Apple Has A New iPad Problem

With the amount of press surrounding Apple’s (NASDAQ: AAPL) services business, some analysts seem to be forgetting that today, right now, the company gets 87% of its revenue from products. In the future, services may outstrip products, but products will still be a gateway. One product that doesn’t seem to get much press is the company’s iPad business. With the iPhone business on shaky ground, Apple really can’t afford for its iPad or Mac business to struggle as well. Last quarter, iPad and Mac made up just over 19% of Apple’s total revenue. Unfortunately, Apple’s most recent iPad announcements could spell trouble for both businesses.

The tablet market is shrinking… wait its growing… actually we don’t know

The tablet business seems to have reached a point where analysts can’t figure out if customers want these devices or not. A study from Statista suggests the following bleak picture:

Year

2018

2019

2022

2023

Tablets Sold

150.3m

136.8m*

134.1m*

122.1m*

(Source: Statista tablet market *projections)

Users are being told that tablet demand will decline as users choose to buy laptops, Chromebooks, and hybrid devices. On the one hand, Apple has a stranglehold on tablet operating systems. On the other hand, it doesn’t do much good to own a market that is falling apart.

There is just one problem… the market may not be falling apart after all. As quickly as you can find a study that says tablet sales will decline, you can find another that suggests tablets will return to growth. According to Frost & Sullivan, the tablet market will grow at a compound annual growth rate of 1.6% through the year 2024. Though this doesn’t sound like fast growth, by 2024, it would mean 187 million units worldwide.

iOS worldwide tablet market share

(Source: iOS Worldwide Tablet market share)

This second study suggests tablets will gain new capabilities and cannibalize laptop sales. Assuming that iOS continues to hold its 74% worldwide market share, by 2024, the company would sell about 138 million of these devices. To give investors an idea of what this growth would look like, during 2018, the company sold roughly 43 million tablets.

In the last four quarters, the average revenue per iPad has hovered around $430. At 138 million devices, this would generate about $15 billion in quarterly revenue. Last quarter, Apple generated $6.7 billion from the sale of iPads. More than doubling its iPad revenue in the next five years, is something investors would be more than happy to accept.

If this were the end of the story

It seems like every time Apple begins to solve a problem it ends up creating another. The first example is the iPhone X. It seems obvious in hindsight, that users who bought the iPhone X were those who waited through the iPhone 6, 7, and 8, for a different form factor. Priced at $999, this premium device seemed to answer a question of demand for something different. Apple mistakenly assumed that everyone would pay $1,000 for a phone, and rolled out the iPhone XS, and iPhone XS Max. The company eventually made the iPhone XR available at $749. In the meantime, Apple witnessed slower iPhone demand than expected and is still trying to make up lost ground.

A second mistake was the timing of the introduction of the iPad Mini. The original iPad was released in April of 2010. Over the next two plus years, others introduced smaller tablets while Apple introduced the iPad 2 and even the iPad 3. With users salivating over the Retina display on the iPad 3, in November 2012, Apple introduced the iPad Mini… without the Retina display. In fact, it took until a year later when the Mini finally gained a Retina display of its own.

Unfortunately, Apple seems to have again created a problem just as it began to solve another. Over the course of 2018, Apple’s iPad sales momentum deteriorated significantly.

Quarter

Q1 2018

Q2 2018

Q3 2018

Q4 2018

iPad Revenue Growth

+7.3%

+5.1%

-6%

-14.6%

(Source: AAPL quarterly results Q1 ’18Q2 ’18Q3 ’18Q4 ’18)

It’s really no surprise this slowdown occurred, given Apple’s iPad release schedule. The iPad from March of 2017, was a step up in performance, but not transformative. June 2017’s introduction of slightly different iPad Pro devices didn’t give users a reason to rush out and upgrade. Users had to wait for the iPad Pro 3rd generation, and the elimination of the home button, to get a change worth noticing. Since the devices weren’t released until the fourth quarter was already one-third over, it’s not surprising that results suffered.

Buyers seemed impressed by the advance of the iPad Pro lineup, because iPad revenue jumped more than 13% in the first quarter of 2019. If Apple left its lineup alone for another quarter or two, iPad results might have continued to improve, but unfortunately that’s not the end of the story.

