with evil as it comes to technology. We should think about what all technologies will mean to humans first, not how exciting the technology is or how much money it could make or some other measure about what the technology could do. Our guiding light should be to ask, “How sure can we be that this technology will improve human life?” If we can’t get comfortable with that answer, we should be prepared to revolt. If we can get comfortable with it, we should be prepared to accept.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. 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.

F8: Community & Privacy Tools, Putting the Hammer Down on VR & AR

Conclusion. This week we’re attending F8, Facebook’s annual developer conference. We have been down on the Facebook story given the negative effects it has on society (i.e. most people don’t feel better after being on Facebook) have recently outweighed the positive effects (groups and social change). It’s not just us who believes this, Facebook openly acknowledges both the positives and negatives of the platform. It’s important to note we believe there are three things humans fundamentally do better than machines: creativity, empathy, and community. Mark Zuckerberg’s comments today were largely about improving privacy and, more importantly, announcing tools to embrace one-to-one and community building. We see these moves as a measurable first step in evolving the platform to make the world a better place. We’re a long way away, but today’s updates are a start.
  • Three areas Facebook wants to build more meaningful communities around are live video and events (i.e. Watch Party), dating/relationships, and Groups. These all facilitate building community.
  • The company announced new measures in privacy and fake news centered around elections, fact-checking, and greater user control of privacy settings. These advancements are largely a result of the election-meddling and Cambridge Analytica scandals.
  • The company is staying committed to its role in advancing VR and AR. They announced the $199 Oculus Go headset will ship today. AR camera effects are being added to Instagram and Messenger, which is bad news for Snap.
Updates to community. Facebook showcased Watch Party, where friends can get together to watch a video and share comments and reactions. The goal is to connect people through video and make it possible to watch with friends and family even if they’re on the other side of the world. The company also announced a new dating feature housed entirely within the app. It will be an opt-in service, and nothing will be posted or shared anywhere else on Facebook. Finally, Facebook showcased a renewed emphasis on groups with a ‘Groups’ tab in the app, making it easier to join and connect with people who share your interests.
Updates to privacy. In compliance with the EU’s GDPR requirements, Facebook is rolling out privacy controls for users making it easier for them to control what data is and is not tracked by Facebook as well as which apps you’ve given access to and what information they’re using. They’re working on a “clear history” feature where users can clear the data Facebook has collected, much like how the feature works in internet browsers. Mark Zuckerberg was again taking the company’s issues head-on and addressed them in his opening remarks, discussing all the various measures they’re taking to ensure privacy and safety (beyond user controls and clearing history) while still building things that connect people.
VR and AR. Both Instagram and Messenger will be getting the augmented reality camera effects currently available on Facebook. Instagram will also get a platform for content creators to create their own AR effects. Separately, Mark Zuckerberg announced that Oculus Go, their new standalone headset, will begin shipping today (and that everyone at F8 would get one for free). A milestone in VR’s evolution is the introduction of an untethered headset (i.e. no phone or computer necessary) that still offers a quality experience, and Oculus Go purports to be the first device that can provide that. The company also demonstrated how they’re using computer vision to recreate locations from photos as 3-dimensional, immersive spaces that users can walk through in VR. We are excited to see the content and experiences that start to emerge surrounding the Oculus Go.
Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. 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. 

Smart Glasses’ Near-Term Lose-Lose Situation

Earlier today, Snap resurrected Spectacles with version 2 for $150 (up from $130). The updated Spectacles have a slightly sleeker design, the ability to take pictures, new colors, optional prescription lenses, and water resistance.

Smart Glasses’ Near-Term Lose-Lose Situation. Over the next 3-5 years, we envision a lose-lose situation for smart glasses: the sleeker they get, the better they look; but the sleeker they get, the more discreet they are. Said another way, they are either too ugly for mass adoption, or too creepy for social acceptance. Beyond the early adoption period, we continue to believe smart glasses will be mainstream, driven by two factors: time and design. Social acceptance will come with time; as the technology and user experience improves, so too will social norms around wearables and smart glasses. Similarly, improved technology will enable design improvements that support mainstream adoption. We saw this with smartwatches and expect the pattern to repeat. Within 5 years we’ve gone from bulky fitness watches and wristbands to the Apple Watch, and that transition has driven mass consumer adoption. In time, and with design improvements, consumers will eventually become comfortable with the reality that everyone is not just carrying a camera in their pockets, but wearing one.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. 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.