iPhone 6, sans sapphire cover: It’s not the canary in a coal mine you might think it isI leave this article up as a reminder that even my best laid plans can be incorrect. There's a double 0 on the roulette board of life, and occasionally the ball lands in it.
September 26th, 2014
Canaries were historically used by coal miners as leading indicators, to test whether air conditions in a mine were safe for humans. An attempt to use the iPhone 6’s lack of a sapphire cover as some sort of leading indicator about future plans between Apple and GT Advanced Technologies might prove unwise.
This article discusses publicly traded companies. By reading it, you affirmatively agree that I shall not be liable, responsible or accountable in damages or otherwise, to you or to any other person or entity. I do not advocate buying any financial instrument of any kind without the prior consultation of the appropriate financial services professional. I own shares of AAPL and GTAT. I began accumulating my current position in GTAT as of 9/16/14 and I've owned shares of AAPL for approximately one year. You agree I have no duty or obligation to update this article or my position in the aforementioned investments, or any other duty or obligation to any person or entity whatsoever, including any responsibility for accuracy with respect to this article's contents. I am not a licensed financial professional of any kind; I'm just a dude sitting in a garage. I have not received any compensation for writing this article. By continuing to read this article, you agree to the above-mentioned terms. If you do not agree to the above-mentioned terms, read no further.
Monday morning quarterbacks
There’s been a lot of talk about sapphire and the iPhone 6 ever since Apple first announced it’s five-year deal with GT Advanced Technologies. Now that we know the iPhone 6 is made of ion-strengthened glass, provided by Corning, GT’s stock has been hammered (ticker symbol: GTAT), and there’s been a fair amount of Monday morning quarterbacking suggesting that we all should have seen this coming. Tim Bajarin of Time put out a recent, widely circulated article stating,
I’m going to do some Monday morning quarterbacking myself, and it’s true what Tim Bajaran says, we all should have seen this coming, but not because of any regurgitation of sapphire’s shortcomings. Sapphire’s brittleness, its susceptibility to subtle flaw accumulation (leading to an increased probability of cracking and further breakage), and its high cost, were widely debated in the months prior to the iPhone 6 launch. To simply put forth these same reasons again, after the iPhone 6 launch, is too simple a play call for me.
GT Advanced Technologies timeline
I’ve listened to every conference call of GT Advanced Technologies since their deal with Apple was announced on November 4th, 2013. Unsurprisingly, there’s a pretty logical argument to be made that sapphire was never planned for the iPhone 6 simply because the timeline would have been impossible to meet production, and because GT’s management would have had to have known. GT’s future revenue and earnings guidance is the real canary in the coal mine here. Let’s take a quick look at what GT’s management has said since the Apple deal was announced (links to conference calls can be found on GT’s investor page).November 4th, 2013 (GT conference call)
- The deal with Apple is announced, involving a multi-year agreement and the building of a one million-plus square foot facility (as we would come to find out) in Mesa, Arizona.
- At the time of this announcement, the iPhone 6 launch is a mere 10 months away.
- Given the large amount of iPhones Apple routinely sells in the first weekend and first year of availability, and given that Apple has shown a propensity to launch new iPhone models around the same time in September, the discerning observer already had reason to be skeptical of GT’s ability to contribute sapphire from its Mesa plant to iPhone 6 covers.
- GT expects to have 2014 revenue in the range of $600-$800 million, with 80% of that coming from the sapphire segment, with only 15% of that coming in the 1st half of the year.
- GT expects to have 1,000 employees (of an eventual 8,000 as they later state in guidance) for the Mesa plant in place by “mid-year."
- GT expects non-GAAP EPS of $1.50 per share for full year 2016.
- The Mesa facility now has about 1,000 employees.
- GT has received the 3rd (out of 4) prepayments from Apple.
- Marques Brownlee made his first video examining the leaked display on July 7th, but his second video, just a couple weeks later, is even more interesting.
- GT holds its most recent conference call to date, approximately one month prior to the iPhone 6’s launch.
- GT reaffirms their previously given $600-800 million guidance, except they narrow it within that range to $600-700 million. GT reaffirms that the 4th quarter of 2014 will be "very heavily loaded" as compared to the third quarter.
- GT reaffirms their previously given 2016 non-GAAP EPS of $1.50 per share.
- GT is in the process of transitioning to "volume production" and that they anticipate full production capacity by the 1st quarter of 2015.
- GT’s states, quite strongly, that they anticipate receiving the 4th and last of the Apple prepayments in October, 2014.
The fall from grace
As we all now know, the iPhone 6, along with the Apple Watch, were announced on September 9th, 2014. We learned that sapphire covers would not be included on the iPhone, however, two of the three Apple Watch models were shown to have sapphire faces (the “Sport” edition would be ion-strengthened glass) and partial sapphire backs. Speculation of sapphire covers for the iPhone 6 was at such a fever pitch around the time of launch, driven in part by certain analysts, that the corresponding let down was fairly dramatic. GT’s stock got clobbered, falling from a 52-week high of $20.54 a share ($17.15 a share the day before the iPhone announcement) to below $11 a share intraday on September 22nd, 2014 (I saw the stock crash and decided to take a closer look. I orignally shared most of this analysis with friends on 9/17/14).
