My take on the Apple iPad

The spectacle…

I haven’t really paid attention to AAPL product launches, even though I’ve been an owner of the stock (not now) for many years.  To my mind, this one broke the hypemeter.  Maybe that’s just the way AAPL does things, but I now know that the iPad is “real,” “natural,” “awesome,” “rad,” and “intimate.”

It does look great, though.  Reviewers have also said the screen is spectacular and the software is up the AAPL’s usual high standards.

…the specs…

The iPad (Fujitsu apparently owns the rights to this name in the US) has:

–a 1GHz Apple-designed microprocessor

–a 9.7″ (diag) backlit LED color touchscreen with 1040 x 768 pixel resolution

–solid-state (flash memory) storage

–10 hour battery life

–9.6″x7.5″x.5″ dimensions, weighing 1.5lb (wifi only) or 1.6 lb (wifi + 3G)

The iPad comes in two versions:  wifi only starting at $499, and

wifi + 3G starting at $629.

The basic units come with 16Gb of storage.  For $100 extra, you can up that to 32Gb and for $200 extra, to 64Gb.

In the US, ATT is offering a 3G connection for either $15 or $30 a month.

A plug-in keyboard is available for users who don’t want to use the touchscreen virtual keyboard.

The iPad also runs iWorks (–does anyone actually use it?).

Engadget has a good review of the iPad, including video from the press conference.

…and the (non) specs.

To start with the obvious, despite looking like a very big iPhone, you can’t make a phone call with it or send a text message.

There’s no videocam or microphone.

It doesn’t support Flash.

No USB port.

It doesn’t allow multitasking.

My take

what the iPad is This is a device somewhere in the evolving netbook, smartbook, e-reader, iPod Touch universe of products.  In fact, I’m struck by how the iPad embodies the principles behind the original Asus netbooks and the forthcoming Chrome OS offerings.  Within the AAPL lineup, you might call the iPad an upscale iPod Touch.

I don’t think anyone has a good idea about how the netbook etc. universe will eventually shape up.  Luckily, as investors, although we may all have our own opinions, we can draw some useful conclusions about the iPad without having to depend on any one outcome for this type of device.

To start an analysis, let’s say the typical iPad sells for $700. (I’ve just averaged the high and low prices and rounded up.  As long as we keep in mind that this is a rough estimate, the figure will be good enough.  We can also adjust as we see the actual pattern of sales.)  Let’s also say that AAPL marks its products up by 30% over its (full) costs.  That would mean a cost of about $540-$550 per iPad and an operating profit per unit sold of $150-$160.

We don’t know whether the ATT arrangement is exclusive, although it sounds like it is, or whether AAPL gets a cut of the 3G fees.  If we guess that half the iPads will have 3G and that (again) half will take the more expensive plan (using 50% means you won’t be spectacularly right, but you won’t be spectacularly wrong, either), then–trust me for the moment (more explanation below)–3G will add $20/year on average to iPad unit profits.

Yes, we have a lot of “ifs.”  And, yes, this is a fact of life for securities analysts.

One more thing.  Let’s say an iPad has a useful life of five years.  Again, I’ve just made this up, but it seems to me that once you buy one of these devices they’ll last a long time.  It’s not like cellphones, where at the end of your two-year contract, if not sooner, you get a new phone.

If so, APPL can expect over five years $150-$160 operating profit from each unit of hardware, and a possible $100 operating profit from the 3G connection.  Why is this important?

what the iPad isn’tan oral communication device.  In other words, a phone.  Besides having lots of netbook features, another thing that strikes me about the iPad is that it has nothing that would make it a substitute for the iPhone.

The reason?  Not only is the iPhone half of AAPL’s operating profit (my estimate) but it’s way more profitable than anything else AAPL does.

I’ve been fooling around with the information AAPL provided with its latest earnings release that reconciles its old and new accounting methods for the iPhone.  I think you can conclude from the data that AAPL earns an operating profit of about $400 from the sale of an iPhone with a two-year contract.  I’ve somewhat arbitrarily broken that down into a profit of $100 on the phone itself and a monthly payment of $12.50 from ATT.  That’s where I got the 15% share of cellphone revenues I applied to the iPad above.

There are two other factors involved in choosing an iPhone:

–For someone who has a cellphone already, the alternative to buying an iPhone for $200 + $70-$100/month for service is not zero. It’s paying $100 +$50 a month for a different (lesser) phone.  So the incremental cost of an iPhone is not that high.

–At the end of a two-year contract users are conditioned to renew their contract and get a new phone.

So, over a five-year period AAPL earns 3x$100 + 60x$12.50 = $1050 from each iPhone user.

Conclusion: If my numbers are at least directionally correct, the sale of an iPhone is 4x as profitable as sale of an iPad.  During its first full year, AAPL sold about 5.5 million iPhones and over 13 million in its second.  To be “another iPhone,” therefore, the sales numbers for iPad would have to be 21 million and 52 million.  That’s not going to happen.

On the other hand, what would it take for the iPad to add 5% to AAPL’s profits–meaning 5% to the company’s growth rate?  By my reckoning, the number is about 4 million units.  I think that’s doable.

So the iPad isn’t a game-changer, but it could be a source of modest positive earnings surprise.  We’ll have to wait for the sales data to come out to see anything more.

One other thought:  Look at the iPad as a media viewing device.  It’s designed so there’s no way to get content into the iPad without going through AAPL.   This implies to me that AAPL is not simply going to use content to drive hardware sales, as it did with the iPod.  Its model is more like what it did with the iPhone, I think.  In the iPhone case, it went to a structurally weak service provider, AT&T, and offered to provide its delivery system, the iPhone, on an exclusive basis in exchange for a portion of the cellphone profits.  That proved much more profitable than using content simply to sell a device.

With the iPad, AAPL appears to want to do the same.  It appears so far that book publishers see themselves as among the AT&Ts of the media world, who stand to gain much more than they lose by signing up with AAPL.  Newspaper publishers, too.  But movie studios and magazine publishers see themselves as having more market power–as evidenced by their conspicuous absence in iPad demos.

It will be interesting to see how events unfold.  One possible risk to AAPL would be if, say, DIS or a consortium of magazine publishers, offered a “free” $200 smartbook to anyone who would subscribe to a rival content-distribution service.

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