Letting the Air out of iPad results

The introduction of the newest iPad Air and the revised iPad Mini is a confusing choice on multiple fronts. First, the iPad Mini hasn’t seen a refresh since 2015. Second, the iPad Air hasn’t been a name used since 2014. It’s almost like Apple forgot it sold these devices in the first place.

Device

Price

Screen

Weight

Storage

Processor

Other

iPad Air 2019

$499

10.5”

1 lbs

64 GB

A12 Bionic – M12 coprocessor

Touch ID – Lightning connector

iPad Mini 2019

$399

7.9”

0.66 lbs

64 GB

A12 Bionic – M12 coprocessor

Tough ID – Lightning connector

(Source: Apple iPad Air and iPad Mini pages)

If these devices were standalone products, the company’s results would likely be amazing. The problem is Apple now gives users a lower-priced choice, that may cut into the average selling price that just started to recover.

Quarter

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Q1 2019

iPad Average Selling Price

$446.97

$450.55

$405.17

$422.68

*$507.57 to $511.45

(Source: AAPL quarterly earnings – *ARPU for Q1 is derived from Apple selling 13.1 to 13.2 million iPads in the first quarter the last two years. Taking the $6.7 billion in iPad sales and dividing by 13.1 or 13.2 million yields the range of $507.57 to $511.45)

iPad Air 2019

(Source: iPad Air page)

On the iPad Air side of things, buyers who are faced with either the iPad Air or one of the iPad Pro models have a relatively simple choice. For $300 to $500 more, they can get a Pro device with a faster processor and a somewhat better screen to form factor, or they can just get the iPad Air. In short, the iPad Air is such a good device, with such impressive specs, that it will likely make buyers wonder why they would waste $300 or more on an iPad Pro.

In addition, if users are considering a MacBook 12”, the pricing between the iPad Air becomes astoundingly challenging. The MacBook is $1,299 to start and has a screen with 226 pixels per inch (PPI). The device weighs 2 pounds and comes with 256 GB of storage. Instead of spending $1,299, a buyer could opt for an iPad Air with the Smart Keyboard. A 256 GB iPad Air costs $649, the Smart Keyboard runs $159 for a total cost of $808.

Though the iPad Air runs a different operating system, the Files app moves the device a little closer to the Mac. What’s more, the iPad Air is half the weight without the keyboard, supports Apple Pencil, and has a higher ppi at 264. This is a case where spending almost $500 less gives the user a little less screen, but is that enough to justify the huge cost difference? Probably not.

Where the iPad Mini is concerned, it’s possible that some users will opt for the Mini at $399 instead of the slower processor and bigger screen iPad at $329. However, it’s equally possible that some buyers who would have bought the Air at $499, will decide to save the $100 and cut weight by going with the Mini. The bottom line is Apple revived two products from multiple years ago, just in time to potentially cut the gains in iPad ARPU that just started.

Today versus tomorrow

A significant number of articles are being written about what Apple will look like tomorrow. The company’s services business is being talked about as though its growth is guaranteed. It’s possible services will overtake products, but that is a long road indeed. To be clear, I own Apple stock, I plan on holding onto my shares. I do think that services will be a growth driver for a long time.

However, Apple has shown it’s not infallible in releasing major products. The iPhone XR was released after the XS, yet based on demand, the situation should have been reversed. Apple made a strong move redesigning the iPad Pro lineup with their beautifully stretched screens, USB-C charging, and keyboard and pencil support. Users had a choice between spending $329 on the cheaper iPad or $799 or more for an iPad Pro. The ARPU seems to have moved up significantly on the strength of Pro sales.

Though the iPad Air and iPad Mini are designed to drive demand for iPad sales, the pricing may put a squeeze on ARPU again. In addition, Apple made the new iPad Air so capable, that some buyers may choose to opt for the Air over certain MacBook models. The company has been successfully pushing the price point for the MacBook up to drive higher revenue usually on relatively tepid unit growth. If the redesigned Air with its keyboard support steals MacBook sales, Apple’s overall revenue could suffer significantly from the massive difference in pricing.

Apple is constantly attempting to improve its hardware options to appeal to many users. At the present time, the lineup between the iPad Mini, iPad Air, iPad Pro, and MacBook has gotten a bit convoluted. Apple is hoping that users will stay in their lane and buy what it wants them to. Unfortunately, Apple may have just caused its own iPad problem.

Disclosure: I am/we are long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.