Taking a step back, today’s announcements from Apple’s special event are further evidence that the company continues to make arguably the best consumer tech products in the world from hardware to software, and the integration therein. At the end of the day, consumers have several simple criteria to evaluate their phone, and at the top of the list are battery life, speed, and camera quality. Apple delivered on all of these desires, stressing the performance of the new camera systems above any other feature.
At today’s event, the company introduced a new iPhone, iPad, and Apple Watch, and provided details around several upcoming services. Overall, we continue to feel confident that iPhone revenue will be flat to up slightly over the next year after being down 15% in the last three quarters.
The highest volume iPhone – now the iPhone 11 instead of the XR – is $50 (7%) cheaper. The price decrease came as a surprise. We think it signals a push to drive unit sales ahead of a 5G iPhone and is not a read on the macro. The entry-level price for the iPhone 11 Pro and 11 Pro Max remains the same as the XS and XS Max at $999 and $1,099, respectively.
Upgrades to the Apple Watch were subtle but important. For example, the always-on display feature eliminates a compromise that Apple made on every Apple Watch to date. Even a brief delay in the screen turning on is abnormal when it comes to glancing at a watch face. Apple Watch Series 5 seems to be all grown up and brings the digital watch on par with traditional watches in a critical use case – telling the time.
With Apple TV+ and Apple Arcade, the company is accomplishing two things:
- Apple is wrapping more services around its hardware and software ecosystem to make it stickier.
- With pricing of $4.99/month each, Apple is slowly ramping its recurring revenue per user.
The pricing of both Apple Arcade and Apple TV+ is more aggressive than we expected at $4.99/month. Apple has the advantage of monetizing an entire ecosystem (hardware, software, services), which allows them to effectively subsidize Apple TV+. Similarly, Disney has the advantage of an entertainment ecosystem built around strong IP that allows them to bring down content costs and subsidize Disney+. Netflix doesn’t enjoy the same ability, which represents a threat to their pricing power.
Missing from the event were new AirPods and the widely rumored Apple Tags. While Apple Tags represent a negligible revenue opportunity, we believe AirPods account for 3% of Apple’s revenue. A material upgrade to the form factor and functionality of AirPods would boost already great sales and continue the upward trend of Apple’s wearables business. We estimate that Apple will grow AirPods sales to 50M units this year, up from 28M last year.
Shares of AAPL have rebounded since US-China trade talks caused a slide in early August, but we believe shares would be trading higher if not for the ongoing tariff disputes. The recently announced October meetings are a step in the right direction, but it’s difficult to predict when a deal will be reached.
The unknown around tariffs and the potential for Chinese consumers to boycott Apple products are top of mind for Apple investors. Lost in the conversation are potential benefits Apple will realize from the dispute, including Huawei getting knocked out of the European high end smartphone market — collateral damage of the trade dispute and US national security restrictions. We estimate this could add about 2% to overall iPhone units over the next year and offset some risk to Apple’s business in China.
Bottom line: Apple’s European business is bigger than its business in China and the number of premium phone manufacturers in the region has effectively gone from 3 to 2, leaving Samsung and Apple.
- Next week Apple will announce the fall iPhone line up, including 3 premium iPhones that will, for the first time, feature 3 camera lenses. These products are entering a reshaped European competitive landscape following US trade restrictions placed on Huawei. We believe these restrictions could cut Huawei’s European smartphone business in half. The result: Huawei will lose market share in Europe; Samsung will be the largest share gainer followed by Apple.
- Huawei’s consumer mobile business is highly reliant on US technologies for both software and hardware. Trade restrictions are limiting Huawei’s access to key components, making it difficult if not impossible to compete in its largest market outside of China.
- Europe is a bigger business than China for Apple, accounting for 22% of Apple’s business in the Jun-19 quarter, while Greater China accounted for 17%. We estimate Mainland China accounted for between 10-12% of overall revenue in Jun-19.
- Before the trade restrictions were announced, we estimated Huawei was on a run rate to sell 36m units into Europe over the next year, compared to Apple at about 28m units. Now we expect Huawei’s European shipments to decline to about 18m units during that period. As a point of reference, in an interview this June, Huawei CEO predicted that the company’s overseas smartphone shipments would drop as much as 40%.
- We estimate Samsung will gain 80% (or about 14m) of Huawei’s 18m units. We believe Apple will capture the other 20% which should add 4m units or about 2% to the overall iPhone business over the next year.
