Apple Television Could Be A $50 Billion Opportunity, May Not Drive Apple’s Value By Much

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With growth in Apple’s (NASDAQ:AAPL) iDevice sales slowing, the focus has shifted to new products that the company may be planning to launch in the coming months. Last quarter, Apple saw its iPhone sales grow by only 7% over the prior year quarter despite adding NTT Docomo as a new carrier partner in Japan and benefiting from a full quarter of availability in China. In comparison, the holiday quarter of 2012 saw iPhone sales grow by nearly 30% year-over-year. Apart from the high-end smartphone market becoming increasingly saturated, the fact that carriers in developed markets – such as Verizon and AT&T – are spending less on subsidies to boost their margins has also contributed to the slow iPhone growth in recent quarters. On the iPad front as well, the company is seeing sales stagnate as ASPs fall amid a growing sales mix of the lower-priced iPad mini. Apple’s iPad revenues last year were nearly flat as compared to the previous year. With both the iPhone and iPad unlikely to drive revenue growth significantly in the near term, investors are looking at new product opportunities that the company might explore in the next year.

While the company hasn’t officially declared anything, there is wide speculation that Apple is working on a full-sized television, dubbed the iTV. The rumors first started when the company’s late co-founder Steve Jobs revealed in his biography that he was looking to reinvent the television viewing experience and had finally managed to “crack” it. Since then, there have been multiple other industry reports claiming that such a TV is in the works and could be unveiled soon.

See our complete analysis of Apple here

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If launched, the iTV would be Apple’s first attempt to enter a huge and mature market in a long time. Unlike smartphones and tablets, two markets that were still very young – or barely existent – when Apple launched the iPhone and the iPad, the TV market is a multi-billion dollar industry that Apple would be looking to penetrate. While an iTV could surely go a long way in helping Apple leverage its huge content library in iTunes and the App Store to drive additional hardware sales, we believe the value would just be incremental for the company, given the low margins in the industry and the longer upgrade cycle usually associated with TVs. We estimate that the potential launch of a full-sized iTV this year could add about $50 billion to Apple’s value, driving its $630 Trefis price estimate up by only 10%.


Assumptions

For our analysis, we have made a few assumptions in order to keep things simple and intuitive. Firstly, we assume that Apple would release the iTV in the second half of 2014 towards the holiday season, in a one-size-fits-all 40-60 inch variant. Apple has historically stuck to this game-plan in launching the iPhone and the iPad, so it is reasonable to assume that it would not want to deviate too much from that successful launch strategy. Our second assumption is that the price of the TV would be in the$1,000 – $2,000 range, consistent with Apple’s strategy of bringing out high-end, premium priced products in the market. Beyond $2000, however, could be making the product too pricey for many customers.

As for gross margins, we are assuming that Apple will not enter the market unless it can command a healthy gross margin of 30-35% at least. Even for the iTunes ecosystem, which Apple maintains in order to drive its core hardware sales, it charges 30% of revenues that developers generate on its platform. Generally speaking, the TV industry has lower margins, with industry leader Samsung’s gross margins standing at around 25% in 2012, by our estimates. But Samsung makes all kinds of TVs, both high- and low-end. Apple, with its high-end focus, should be able to command higher margins.

Individual Driver Forecasts

In order to estimate the value that Apple could generate out of launching an iTV, we need to get an idea of the ongoing trends in the TV market. According to NDP DisplaySearch, TV sales have stagnated at around 230 million units over the last two years and are expected to see a slow pace of growth in the coming years as well. [1] However, the LCD segment of the market is fast cannibalizing the outdated CRT TV market, and is expected to account for almost the entire TV market in the next few years. Most of the future growth in this segment is going to be driven by premium-priced products in newer technologies such as LED, 3D and 4K ultra-HD. As premium TVs see high demand and CRTs are phased out, we see worldwide TV sales growing to around 260 million units by the end of our forecast period, a CAGR of 2%.

From a market share standpoint, we assume that the Apple iTV is able to grow its market share from 0% in 2013 to about 8% by the end of the decade, charting about the same market share growth trajectory as the iPhone. We are assuming an iPhone-type market share rise as we believe Apple will look to compete in the high-end smart TV category only. This means that Apple could be looking at sales of around 20 million iTVs by the end of the decade.

As for pricing, we estimate the iTV ASP to start at $1500 in 2014 and then decrease to around $1,300 by the end of the forecast period, as Apple brings out newer models every year and slashes the prices of its older variants.

Our current Apple TV division estimates the value from the $100 set-top box that Apple sells currently, and contributes less than 1% to Apple’s total value. Since the Apple TV in its current form hardly makes any difference to Apple’s value, we assume that the company will be selling only the new iTV from this year onward and feed in our estimates of:

1. iTV unit sales gradually reaching 20 million sales by the end of the decade

2. iTV ASPs declining from $1,500 in 2014 to $1,300 in 2020

3. iTV gross margins of 35% starting out initially and then declining to around 30% by 2020

We arrive at a long-term revenue potential of $25-30 billion for Apple from iTV sales. We estimate that this would drive Apple’s annual operating profits up by about $6 billion, and cash flow by about $4.5 billion by the end of our forecast period. This translates to a $690 price estimate for Apple, an increase of less than 10% over the current $630 price estimate.

iTV Not A Big Driver Of Apple’s Value

While the iTV could help Apple create meaningful value ($50 billion) in the TV market, its estimated upside to the Trefis valuation is relatively unimpressive. In fact, given that Apple has no presence in the TV market currently and will be looking to disrupt a mature industry, market share gains are unlikely to be very dramatic. The iPhone is a stellar product, whose sales have been driven by carrier subsidies to a large extent, especially in developed markets. It is less likely that the iTV will see such a backing in the coming years. Moreover, since televisions are much pricier, customers don’t tend to upgrade their TV sets as quickly as mobile devices. Consequently, customer upgrades are unlikely to drive iTV sales as much as they do with the iPhone or the iPad. Where Apple could prove us wrong is by coming out with a game changing product like the iPhone, pricing it at an aggressive $2,000 or more and seeing an iPhone-like growth trajectory due to strong iTunes integration and potentially aggressive content deals. However, even then we see the value opportunity for Apple increasing by only another $20 billion, taking its price estimate up by another 3%.

It should be noted here that we haven’t even considered the high near-term growth in SG&A and R&D expenses that selling the iTV would likely cause Apple to incur. Add to that the capital expenses that Apple would incur on increasing floor space in its retail stores and the incremental value of the iTV diminishes further. This is not to say that Apple should not launch an iTV, given that a potential market value of $50 billion is nothing to scoff at. Additionally, the iTV would help Apple expand its ecosystem of hardware devices and iTunes content, which could in turn drive future sales of the iPhone and iPad. However, the iTV alone doesn’t seem to be as big a driver of Apple’s value as many seem to think.

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Notes:
  1. 2014 4K TV Shipments to Rise Dramatically in China, According to NPD DisplaySearch, DisplaySearch, May 9th, 2012 []