What Do Cheaper iPhones Mean for Apple?

Apple AAPL held its annual product showcase this week, during which it announced the launch of three new iPhone models: iPhone 11, iPhone 11 Pro, and iPhone 11 Pro Max. The last two devices feature an OLED display while the former has a liquid-crystal display. Apple modified its pricing strategy with the iPhone 11; the upgraded equivalent of last year’s iPhone XR will start at a price of $699, compared with the XR’s starting price tag of $749. The $50 drop for the newest least expensive model supports our belief that Apple’s switching costs have a limit and thus merit a narrow--not wide--economic moat rating.

We consider the improvements in the iPhone 11 series to be relatively marginal and suspect many users will opt to wait for a 5G-compatible iPhone in 2020. Thus, we are not forecasting a rebound in iPhone unit sales this year, particularly in China, where we believe 5G will be a bigger factor as many Android devices already include 5G modems. We are maintaining our $200 fair value estimate for Apple, and we view the shares as overvalued at current levels.

The iPhone 11 Pro and 11 Pro Max will start at $999 and $1,099, respectively, in line with the starting prices of their equivalents from 2018. For all three new models, we think the primary attractions are new camera systems and improved battery life. The iPhone 11’s dual camera system boasts a wide and ultrawide view camera along with added features such as night mode (which we note the Google GOOG/GOOGL Pixel has boasted for multiple iterations). The Pro and Pro Max add a third telephoto camera, which brings in 40% more light. The emphasis on camera features is consistent with Android-based smartphone vendors that have been also adding cameras and claiming superiority to Apple devices in picture quality.

Battery life continues to expand thanks to the new A13 Bionic chip, which is manufactured on TSMC’s 7-nanometer-plus process technology that leverages extreme ultraviolet lithography. Apart from the normal performance improvements, Apple claims the iPhone 11 will offer an additional hour of battery life versus the XR, while the 11 Pro and Pro Max will last 4 and 5 hours more, respectively, than their predecessors.

Apple also launched the next generation of the Apple Watch, Series 5, with an always-on retina display that is low-power to maintain the watch’s 18-hour battery life, as well as a built-in compass. The company gave a preview of upcoming Watch features associated with three new research studies on hearing health, menstrual cycle tracking, and heart and movement. Series 5 maintains pricing levels from Series 4. We continue to view the wearables subset of Apple’s product portfolio favorably, as the Apple Watch and AirPods have both exceeded our expectations and help maintain stickiness for the iPhone installed base.

As the iPhone business has leveled off in recent years, Apple’s services have come to the forefront of its overall strategy. Two examples are the Apple TV+ and Apple Arcade offerings, which were explained in greater detail during the event. The first Apple TV+ shows will be available Nov. 1, with a family subscription coming in at $4.99 per month. This price undercuts Netflix’s NFLX current offering (starting at $12.99) as well as Disney’s DIS upcoming platform (starting at $6.99), though Apple has a much shallower content library. Beyond the lower price, Apple will attempt to convince users to try its offering by giving Apple TV+ for free for one year with the purchase of a new iPhone, iPad, or Mac. Although the initial slate will feature relatively high-profile shows such as “The Morning Show” starring Jennifer Aniston and Reese Witherspoon, we don’t think Apple will be anything more than an also-ran in the current streaming wars among giants such as Netflix, Disney, and others, at least for the foreseeable future.

Apple Arcade will also be $4.99 per month, with access to about 100 games without ads or in-app purchases. The current market for mobile games is heavily ad- and in-app purchase-based, and we question the amount of traction Apple will be able to generate. However, the company does have a deep chest of resources, and during the event it had game publishers such as Konami, Capcom, Square Enix, and Annapurna Interactive on stage to showcase games that will be featured in Apple Arcade.

Ultimately, while no single service moves the needle for our investment thesis on Apple, we think the service business in aggregate will remain a vital cog in the company’s ability to monetize and, more important, retain its highly valuable iOS installed base.