How Scary Are Apple's iPhone Cuts?

This sounds downright terrifying for Apple (AAPL 0.39%) investors, doesn't it? "Apple has cut its orders for components for the iPhone 5 due to weaker-than-expected demand," says the venerable Wall Street Journal. The report echoes one from Japan's Nikkei news service (via MarketWatch).

That does sound frightening and investors are indeed quite frightened. Shares dipped to as low as $497 in pre-market trading following the report, which was posted late Sunday night. During the regular session, shares were down nearly $22, or over 4.1%.

Let's dig into this rumbling and see if it has any legs. Is there real cause for concern?

Stop me if you've heard this one before
This news isn't actually news at all, as exactly one month ago Jefferies analyst Peter Misek noted that Apple component suppliers had received order cuts. Numerous other Street analysts have been adjusting their estimates downward over the past couple of months, in part due to these order cuts that have already made the rounds.

Display vendors Sharp, Japan Display, and LG Display (LPL -0.38%), which source the iPhone 5's display, have supposedly been hit with order reductions. Combined, the three vendors were reportedly set to build 65 million iPhone displays for the current quarter, a figure that's now half of what it was.

Too much, too fast
When someone's bluffing in poker, a common tell is that they bet too much and too fast. This 65 million figure is nothing short of astronomical to begin with. Apple is expected to ship between 45 million and 50 million iPhone units in the fourth quarter, so building 65 million units for the following quarter would represent a sequential increase of 44% and 30%, respectively. That's absurd.

The fourth quarter is the big money maker, and no one should expect Apple to follow up a monster fourth quarter with an even monster-er first quarter. For context, this is how tall of an order that would be to fill relative to prior first-quarter shipments.

Source: SEC filings. Calendar quarters shown.

Apple has managed to post a sequential increase coming into the first quarter only once before in 2011. All other times the company has expectedly declined sequentially along with just about every other consumer-oriented manufacturer.

Source: SEC filings. Calendar quarters shown.

No one would ever expect Apple to sell 65 million units in the first quarter, given it's a seasonally slow time frame and Apple already rolled out the new device to virtually all of its carriers in the fourth quarter.

The weakest link
The displays were initially pegged as one of the primary bottlenecks when the iPhone 5 launched, with the other one being the aluminum unibody assembly. Misek's initial report believed assembly orders to be unchanged. Assuming all of these reports are interrelated, which they appear to be, that may simply mean Apple ordered too many of certain components and is reducing them as another bottlenecks production.

Apple's supply chain is a living, breathing entity with a lot of moving parts. I wouldn't purport to know more than Tim Cook about how all those pieces fit together, and neither should the WSJ, Nikkei, or investors.

The first 150 days
There's been some chatter that Apple may be shortening its product cycles, which coincides with the surprise release of the fourth-generation iPad late last year. Topeka Capital Markets analyst Brian White believes that both the iPhone and iPad will see speedy releases this year. White believes a fifth-generation iPad and second-generation iPad Mini are due out in March -- just five months after the last update.

He also believes new iPhones will be launched over the summer between May and June, including new configurations and choices regarding display sizes and colors. That's just four to five months from now.

As it turns out, many of Apple's component orders actually cover what the company thinks it will need for the next five months (according to its 10-K):

The Company must order components for its products and build inventory in advance of product announcements and shipments. Consistent with industry practice, components are normally acquired through a combination of purchase orders, supplier contracts, open orders and, where appropriate, inventory component prepayments, in each case based on projected demand. Such purchase commitments typically cover forecasted component and manufacturing requirements for periods up to 150 days.

Apple's manufacturing and component purchase commitments have skyrocketed to a whopping $21.1 billion as of September. If the company is indeed preparing to launch a new iPhone family, it could be preparing to ramp down 4-inch displays for the iPhone 5 in advance of ramping up smaller and/or larger iPhone displays over the next five months.

Who's coming with me?
Apple supplier plays are similarly dropping today. Cirrus Logic (CRUS 0.40%) is taking a beating today, down 8% at the low, as Apple continues to comprise the majority of its audio codec business, for better or for worse. Today, that's worse.

Qualcomm (QCOM 0.61%) was faring better than other suppliers, down "only" 1.5%. That's fair because the baseband modems it sells to Apple are a relatively smaller part of its business than some of its Apple supplying peers.