The Obligatory iPhone 7 Show

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iPhone 7. Image source: Apple.

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Apple (NASDAQ: AAPL) unveiled its new iPhone 7 and iPhone 7 Plus recently, and though the company has come under a lot of heat from the media for doing away with the phone's headphone jack, the company is up a whopping 10% since.

In this week's Industry Focus: Tech, Motley Fool analysts Dylan Lewis and Evan Niu recap the highlights from the release (including some big tech-side improvements that Applehardly emphasized). Then, they look at the pre-order numbers we have so far, why the stock is up so much, where the company seems to be heading, and what investors can take away from this exciting news.

A full transcript follows the video.

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This podcast was recorded on Sept. 16, 2016.

Dylan Lewis: Welcome to Industry Focus,the podcast that dives into a different sector of the stock market every day. It's Friday, September 16th, and we're recappingApple'sevent from last week. I'm your host,Dylan Lewis, and I'm joined on Skype by Fool.com'ssenior technology specialist Evan Niu. Evan,how's it going?

Evan Niu: Pretty good,it's iPhone day.

Lewis: iPhone day, yes. So, Apple'santicipated press event went down last week on the 7th. They are nowgoing to actually go on sale. So people are getting their hands on the phonestoday. Some interesting news coming out of that. But this is the Cupertino company'slatestupdate to the iPhone line. They're calling it the 7 and the 7 Plus.I know there's some speculation there. Given that the iPhone lineaccounts for about 60%of Apple's revenue,it fluctuates quarter to quarter, tech insiders and investors alike are eagerlyanticipating this unveilingand see what the next-generation device looks like. So,why don't we hop right in? What does the new line offer users?

Niu: I think it's pretty modest and incremental. Every year, it's getting more and more incremental,just because smartphones are so good nowadaysthat it's hard to really make them that much better. The improvements a few years agoused to be so mind-blowing, that it's like, yeah,you have to upgrade if you care about it. But I'm actually skipping this yearfor the first time in eight years,which is weird for me,just because I don't think it's that compelling.

So far, theearly indications look pretty strong, in terms of... again, the lines at the stores,you have the carriers announcing a lot of good, strong activities. There'sa lot of positive sentiment right nowaround this device,even though it seems, in my opiniona little incremental.I don't think the improvement's all that great.

Lewis: I think one of the biggest,and probably got the most pressin terms of features or changeswas the removal of the headphone jack. Definitely one of the more controversial elements of the new phone.Apple decided to shiftconsumers toward wireless connections usingBluetooth and things like that. And, of course,they're offering $159 AirPods to help ease that pain. But, the new phones will be shipping with a Lightning port adapter that will allow people to plug in their headphones. It seemed like the removal of the headphone jack was really something that enabled them to up the processing power, improve the battery life, make some camera improvements. It was a form-factordecision that help to them juice the gutsof the phone itself.

Niu: Yeah. It's just Apple's same thing ofidentifying that some technology standard is outdated. And the headphone jack is 100-plus years old. So, of all the standards they've killed in the past, this is one of the oldest ones. Arguably, it'skind of surprising but they haven't done it already. But every time they do this, they get a bunch of crap, and people don't like it. But the market always survives. And yeah,there's always these big ecosystems that are built around these ports of standard. But at the same time, they're the only company that does this, thatpushes the industry forward in this way,because all the other companies are too afraidto make these controversial decisions. This is not a new thing for Apple. They have done this for the past four years,and every time they do it it'scontroversial.

You can see both sides. Just likeevery other time they've done it, there's two sides. Everyone's like, "Hey,I want to still be able to use all my stuff." But then, if you lookforward into the trajectoryof audio connectivity, yeah,Bluetooth, like you mentioned,is getting a lot better, especially with Bluetooth low energy. It's justkind of like analog going to digital. The Lightning audio is a digital connection, versus the headphone jack, which is an analog connection. It's just one of those things that probably needs to happen eventually, and Apple is making the leap now. And there's even suggestions now,they actually just sent out a surveyto their users asking if peopleuse headphone jacks on their laptops. So they're obviously thinking aboutkilling it on the laptopeventually, which isn't surprising. But for people'scomputers, there are people who plug in their home audioand computer speakers in there too,in addition to headphones. It's an even bigger ecosystem ofdevices that you would have to try to transition somehow,versus on a smartphone. It's just headphones, versus speakers. It'spretty big change, it's one of the bigger ones.

