Visible Alpha Technology

Apple (NASDAQ: AAPL) made a number of new announcements during its Worldwide Developers Conference (WWDC) keynote on June 10, 2024, most notably Apple Intelligence. What happened during the conference and what are analysts expecting?

Could Apple become a $5 trillion company?

The arrival of Apple Intelligence at WWDC demonstrated that Generative AI (GAI) is going to get embedded into our daily workflows. Moving beyond tech infrastructure, GAI is evolving into a broad trend likely to provide many productivity and entertainment benefits to consumers through Apple’s massive installed base and ecosystem. With Apple now firmly a part of the GAI movement, the popularity of its new tools and capabilities will likely dictate the magnitude of its earnings potential. The more users get hooked on GAI, the more likely they are to upgrade their hardware and subscribe to more lucrative services.

To get to a $5 trillion valuation, Apple needs to generate $180 billion in operating profit and $11.50/share in diluted EPS at a P/E of 30x. Only a few sources expect Apple to generate this level of profitability and not until the end of FY 2032. Currently, the consensus P/E ranges from 27-32x over the next few years and the target price is $210, implying no upside to the share price. If Apple gets the GAI trend right, could profitability come faster than current expectations and drive a wave of upward revisions over the next few years?

Apple Intelligence: Will this drive an upgrade cycle and grow Services?

Apple entered the Generative AI (GAI) movement and announced its version of a new personal intelligence system, Apple Intelligence, at WWDC on June 10, 2024. In the keynote, Craig Federighi, SVP of Software Engineering, showcased the updates and highlighted the new partnership with OpenAI. Apple Intelligence is only available on iPhone15 Pro/Pro Max, select iPads and Macs. Could Apple Intelligence help to drive a new replacement cycle for Apple hardware?

Figure 1: Apple Intelligence

Source: WWDC (June 10, 2024)

ChatGPT and Apple Intelligence will integrate new GAI writing, summarization and image tools later this year. These new capabilities will also work with Siri and Apple’s iCloud. These enhancements have the potential to take GAI mainstream and become part of users’ daily lives. The popularity of these new tools and enhancements could be a catalyst for a new iPhone, iPad and Mac replacement cycle.

Figure 2: OpenAI Partnership: ChatGPT embedded into the iPhone

Source: WWDC (June 10, 2024)

Given the enormous installed base of iPhones, Pre-15 Pro users may be motivated to upgrade their earlier version phones and both expand and extend the pace of the new upgrade cycle. Based on Visible Alpha, analysts expect iPhone 15 unit sales to range from 126 million to 149 million with consensus at 139 million this fiscal year.

Figure 3: Apple iPhone 15 expectations

Source: Visible Alpha (June 18, 2024)

Figure 4: Apple Total iPhone expectations

Source: Visible Alpha (June 18, 2024)

In addition to a potential hardware replacement cycle, Apple Intelligence may help to fuel a surge in Services growth. Services sales are expected to grow 12% this fiscal year, up from 9% last year and to maintain that pace through FY 2026. However, if the new GAI tools gain in popularity and usage, more users may be inclined to subscribe to more Apple Services, like iCloud and Apple Pay. Increases in Services revenue is impactful to the bottom line, since this segment generates ~73% gross margin, nearly 2x the 37% gross margin of hardware products.

Figure 5: Apple Services expectations

Source: Visible Alpha (June 13, 2024)

The success of Apple Intelligence has the potential to drive a hardware replacement cycle, in tandem with increased usage of lucrative Services. This possible dual impact to sales and operating profit may drive further earnings revisions over the next two years, if GAI takes off with consumers.

Figure 6: The Range of Apple expectations

Source: Visible Alpha (June 13, 2024)

Vision Pro expands

Last year at WWDC, Vision Pro was the big announcement. However, this year, with the Generative AI (GAI) movement broadly driving momentum across the sector, the Vision Pro seems to have taken a backseat to Apple Intelligence. Apple announced Vision Pro roll outs to new international markets over the next month. There was also a significant software update and a growing number of apps. Based on several Visible Alpha sources, Vision Pro is expected to sell close 500,000 units and to generate nearly $2 billion in revenue by the end of FY 2025.

