
Apple May Have Completely Flipped Its Business Model Upside Down -- Here's Why That's a Good Thing
SAN FRANCISCO (TheStreet) -- By unveiling a new leasing program, Apple (AAPL) - Get Report may have done more than just unveil an easier way to buy an iPhone -- it may have completely changed its business model.
Apple has taken its cash cow iPhone, which accounts for more than two-thirds of quarterly revenue, and effectively turned it into a subscription business. By doing so, this may warrant a higher earnings multiple over time, as Wall Street begins to fully understand the nature of this change.
By allowing customers to pay roughly $27 a month for the iPhone 6s or $31 for the iPhone 6s Plus, Apple has effectively created an iPhone-as-a-service business. Apple thus becomes less reliant on the number of iPhone units sold each quarter.
(For an additional primer on the subscription business and why investors like the business model, click here.)
Software-as-service (SaaS) businesses such as Salesforce.com (CRM) - Get Report , Workday (WDAY) - Get Report and other SaaS businesses receive a higher earnings multiple because they provide predictable cash flows and sustainable revenue.
The CEO of one of the largest SaaS businesses, SugarCRM's Larry Augustin, says the model is attractive to investors because of its predictability. "It's a business that can have very attractive cash flows," Augustin noted in a recent interview with TheStreet.
Currently, Apple trades at a forward earnings multiple of roughly 12 times fiscal 2016 earnings, while San Francisco-based Salesforce trades at a multiple of 73 times earnings and Workday trades at a gregarious 996 times forward earnings. It's highly unlikely that Apple would trade at either of these multiples, but a smoothing out of revenue (Apple is slightly dependent on the holiday season) could cause investors to re-rate shares considerably higher.
To highlight the issue, take a look at Apple's Apple's cash flow from operations in fiscal 2015:
Q1: $33.7 billion
Q2: $19.1 billion
Q3: $15 billion
If customer retention is high (Apple CEO Timothy D. Cook constantly talks about 90%+ satisfaction rates), then a company can keep customers for years and years, growing cash flows to make for a more attractive business for investors.
Not only would Apple then be able to smooth out revenue over time thanks in part to the leasing program, it would then be able to re-sell the iPhones that are traded in as part of trade-in program that was announced last year, as well as the expansion of the program this year.
The move is important as well to keep up with changing trends in the smartphone business. Phones are no longer subsidized by carriers such as Verizon, AT&T (T) - Get Report , T-Mobile and Sprint (S) - Get Report . Instead, consumers now bear the full price of the phone, paying for it over time.
Starting at $32 a month for the 6s and $37 a month for the 6s Plus (including Apple Care+), customers can upgrade their iPhones annually, getting an unlocked iPhone 6s or iPhone 6s Plus exclusively at Apple's U.S. retail stores.
This would allow Apple to re-sell these iPhones at a higher gross margin than usual, effectively selling the iPhones every time a customer trades one in.
Currently, Apple's gross margins sit around 40%, the highest in the industry.
The upgrade program from Apple is part of the reason we've seen exceptionally strong and generous trade in programs from the likes of Verizon (VZ) - Get Report and T-Mobile (TMUS) - Get Report . They do not want to become simply "dumb pipes" as it relates to the smartphone business.
If they lose that part of the business, the most valuable part of what is left for the carriers is the billing relationship with customers. Apple will own almost everything else.








