Monday, September 3, 2007

Apple's September 5th "The Beat Goes On" Media Event

With the September 5th Apple Special Media Event fast-approaching, I thought that I would weigh in with my thoughts and predictions for the event on Wednesday and the road ahead for Apple.

The event takes place at the Moscone Center in San Francisco on Wednesday September 5th at 11:00 am Pacific.

Note: This post is not and is not intended to be financial advice. It should therefore not be taken as such and you should contact a professional investment advisor before making any investment decisions. No guarantees are made as to the accuracy or completeness of any information contained herein.

It is widely expected that Apple will use this event to introduce its new iPod lineup for the holiday season. The iPod lineup will undergo a very dramatic change and will see a major overhaul, it will be almost unrecognizable. The entire iPod lineup will become part of Apple’s new aluminum and glass design philosophy and with this philosophy implemented all of these new iPods will look very elegant. Neither the iPod nano nor the full-size iPod have seen major changes since their introductions in 2005, but this event will take them up to a new level. In 2006 there was little to change because Apple seemed to have achieved perfection for that category- what more could they tweak? But now the iPod lineup will be brought to a new category. This event will be huge.

iPod shuffle:
It appears that the iPod shuffle will see a revision of some sort, but exactly what remains difficult to tell, maybe becoming smaller (if that is possible.) It could see a price cut to $69 or even as low as $49. It is also possible that a 2GB version could be introduced to replace the 2GB iPod nano (more on that later.)

iPod nano: Design-wise the iPod nano will gain proportions that resemble the full-size iPod- it will look less tall and skinny (long might be a better word) and more square. The size (both width and height) of the click wheel and the screen will remain the same relative to each other, proportionally speaking, but the space between the screen and the click wheel and the click wheel and the bottom of the device will become smaller. When looking at the iPod nano, you can see immediately how long or tall the device is. One major flaw with recent mockups is that the screen has been made larger (320x240) while the size of the click wheel remains the same. This causes the iPod to look "fat." While I do not believe that the iPod nano will look like the 9-to-5 Mac photo, it is possible that the photo was Apple property and was an internal fake generated by Apple, the way several different models and mockups were created with the iPhone. I do not think that the iPod nano will look “fat” but only less thin/tall/long and with proportions more like a full-size iPod shrunk down to nano size, even though evidence circulating around the web has convincingly pointed to the emergence of the iPod nano “phatty.” The screen will be glass instead of plastic, which combined with the aluminum casing, will make the nano virtually scratch-proof. This will extend Apple’s new aluminum and glass design philosophy to the iPod nano. The colors depicted by the 9-to-5 Mac photo don’t particularly make sense to me, largely because using a color of red like the one in the photo would eliminate the (Product) RED version of the nano. If these colors were covered with glass, they might look better, giving them an effect similar to the co-molding on the full-size iPod. The glass covering on the surface of the iPod nano would make it look elegant- a quality that the iPod nano and the full-size iPod will emanate once refreshed. The iPod nano will run Mac OS X, the metaphorical “core” or foundation of Apple. Earlier in the year, Steve Jobs said at an internal Town Hall Meeting that the OS X group was involved in addition to Leopard and the iPhone “on some iPods we are working on.” This interface will have a black and white theme, like the iPhone’s interface. It will have a black background with white text. Cover Flow will be included and the new nanos will have a focus on prominently featuring album art throughout the interface. This will be a more modernized, up-to-date interface that will look absolutely beautiful. It will incorporate the effects and animations seen in the iPhone. To browse music, you will have the option of browsing the way you did before, with every screen a multiple-choice test with limited options to bring you up to another screen or in cover-flow mode. Mac OS X will allow the iPod nano’s processor to handle Cover Flow and will provide power-saving features that will extend the iPod’s battery life. I doubt that the iPod nano will play video, contrary to recent reports, although this would be very easy to implement on a larger screen. Also, if the full-size iPod has a full touch screen display, this iPod nano with video would fill the gap for both the nano and the full-size click wheel iPod in a nano-size price range.

