iPad Observations Heading into Apple Earnings
In connection with establishing iPad sales, margin, and average selling price (ASP) expectations for 2015, I complied a few observations, including thoughts on the iPad mini, upgrade cycles, and the iPad's placement within the Apple ecosystem.
iPad Mini
I'm increasingly becoming confident in my theory that the iPad mini was a product released with a mission: serve as a hedge against low-end Android tablets in the beginning years of the tablet market. With Apple still selling the original iPad mini for $249, a quick comparsion between iPad mini prices and the rest of the iOS lineup (Exhibit 1) would suggest that the iPad mini exists for more than just to sell more iPads, but instead serve as a defense for the iOS ecosystem. Steve Jobs infamous "price umbrella" quote, which was initially said with the iPhone in mind, can be used to describe the iPad mini. Apple is relying on the iPad mini as one of the lower-cost entry points into iOS (let's not ignore the iPod touch just yet) in order to prevent Android from establishing a position under Apple's prices. By not selling an inexpensive iPad, Apple risked mediocre Android tablets grabbing enough share of the market to squeeze Apple out. While Android tablets are selling for under $100, their use cases have proven to be more rudimentary than true table computing. Exhibit 1 depicts iOS device price levels in the U.S. as of January 2015. Note that the iPhone 4s (not included in table) is still being sold in select emerging markets, like India.
Exhibit 1: iOS Device Prices (Unsubsidized) - January 2015
With the iPad mini positioned at the low-end (grey columns in Exhibit 1), the lack of a significant update this past October shouldn't stand out as too meaningful given that the expected iPad mini buyer has different value priorities than an iPad Air buyer. There have been a few scattered rumors of a mid-cycle iPad mini 3 refresh. I am beginning to question my initial hypothesis from last year that the iPad mini would be discontinued in the near-term, unless Apple is planning to launch a new product that would fill the price layer that the mini currently occupies. While a revamped iPod touch with a 5.5-inch screen would surely sell, the price would suggest it wouldn't be an iPad mini replacement.
Data from mobile ad analytics company Fiksu suggest the iPad mini still represents approximately 30% of iPad sales. Reported ASP and margins will help confirm if the iPad mini is indeed selling as Fiksu would suggest.
Upgrade Cycle
One of the bigger questions plaguing iPad is whether the replacement cycle is to blame for slowing sales momentum, or if the tablet market is saturated. Tim Cook addressed the question on Apple's last earnings call:
“[I]if you look at our top six revenue countries, in the country that’s sold the lowest percentage of iPads to people who have never bought an iPad before that number is 50%. And the range goes from 50 to over 70. And so when I look at that number, our first time buyer rates in that area, that’s not a saturated market. You never have first time buyer rates at 50% and 70%. What you do see is that people hold on to iPad longer than they do a phone. And because we’ve only been in this business four years, we don’t really know what the upgrade cycle will be for people.”
Cook sounds confident that given roughly 50-70% of iPads are sold to new customers, the lack of unit growth is due to the dearth of repeat buyers. As a frame of reference, according to Apple, 25% of customers that bought iPhone 5s in the U.S. were buying their first iPhone. In that context, one can understand why Apple thinks slowing iPad sales momentum is more like a speed bump. What is iPad's average upgrade cycle? Using data from Fiksu, Exhibit 2 highlights the breakout of iPad devices currently in use, which leads to a 2.4-year rudimentary estimate as to the average life of an iPad. It is important to note one can not distinguish between new and used iPads using Fiksu data and with the iPad Air and iPad mini on the market for only 1.25 years, average life figures remain skewed. Another way to look at the data is approximately 1 out of 4 iPad users have owned their iPad for nearly four years (iPad 2).
Exhibit 2: Current Breakout of iPad Devices in Use as of January 5, 2015
Exhibit 3 charts the iPad's initial sales success compared to iPhone's more gradual sales levels. The iPad is now facing a leveling off of sales, while the iPhone is seeing accelerating sales growth. Based off of Tim Cook's comments on iPad upgrade cycle and new customers to iPad, Exhibit 3 depicts the big question for iPad: What is causing sales growth to slow?
