October 16, 2017 Daniel Ives, Head of Technology Research | 917.210.3220 | [email protected] iPhone X - The Start of a Super Cycle or the End of an Era of Growth? In this research piece we take a deeper dive into Apple through industry analysis, survey work compiled by the GBH team, and a closer look into the potential impact the iPhone X launch will have for Apple and the smartphone industry moving ahead. In a nutshell, we believe iPhone X demand will be strong in the US and especially China as overall our survey feedback indicates that 40% to 45% of iPhone upgrades in FY18 will be iPhone X devices with iPhone 8/8+ tailwinds helping set up a “super cycle” upgrade over the next year. We note in past upgrade cycles for Apple the current iPhone accounts for 50%-60% of overall iPhone sales, while based on our work in the field we believe this time around roughly 65% to 70% of sales will be either iPhone X or iPhone 8 (likely 8+ stronger) which should support a higher ASP and growth thesis for the course of FY18 and 1HFY19 for Apple. While supply chain issues will elongate the iPhone X upgrade cycle well into FY18, we believe seeing the “forest through the trees” will translate into this super cycle upgrade being a major growth catalyst for Apple (and its investors) over the coming year. We rate Apple a Highly Attractive on our GBH Value Matrix. • Pent up demand a key ingredient to Apple’s success. In addition to a more robust upgrade in terms of form/function on iPhone X, we believe iPhone units will benefit from a massive iPhone installed base that is ~2 years old (or older). Our analysis suggests that there is an installed base of 350M+ users on an iPhone that's at least 2 years old and potentially gearing up for an upgrade during FY18. Ultimately, we believe our above the Street iPhone unit shipment forecast of 265 million in FY18 materializes as Cook & Co. benefit from the trifecta of a 1) transformational form factor release for the first time in three years, 2) massive pent up installed base demand globally, and 3) strong China growth returning back to the Apple story in what we believe is a $200 billion linchpin opportunity in this all-important region over the next three years. October 16, 2017 iPhone X-The Start of a Super Cycle or the End of an Era of Growth? Unless you have been living under a rock, one of the biggest and most debatable technology product launches in the last few decades has been Apple’s highly anticipated iPhone X launch announced in September. With Apple selling over 1.2 billion iPhones since its iconic launch in 2007, the big question on the minds of technologists, investors, and the smartphone industry is “Will iPhone X be a major super cycle for Apple or signify the end of this unprecedented decade of growth for Cook & Co?”. To this point, in this research piece we take a closer look into this key question through industry analysis, survey work compiled by the GBH team, and a deeper dive into the potential impact the iPhone X launch will have for Apple (and its investors) moving ahead. iPhone X and its vital importance to Apple’s growth. We believe Apple’s product announcements in September kicked off a “major prove me” time for Cupertino to show the industry and the Street that there is much fuel left in the tank on the smartphone upgrade cycle. Many skeptics believe the $999 price for the iPhone X, near-term production issues out of Asia (OLED, facial technology hiccups), a more crowded smartphone market, and slowing Chinese consumer demand could translate into disappointment around this iPhone X product cycle. Is this going to be a “super cycle” or just a traditional iPhone cycle, that is the key focus and debatable topic for investors heading into the seminal November 3 official launch in a few weeks. In addition, this product cycle has far reaching implications for Apple to further catalyze its services and other device growth (e.g. Apple Watch) over the next few years within its all-important installed base. Daniel H. Ives 917.210.3220 [email protected] Copyright © 2017 GBH Insights Page 2 October 16, 2017 Live and die by the iPhone launch sword. Over the last few years we have seen the ups and downs of Apple’s iPhone cycles. The iPhone 6 cycle far exceeded Street expectations and was a major launching pad for Apple’s stock and its smartphone growth prospects in what we would characterize as the best pure technology product cycle we have ever witnessed selling 231 million peak iPhone units. With a muted iPhone 6s and 7 upgrade cycle over the last few years, the industry and the Street experienced