Lewis: Yeah. To quote Apple, "itdefinitely takes courage to make a decisionlike that." I know as someone with a nice set ofBose headphones that are not wireless...

Niu: Yeah, like these.

Lewis: Yeah. I'm going to need to use that adapter.Like I said, they will ship with the phones. One of the criticisms is that,unless you use a different type of adapter,you won't be able to charge and listen to music at the same time. Some of the other big things with this product release,they introduced water resistance. The iPhone 7 and 7 Plus can be submerged under three feet of water for 30 minutes. That's the benchmark that they're using there.Apple is not the first company to do this.Samsungprettyheavily promotes theirwater-resistant products. So, just aninteresting thing. I know that they deal with a lot of water-damagedproducts, and I don't believe that water damage will be covered under warranty.

Niu: That's true. Thefunny thing about the waterproofing thing is that last year's iPhonewas actually surprisingly waterproof. There are test videos from last yearof people putting iPhonesinto a bowl of water for literally an hour. They time lapsed it. And it still works. They would check every 30 minutes or so. So,I think they had made a lot of progress last year, but, if you market it, people are going to do it, and if they'redisappointed, you're in a hot spot. So,I think that what they did is start this process last year, didn't tell anyone about itbecause they didn't want to invite people to test it, even though, of course, people tested it anyway,another felt more confidentwith the changes they did this yearwith making it even more sealed. So now, they're touting it as a big thing,but it's actually something I think they started last yearor maybe even the year before that.

Lewis: Yeah,I think that's a feature that's better tosurprise consumers with thanhave them expect it and not quite deliver on it. So,that's something you can look forward to if you were thinking about upgrading. The phones also tout a longer battery life, I believe it's an extra two hours for the iPhone 7 over the iPhone 6S, and I believe it's an extra one hour over the iPhone 7 Plus over the iPhone 6S Plus.

Niu: I think that's a big achievement,because I think most of that is coming from this A10 fusionprocessor with its greaterefficiency. I can't remember the numbers,but I think the battery is a little bit bigger. But the majority of that gainis probably coming fromefficiency gains on the power side of the processor,because they're finally doing this process or architecture that has the two powerful cores, plus the two little cores, which is similar to something ARMused to do called big.LITTLE. But, this implementation is not exactly that, this one is much moresophisticated. But the concept is, you use these low power coreswhen you have low power tasks,and you save a ton of energy. I think it's a huge testament to how farApple's chip team has come. It's crazy that they've come this far, and they're nowone of the most sophisticated process makers in the world. And their first proprietary chip was in 2010. So, we're talking about six years. The A4 was the first one, in 2010. And now, they're at this insane level, where they're basically... the iPhone 7 Plus isbasically stronger than a MacBook Air.

Lewis: That'sincredible.

Niu: In six years, they've done this. It'sreally mind-blowing. And they don't get much credit. It's weird, because they don't talkabout this very much.

Lewis: Yeah,I think they tend to focus onthe very visiblefeatures and form factor elements of the product. Togive you an idea ofwhat the performance numbers look like from generation to generation, the A10 chip isapproximately 40% faster than the A9, which is what they used to power the 6S. The A10 chip is twice as fast as the A8, which powered the iPhone 6. You'redefinitely getting a pretty good performance boost there. That and the battery life are twoof the really big elements thatyou might not notice right awayjust looking at the product,but once you start really using it, you'll start to feel it.

They're also touting some newcamera systems. The 7 and the 7 Plus both support 12-megapixel cameras. But I think one of themore noticeable things as well is the base level storage. This is something that I've been expecting for a while.I was kind of thinking they might do it with the 6S. The 7 line runs 32GB, 128GB, and 256G of storage. That's up from the 16GB and 64GB and 128GB on the iPhone 6S. They'vealso decided to increase the storage of new 6S phones to be in line with that. So, if you're buying a new 6S, you can get it and the base level will be 32GB.I think that makes sense. I know we're moving to a lot of cloud storage,but it's nice to have some extra space on their,particularly if you're a metro commuterand you're in a lot of areas where you'll be offline.I know that I always appreciate that.