Exhibit 3: iPhone vs. iPad Sales
Where do iPad sales go from here? Exhibit 4 highlights three possibilities: 1) increase and start to track iPhone adoption, 2) remain relatively steady to slightly down until a more sustainable sales level has been reached, 3) decline due to other reasons. My 2015 iPad estimates run with a scenario that falls somewhere between options 2 and 3.
Exhibit 4: Possible iPad Sale Trajectories
If iPad sales (red line in Exhibit 4) continue to trend down gradually, and do not fall precipitously, than there would be a higher likelihood that the extended upgrade cycle is the primary culprit impacting iPad. If sales decline momentum worsens rather quickly in 2015, than I would position iPhone 6 and 6 Plus popularity, including the Mac, as primary culprits for iPad's weakness.
Finding iPad's Niche Within Apple's Ecosystem
I continue to think we are in a period where the iPad is finding its niche markets, as well as its place within Apple's ecosystem. Recently, iPad has been included in Apple marketing campaigns like "Start Something New" alongside the iPhone and Mac, suggesting that management may have recalibrate iPad expectations over recent months and now position iPad as being able to fill certain demand holes that the iPhone and Mac are not able to fill on their own, such as an inexpensive video player and email machine (iPad mini) to high-end mac-like devices for creation (iPad Air and eventually iPad Pro). No longer is the iPad destined to the space between the iPhone and Mac.
In such a scenario, a larger iPad Pro continues to make sense for being able to stand out from an iPhone 6 Plus, while also setting itself apart from the Mac, especially the rumored new MacBook Air, due to a touch interface. While the device wouldn't seem to have characteristics of being a mass-market hit like iPhone due to a high price and large-screen form factor, the iPad Pro may help keep some customers interested in the iPad, and more importantly, iOS. On the low-end, iPad mini may in some ways represent the "cheap" iPhone for consumers that position price as the determining factor for a purchase.
Expectations for 2015
With Apple's upcoming earnings report in two weeks, and given the greater level of uncertainty when establishing iPad expectations for 2015, I asked myself two basic questions:
1) Will there be any catalysts that would change iPad's sales decline momentum from 2014?
2) What are Apple's goals with iPad?
The iPad's sale trajectory is not clear (Exhibit 4). In my Apple Questions for 2015 post, I mentioned looking at iPad average selling price (ASP) as a way of figuring out how the iPad mini is selling. I continue to think that data point will give hints as to what Apple will ultimately do with the mini. I'm also assuming that the iPad Pro will help maintain the current iPad trajectory, rather than improve it.
I estimate Apple sold 19.5M iPads for the three months ending December 2014 (FY1Q15), down 25% from 2014. As shown in Exhibit 5, my unit sales growth estimate improves through 2015 due to easier year-over-year sales growth comparisons (iPad sales were weaker in the back half of 2014), and a slight pick-up in demand related to an iPad Pro (reflected mostly in 3Q15). Obviously, if the iPad Pro does not materialize, my estimates would need to be adjusted a tad downward.
Exhibit 5: Above Avalon iPad Sales Expectations
My estimates were reached by a combination of analyzing Fiksu iPad model share trends from September to December, in addition to taking Apple's comments about expanding the supply chain (1.5M channel build estimate). Given the high degree of uncertainly, I would position Pad unit sales of 17-21 million units as my wider expectation range. If sales come in weaker than 17 million than it is likely that other iOS devices are being bought in place of iPad. If sales are stronger than 21M than the iPad is likely suffering more from a longer replacement cycle with core sales trends holding up well.
Another way to put my estimates in context would be comparing my growth expectations with iPad's historical growth rates, highlighted in Exhibit 6. After two years of strong growth, the iPad is now bouncing around double-digit unit sales percentage declines.
Exhibit 6: iPad Quarterly Growth Rates
As my 1Q15 quarterly sales decline estimate shows, the iPad is still in flux. Apple's upcoming earnings release on January 27 represents the next event that may provide additional clues and data points as to how to think about iPad.
This report was produced by Neil Cybart on January 12, 2015 and is not meant to be used as investment advice. Risks to my estimates primarily include customer demand. I publish a daily email about Apple called AAPL Orchard. Click here for more information and to subscribe.