Macopinion

Cup Half Full or Half Empty?

by Marc Zeedar macopinion@designwrite.com

Let's go back in time one month. Prior to the iPhone launch, financial analysts were not predicting a guaranteed hit. Of course there was reason to suspect the iPhone would be a success -- Apple's iPod track record, the tremendous iPhone interest, Steve Jobs' electrifying keynote demonstration -- but analysts were cautious. After all, this was an expensive device and there were no guarantees that customers would actually rush out to buy a $600 cell phone. Remember all the negatives: two-year contract, AT&T only, no 3G, no keyboard, poor battery life, etc.

There were many who wondered if the iPhone would be a huge flop. Their reasoning was that very few 1.0 products are huge successes: it takes time for a product to mature into usability beyond the "early adopter" crowd. Sure, there would be a large spike of sales the first weekend -- the pent-up demand and Apple's loyal fanbase guaranteed that. But would sales continue? That was the real question.

Back then, I saw articles claiming that Apple might sell as many as 50,000 phones in that first weekend. The interesting thing is that was considered an extraordinary amount for a brand new item in an extremely competitive product category.

As we got closer to the launch date, however, perceptions began to change. The AT&T rate plans were announced and were surprisingly reasonable. People began lining up to buy the phones days in advance. When the first reviews came out (Mossberg and Pogue), they were astonishingly positive. No doubt competitors like Nokia were cursing because their hopes of a flashy-but-flawed device were broken. Suddenly it seemed like the demand for the iPhone was genuine, and not just from a few fanboys.

That's when the sales speculation began. With nothing more than rumors and innuendo for data, analysts began to up their projections: 100K, 150K, 200K. One analyst actually revealed his calculation method: he guesstimated how many minutes a sale would take, multiplied that by a guess at the number of sales clerks in a store, and multiplied that by the number of stores. His assumption, of course, was that the stores would run at maximum capacity -- essentially doing nothing but selling phones for the entire weekend nonstop -- and the result was a 450,000 phone sales mark.

After that the damn broke, and I saw articles claiming 500K as the "expected" number, and others stretched it to 700,000!

Then, as the weekend hit and -- surprisingly -- there were not huge shortages of iPhones, with many stores still having stock Monday morning, the rumor started going around that Apple must have manufactured one million phones in expectation of heavy demand. So that sort of "confirmed" the idea that Apple must have sold a half million or so iPhones: the sales guesses and inventory levels sort of matched.

Forget that Apple had never revealed any inventory amounts, never stated how many units were sent, on average, to their stores or to AT&T stores, nor even speculated at how many iPhones they hoped to sell over the initial weekend.

The bottom line is that the only number Apple has ever stated was a goal of "10 million iPhones sold by the end of 2008." All the other numbers we had were figments of people's imaginations. In other words, wild guesses!

So, this brings us up to Tuesday, when Apple's stock got knocked down about eight percent when AT&T, in their quarterly statement, revealed they'd "only" activated 146,000 units. AT&T's numbers seemed low compared to reports of 500,000+, and a few worried investors sold Apple stock.

Of course this was in just 30 hours, not the whole weekend, and AT&T's initial activation problems were widely reported. The AT&T number also didn't take into consideration phones being bought as gifts or with the intention of reselling on eBay (a plan that flopped for most).

So we still had no idea how many phones were sold.

Then yesterday Apple released their quarterly financial statements. Buried in them was the news that Apple sold 270,000 iPhones in those 30 hours. Horrible, right? Half of the "expected" 500,000 phones?

But wait. Let's look at things more deeply. Actually, it was closer to 20 hours since the Apple Stores were only selling iPhones for six hours on Friday the 29th and (maybe) 14 hours on Saturday. Remember, Apple's sales numbers are only for the quarter, which ended that Saturday night. While AT&T's automated activations could take place all night, Apple's stores were only open during business hours.

Next, let's remember that Apple, like most online merchants, does not charge credit cards until a product ships -- and since online orders had a "2-4 week" ship schedule we can assume that no online orders shipped that weekend. Which means that Apple's quarterly results includes no online orders, and no sales from the rest of the weekend.

