Apple’s Most Important Product of 2014

Forget watches and TVs; Apple needs this product to beat back Samsung and Google in 2014.

Jan 4, 2014 at 9:45AM

If you believe Apple's (NASDAQ:AAPL) management, 2014 will be a big year for the company product-wise. An Apple-made smartwatch, a big iPad, maybe even a full-featured TV set could debut at Apple stores later this year.

But while these products could all add to Apple's bottom-line, none will be as important as a larger-screen iPhone. To its detriment, Apple has ceded the phablet market to Google (NASDAQ:GOOGL) and Samsung (NASDAQOTH:SSNLF). But based on numerous reports, Apple has its own phablet in the works -- and if it's released this year, it will quickly become Apple's most important product of 2014.

TVs and smartwatches remain unproven
Should they also go on sale in 2014, I would expect both an Apple-made smartwatch and TV set to draw more attention from both consumers and investors. Indeed, as radical new product categories, they would be far more exciting.

But how much they would affect Apple in the near term, if at all, remains completely unknown. Despite Samsung's best efforts, the smartwatch remains a niche product. Samsung said it had shipped just 800,000 Galaxy Gears (its own smartwatch) two months after its release. Samsung claimed that figure exceeded its expectations, but compared to the 20 million Galaxy S4s Samsung shipped over a comparable amount of time, it's clear that the smartwatch has not yet caught on.

Smart TV, too, is an area of intense interest for Samsung, but its smart TVs haven't exactly captivated the minds of consumers. Samsung's built-in apps offer an experience that's about the same as Apple's own set-top box or Google's Chromecast -- it serves as a gateway to apps like HBO Go and Netflix, but doesn't radically transform the TV viewing experience.

Perhaps that's why Samsung, despite being one of the world's biggest TV makers, gets about two-thirds of its profits from its mobile devices. Other companies, notably Sony, have struggled to profitably sell TVs in recent quarters.

Many investors may assume that Apple's efforts will be different; that the company will deliver transformative products that will bring iPhone-like success. Perhaps, but that's a large assumption.

The market for phablets is huge
In contrast, the market for phablets is well-established, and the potential for profitability is clearly defined. Samsung has released three Galaxy Note smartphones, each one more popular than the last. The first Galaxy Note was openly mocked by reviewers, but Samsung's most recent Galaxy Note III was favorably received and shipped 10 million units within its first two months on sale -- the Galaxy Note II took twice as long.

Google's other hardware partners have all followed Samsung's lead, with similarly sized superphones. Although Samsung's Notes are high-end handsets outside the price range of most consumers in developing economies, phablets have seen the strongest demand in Asia.

In fact, according to IDC, phablets actually outsold both tablets and laptops combined in the second quarter of last year. Virtually all of these devices run some form of Google's Android operating system.

Gross margins and ASPs
Many of these phablets are cheap devices (around $200) manufactured by Chinese companies. I doubt that Apple will release a cheap phablet -- its unwillingness to release a low-cost iPhone in 2013 suggests that it will maintain its premium pricing -- giving Google's operating system the edge in terms of raw market share.

But a high-quality Apple-made phablet on-par with Samsung's Note line should be a boon to Apple shareholders. An unlocked Galaxy Note III retails for $900 at Best Buy -- about $100 more than a Galaxy S4 with comparable storage.

Assuming Apple does something similar with its own phablet, it should help the company to raise its gross margin, and average iPhone selling price. Both figures have fallen dramatically in recent quarters, much to the detriment of Apple shareholders. In fact, on Thursday, Wells Fargo downgraded Apple shares partially on gross margin concerns.

The iPhone remains king
The iPhone remains Apple's most important product, accounting for about two-thirds of the company's profit. It's been somewhat alarming, then, to see the average iPhone price plummet from well over $650 in 2012 to just $557 last quarter. Apple's overall gross margin has been affected by other things, including the iPad Mini and lower-priced MacBooks, but has fallen alongside the iPhone's ASP, from over 47% in the second quarter of 2012, to just 37% last quarter.

I would expect a larger, more expensive iPhone to do much to reverse these trends, affecting Apple's underlying fundamentals nearly immediately. In the long-run, an Apple-made TV or smartwatch could be more consequential to the company, but going into 2014, Apple investors should anticipate Apple's phablet more-so than anything else.

Our top stock pick for 2014
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Sam Mattera owns shares of Best Buy. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple and Google. 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.

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