An Unappreciated Growth Story
By Clear Perspective Advisors on June 27, 2024
Leading the AI-to-Consumer Race
Two weeks ago at the Worldwide Developers Conference (WWDC), Apple (AAPL) announced its forthcoming partnership with OpenAI. Coined “Apple Intelligence,” Apple products will be receiving a tremendous advancement with iOS18 and the coming upgraded product cycle. Apple is currently the third-largest company in the world and accounts for 6.6% of the S&P 500 and 8.4% of the Nasdaq 100. We dove into the details following WWDC in a recent Weekly Wisdom, and are now diving deep into the company’s latest AI (artificial intelligence) news, which we believe will lead to a faster iPhone replacement cycle.
Apple is on the cusp of leading the world in AI-to-consumer technology. Through AI integration into its products, consumers will be interacting with artificial and general intelligence daily – and at a much higher rate than today. ChatGPT reached 100 million users in just two months – notably quicker than both TikTok (9 months) and Instagram (30 months) reached that feat. ChatGPT receives about 10 million daily queries, less than 1% of Siri’s 1.5 billion daily voice requests. With Siri’s improved capabilities, it will become even more useful to the 1.5 billion iPhone (and 2.2 billion iOS) users to tap into the new features.
Apple’s expansive and loyal user base provides the perfect opportunity to train, and thus improve, generative AI technology. Generative AI is a subset of AI that can create original content, text and images. Examples include OpenAI’s ChatGPT, Alphabet’s Gemini, Microsoft’s Copilot and soon, Apple Intelligence. These technologies run on large language models (LLMs) that are trained on immense datasets to improve functionality at an exponential rate.
A study released earlier this year found that the calculation required to reach a set performance threshold across LLMs halves approximately every 8 months – substantially faster than the two-year doubling time behind Moore’s Law.[1] This speed of advancement was experienced in the growth between ChatGPT-3.5 and ChatGPT-4. GPT-3.5 failed the Uniform Bar Exam (UBE), scoring in the bottom 10th percentile. OpenAI’s next iteration, GPT-4, not only passed but scored in the 90th percentile.[2] We expect to see similar growth and breakthroughs with Apple Intelligence, as generative AI will be in the hands of over 1 billion people and be used on a daily basis.
Chart 1: Investors Are Underappreciating the Opportunity That Awaits Apple[3]
Apple’s AI integration is just what was needed for a consumer-driven upgrade cycle. 270 million iPhone users have not upgraded their devices in over four years, and only 5% of current users will be able to access Apple Intelligence software once it is released – ultimately driving a new wave of upgrades.[4]
China has recently been a point of pain for Apple, which is likely to subside in the coming quarters. China’s regulations against the use of Apple’s products have hurt sales, along with increased mainland competition. Q2 net sales from the Greater China segment were -8% y/y with revenues of $16.3 billion, both beating consensus estimates. In April, Apple smartphone shipments rose 52% y/y – a possible sign that the worst is behind the company.[5] China accounts for 17% of Apple’s total revenues.
Chart 2: Less than 20% of Apple’s Revenues Come From China[6]
Growing AI Partnerships
Apple has been in discussion with companies such as Meta (META) and Alphabet (GOOGL) to integrate their generative AI models into Apple Intelligence. Meta’s most recent AI model, Llama 3, was released earlier this April. Llama 3 is a LLM used across Facebook, Instagram, WhatsApp and Messenger’s search engines to provide curated content tailored to the user, answer questions and interpret data. Apple’s possible partnership with these companies would put less reliance on OpenAI and provide more generative AI options to users – as well as create broader revenue streams for Apple Services.
OpenAI is not formally paying Apple for ChatGPT’s integration into iOS18. ChatGPT will offer both a free and paid version to Apple users, as it currently does on its site. Similar to the App Store, Apple is likely to keep a cut of subscription revenues from its devices, greatly enhancing its Apple Services offerings. It is probable that 10% to 20% of Apple users will opt into paying for a premium AI subscription, bringing billions of dollars to Apple Services and further diversifying away from hardware revenues.[7] In Apple’s most recent quarter, Services grew 14% y/y and boasted a 74% gross margin.
With the use of Apple’s vast ecosystem, Apple Intelligence’s dataset is going to be a goldmine for developers. iOS18 will bring the brightest developers to the software to create new apps for the App Store and enhance the user experience. Siri’s ability to take action across apps will further provide opportunities for developers to create new, exciting possibilities with the technology. From ordering food delivery by voice to asking Siri to find optimal flight options – the possibilities will be endless with Apple Intelligence.
[1] Source: Epochai.org. As of March 9, 2024.
[2] Source: Standford Law. As of April 19, 2023.
[3] Source: FactSet. As of June 24, 2024.
[4] Source: Investors.com. As of June 12, 2024.
[5] Source: Reuters. As of May 28, 2024.
[6] Source: FactSet. As of June 24, 2024.
[7] Source: WSJ. As of June 23, 2024.