But why? Did Apple nix sapphire for the iPhone 6 just weeks before Apple’s “internal deadline” as some analysts have claimed? Is GT going to have a difficult time hitting their future revenue and earnings guidance, as analyst Pavel Molchanov of Raymond James just claimed on CNBC's Fast Money, now that sapphire will not be included on the iPhone 6? I have reason to doubt that. That would imply that GT’s management had no idea what was going on at the time of its August conference call (which is pretty much impossible), and that they no idea what was going on at the time of its May conference call (also highly unlikely). I don't mean to pick on Mr. Molchanov, but you have to love his response to a question from Karen Finerman:
"I think that if Apple wanted to implement sapphire across its broad portfolio, they could have easily revealed those plans two weeks ago at the product launch."
Ah, yes, Apple so often tells us what they're going to do before they do it. It's just a really silly thought.
Thank Mr. Brownlee for reminding us about "lead time"
At least as early as July 7th, 2014 (refer to the timeline above), as it is now apparent being the Monday morning quarterbacks we are, Apple had definitively chosen to go with Corning’s new and improved, ion-strengthened Gorilla Glass. Read that again, July 7th. Mr. Brownlee provided a very interesting demonstration by testing the leaked cover’s hardness rating according to the Mohs scale (via objects like metal knives and sandpaper of various Mohs ratings). By doing so, he was able to conclude that the leaked display was not “pure sapphire,” in his words, but was indeed harder than last year’s iPhone 5 displays. He concluded that the display was partially made of sapphire somehow. We can now clearly see what threw him off the scent; the leaked display was in fact new and improved, and as of then unannounced, Gorilla Glass. It was a completely understandable hypothesis for him to make at the time.
We have to keep in mind, although Mr. Brownlee’s first video showing the leaked display is dated as of July 7th, the leaked display obviously needed time to get manufactured, and it needed time to then leak to him. How much time you might ask? I don’t know, but decisions on these sorts of components likely need to be made well in advance of actual production. Therefore, it's very reasonable to conclude that GT’s management was aware of Apple’s plans to go with, or not go with, GT's sapphire (in bulk quantities sufficient to satisfy a 10 million unit opening weekend launch), at their August 5th conference call. Further, it’s reasonably likely that they would be in the know even as far back as their May conference call. In reality, GT likely knew the whole time. After all, GT’s guidance never really changed, even going as far back as their February conference call. GT did narrow their 2014 revenue guidance from $600-800 million to lower end of the same range (revised to $600-$700 million), but that’s hardly surprising given that they originally guided the $600-800 million range as far back as February of 2014. We now know that the Apple Watch has had some delays due to the development of its software (most people can agree on this after seeing how Apple limited reporters ability to perform hands-on tests at the announcement), so perhaps GT's tightened guidance to the lower end of the range for 2014 as a result of the Apple Watch getting pushed back a few months.
Go listen to the conference calls. There are other interesting tidbits, like this one from GT on the August 5th conference call in response to a question regarding their confidence in receiving the 4th and final prepayment from Apple in October of 2014:
"I feel very confident based on the progress that we're making that we will achieve the milestones in the timeframe . . . again, I don't anticipate that it will slide." (He put the voice emphasis on don't)
So what's the play call?
What’s all this mean to this Monday morning quarterback?
- It's fairly obvious, based on nothing other than pure commonsense notions of lead time, that GT's management had knowledge of Apple's plans for the iPhone 6 as of August 5th. However, I think there's reason to conclude even more.
- It seems very logical to conclude that both GT, and Apple, never had plans for sapphire covers in the iPhone 6. What we now know to be the actual display leaked on July 7th, and therefore the decision to go with that display was made even prior thereto (if your objection is that Apple potentially made other displays around that time as well...those didn't leak, did they?). If one takes into account that GT was still quite early in the process of building out their Mesa facility at the time of their May 8th conference call (look at the timeline above, or better, go listen to the call), and that Apple must have planned ahead for what Tim Cook called, "the mother of all upgrade cycles" (i.e. huge volume needs, immediately upon launch), the most reasonable conclusion is that GT also knew the score at their May 8th conference call.
- Just because sapphire has some stubborn qualities, such alone are not proper justification for pointing to its exclusion from the iPhone 6. After all, one could say the same things and conclude it won't be on the eventual and assumed iPhone 6s. But that that reasoning isn't quite right, is it?
- The market was unreasonable to get so worked up about sapphire covers for the iPhone 6 in the first place...because the timeline did not make sense.
- Finally, and perhaps most importantly depending on your interests, if sapphire covers were never planned for the iPhone 6, then GT's management has not been caught by surprise, and perhaps there's no reason to doubt GT's forward looking revenue and earnings guidance, as Pavel Molchanov of Raymond James suggests. And if you do not doubt their guidance, the value does look good.
- There are three possibilites, if we conclude that GT's management was NOT caught by surprise in 2014: (i) GT's management is untruthful, or (ii) GT's management is incompetent, or (iii) Neither (i) nor (ii) are true. There's no way of being sure, but I think it is most reasonable to conclude they were not caught by surprise, and I think it is most reasonable to assume (iii).
Although Apple has reportedly been very bullish on its sales prospects for the Apple Watch, it’s certainly possible a five-year deal with GT is about more than that one product (yes, in addition to the home buttons and camera lens covers we're all aware of). Right now, only Apple and perhaps GT know if sapphire covers are in other Apple products’ future. All we can do for now is read this recently published sapphire patent from Apple while we sit on the couch calling out everyone's mistakes. Feel free to reach out on Twitter and tell me about mine, civilly.
GT plans to hold a business update the week of September 29th.
I may continue to write about GTAT, AAPL, or not. I may post on Twitter if I do.