the disappointment coming off this unprecedented product cycle with now all eyes are focused on iPhone 8/8+ and especially the iPhone X official launch in November. With no major product cycle, iPhone product demand has been under pressure since the flagship iPhone 6 release with all bets from Cupertino now on the iPhone X product cycle being the long awaited “silver bullet of growth” to unleash Apple’s next phase of consumer growth. iPhone X is a potential “game changer”. At its annual launch event in early September Apple announced the flagship iPhone X device (available for pre-order Oct. 27, ships Nov. 3) along with the iPhone 8/8+, Apple Watch Series 3 (cellular- enabled), and TV 4K in addition to software updates (iOS11, WatchOS, 4 and tvOS). From a retail price perspective, a base 64 GB iPhone X model will be priced at $999, with a 256GB model at $1,149. The new iPhone X is Apple’s first major form factor change in three years and will feature: 1) edge-to-edge 5.8" Super Retina OLED display; 2) upgraded A11 bionic neural engine processor; AI capabilities; 3) wireless/inductive charging capability on Air Pad and/or third party pads; 4) Face ID (replacement for Touch ID) that enables facial recognition technology; 5) AR- enabled rear-facing vertical dual-lens camera; 6) glass front and back with stainless steel edges; 7) dust/water resistance; 8) longer battery life lasting 2 hour longer than iPhone 7; and 9) 64GB and 256GB storage tiers. OLED display, facial recognition, and no home button (bigger screen) are the major changes to this form factor as has been rumored for many months. This is the Daniel H. Ives 917.210.3220 [email protected] Copyright © 2017 GBH Insights Page 3 October 16, 2017 first true form factor change in three years (since the iPhone 6 launch) out of Apple and in our opinion, will be a “game changing” release for Cupertino as well as the broader smartphone industry. iPhone 8/8+ out now; all eyes on X: Along with the iPhone X excitement, Apple also unveiled iPhone 8/8+ into the market last month which are two new LCD iPhones (4.7" and 5.5"), with: 1) glass bodies/aluminum frames; 2) A11 bionic processors; 3) wireless charging; 4) Touch ID; 5) dual-lens camera for the Plus model, 6) AR capabilities; and 7) 64GB and 256GB storage tiers. The iPhone 8 (4.7") and iPhone 8+ (5.5") base model will start at $699 and $799, respectively. Both models shipped in September and have been slow out of the gates based on our and initial industry data, not surprising in our opinion as we view this release as the “appetizer” to the main event being the iPhone X launch and product cycle. With more complex production issues with this next generation OLED device, Apple needed to release these new phones back to back in our opinion even though it has naturally tempered demand for the iPhone 8 product family in the near-term as consumers await for the next generation iPhone X release to hit the stores. 10-year anniversary-iPhone remains the driver of Apple. Since the release of the original iPhone in 2007, sales have grown to represent more than 60% of Apple’s total revenue (18% in FY08 to 63% in FY16). With stellar gross margins relative to other product categories and competitors, Apple should help the company maintain a nearly 40% gross margin profile if sales continue to represent 60%+ of Apple’s total revenue which we are modeling for the foreseeable future. While the software/services segment for Apple is a major growth (represents roughly between 12% to 15% of overall revenue) and margin opportunity over the coming years and will help drive the Apple ecosystem, the success of the iPhone remains the bedrock of the Apple story. Wearables, services/software, multimedia Daniel H. Ives 917.210.3220 [email protected] Copyright © 2017 GBH Insights Page 4 October 16, 2017 content, self-driving cars (e.g. Project Titan), potentially Apple augmented reality glasses, and any other organic or acquisitive product initiatives all builds on the unparalleled iPhone franchise with iPhone X being a pivotal and historical launch period for Apple. This speaks to why there is so much focus on the demand/supply trajectory of iPhone X as key questions industry experts and investors are searching for revolve around 5 key areas : 1) will consumers pay roughly $1,000 for this new smartphone, 2) what does this upgrade cycle mean for the iPhone installed base, 3) how big will China growth be in this product cycle, 4) will this cause a major ripple effect across the Apple services/device ecosystem, and 5) what does this mean for investors/stock.