Niu: It's weird, becauseI was always one of the few people that actually liked the 16GB model, purely from an investing standpoint, because it's so bad for consumers thatit's actually really good for investors, if that makes sense. 16GB isreally so insufficient that you have to upgrade to the mid-tier 64GB at a minimum, which boosts your revenueaverage selling price and all this. So,from an investment standpoint,I was actually a huge fan,even though from a consumer standpoint,it's pretty bad and annoyingbecause it's so insufficient. But now, with this 32GB, it's a harder call,because people will have to ask...before, it was like, "There's no way you could get away with 16GB,because that's just a joke." But now, with 32GB, maybe I could." You have to actually think about the decision, do you spend the extra $100 to go to 128GB, or can you actually stick with 32GB? So,I think it'll be interesting to see what happens with ASPs going forward. But,at the same time, they just introduced SE, whichstarts at $400, and thatalready puts pretty bigdownward pressure on ASPs in general.

Lewis: Yeah, maybethe logic there was the SE isgoing to fill that niche andmake it a little bit easier. I know, when I got the 6S,it wasn't even a consideration. I want for the 64GB model.

Niu: Exactly, right? And you knew,Apple made another $100.

Lewis: Just tobring it around to prices, because we talked about ASP,average selling price, the iPhone 7 will start at $650, and the 7 Plus will start at $769. That's the starting point there.

Niu: That'sinteresting too,because they're bumping the 7 Plus by an extra $20. It used to just be $100 more, and now it's $120 more.I tend to think that the extra $20 that they're charging isrelated to the camera system. That camera system is expensive.

Lewis: And the iPhone 7 Plus has a two-lens camera now,whereas in the past there was just one. The 7 maintains the one-lens camera. Certainlysome added features there,and a little bit of extra stuffunder the hood, so to speak. So, I think that makes sense. The company predictably took some flakfor its decision to ditch the headphone jack,like we talked about, and questionable use of the word "courage" throughout the presentation. But, the stock is up 10%in the last 5 days. For a company Apple's size, that's pretty noteworthy. Any timeyou see something like that, I think it's less to do withthe product specsand more to do with what's going on withpre-order information that we've seenfrom a couple different outlets.

Some of thedifferent wireless carriersannounced what they were seeing in terms of pre-order activity.T-Mobilesaid the two new iPhones haveshattered previous sales records.I believe orders are coming in at something like 4X what the iPhone 6 did.Sprintalso saw very highpre-order numbers. They said orders were up 375% over the first three days ofpre-order availability compared to last year.AT&TandVerizonwere a bit more muted inwhat they were talking aboutrelated to the iPhone line, and said that pre-orders werepretty much business as usual, business as expected.

Niu: I think AT&T saidat a conference the other daythat they were just above expectations. Still pretty vague.

Lewis: Yeah. Some really nice color from T-Mobile and Sprint,not so much AT&T and Verizon. But, I can't say that I'm surprised we're seeing some really good pre-orders. 1. it's an iPhone, and 2.the wireless carriers, most of them,I think all four of them, have gone with the free iPhone 7promotion. So, it's tough to parse out how much of that is what would be a full-price purchase iPhone versus a free iPhone that'scoming with an upgrade and a two-year commitment to that wireless provider. So,that's the grain of salt that you need to takewith any of those pre-order numbers.

Niu: Like you said,the stock has been up 10% or so over the past few days. And I think that's interesting,because it's on heavy volume. If you look at the volume activity, the gain is on in the back, there's a lot of volume. There's a lot of people coming in, it's not a light volume move. There'sa lot of people that are coming into the stock on all this iPhone 7optimism,which is kind of ironic,because there's basically this idea, there's asentiment that iPhone 7 is going to be strong, the carrier stuff you mentioned. But the irony is, Apple has been trying really hard to shift away fromfocusing so much on unit sales numbers, which is also partly why I think they're not going to release their launch weekend sales for the first time in five-plus years. They've always announced launch figures every year, but this year, they said they're not going to.

