Analysts say iPhone sales could shrink by 17 percent if Apple doesn't make a drastic change to its business

  • Apple faces exactly the same problem with the iPhone as it did with the iPad — people are hanging onto older models for longer.
  • That's a problem for Apple's profits and stock price as long as the company primarily relies on selling hardware.
  • A leading Apple analyst thinks the company could make its stock more valuable by becoming a subscription company like Netflix or Spotify.
  • Apple is already doing this in a small way through the iPhone Upgrade Programme, which lets you buy the newest iPhones SIM-free through monthly installments.

The fact that more people are hanging onto older iPhones for longer is good news for customers' wallets, but bad news for Apple's future stock price.

One of the most respected Apple analysts out there, Bernstein's Toni Sacconaghi, has said that the iPhone is at risk of turning into the iPad, and that Apple needs to move fast to head off that problem.

Apple CEO Tim Cook:

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Apple CEO Tim Cook attends the opening ceremony of the fourth World Internet Conference in Wuzhen, Zhejiang province, China, December 3, 2017. REUTERS/Aly Song
Nov 25, 2017; Auburn, AL, USA; Apple chief executive officer Tim Cook arrives for College GameDay before the game between the Auburn Tigers and the Alabama Crimson Tide at Jordan-Hare Stadium. Mandatory Credit: Christopher Hanewinckel-USA TODAY Sports
Apple CEO Tim Cook speaks at The Bloomberg Global Business Forum in New York, U.S., September 20, 2017. REUTERS/Brendan McDermid
Apple CEO Tim Cook (R) plays with an iPhone as Jonathan Ive, Apple's Chief Design Officer, looks on during a launch event in Cupertino, California, U.S. September 12, 2017. REUTERS/Stephen Lam
Apple CEO Tim Cook speaks during Commencement Exercises at Massachusetts Institute of Technology (MIT) in Cambridge, Massachusetts, U.S., June 9, 2017. REUTERS/Brian Snyder
Apple CEO Tim Cook smiles as he arrives to a product demo during the annual Apple Worldwide Developer Conference (WWDC) in San Jose, California, U.S. June 5, 2017. REUTERS/Stephen Lam
Tim Cook, CEO, speaks during Apple's annual world wide developer conference (WWDC) in San Jose, California, U.S. June 5, 2017. REUTERS/Stephen Lam
Apple CEO Tim Cook attends the China Development Forum in Beijing, China, March 18, 2017. REUTERS/Thomas Peter
Apple Inc CEO Tim Cook waves during an Apple media event in San Francisco, California, U.S. September 7, 2016. REUTERS/Beck Diefenbach
Apple Inc CEO Tim Cook makes his closing remarks during an Apple media event in San Francisco, California, U.S. September 7, 2016. REUTERS/Beck Diefenbach
Apple CEO Tim Cook speaks during an event at the Apple headquarters in Cupertino, California March 21, 2016. REUTERS/Stephen Lam
Apple Chief Executive Officer Tim Cook speaks during a event for students to learn to write computer code at the Apple store in the Manhattan borough of New York December 9, 2015. REUTERS/Carlo Allegri
Apple CEO Tim Cook speaks during the Wall Street Journal Digital Live ( WSJDLive ) conference at the Montage hotline Laguna Beach, California October 19, 2015. REUTERS/Mike Blake
Apple CEO Tim Cook introduces the new iPad Pro during an Apple media event in San Francisco, California, September 9, 2015. Reuters/Beck Diefenbach
Apple CEO Tim Cook delivers his keynote address at the Worldwide Developers Conference in San Francisco, California June 8, 2015. REUTERS/Robert Galbraith
PALO ALTO, CA - NOVEMBER 03: Apple CEO Tim Cook looks on as the new iPhone X goes on sale at an Apple Store on November 3, 2017 in Palo Alto, California. The highly anticipated iPhone X went on sale around the world today. (Photo by Justin Sullivan/Getty Images)
Tim Cook, chief executive officer of Apple, Inc., smiles as he greets customers during the opening of the new Apple Michigan Avenue store in Chicago, Illinois, U.S., on Friday, Oct. 20, 2017. The building features exterior walls made entirely of glass with four interior columns supporting a 111-by-98 foot carbon-fiber roof, designed to minimize the boundary between the city and the Chicago River. Photographer: Daniel Acker/Bloomberg via Getty Images
CHICAGO, IL - OCTOBER 20: Apple CEO Tim Cook greets guests at the grand opening of Apple's Chicago flagship store on Michigan Avenue October 20, 2017 in Chicago, Illinois. The glass-sided store sits on shore of the Chicago River in the city's downtown. (Photo by Scott Olson/Getty Images)
CHICAGO, IL - OCTOBER 20: Apple CEO Tim Cook greets guests at the grand opening of Apple's Chicago flagship store on Michigan Avenue October 20, 2017 in Chicago, Illinois. The glass-sided store sits on shore of the Chicago River in the city's downtown. (Photo by Scott Olson/Getty Images)
Tim Cook, chief executive officer of Apple Inc., speaks during the Bloomberg Global Business Forum in New York, U.S., on Wednesday, Sept. 20, 2017. The forum, hosted during UN General Assembly week, brings leaders to work together, through on-the-record main stage discussions and private bilateral and multilateral meetings, to address the most pressing economic issues facing us today. Photographer: Misha Friedman/Bloomberg via Getty Images
CUPERTINO, CA - SEPTEMBER 12: Apple CEO Tim Cook (R) and Apple chief design officer Jonathan Ive (L) look at the new Apple iPhone X during an Apple special event at the Steve Jobs Theatre on the Apple Park campus on September 12, 2017 in Cupertino, California. Apple held their first special event at the new Apple Park campus where they announced the new iPhone 8, iPhone X and the Apple Watch Series 3. (Photo by Justin Sullivan/Getty Images)
Apple CEO Tim Cook speaks during a media event at Apple's new headquarters where Apple is expected to announce a new iPhone and other products in Cupertino, California on September 12, 2017. / AFP PHOTO / Josh Edelson (Photo credit should read JOSH EDELSON/AFP/Getty Images)
SUN VALLEY, ID - JULY 12: Tim Cook, chief executive officer of Apple, attends the second day of the annual Allen & Company Sun Valley Conference, July 12, 2017 in Sun Valley, Idaho. Every July, some of the world's most wealthy and powerful businesspeople from the media, finance, technology and political spheres converge at the Sun Valley Resort for the exclusive weeklong conference. (Photo by Drew Angerer/Getty Images)
BOSTON, MA - JUNE 09: CEO of Apple Tim Cook looks on before a game between the Boston Red Sox and the Detroit Tigers at Fenway Park on June 9, 2017 in Boston, Massachusetts. (Photo by Adam Glanzman/Getty Images)
CAMBRIDGE, MA - JUNE 9: Apple CEO Tim Cook delivers the commencement address during the Massachusetts Institute of Technology Commencement at Killian Court on the MIT campus in Cambridge, MA on Jun. 9, 2017. (Photo by John Tlumacki/The Boston Globe via Getty Images)
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Tim Cook, chief executive officer of Apple Inc., speaks during a Bloomberg Technology television interview at the Apple Worldwide Developers Conference (WWDC) in San Jose, California, U.S., on Monday, June 5, 2017. Cook�said the company has helped U.K. officials investigate terror attacks, while reiterating his dismay over U.S. plans to quit the Paris agreement on climate change. Photographer: David Paul Morris/Bloomberg via Getty Images
SAN JOSE, CA - JUNE 05: Apple CEO Tim Cook delivers the opening keynote address the 2017 Apple Worldwide Developer Conference (WWDC) at the San Jose Convention Center on June 5, 2017 in San Jose, California. Apple CEO Tim Cook kicked off the five-day WWDC that runs through June 9. (Photo by Justin Sullivan/Getty Images)
Apple CEO Tim Cook looks on during a visit of the shopfitting company Dula that delivers tables for Apple stores worldwide in Vreden, western Germany, on February 7, 2017. / AFP / dpa / Bernd Thissen / Germany OUT (Photo credit should read BERND THISSEN/AFP/Getty Images)
CUPERTINO, CA - OCTOBER 27: Apple CEO Tim Cook smiles during a product launch event on October 27, 2016 in Cupertino, California. Apple Inc. unveiled the latest iterations of its MacBook Pro line of laptops and TV app. (Photo by Stephen Lam/Getty Images)
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The iPad has experienced major shrinkage this year partly because people are hanging onto the devices they bought for longer. Even in the third quarter, when Apple finally saw a boost in iPad sales numbers, revenue from tablets was only up 2% because people were buying the cheaper versions.

