Edge AI will drive iPhone upgrade Supercycle
EdgeAI, LLMs, WWDC, Siri, China & More
This is a follow up article to my original Apple article that I published in September 2023. In that article, I recommended accumulating Apple below $175. The market has given us ample opportunity to buy below that price level. I had highlighted China as the primary risk to Apple and that remains the case. In this article, I update my thesis on Apple incorporating Apple’s AI efforts.
iPhone Upgrade Supercycle:
In 2020-2021, the world upgraded their hardware, laptops, phones, etc…The following years, these segments saw a drop in demand globally.
As those machines, purchased during covid get older, the world is going to start to upgrade again. PC and phone shipments are likely to start seeing demand going up again just as part of the business cycle. This has already started happening.
But this cycle is different, Nvidia has changed the world effectively making all existing hardware obsolete. AI is front and center and all hardware companies are racing to develop technology that will allow AI computation on devices also known as Edge AI.
Despite China's struggles, the recovery is expected to continue in 2024 as newer AI PCs hit shelves later this year and as commercial buyers begin refreshing the PCs that were purchased during the pandemic.
Source: IDC
Overall, the worldwide PC market had a healthy start to 2024, with total shipments of desktops and notebooks growing 3.2% annually to 57.2 million units in the first-quarter. Notebook shipments were up 4.2% to 45.1 million units, while desktop shipments were relatively flat, down just 0.4% at 12.1 million units.
According to Canalys, this growth highlights the ongoing recovery in PC demand across all segments, with purchases set to accelerate throughout the year, supported by the tailwinds of Windows 11 refresh and AI-capable PCs.
Source: Seeking Alpha, Canalys
In 2024, about 18% of total personal computer shipments globally will be AI-capable PCs, and this would only be the start of a major market transition, according to research firm Canalys.
These computers — integrating dedicated AI accelerators, like as Neural Processing Units, or NPUs — will have new capabilities for productivity, personalization and power efficiency and will disrupt the PC market, providing value gains to vendors and their partners, the report added.
Source: Seeking Alpha
Extrapolating this to iPhones, if the new iPhone every year is only marginally better than the previous one, then it makes sense to hold on to your old device. However, if it is a completely new technology with AI capabilities enabled at the edge, that is a catalyst that will drive users to upgrade leading to an iPhone upgrade supercycle.
Edge AI is likely to drive an upgraded supercycle on Phones, PCs and Laptops across the board which are all going to benefit Apple.
WWDC:
Apple was without a doubt late to AI and they’ve been scrambling over the past year to build their AI strategy. The first announcements are expected to come at WWDC this year which is scheduled to start on June 10th.
Apple is widely expected to add AI capabilities to its flagship programming software, Xcode, to predict and complete blocks of code, among other things, Bloomberg reported in February.
I expect Apple to make more AI related announcements at WWDC beyond Xcode. This WWDC should set the tone for Apple’s AI strategy going forward and give us a peek into what might be coming in 2025.
LLMs:
I don’t think there is any real differentiation in having an LLM anymore, seemingly everyone has an LLM now. Apple’s biggest AI opportunity in the short term lies in EdgeAI and driving a hardware refresh cycle.
Nonetheless, Apple has been trying to build LLMs too. Bloomberg reported in July 2023 that Apple has built its own framework to create large language models. With that foundation, known as “Ajax,” Apple also has created a chatbot service that some engineers call “Apple GPT.”
Besides, it was reported in February 2024 that Apple has started internally testing a generative artificial intelligence tool called “Ask” to help employees provide technical support in a more efficient manner.
So even though Apple is working on LLMs, I think the hardware upgrade cycle is underappreciated in the short term. The LLMs are going to be in service of the hardware. However, as Apple grows its services revenue, LLMs will become integral for Apple to have a foothold in this market and to continue to grow. Which is why Apple needs to continue to develop LLMs, even though everyone seems to be doing the same.
ReALM:
Apple recently published a research paper on April 1st, 2024 describing Apple's newest language model, known as Reference Resolution As Language Modeling, or ReALM.
Based on the research paper, smaller ReALM models delivered similar performance as OpenAI's GPT-4, and with fewer parameters. This could make it easier for Apple to deliver AI to the edge with the same performance as AI in data centers.
“The key innovation here appears to be around reference resolution, which refers to how AI can understand references to on-screen data as well as more conversational context," Evercore ISI analyst Amit Daryanani posited. "Apple simplifies the normally complex task of reference resolution by converting all on screen data to text, which is far easier for an [large language model] to parse relative to images. This is the key feature that enables Apple to deliver high performance with a more limited number of parameters."
