Has Apple, Inc.'s iPad Business Stalled?

Weaker-than-expected second-quarter iPad sales has some investors worried. Has Apple's iPad business already maxed out?

May 10, 2014 at 12:30PM

In Apple's (NASDAQ:AAPL) second fiscal quarter 2014 results, unit iPad sales were down 16% from the year-ago quarter. Should investors be worried about the tech giant's iPad business? While the quarterly figures may make the outlook for Apple's iPad business appear bleak, zooming out to a 10,000-foot view shows an entirely different story -- one that is quite bullish, in fact.

Ipad Mini Retina

iPad Mini with Retina display. Image source: Apple.

The tablet market dilemma
While some analysts and investors may be worried about Apple's iPad business, Apple CEO Tim Cook didn't seem to share even a hint of this pessimistic view in the company's second-quarter earnings call.

"We continue to believe that the tablet market will surpass the PC market in size within the next few years, and we believe that Apple will be a major beneficiary of this trend," Cook told investors.

And the company's new CFO, Luca Maestri, reminded investors that there is a fundamental reason for investors to remain confident in the company's iPad business as a leader in tablet adoption of the long haul: "iPad continues to lead all other tablet by far in terms of user engagement, size of ecosystem, customer satisfaction, and e-commerce."

But is the meaningful growth in global tablet sales over? Recent IDC data that shows only 3.2% year-over-year growth in first-quarter global tablet sales certainly provides some evidence that this is a possibility. That rate is dramatically slower than the impressive 142% growth in the year-ago quarter. If overall global tablet sales were, indeed, poised to stay at current levels, Apple investors would have a reason to worry.

Zoom out
Fortunately, the likelihood is slim that the most recent quarter's global tablet sales growth is a representation of what to expect in the next several years. Here are two reasons why:

Ipad Air

iPad Air. Image source: Apple.

First, the sudden onslaught of smartphones with displays larger than 4 inches, often referred to as phablets, has resulted in a temporary hiccup in tablet adoption. While many third-world consumers may have opted to choose between a phablet and a tablet in the past year, there's no considerable evidence yet that the broader trend for consumers won't eventually be to own a smartphone and a tablet -- a trend that is growing in the U.S., where technology adoption and penetration trends are almost always set.

Second, from a 10,000-foot view, tablet and iPad sales appear to have immensely more upside.

Looking at iPads specifically, the adoption in the first four years of sales was twice as fast as iPhones. Clearly there is fast-growing demand in the market for Apple tablets -- you just have to zoom out to see it.

Further, tablet adoption in the U.S. is only at 42%, a figure Apple analyst Horace Dediu of Asymco thinks is posed to grow:

It's possible that saturation for tablets could come well below 100% and that we are on a different curve than the model above. However, the ubiquity of the product and broadness of appeal, even within non-consumer (i.e. education and enterprise) makes it difficult to reconcile. In addition, the penetration data is self-evident. It's improbable that penetration goes to 42% as it just did, and then stops suddenly. These decelerations of adoption have been observed historically but they are usually explained by cataclysms such as wars and economic contractions, neither of which are affecting the US right now.

While CEOs are often blindly biased, this time around observing Tim Cook's confidence in the iPad business at a time when sales look lackluster may prove to be a smart decision:

I feel great [about Apple's iPad business]. That doesn't mean that every quarter, every ninety days is going to be a number that everybody is thrilled with. But what it means to me is that the trend over time -- over the arc of time, that things look very, very good, that iPad has a great future.

Bigger than the iPad?
If you thought the iPod, the iPhone, and the iPad were amazing, just wait until you see this. One hundred of Apple's top engineers are busy building one in a secret lab. And an ABI Research report predicts 485 million of them could be sold over the next decade. But you can invest in it right now, for just a fraction of the price of Apple stock. Click here to get the full story in this eye-opening new report.

Daniel Sparks owns shares of Apple. The Motley Fool recommends and owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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