While it is still early days, the high price point and limited functionality have limited the growth expectations. How long will it take the Vision Pro itself to account for $10 billion in revenues? There is also a big question about what level of gross margin the new product will generate and what role it will play in driving more high margin services sales. Longer-term, will Apple Intelligence help drive growth of the Vision Pro?

Figure 7: Analyst estimates for Vision Pro

Source: Visible Alpha (June 13, 2024)

Dell Technologies (NYSE: DELL) reported fiscal Q1 2025 results on Thursday, May 30, 2024. What happened during the release and earnings call, and what are the key points to focus on?

Dell’s fiscal Q1 2025 earnings release

Dell delivered total revenues for Q1 of $22.2 billion, beating Visible Alpha’s consensus estimate of $21.5 billion by $0.7 billion, driven by strong demand for AI servers. The Infrastructure Solutions Group (ISG) segment saw its Q1 revenue surge to $9.2 billion, slightly ahead of the $9.0 billion consensus estimate coming into the quarter.

Based on three Visible Alpha sources prior to the earnings release, the AI server backlog was estimated at ~$3.5 billion. In addition, in their notes ahead of the quarter, a few analysts called out the potential for the AI server backlog to meet or exceed $4 billion on higher-than-expected orders. This backlog expectation seemed to create some over-optimism about Dell’s growth momentum. While the company delivered a respectable AI server backlog of $3.8 billion in Q1, the disappointment in the stock came from the lack of ISG operating profit growth generated by an additional $1.7 billion in AI server shipments year over year in Q1.

The ISG segment’s non-GAAP gross margin came in at 35.2% in Q1, a bit below consensus of 36.4% and down from 37.1% in Q1 2023. This decline in gross margin contributed to the miss on the ISG operating profit margin, which delivered an 8% margin, missing the 10% expected. ISG operating profit was expected to generate nearly $900 million in Q1 2024 but instead the company reported $736 million, almost flat with last year’s $740 million. This performance implied that the $1.7 billion surge in AI server orders year over year did not see enough profitability to offset the seasonally low profitability of the traditional storage and server lines in Q1.

Figure 1: Revisions of Dell estimates

Source: Visible Alpha consensus (June 3, 2024). Stock price data courtesy of FactSet. Dell’s current stock price is as of the market close on May 31, 2024.

The outlook

Near-term growth

For fiscal Q2 2025, Dell guided ahead of the expected $23.0 billion to $23.5-24.5 billion in total revenue, with analysts now projecting $24.1 billion for Q2. The ISG segment revenue is projected to make up $10.5 billion, up from $9.2 billion in Q1, and to see its margin improve quarter over quarter. The company called out expected improvements in the storage business and said that they expect ISG margins to expand to 11-14%. The ISG consensus margin for Q2 is expected to be 10.4%, down from 11.8% ahead of the release.

Long-term outlook

Dell guided FY 2025 revenues to $93.5-97.5 billion, in line with the $96.2 billion expected by analysts. In addition, the company highlighted that ISG will deliver 11-14% long-term margins. Currently, Visible Alpha consensus is projecting ISG operating profit margin to jump from 8% in Q1 this fiscal year to over 12% by the end of fiscal year 2026.

Looking further out, analysts remain bullish on the demand for AI servers. Based on four sources, analysts expect to see AI server revenue generate $9.5 billion in FY 2025 and to expand to $13.4 billion in revenue in FY 2026.

ISG revenue is expected to grow to $47.8 billion in FY 2026, with nearly all of the year-over-year increase coming from the AI servers. ISG profitability is expected to return to 11.5% operating profit margin this year and to increase to 12.1% by FY 2026.

According to Visible Alpha consensus, EPS is expected to grow nearly 20% from $7.77/share in FY 2025 to $9.28/share in FY 2026. Estimates range from $8.25/share to $10.34/share, putting the FY 2026 P/E consensus at 14x, and in the 13x-16x range.

DELL stock has traded down around 22% since last week’s earnings release, but is up around 40% since the Q4 release on February 29, 2024. Will the ramp in AI servers continue? Will ISG profitability return to beat expectations and be a catalyst in FY 2025?