"We think AAPL’s AI strategy will focus on incorporating on-device inference for [large language models] that will substantially uplift the user experience for not only the iPhone but also Mac/iPad," Daryanani explained. "Given their vertical integration and especially their control over their own silicon, AAPL is best positioned to not only expand the moat surrounding the iOS ecosystem but also potentially drive an accelerated refresh cycle should the final implementation be deemed a big enough change."
Source: Seeking Alpha
Siri & LLMs:
In terms of LLMs, the biggest opportunity for Apple is with Siri. A future state of the current AI chatbots is going to be personalized AI assistants that have memory (can remember things about you vs being transactional) and they will run everything on your behalf. They will respond to texts, filter out your emails, make reservations, make sure you remember important things, you know, like an assistant.
Apple needs to be able to deliver with Siri or else Apple’s risks losing market share to younger competitors over time.
I’ll close the bullish section of this article by reiterating that Apple will witness one of the most powerful upgrade cycles over the next 3-4 years driven by AI on the edge. Apple is definitely worth accumulating below $175.
Risks to Apple
Competition:
Apple is not alone in trying to get to Edge AI and competitors like Huawei and Qualcomm are also making ground. Last month Qualcomm announced their chip capable of providing on-device AI computation or Edge AI.
There is a new global race to build a new type of computer and Apple will have to prove its dominance once again, to maintain its global leadership.
At this point, I’m placing my bets on Apple’s leadership, given their reputation in delivering the best hardware in the world. I expect Tim Cook and company to eventually figure out how to best incorporate AI into their products along with industry leading hardware.
China:
China remains a big risk for Apple. I still don’t think that the masses will want to use an inferior phone, something that is two generations behind. However, if they do eventually start shifting, then as I made the case in my last article, I think developing markets, especially India will support Apple’s iPhone sales. However, developing markets will not immediately be able to make Apple whole again and the stock could remain under pressure if China continues to shift away from iPhones.
As things stand now, on a 5 year chart Apple has support at its 200 day moving average at $150. If the news cycle gets worse for Apple, then the stock could test $150. I intend to continue dollar cost averaging throughout and will buy more aggressively near $150, if it gets there.
Services:
The other risks that Apple faces are regulatory. Apple is being forced to bring down its commission on the app store as well as allow businesses to accept payments outside Apple’s ecosystem.
Apple’s services revenue is one of Apple’s big bull cases. Apple has built a strong customer base globally and it brings in revenue at a higher margin than its hardware business. Services revenue will eventually outgrow the hardware revenue making it critical for Apple.
So governments around the world, forcing Apple to reduce its commission is detrimental to the services bull thesis.
However, we are still early in the life cycle of Apple’s services business. Unlike iPhones which is a mature business (and therefore is hit hard by the China issue), the Services business is still growing fast and Apple should be able to outgrow the loss in commissions as it further expands its user base.
Google & Apple:
If the government forces Apple and Google to terminate their contract where Google pays Apple $20+ Billion each year to be the default search engine on Apple devices, then that would be a huge hit for Apple given that the entire payment from Google goes to Apple’s bottom line. So that would severely affect Apple’s earnings.
In December 2023, I wrote an article where I made the case for Apple to start building its own search engine to protect itself from the Google fallout (if it happens). However, Apple has gone in a totally different direction, instead planning to incorporate Google AI Gemeni into iPhones.
If Apple continues to go down this route, instead of developing their own in-house AI and incorporating it into Siri, then iPhones are at risk of losing their differentiation. If AI is the main way you communicate with technology in the future, and Apple is outsourcing that AI to Google, that does not bode too well for Apple. Apple will lose its differentiation over Android if the key software underpinning the device is the same or worse than Android.
Having said that, I think this is a stop-gap measure for Apple, as it is trying to put together an AI narrative that the market will appreciate and so far it’s been kind of lackluster. And that is, often, exactly the time you want to be buying companies with great management teams.
Conclusion:
I continue to accumulate Apple below $175. Edge enabled hardware refresh supercycle is coming. Apple needs to fix Siri. China remains a risk. Sentiment is washed out on Apple, making it a good time to dollar cost average into it.
Borrowed Conviction Rarely Works
Past performance is no guarantee of future results.
The ideas discussed in this article should not be constituted as investment advice.
I reserve the right to change my mind if the facts change.
Disclosure: We own positions in some/all of the tickers mentioned in this article.