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. 

Amazon’s Next Massive Market: Healthcare

  • CNBC reported on Friday that Amazon is building a health and wellness team inside its Alexa division to work on making Alexa a better tool for healthcare.
  • Amazon, Berkshire Hathaway, and JP Morgan recently announced plans for a joint healthcare company focused on reducing costs and improving care for their combined 1.2m employees.
  • The $3.3T U.S. healthcare industry is notoriously slow to innovate.
  • We think Amazon will change healthcare on three fronts: 1) Logistics: Help reshape the $453B Pharmacy Benefit Management industry; 2) AI: Alexa will help both patients and providers with everything from in-home care to allowing providers more time with patients instead of paperwork; 3) Cloud: AWS will continue to allow Amazon to partner with the world’s leading patient data networks.

Source: CNN Money

Dr. Alexa. Today’s news around Amazon’s new Alexa healthcare team got us thinking about Amazon’s prospects for breaking into healthcare.  Companies across the entire healthcare industry are quickly discovering that AI will be used in everything from operations to enhancing quality of life for patients. Imagine the safety, information, connectivity, and entertainment that an Alexa near every hospital bed could offer patients.

Amazon’s Medical History. Amazon’s first foray into healthcare came with a 2014 deal with Cardinal Health leveraging Amazon’s e-commerce capabilities to sell medical supplies to hospitals and clinics. Amazon announced another major move into healthcare when they, JPMorgan Chase, and Berkshire Hathaway outlined plans to start a company that would provide and manage healthcare for the three companies’ combined 1.2m employees, focusing particularly on reducing costs. Separately, Amazon announced that they have put their plans to become a pharmaceutical wholesaler on hold (for now). The company found it difficult to bring major hospitals on board due to their reluctance to deviate from the purchasing process they’ve grown used to. 

Amazon’s Next Moves. We believe Amazon will have a major impact on the $3.3T U.S. healthcare industry by leveraging three core competencies: Logistics, AI, and cloud infrastructure to transform delivery of care, population health management, and healthcare software services.

  1. Logistics: Logistical expertise will most directly impact the highly concentrated Pharmacy Benefit Management (PBM) sector. Rising drug prices and rising drug demand has driven considerable backlash recently among American consumers. We feel this could be a golden ticket for disruption to a cost-conscious, logistics expert like Amazon.
  2. AI: Alexa’s artificial intelligence could significantly reduce the amount of busywork for doctors and accelerate the adoption of in-home telehealth. From checklists to note taking to logging patient symptoms, Alexa could streamline many healthcare operational functions by eliminating menial tasks and allowing providers to spend more time with patients. In the home, patient rooms, and at senior living facilities, Alexa could do everything from reminding patients to take their medicine, to helping manage care for diabetics, to helping patients notify staff if they’ve fallen.
  3. Cloud: Amazon’s $5.4B AWS business is poised to provide incumbent electronic health record systems with the storage, analytics, and population health management tools needed to provide a full stack of services around patient data. Evidence of this came as Cerner, one of the world’s largest health technology companies, partnered with AWS to utilize the platform’s data analytics strengths to provide more real-time care coordination amongst providers. Cerner also looks forward to leveraging Amazon’s AI to take a more proactive approach to cross-sector population health and wellness, and we anticipate they will be one of many healthcare firms in the future using AWS in similar capacities.

Whole Foods + Healthcare. The acquisition of Whole Foods gives Amazon another unique product and product delivery method, although we can’t call it a core competency yet. Food as medicine will be an important part of healthcare’s future and, as a leading grocer, Amazon is well-positioned here. Whole Foods locations also provide Amazon with the physical presence, and the brand recognition in health and wellness, to potentially address the need for more convenient healthcare clinics.

Bottom line. Amazon’s aspiration to be “Earth’s most customer-centric company” provides it with seemingly unlimited growth potential (and uncanny ability to find success in new markets). While they may be king when it comes to e-commerce, their entry into the healthcare market will likely prove to be one of their toughest tests to date. They face an extremely complex and concentrated industry and the regulatory quagmire that comes with it. Amazon has its work cut out in convincing the healthcare system that it belongs at the table, but it’s made sensible first steps and we’ve learned not to bet against them.

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.

Lights Out: Amazon Flexes Its Profit Muscle

  • Amazon reported Mar-18 results highlighted by profitability that was 2x analyst expectations.
  • Recall that from time to time Amazon will flex its gross margins to remind investors of the model’s leverage potential. Going forward we expect margins to dip lower as the company continues its aggressive investment pace into fulfillment, lower AWS pricing, and content.
  • Retail growth of 22% y/y was consistent with growth over the past two years. More room to go given the company added ~15m Prime members in 2017, which will drive spending in 2018. Prime members spend 3-4x more on Amazon than non-Prime users.
  • AWS growth accelerated for the second straight quarter to 49% y/y, compared to 45% y/y in Dec-17 and 43% y/y in Sep-17. Cloud is still a nascent market and AWS is a killer platform that should yield favorable growth going forward.
  • The company also announced a 20% increase in the price of a Prime membership. This should yield about $2B per year in incremental revenue that will most likely be reinvested in the business, and occasionally allow the company to flex its profit margin muscle once again.

