Apple's AI Boom to Bust: Entrenched Market Share Loss Is Now the Base Case
Apple’s blistering rally since June may finally be coming to an about-face.
Not too long ago, the Apple bulls were still chiming of an AI-driven upgrade super cycle. But that narrative’s taken a complete 360 in the last few weeks. It’s evident in the slew of recent analyst downgrades, which have likely been triggered by bleak iPhone sales data from third-party research firms – particularly in China, one of Apple’s most important markets.
However, this shouldn’t have come at such a surprise. Apple Intelligence’s lacking muscles in reaccelerating growth for Apple was blatantly evident in the details.
Between the introduction of Apple Intelligence in June and when the company reported its F4Q24 earnings results in late October, the stock had already surged 17%. Yet there was nothing to show for it. iPhone 16 upgrades were mediocre at best during the September quarter compared to the AI hype leading up to its go-to-market – and to give it the benefit of the doubt, maybe it was just because the full slate of Apple Intelligence features weren’t readily available yet at the time, and the period had just captured a week-ish of new iPhone 16 sales.
But the devil was in the details all along. Management had never guided an outsized upgrade cycle for the iPhone 16. Despite calling Apple Intelligence a “compelling upgrade reason”, management went on to do otherwise with a December quarter guidance that followed in whimper. As usual, Apple didn’t provide a direct guidance for iPhone sales. But given management’s expectations for low- to mid-single digits y/y growth in total company revenue for the December quarter, which would consist of services revenue growth in the mid-teens percentage range, it was safe to assume that iPhone sales growth for the period would be in line with historical seasonality observations – no more, and no less, not even with Apple Intelligence.
There was also a unanimous tone of doubt coming from the US big 3 telcos’ CEOs on anticipated AI-driven iPhone upgrades at home for the holiday season. Worst off, Apple was in lack of an AI strategy for China as well, while local rivals were capitalizing on the AI-driven tailwind with new innovations and homegrown operating systems that would detract users further from iOS. By then, it should’ve been evident that cracks were showing in the AI upgrade super cycle thesis that’s been buoying the Apple stock’s ballooning premium.
Yet Apple bulls were still holding steadfast on their conviction that an upgrade super cycle driven by the AI sensation was imminent – their confidence basically went something like this: if not now, then later 2025 with the iPhone 17 and Apple Intelligence for China; hell or high water, Apple’s going to win the AI race. Paired with Apple’s ongoing share buybacks, analysts were still eager in upgrading the stock’s outlook.
But by December, it was evident that entrenched market share loss in China had become Apple’s base case. It didn’t help that third-party research data was also estimating a 5% y/y decline in global iPhone sales during the December quarter – Apple’s largest sales period of the year. And at a time when 2024 global smartphone shipments had recovered from its bottom with 4% y/y growth, Apple iPhone shipments were predicted to have fallen by 2% y/y, leading it to relinquish a whole percentage point of its global market share to 18%.
Looking ahead, Apple’s positioned for nothing but an imminent one-two punch that will take the stock correction-bound.
One – based on the current situation of entrenched market share loss in China and limited AI-driven iPhone upgrades at home in the US, Apple’s likely to underperform even its own conservative growth guidance for the device. This would set a weak base for an even weaker March quarter outlook given inevitable seasonality-driven headwinds. The ensuing downward shift in Apple’s fundamental trajectory should lead to an imminent reduction of the stock’s currently lofty premium.
And two – the next wave of correction will come when Apple Intelligence goes to China. It may sound ironic, since most still assume that the software’s China debut would lead to a release of pent-up iPhone upgrades. But instead, it’s more likely that Apple Intelligence’s eventual China debut will yield no incremental iPhone demand to show for it. That’d be the moment of truth to put all of market’s remaining confidence in Apple’s AI upgrade super cycle to rest. And the downside risks won’t stop there. With the iPhone being the anchor to Apple’s broader ecosystem (particularly the higher growth and more profitable services revenue stream), a weakening installed base would also deteriorate Apple’s longer-term earnings quality and FCF outlook.
Apple’s outlook is bound to worsen until it proves a new innovation cycle’s coming along that can drive additive growth for the company. But with no immediate respite on that end, its weakening fundamentals will eventually take precedence over the superficial upgrade cycle narrative that’s been driving the stock’s valuation, leading to a fast-approaching eventual correction.