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According to Sacconaghi, annual iPhone sales might follow the same trend and tank by as much as 17%. That's extremely bad news for Apple, given the iPhone alone accounted for 62% of the company's revenue and profits this year.

Here's what Sacconaghi wrote, emphasis ours:

"Investors worry that the smartphone market is becoming increasingly saturated, especially at the high end, where Apple competes, and that over time, the market for iPhones will largely become a replacement market. Moreover, over time, we believe that successive generations of iPhones will likely become less differentiated (i.e. new iPhones will become "good enough" to forestall further upgrades), resulting in the elongation of replacement cycles. Such a development could materially pressure iPhone revenues; to a lesser degree, Apple has already faced these challenges in its iPad business, where annual revenues declined 37% from 2014 to 2017. We note that if the average iPhone replacement cycle were to eventually lengthen from 2.5 years (roughly where we are today) to 3 years, annual iPhone annual unit sales would ultimately fall by 17%."

The good news for Apple's stock price is that it's already sitting on one of the solutions: The iPhone Upgrade Programme. This essentially lets people buy the newest iPhones from Apple SIM-free with 20 monthly payments. If a new iPhone comes out, customers can upgrade halfway through the programme to the new phone.

The upshot of this model is that customers get a new iPhone every year and Apple gets guaranteed, ongoing payments that increase every year if people decided to swap to a new, more expensive phone.

Bernstein wants Apple to make more of this and become a subscription business. Sacconaghi calculated that the upgrade programme accounts for a "low single digit percentage" of annual iPhone sales.

If Apple can pull this off, Bernstein believes the firm's stock will be "re-rated" higher, essentially meaning investors will be willing to pay more for its shares. Currently, Apple's price to earnings (P/E) ratio is 18x. P/E ratios for software rivals are bigger, with Amazon at 289x, Alphabet at 33x and Netflix at 184x.

Here's what he said:

"We have long believed that Apple's transactional business model is a big reason why the stock trades where it does, and that the company should look to migrate to a subscription model going forward. As consumers become increasingly accustomed to paying monthly subscriptions, especially for key "tech utilities" (e.g. Netflix, Spotify, Microsoft Office 365), we could imagine Apple implementing a subscription plan of its own. In such a plan, customers could lease iPhones, iPads, Macs, and services such as iCloud and Apple Music for one "low" monthly fee, and have their hardware upgraded after a certain number of years. By moving to a subscription model, Apple would be able to lock in recurring revenue streams and freeze the length of replacement cycles, likely leading to a material re-rating of its stock's multiple."

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