iPad Underperformance Could Be Good For Apple’s Margins

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Despite Apple’s (NASDAQ:AAPL) stellar growth over the past year, its iPad product line has been struggling, with unit shipments contracting for seven straight quarters on a year-over-year basis. The device now accounts for less than 10% of Apple’s total revenues and under 5% of Apple’s value, by our estimates. Although we don’t expect to see a reversal in that trend in the interim, there could be a silver lining in the form of better overall margins for the company.

Our $144 price estimate for Apple is about 25% ahead of the current market price.

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Why Have iPad Sales Been Declining?

There are multiple trends behind the decline in iPad sales. Firstly, the global tablet market has been shrinking, with IDC projecting that tablet shipments will contract by 8% for 2015 to about 212 million units. [1] The decline has been more pronounced for Apple (20% dip in iPad shipments for FY 2015 ) considering cannibalization from the iPhone Plus models and the company’s relative weakness compared to Android vendors in emerging markets, where there is still some scope for improved tablet penetration. The tablet market also sees a longer upgrade cycle compared to the smartphone market, where evolving wireless standards as well as device subsidies and financing schemes typically drive customers to upgrade every two years or so. For instance, according to mobile app analytics company Localytics, the most popular iPad currently in use is still the iPad 2, which was released in early 2011.

iPad Shipments

How Margins Could Improve

Although Apple does not break down product-specific margins, the iPad appears to be one of its least profitable products based on widely available bill of materials data. The iPad Air 2 with 16GB of memory costs Apple about $275 to build, while it sells for about $499 (street prices are often lower). [2] The margins on the iPad Mini 2  ($269) – likely one of the more popular iPad models – are likely lower. Now, with iPad sales on the decline, Apple appears to be focusing on boosting average selling prices and margins, rather than resorting to discounting to drive growth, and we largely believe that this is the right strategy.

For instance, the new iPad Pro is targeted squarely at enterprises, creative professionals and power users, with a price tag ranging from $800 to $1080, excluding high-margin accessories such as the Apple Pencil and keyboard. Apple also chose not to refresh its iPad Air and Air 2 models this year, while maintaining their respective 2014 price points, allowing the company to absorb the benefits of lower components costs and potentially improved yield rates. Separately, the cannibalization of the iPad by the plus-sized iPhone lineup should prove positive, given the iPhone’s shorter upgrade cycles and thicker margins. For instance, the 64GB iPhone 6S Plus costs a little over $250 to build, per IHS, but it retails for about $849, implying significantly more generous gross margins compared to the iPad. [3] The cannibalization could also have a positive impact on Apple’s overall product strategy, driving customers to purchase the larger screen iPad Pro or more expensive MacBooks as a second device.

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Notes:
  1. Worldwide Tablet Shipments Expected to Decline -8.0% in 2015 While 2-in-1 Devices Pick Up Momentum, Growing 86.5%, According to IDC, IDC, August 2015 []
  2. Corrected: Still Air: Apple iPad Air 2 Largely Holds the Line on Features and Costs, IHS Teardown Reveals, IHS, October 2014 []
  3. Upgraded Components in iPhone 6S Plus Costs Apple an Extra $16 Per Device, IHS, September 2015 []