Lewis: Yeah,I believe a company spokesperson said,and I'm actually taking this from an article you wrote, "Theseinitial sales will be governed by supply, not demand, andwe have decided that it is no longer a representative metric for our investors and customers."

Niu: Thesilly part about that is that that's been true every year.

Lewis: Yeah, that's always the case.

Niu: I don't really believe their reasoning for why they're saying it, becausethere has always been supply constraints. Every year it's supply constraint. That's not a new thing. So, them saying they're not going to give this number because of that,I think that's kind of a cop-out. I think it's part of the broader strategyto get people to stop focusingon unit sales, because what they want people to focus on,particularly investors, is to look at these recurring revenue sources. They've been touting all thisinstalled base purchases and services revenue andall these things that are not tied to unit sales. They'retrying to get investors to focus on those numbers instead of unit sales.

But,obviously, investors are still focused on unit sales,because when you hear all these positive storylines about the iPhone 7, they go out and buy the stock. Also, combine this with the fact that the Samsung Note 7s are exploding,that also help. So I thinkthere's a lot of positivityaround the iPhone 7,despite the fact that Apple is trying toshift the focus away from how many units they sell.

Lewis: Yeah.I think you're absolutely right. You look at the way their revenue mix is going, it's going to play out that way.Like I said earlier, the iPhonecontribution to revenue was, in the past, about two-thirds.I believe it was down to about 56%as of their most recent quarter, and that's because of that rising service revenue. You also have the introduction of the Watch line, and things like that, which theyupdated in this most recent press event. But, yeah, the iPhone, while it'sgoing to be the cash cow for them,I think they're making efforts tohighlight other parts of the business. This recent rise that we talked about actually pushes Apple above a 13 P/E on a trailing basis for the first time in a year.

Niu: Ooh, so expensive! (laughs)

Lewis: Yeah, right? It'skind of insane. But looking athow all of this fits intowhere the business is going,last quarter, the company guided forrevenue between $45.5 billion and $47.5 billion. Andeven if they dramatically beat that guidance, which, they'vetypically been in the high end of their guidancerange or slightly above it,they will likely fall short of previous years' number for thethird straight quarter. I believe lastyear ago quarter,the fourth fiscal quarter, they were around $51 billion, justto give you an idea of how different the guidance is there. It's tough to keep seeing this. Theproduct is really successful. Customer satisfactionwas really great. They just keepgoing up against these really tough comps. Eventually that's going to change, but don't expect thattrajectory to be any different for the next couple quarters. I think that's one of the key thingsinvestors need to keep in mind here. You're going to probably seeyear-over-year declinesfor this quarter, next quarter, possibly eventhree quarters out.

Niu: I think there's a chance the iPhone 7could, generally speaking regardless of the time... thetiming for the year-over-year comps isalways tricky, because it's always really dependent onwhen they launched the phone. In this case, they're launching the phonewith two or three weeks left to the quarter. Last year, I think they hadjust a couple days.So, the launch timing really has a big impact on how much of that launch getscaptured in which quarter. But,in general, I think there's a chance that the 7 could push the cycle up.

The sense is,iPhone unit sales have picked because they've been flat-ish,roughly, over the past year,year-over-year or whatever. But if you look, every two years,they basically pushed higher because of the cycle, this two-year design cycle of 5, 5S, 6, 6S, etc. So,the performance ofthe sales, at least for the past twomajor product cycles,they tend to go in tandem. Because if most people upgrade their phonesevery two years, and all the people who upgraded for the 6 areprobably all going to upgrade for the 7, they had this pattern of going in pairs. Who knows if thatactually plays out again this year,because thesales are so high that is hard to really grow. ButI think there's a possibility,particularly with all the kinds of indications that we're seeing. ButI wouldn't bet on it. I'm just saying,it's like a curveball, it's possible.