The Premium Smartphone Market
There are three market leaders in $600 plus smartphone segment: Apple, with the iPhone 8, iPhone XR, and iPhone XS; Samsung with the Galaxy S and Galaxy Note including the new Galaxy Note 10; and Huawei with Huawei P30 and the Huawei Mate Pro line. The premium smartphone segment is characterized by the highest resolution cameras, the most powerful core and graphics processing chips, the fastest RF internet connectivity, the largest battery sizes, and the latest operating systems. Overall Apple leads the premium smartphone segment with 42% market share worldwide in Jun-19 (IDC). Huawei and Samsung make up around 40%, both using the Android Operation System. Google Pixel, OnePlus, Xiaomi, and a host of others make up the 18% balance.
US Entity List Pressures Huawei
In May, Huawei was put on the US Entity List, which means “the U.S. Government has determined that there is reasonable cause to believe that Huawei has been involved in activities contrary to the national security of the United States.” As a result, US-based firms are no longer able to work directly with Huawei without a waiver exemption from the US Department of Commerce. This designation is impacting Huawei’s Consumer Business Segment which consists of mostly smartphone sales. On August 19th, the US extended the waiver exemption for another 90 days. The details of the exemption and waivers are complex, but it’s been reported that Huawei has been prohibited from working with US companies to develop their next generation smartphones. US companies are still supporting Huawei on their existing products including software security patches and to fulfill certain existing purchase orders. In this environment it should be expected that Huawei’s US supplier relationships will be significantly disrupted.
Huawei Relies on Google
On August 29th, Google confirmed that they are not releasing the Google APIs on next generation smartphones from Huawei. This is important because it prevents Huawei from using three core Google services:
- Android: Historically, several large technology companies have tried to break into iOS/Android OS duopoly without success, including Nokia’s Symbian OS, followed by Windows Mobile OS, and most recently Samsung’s own OS. Huawei announced that it has been working on its own proprietary smartphone OS, Harmony, for last 7 years and is likely still years behind Android.
- Google Play app store: Google Play is where most Android users download apps. In Europe, Google Play app store has a dominant market share despite the fact that in 2018, the European Commission’s antitrust required Google Play app store to be unbundled with the Android OS. Technically, Huawei, Samsung, or any other phone maker can install their own app store and encourage app developers to use their ecosystem with differentiated pricing and revenue sharing agreements. In China, the Google Play app store is banned, and in its place there are over 400 app stores. Huawei’s app distribution platform in China is named Huawei AppGallery and is one of the top 10 app stores that controls the app download market in China. Huawei has been asking more European software developers to design apps exclusively for Huawei AppGallery.
- Google Mobile Services (GMS): GMS is a collection of popular Google apps including YouTube, Gmail, Google Maps, Hangout, Waze etc. GMS certification means that Google application programming interfaces (APIs) will properly install and support functionality across various phone models and devices. With the appropriate APIs, Google’s apps will also work together seamlessly to ensure that the smartphone user has the best experience. If Google is no longer allowed to work with Huawei, Google’s most popular apps will have a downgraded experience on Huawei devices.
Huawei Relies on Facebook & Twitter
Depending on the particular details of the US government ban on working with Huawei, other popular US app developers like Facebook and Twitter may also have to stop porting their APIs on Huawei’s products. This is irrelevant in the Chinese market where Google, Facebook, and Twitter are all currently banned, but the lack of app integration would be another headwind for Huawei in the European market.
Huawei Relies on US Semiconductors
Huawei is reliant on US intellectual property in core smartphone semiconductor components. The mobile CPU and the radio modem are arguably the two most complex semiconductor components in any premium segment smartphones. Huawei designs these components internally through a wholly-owned silicon design subsidiary. That said, Huawei is still reliant on US companies including Qorvo and Skyworks Solutions for their RF front end modules. In addition, Huawei pays a licensing fee to Qualcomm for use of their IP for each radio modem chip. Lastly, all modern smartphone CPUs are based off on the Advanced RISC Machine (ARM) architecture. Even though ARM is a Softbank subsidiary based in London, under US export control laws, ARM, which was originally founded in the US, would also have to cease cooperating with Huawei on licensing their technology for any new products. This would be a challenging hurdle to Huawei’s hardware design efforts in the short-term, even effecting their competitiveness in the Chinese domestic smartphone market. Huawei premium phones also incorporate a significant volume of flash storage and DRAM from US suppliers, but those components are much more easily replaced by Korean and Japanese semiconductor memory suppliers that are not impacted by the trade ban.
How Long Will This Take To Resolve?
The simple answer is: we don’t know. Our sense is that the road ahead for Huawei in Europe will be challenging for a couple of years. The companies recent challenges outside of China stem from a combination of two very complex issues: the US China trade dispute, and US national security interests. While the timing of a resolution is difficult to predict, it is clear that Samsung and Apple are near-term beneficiaries.
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