The $50B automated retail opportunity. In 2016 there were 3.5 million cashiers in the U.S., according to the Department of Labor, with an average salary of $13,574, according to Data USA. That makes for a nearly $50 billion opportunity in cashierless retail that Amazon is well positioned to attack. Of those 3.5 million cashiers, 323,000 are convenience store or gas station employees, or 9% of the cashier workforce. The automated retail space is getting more and more crowded, but the Go store suggests that Amazon has the pole position.

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. 

Transformations: Wrapping an Old Fish in a Piece of Paper Called Change

Written by guest author Carlos Castelán with Andrew Murphy. Carlos is Managing Director of The Navio Group.

Note: size of bubble represents FY 2017 company revenue

In recent years, companies in the retail and consumer goods space have touted “business transformations” – a cue to analysts and Wall Street that they were launching innovative products and services or becoming more digital, to name a few themes. To understand the success rate of transformations in the retail and consumer good markets, The Navio Group partnered with Loup Ventures to identify a basket of companies and analyze key performance metrics over the last five years.

The results were surprising: companies that frequently touted a transformation on their earnings calls were less likely to succeed in driving long-term revenue lifts and generating growth.

More often, companies with executives that were eager to publicize transformation efforts were either a) unsuccessful driving top-line and bottom-line improvements or b) only succeeded in cost-cutting to improve margins, despite stagnant or declining revenue. In effect, transformations touted by executives at these companies resulted in operational restructuring.

One notable exception stood out amongst the list of companies: Domino’s. Between 2013 and 2017, its executives never mentioned a transformation and instead took a workmanlike approach to change their company to drive outsized results. Domino’s drove a staggering 30% revenue growth and increased its operating income by more than 40% over the five-year period.

We believe the genesis can be traced back to the CEO, Patrick Doyle’s, early declaration on Jim Cramer’s show that “Our pizza tastes worse than the box…I’m gonna tell people.” Rather than dust off the traditional turnaround playbook, the management team came out and exposed the underlying, widely known issue– the product. As Doyle told CBS, “We went on air on a Monday, and by Wednesday, our sales were up double-digit. And we hadn’t even told them how we’d fixed it.” The leadership team and organization focused on fixing the product and, in doing so, reinvigorated the brand. It then focused on enhancing customer experience through the facilitation of convenience by turning itself into a technology-focused company. The results speak for themselves as the company’s stock outperformed traditional high-achievers Amazon, Apple, and Facebook over a seven-year period.

So, what can we conclude from the data and from Domino’s success?  Three themes stick out:

  • Leadership and courage make all the difference. It doesn’t show up in any of the numbers but leadership and the courage to fundamentally address and then fix underlying issues separates companies like Domino’s. It’s hard to publicly acknowledge to both customers and Wall Street – particularly when executives’ compensation is tied to stock price – that your company has problems, but leadership is about making difficult decisions. As Doug Stephens writes in the Business of Fashion:

It requires significant organizational introspection, courage, honesty, design thinking and research. There is no off-the-shelf solution, no app and no magic to it – just the willingness to reinvent, reimagine and risk the occasional screw up. Think of it this way; if it’s not risky, it’s probably not innovative.

  • Understanding what a company sells and then reinventing the product is core to a successful transformation. Identifying the customer value proposition in terms of both product and experience– not how the company maximizes profit – is how a company reinvents itself. Domino’s went about fixing its product (pizza) and then creating a seamless customer experience through digital and mobile. It did this even though the legacy business and its processes relied on physical locations. Nordstrom is experimenting with service-only locations because it believes this to be a resonant experience for its customers. As Mr. Stephens writes, “Customer experience is…the future of how physical retailers will generate revenue. Experiences won’t just sell products. Experiences will be the products.”
  • Rethinking the talent strategy – both internal and external – is critical. To reinvent a business, leadership needs to also rethink its talent strategy. According to Rob Biederman, CEO of technology platform Catalant, 53% of individuals in the C-Suite are now thinking about a more agile workforce as a top priority. Domino’s now has 50% of its headquarters employees in software and analytics. The transformation of the organization is key to reinventing the customer experience and building an exponential mindset in the organization as the industry continues to evolve.

As change becomes the norm in the retail and consumer goods industry – as well as most others – executives and leaders will need to re-think what it means to transform their businesses rather than, as Barack Obama once said of his opposition, “wrapping an old fish in a piece of paper called change.” Leaders should ask themselves: what are the underlying issues? And how do we take a non-linear approach or exponential mindset to transforming the business, even if it disrupts our current model?

