iAd Platform Could Drive 5% Upside for Apple Stock

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Advertisers and mobile app developers have responded well to Apple‘s (NASDAQ:AAPL) new  iAd platform, a mobile advertising network that developers can use to incorporate advertising into their apps. Apple both sells and serves ads on iAd, and has already established advertising contracts with major clients like Unilever and Nissan.

We expect Apple’s ad revenues per impression to decline in coming years due to the explosive growth of new apps on the Apple platform, which has increased Apple’s available ad inventory and driven down rates. However, iAd could slow this decline if it encourages consumers to spend more time viewing mobile ads. In this scenario we see a potential 5% upside to our $361 stock price estimate for Apple. Our analysis follows below.

Apple vs. Google

Apple built the iAd platform using technology developed by Quattro Wireless, a mobile ad network provider that Apple bought fot $275 million last January. Mobile ad competitor Google (NASDAQ:GOOG) acquired a similar network called Admob for $750 million in November 2009. Apple recently indicated that it would restrict AdMob’s access to its mobile platform.

Apple takes a cut of 40% from total iAd revenues and gives the rest to app developers. We have incorporated Apple’s 40% cut in our gross margin estimate for the apps business. You can drag the trend-line in the chart below to create your own gross margin forecast for Apple’s advertising business and see how it impacts the company’s stock price.

Early reviews from  Apple’s advertising clients have been favorable, according to a recent article in the Los Angeles Times. For example, Nissan said that its customers spent an average of 90 seconds with each ad served on iAd. That’s ten times times longer than the interaction times that Nissan found for comparable online ads.

That translates into higher advertising revenue for both Apple and app developers. For example, CBS has released iPhone apps for CBS Sports, CNET and other news services. The company told the L.A. Times  that advertisers have been paying CPM rates (cost per thousand impressions, a common online advertising metric) of up to $25 for ads served on its apps via iAd.

That’s significantly higher than average iPhone CPM rates.  Prior to the Google acquisition, AdMob reported average CPM rates of between $12 and $14 for iPhone ads, according to the BusinessInsider blog. However, we believe that Apple’s mobile CPM rates have trended downward since the publication of AdMob’s results. The  rapid increase in the number of apps available for the iPhone, iPod Touch and iPad is driving further rate declines.

As the number of mobile apps increases, competition among apps for advertising slots will lead to a rise in available ad inventory, driving CPM rates down. Apple’s App Store now offers around 250,000 apps, according to the company.

We currently expect Apple’s average CPM rates to decline from $10 in 2010 to less than $5 by the end of the Trefis forecast period. In the next interactive chart you can drag the trend-line to create your own average CPM forecast for Apple and see how it impacts the company’s stock price.

Bottom line

Based on initial feedback from advertisers and app developers, it seems possible that Apple’s average CPM rates could decline more slowly than we expect. There could be an upside of 5% to the $361 Trefis price estimate for Apple’s stock if average CPMs declines to $7.50 by the end of our forecast period,  instead of the $4.70 that we currently forecast.

You can see the complete $361 Trefis Price estimate for Apple’s stock here.

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