How many people were put off by the initial crowds and lines and figured they'd wait, only to hear over the weekend that the lines were gone and Apple still had phones in stock? Those people might have gone out on Sunday or Monday to pick up their iPhones!

Finally, do the weekend sales really matter? The analysts all got caught up in the numbers game, but would it matter if Apple sold 70,000 over the weekend and 200,000 on Monday? No. What's significant is how many Apple has sold overall, not just in one weekend.

Some might think the initial weekend is a good number to know because it gives us an idea of the appeal, but with six month's anticipation and hype over the product, judging long-term demand by one fervid weekend is a giant mistake. No matter what the first weekend's numbers are an anomaly. Sales will obviously cool after that initial surge and the real question is, "How many iPhones continue to be sold today?"

The answer is: we don't know. Apple hasn't told us. Apple did report that they are on target for one million iPhones to be sold in the iPhone's first quarter (end of September). That sounds like a much more reasonable number. I think Apple will beat it (they might have already, for all we know), but it's a solid, conservative, and totally reachable goal. It also fits in perfectly with their 10 million goal. And keep in mind, not only is this iPhone 1.0, but it's also USA-only: with Europe and Asia to come, Apple's got a lot of room left for iPhone growth.

Remember, it took Apple nearly two years to sell one million iPods. Granted, the iPhone is building on the iPod's foundation, but it's also a different category of product, and it's much more expensive (especially when you total in the monthly service fees). A million iPhones in their first quarter is phenomenal, and 270,000 -- over a quarter million -- in less than 24 hours is insanely great. Savvy investors will realize that it is the long-term numbers we care about, not one weekend's results.

I have no idea what this news will do to Apple's stock. Judging from how the AT&T announcement made it drop, it might well slip a bit, at least temporarily. But the iPhone reality check is complicated by the fact that Apple announced record-breaking revenue and profits in their non-iPhone businesses. Keep in mind that Apple is spreading the revenue of iPhones across a 24-month period (because Apple receives a portion of iPhone service payments from AT&T), so this quarter's results only include about $5 million in iPhone revenue. This means that despite all the excitement and hype over the iPhone, Apple's other businesses are doing exceptionally well -- and people should be buying Apple stock for those other reasons, not just in the hopes that iPhones will be successful.

Apple reported revenue of $5.41 billion and net quarterly profit of $818 million on the best Mac sales in company history: over 1.7 million Macs sold, up 33% from a year ago. Sales of iPods were solid at nearly 10 million, a 21% increase from last year.

This is Apple's best June quarter in history and in normal circumstances would make the stock stronger. If people are smart, they'll buy more.

However, the iHype surrounding the iPhone makes things complicated. Some feel the stock already grew a lot based on iPhone speculation and this reality check means the stock has peaked.

But smarter investors should realize why the iPhone is important: just like the iPod brought more customers to Apple who have started purchasing Macs and other products, the iPhone will create even more Apple fans. Ultimately it's not about how many iPhones Apple sells, but the total Apple picture. If Apple's other businesses -- Macs, music, etc. -- benefit from iPhone it's a double win for the company. Such product synergy is a dream for most companies and creates tremendous growth. Savvy investors know this and shouldn't be speculating on Apple just because of the iPhone, but because of Apple as a business.

Another couple critical things to remember that tend to get lost in all the numbers: AT&T reported 40% of their iPhone activations were "switchers" from other carriers, and Apple said that half of their Mac sales were to people new to the Mac platform. Those numbers are huge. Most companies would love it if 10% to 20% of their customers were stolen from their competitors, so Apple and AT&T have got to be thrilled at their growth rates. These numbers bode well for the future. Don't forget the iPhone's astronomical satisfaction rating (90% are happy with it): this is just the beginning.

The bottom line is Apple's businesses are doing extremely well, especially when you compare them to most PC makers. I'd say buy more stock, but then again, I'm not an analyst. But perhaps that's a good thing. (Warning: I do own a little Apple stock.)

macopinion@designwrite.com