What a Lower Priced iPad Refresh Means for Apple
Today's price cut will create stickiness around iOS, making iPad users today far more likely to buy iPhones at premium prices (and robust gross margins) well into the future.
We will maintain our $138 fair value estimate and narrow moat rating for Apple (AAPL) as the firm issued a press release announcing a refresh to its 9.7-inch iPad lineup, with aggressive pricing starting at $329, versus $499 in years past. We estimate that any rise in iPad revenue from higher unit sales will be mostly offset by lower prices and gross margins earned per iPad, thanks to the price cut. With Apple continuing to trade near all-time highs, we still view shares as fully valued.
We see two aspects to Apple's aggressive pricing strategy. First, we suspect that Apple is trying to accelerate replacement cycles for the iPad, as it appears that the useful life of an iPad does not mirror that of a smartphone in the two- to four-year range, but rather approaches the life of a PC in the four- to six-year range. Apple's iPad unit sales in 2016 were 43% lower than those in 2013, which we attribute not only to longer useful lives for iPads, but also to cannibalization from larger-screen iPhones. Second, in light of aggressive low-end tablet competition from Amazon in particular, we think it is important that Apple keeps iPhone users within the iOS ecosystem as much as possible, rather than having users become device- and operating-system-agnostic, which in turn could limit Apple's pricing power on its crown jewel iPhones over time. We estimate that iPad gross margins have been far below Apple's corporate average for quite some time, and today's price cut probably won't help matters. Yet the more important consideration for Apple continues to be creating stickiness around iOS (the source of our narrow moat rating for Apple), and we think that iPad users today will be far more likely to buy future iPhones at premium prices (and robust gross margins) well into the future.
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Brian Colello does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.