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Morgan Stanley Believes Apple (AAPL) CAN Disrupt the Auto Industry

February 24, 2015 11:51 AM EST
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Morgan Stanley's auto analyst Adam Jonas and tech analyst Katy Hubberty weighed in on recent media speculation that Apple (NASDAQ: AAPL) is actively pursuing building its own car. The analysts said while this may not be a near-term event, they would not be dismissive of reports the world’s richest, most valuable company is taking on the world's most disruptable business. (highlights from the analysts)

First the analysts note that being in the car is hugely important for Apple. "By our calculations, the automotive TAM is $10 trillion of installed base, with and annual new vehicle revenues of ~$1.6 trillion. This dwarfs smartphones at $400 bn and PCs at $266 bn of annual revenue. These are high level numbers and do not account for the value of the rest of the auto industry (aftermarket, service, etc.) or PC / smartphone industry (apps, subscription-based models, etc.). If AAPL were to corner just 25% of the value of the car, it would be equivalent to the entire smartphone industry today. The average US driver today spends about 25% of his/her free time in the car and Apple will want to target this captive audience – especially if we go autonomous. The auto industry also needs Apple, we argue, because after over 100 years of status quo, the industry needs a change agent. This disruption will bring significant rewards to new entrants and existing players willing and able to adapt quickly."

Discussing how Apple might enter the car, the analyst said while they do not completely rule out Apple "making" its own car one day, they believe AAPL can start with what it knows best – infotainment – and point out that it is already in cars today, with Carplay. "Very quickly, the infotainment starting point can spread to the rest of the interior especially the HMI (human machine interface), ergonomics/controls and even interior design." they comment. "We would be surprised if Apple stopped there, however, and over time it could grow from the inside out to be a bigger part of the car. Apple has the brand and the design talent to take on the best in the traditional auto industry and it can rely on the existing automotive supply chain for non-critical components. We note that Apple prefers to develop and design its products in-house, and to outsource the actual production and assembly process. This could be enabled by cars going autonomous – we estimate over 60% of the value of the autonomous car will come from software vs. 10% today. "

The analyst go on to say typical Apple proprietary software ownership and innovation could overcome the traditionally low returns of the auto industry. "Returns for the traditional auto industry – mid-cycle operating margins in the mid-single digits and similar ROIC – are very poor compared to what Apple is used to. However, we believe returns could be much better for “new-age” automakers. Note also that returns in other businesses that AAPL is already in – smartphones, PCs and consumer electronics – offer returns almost as low as traditional auto. However, AAPL is able to generate more profits because it owns the software, as opposed to other device makers. Apple also tightly integrates its products and charges what it thinks are fair prices (read: generally higher than the rest of the market) for the best user experience available. Ultimately, the size of the auto TAM and the additional opportunity of the car as the “fourth screen” for media consumption are too large for Apple to ignore, in our opinion, and likely will drive it to look to solutions around traditional auto industry bottlenecks."

Commenting on investment implications, the firm reiterated a Buy rating and $150 bull case on Apple, noting that looking beyond the next 1.5 years, cars, along with wearable devices, TVs, and new services, provide opportunities for Apple to continue to drive revenue and earnings growth.

For auto OEMs, they believe the end game is fewer players and some very powerful all-new players who don't even make cars today. "A push toward Silicon Valley motors could result in a divergent path for traditional auto OE suppliers," they said.

The firm classifies suppliers into 4 groups:

1) Content leaders who make high tech and scarce technologies that are seeing growing penetration within the car (BWA, MBLY, DLPH, TRW);

2) Tier-0 suppliers who can become so large and powerful over time that they can add more value to the car than the OEM and sit alongside the OEMs in the automotive supply chain (DLPH, TRW+ZF);

3) Silicon Valley enablers who do enough of the “dirty work” around design, engineering and assembly of cars that new entrants may not want to focus on (MGA); and

4) secular stragglers who make products that either will likely see falling importance within the car as we move toward a highly efficient, autonomous offering or whose products may get commoditized with the transition (TEN, AXL, HAR, GT).



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