Figure 2: Dell consensus estimates

Source: Visible Alpha consensus (June 3, 2024). Stock price data courtesy of FactSet. Dell’s current stock price is as of the market close on May 31, 2024.

Here is a look at the key highlights from Microsoft’s (NASDAQ: MSFT) recent conference, Microsoft Build 2024. The conference underscored how Microsoft is thinking about the future direction of AI for their business and the potential opportunities that lie ahead.

Key highlights from Microsoft Build 2024

At the Microsoft Build conference last week, CEO Satya Nadella reiterated that every aspect of the tech stack is changing. Then, he highlighted the key updates. These innovations seem to position Microsoft’s Azure well for future growth. Based on Visible Alpha consensus, the Intelligent Cloud business is projected to grow from $105.5 billion this year to $185.1 billion over the next three years. This strong growth is driven by Microsoft Azure revenue, which is expected to grow from nearly $75 billion this fiscal year to over $150 billion by the end of fiscal year 2027 and to generate a 45% operating margin.

Here are some of the key takeaways:

1) Smarter models are coming: Microsoft’s CTO and EVP of AI, Kevin Scott, and Open AI CEO, Sam Altman, took the stage and highlighted what’s next for Generative AI (GAI). GPT-4o, the latest multi-modal model trained on Azure, has text, audio, image and video. According to Scott, engaging with ChatGPT is going to get cheaper and faster. In a demo of the latest version of GPT-4o, users can interrupt the model and get it to pivot. This is an important step to advancing users’ interactions with the technology.

A GAI layer is going to be built into every product and service, according to Altman. The goal is to make it easy for users to engage with GAI. Based on Altman’s comments, ultimately, this is going to help the models be more robust, safer, and useful. It will also enable the model to get smarter, which will reduce the price and increase the speed.

Figure 1: Microsoft’s CTO and EVP of AI Kevin Scott and Open AI CEO Sam Altman

Source: Microsoft Build (May 21, 2024)

2) Laptops for the AI era: In a special session on Monday, May 20, 2024, ahead of the Microsoft Build presentations, Microsoft introduced a new category of Windows PCs designed for AI: Copilot+ PCs. Pre-orders started last week and these new AI laptops will be available from June 18, 2024, starting at $999. According to Microsoft, Copilot+ PCs are notably faster than Macs and are “the most intelligent Windows PCs ever built.”

Based on Microsoft’s demo, Copilot+ PCs will enable users to easily find what has been worked on on a PC with Recall; to generate and refine AI images directly using Cocreator; and to translate audio from 40+ languages into English with Live Captions. These features are going to integrate GAI into core use cases.

Figure 2: Copilot+ PC = The AI Laptop

Source: Microsoft Build (May 20, 2024)

3) Copilot stack enhancements: With every layer of the tech stack changing, Nadella gave an overview of these in his keynote. The improvements to Azure jumped out and are projected to enable cheaper and faster capabilities for training and inferencing.  According to Nadella, the Microsoft Azure end-to-end systems optimization from the data center to the network is designed to use less power and reduce the cost of AI. At the silicon layer, Microsoft can dynamically map workloads to the best accelerated AI hardware to produce better performance.

Microsoft’s end-to-end approach is helping Azure to scale. Over the past six months, Microsoft has added 30x supercomputing power to Azure. Microsoft’s partnership with Nvidia, which spans the entirety of the Copilot stack, will use both Hopper (H200) and Blackwell (B100 and GB200) to train and optimize both LLMs and small language models, according to Nadella.

Given the enhancements to the tech stack, how can more scale, automation, and efficiency in their tech stack support further revenue margins?

Figure 3: Microsoft Copilot

Source: Microsoft Build (May 21, 2024)

Figure 4: Microsoft consensus estimates

Source: Visible Alpha (May 28, 2024)

The bottom line

The potential for AI developers to create the next generation of must-have applications at scale has only just started. Over the next 4-5 years, there will likely be significant CapEx investment in data centers, development, and integration to ready the world for what’s to come next. The magnitude of the shifts is likely to blur the lines between cloud, chip, software, and search providers. Both workplaces and consumers are likely to win in the end with enhanced efficiency and productivity coupled with a better-curated workflow. Like it or not, AI is off and running.