Quick Thoughts: Apple – We Didn’t Want those Cheapskate Customers Anyway!

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–          Apple is all-in on its premium price strategy, defiantly raising its price point for the iPad Mini and holding the line on the iPad Air in the face of falling market share.

–          The new iPads are terrific, and sure to inspire well-heeled upgrade buyers at Xmas, but will bleed share to much lower cost and much improved Android tablets.

–          Less than 15M iPads sold in 4Q, flat vs. 3Q and up ~7% YoY. Factor in lower ASPs from the Mini and iPad sales were probably down YoY for the 2nd straight quarter.

–          Curiously, Apple DID get price aggressive with its new Macs and will offer new software – OS X Mavericks, iLife and iWork – for free

In September, Tim Cook confidently dismissed the market for smartphones priced below $450 as uninteresting to his company, despite the ravenous demand for such products from emerging markets and the signs that Apple’s bread-and-butter high end could be heading into its dotage. Today’s “More to Cover” presentation took that confidence a step further. Even though Apple’s tablet market share has plummeted, according to IDC, from 63% in the summer of 2012 to a mere 32% during this past quarter, its competition, with their non-tablet optimized apps, fragmented OS builds and confused detachable keyboard form factors, are more to be ridiculed than feared. Those ridiculous rivals, peddling Android powered tablets at price points 40-50% lower than Apple, are the big reason that September quarter iPad unit sales were, apparently, flat QoQ and up about 7% YoY in a global market growing MUCH faster than that. Factor in a mix shift toward the 25% cheaper iPad Mini and the quarter’s iPad sales were almost certainly down for the second consecutive quarter.

Note: The 4QFY13 iPad unit sales can be inferred from Tim Cook’s comments that the 170 millionth iPad was sold in October. Given that 155 million had been sold at the end of 3QFy13, the September quarter number would be somewhere less than 15 million units.

As in September, the hero product, this time the lyrically named iPad Air, was damned impressive. Apple shaved of 20% of the thickness and 30% of the weight from the previous generation, delivering a full sized tablet with the heft of an 8 incher. Add in the 64 bit A7 processor, and faster WiFi connectivity with MIMO, along with those tablet optimized apps, and Apple certainly seems to have a winner that will have fanboys braving the early morning cold to get a place in line on November 1. The Air starts at $499 for a 16GB Wi-Fi model, but gets a characteristic $100 bump for each new level of flash memory and $130B for the LTE modem. Given that tablets sell without subsidy, the iPad Air is positioned as an aspirational product.

The updated iPad Mini – which gets the A7 processor like its big brother and a hi-res “retina” display – maintains the form factor of its predecessor, but takes the price point $70 higher. In a world where Google, Amazon and Samsung are selling well reviewed Android powered tablets in a similar form factor for less than $250, the $399 Retina Mini asks a big premium. The original iPad Mini, its priced reduced $30 to $299, and the 4th Generation iPad, now $399, may be even more ambitious asks.

Really, the only way the pricing strategy makes sense is through the lens of Apple’s margins. The iPhone 5C couldn’t be the low priced emerging market Android killer for which the analysts and bloggers clamored, because Apple couldn’t do it without trashing its already deteriorating margins. Hence the $550 price tab and the reportedly sluggish global sales. The same thing is true in tablet land. Problem: The original Mini cannibalized more of the iPad market than Apple had expected and weighed on margins for the whole category. Solution: Raise the price of the Retina Mini so that it cannibalizes less and delivers better profitability. Bang – Apple sustains its margins at the cost of letting 10s of millions of potential iPad buyers begin their lives as tablet users with an Android product in their hands.

Interestingly, the first hour of the 90 minute presentation was devoted to announcing unexpectedly free software and surprisingly inexpensive Mac computers. Across the board, the new MacBook Pro laptops and the cylindrical Mac Pro desktop computer were all $100-200 cheaper than their predecessors. New versions of OS X and the iLife and iWork suites were announced as free upgrades, amidst ironic finger wagging at competitors that actually charge for software. Of course, the post-tablet PC market is hardly the place to go fishing for margins, and the Mac line is by now far too small to move the needle for Apple either way.

What does all of this mean for Apple investors? I think the iPhone 5S and the iPad Air will bring a lot of loyal fans to the Apple Store this Christmas for upgrades, and the premium pricing will mean fat margins while demand holds. The question is what happens in the post-Holiday doldrums and thereafter, as the new Apple products begin to feel a lot less new, as demand continues to shift to emerging markets, and as the Android nation continues to roll out new products. Apple’s seasonality has been getting more extreme year to year, and unless Tim Cook has price cuts or an accelerated upgrade cycle up his sleeve, I suspect iPhone and iPad share loss will get worse in 2014. Consensus is looking for 9.7% EPS growth for Apple’s fiscal 2014 on 6.7% top-line growth and improving margins. Given Apple’s defiant pricing strategy, I suspect the margins will be a lot easier to deliver than the revenues.

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