Apple is ‘more like Harry Potter than Pixar’, says Needham & Co.

Apple's revenue streams are recurring revenue streams, not hit-driven, non-visible, hardware-type revenue streams, Needham & Co. claims.

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Mid-eighties crooner, Robert Palmer told us we were Addicted to Love, but he could have said the same about Apple: customers stick with the brand for around a decade, and when they get addicted to iPhones they also get hooked on the company’s services, the latest Needham & Co. research note suggests.

The Harry Potter business

In her latest research note, analyst Laura Martin points out that Apple’s value is not totally defined by its indisputable ability to introduce hit products, but also by its capacity to convince its highly-satisfied consumers to pick up on its sequels.

“We think Apple shareholders retain the upside of its device “hits”, but have strong downside protection from its typical “sequels”,” the analyst explains.

“The reason film studios release so many sequels is that an installed base of consumers that saw the prior movie lowers the risk on invested capital for the next movie. Metaphorically, Apple is more like Harry Potter than Pixar.”

Apple’s skill is that it is also like Pixar, with the creative capacity to introduce new product successes – iMac, iPod, iPad, iPhone to name but four.

Even the Apple Watch is the most successful smartwatch. (I personally believe that wearables are early in the hype cycle – in future the category will inevitably replace the smartphone for many users, just as the smartphone has become the primary computing device for tens of millions of people worldwide).

Happiness is everything

Apple’s services income acts as a kind of lock-in.

The company’s customers (who comprise “the wealthiest 20 percent” of global smartphone users) invest in services, apps, and other content and then become hooked on the brand. The thing is, Apple’s ability to keep customers happy means they are prepared to continue to invest in solutions from the brand.

“According to this year’s survey, about 90 percent of current Apple smartphone owners stated that they were likely, extremely likely or 100 percent sure that they would replace their current iOS devices with another iOS device,” the analyst said.

Why?

Services keep consumers hooked, additional products like Apple Watch maintain interest, and (this year, at least), Samsung’s fatal self-harming move to release an inadequately tested and unsafe Galaxy product to keep up with the Cupertino’s has damaged Apple’s leading competitor’s brand.

Needham’s data points out that Apple’s users stick with the brand for at least a decade, upgrading their devices every 2-4 years.

That’s significant, as it’s twice the length of time customers stick with cable companies.

“If Apple traded at an average cable company multiple, its price would be $189/share, up 35%,” the analyst observed.

Not only this, but the company takes 30 percent of most of the content sold to or through its devices. That’s a whole heap of different recurring incomes, which is why it’s a false logic to say Apple is defined by hit products alone. The hits matter too, but the sequels make the gold mine.

Once bitten, forever smitten

Like any reputable movie studio, Apple has a host of different products and services customers can explore once they catch the bug.

“It appears that owning any Apple product has a halo effect, according to our research,” the analyst explained. Most Apple owners said they would “consider” or were “likely” or “very likely” to buy additional (not replacement) Apple products, such as the Apple Watch or the new iPad.

“Our research suggests that an average iOS user owns 1.3 devices, implying that the 1B active Apple devices are owned by 770mm different users.”

The phantom menace

What of Android?

Needham & Co. note that Android users are far more likely to switch to Apple’s platforms than to migrate in the opposite direction.

Not only this, but they cite Cisco’s 1Q17 VNI report which points out that the volume of data used by each iOS mobile device (smartphones and tablets) was higher than Android globally.

Cisco also found that average iOS consumption (ie, time spent) exceeded average Android consumption in both North America and Western Europe, two of the largest revenue centers.

So much confusion

Needham & Co. also point out that most consumers in the market for a smartphone already know which brand to get (in the same way as they might decide between Harley Davidson or Yamaha when buying a motorcycle).

“We believe most consumers enter the smartphone purchase funnel with a preferred ecosystem in mind,” they said. “Apple’s strong pricing and profit margins over the past 3 years support our view that Android pricing competition has not pierced Apple’s protective armor.”

Not only this, but with over 24,000 different Android devices to choose between, consumers get confused when making a purchase which also makes them less likely to make that purchase at all.

The wolf of iOS street

Perhaps one of the most telling statements across the report is blunt: “Apple users spend more money,” the analyst said, listing a whole series of powerful economic arguments to suggest the power of the Apple brands.

“iPhone owners spent about 75 hours per month on their phone, 11 percent longer (7 extra hours/month) than Android users’ 68 hours each month.”

They spend twice as much money, download twice as many apps, spend more money in apps, spend more money online when shopping from an Apple device – the list goes on.

Services revenue is already 11 percent of the company’s total revenue, and we know that’s going to rise.

Something in the way

Reading the report, it’s no surprise the firm rates Apple a “Buy” (down from “Strong Buy”) with a $165 price target.

However, they do concede that continued economic weakness, political challenges and problems in key markets (such as China) could impede company results.

They also point out that “many millennials prefer to rent rather than own assets”, citing this as a potential threat to iTunes sales. (Though I think Apple is planning for this market shift).

“The type of long-term loyalty that AAPL users report implies that AAPL’s revenue streams are recurring revenue streams and NOT hit-driven, non-visible, hardware-type revenue streams,” they said.

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