Entrenched China Market Share Loss is Now the Base Case
I switched gears from seeing entrenched China market share loss for Apple as merely a “risk” to an imminent base case “reality” in late 2024 when iPhone shipment trends in the region were consistently diverging from those observed at its local rivals. The first warning was when third-party research data showed iPhone sales during China’s hottest 11.11 shopping festival in November had fallen in the double-digits percentage range. This was followed by confirmation that foreign smartphone sales in China, a category dominated by the iPhone, had fallen by 47% y/y in November.
Blighted by intensifying competition and a lacking AI strategy to appease the crowds, Apple turned to promotions and discounts (a rare sighting) for its Chinese buyers. And while that’s done little in lifting local interest for the iPhone, the stock continued to fail in reflecting Apple’s bleak reality, considering its resilient upsurge heading towards the end of 2024.
But going into 2025 was a different reality. Industry data and analyst reports were starting to fight for airtime in proclaiming Apple’s China demise. iPhone shipments were reported to have fallen by 17% y/y in 2024, while smartphone sales from local rivals like Huawei had grown by as much as 37% y/y. Apple’s disappointment’s even more evident when compared to the 4% y/y recovery in China smartphone shipments following a two-year slump. December quarter sales – which represent the first full quarter of iPhone 16 shipments – fell by more than 18% y/y in China. The persistent weakness has effectively dropped the iPhone’s China market share from 24% in 2023 to 17% by the end of 2024.
And the outlook remains grim, with local policy support providing further favours to Apple’s Chinese rivals. Beijing was clear that boosting consumption was a priority in 2025 – but the caveat was that foreigners like Apple would be largely excluded. This was evident in the extension of consumption vouchers to purchases of smartphones, tablets and smartwatches. Eligible purchases priced at under 6,000 RMB can get a 15% subsidy, up to a maximum of 500 RMB. And for the iPhone 16, only the standard 128GB model would meet the pricing threshold, yet it’s not even Apple’s best-seller in China. It’s evident the new subsidies will only further market share gains for Apple’s local rivals at the continued expense of China iPhone demand.
Apple Intelligence for China’s also becoming a “too little, too late” strategy for the company in reviving local demand for the iPhone. The eventual rollout of Apple’s newest AI features is, ironically, likely to become the telling tale of the iPhone’s deteriorating growth outlook. It’s already evident that Apple Intelligence’s been doing little in encouraging upgrades in the US. These observations have been unanimously shared by executives across AT&T, Verizon and T-Mobile (collectively, the big 3 US telcos). And the same trend will emerge when Apple Intelligence goes to China (later this year, if its lucky in getting the regulatory greenlight from Beijing). The new features are unlikely to resuscitate local iPhone demand, especially given the uprise of rivalling AI smartphones and homegrown operating systems that continue to upend the appeal of Apple’s broader ecosystem.
And neither are the recently speculated new form factors for the next-generation iPhone 17 going to do the trick. Industry reports have been anticipating foldable and thinner “Air” variants of the iPhone 17 to debut later this year. But they aren’t going to be the answer in reviving iPhone demand in China. Since the thinner “Air” variant relies solely on eSIM technology, the design wouldn’t abide by China’s requirements for physical SIM cards with real name registration. Meanwhile, foldable smartphones are also losing their lustre amongst Chinese consumers. While Huawei has maintained its leadership in the segment, which was recently reinforced by its launch of the world’s first tri-fold smartphone, broader foldable smartphone shipments have been in steep deceleration over the past two years.
The implications of continued iPhone market share haemorrhage in China are significant for Apple, as it challenges the AI upgrade super cycle currently priced into the stock’s premium. The increasingly entrenched market share loss suffered in the region underscores vulnerability to Apple’s broader growth outlook. Given the iPhone represents the anchor of Apple’s broader ecosystem, the product’s diminishing installed base risks spilling over into adjacent components of business. This includes impacting the higher growth and more profitable services revenue stream that have been a key medium in underpinning the company’s cash flows in recent years.
Imminent Earnings Underperformance
Taken together, I anticipate Apple to underperform December quarter results at its upcoming earnings update on January 30. Remember, Apple management had never guided an outsized holiday season outlook despite the launch of AI-enabled iPhone 16s. And neither have US telco executives been preparing for significant AI-driven upgrades, nor were they shy in cautioning about the doubtful reality. The AI upgrade super cycle has always been a bull-constructed concept.
