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On Wednesday afternoon, Apple (AAPL) CEO Tim Cook and his talented product team took the stage to announce the next generation rollout of Apple products -- including the iPhone 7 and Apple Watch Series 2 -- and services -- including iOS 10, which is dubbed the best mobile operating system of all time.
Overall, while many of the updates may seem only incremental on the surface, we believe Apple told a strong story, with many moving pieces that could combine to encourage more consumer demand than the market may recognize. You can watch a replay of the keynote here. AAPL is a holding in the Action Alerts Plus portfolio.
Investor reaction is likely to remain muted until the impacts of the new products and features settle in, but we ultimately believe Apple did what it needed to in order to reignite consumer interest for upgrades. That is not to say this Apple launch is the best of its kind, but it does the job to appease consumers and investors alike -- until the next product rollout, which happens to be the 10th anniversary iPhone.
Before we fully dissect the event, we first wanted to point out the updates provided on the Services business, which has underpinned our long-term bullish thesis for Apple. During the keynote, management discussed some very encouraging numbers that should not be overlooked. First off, downloads in the App store were up more than 100% on the year in July and August, likely driven by Pokémon Go, but still implying an inspiring 37% acceleration from June. This not only contributes to a growing recurring revenue stream, but also to improved margins company-wide, as Services becomes a larger component of the overall business.
On top of this, Apple said that Apple Music now has about 17 million paid subscribers (up from 15 million in June). Assuming $10 a month individual subscription fee, this amounts to an annualized revenue run-rate of over $2 billion. Clearly, the updates Apple has made to the service have begun to pay off. We believe this all indicates that Services continues to accelerate -- and that it will prove to be a major contributor over the long-term for Apple.
Now, moving onto the star of the show: Products. Below, we highlight the new iPhone, as well as the other new products, features, and services -- and where each fits into Apple's story.
The iPhone 7 and 7+
As expected, Tim Cook saved the best for last at his keynote speech yesterday. But we, of course, must bring the discussion of the iPhone to the forefront, given its importance in Apple's revenue stream. The new iPhone 7 and 7+ look largely the same as the previous versions (6s and 6s+), but under the hood, there is certainly more than meets the eye.
The key draw for the new phones is the overhauled photo experience -- including a 12 megapixel camera, optical image stabilization (to remove background noise and unwanted movements), an improved FaceTime (front-facing) camera, and true-tone flash to capture as much vibrant color as possible. The iPhone 7+ camera is even more impressive, adding a second camera ("dual camera system"), in addition to the features explained above, that allows for 2x optical zoom and wide-angle telephoto pictures.
Just as important as the new cameras in terms of updates is the improved performance and battery life of the new phones. The iPhone 7's battery will have, on average, two hours of extra battery life than the previous generation, and 7+ will have one extra hour, on average. While this additional time may only seem incremental, those few precious hours could be the difference between your phone living through the day at work, finishing a game of Pokémon Go on-the-go, or anything of the sort. All of this is made possible by the new A10 Fusion processor chip, allowing the 7 and 7+ to process up to 2x faster than the iPhone 6. The graphics processor is also 3x better than in the iPhone 6.
Aside from the major feature updates addressed above, the new phones will also be splash and water resistant (consumers everywhere rejoice), will have the first-ever stereo speakers for iPhones, and will display a wide color gamut (brightest and clearest display ever in an iPhone). In addition, as expected, the headphone jack has been removed from the new phones (more on this, below, with additional products), now leveraging Bluetooth technology and the lightning port for enhanced sound capabilities. For those worried, Apple will be providing a standard adapter to easily use your old headphones. An updated, pressure-sensitive home button will also add additional functionality.
So let's bring this all together and look at it from an investment perspective. The iPhone 7 will be a millennial phone. And it will be international. What does this mean? It has been optimized for our ever-evolving, content-driven, mobile, social and gaming world. The improved battery life is essential for all of the time we spend handcuffed to our phones, and the new camera is critical for creating that perfect Instagram photo. The updated display, processing capability, and software functionality lends perfectly to the gaming market, which is enormously important internationally -- especially in Asia (recall the heightened sensitivity to Apple's China numbers). Not to mention, the addition of a new Mario game in the App store that will have the gaming community nostalgic and buzzing.
All in, we believe these updates are enough to move the needle, especially given that estimates remain low from disapproving analysts. Our opinion? They simply don't get it. Apple remains the leader of innovation in the modern world, and the iPhone 7 is the gateway into a new world of mobile computing. Sure, we expect a bigger splash when next year's 10th anniversary iPhone is released, but this version exceeded our expectations.
Combined with the iPhone upgrade plan (where consumers can pay a monthly fee to have the ability to upgrade along with each version), we believe this selling season will have momentum. Even better, purely from a numbers perspective, an extra week of selling opportunity benefits the December quarter. Apple is also planning to make the devices available in 28 countries on initial launch, up from just 12 last year.
Lastly, we believe the dual camera on the iPhone 7+, when combined with the bigger screen display, could entice enough consumers to opt for the larger model. In a world where we use our phones for work, fun and everything in between, a larger screen is becoming more valuable, and the iPhone 7+ has optimized features to capitalize on this trend. Should we see a shift towards this model, that would mean better average selling prices and improved margins for Apple.
Apple Watch Series 2
In addition to the iPhone 7, Apple announced a revamped version of the Apple Watch. While many analysts have consistently dampened the impact of the Watch over the past 18 months, Apple said yesterday that the Apple Watch, in revenue terms, was second only to Rolex in 2015 -- and that's without the benefit of a full year of shipping. The Series 2 should help build upon the product's popularity, as enhanced integration with the phone, improved standalone software features, and new product updates help address any consumer complaints -- which, by the way, have been few and far between, according to Cook.
Apple's new Watch Series 2 is water resistant up to 50 meters and has built-in GPS -- both key additions for the fitness market, which Apple is clearly targeting with this rollout. The new Watch also comes with a new dual core processor and improved graphics/screen. In addition, a version specific to Nike (NKE) to be released later in the year, adds another dimension to help Apple compete with Garmin (GRMN) and Fitbit (FIT) in the wearables/tracker market. The new focus on fitness will offer a wider consumer appeal while still allowing it to double as a general-purpose watch and smartphone companion.
Other Items of Note
iWork Collaboration: Apple introduced a real-time collaboration feature for its iWork application, making the product similar to Google Docs, where users can update spreadsheets, presentations, and documents in real time, together, for more timely feedback. While this functionality is a bit late to the party, it could be an understated play, as Apple continues to push into the enterprise.
Wireless AirPods: Along with Apple's decision to remove the headphone jack from its new line of phones, it is also introducing a new wireless headphone product. This was one of the major unexpected announcements of the event, surprising to the upside, given that they should drive better accessory demand. The product encompasses many innovations in the personal audio space, including motion detection and control, noise reduction (knows when you are talking vs. when you are listening to music), voice command, battery control, seamless and wireless pairing (AirPods will be able to sense when they're in your ears and pause when you take them out), and a portable charging case.
iOS 10 and Siri: Siri has been overhauled to improve image searches, handle transcribing voicemails, and even make easy payments. Importantly, Apple is opening up Siri to developers so that you'll be able to, for example, ask the assistant to send a message to a friend on third-party apps (like WhatsApp) or book an Uber with your voice. By opening up the rest of the operating system to outside developers, users will now also have a much more seamless experience with iMessages, Maps, News, Photos, and all of the other native apps. iOS 10 is a major overhaul, and optimizes the user experience, which has always been the calling card for Apple and has allowed it to become the most-recognizable brand in the world.