It is possible that the iPod nano will become a phone as well, in addition to all the nano functionality that I described above. This phone would be the iPhone nano- the iPhone’s little brother. It would retain the click wheel and dial in the rotary phone style depicted in Apple patents. If the iPod nano is in fact the iPhone nano, it will not become a miniature version of the iPhone- it will not have a full touch screen, no wi-fi, no internet browsing, no widgets and no e-mail but only iPod nano features (music and photos, maybe video) the ability to make calls and SMS text messaging. While placing calls and text messaging might seem cumbersome with only a click wheel and no keypad, keyboard or touch screen, the phone would rely heavily on dialing using a list of contacts and text messaging would rely heavily on error-prevention and correction software already in the iPhone. This would make the task much less cumbersome and even enjoyable. It is also possible that the click wheel could still be a wheel but becomes a large multi-touch pad with different input areas for different tasks. The wheel would still be opaque but could display different things with a screen behind the multi-touch pad that shows a keypad at some times and the current menu, play, pause, forward, back at other times. This phone would be the real killer, just as the iPod nano sells more units than the full-size iPod. If the iPod nano gains phone features, it would be branded as an iPhone nano or mini- part of the iPhone family and not an iPod nano that has phone features. It will be part of the phone family and not part of the iPod family. There would only be an iPhone nano and no iPod nano anymore. This is obviously a delicate task, discontinuing your bestselling product and transferring it to a different division. When it comes to activation, you could have the choice of activating the phone and using it as a phone, or only using the iPod part, which would not require activation, unlike the iPhone. The iPod nano being a phone causes some problems when attempting to bring the phone to market internationally. The U.S. and Europe will have the iPhone in 2007, making it easy to integrate the iPhone nano with the existing carrier that Apple has a relationship with. Asia and possibly Canada will see the phone division of Apple at some time in 2008, but this creates an issue for all of the other countries for which Apple does not have a relationship with a provider (and Asia and Canada until 2008 and a carrier relationship rolls around.) Only being able to sell the iPhone nano in the U.S. and Europe would cause a serious dent in the number of units sold in the iPhone and iPod nano’s price range and category. Selling an iPod with phone features that you can’t use in all the other regions wouldn't go over too well either.

It would clearly not make sense to include both an iPod nano and an iPhone nano where the price points are very similar, they both look very similar and media functionality is exactly the same because cannibalization would occur. It is also possible that Apple would market two different versions of this product, branded as the iPhone nano with phone capabilities in some regions and the iPod nano without phone capabilities in other markets. This also seems unlikely because region-specific versions of the nano would not make sense in terms of production lines and is not a very elegant or Apple-like solution.

The iPhone nano would be a hit despite its lack of a traditional keypad (or just incorporation of a multi-touch click wheel and keypad combined) because it would be a fully functioning iPod, would be a phone that you actually enjoy using, would have a clean, simple, intuitive user interface that only Apple seems to be able to create, would sync painlessly with your computer, would look beautiful, would have mass market appeal at a very affordable price point and would come with competitive pre-paid service or monthly plans to go with it. Of course, it is possible that Apple won’t release an iPhone nano and just stick with the iPod nano until it has relationships with carriers in more locations, even though now would be a very very opportune time for Apple to announce it- just before the holiday buying season (where affordability makes it a great gift and the buying process is painless and activation occurs at home, not at the store, making it an easy gift) when Apple is the darling of the media, and when few people expect it.

Pricing on the iPod nano would be $149 for 4GB and $199 for 8GB if the iPod nano does not have phone features. It is possibly and entirely likely that the 2GB version of the iPod nano will not exist after this event and could be replaced with a 2GB version of the iPod shuffle. If the iPhone nano makes its debut, it would be priced at $199 for 4GB, $ 249 for 8GB and possibly a 2GB version for $149, the same pricing as the current iPod nano.

Full-Size iPod: The full-size iPod could either retain the click wheel or have a full touch screen just like the iPhone’s. Right now the full touch screen seems like the more likely version. Just like the other iPods, the full-size iPod will be a part of Apple’s new aluminum and glass design philosophy and will look very elegant. The display will be made of glass, like the iPhone’s screen. This iPod will also run Mac OS X with many effects and animations, a black theme, cover flow, and power-saving features that would enhance battery life. This interface will resemble the iPhone’s and will look beautiful. There would also be a focus, like the nano, on album art.