Despite management calling Apple Intelligence a “compelling upgrade reason”, the December quarter guidance was much more modest and suggested iPhone growth in the mid- to high-single digit percentage range, in line with historical observations. It also aligned with commentary from leadership across Apple’s key US carriers:
AT&T Inc. 3Q24 Earnings Call:
As expected, service revenue growth was partially offset by lower equipment revenues with a postpaid upgrade rate of 3.5%, which was down from 3.9% last year…So I don't know that I can give you an answer that's more satisfying than last quarter on projecting what Apple phone sales might be. You've seen the numbers, they're down slightly over last year's levels on an introduction. We're still waiting, obviously, for the software release and whether or not that software release drives interest in the consumer base to accelerate that remains to be seen…I think some of these things are going to be a little bit more graceful ramp-up in consumer interest as opposed to a big bang.
Verizon Communications Inc. 3Q24 Earnings Call:
…we're not seeing a big upgrade cycle right now. The upgrades were down 10%. Right now, customers are choosing to hang on to their phones a lot longer, and that's by choice. The average upgrade rate [is] probably 40 months or so…I mean many of the AI application, of course, are very helpful. But when it comes to consumer devices, we also need to think about the processing power for this application, if you want to do something really innovative…I usually say, historically, when we've seen sort of cycles in our industry that's been 4G to 5G or hardware redesign…Now we're talking about is a software cycle's going to do it. It's too early for us to say at least, we're so far, and I'm looking at my colleagues, we haven't seen that. We haven't seen that is creating the cycle.
T-Mobile US, Inc. 3Q24 Earnings Call:
I mean in terms of the current upgrade rates, like you said they were low…So what we see is customers having devices that generally work better and devices that are becoming more expensive and lasting longer. And we think all those factors have come into play affecting and you are seeing the outcomes of the upgrade rates…as I think about Q4, we'll probably see the same seasonality from an equipment revenue perspective that we saw last year. So the same kind of absolute dollar increase that we saw Q3 to Q4 is, what I expect to happen from Q3 to this Q4.
Recent operating results from Apple’s largest global supply chain partners, including Foxconn and TSMC, have also shown early indicators of slowing iPhone uptake, let alone an outsized upgrade cycle. Foxconn (Apple’s key assembly partner) is now expecting AI server sales to eclipse iPhone assembly sales this year, despite the latter having historically been the manufacturer’s largest business segment. Meanwhile, TSMC (Apple’s chip manufacturer) has also been consistently reporting a diminishing share of smartphone revenues in the last two years.
These combined observations from Apple’s key industry partners give weight to the recent slew of weak global and China iPhone sales data for the December quarter. And the set-up is accordingly harbingering incremental downside risks of underperformance for Apple, which would bode unfavourably with the slow March quarter guide due to inevitable seasonal weakness.
However, current Wall Street estimates are still predicting outsized full year results that encapsulate expectations for an AI upgrade super cycle. Industry had previously estimated that a third of the 300 million iPhone 12 installed base that’s ready for upgrades is currently concentrated in China. But that optimism’s evidently stale now, given the sizable market share loss that the iPhone’s suffered in the region over the past year.
While some may blame Apple’s China weakness to the region’s mixed macro backdrop, demand dynamics for rivalling offerings are showing that the iOS exodus in the region is actually becoming increasingly structural. This is proven in the relentless demand for Huawei’s Mate XT trifold. Despite it being the world’s most expensive mass market smartphone, the Mate XT had garnered a waitlist of more than six million buyers leading up to its launch. Many are also still struggling to get their hands on the device today even if they’re willing to pay the hefty price. A similar trend’s also been observed in Huawei’s newest Mate 70 smartphone, which is the closer rival to the iPhone.
Assuming Apple’s more profitable services revenue stream continues to lead its growth in the double-digits percentage range going forward. And Mac, iPad, and wearables and accessories maintain a similar forward growth trajectory as historical levels. The iPhone would need a multi-year double-digit CAGR to support Apple’s current price of $223 per share:
And there are only a few scenarios where this upside scenario would materialize, yet none are feasible:
1. Apple benefits from AI-driven smartphone TAM expansion, while holding the iPhone ASP unchanged: This isn’t going to happen, since Apple Intelligence’s already proven to be a bust in spurring upgrades (both at home in the US and in China), let alone encouraging switches from non-Apple users to the iPhone.
