MorningWord 8/2/16: The reports of iPad’s death are greatly exaggerated

by Dan August 2, 2016 10:01 am • FREE ACCESS

Yesterday Apple introduced a new commercial on its YouTube channel for the iPad Pro, titled – “What’s a Computer?”


This ad comes a week after Apple’s fiscal Q3 earnings report that showed that despite a 9% year over year decline in units, iPad sales grew 7% yoy, the only hardware division to show yoy growth in the period. That was iPad’s first yoy quarterly revenue increase since Q1 in fiscal 2014, more than two years ago.

From Apple Fiscal Q3 report
From Apple Fiscal Q3 report

With the launch of the iPadPro 12.9′ version last November, Apple CEO Tim Cook was pretty clear that the new product was a shot across the bow of their own products, not just Microsoft’s Surface and to make a case for Apple’s computing prowess for broader enterprise uses. As for consumers, it’s meant to make sure they steal from their own MacAir and MacBook sales, and make sure someone else doesn’t. Tim Cook via Recode:

“Yes, the iPad Pro is a replacement for a notebook or a desktop for many, many people. They will start using it and conclude they no longer need to use anything else, other than their phones,” Cook said. He added that it doesn’t bother him if consumers move to iPads and smartphones instead of Macs or MacBooks, because “as long as we cannibalize [ourselves], it’s fine.”

This is important, because in the quarter just reported, iPad units were more than 2x that of Macs, despite those sales just 7% below that of Macs.  For a hardware company with 39% gross margins, I think it is safe to assume that iPad margins are greater than that of more complicated Mac notebooks, and the adds-ons like the keyboard, pencil and cloud subscription are very additive to margins, bringing the iPad Pro to a price point of most MacAir & MacBooks (iPadPro comes in 12.9′ & 9.7′ inch versions, starting at $799 & $599 respectively, and depending on wifi & the amount of geebees tops out at $1229 & $1029, plus $250 for pencil & keyboard).

The only other segment that grew in the quarter just reported was Services (iTunes, Music, iCloud, Pay etc), which also happened to be the second largest product segment by revenue behind iPhone, but also a segment (like iPad) that likely has a gross margin above the company average.

As Apple sputters a bit with new product lines, (the Watch which falls in Other Products, came in at $2.2 billion, with revenues up 1% sequentially and down 16% yoy), and the obvious pressures on high-end smartphones, the proliferation of the iPhone SE, the cheaper iPhone for emerging markets, which also likely has higher margins than the 6s, and growth in iPad could be key to offset the year over decline in iPhone’s sales for the first time ever in 2016 as it relates to the company’s profitability (EPS expected to decline 10% yoy, on an 8% sales decline, the first anual decline in more than 10 years).

While iPad may be showing greenshoots after a long dirtnap, remember that Macbook cannibalization may not be additive to the overall pie, but merely temporarily halt the effects of the category decline and aid company wide profitability.

iPhones sales made up about 56% of AAPL’s total sales in the quarter just reported, the lowest percentage in a year (had been averaging 65% in fiscal 2015/16), while also printing the lowest gross margin at 38% in 2 years. This could be the reason the company which historically has be known to cede market share in order maintain profitability wants to eat their young in the form of their own Macbooks.

All this comes as the stock has risen nearly 20% from its 2 year lows made in May. This week it even broke above the downtrend that had been in place since the all time highs last Spring/Summer. Even with that it is still down 20% from those all time highs:

AAPL 2yr chart from Bloomberg
AAPL 2yr chart from Bloomberg

Like the company and its products, the stock is at an inflection point. It’s shaking out some of the haters, and waiting for the true believers to step back in and take it back to prior highs.

And one more thing. At the unveiling of the first iPhone back in January 2007, Apple fittingly dropped the Computer from its official name. After nearly 10 years of redefining what computing is, the company is now looking to permanently retire one such device in their stable.