Capacities for this iPod could grow as high as 120GB. The most likely capacities would be somewhere around the range of: 16GB, 40GB and 100GB. The 16GB model would be flash memory and the other two would be hard disk drive-based. The 16GB model would look exactly the same as the other full-size iPods complete with a full touch screen. It would belong to the full screen iPod family and would not be an extension of the nano. People do not carry 16GB of only music and a few photos around. 16GB would make much more sense for video and I do not think that the iPod nano will play video. Apple itself has said that 4GB is the “sweet spot” for the amount of music that people want to carry around. 16GB would be four times that in a music and photos-only device like the nano. The use of flash memory in the video iPod would allow the device to be very thin and would provide long battery life. Flash memory would also make it very responsive, smooth and quick, things that would be essential with a touch screen. A full screen hard drive-based iPod would require some internal tweaks to allow it to be responsive enough to handle many inputs from a large touch screen, but these are easily within Apple’s reach. The other two models of the iPod would use a hard drive for storage. This is because a 32 GB model based solely on flash memory is highly unlikely because chips that cram 32GB of flash memory onto a single chip are very expensive and supply is limited. Securing large numbers of 32GB SSDs to fit in a laptop computer is still difficult. The solution to this would be to take two 16GB flash memory chips and put them in the iPod. This would significantly raise the cost and I believe that 16GB flash chips are still in short supply. It is clear that iPods with a large amount of storage are essential and while 32GB would be just fine for the lower-capacity full-size iPod, the cost and supply issues associated with 32GB flash are too great. A higher capacity iPod in the 60GB-120GB range is essential and 64GB of flash would be absurd to place in the number of iPods that will be manufactured. This makes an all-flash iPod lineup very unlikely, almost impossible in my view. Apple’s margins on the higher capacity iPod are high and Apple would be interested in retaining these and would not want to discontinue this model. For the highest-capacity iPod the base cost of all the other components is the same as for the lower capacity. The only higher cost is to have a higher-capacity platter in the iPod, placing an 80GB hard drive in instead of a 30GB platter or a 100GB platter instead of a 40GB platter. Apple is able to add a proportionately much larger dollar amount on to the price for the end consumer than for its cost for the larger hard drive, which increases Apple’s margins. I think that it is a definite possibility that Apple will celebrate its first 100GB iPod at this event in addition to the full screen video iPod in 40GB and 16GB iterations.

In terms of design, this full screen iPod would resemble the iPhone, but with some differences that would distinguish it from the iPhone and show that the iPhone is a higher-end product. It is likely that the chrome around the front edges of the iPhone will not be included in the iPod; this will enhance the iPhone’s elegance and assert it as the higher-end device. The backing used on the iPhone will replace the chrome backing of the iPod, which will be retired after this event. I doubt that the touch screen version of the iPod will include wi-fi capability or Safari, even though implementing this would be very easy, with the full touch screen making for easy internet browsing and Safari would be easy to include running on Mac OS X on the iPod. This would also encroach on the iPhone’s feature set and it would be easy for developers and hackers to recreate the e-mail, widgets and SMS text messaging features of the iPhone, possibly even Youtube. This would leave the iPhone differentiated by voice capability and a 2-year lock to AT&T. When price is taken into account, the iPod would be a very compelling alternative and this could take market share away from the iPhone. The screen would be made of glass, like the iPhone’s screen. This iPod would come in two colors-black and something lighter, similar to the white currently used on the full-size iPod. However, it is likely that the white becomes closer to an aluminum color. While having a full touch screen iPod may seem like just a stripped-down iPhone with only iPod features and might take away some of the exclusivity of the iPhone’s interface, this device will be part of Apple’s multi-touch strategy- bringing the multi-touch interface to many products. The multi-touch interface will eventually spread to the majority of iPods just as the click wheel eventually made its way into the many models of the iPod lineup. Apple has touted multi-touch as the next revolutionary user interface after the mouse and the click wheel and it is certain that multi-touch will pervade Apple’s products in the next few years. This will be the next step (and possibly the next step after that in the iPhone nano, if the click wheel-multi-touch combined interface makes it into the iPhone nano and the iPhone nano does in fact make its debut) after the iPhone in completing this process. Apple’s multi-touch interface is seemingly proprietary (or at least Steve would have you think this way when he mentioned the over 200 patents Apple had related to its multi-touch technology at Macworld 2007.)