Lewis: We'vetalked in the past about the idea of two-year comps being a bit more relevant for Apple,because of the update cycle that they're on. I think, as you talked about before, their refreshes on the product become moreincremental and less major step changes, thenI start to look at them moreon a year-over-year basis. To your point about releases,another important thing to remember here is,all the numbers that Apple will be reporting for fiscal Q4,calendar Q3, only two weeks of that period will have the iPhone 7 available. It will be a part of those numbers,but it will not be a major contributor. You're going to really want to look at fiscal Q1, calendar Q4, forwhat it's going to be doing for the financial statements. I'm sure we're going to get some commentaryin the company call come fiscal Q4. But,that's something to keep in mind.

Niu: Andit's weird, because this is the first time they've ever pushed a three-yeardesign cycle. It'll be really interesting to see how that changes theperformance. They've never done a three-yeardesign cycle before. And it's also a testament to smartphones getting more mature. It'skind of like laptops. They redesign laptops every four to five years, but they would redesign their phones every two years. So now you're seeing, they feel comfortable that they can push that limit on the design side. But then,the real question is, what happens next year? Because everyone is expecting a new design next year, maybe another display, maybeno home button, maybe curb display, whatever. Then,it just throws everything out of whack,the fact that they're changing the timing of these cycles. It'sgoing to be cool to see what happensgoing forward. And plus,what are they going to call it? They can't call it the 7S if they change the design altogether.

Lewis: Eventually they're going to have to ditch that naming convention,one way or another.

Niu: I've been saying they should ditch that thing for years. This is the iPhone 7. It's the 10th iPhone. And what, next year it'll be the iPhone 8, the 11th iPhone? It justmakes no sense.

Lewis: Yeah. I think, to bring itback around, and what to watch for here, if the productincremental upgrades that we talked about,some of their performance changes are visible enough to people that maybe currently hold an iPhone 6, or the offers from these wireless carriers look compelling enough,I think you could seesome really great numbers for fiscal Q1, which will be calendar Q4. But you won't get a report on that for quite a bit. Be wary of that, and know that any really bigenthusiasm is going to come through more onthe company's call than in the numbers that the company reports next quarter.

Anything else on this? That'skind of investing take away. Obviously,everything that they delivered here was what we'd been expecting from pre-launch leaks and rumors.

Niu: Yeah. Everythingpretty much came in right on target withexpectations, as far as the product specs and things like that. I think the Watch 2 looks OK,it's kind of the same thing, Watch 2looks like what they should have done with the first one. I don't thinkmany people are going to upgrade from the Watch 1 to the Watch 2.It just doesn't seem very compelling. Butmaybe they get more first-time adopters that were on the fence about Watch 1 and didn't do it, but now Watch 2 is more compelling, a stronger product, so maybe the people that wereon the fence will jump in and go ahead and be a first-time buyer for the smartwatch. And, of course, once they do that, they're on this upgrade track, and they're going to eventually upgrade, however long, who knows.

Lewis: Yeah,you have the chance towin over those people who don't want to own a first-generation device with the Watch, basically.

Niu: Right. I think the Watch 2 does lookcompelling in that sense. Of course,there's no detailed results to compare to, because Apple won't give them to us. But just generally, I think,products just get better over time. Next month, they'resupposed to have these new Macbook Pros, whichmight reinvigorate the Mac lineup. That lineup has been there for four years. So,coming out with a new thing there could really juice the Mac performance for the next few years.

Lewis: Certainly more to watch there. Listeners, you canguarantee that we will be sure to comment on it in several episodes down the road, doa little checking. Anything else before I let you go, Evan?

Niu: No,I think we covered most of it.

Lewis: Awesome. Well,listeners, that does it for this episode of Industry Focus. If you haveany questions, or you just want to reach out and say hey,you can shoot us an email at industryfocus@fool.com. You can always tweet us @MFIndustryFocus. If you'relooking for more of our stuff, subscribe on iTunesor check out the Fool's family of shows at fool.com/podcasts. As always,people on the program may own companies discussed on the show, and The Motley Fool may haveformal recommendations for or againststocks mentioned, so don't buy or sell anything based solely on what you hear. For Evan Niu, I'm Dylan Lewis,thanks for listening and Fool on!

Dylan Lewis owns shares of Apple and Verizon Communications. Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Verizon Communications. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends T-Mobile US. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.