Don’t laugh at AirPods — they’re part of Apple's ‘ambient paradigm’: UBS

Apple shares are being undervalued because investors are too bearish on the "ambient paradigm" – an era of technology where the company's iOS operating system is everywhere through different devices - according to a note by UBS on Wednesday.

Essentially, the investment bank is suggesting that traders aren't fully appreciating the potential success of future products which could create a much bigger ecosystem than what Apple currently offers.

To explain this, UBS said that the future consists of an "ambient paradigm" which Apple could win.

"The ambient paradigm consists of a many devices providing different input/output methods that can be flexibly utilized depending on the situation (sitting, walking, running, driving). Collectively these devices offer the capability of earlier products and more delivered as a seamless user experience," UBS wrote in a note.

"Devices become extensions of one another rather than discreet, computing platforms. It is an expression of what Tim Cook has described as 'iOS everywhere.'"

Apple Watch sales not indicative of future

AirPods from Apple
Josh Edelson | AFP | Getty Images

Currently, investors have a "linear view", believing the idea that volumes of new products such as the Apple Watch falling short of the iPhone reflect a decline. Instead, Apple's products exist within paradigms.

The computer paradigm came first followed by the mobile paradigm with the iPhone and iPad. But in between the two came the iPod. UBS describes the iPod's functionality as "modest", but explains that it was a "transition product between two paradigms", which could reveal the long-term direction for the company. Focusing on the iPod as merely a music player would have indicated little about Apple's future in mobile, UBS argues.

So investors need to see the Apple Watch and wireless AirPods as transition products into whatever the next paradigm for Apple might be.

"Apple often introduces important long-term technology in a more modest form that reveals only part of its eventual capability. For instance, Apple appears to have settled on the recent version of the Watch as a fitness play, but we expect health and Internet of Things interactions to become integral over time," UBS wrote.

For the "ambient paradigm" to be achieved, Apple will need to integrate the user experience so that all these devices connect seamlessly. For example, you could speak to Siri – Apple's digital person assistant – via the AirPods and ask for directions which then show up on the Watch.

‘Scarcity theory’

If Apple gets this right, it will win what UBS calls the "new scarcity". In its "scarcity theory", it explains, "new technology makes previously scarce resources abundant while creating new scarce resources. Users are both overserved and underserved at the same time, creating demand for the new job-to-be-done enabled by new capabilities. Winning vendors identify and own the next scarce resource."

"A potential scarcity is a lack of ambient delivery—continuous, always available services provided in the most convenient and unobtrusive way. Apple will work to abstract away this new scarcity by delivering devices and an ecosystem that enable apps to service our needs in a seamless manner. The new scarcity is the integrated devices/ecosystem within which these apps operate. By owning the devices and software that enable delivery of apps in this new paradigm, Apple may again own the new scarcity."

Stock outlook

UBS said health and the auto industry could be key areas in Apple's pursuit of this, even claiming that an autonomous car could be the "ultimate expression of the ambient paradigm."

But currently, Apple shares are not factoring in the potential of these new product categories UBS said, suggesting that the company's share price "appears to assume gradual erosion in Apple's installed base and the amount each user spends per year."

UBS has a buy rating on the stock with a price target of $127. As Apple reveals these future products in the "ambient paradigm", the share price should rise.

"As long-term opportunities become more evident, we expect the stock to respond," UBS wrote.

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