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This Is "Bad" News for Apple?

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You know a company is doing well when its bad news is actually good for the company. According to a report from The Wall Street Journal, Apple (NASDAQ: AAPL  ) is facing the oh-so-terrible truth that the iPhone 5c has not sold as well as the company expected. The company is being forced to ramp down production of the model while it ramps up production on the cutting-edge 5s model.

This is bad news?

Why Apple made the 5c
Before Apple announced the iPhone 5s and 5c last month, many analysts were expecting the company to release a new low-end phone. When Apple unveiled the 5c, those same analysts were very disappointed in the pricing. Apple is losing global market share to Samsung (NASDAQOTH: SSNLF  ) , and the 5c isn't inexpensive enough to compete with its competitors on price.

Those analysts have been proven right -- 5c sales have been largely outpaced by 5s sales -- but they've missed the point of the 5c.

Apple is addressing a problem that came up in its last iteration of the iPhone -- older models are cannibalizing it. The 5c is basically the same phone as the iPhone 5, but with a colorful plastic shell. I would expect sales to mimic those of the iPhone 4s last year.

How do sales compare?
Last year, the iPhone 5 outsold the 4s 3-to-1 in the quarter the new phone was launched. In the subsequent three quarters, there was an approximate 50/30/20 split between the iPhone 5, 4s, and 4.

Early data indicates the iPhone 5s is outselling the 5c by a ratio of 3.7-to-1. Couple this with the fact that Apple sold 9 million units in its launch weekend compared to 5 million last year -- 7 million if you include the China launch later in the year -- and its clear the 5s is a bigger hit than the iPhone 5.

That's a good thing. The 5s sells at a higher margin than the 5c. It brings in $100 more in revenue, too. In short, Apple would rather sell you the 5s than the 5c.

Why analysts worry
Perhaps analysts believe that Apple is limiting itself to the top end of the smartphone demand curve. If anything, the success of the 5s compared to the 5c indicates that there's more money to be made at the top of the curve, rather than selling volume at the bottom.

Profit share data would corroborate that argument. Apple had 53% of the smartphone profit share in the second quarter. Samsung had 50%. This left Nokia (NYSE: NOK  ) , Blackberry, Motorola, and HTC with a net loss on their combined smartphone sales. In fact, HTC and Sony have been very vocal about their desires to move up the demand curve, and get out of the low-end phone business.

That's easier said than done. Nokia struggled with the transition to smartphones. A leader in feature phones, the company saw its smartphone sales drop 24% last quarter as its Lumia line largely failed to catch on. The company's struggles prompted a sale to its software partner, Microsoft.

Samsung's global dominance of the smartphone market came from its low-end phones capturing a large share of the market. Yet the company sells those cheap phones -- about 300 million per year -- at an estimated operating margin of just 1%. Overall, it's dilutive to its high-end smartphone business, which sold approximately 75 million units last year.

An Apple move down the demand curve would likely have a similar result. Currently, there's very little profit to gain from offering a cheaper phone.

At $550 ($99 subsidized), the iPhone 5c appears relatively inelastic -- meaning a lower price won't draw enough buyers to offset the lost profit margin. Instead, it seems people would rather spend more on their phones. This is logic that only works with Apple products because Apple is an aspirational brand -- the price tag is a status symbol.

Why can't all news be this bad?
If Apple's weak 5c sales are the worst thing that happens to the company this year, the company is set to improve its revenue, margins, and profits. This ought to drive the stock price higher, as its already trading at relatively low multiples.

When will Apple destroy the 5s and 5c?
Apple has a history of cranking out revolutionary products... and then creatively destroying them with something better. Read about the future of Apple in the free report, “Apple Will Destroy Its Greatest Product.” Can Apple really disrupt its own iPhones and iPads? Find out by clicking here.

Read/Post Comments (5) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 22, 2013, at 12:43 PM, Mathman6577 wrote:

    Good article and analysis. The Wall Street boys have their heads buried in the sand regarding margin (it was drummed into their heads in MBA school). The analyst focus should be on cash. Lot of it flows to Apple and they put it in the bank and give some to investors in the form of dividends and buybacks.

  • Report this Comment On October 22, 2013, at 1:05 PM, TEBuddy wrote:

    The 5c is likely intended for the Chinese market, when or if those deals with the carriers are solidified. I think you would then see a lot more 5c shipments. But those deals have been delayed.

  • Report this Comment On October 22, 2013, at 1:18 PM, drgreg4stocks wrote:

    I liked the article up to the point you sate "Apple had 53% of the Smartphone Market . . . Samsung had 50%." Not correct math which always makes me wonder what else is not correct.

  • Report this Comment On October 22, 2013, at 2:27 PM, adamlevy wrote:

    @zxvb98789 Those numbers are profit share not market share.

    @TEBuddy I disagree. I don't think the 5c was really intended for the Chinese market. I think it was meant to replace the mid-range iPhone, which would have been the iPhone 5, and produce better margins. Success in China would be a pleasant side effect.

  • Report this Comment On October 23, 2013, at 9:11 PM, drewrking wrote:

    It makes sense the fans waiting for the new iPhone will buy the 5s. It is customers new to the iPhone that will take a closer look at the iPhone 5c as they become eligible for upgrades. These customers will come over the year, not immediately after release.

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