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.

How To Think About Recent Volatility in Tech

Market decline does not change the mega growth opportunities. The heart rate of the market increased the past week because of fears of a trade war, Facebook data privacy, and broken market technicals, but the health of the market is unchanged and the health is good. Core underlying tech trends including artificial intelligence, robotics, big data, and autonomous transportation, will support continued growth.

Hold tech for the long-term. We believe that tech is essentially taking over the rest of the economy; therefore, investors should hold tech long term. Just as every company is now an internet company to some degree, we believe that eventually every company will be an AI company.

Market undervalued. From a valuation perspective, our view is undervalued. The market has rallied back to the old highs, but the S&P is up only 3% per year over the past 17 years, compared to the previous 17 years (1983-2000) when it was up 17% per year.

Putting the size of tech into perspective. The tech sector’s growing clout is not just a U.S. story. Tech stocks have become so dominant in emerging markets that for the first time since 2004, the industry last year overtook finance as the biggest sector in the MSCI Emerging Markets Index. Tech had a 28% weighting near the end of 2017, more than double its level six years ago, according to data provided by MSCI. Facebook, Amazon, Netflix Inc. and Alphabet together account for a 7.8% weighting in the S&P 500, more than double from five years ago.

Company Updates:

Tesla. We remain positive on TSLA. Shares are down 20% in the past month mostly due to fears of another miss in Model 3 production. The recent stock dive is due to a combination of a Model X accident that is being investigated, Waymo’s partnership with Jaguar, which legitimizes a key competitor (the I-Pace electric SUV), growing concern among all companies testing self-driving vehicles amid the Uber fatality, and news that Moody’s has downgraded Tesla’s bonds to B3 from B2, citing significant shortfall in the Model 3 production rate and a tight financial situation. We continue to believe the Tesla story has the best risk-reward among tech companies over the next 5 years.

  • Model 3 production. We’re expecting another miss in Model 3 production in the March quarter but that does not change the story. There is more demand than supply for the Model 3 (about 400k preorders which is unheard of in automotive). It might take a year, but eventually, Tesla will get the Model 3 production right, and ramp output.
  • Model X accident. We see the recent Model X accident the same as accidents with gas cars. It is unlikely that the battery or Tesla’s advanced cruise control “autopilot” were to blame. Tesla disclosed that the autopilot feature properly functions 200 times a day on the same stretch of road where the accident happened.

Facebook. Limited upside to FB. Given the privacy issues, for the first-time advertisers have to think about Facebook as a liability. Separately, it’s unclear about how the recent privacy changes will impact Facebook’s ability to make money.

Nvidia. We remain positive on NVDA. Shares of NVDA dropped 11% in the past week following the announcement that they temporarily stopped autonomous testing, and in part because of the broader market sell off. While the company did not comment on timing, we expect testing to resume in the next 3 months. The big picture is the company is well positioned to capitalize on four mega trends, AI, autonomous cars, gaming, and blockchain through their dominance of GPU processors.

Apple. We remain positive on AAPL. Concern is emerging that iPhone demand in June will fall below Street expectations. We think iPhone demand over the next two quarters is not important to the story. What’s important is the share buyback, services, and the next iPhone.

  • Share buyback. Apple can add 4% per year to the stock price (assuming they use $40B of the $55B they generate in cash each year to buy back stock). Apple will give an update on the share buyback when they report the March quarter, likely late in April.
  • Bigger screen iPhone this fall. We expect Apple will announce a 25% bigger phone in the fall. This will be a positive for unit demand and average selling price.
  • Services. Services account for about 15% of revenue and are growing at 15-20% year over year. We believe this segment will continue to grow at a 15% or better rate over the next five years. This is important because the earnings multiple on shares of AAPL will likely increase as investors view the predictability of services are more attractive.

Google. We remain positive on GOOG. We expect the next six months to be rough for shares of GOOG as questions emerge about how the company uses data. Despite that negative potential, Google is too tightly woven into the fabric of the internet. The company is one of the best ways to invest in AI, given the company has a stated their intention to move from a mobile-first company to an AI-first company over the next several years. Lastly, the company has a stake in Waymo, the leading autonomous car company. We expect years of positive news to come from Waymo.

Amazon. We remain positive on AMZN. The company is best positioned for the future of retail. We see that future as a combination of both online and offline retail. Online sales account for about 15% of global retail, and in the future, we believe it will eventually reach 55% of sales. We also expect Amazon to do more with physical retail locations and we continue to believe the company will eventually acquire Target (TGT). The company’s AWS web hosting business is only 15% of revenue, but it is growing at greater than 30% for the next several years.

Twitter. Limited upside to TWTR. About 14% of Twitters 2017 revenue came from selling data, growing at 18% y/y, compared to Twitter’s ad business that declined by 6%. Selling private data is a toxic label, and this could limit the upside to shares over the next year.

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.