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Apple: Growth Opportunities Are Underestimated

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Jay Arrow from Business Insider recently published an interesting article regarding Apple (NASDAQ: AAPL), basically stating that the years of extraordinary growth for the company are now in the past. Some Wall Street analysts have been reducing their price target for the company due to lower growth forecasts, so the issue is quite relevant for investors.

There are some strong reasons to believe that these observers may be underestimating Apple´s growth opportunities for years to come, especially when it comes to media and digital content.

A Short Sighted Thesis

Arrow analyzes products like the iPad or the much expected Apple TV, and he comes to the conclusion that Apple won´t probably get from them the same kind of growth it achieved in previous years due to the iPhone.

Thanks to carrier subsidies in most developed countries, consumers pay an affordable $200 for the phone when they sign up for a two-year contract. Apple, however, collects $650, with carriers covering the other $450. This is perfect for Apple. It gets mass-market pricing and premium pricing. Plus, its customers come back every two years to get a new phone. And, thanks to Apple's manufacturing efficiency, the company's profit margin on the phone sales is extraordinary.

The author then explains that the next growth phase in the smartphone business is coming from emerging markets, where pricing is more relevant to a clientele of lower income customers, and the carrier subsidy model is not so popular.  

On a global scale Google (NASDAQ: GOOG) is the leader in smart phones platforms thanks to its Android operating system which reportedly has a 75% market share. Growing demand for low cost smart phones in emerging markets probably means that Android products will remain ahead of the iPhone when it comes to market share.

A similar case can be made for low cost Android tablets like the Nexus 7 form Google and Amazon´s (NASDAQ: AMZN) Kindle, they are cheaper than the iPad, and because of that reason they are supposed to be better positioned for growth in emerging markets.  

The article ends up by concluding that introducing the iPhone in developed countries was a unique growth phase for Apple, and that it won´t be repeated in the future:

One thing Apple investors are waking up to, in other words, is that the iPhone's amazing run is winding down. And that there may never be another iPhone.

Counterpoint

I wouldn´t be so sure about the end of subsidies for the iPhone, in emerging markets or anywhere else for that matter. To begin with, iPhone users generate more revenue for carriers over the life of the contract, since they purchase more expensive plans and consume more data and other services. Besides, competition can be a serious problem for carriers cutting subsidies, as they may end up losing lots of clients to other players.

Vodafone (NASDAQ: VOD) decided to experiment with cutting subsidies in Spain this year, and the company announced in November that it will be reversing the decision after losing nearly 178,000 customers to other carriers. Competition is tough among carriers, and iPhone users are probably the most desired customer group, this gives Apple a lot of leverage in its negotiations regarding subsidies.

The tablets market is still quite young, and even if the iPad has lower margins than the iPhone, it still means growing earnings and cash flows for Apple. Tablets are stealing customers away from PCs, and the iPad is still the undisputed leader in that segment, so there is no slowdown at sight for iPad sales at this stage.

The company is working on a new Apple TV, and customers are eagerly awaiting a new and revolutionary product from the company. Just like the iPad, the Apple TV will probably have much lower margins than the heavily subsidized iPhone, but this still means growing earnings for the company.

The Next Explosive Growth Driver

Even assuming that Apple will see slower growth from the sale of devices over the next years, content and digital products should not be underestimated, as this business presents an enormous potential for growth and profitability. This segment is already huge, but still in its initial growth phase.

Apple made more than $8.5 billion in sales from digital media and apps last year, and a customer base of more than 435 million iTunes accounts - and growing - provides an idea about the size of the opportunity. As Apple sells more iPods, iPhones, iPads and probably smart TVs too, it will solidify its strategic positioning in digital media and applications.

Margins should be very exciting too; Apple charges 30% of the sale price in exchange for taking care of credit card transaction costs. When customers purchase a song for $1 the cost impact is much higher than when they pay $15 for a book, $20 for a movie or $500 for an annual newspaper subscription. More expensive digital media means a juicy combination of growing sales and increasing margins for Apple.

The digital media business is booming, just like Apple revolutionized music with the iPod and iTunes; it’s on track to doing the same with books, newspapers and movies. While companies like Netflix (NASDAQ: NFLX) are heavily investing to buy and produce the desired content in exchange for razor thin profit margins, Apple is in a much more comfortable position to benefit from that trend via a much more profitable business model.

 Bottom Line

Apple is still going strong with devices like the iPhone and the iPad, and other products like a smart TV hold plenty of potential. Perhaps more important, these products are the Trojan horse for a fantastic position in digital media and applications, which could be a business with booming sales and profitability. Arrow and other analysts are seriously underestimating Apple´s growth potential.


acardenal owns shares of Apple, Google and Amazon. The Motley Fool owns shares of Apple, Amazon.com, Google, and Netflix. Motley Fool newsletter services recommend Apple, Amazon.com, Google, Netflix, Vodafone Group Plc (ADR), and Vodafone Group Plc (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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