If on the outside chance (or at least it seems like an outside chance now) the full-size iPod retains the click wheel on at least the higher-capacity versions, it would still run OS X with the black interface theme, have a backing like the iPhone, come in two colors- black and white/aluminum, could possibly have a glass face which would give it the co-molding effect and definitely a glass screen. This iPod would be made out of aluminum and have a distinctly different design feel than the current full-size iPods have. It would be more iPhone-like in design. The click wheel might look like it is made of aluminum as well which would give the iPod a very elegant look, a quality that will emanate from all the iPods after the September 5th refresh.

Pricing on the full screen iPod would run at $249 for the 16GB model, $299 for the 40GB model and $399 for the 100GB model.

The Apple Product Line would look something like this after the event:

1GB iPod shuffle $ 69 or lower
(Possibly a 2GB iPod shuffle- $79)
4GB iPod nano $149 (Possibly a 2GB iPhone nano- $149)
8GB iPod nano $199 (4GB iPhone nano- $199)
16GB iPod (flash) $249 (8GB iPhone nano- $249)
40 GB iPod (HDD) $299
100GB iPod(HDD) $399

Also at this event, the Beatles could finally make their debut on iTunes, the iPhone could be finally available in Europe, along with new ads for sure and possibly other content announcements.

After the Event-Product Transition:When Apple’s CFO Peter Oppenheimer was questioned during Apple’s third quarter conference call in July as to why Apple was guiding so low for the current quarter, he responded with three reasons, one of which was a mysterious “product transition” that was going to take place over the course of the current quarter. He refused to give any further color on this product transition.

I believe that this product transition is the iPod refresh coming September 5th. The new iPod lineup will rely heavily on NAND flash. All but two models of the new iPods will rely on NAND flash and the inclusion of a 16GB full touch screen iPod will skew Apple even more towards flash. In addition, if an ultraportable based on SSDs was introduced, this would exacerbate this even more. Now, keep that thought in mind. Over the past three or four Apple earnings conference calls, Apple has cited a “favorable component environment” that was responsible for the unusually high earnings and more specifically margins Apple was enjoying. This “favorable component environment” (I believe) has been due largely to the extremely depressed state of the flash memory market. Flash memory is a major part and therefore a major cost that goes into each flash-based iPod Apple sells. This huge decline in flash memory prices has forced flash memory companies like SanDisk (SNDK) to report corresponding huge declines in earnings; in their most recent quarter they reported that EPS declined upwards of 70% from the same quarter last year. SanDisk was recently forced to lay off 10% of its workforce, cut executive salaries and put a cap on all other salaries. However, there have been clear signs that the flash memory market has stabilized and is beginning to drastically improve- even more recently, SanDisk has announced that it is reversing its executive pay cut, citing the very rapid turnaround in the flash market. This same anticipated turnaround has been giving stocks like SanDisk absurd valuations like 125 for the current year’s earnings and only 19 for the next year’s earnings. This shows the drastic way in which the market thinks that the flash market is supposed to turn around. If this drastic turnaround was to take place, there would be a “favorable component environment” no more. The upcoming iPod refresh combined with the inclusion of the flash-based iPhone and possibly the distant release of an ultraportable based on SSDs has placed Apple in a position of heavy reliance on flash memory and has skewed it towards a very NAND-based product mix. It is possible that Apple’s executives have acknowledged this forthcoming change and guided conservatively for the current quarter. Apple would not be able to secure all the flash memory needed for the millions of iPods and iPhones it expects to sell in the current and future quarters at current depressed prices and could be forced to buy a significant amount of the flash memory it needs at potentially much higher market prices. Depending on how fast and how high the flash market moves, it could affect Apple’s margins and Apple’s earnings. Apple’s great executive team working behind the hype to manage the business aspect of the company could be anticipating this and ensuring that they are conservative in their guidance just in case. Apple has been cautious and conservative in its guidance, as always.

This is what I believe this “product transition” mentioned by Peter Oppenheimer in Apple’s third quarter 2007 conference call means. We will need to wait and see whether this turnaround happens and whether it has a material impact on Apple’s financials.

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