Debunking iPad Mini Rumors – Part III

In the first two parts of this three part series, we made estimates for the cost of manufacturing an iPad mini taking into account all the individual component costs of Amazon’s (NASDAQ:AMZN) Kindle Fire, the iPad 2 as well as the new iPad. Of the two versions of the iPad 2 considered – the low-end and the high-end – we saw that the low-end iPad mini was more feasible to make for Apple (NASDAQ:AAPL) considering the lower costs of manufacturing and the appeal to the price sensitive customer. In this final part of the series, we will take a look at how it might impact Apple’s stock should the company decide to make a low-end iPad mini. For our analysis, we will assume two price points of entry – $249 and $299 – and see the impact on each of the iPad drivers as well as the corresponding impact on Apple’s stock.

See Debunking iPad Mini Rumors Part I

See Debunking iPad Mini Rumors Part II

$249 iPad mini

If we consider such a scenario where Apple launches a $249 low-end iPad mini (with a manufacturing cost of about $194), it would have a manufacturing gross margin of around 22%. Considering all the other costs that have not been accounted by iSuppli such as technology licensing and royalties, it would come out to be even lower, say 20%. Our DCF model assumes all these costs already to show a gross margin of around 30% for the current generation of iPads.

For modeling the impact that such a decision might realistically have on Apple’s stock, we look at how the various drivers of the iPad division may be individually impacted.

1. iPad sales: Since the launch of the iPad mini would be made with the target of selling the tablet to a wider base of price sensitive customers, we believe that Apple will look to sell more number of minis than the bigger tablet by the end of our forecast period. Starting in 2013, we model iPad mini sales to be 40% of our current forecasts for the iPad. Going ahead, we forecast it to account for more than half the total iPad sales by 2018 with no impact on the bigger iPad sale forecasts assuming little cannibalization. This takes iPad sales from the current forecast of 60 million unit sales in 2013 to 260 million by 2018, up from our initial forecast of $120 million iPad sales for 2018.

2. iPad pricing: We assume that the pricing for the iPad mini declines from a $249 price point in 2013 to about $200 by the end of our forecast period. This causes overall average iPad pricing to fall from our 2013 forecast of $540 to $460 for the same year. Going ahead, we use our earlier iPad sales estimates and the $200 price estimate for the iPad mini and our current 2018 iPad price estimate of $430 to arrive at an average iPad pricing of just above $300 in 2018.

3. iPad gross margins: We assume that the iPad mini gross margins declines from 20% in 2013 to about 14% by the end of our forecast period. This causes the overall iPad margins to decline to about 28% in 2013 and 21% by 2018 as the mix skews towards the smaller tablet in the outer years.

Feeding these estimates into our model, we see Apple reaching a price estimate of about $725, less than 4% ahead of our current price estimate. The value add due to this low-margin $249 offering seems to be pretty minuscule in our opinion. Now lets see if offering the higher-margin mini version is more lucrative for Apple’s stock.

$299 iPad mini

For the $299 iPad, we will make a little conservative estimate for the iPad sales due to the higher price point. We assume that the 2018 iPad sales will be about 230 million, a tad less than the 260 million we estimated for the $249 iPad case.

For the years between 2012 and 2018, we assume a linear increase. We also assume the corresponding iPad average pricing for 2013 to be about $485 and decrease to around $340 by 2018, higher than the $300 assumption made for 2018 in the $249 case. As for the iPad gross margins, we see no reason to change the trend line since the current gross margins of the iPad and the assumed $299 iPad mini are nearly the same.

Making these driver changes, we see that Apple reaches a price estimate of about $735, still only 5% ahead of our current price estimate. While the value add of this offering may be higher than the $249 offering, it is still not enough to justify bringing out such a product into the market.

Maybe Apple can try bringing out a higher priced mini offering you say? But keep in mind that as Apple increases the price of the low-end offering and adds more features to justify the price, the possibility of cannibalization of the bigger iPad sales becomes higher.

You can tweak the trend drivers in the graphs shown in this piece to test your assumptions and form your own price estimate.

Conclusion: In our brief analysis, we believe that Apple is unlikely to enter the smaller tablet market. If it does, it is more likely to launch a low-end iPad mini than the higher end version. Moreover, the price point for this product will be at around $299 or possibly even higher — but will most likely not be $199. The only reasons why Apple would launch such a product are that the tablet market has matured to an extent that it justifies the need to cannibalize its bigger iPad sales or the technology improves enough to enable such a design change.

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