By Philip Elmer-DeWitt
July 29, 2009

Turley Muller has been arguing for more than a year that Wall Street seriously underestimates the impact of the iPhone on Apple’s (AAPL) bottom line.

Muller, a former mortgage trading analyst, currently unemployed, tracks Apple’s performance in his blog Financial Alchemist, where his estimates of Apple’s earnings put the Street’s consensus to shame. Over the past four quarters, he has missed reported EPS by 4 cents, 2 cents, 1 cent and 0 cents, respectively. (In those same four quarters, the Street underestimated Apple’s EPS by 15 cents, 40 cents, 24 cents and 18 cents.)

In fact, in our latest Analyzing the Analysts report, Muller’s predictions were closer to actual results than any other analysts’ in four categories out of seven — including the tricky non-GAAP revenues non-GAAP earnings.

On Wednesday Muller issued his third detailed report on the iPhone’s profit margins, and it’s an eye opener. Bottom line: Apple’s gross margins on the iPhone are now so high — Muller’s estimate is 58.4% — that the company can use them to subsidize price cuts on the rest of its product line without any noticeable impact on overall gross margins.

It’s striking, says Muller, that Apple’s typically conservative gross margin guidance for the fourth fiscal quarter, which ends in September, is an enviable 34%, despite all the mitigating factors pushing margins down — some of Apple’s own doing, some coming from outside the company. Muller lists a few:

  • [Apple] transitioned entire notebook line.
  • Cut prices across entire notebook line and/or added increased performance.
  • Back to School promotion (Mac discounts plus free 8GB iPod touch).
  • Revenue mix shifted towards lower margin Macs from weak business spending affecting the Mac Pro line.
  • Component prices increased, coupled with higher commodity and energy prices.

Offsetting all this are the iPhone’s steadily rising gross margins, due to a complex mix of current and deferred revenue from several generations of iPhones — each with their own individual margins.

This is not an easy thing to explain. Muller takes a crack at in the full report — which you can read here. But the takeaway message is that profit margins from current iPhone sales are extraordinarily high, despite the $99 price tag on the original 8GB model, as summarized in Muller’s final spreadsheet:

(Key: ASP = Average selling price; IP = Intellectual property; COGS = Cost of goods sold; GP = Gross profit)

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