Apple’s Foe Is Margin Risk, Not Fire Phone

Apple’s Foe Is Margin Risk, Not Fire Phone

Amazon’s phone is limited to maintaining and expanding the Prime user base.

June 20, 2014 11:00 a.m. ET

Credit Suisse

Amazon.com launched a new smartphone, which they named the Fire Phone.

The Fire Phone has a rubberized frame, Gorilla Glass, and a 13 megapixel (MP) rear-facing camera. It also has a 4.7 inch liquid crystal display high-definition (LCD HD) display, a Qualcomm (ticker: QCOM ) Snapdragon chipset, and 2 gigabytes (GB) of RAM.

The Fire Phone features what Amazon ( AMZN ) calls “Dynamic Perspective,” a custom-designed sensor system that responds to how the user holds, view, and moves their phone. The phone also comes with a full year of Amazon Prime, unlimited photo storage on Amazon Cloud Drive, and is integrated with Kindle Fire TV. Furthermore, Amazon also introduced a new feature on the Fire Phone called Firefly, which can identify products, songs and even TV shows, all of which have links to Amazon’s online store for purchase. The Fire Phone will be available exclusively to AT&T (T) and is expected to be priced at $200 for the 32GB [storage] version and $300 for the 64GB [storage] version.

While the Amazon Fire Phone has some innovative features such as dynamic perspective and Firefly, we think differentiation is limited compare to other mainstream smartphones, especially given its premium pricing ($200 for a two-year contract or $649 without contract). In today’s smartphone market, [Google ( GOOG )] Android vendors find it difficult to offer differentiated products to get enough traction because of the lack of control of ecosystem, and we believe this is the case with Amazon, too. At this stage, we think the Fire Phone is targeting more on maintaining and expanding Amazon Prime user base, and its impact on the smartphone industry remains to be seen.

In a multidevice world, Apple ( AAPL ) remains materially advantaged over others due to the power of its ecosystem. While the Fire Phone is more closely bundled with Amazon services, it is not fundamentally different from other Android vendors. However, our concern for Apple is more about its ability to maintain profitability through product transitions. Despite excitement for Apple’s forthcoming product cycle, we think there is potential risk on gross margin due to product transition, and we see the stock valuation as range-bound, with 13% upside and 25% downside.

Similar to Kindle Fire, the Fire Phone also uses the most advanced Qualcomm Snapdragon. The design win shows that Qualcomm maintains its dominant position in chipsets. We believe Qualcomm is poised to benefit from its heavy levels of historical investments in long term evolution (LTE), which will ensure the company an enduring competitive advantage in the wireless chipset market.

Our sum-of-the-parts analysis shows that Qualcomm Technology Licensing (QTL) is worth $47 (based upon discounted cash flow) and Qualcomm CDMA Technologies ( QCT) is worth $24 on a multiple in line with peers despite superior growth prospects and taxed net cash per share of $14.