2. Apple instigates a double-digit percentage increase to the iPhone ASP without compromising demand: Also unlikely, especially given the mixed global macroeconomic outlook and cheaper priced rivals in China that’ve already been eating Apple’s lunch.
3. Apple eliminates SE, non-Pro and low GB Pro options to artificially hike ASP: This would lead to the same conclusion as scenario (2). By eliminating the currently less expensive and lower-performance iPhone offerings, Apple risks further limiting its installed base by excluding price sensitive mass market consumers. This would also impact overall services uptake in the longer-term, leading to an adverse domino effect for Apple.
Looking ahead, Apple lacks new additive growth catalysts to support the stock’s valuation premium that’s been ballooning since June. Considering entrenched market share loss in China as the base case, and absent new growth catalysts, Apple’s intrinsic value veers closer to $200 per share.
The analysis estimates Apple’s net income to expand at an 8% five-year CAGR, driven by total net sales at a 5% CAGR over the same period. Ensuing free cash flows, inclusive of a terminal value estimated at a perpetual growth rate of 3.5%, are discounted at an 8.7% WACC. The perpetual growth rate considered is consistent with the estimated pace of expansion across Apple’s core operating regions, and reflective of Apple’s anticipated pace of steady-state growth in the long-run. Meanwhile, the discount rate applied in the analysis is consistent with Apple’s current capital structure and risk profile as well.
In the downside scenario, Apple could see a further entrenched “iPhone winter” in China, considering signs of large-scale user exodus to local rivals. This would also risk a spillover impact to services revenue growth, as the segment is largely dependent on the global iPhone installed base. The impact of margins would be equally detrimental as well. Slower uptake of Apple devices will trigger further discounts to encourage sales, leading to a reduced ASP. It’d also impact the longer-term growth trajectory for Apple’s currently most profitable and fastest growing services revenue stream, thus leading to further margin deterioration. This could easily take the Apple stock back to the $180-range that was observed prior to the introduction of Apple Intelligence during WWDC 2024, putting a full stop to the AI upgrade super cycle narrative.
Risks to Consider for Apple Bears
Shorting Apple is no easy feat. Apple’s still a great company with a loyal fanbase after all, thanks to its simple-to-use and seamlessly integrated ecosystem. The company also boasts one of the strongest balance sheets with a robust buyback program in place. This has, time and again, injected durability to the stock against wide swings driven by broader market volatility.
More importantly, Apple’s robust checkbook also makes its stock an attractive haven trade whenever market sentiment turns risk-off. This likely explains Apple’s rally observed during the final weeks of 2024. The adverse headlines pointing to risks of slowing growth at Apple at the time were likely overshadowed by market’s anticipation of a reduced scale of rate cuts heading into the new year instead. Yet shortly after stepping into the new year, Apple had relinquished the gains upon the release of a softer-than-expected December CPI report.
This suggests that Apple’s valuation is currently heavily influenced by macroeconomic dynamics. But this doesn’t discount the fact that Apple’s underlying fundamentals are weakening. And when Apple’s operating results regain precedence in dictating the stock’s valuation (which I expect to return post-earnings later this month), it’d give the short catalysts (i.e. F1Q25 earnings underperformance and nominal Apple Intelligence uptake in China) incremental weight.
Final Takeaways
Market confidence in Apple’s AI upgrade super cycle is rapidly fizzling, and urgency for management to come up with new growth catalysts is only increasing. What this means for now is that the risks remain skewed to the downside for Apple. This is evident in the Vision Pro’s failure in generating incremental growth momentum for the company, which was only made worse when Apple Intelligence debuted with a whimper in reaccelerating iPhone sales.
Despite Apple being a mainstay winner amidst macro-driven market volatility, the underlying business’ deteriorating growth outlook and earnings quality shouldn’t be dismissed – especially as fundamentals always take precedence in driving a stock’s ultimate valuation outlook.
This Apple analysis marks my first fundamental trade idea deep-dive on Substack — and it certainly won’t be the last, so please subscribe for follow-ups on Apple and other future deep-dives. I’d value any feedback as I continue to experiment with sharing on this platform. Thank you for reading.
Disclaimer: This analysis is for informational purposes only and represents the opinions of Livy Research. It is not investment advice nor a recommendation to buy or sell the securities discussed.