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January 29, 2008

Missing iPhones Found at Sundance

I've been reading up on the phenomenon of the missing iPhones and the only thing I can conclude is they might all have been at Sundance. Honestly, it seemed every line we were standing in had multiple iPhones in use. I know that speaks more to where Apple has mindshare than anything else, but I can confidently state that iPhone market share among movie fans and Hollywood types is at least meeting expectations.

On a serious note, I think there are two issues. First is whether demand for the iPhone at current prices and as currently configured is less than expected. Second is whether meeting unit volume expectations through sale of unlocked phones is positive or negative for Apple.

The answer to the first question may be yes, particularly in Europe. However, enough phones have been sold and current customers are satisfied enough that demand issues can be solved with a 3G phone, a lower-priced unit, lower prices, or increased functionality. Say what you want but the activation of over 2 million phones in seven months suggests that the iPhone is here to say.

As for unlocked phones, Bernstein did some interesting work, suggesting that there is earnings downside if a higher-than-expected portion of the unit volume is unlocked due to the loss of carrier payments. Carrier payments might be as high as $20 a month at close to a 100% margin. Bernstein believes that if 3 million of the 10 million phones that might be sold in 2008 are unlocked, Apple would earn 37 cents less in EPS this year and next year. That works out to 8% and 6% of current 08 and 09 EPS estimates, respectively....

....I think that Bernstein was already assuming that as many as 2 million phones were going to be sold unlocked. In other words, the fact that it appears that an incremental 1 million phones are going to be sold unlocked is what generates the 37-cent shortfall. I may be misreading the report, however, so if you think I got it wrong, please let me know.

I don't know exactly what assumptions all the analysts are making about unlocked phone sales in their models, but in October, Apple itself estimated publicly that unlocked phones were 22% of sales. If analysts took the company at its word and built that or higher into its models for 2008, then the 37-cent penalty might not be fully realized. Then again, some analysts may have underestimated unlocked phones in their models

The final piece of the puzzle is how this impacts Apple shares looking forward. If estimates need to fall by 6% to 8%, the current drop in the stock seems to have captured it. The issue is then with the multiple as a less successful iPhone cuts into the company's long-term growth rate.

I think Mac momentum alone justifies the current stock price, which is about 20 times 2009 estimates before adjusting for $20 in cash that will be near $30 at the end of 2008. However, the stock is broken, and the rebound will be slow until iPhone, iPod and Mac demand trends for early 2008 are clearer or more new product introductions are made. The shares are over-owned, leaving demand lacking relative to supply as long as a confidence crisis exists concerning Apple's fundamentals.

Posted by Steve Birenberg at January 29, 2008 10:19 AM in AAPL